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Implication of deferred tax under IAS 12 and revised SOCPA zakat standard

ICAP KSA members

28 December 2016

Implication of deferred tax and revised zakat standard

Agenda

► Overall understanding of deferred tax under IAS 12

► Accounting gaps between SOCPA and IFRS

► Requirements of IFRS 1 pertaining to reporting of deferred

tax and zakat for first time adoption

► IAS 12 disclosure challenges

► Basis of revision of SOCPA Standard on zakat


Current status


Standards in place

► SOCPA had separate standards for zakat and income tax

accounting

► Under IFRS there is an accounting standard for income

tax but none for Zakat

► SOCPA has amended its zakat accounting standard in

September 2016 to bring it in line with the IFRS

requirements. Applicable from 1 January 2017

► SOCPA has also issued an opinion to disclose the impact

of zakat and income tax on individual owners’ equity


Accounting for zakat and income tax under SOCPA

Zakat is an obligatory payment made by Muslims annually under Islamic law on certain

kinds of assets and for charitable purposes. It is considered a religious obligation.

► For fully zakatable entities (Saudi + GCC) in the statement of income

► For Mixed entities (Saudi + foreign partner) in the statement of changes in

equity

Income tax as computed under Income tax law of Saudi Arabia

► For fully income tax entities (foreign partners) in the statement of income

► For Mixed entities in the statement of changes in equity

Deferred tax► Standard require the accounting in line with income tax accounting

Variety of accounting treatment

Deferred zakat► No requirement to account for deferred zakat


Concepts of IAS 12


Key concepts of IAS 12Current tax

Accounting profit/(loss) = Revenue - cost

Taxable profit (tax loss) = Accounting profit +/- Tax

adjustments

Current tax (Tax liability) = (Taxable profit * % of tax)


Recognizing current tax liabilities and assets

1) Income tax provision- 31 December

Dr Tax Expense (I/S)

Cr Tax Provision (B/S)

2) Tax adjustment (prior period adjustment) – 30 April next year

- Under provided

Dr Tax Expense (I/S)

Cr Tax Provision (B/S)

- Over provided

Dr Tax Expense (B/S)

Cr Tax Provision (I/S)

3) Tax payment

Dr Tax Provision (B/S)

Cr Cash (B/S)

Exception to the normal treatment

Any current tax on items recognized either in other

comprehensive income or directly in equity shall be

recognized in other comprehensive income and

equity


Key concepts of IAS 12Deferred tax

Permanent difference

Differences between tax and accounting that never reverse

Eg: Entertainment; fines and penalties

Temporary difference

Differences between the carrying amount of an asset or a liability and its

tax base.

Equation: carrying amount – tax base = temporary difference

In contrast with permanent differences, temporary differences do

reverse.

Eg: Tax and book depreciation, certain income or expense is taxed on a

cash basis, provisions for doubtful debt; provision for end of service

benefit


Key concepts of IAS 12Tax base

Tax base is the amount attributed to that asset or liability for

tax purposes

For an asset

► Amount that will be deductible for tax purposes against

the taxable economic benefits that will flow to the entity

when it recovers the carrying amount of the asset.

► If economic benefits will not be taxable, then the tax base

of an asset is equal to its carrying amount.

The purpose is to identify the incremental tax effect of liquidating each

asset in the balance sheet at its carrying value.


Example of Tax base of an asset

A loan receivable is carried at 100. Its principal repayment will have no

tax. What is the tax base of this loan?


Knowledge test relating to tax base of an asset


Knowledge test – Scenario 1

A machine was acquired for 100. Tax depreciation of 30 has already been

deducted in the current and prior periods and the remaining cost of 70 will be

deductible in future periods. Revenue generated by using the machine is taxable

and it is the company’s intention to use the machine, not to sell it. Decide what is

the tax base is for this scenario

A. 0

B. 30

C. 70

D. 100



Accrued interest receivable has a carrying amount of 100, and it will be taxed on

receipt. Out of this amount, 30 is expected to be received in the next accounting

period and 70 in the year thereafter. Decide what the tax base is for this

scenario?

A. 0

B. 30

C. 70

D. 100



A research expenditure of 100 is expensed in the period, but this will be allowed

as a tax deduction next year. The income tax rate is 30%. Decide what the tax

base is for this scenario

A. 0

B. 30

C. 70

D. 100


Determining the tax base of a liability

► The tax base of a liability is its carrying

amount, minus any amount that will be

deductible for tax purposes in respect of that

liability in future periods.

► In the case of revenue received in advance,

the tax base is its carrying amount, minus

any amount of revenue that will not be

taxable in future periods.

The aim is to identify any incremental tax effect of settling every liability at its carrying value, and if there is no such tax effect, the tax base value is the same as the carrying value.

Two key rules apply when determining the tax base of a liability.


Calculating the tax base of a liability: case 1

The following example illustrates how the tax base of a liability is calculated.

Details: Expenses of 100 have been accrued — 80 already have given rise to a

tax deduction and 20 will be deductible for tax purposes when paid.

