Sri Lanka Accounting Standard SLAS 14 Accounting for Taxes on Income 199
Contents Sri Lanka Accounting Standard SLAS 14 Accounting for Taxes on Income Scope Paragraphs 1-2 Definitions 3 Differences Between Taxable Income and Accounting Income 4-9 Tax Effect Accounting 10-11 Deferral Method 12-14 Liability Method 15-17 Application 18 Deferred Tax Debits 19-20 Tax Losses 21-30 Revaluation of Assets 31-33 Undistributed Earnings of Subsidiaries and Associates 34-37 Financial Statement Presentation 38-47 200
Disclosures 48-49 Tax Contingencies 50 Compliance with International Accounting Standards 51 Effective Date 52 201
Sri Lanka Accounting Standard SLAS 14 Accounting for Taxes on Income The standards, which have been set in bold italic type, should be read in the context of the background material and implementation guidance in this Standard, and in the context of the Preface to Sri Lanka Accounting Standards. Sri Lanka Accounting Standards are not intended to apply to immaterial items. Scope 1. This Standard should be applied in accounting for taxes on income in financial statements. This includes the determination of the amount of the expense or saving related to taxes on income in respect of an accounting period and the presentation of such an amount in the financial statements. 2. This Standard does not deal with the methods of accounting for government grants or investment tax credits, and the following taxes are not considered to be within the scope of this Standard: (a) taxes based on income that are refundable to the enterprise to the extent that the amount of income upon which the tax was based is distributed in the form of dividends; and (b) taxes paid by the enterprise at the time a dividend is distributed that the enterprise may offset against taxes due in respect of its income. Definitions 3. In this Standard the following terms are used with the meanings specified: Accounting income is the aggregate income or loss for a period, including extraordinary items 1, as reported in the income statement, 202
before deducting related income tax expense or adding related income tax saving. The tax expense or tax saving for the period is the amount of the taxes charged or credited in the income statement, excluding the amount of taxes related and allocated to those items not dealt with in the current income statement. Taxable income (tax loss) is the amount of the income (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which the provision for taxes payable (recoverable) is determined. Provision for taxes payable is the amount of taxes currently payable in respect of taxable income for the period. Timing differences are the differences between the taxable income and accounting income for a period that arise because the period in which some items of revenue and expense are included in taxable income does not coincide with the period in which they are included in accounting income. Timing differences originate in one period and reverse in one or more subsequent periods. Permanent differences are the differences between taxable income and accounting income for a period that originate in the current period and do not reverse in subsequent periods. Differences between Taxable Income and Accounting Income 4. The provision for taxes payable is calculated in accordance with rules for determining taxable income established by taxation authorities. In many circumstances these rules differ from the accounting policies applied to determine accounting income. The effect of this difference is that the relationship between the provision for taxes payable and accounting income reported in the financial statements may not be representative of the current level of tax rates. 1 Extraordinary items is defined in Sri Lanka Accounting Standard 10, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies. 203
5. One reason for a difference between taxable income and accounting income is that certain items are considered to be appropriately included in one calculation but are required to be excluded from the other. For example, some donations are not an allowable deduction in determining taxable income; however, such amounts would be deducted in determining accounting income. Differences such as these are described as "permanent differences". 6. Another reason for a difference between taxable income and accounting income is that certain items, considered in determining both amounts, are included in the calculation for different periods. For example, accounting policies may specify that certain revenues are included in accounting income at the time goods or services are delivered but tax rules may require or allow their inclusion at the time cash is collected. The total of these revenues included in accounting income and taxable income will ultimately be the same, but the periods of inclusion will differ. Another example is when the depreciation rate used in determining taxable income differs from that used in determining accounting income. These types of difference are described as "timing differences". 7. When gains or losses are credited or charged directly to shareholders' interests, timing differences and permanent differences may also occur. 8. The origination and reversal of timing differences may relate to more than one accounting period. Information on the nature and amount of these timing differences is often considered to be useful to the users of financial statements. However, the method of reflecting the effect of timing differences varies. Sometimes the information is included in notes to the financial statements; sometimes the effect of these differences is reflected by the application of tax effect accounting methods. 9. The revaluation of individual assets in the financial statements or the general application of current value accounting may result in differences between taxable income and accounting income. This matter is dealt with in paragraphs 31-33. 204
