APPLICATION GUIDANCE TO

NAS 12 INCOME TAXES

ACCOUNTING STANDARDS BOARD (ASB)

NEPAL

ASB-NEPAL 2

PREFACE The earlier version of IAS 12 Income Taxesrequired an entity to account for deferred tax using either thedeferral method or a liability method which is popularly known as the incomestatement liability method. IAS 12 (revised) prohibits the deferral method andrequires balance sheet liability method. NAS 12 has converged to IAS 12 (revised). Under the income statement liability method deferred tax income or expense has been computed applying timing differences which are differences between taxable profit and accounting profit thatoriginate in one period and reverse in one or more subsequent periods. On the other hand, the balance sheet liability method is based on temporary differences that are differences between the tax base of an asset or liabilityand its carrying amount in the statement of financial position. The tax base of anasset or liability is the carrying amount of that asset or liability for tax purposes. This Application Guidance explains and illustrate methodology to be applied for computation , presentation and disclosure of deferred taxes. Case analysis covers the following issues:

• Computation of deferred tax arising out of differential depreciation charge of a depreciable asset as per accounting principle and tax ;

• Deferred tax incidence arising out of carry-forward of tax loss ; • Deferred tax incidence arising out of reclassification of depreciable asset into

held for sale; • Non-depreciable investment property like land and deferred impact [ Example; • Depreciable investment property like building and deferred tax impact ; • Deferred tax impact on provision for product warranty; • Revaluation of depreciable asset and deferred taxation ; • Deferred tax incidence arising out of financial assets and financial liabilities

and • Business combination and deferred taxation.

This Application Guidance is expected ti supplement the illustration given in the NAS and illustrative examples provided in Part B of IAS 12. We thank Dr. T.P.Ghosh who has prepared this Application Guidance. Accounting Standard Board

Nepal

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CONTENTS

Page 1. Introduction 6

2. Scope of NAS 12 6

3. Explanation to definition 6

4. Tax base 7

5. Temporary differences

10

6. Deferred tax assets and deferred tax Liabilities 11

7. Deferred tax expense and deferred tax Income

13

8. Investment property 18

9. Employee benefit provision

22

10. Provision for product warranty

22

11. Assets carried at fair value

23

12. Financial liabilities measured at fair value 26

13. Available for sale financial assets 28

14. Research costs 28

15. Business combinations 29

16 Recognition principle 31

17. Reassessment of unrecognised deferred tax asset 32

18. Unused tax losses and tax credits 32

19. Investments in subsidiaries, Branches, Associates and Interest in Joint Arrangements

33

20.Presentation 33

21. Disclosures 34

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LIST OF EXAMPLES

Page Example 1 Tax expense 6 Example 2 Computation of deferred tax of a depreciable asset 14 Example 3 Deferred tax liabilities and carry-forward loss 15 Example 4 Change in classification of depreciable asset to held for sale

16

Example 5 Non-depreciable investment property 18 Example 6 Depreciable investment property 19 Example 7 Provision and deferred taxation 22 Example 8 Revaluation of machinery and deferred taxation 23 Example 9 Financial liability carried at amortised cost and deferred taxation

26

Example 10 Available for sale financial assets and deferred taxation 28 Example 11 Research costs 28 Example 12 Deferred tax incidence of business combination 29

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Application Guidance to NAS12Income Taxes

1. Introduction NAS 12 explains principles of accounting for taxes. It requires accounting for income taxes taking into account the current and future tax consequences of: (a) the future recovery (settlement) of the carrying amount of assets (liabilities) that are recognised in an entity’s statement of financial position; and (b) transactions and other events of the current period that are recognised in an entity’s financial statements. If tax expense or tax refund computed as per the applicable tax law and rules is taken as the basis of accounting charge , then upfront tax benefit accrued that will reverse in future would cause distortion in performance measurement over the future accounting period(s). Initially when tax benefit has been received performance will be better as compared to when tax benefit will reverse. Deferred tax accounting intends to neutralize the effect of such temporary differences. This Application Guidance explains and illustratesmethodology to be applied for computation , presentation and disclosure of deferred taxes. 2. Scope of NAS 12 For the purposes of NAS 12 , income taxes include all domestic and foreign taxes which are based on taxable profits. Income taxes also include taxes, such as withholding taxes, which are payable by a subsidiary, associate or joint venture on distributions to the reporting entity. It also deals with deferred tax impact arising out of government grants or investment tax credits. 3. Explanation to definitions 1. Tax expense - Tax expense presented in the Statement of Income comprises of two separate elements :

• Current Tax Expense ( or current tax income ) meaning tax expense or income arising our of the current year’s assessment

• Additional tax expense ( tax refund) arising out of any previous year(s) • Deferred tax expense ( deferred tax income)

Example 1[ Tax expense]X Ltd. has worked out current year’s ( as on 31.3.2014) tax provision of NPR 5,00,000. There is an additional demand of NPR 10,000 arising out final tax assessment for the previous year 2011-12. Balances of deferred tax liability as on 31.3.2013 NPR 2,00,000 and as on 31.3.2014 NPR 1,95,000.

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What is tax expense for the purpose of Statement of Income for the year ended on 31.3.2014? Analysis Amount in NPR Current Tax 5,00,000 Additional tax demand for 2011-12 10,000 Deferred Tax Income – reversal of deferred tax asset

( 5,000)

Tax Expense 5,05,000 2. (a) Accounting profitis profit or loss for a period before deducting tax expense.

(b) Taxable profit (tax loss) is the profit (loss) for a period, determined in accordancewith the rules established by the taxation authorities, upon which income taxesare payable (recoverable).

4. Tax base The tax base of an asset is the amount that will be deductible for tax purposesagainst any taxable economic benefits that will flow to an entity when it recoversthe carrying amount of the asset. If those economic benefits will not be taxable,the tax base of the asset is equal to its carrying amount. Tax baseof an asset is the amount that will be deductible for tax purpose against any taxable economic benefit that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxed, the tax base of the asset is equal to its carrying amount. So if the carrying amount of an asset does not have any tax consequence , its tax base is the carrying amount of the asset. If an asset represents untaxed income which will be taxed in future its tax base is nil. Tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In case no portion of a liability will be taxed in future, the full carrying amount is its tax base. If the entire liability is currently untaxed but to be taxed in future periods its tax base is nil. Presented below in Table 1 are the examples of tax base of an asset or a liability:

Table 1 Examples of Tax Base of an asset

1. Tax base of a depreciable asset is the carrying amount of the assets which is allowable for depreciation in future periods as that amount will be deducted in future from taxable income. For the purpose of this example depreciation includes amortisation.

A company has recognised plant and machinery in its accounting record for NPR100 million and charges depreciation of NPR 5 million for the first year whereas under the tax rule a depreciation charge of NPR 20 million is allowed. So carrying amount of the asset at the end of Year 1 ( after charging depreciation for Year 1) is NPR 95 million whereas its tax base is NPR 80 million.

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This gives rise to taxable temporary difference. Also refer to Example 2.

2. Any uncollected income, like interest receivables, if taxed on cash basis has a nil tax base as it is to be added in full to future taxable income.

Interest receivable has a carrying amount of NPR 10 million . It is taxed on cash basis , so the tax base of the interest receivable is nil as it will be taxed in future. This gives rise to taxable temporary difference .

3. Any uncollected income , like trade receivables, which is already taxed based on accrual concept has the carrying amount as its tax base.

Trade receivables have a carrying amount of NPR 20 million. The related revenue has already been included in taxable profit (tax loss) , so the tax base of the trade receivables is NPR 20 million. There is no temporary difference.

4. Any tax exempt uncollected income has the carrying amount as its tax base.

Dividends receivable from a domestic company have a carrying amount of NPR 10 million. If the dividends are not taxable in the hands of the recipient, in substance, the entire carrying amount of the asset is deductible against the economic benefits. So , the tax base of the dividends receivable is NPR 10 million. There is no temporary difference.