What is the tax base of the accrued expenses?

Carrying amount 100

Tax Deduction (past) 80

Tax Deduction (future) 20

Tax base 80


Calculating the tax base of a liability: case 2

This second example illustrates how another tax base of a liability is calculated.

Details: Revenue of 100 has been received in advance and is shown as a

liability, but it already has been taxed.

What is the tax base of the revenue received in advance?

Carrying amount 100

Tax Deduction (past) 100

Tax Deduction (future) 0

Tax base 0


Temporary differences

1) Taxable temporary differences

The recognized tax effect of future taxable temporary differences.

Give rise to a deferred tax liability.

► The carrying amount of an asset is higher than its tax base

► The carrying amount of a liability is lower than its tax base

2) Deductible temporary differences

The recognised tax effect of future deductible temporary differences.

Give rise to a deferred tax assets

► The carrying amount of an asset is lower than its tax base

► The carrying amount of a liability is higher than its tax base

If it is probable that recovery of an asset or settlement of a liability will make

future tax payments larger or smaller than they otherwise would be, then

deferred tax should be recognized as a liability or asset in respect of this

difference


Recognizing deferred tax

1) Deferred Tax Liability

Debit to: Tax expense (I/S)

Credit to: Deferred tax liability (B/S)

2) Deferred Tax Assets

Debit to: Deferred Tax Assets (B/S)

Credit to:Tax expense (I/S)

There are two exceptions to this normal treatment

of the deferred income tax and expense rules:

1. any deferred tax on items recognized either in

other comprehensive income or directly in

equity shall be recognized in other

comprehensive income and equity

respectively.

2. temporary differences created as a result of

the fair value allocation following a business

combination


Knowledge test – Current and deferred tax


Knowledge test – Question 1

An entity reported net profit before tax for the year of 5,600 in its financial

statements prepared under IFRS. Profit for the year, determined in accordance

with local tax legislation and upon which income tax is payable, amounts to

6,000. Considering the key definitions you have learned in this lesson, reconcile

the amounts in this scenario with the appropriate terms under IAS 12.

A. 5,600 – accounting profit; 6,000 – deferred tax liabilities

B. 5,600 – deferred tax assets; 6,000 – taxable profit

C. 5,600 – accounting profit; 6,000 – taxable profit

D. 5,600 – taxable profit; 6,000 – accounting profit



An entity has a tax loss for the current period that can be used to recover tax paid

in respect of profits of an earlier period. How should this amount be reported in

the financial statements, prepared under IFRS?

A. As a current tax asset

B. As a current tax liability

C. As a deferred tax asset

D. As a deferred tax liability



Which of the following represent taxable temporary difference(s)? A. Expenses were accrued in the accounts in the amount of 40, but will be taxed on a cash basis.

B. A loan receivable has a carrying amount of 80. The repayment of the loan will have no tax

consequences.

C. A machine was revalued for book purposes but not for tax purposes, so that the carrying value

of the machine exceeds its tax base by 150.

► A

► B

► C

► B and C


Case Study – Current and Deferred tax


Calculating current and deferred tax

Scenario:Production machinery acquisition cost: SR 100,000

Depreciation method: Straight-line

Accounting depreciation rate: 25%

Tax depreciation rate: 20%

Accounting profit: SR 30,000 for each year

Corporate tax rate: 20%

Non-Saudi Shareholding: 100%

Required:

1. Calculate the taxable profit and current tax expense.

Current tax, Year 1 - 5

Year1 2 3 4 5 Total

Accounting profit 30,000 30,000 30,000 30,000 30,000 150,000

Add: Accounting depreciation 25,000 25,000 25,000 25,000 - 100,000

Less: Depreciation for tax purposes 20,000 20,000 20,000 20,000 20,000 100,000

Taxable profit (tax loss) 35,000 35,000 35,000 35,000 10,000 150,000

Current tax expense (income) @ 20 %

7,000 7,000 7,000 7,000 2,000 30,000



Accounting depreciation schedule

Tax depreciation schedule

Required:

Calculate deferred tax for year 1 to 5

Year 1 Year 2 Year 3 Year 4

Cost 100,000 100,000 100,000 100,000

Accumulated

depreciation

25,000 50,000 75,000 100,000

Book value 75,000 50,000 25,000 -

Year 1 Year 2 Year 3 Year 4 Year 5

Cost 100,000 100,000 100,000 100,000 100,000

Accumulated

depreciation

20,000 40,000 60,000 80,000 100,000

Book value 80,000 60,000 40,000 20,000 -



Deferred tax computation


Accounting base 75,000 50,000 25,000 - -

Tax base 80,000 60,000 40,000 20,000 -

Temporary difference 5,000 10,000 15,000 20,000 -

Deferred tax asset 1,000 2,000 3,000 4,000 -


At the beginning of the year

- 1,000 2,000 3,000 4,000

Deferred tax movement

1,000 1,000 1,000 1,000 (4,000)

At the end of the year

1,000 2,000 3,000 4,000 -



Required:

1. Journal entries to record current and deferred tax for Year 1 to 4.

Corporate tax expense 7,000

Corporate tax payable 7,000

Deferred tax asset 1,000

Deferred tax income 1,000

2. Journal entries for Year 5

Corporate tax expense 2,000

Corporate tax payable 2,000

Deferred tax expense 4,000

Deferred tax asset 4,000


Current tax expense

7,000 7,000 7,000 7,000 2,000

Deferred tax expense

(1,000) (1,000) (1,000) (1,000) 4,000

Total tax expense 6,000 6,000 6,000 6,000 6,000


Recognition of deferred tax


Recognising deferred tax assets and liabilities

► Deferred tax liability is recognized in respect of all taxable

temporary differences.