Tax Effect Accounting 10. The tax expense for the period should be determined on the basis of tax effect accounting, using either the deferral or the liability method. The method used should be disclosed. 11. Under tax effect accounting methods, taxes on income are considered to be an expense incurred by the enterprise in earning income and are accrued in the same periods as the revenue and expenses to which they relate. The resulting tax effects of timing differences are included in the tax expense in the income statement and in the deferred tax balances in the balance sheet. The tax effect accounting methods in common use are described as the deferral method and the liability method. Deferral Method 12. Under the deferral method, the tax effects of current timing differences are deferred and allocated to future periods when the timing differences reverse. Since deferred tax balances in the balance sheet are not considered to represent rights to receive or obligations to pay money, they are not adjusted to reflect changes in the tax rate or the imposition of new taxes. 13. Under the deferral method, the tax expense for a period comprises: (a) the provision for taxes payable; and (b) the tax effects of timing differences deferred to or from other periods. 14. The tax effects of timing differences originating in the current period are determined using the current tax rate. The tax effects of individual timing differences originating in previous periods and reversing during the current period are generally determined using the tax rates originally applied. For ease of applying the method, similar timing differences may be grouped. 205
Liability Method 15. Under the liability method, the expected tax effects of current timing differences are determined and reported either as liabilities for taxes payable in the future or as assets representing advance payment of future taxes. Deferred tax balances are adjusted for changes in the tax rate or for new taxes imposed. The balances may also be adjusted for expected future changes in tax rates. 16. Under the liability method, the tax expense for a period comprises: (a) the provision for taxes payable; (b) the amount of taxes expected to be payable or considered to be prepaid in respect of timing differences originating or reversing in the current period; and (c) the adjustments to deferred tax balances in the balance sheet necessary to reflect either a change in the tax rate or the imposition of new taxes. 17. Under the liability method, the tax effects of timing differences originating or reversing in the current period and adjustments to deferred tax balances are determined using the current tax rate, unless other information indicates that another rate would be more appropriate, for example, where a change in tax rates has been announced as applicable to future years. 206
Application 18. The tax effect accounting method used should normally be applied to timing differences. However, the tax expense for the period may exclude the tax effects of certain timing differences when there is reasonable evidence that these timing differences will not reverse for some considerable period (at least three years) ahead. There should also be no indication that after this period these timing differences are likely to reverse. The amount of timing differences, both current and cumulative, not accounted for should be disclosed. Deferred Tax Debits 19. The tax effect of timing differences that result in a debit balance or a debit to the deferred tax balance should not be carried forward unless there is a reasonable expectation of realisation. 20. The accounting for timing differences may result in a debit balance or a debit to the deferred tax balance. The consideration of prudence requires that such a debit be carried forward in the balance sheet only if there is a reasonable expectation of realisation, for example, if sufficient future taxable income will be generated in the period in which the timing differences will reverse. Tax Losses 21. Tax legislation provide that tax losses of the current period may be used either to recover tax paid within a specified carryback period or to reduce or eliminate tax to be paid in future periods. The loss provides a tax saving in the period of the loss or a potential tax saving in some subsequent period. The accounting period in which such a tax saving is included in determining net income in the financial statements varies. 207