5. Any asset,which has no tax consequence , has the carrying amount as its tax base.

A loan receivable has a carrying amount of NPR 25 million. The repayment of the loan will have no tax consequence, so the tax base of the loan is NPR 25 million. There is no temporary difference.

6. Tax base of inventory is its carrying amount

By definition, the tax base of an asset is the amount that will be deductible for tax purposesagainst any taxable economic benefits that will flow to an entity when it recoversthe carrying amount of the asset. In this case, recovery of the asset implies consumption or sale.The carrying amount of the inventory is charged against revenue when consumed or sold in full so its tax base is the carrying amount. There is no temporary difference.

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7. Assets carried at fair value (i) Depreciable asset carried at fair value but fair value is not allowed for charging depreciation for tax purpose. (ii) Depreciable asset carried at fair value but fair value is allowed for charging depreciation for tax purpose. For the purpose of this example depreciation includes amortisation. (ii) Financial assets carried at fair value when fair value gain is not taxed and fair value loss is disallowed for tax purpose.

Carrying amount is fair value, and original cost allowed as per tax law less tax depreciation is the tax base. Refer to Example 5&6. Carrying amount is the tax base. Carrying amount is fair value but tax base is original cost. In case indexation is allowed , indexed original cost becomes the tax base.

Examples of tax base of liability

1. In the case of future revenue which is received in advance but will be taxed in future on accrual basis the tax base is the carrying amount.

Advance received for supply of goods and services has nil tax base as those advances are taxed on accrual basis.

2. The tax base of a liability, like payables , outstanding expenses or accrued expense, which has already been deducted in the form of expense while determining tax profit is its carrying amount.

Current liabilities include outstanding expenses with a carrying amount of NPR 5 million. The related expense has already been deducted for tax purposes. The tax base of outstanding expenses is NPR 5 million. Current liabilities include trade payables with a carrying amount of NPR 10 million. It arises out of purchases and related the expense has already been deducted for computing tax profit. So its tax base is also NPR 10 million. There is no temporary difference.

3. An outstanding expense that is not deductible in computing tax profit has a tax base to the extent it is not deductible for tax purpose

Current liabilities include accrued fines and penalties with a carrying amount of NPR 10,000 . Fines and penalties are not deductible for tax purposes. The tax base of the accrued fines and penalties is NPR 10,000. There is no temporary difference.

4. If a liability represents an outstanding expense that is taxed on cash basis then its tax base is nil

Outstanding contribution to employees’ provident fund of NPR 1 million . Carrying amount of the liability = NPR 1 million

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- Amount to be deducted from future tax income = NPR 1 million ------------------------ Tax base Nil --------------------------

5. A liability having no tax consequence has the carrying amount as its tax base. It has no material transaction cost.

A company has outstanding Loan liability of NPR 10 million. Its Tax base is NPR 10 million. Carrying amount of the liability = NPR10 million - Amount to be deducted

from future tax income = 0 ------------------------ Tax base NPR 10 million --------------------------

6. Loan payable having material transaction cost: Transaction cost is included at the initial recognition and then it is measured at amortised cost under IAS 39 But tax law may require charge of transaction cost over the maturity period of the loan.

The carrying amount of the loan is determined applying amortised cost as per NAS 39 whereas tax base is the original loan amount. Carrying amount of unamortised transaction cost is nil. Refer to Example 9.

Items already charged off – Certain items are expensed as per NFRSs and so their carrying amount is nil but may have tax base as these items are deductible from taxable profit at a future dates(s). Examples are research costs and issue expenses of loans and debentures. Research expense is expensed in the period in which it is incurred in accordance with NAS 38 but the tax law may allow amortisation over a period of time. So its tax base is amount allowed to be deducted in future from the taxable profit i.e. unamortised amount and the carrying amount is nil . Refer to Example 11. Issue expense , discount on issue of debentures etc. which are integral part of amortised cost are adjusted against fair value of the loan or debentures at initial recognition. These financial liabilities are measured at initial recognition at fair value and subsequently carried at amortised cost. So amortised cost becomes the carrying the amount. But tax law may allow issue expense, discount etc. on straight line basis over the maturity of the loan or debenture. So there will arise unamortised expenses against the already charged off items.Refer to Example 9. 5. Temporary differences It is difference between the carrying amount of an assetor liability in the statement of financial position and its tax base. Temporary difference is of two types – (a) taxable timing difference , and (b) deductible timing difference. Taxable temporary differences, which are temporary differences that willresult in

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taxable amounts in determining taxable profit (tax loss) offuture periods when the carrying amount of the asset or liability is recovered or settled. Deductible temporary differences, which are temporary differences that willresult in amounts that are deductible in determining taxable profit (taxloss) of future periods when the carrying amount of the asset or liabilityis recovered or settled.

Table 2 Analysis of Nature of Temporary Difference

Taxable timing difference arises in case of assets - Carrying amount as per Balance Sheet > Tax Base Taxable timing difference arises in case of liabilities - Carrying amount as per Balance Sheet < Tax Base It gives rise to deferred tax expense Deductible timing difference arises in case of assets - Carrying amount as per Balance Sheet < Tax Base Taxable timing difference arises in case of liabilities - Carrying amount as per Balance Sheet > Tax Base [ Refer to Paragraph 10, NAS 12 for fundamental principle of determining tax base.]

Tax base of an asset or a liability may not be immediately apparent. For example, a machinery is acquired primarily for use and for sale. However, this does not preclude the possibility that the depreciable asset shall be sold at a future date. The tax base of the asset initially determined based on amount to be allowed for charging depreciation rather than for computing capital gains. When it has been decided to sale the asset, the tax base shall be decided based the principle of computation of capital gain tax. Refer to Example4. 6. Deferred tax assets and deferredtax liabilities Deferred tax liabilities are the amounts of income taxes payablein future periods in respect of taxable temporary differences. Deferred tax assets are the amounts of income taxes recoverable infuture periods in respect of: (a) deductible temporary differences; (b) the carryforward of unused tax losses; and (c) the carryforward of unused tax credits.

Table 3 Tax Liabilities and Deferred Tax Assets

Deferred tax liability as on a reporting date T0 [ DTL0] = Taxable timing difference as on T0 × Tax rate Deferred tax liability as on a reporting date T1[ DTL1] = Taxable timing difference as on T1 × Tax rate

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Deferred tax asset as on a reporting date T0 [ DTA0] = Deductible timing difference as on T0 × Tax rate Deferred tax asset as on a reporting date ( T1) [ DTA1] = Deductible timing difference as on T1 × Tax rate T0 and T1 are two successive reporting dates. Deferred tax liabilities are classified in the Balance Sheet as non-current liabilities, and deferred tax assets are classified as non-current assets. Refer to NAS 1 regarding the presentation of classified Balance Sheet. Case 1 : Depreciable amount of a depreciable asset as on 31.3.2013 is NPR 1,00,000 and as on 31.3.2014 is NPR 90,000. Tax base of the depreciable asset as on 31.3.2013 is NPR 1,00,000 and as on 31.3.2014 is NPR 75,000. Taxable temporary difference as on 31.3.2013 is nil and as on 31.3.2014 is NPR 15,000. Deferred tax liability is NPR 15,000 × Tax rate ( say 30%) = NPR 4,500. Case 2 : Provision for pending court case ( in NPR thousand) As on 31.3.2013 31.3.2014 Provision for pending court case 20.00 25.00 Tax base 0 0 ---------- ------------- Deductible temporary difference 20.00 25.00 Deferred Tax asset ( at tax rate 30%) 6.00 7.50 Assumed that provision is not allowed for tax purpose. Actual expense on litigation compensation is allowed as and when incurred. Measurement of deferred tax liabilities and deferred tax assets [ Reference Paragraphs 46-56, NAS 12 The critical parameter of the measurement is tax rate. Deferred tax liabilities and assets are measured applying a tax rate that are expected to apply when liability is expected to be settled or asset is expected to be realized. It is the tax rate that has been enacted or substantively enacted by the end of the reporting period. - Current tax liabilities (assets) for the current and prior periods are measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period [ Paragraph 46, NAS 12]. - Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period [ Paragraph 47, NAS 12]. - Measurement of deferred tax asset or liability is linked to tax consequences of recovery of the carrying amount . It means if the entity wishes to sell the asset and

