Enquiry:

We are a non-quoted public company and we seek your guidance regarding recognition of
deferred tax asset / liability.

We have made long term investments in our associated companies (non-quoted), having same board of directors and shareholding. The income of investor and investee Company, both is taxable under section 169 of the Income Tax Ordinance 2001. The company has been recognising re-measurement gain on long term investments through equity method.

Now the auditors are of the view that we should provide deferred tax liability on these gains.

As per para 38 and 39 of the IAS 12:

Investments in subsidiaries, branches and associates and interests in joint arrangements

38 Temporary differences arise when the carrying amount of investments in subsidiaries, branches and associates or interests in joint arrangements (namely the parent or investor’s share of the net assets of the subsidiary, branch, associate or investee, including the carrying amount of goodwill) becomes different from the tax base (which is often cost) of the investment or interest. Such differences may arise in a number of different circumstances, for example:

(a) the existence of undistributed profits of subsidiaries, branches, associates and joint arrangements;
(b) changes in foreign exchange rates when a parent and its subsidiary are based in different countries; and
(c) a reduction in the carrying amount of an investment in an associate to its recoverable amount.

In consolidated financial statements, the temporary difference may be different from the temporary difference associated with that investment in the parent’s separate financial statements if the parent carries the investment in its separate financial statements at cost or revalued amount.

39 An entity shall recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, except to the extent that both of the following conditions are satisfied:

(a) the parent, investor, joint venturer or joint operator is able to control the timing of the reversal of the temporary difference; and

(b) it is probable that the temporary difference will not reverse in the foreseeable future.

We are of the view that we met both the conditions of para 39 and we don’t foresee that these differences will reverse in future, so we need not to provide the deferred tax liability.

Further, the guidance available in ICAP selected opinions (17.1.02) suggests that no deferred taxation is to be recognised, when the temporary differences are not expected to reverse in future. Moreover, many listed companies like Nishat Mills Limited, Fuji Fertilizer Company Limited, Mahmood Texilte Mills Limited etc. has not provided deferred taxation liability for long term investment in associates. Kindly give your advise on the issue.

Opinion:

The Committee would like to draw your attention to para 38, 39 (reproduced above), 42, 51 and 51A of IAS 12 for guidance:

42   An investor in an associate does not control that entity and is usually not in a position to determine its dividend policy. Therefore, in the absence of an agreement requiring that the profits of the associate will not be distributed in the foreseeable future, an investor recognises a deferred tax liability arising from taxable temporary differences associated with its investment in the associate. In some cases, an investor may not be able to determine the amount of tax that would be payable if it recovers the cost of its investment in an associate, but can determine that it will equal or exceed a minimum amount. In such cases, the deferred tax liability is measured at this amount.

51 The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities.

51A In some jurisdictions, the manner in which an entity recovers (settles) the carrying amount of an asset (liability) may affect either or both of:

a. the tax rate applicable when the entity recovers (settles) the carrying amount of the asset (liability); and

b. the tax base of the asset (liability).

In such cases, an entity measures deferred tax liabilities and deferred tax assets using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement.

The Committee is of the view that as stated in para 42, an investor in an associate does not control the investee entity and is usually not in a position to determine its dividend policy. Therefore, an investor recognises a deferred tax liability arising from taxable temporary differences associated with its investment in the associate, unless there is an agreement requiring that the profits of the associate will not be distributed in the foreseeable future. Further, an entity measures deferred tax liabilities and deferred tax assets using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement, in accordance with para 51A of IAS 12.

(January 01, 2016)