22. Taxes relating to a previous period which are recovered as a result of carrying back a tax loss should be included in net income in the period of the loss. Amounts recoverable but not yet received should be included in the balance sheet as receivables. 23. A recovery of taxes through the application of a tax loss to the carryback period represents a tax saving that is effectively realised in the period of loss and is included in net income or net loss in the financial statements for that period. In determining the amount of the saving, appropriate adjustment of existing deferred tax balances may be necessary. 24. The potential tax saving related to a tax loss that is available to be carried forward for the determination of taxable income in future periods should not be included in net income until the period of realisation, except as described in paragraphs 25 and 26. 25. The potential tax saving relating to a tax loss carryforward may be included in the determination of net income for the period of the loss if there is assurance beyond any reasonable doubt that future taxable income will be sufficient to allow the benefit of the loss to be realised. 26. If the criterion set out in paragraph 25 is not satisfied, the tax saving relating to a tax loss carryforward should be included in the determination of net income for the period of the loss to the extent of the net credits in the deferred tax balance that will reverse or can be reversed within the period during which the loss can be claimed as a tax benefit. 27. The realisation of a potential tax saving related to the amount of a tax loss remaining after the carryback described in paragraph 23 requires the existence of taxable income in future periods. For this reason, the potential tax saving related to a tax loss carryforward is generally not included in the determination of net income in the period of the loss. 28. However, in rare circumstances, the inclusion of this potential tax saving in the determination of net income for the period of the loss may be considered appropriate. If a potential tax saving is to be dealt with in this 208
manner, the consideration of prudence requires that there is assurance beyond any reasonable doubt that future taxable income will be sufficient to allow the benefit of the loss to be realised. For example, the condition of assurance beyond any reasonable doubt would be satisfied if the following conditions exist: (a) the loss results from an identifiable and non-recurring cause; and (b) a record of profitability by the enterprise has been established over a long period and is expected to continue. 29. The existence of a credit amount in the deferred tax balance may provide evidence that the tax saving related to a tax loss carryforward can be realised at least in part. The reversal of the timing differences reflected in the deferred tax credit balance will of itself create a corresponding amount of taxable income, against which the tax loss can be offset to realise a tax saving. If the tax rules limit the period during which a tax loss may be carried forward for offset against future taxable income, only those timing differences that will reverse or can be reversed during the limited period are considered in offsetting a tax loss to realise a tax saving. The tax saving as a result of offsetting a tax loss is included in net income for the period of the loss and the debit is carried forward as part of the deferred tax credit balance in the balance sheet. The amount of such a debit may be disclosed. 30. If the tax saving related to a past tax loss was not included in net income in the year of the loss, a tax saving later realised by offsetting such a tax loss against taxable income is included in net income in the period of realisation and disclosed. Revaluation of Assets 31. In circumstances in which an asset is revalued in the financial statements to an amount in excess of its historical cost or previous revaluation, the substituted amounts do not generally form the basis for the determination of taxes payable. To the extent that revalued assets give rise to charges or credits in accounting income that are not based on historical cost or other bases permitted under the tax rules there will be a difference between taxable income and accounting income. The accounting treatment of this 209
type of difference depends on the accounting treatment accorded the revaluation. 32. One approach is to determine the tax effect related to the increase in the carrying value of the asset and transfer that amount from the revaluation account to the deferred tax balance. Under this approach when a difference such as described in paragraph 31 occurs in a period subsequent to the revaluation the tax effect relating to that difference is charged to the deferred tax balance and consequently is not reflected in the tax expense. In some cases the tax effect is reflected in tax expense and a corresponding amount is transferred from the deferred tax balance to the revaluation account. 33. Another approach is to disclose in the notes to the financial statements the amount of the potential tax effect related to the increase in the carrying value of the asset at the date of the revaluation. In subsequent periods the amount of potential tax effect is revised to reflect the tax effect of the differences described in paragraph 3l. Undistributed Earnings of Subsidiaries and Associates 34. Taxes payable by either the parent company or subsidiaries on distribution to the parent company of the undistributed profits of subsidiaries should be recognised as an expense and a liability unless it is reasonable to assume that those profits will not be distributed or that a distribution will not give rise to a tax liability. 35. A reason for not recognising taxes payable by either the parent company or subsidiaries on distribution to the parent company of the undistributed profits of subsidiaries may be the parent company's intention and power to retain those profits in the subsidiary for long-term reinvestment. If taxes are not recognised in respect of undistributed profits, there is sometimes disclosure of the cumulative amount of those profits. 210