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recover the carrying amount , then deferred tax asset / liability is measured applying capital gain tax rate. Alternatively , if the entity wishes to consume the asset and recover the carrying amount , then deferred tax asset / liability is measured applying rate of business profit tax. [ Refer to Paragraphs 51 , 51A, 51B , 51C, 51D, 51E, 52A, 52B of NAS 12 , and Examples 2-5]. - Average tax rate is applied when different tax applies to deferred tax liabilities or assets. [ Paragraph 49, NAS 12] - Deferred tax assets or liabilities is measured undiscounted basis. [ Paragraphs 53-55, NAS 12]. However, the carrying amount of an asset or liability might have been determined on a discounted basis. For example, as per NAS 39 provisions are determined on discounted basis. Provision for Litigation Compensation illustrated in Cases 2 & 4 are actually measured on discounted basis. But no discounting is done while measuring deferred tax liabilities and assets although those are expected to be settled or realised respectively at a future date. - Carrying amount of deferred tax assets is reviewed at the end of each reporting period. It may assess that in future adequate taxable profit will not be there to recover the economic benefits embodied in the deferred tax asset . In that case the carrying amount of deferred tax asset is reduced to the extent it is estimated to be not recoverable. [ Paragraph 56, NAS 12] - The carrying amount of deferred tax assets / liabilities may change although there is no change in the carrying amount or tax base . This may occur because of change in the tax rate or tax laws , reassessment of deferred tax asset or change in the expected manner by which the carrying amount will be recovered. The resulting difference is recognised in profit or loss or other comprehensive income.

7. Deferred tax expense and deferred tax income Deferred tax expense arises when –

• deferred tax liabilities of the current period are more than that of the immediately preceding period , or

• deferred tax assets of the current period are less than that of the preceding period.

The first case reflects increase in deferred tax liabilities , and the second case reflects reversal of deferred tax asset. Deferred tax income arises when –

• deferred tax assets of the current period are more than that of the preceding period , or

• deferred tax liabilities of the current period are less than that of the immediately preceding period.

The first case reflects increase in deferred tax asset , and the second case reflects reversal of deferred tax liabilities.

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Table 4 Deferred Tax Expense If DTL1> DTL0 , it gives rise to deferred tax expense to the extent of [ DTL1 - DTL0] If DTA1< DTA0, it is a case of reversal of deferred tax asset to the extent of [ DTA0– DTA1] which is negative deferred tax income. Deferred tax income If DTA1> DTA0 , it gives rise to deferred tax income to the extent of [ DTA1 - DTA0] If DTL1< DTL0 , it gives rise to reversal of deferred tax liabilities to the extent of [DTL0– DTL1] which is negative deferred tax expense. Deferred tax expense forms part of tax expense for the reporting period. Deferred tax income is adjustment to the tax expense for the reporting period. Case 3 : [ Depreciable asset] Figures in NPR thousand As on 31.3.2013 31.3.2014 31.3.2015 Carrying amount 100.00 90.00 80.00 Tax base 100.00 75.00 55.00 Taxable temporary difference 0 15.00 25.00 Deferred Tax Liabilities ( at 30% tax rate) 0 4.50 7.50 Deferred Tax Expense 0 4.50 3.00 Case 4 : Provision for pending court case ( in NPR thousand) As on 31.3.2013 31.3.2014 31.3.2015 Provision for pending court case 20.00 25.00 0 Tax base 0 0 0 ---------- ------------- -------- Deductible temporary difference 20.00 25.00 0 Deferred Tax asset ( at tax rate 30%) 6.00 7.50 0 Deferred Tax Income 6.00 1.50 - 7.50 Assumed that the provision is not allowed for tax purpose. Actual expense on litigation compensation is allowed as and when incurred. During 2014-15, obligation for litigation compensation accrues base don court order or arbitration settlement or by way of constructive obligation. Example 2[ Computation of deferred tax of a depreciable asset] X Ltd. purchased a machinery at T0 for NPR 10,00,000. Its estimated useful life 5 years and residual value 5% i.e. NPR 50,000. Accounting depreciation is charged applying straight line basis i.e. @ NPR 1,90,000 p.a. Assume that tax depreciation is allowed as per reducing balance method – applicable rate is 45.072%. Applicable tax rate is 30%. Illustrated below is the process of computation of deferred tax liability and tax expense:

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Computation of deferred tax liabilities and deferred tax expense ( Amount in NPR)

Years

0 1 2 3 4 5

Carrying amount 10,00,000 8,10,000 6,20,000 4,30,000 2,40,000 50,000

Accounting Depreciation 1,90,000 1,90,000 1,90,000 1,90,000 1,90,000

Tax Base 10,00,000 5,49,280 3,01,708 1,65,722 91,027 50,000

Tax Depreciation 4,50,720 2,47,572 1,35,986 74,695 41,027

Temporary difference 0 2,60,720 3,18,291 2,64,277 1,48,973 0

Deferred Tax liability 78,216 95,487 79,283 44,692 0

Deferred tax expense* 78,216 17,271 -16,204 -34,591 -44,692

* Negative deferred tax expense means deferred tax income ** Selection of tax rate is discussed in Paragraph 6 of this Application Guidance. Example 3 [ Deferred tax liabilities and carry-forward of tax loss] In continuation of the illustration of deferred tax liability and deferred tax expense given in Example 2, let us assume that taxable profit before charging depreciation of XLtd. during Years 1-5 are : Year 1 NPR 3,50,000 ; Year 2 NPR 250,000 ; Year 3 NPR 6,00,000; Year 4 NPR 6,00,000 ; and Year 5 NPR 7,00,000. Assume that tax laws allows carry forward of loss over 8 years and unabsorbed depreciation indefinitely. Illustrated below is the deferred tax asset to be recognised out of carried forward unused tax loss which is of thenature of unabsorbed depreciation. Year

1 2 3 4 5

Taxable profit before depreciation

3,50,000 1,50,000 6,00,000 6,00,000 7,00,000

Tax Depreciation 4,50,719 2,47,571 1,35,986 74,694 41,028

Taxable profit before adjustment of carry forward

-1,00,719 -97,571 4,64,013 5,25,305 6,58,971

Cumulative carry - forward loss

-1,00,719 -1,98,291

Taxable Profit 0 0 2,65,723 5,25,305 6,58,971

Current tax (A) 0 0 79,717 1,57,592 1,97,692

Deferred tax asset 30,216 59,487

Deferred tax income arising out of carry-

30,216 29,271 -59,487

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forward unused tax loss (B)

Presentation of Tax Expense:

Current tax expense 0 0 79,716 1,57,591 1,97,691

Deferred tax expense 78,216 17,271 -16,204 -34,592 -44,692

Deferred tax income arising out of tax loss

-30,216 -29,271 59,487 0 0

48,000 -1,20,00 1,23,000 1,23,000 1,53,000

Check :

Taxable profit before depreciation

3,50,000 1,50,000 6,00,000 6,00,000 7,00,000

Accounting depreciation

1,90,000 1,90,000 1,90,000 1,90,000 1,90,000

Accounting profit 1,60,000 -40,000 4,10,000 4,10,000 5,10,000

Tax 48,000 -12,000 1,23,000 1,23,000 1,53,000

Note : In this example it is explained that Tax Expense as per NAS 12 would reflect tax impact on accounting profit. However, this reconciliation would require adjustment for certain expenses which are disallowed as per tax laws and certain income which are exempt from tax. Example 4 [ Change in classification of depreciable assetto held for sale] Details of a depreciable asset that has been classified as held for sale by X Ltd. as on 31.3.2014 are as follows ( Amount in NPR thousand): As on 31.3.2013 31.3.2014 Carrying amount 90.00 80.00 Tax base 60.00 55.00 Taxable temporary difference 30.00 25.00 Deferred tax liability 9.00 Fair value less costs to sale 75.00 The company recognises a deferred tax liability of NPR 9,000 at 30%. It has considered that the asset will be recovered through use and therefore, it has applied the tax rate applicable to business profit. During 2013-14 , it has decided to sell the asset. Assume that the applicable capital gain tax rate is 20%. The company shall bring down the carrying amount of the asset to its fair value less costs to sale as per NFRS 5 by writing off NPR 5,000. How should the company re-measure the deferred tax liability and how shall it account for any change?

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Analysis Assumption : Tax law disallows write down ( Amount in NPR thousand) Carrying

amount Tax base Temporary

Difference Deferred tax liability

As on 31.3.2014

75.00 55.00(a) 20.00 4.00

Assumption : Tax law allows write down As on 31.3.2014

75.00 50.00(b) 25.00 5.00

(a)Tax base is the amount that will be allowed to be charged against the expected sale proceeds i.e. tax base of NPR 55 million. When an entity expects to recover the carrying amount by selling the asset, the capital gain = Sale proceeds – Allowed cost i.e. NPR 20 million and expected capital gain tax is NPR 4 million. Deferred tax liability of NPR 5 million is reversed through Profit and loss i.e. adjusted to tax expense. (b) Tax base is adjusted for write down already allowed. If it is assumed only for simplified understanding that rates of tax on business profit and capital gain are the same (say 20%) and Profit Before Tax is NPR 20 million before charging write down then tax expense can be worked out as follows ( in NPR million): Tax law disallows

write down Tax law permits write down

Taxable profit before write down 20.00 20.00 Write downs 0.00 -5.00 Taxable profit 20.00 15.00 Tax expense 4.00 3.00 Deferred tax income -Reversal of deferred tax liability

-5.00 -4.00

-1.00 -1.00 It is possible that capital gains represented by cumulative depreciation charge is taxed at tax rate applicable. Assume that applicable tax rate for business profit is 30% and applicable tax rate for capital gain is 20%. Deferred tax liability shall be computed breaking down the temporary difference into two components – (i) Cumulative depreciation and (ii) pure capital gain that reflects excess of sale proceeds over tax base plus cumulative depreciation. Assume that in the given case original cost of the asset is NPR 150 million , cumulative depreciation as 31.3.2014 is NPR 70 million. In both the cases estimated capital gain would recover only cumulative depreciation. So deferred tax liability shall be computed at 30%.

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Assumption : Tax law disallows write down ( Amount in NPR thousand) Carrying

amount Tax base Temporary

difference Deferred tax liability

Reversal of deferred tax liability

As on 31.3.2014

75.00 55.00(a) 20.00 6.00 3.00

Assumption : Tax law allows write down As on 31.3.2014

75.00 50.00(b) 25.00 7.50 1.50

Tax impact analysis Tax law disallows

write down Tax law permits write down

Taxable profit before write down 20.00 20.00 Write downs 0.00 -5.00 Taxable profit 20.00 15.00 Tax expense 6.00 4.50 Deferred tax income -Reversal of deferred tax liability

-3.00 -1.50

3.00 3.00 8. Investment property If a deferred tax liability or asset arises from investment property that is measured using the fair value model in IAS 40, [Refer: NAS 40 paragraphs 35–55] there is a rebuttable presumption that the carrying amount of the investment property will be recovered through sale. Accordingly, unless the presumption is rebutted, the measurement of the deferred tax liability or deferred tax asset shall reflect the tax consequences of recovering the carrying amount of the investment property entirely through sale. This presumption is rebutted if the investment property is depreciable and is held within a business model whose objective is to consume substantially all of the economic benefits embodied in the investment property over time, rather than through sale. If the presumption is rebutted, the requirements of paragraphs 51 and 51A of NAS 12 shall be followed. A building is rent out and it is assumed that the carrying amount shall be recovered by way of rent. In that case deferred tax shall be computed applying tax rate applicable to business profit. Whereas the building is held for sale then deferred tax is computed applying capital gain tax rate. Example 5 [ Non-depreciable Investment Property] (A) [ Investment property carried at fair value ] X Ltd. acquired an investment property ( land) as on 31.3.2013 at a cost inclusive of incidental expenses of NPR 50 million. This is held for capital appreciation. The company follows revaluation model of NAS 40 . The company intends to hold it for long term.

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Market value of the land as on 31.3.2014 is NPR 60 million and as on 31.3.2015 is NPR 55 million. The company has accounted for the fair value gain in the profit and loss as per NAS 40. Assume that indexation benefit is available for long term capital gains. Applicable index as on 31.3.2014 is 105 and as on 31.3.2015 106. What should the tax base , temporary difference and deferred tax ? Assume tax rate of 20%. Analysis ( Amount in NPR million)

As on 31.3.2013 31.3.2014 31.3.2015

Carrying amount 50.00 60.00 55.00 Tax base* 50.00 52.50 53.00 Taxable temporary difference 0 7.50 2.00 Deferred tax liability 0 1.50 0.40 Deferred tax expense 0 1.50 -0.90 Tax base = Indexed cost (B) [ Investment property carried at cost] ( Amount in NPR million)

As on 31.3.2013 31.3.2014 31.3.2015

Carrying amount 50.00 50.00 50.00 Fair value adjustment to arrive at expected realisable value

0 10.00 5.00

Adjusted carrying amount* 50.00 60.00 55.00 Tax base** 50.00 52.50 53.00 Taxable temporary difference 0 7.50 2.00 Deferred tax liability 0 1.50 0.40 Deferred tax expense 0 1.50 -0.90 * Adjusted for expected increase in realisable value over cost **Tax base = Indexed cost When the asset is expected to be realised through sale , its carrying amount shall be the expected realisable value even though in the Balance Sheet the asset is carried at cost. Example 6 [ Depreciable investment property ] X Ltd. purchased a building as on 10.7.2013 for NPR 10 million including incidental expense. The company uses it as an investment property. Estimated useful life of the building is 50 years. The company expects to recover the carrying amount by use. Applicable tax rate for business profit 30% and for capital gains 20%.

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Relevant information ( in NPR million) As on 1.4.2013 31.3.2014 31.3.2015 31.3.2016 Fair value 11.00 11.00 12.00 Cost 10.00 The company charges straight line method depreciation ( SLM) for accounting purpose and for tax purpose applicable rate of depreciation is 2.5% SLM. Application of NAS 12 is explained under the following alternative assumptions : (i) It follows fair value model as per NAS 40. (ii) It follows cost model of NAS 40. (iii) It follows fair value model of NAS 40. It has decided to sale to property. (iv) It follows cost model of NAS 40. It has decided to sale the property. Indexation applies for computation of capital gain tax . Applicable cost index as on 31.3.2014 : 05 , 31.3.2015 : 107.5 and as on 31.3.2016 : 108 Analysis (i)Fair value Model without sale

( Amount in NPR Million) 1.4.2013 31.3.2014 31.3.2015 31.3.2016 Fair value 10.000 11.000 11.000 12.000 Depreciation 0.200 0.224 0.224 Carrying amount (Depreciated value)

10.800 10.776 11.776

Tax base 10.000 9.750 9.500 9.250 Tax depreciation 0.250 0.250 0.250 Temporary difference 0.000 1.250 1.500 2.750 Deferred tax liability 0.375 0.450 0.825 Deferred tax expense 0.375 0.075 0.375 Temporary difference = Depreciated fair value minus Tax base. Deferred tax liability is computed applying rate of tax applicable to business profit. (ii) Cost model without sale

( Amount in NPR Million)

1.4.2013 31.3.2014 31.3.2015 31.3.2016 Cost 10.00 Depreciation 0.200 0.200 0.200 Carrying amount (Depreciated value)