36. For investments in associates accounted for under the equity method, taxes that would be payable on distribution to the investor of the investor's share of the undistributed profits of the investee should be recognised as an expense and a liability when the profits are recognised by the investor. An exception may be made when it is reasonable to assume that those profits will not be distributed or that a distribution will not give rise to a tax liability. 37. If taxes are not accrued in full, there is sometimes disclosure of the cumulative amount of the portion of undistributed profits applicable to the investor on which taxes are not accrued. Financial Statement Presentation 38. The tax expense for the period should be included in the determination of net income of the enterprise. 39. The taxes on income relating to an item that is charged or credited to shareholders' interests should be accounted for in the same manner as the relevant item and the amount should be disclosed. 40. Taxes on income are generally accounted for as tax expense in the determination of net income of the enterprise. However, in some circumstances in which the effect of a transaction is charged or credited directly to shareholders' interests, the related tax effect of the transaction is accounted for and disclosed in the same manner so that the taxes may be directly related to the item to which they apply. 4l. The tax expense related to accounting income from the ordinary activities of the enterprise is usually presented as a separate item in the income statement. The tax attributable to an extraordinary item is included with that item because it directly relates to it. Disclosure is made of this related tax amount. 42. Deferred tax balances should be presented in the balance sheet of the enterprise separately from the shareholders' interests. 211
43. Deferred tax balances are not part of the shareholders' interests and are generally presented as separate items in the balance sheet. Debit and credit balances representing deferred taxes may be offset. 44. In circumstances in which a distinction is made between current and long-term assets and liabilities in the financial statements, the net current and net long-term portions of the deferred tax balance are sometimes presented separately so as to maintain the appropriate distinction between current and long-term items. 45. Taxes on income which were previously paid and are due to be recovered as a result of the application of a tax loss in accordance with paragraph 22 are shown in the balance sheet as a receivable separate from deferred tax balances. 46. Loss carryforward benefits resulting from the application of tax losses in accordance with paragraph 24 are different from other deferred tax balances. The amounts of such carryforward benefits may be disclosed separately in the balance sheet. 47. The relationship between tax expense and accounting income may be affected by such factors as permanent differences, and tax rates in the locations of foreign based operations. Accordingly, an explanation of the relationship is sometimes presented in the financial statements. Disclosures 48. The following items in respect of tax losses should be disclosed: (a) the amount of the tax saving included in net income in the period of the loss in accordance with the criteria in paragraphs 25 and 26; (b) the amount of the tax saving included in net income for the current period as a result of the realisation of a tax loss carryforward that had not been accounted for in the year of the loss; and 212
(c) the amount and future availability of tax losses for which the related tax effects have not been included in the net income of any period. 49. The following should be disclosed separately: (a) the tax expense related to income from the ordinary activities of the enterprise; (b) the tax expense relating to extraordinary items, to fundamental errors, and to changes in accounting policy - see Sri Lanka Accounting Standard SLAS 10, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies; (c) the tax effects, if any, related to assets that have been revalued to amounts in excess of historical cost or previous revaluation; and (d) an explanation of the relationship between tax expense and accounting income if not explained by the tax rates effective. Tax Contingencies 50. Any contingency related to taxes on income not referred to in this Standard should be dealt with in accordance with Sri Lanka Accounting Standard SLAS 36, Provisions, Contingent Liabilities and Contingent Assets. Compliance with International Accounting Standards 51. Compliance with this SLAS ensures compliance in all material respects with International Accounting Standard IAS 12, Accounting for Taxes on Income. Effective Date 52. This Sri Lanka Accounting Standard becomes operative for financial statements covering periods beginning on or after 1 January 1984. 213