9.800 9.600 9.400

Tax base 10.00 9.750 9.500 9.250 Tax depreciation 0.250 0.250 0.250 Temporary difference 0.00 0.050 0.100 0.150 Deferred tax liability 0.015 0.030 0.045 Deferred tax expense 0.015 0.015 0.015

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Temporary difference = Depreciated cost minus Tax base. Deferred tax liability is computed applying rate of tax applicable to business profit. (iii) Fair value with sale decision

( Amount in NPR Million)

1.4.2013 31.3.2014 31.3.2015 31.3.2016 Fair value 10.000 11.000 11.000 12.000 Depreciation 0.200 0.224 0.224 Carrying amount (Depreciated value) 10.800 10.776 11.776 estimated sale price 12.000 Tax base 10.000 9.750 9.500 9.250 Tax depreciation 0.250 0.250 0.250 Indexation adjusted Tax Base 9.990 Temporary difference 0.000 1.250 1.500 2.010 Deferred tax liability 0.375 0.450 0.402 Deferred tax expense 0.375 0.075 -0.048 Temporary difference as on 31.3.2014 & 31.3.2015 = Depreciated fair value minus Tax base. Deferred tax liability is computed applying rate of tax applicable to business profit. Temporary difference as on 31.3.2016 = Estimated market value minus Tax base adjusted for indexation benefit. Deferred tax liability is computed applying rate of tax applicable to capital gain tax. (iv) Cost model with sale decision

( Amount in NPR Million)

1.4.2013 31.3.2014 31.3.2015 31.3.2016 Cost 10.00 Depreciation 0.200 0.200 0.200 Carrying amount (Depreciated value)

9.800 9.600 9.400

Estimated market value 12.00 Tax base 10.000 9.750 9.500 9.250 Tax depreciation 0.250 0.250 0.250 Indexation adjusted Tax Base 9.990 Temporary difference 0.050 0.100 2.01 Deferred tax liability 0.015 0.030 0.402 Deferred tax expense 0.015 0.015 0.372 Temporary difference as on 31.3.2014 & 31.3.2015 = Depreciated cost minus Tax base. Deferred tax liability is computed applying rate of tax applicable to business profit.

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Temporary difference as on 31.3.2016 = Estimated market value minus Tax base adjusted for indexation benefit. Deferred tax liability is computed applying rate of tax applicable to capital gain tax. 9. Employee benefit provisions Retirement benefit costs are deducted while computing accounting profit but allowed for tax when contributions are actually made to a fund or retirement benefit expense is actually incurred. Similarly, an entity provide for other short term and long term employee benefits like leave travel concession, encashable earned leave , etc. These provisions will give rise to deductible temporary difference. 10. Provision for product warranty Provision is deducted as an expense when created but is normally allows as per tax law when actually a product warranty expense is met. This gives a deductible temporary difference. Example 7 [ Provision and Deferred Taxation] [ Refer to Paragraph Product warranty account of X Ltd. is as follows:

Amount in NPR thousand Warranty provision 2011-12 2012-13 2013-14 Balance as on 1.4.2011 20 30 40 Payment for product warranty 40 30 45 Provision made during the year 50 40 40 Balance as on 31.3.2012 30 40 35

Tax rate 30%. In case of provision , the tax base is nil. So carrying amount is higher than tax base , and it gives rise to deferred tax asset. Presented below is the analysis of deferred tax arising out of provision for product warranty: Amount in NPR thousand Deferred tax asset 1.4.2011 31.3.2012 31.3.2013 31.3.2014 Carrying amount 20 30 40 35 Tax base 0 0 0 0 Deductible temporary difference

20 30 40 35

Deferred tax asset 6 9 12 10.5 Deferred tax income 3 3 -1.5 Accounting Entries ( Amount in NPR thousand) 31.3.2012 Deferred Tax Asset Dr. 3.00 Deferred Tax Income Cr. 3.00 31.3.2013

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Deferred Tax Asset Dr. 3.00 Deferred Tax Income Cr. 3.00 31.3.2014 Deferred Tax Expense Dr. 1.50 Deferred tax Asset Cr. 1.50 ( reversal of deferred tax asset) 11. Assets carried at fair value [ Paragraph 20 , NAS 12] In certain countries , the revaluation or other restatement of an asset to fair value affects taxable profit (tax loss) for the current period. As a result, the tax base of the asset is adjusted and no temporary difference arises. However, in many other countries , the revaluation or restatement gain / loss does not affect taxable profit in the period of the revaluation or restatement and, consequently, the tax base of the asset is not adjusted. Now the depreciation / amortisation in the post-revaluation period may be higher or lower than which is deductible for tax purposes. The difference between the carrying amount of a revalued asset and its tax base is a temporary difference and gives rise to a deferred tax liability or asset When revaluation model is adopted for subsequent measurement of tangible fixed assets ( refer to NAS 16) , intangible assets ( refer to NAS 38) and investment property ( refer to NAS 40) , carrying amount of the asset is increased by revaluation surplus but this increment is disallowed for the purpose of charging depreciation as per Tax law. Therefore, tax base remains the same. As a result deferred tax liabilities arise out of revaluation. Revaluation surplus is accounted for in other comprehensive income. So as per Paragraphs 61A and 62 of NAS 12 deferred tax expense shall also be charged to other comprehensive income. Example 8 [ Revaluation of Machinery and Deferred Taxation] (A) X Ltd. acquired a machinery on 1.4.2006 for NPR 10,00,000. The company follows straight line depreciation for accounting purpose whereas reducing balance method is applicable for tax purpose. Estimated useful life is 20 years and estimated scrap value 5%. The company revalued the asset at the beginning of 2014-15 by 20% of the net balance. Estimated scrap value after revaluation is NPR 80,000. The impact of revaluation on temporary difference and deferred tax is analysed in the case study. (B) The company adopts a policy of transferring from revaluation reserve in proportion to additional depreciation charge arising out of revaluation . An entity may adopt a policy of transferring a portion of revaluation surplus on the basis of usage. When revaluation reserve is transferred related deferred tax liability is also adjusted :

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“If an entity makes such a transfer, the amount transferred is net of any related deferred tax. Similar considerations apply to transfers made on disposal of an item of property, plant or equipment.” [Paragraph 64, NAS 12] The amount of the surplustransferred would be the difference between depreciation based on the revaluedcarrying amount of the asset and depreciation based on the asset’s original cost.Transfers from revaluation surplus to retained earnings are not made through profit or loss. [ Paragraph 41, NAS 16] Therefore, applying Paragraph 64, NAS 12 and Paragraph 41, NAS 16 , amount of revaluation reserve can be directly transferred to retained earnings. But related deferred tax liability can be transferred to Statement of Income by virtue of Paragraph 20, NAS 12 which states that – “If the entity does not intend to dispose of the asset. In such cases, the revalued carrying amount of the asset will be recovered through use and this will generate taxable income which exceeds the depreciation that will be allowable for tax purposes in future periods.” Accordingly, when the revalued asset is used it is possible to transfer an appropriate portion to Income Statement. ( C) The company sold the asset at the beginning of 2016-17 for NPR 7,00,000. Capital gain tax rate is 20%. When the asset is sold, the balance of deferred tax liability arising out of revaluation reserve shall be transferred to Income Statement. In case the sale proceeds are re-invested in similar assets as per Tax law by which capital gain tax is deferred till the new asset is sold. Deferred tax liability is deferred and reversed when capital tax is ultimately payable. (A) Analysis of deferred tax liability arising out of revaluation of depreciable asset Table : Deferred tax on revaluation of depreciable asset

( Amount in NPR) Carrying

amount Tax Base Taxable

temporary difference

Deferred tax liability

Deferred tax expense

Balance as on 1.4.2014

6,67,500(a) 3,50,461(b) 3,17,039 95,112

During 2014-15 Revaluation surplus

1,33,500(c ) 0

8,01,000 3,50,461 4,50,539 1,35,162 40,050(d) Depreciation 55,462 48,752 Balance as on 31.3.2015 7,43,231 3,01,709 4,41,522 1,32,457

-2,705(d)

Depreciation 2015-16 57,769 41,970 Balance as on 31.3.2016 6,85,462 2,59,739 4,25,723 1,27,717 -4,740

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Notes : (a) SLM depreciation before revaluation = ( 10,00,000 – 5% × 10,00,000)/20 = NPR 47,500. Carrying amount as on 31.3.2014 = 10,00,000 – 7 years × 47,500 = NPR 6,67,500 (b) Rate of WDV depreciation = 1- (5% × 10,00,000/10,00,000) (1/20) = 13.9108% Tax base as on 31.3.2104 = 10,00,000 ×( 1-13.9108%) ( c) Revaluation surplus = 6,67,500 × 20% = NPR 133,500 (d) Deferred tax expense and income : Deferred tax expense arises out of revaluation of asset. But there is reversal of deferred tax liability in post-revaluation period. This results in deferred tax income of NPR 2705 in 2014-15. Accounting Entries for revaluation and resultant deferred tax liability Machinery A/c Dr. 1,33,500 Revaluation Reserve A/c Cr. 1,33,500 Revaluation Reserve A/c Dr. 40,050 Deferred Tax Liability A/c Cr. 40,050 Deferred tax expense is deducted from revaluation reserve in Statement of Other Comprehensive Income. It may be noted that as per NAS 1 revaluation surplus is presented in the Statement of Other Comprehensive Income. (B) Transfer from revaluation reserve Annual transfer from Revaluation Reserve to Statement of Income is NPR : ( 1,33,500 – 40,050 ) / 13 = NPR 7,188 Consequential transfer from deferred tax liability: 40,050 /13= NPR 3,081 Accounting Entries ( Amount in NPR) Revaluation Reserve A/c Dr. 7,188 General Reserve A/c Cr. 7,188 Deferred Tax Liability A/c Dr 3,081 Profit and Loss A/c Cr. 3,081 [ Ref : Paragraph 64, NAS 12] Revaluation

Reserve DTL

Amount in NPR Balance on revaluation 1,33,500 Adjustment for deferred tax liability -40,050 40,050

93,450 40,050 Transfer to P&L as on 31.3.2015 7,188 3,081 Balance as on 31.3.2015 86,262 36,969 Transfer to P&L as on 31.3.2016 7,188 3,081 Balance as on 31.3.2016 79,073 33,888 ( C) Sale of revalued assets Amount in

NPR Sale proceeds 7,00,000

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Profit 14,538 Current tax 2,908 Reversal of deferred tax liability to P&L 33,888 Reversal of Revaluation Reserve to Retained Earnings 79,073 Accounting Entries : Accumulated Depreciation A/c Dr. Bank A/c Dr. Machinery A/c Cr. Profit on sale of Machinery A/c Cr. Deferred Tax Liability A/c Dr. Profit and Loss A/c Cr. Revaluation Reserve A/c Dr. General Reserve A/c Cr.

4,48,038 7,00,000

11,33,500 14,538

33,888

33,888

79,073 79,073

Revaluation reserve is not recycled through Statement of Income , but deferred tax liability arising out of revaluation of depreciable asset is adjusted against Tax Expense in the Statement of Income when the asset is used or sold. However, when there is reversal of previously revalued asset, and there exists balance of revaluation surplus , then revaluation loss is adjusted against the revaluation surplus in the Statement of Other Comprehensive Income. Also related deferred tax liability is reversed through Statement of Other Comprehensive Income.

12. Financial Liabilities measured at amortised cost As per NAS 39 financial liabilities ( other than liabilities which are classified as held for trading) are measured at fair value at initial recognition and at amortised cost at subsequent measurement. The fair value at initial recognition is adjusted for issue expense , discount etc. The tax law may require amortisation of expenses and discount on straight line basis over the maturity of the financial liability. Example 9 [ Financial liability carried at amortised cost and deferred taxation] X Ltd. raised 12% Loan on private placement basis as on 1.4.2014 amounting to NPR 100 million for a period of 5 years. It has incurred issue expenses ( commission , legal expenses etc.) of NPR 1 million. Analysed below is the deferred tax impact of unamortised expenses. Analysis By definition the loan does not have any tax incidence so its carrying amount (amortised cost) is the tax base. Therefore, amortised cost presented below is the tax base.

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( NPR in Million) Year Cash flows Amortised

cost Borrowing costs

Adjustment to amortised cost

0 99

1 -12 99.16 12.16 0.16

2 -12 99.33 12.18 0.18

3 -12 99.53 12.20 0.20

4 -12 99.75 12.22 0.22

5 -112 100.00 12.25 0.25

12.28%

Analysis of Current Tax and Deferred Tax

( Amount in NPR Million)

0 1 2 3 4 5 Total

Borrowing cost as per Tax law

12.00 12.00 12.00 12.00 12.00

Borrowing cost as per Tax law

12.16 12.18 12.20 12.22 12.25

Difference in borrowing cost

0.16 0.18 0.20 0.22 0.25 .

Impact on Current tax because of disallowance of higher borrowing cost

0.05 0.05 0.06 0.07 0.07 0.30

Unamortised cost 1.00 0.80 0.60 0.40 0.20 0.00

Deferred tax asset 0.30 0.24 0.18 0.12 0.06 0.00

Deferred tax income 0.30 -0.06 -0.06 -0.06 -0.06 -0.06

Accounting Entries: Amount in NPR Dr. Cr. Date of raising loan Deferred tax Asset A/c Dr Deferred Tax Income A/c Cr. ( Recognition of deferred tax asset and income on recognition of loan resulting in unamortised cost )

3,00,000

3,00,000

Year 1-5 Deferred Tax Income A/c Dr. Deferred Tax Asset A/c Cr.

60,000

60,000

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13. Available for sale financial asset Financial Assets Financial assets classified as available for sale as per NAS 39 is measured at fair value through other comprehensive income. The change in fair value is recognised in the Statement of Other Comprehensive Income. The unrealised fair value loss is generally not taxed , and therefore , deferred tax liability arises on cumulative fair value gain.Deferred tax asset arises out of cumulative fair value loss if it is probable that capital gain will arise in future to carry forward and set –off the loss. Generally, as per the tax law the long term capital gain loss is allowed to be carried forward and set of against long term capital gains. Example 10 [ Available for sale financial asset and deferred taxation] X Ltd. purchased equity shares costing NPR 10 million as on 2.7.2013. Fair value as on 31.3.2014 is NPR 12 million and as on 31.3.2015 is NPR 11 million. Capital gain tax rate is 20%. Assumed that unrealised capital gain is not taxed. Indexation is ignored. Presented below is the deferred taxation impact of the fair value gain. Analysis

( Amount in NPR million)

31.3.2014 31.3.2015 Carrying amount 12.00 11.00 Tax base 10.00 10.00 Temporary difference 2.00 1.00 Deferred tax liability 0.40 0.20 Deferred tax expense 0.40 -0.20

Deferred tax expense is presented in the Statement of Other Comprehensive Income and reversed therein. 14. Research costs As per NAS 38 Intangible Assets research costs is expensed in the reporting in which those are incurred. The tax law may require straight amortisation of those costs over 5 years. Example 11 [ Research costs] X Ltd. incurs research costs NPR 1,00,000 during 2013-14 , and charged off to Profit and Loss Account. As per tax law research costs are allowed to be amortised over 5 years on straight line basis. Determine temporary difference , deferred tax asset and deferred tax income.

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Analysis Research costs ( NPR in thousand) 0 1 2 3 4 5

Research expense 100000 100000 0 0 0

Charged off -100000

Carrying amount 100000 0 0 0 0 0

Tax base 100000 80000 60000 40000 20000 0

Amortisation 20000 20000 20000 20000 20000

Temporary difference 0 -80000 -60000 -40000 -20000 0

Deferred Tax Asset 24000 18000 12000 6000 0

Deferred Tax Income / Reversal of deferred tax asset

24000 -6000 -6000 -6000 -6000

15. Business Combination [ Ref Paragraphs 19, 21, 21A, 21B &22] As per NFRS 3 assets acquired and liabilities taken over in a business combination transaction are measured at fair value. This may result in difference between carrying amount and tax base of those assets and liabilities. In particular when depreciable asset is acquired in business combination , the tax law generally allows tax base of the previous owner as the tax base of the acquirer. The fair value of the asset may be higher or lower than its tax base giving rise deferred tax liability or asset. Similarly when receivable is written down , the tax law does not allow such valuation allowance as deductible expense. Bad is allowed only when loss is actually incurred. As per NAS 39 goodwill is classified as intangible asset having indefinite useful life, It is not amortised but subjected to impairment. If goodwill is not allowed to be amortised as per Tax law as well , then its tax base is nil that will result in deferred tax liability. However, Paragraph 21 read with Paragraph 15(a) of NAS 12 prohibits recognition of such deferred tax liability. Any subsequent change in the carrying amount of goodwill arising out of impairment charge will reduce the deferred tax liability. This subsequent reduction in deferred tax liability is not recognised by virtue of Paragraph 21B of NAS 12. However, if amortisation of goodwill is allowed as per the tax law, then deferred tax arising out of subsequent change in the carrying amount and tax base of goodwill is recognised. When deferred tax asset or liability arises out of initial recognition of assets and liabilities in a business combination , then goodwill or bargain purchase is adjusted. Goodwill is increased to recognise deferred tax liability, and reduced to recognise deferred tax asset. Example 12[ Deferred tax incidence of business combination] X Ltd. acquired the business of Y Ltd. at purchase consideration of NPR 122.5 million for net assets value measured at fair value of NPR 115 million. Accordingly, there is goodwill of NPR 7.5 million. However, deferred tax liability arises out of taxable temporary difference of machinery and other current assets would give rise to deferred tax liability of NPR 16.5

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million , and deferredtax asset amounting to NPR 1.50 million arises out of deductible temporary difference of equipment. Assume tax rate of 30% for measuring deferred tax. ( Amount in NPR in thousand) Assets Carrying

amount of the acquiree

Fair value Tax base

Taxable Temporary difference

Deductible temporary difference

Machinery 100.0 110 80 40

Equipment 30.0 20 25

Inventory 20.0 15 15 5

Trade receivables 40.0 30 40 10

190.0 175

Liabilities

Payables 60.0 60 60

Deferred tax liability

7.5

Net assets value acquired

115

Fair value of purchase consideration

135

Goodwill 20

Initial recognition of deferred tax asset and liability by adjusting goodwill is explained in this example. Assume that amortisation of goodwill over 10 years on straight line basis is allowed as per tax law. Analysis NPR in million

Goodwill 15.0

Deferred Tax on initial recognition of assets and liabilities:

Deferred tax liability +12.0

Deferred tax - 4.5

Adjusted Goodwill 22.5

Accounting entry: Amount in NPR million

Dr. Cr.

Goodwill 22.5

Machinery A/c Dr. 110.0

Equipment A/c Dr. 20.0

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Inventory A/c Dr. 15.0

Trade Receivables A/c Dr. 30.0

Deferred Tax Asset A/c Dr. 1.5

Payables A/c Cr. 60.0

Deferred Tax Liability A/c Cr. 16.5

Purchase consideration A/c Cr. 122.5

199.0 199.0

Deferred tax analysis on amortisation of Goodwill: Year Carrying

amount Amortisation for tax purpose

Tax base

Taxable Temporary difference

Deferred tax liability

Deferred tax expense

0 22.5

1 22.5 2.25 20.25 2.25 0.68 0.68

2 22.5 2.25 18.00 4.50 1.35 0.68

3 22.5 2.25 15.75 6.75 2.03 0.68

4 22.5 2.25 13.50 9.00 2.70 0.68

5 22.5 2.25 11.25 11.25 3.38 0.68

6 22.5 2.25 9.00 13.50 4.05 0.68

7 22.5 2.25 6.75 15.75 4.73 0.68

8 22.5 2.25 4.50 18.00 5.40 0.68

9 22.5 2.25 2.25 20.25 6.08 0.68

10 22.5 2.25 0.00 22.50 6.75 0.68

Deferred tax liability on goodwill is reversed when goodwill is impaired. 16. Recognition Principles Current Tax Liabilities and Current Tax Assets – Any unpaid tax for current period or prior periods is recognised as a liability. Therefore , provision is created in the statement of income for any unpaid tax. [ Paragraphs 12-14 of NAS 12] Tax paid in advance is recognised as an asset. NAS 1 is applied for offsetting balance of advance tax against tax provision and net presentation in the Balance Sheet. Deferred Tax Liabilities –A deferred tax liability shall be recognised for all taxable temporary differencesexcept in the following two cases: i. the initial recognition of goodwill ; ii. initial recognition of an asset or liability in a transaction other than business combination and the transaction does not affect both the accounting profit or taxable profit .

ASB-NEPAL 31

Example of transaction as mentionedin (ii) above is land given by the government for limited use. At the end of limited usage period , it will be returned to the government. Thereis accounting depreciation or tax depreciation to affect the accounting profit or tax profit. Carrying amount of the land may its fair value but tax base is nil. This temporary difference does not give rise to deferred tax liability. The taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, a deferred tax liability is recognised as per Paragraph 39 of NAS 12. Deferred tax asset – As per Paragraph 24, NAS 12 , adeferred tax asset is recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised. Exception to this principle is the deferred tax asset arises from the initial recognition of an asset or liability that : (i) is not a business combination ; and (ii) at the time of recognition affects neither the accounting profit nor the tax profit. The deductible temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, a deferred tax asset is recognised as per Paragraph 44, NAS 12. 17. Reassessment of unrecognised deferred tax asset An entity re-assesses unrecognised deferred tax asset at each reporting date. In case it becomes probable that the future taxable profit will allow the deferred tax asset to be recovered , the entity recognises deferred tax income. Improvement in the trading conditions is one reason that signifies increased probability of recovery of economic benefit embodied in deferred tax asset. The entity may also re-assess the unrecognised deferred tax asset at the time of a business combination or after implementation of a business combination . 18. Unused tax losses and tax credits As per Paragraph 34, NAS 12 an entity shall recognise deferred tax asset for the carry forward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised. The criteria for recognising deferred tax assets arising from the carry forward of unused tax losses and tax credits are the same as the criteria for recognising deferred tax assets arising from deductible temporary differences. For the purpose recognising any deferred tax asset an entity shall assess the following criteria in assessing the probability that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised : i. evaluation of the existing level of taxable temporary differences relating to the same taxation authority and the same taxable entity, which will result in taxable amounts against which the unused tax losses or unused tax credits can be utilised before they expire ;

ASB-NEPAL 32

ii. assessing the probability of the entity having taxable profits before the unused tax losses or unused tax credits expire; iii. whether the unused tax losses result from identifiable causes which are unlikely to recur; and iv. availability of tax planning opportunities (see Paragraph 30, NAS 12 ) that will create taxable profit in the period in which the unused tax losses or unused tax credits can be utilised. In case the probability that ‘ the taxable profit will be available against which the unused tax losses or unused tax credits can be utilised’ is low, deferred tax asset is not recognised out of carry forward losses or unused tax credits. 19. Investments in Subsidiaries , Branches , Associates and interest in Joint Ventures Temporary differences arise when the carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures (i.e. the parent or investor’s share of the net assets of the subsidiary, branch, associate or investee’s interest in joint venture , including the carrying amount of goodwill) becomes different from the tax base (which is often the cost of the investment) of the investment or interest. Reasons for such differences are –

i. Undistributed profits of subsidiaries, branches, associates and joint ventures;

ii. Changes in the exchange rate for foreign operation or iii. Reduction in the carrying amount to recoverable amount.

Paragraph 39, NAS 12 requires an entity to recognise deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures. Exceptions are the cases when parent, investor or venturer is able to control the timing of the reversal of the temporary timing difference , and it is probable that the temporary difference will not reverse in the foreseeable future. Since the investor of the associate do not enjoy control, this exception would apply only if by virtue of shareholders’ agreement the investor enjoys the control over the dividend policy. When exception is applied, an entity shall provide disclosures in accordance with Paragraph 82A, NAS12. Similarly, Paragraph 44, NAS 12 requires an entity to recognise deferred tax asset for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures. Conditions to be checked and satisfied for recognising deferred tax asset are – (i) the temporary difference will reverse in the foreseeable future, and (ii) taxable profit will be available against which the temporary difference can be utilised. Deferred tax shall be computed applying capital gain tax rate. 20. Presentation Tax expense or income arising out of ordinary activities are presented in the Statement of income. For example, if an entity has incurred a loss before tax NPR 20 million , it

ASB-NEPAL 33

shall recognise NPR 6 million ( assuming 30% is rate of tax on business profit) deferred tax asset provided it is probable that there shall be taxable profit in future against which deferred tax asset shall be recovered. Amount in NPR Million Deferred Tax Asset A/c Dr. 6 To Deferred Tax Income A/c Cr. 6 Deferred Tax Income A/c Dr. 6 To Profit and Loss A/cCr. 6 [ Deferred tax asset arising out carried forward loss] This deferred tax income is presented in the Statement of Income. Similarly, any deferred tax expense or income which arises out of ordinary activities like depreciation, provision , etc. is presented in the Statement of Income. Deferred tax expense or income arising out of items of other comprehensive income is presented in the Statement of Other Comprehensive Income. Examples are revaluation surplus on asset as per NAS 16, fair value gain on available for sale financial asset classified in accordance with NAS 39, and translation difference in consolidated financial statement in accordance with NAS 21. Offsetting - An entity shall not offset assets and liabilities or income and expenses, unless required or permitted by a particular NFRS. Offsetting of current tax assets and liabilities is permitted are – (i) the entity has a legally enforceable right to set off the recognised amounts , and (ii) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. These conditions are satisfied if an entity will normally have a legally enforceable right to set off a current tax asset against a current tax liability as they relate to income taxes levied by the same taxation authority . Moreover , the taxation authority permits the entity to make or receive a single net payment. In the consolidated financial statements offsetting of current tax liability of one group entity against current tax asset of another group entity is permitted only when the entities have legally enforceable right to receive or make single payment. Therefore, unless the group entities are assessed together, offsetting is not possible.

[Paragraphs 71-73& 77 ,NAS 12] As regards offsetting of deferred tax assets and liabilities only when :

(a) The entity has legally enforceable right to set off current tax asset with current liabilities as covered in Paragraphs 71-73 of NAS 12;

(b) Deferred tax assets and liabilities relate to income taxes levied by the same authority. [ Paragraph 74-76, NAS 12]

21. Disclosures Paragraphs 79-88 , IAS 12 sets out disclosure principles as regards taxes on income.

ASB-NEPAL 34

1. Disclosure of tax expense with break-up of the charge Break-up of the components of tax expense including current tax and deferred tax expense presented in the Statement of Income is disclosed in the note: For the year ended on Disclosure of details of current tax and deferred tax as per Paragraph 80, NAS 12

31.3.2014 31.3.2013

(a) Current tax expense (income) - Disclose separately any tax adjustment resulting from unrecognised tax loss etc. stated in item (e) below - Disclose separately tax expense (income) arising out of change in accounting policies and errors as state din item(h) below.

(b) Adjustment for prior periods ( c) Deferred tax expense (income) arising out of origination and reversal of temporarydifferences - Disclose separately any change in deferred tax expense (income) arising out of change in tax rate stated in item(d) below - Disclose separately adjustment arising out of item (f) below out of deferred tax benefit arising out of previously unrecognised tax loss etc. - Disclose separately impact of write downs and reversal stated in item (g) below.

(d) Deferred tax income ( expense) resulting from change in tax rate or introduction of new tax

(e) Tax benefit arising out of previously unrecognised tax loss or tax credit or temporary difference of a prior period that reduces current tax expense

(f) Tax benefit arising out of previously unrecognised tax loss or tax credit or temporary difference of a prior period that reduces deferred tax expense

(g) Deferred tax expense from write downs or reversal of previous write downs of deferred tax asset.

(h) Tax expense relating to changes in accounting policies and errors as per IAS 8

For the year ended on 31.3.2014 31.3.2014 Break-up of current and deferred tax as per statement of charge as per Paragraph 81, NAS 12

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(a) Aggregate current and deferred tax charged or credited directly to equity This arises out of Paragraph 62A , NAS 12 adjustment to opening balance of the retained earnings as per NAS 8 relating to change in accounting policies and errors; or Initial recognition of equity component of a compound financial instrument as per Paragraph 23 , NAS 12

(b) Amount of income tax relating to each component of other comprehensive income

( c) Explanation of the relationship between tax expense (income) and accounting profit

(d) Explanation to applicable tax rate as compared to previous accounting period

(e) Amount along with expiry date , if any, of deductible temporary difference, unused tax loss or unused tax credit for which no deferred tax asset is recognised

(f) Aggregate amount temporary difference relating to investments in subsidiaries, associates, branches and interests in joint arrangements

(g) Detailed disclosures for each type of temporary difference , and each type of unused tax loss or tax credits : (i) Amount of deferred tax assets and liabilities recognised in the Balance Sheet for each period presented (ii) Amount of deferred tax expense or income recognised in the profit or loss ( in case it is not apparent from thechanges in the amount recognised in the Balance Sheet)

(h) Disclosures regarding discontinuing operations: (i) Tax expense on gain or loss on discontinuation (ii) Tax expense on profit or loss from ordinary activities with comparatives

(i) Income tax consequence of dividend Includes disclosure of dividend distribution tax, if any

(j) Change in the pre-acquisition deferred tax of the acquirer resulting from business combination

(k) Description of the change of events or circumstances leading to recognition of deferred tax relating to business combination subsequent to date of acquisition.

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It relates to case when deferred tax is recognised as on the date of business combination but recognised at a date subsequent thereto.

2. Disclosure relating to deferred tax asset. In case utilisation of deferred tax asset is dependent on future taxable profit ( for example deferred tax asset on Carry-forward of previous loss) after adjustment reversal of existing taxable timing difference , and the entity has suffered loss in either current or preceding period , the following disclosures are required as per Paragraph 82, NAS 12: - Amount of deferred tax assets recognised - Nature of evidence supporting the recognition.

3. Disclosures regarding tax incidence of distributable profit . Paragraph 52A , NAS 12 requires to compute deferred tax on undistributed profit that shall taxed if distributed. If transfer to special reserve is tax exempt subject to condition that distribution of dividend out such reserve will attract tax at prescribedrate. Then deferred tax liability is recognised when it is likely that distribution shall be made out of such restricted reserve. An entity to which Paragraph 52A, NAS 12 applies shall disclose – - Tax consequences of distribution if it is practicably determinable; or - Disclose the fact that tax consequence cannot be practicablydetermined. Disclosure under Paragraph 52A, NAS 12 also applies to deferred tax incidence on undistributable profit of subsidiary , associate, branch and joint arrangement. Applying the exception granted in Paragraph 39 , NAS 12 if an entity does not recognise deferred tax on temporary difference in relation to investments because it controls dividend distribution and so such temporary difference will not reverse. It shall disclose the tax consequence as per Paragraph 82A , NAS 12. Often it becomes impracticable to compute deferred tax arising out temporary difference relating to investments in subsidiary, associate, branch or interests in joint venture. To comply with the requirements of Paragraph 82A. In such a case an entity may disclose the temporary difference only. 4. Tax related contingent liabilities . An entity is required to disclose tax related contingent liabilities like disputed tax liability. It is suggested to provide – (i) item-wise disclosure of all significant tax disputes along with claims which have been disputed; (ii) amount of provision already recognised; and (iii) status of the dispute .