► A deferred tax asset is recognized for:

► all deductible temporary differences.

► the carry-forward of unused tax losses and tax credits

to the extent that it is probable that taxable profit will be available

against which the deductible temporary difference can be utilized

Key points to consider:

Easy to demonstrate they will be created by the reversal of taxable

temporary differences for which a provision has been made.

These must relate to the same taxable authority and the same

taxable entity, and they must arise when they will allow the deferred

tax asset to be recovered.

It is not possible to consider future deductible temporary differences

that are forecast to arise, because they must be recovered as well.


Deferred tax arising from unused tax losses or credits

► Four criteria to be considered before a deferred tax asset can be

recognized in respect of unused losses or credits

1. Enough taxable differences to create taxable amounts against which the

losses or credits can be used.

2. It is otherwise probable that the entity will have taxable profits.

3. Whether the unused tax losses result from identifiable causes that are

unlikely to recur.

4. Are tax-planning opportunities available to allow taxable profits to be

created in the period in which the losses or credits can be used?

► The availability of future taxable profits must be reassessed at each balance

sheet date, and the amount of deferred tax assets must be adjusted, if

necessary.


Deferred tax recognition rules: The two exceptions!

► Deferred tax liabilities are not recognised on temporary

differences that arise from the initial recognition of

goodwill.

► Deferred tax assets and liabilities are not recognised on

temporary differences that arise from the initial recognition

of an asset or liability in a transaction that:

► is not a business combination; and

► at the time of the transaction, affects neither accounting profit nor

taxable profit (tax loss).

Example:

An entity acquires an asset for 1,000 which it intends to use for five years and

then scrap (i.e. the residual value is nil). The tax rate is 40%. Depreciation of the

asset is not deductible for tax purposes. On disposal, any capital gain would not

be taxable and any capital loss would not be deductible.


Cheat sheet!

Asset/liability Carrying

amount higher

or lower than

tax base?

Nature of

temporary

difference

Resulting

deferred tax

(if

recognised)

Asset Higher Taxable Liability

Asset Lower Deductible Asset

Liability Higher Deductible Asset

Liability Lower Taxable Liability


Special case – Deferred tax on investment in other entities


Recognizing deferred taxes related to investments in other entities (IOE)

► IAS 12 has special rules for the recognition of deferred tax on

temporary differences that are associated with investments in certain

entities.

► These special rules apply to investments in subsidiaries, branches,

associates and joint arrangements.

► Temporary differences arise when the carrying amount of investments

becomes different from its tax base of investment

► Such differences may arise due to:

► Existence of undistributed profits

► Changes in foreign exchange rates and etc.


Special rules for recognizing deferred taxes liabilities related to IOE

An entity shall recognize 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:

► The parent, investor, joint venturer or joint operator is able to control

the timing of the reversal of the temporary difference

And

► It is probable that the temporary difference will not reverse in the

foreseeable future


Special rules for recognizing deferred taxes assets related to IOE

An entity shall recognize a deferred tax asset for all deductible

temporary differences arising from investments in subsidiaries, branches

and associates, and interests in joint arrangements, to the extent that,

and only to the extent that, it is probable that:

► The temporary difference will reverse in the foreseeable future

And

► Taxable profit will be available against which the temporary difference

can be utilized


Measuring deferred tax

► Deferred tax is calculated at the tax rates that are expected to apply in

the period when the deferred tax asset is realized or the liability is

settled

► The tax must be based on tax rates and laws that have been enacted,

or substantively enacted, by the end of the reporting period

► It should be based on how the entity expects to recover or settle the

asset or liability.

► It cannot be discounted.

Example of “expects to recover or settle”

IAS 12 clarifies that where a non-depreciable asset is revalued, any

deferred tax on the revaluation should be calculated by reference to the

tax consequences that would arise if the asset was sold, on the basis

that the absence of any depreciation charge implies that the asset will

not be recovered through use.


Differences between SOCPA and IFRS


Differences between SOCPA and IFRS

► Difference in accounting

treatment depending on

nature of entities

► Deferred tax based on

income statement

approach

► Definition of temporary

differences only

► No elaborated rules on

deferred tax assets and

liability

► Consistent accounting

treatment of statement of

income

► Deferred tax based on

balance sheet approach

► Temporary differences are

further elaborated as

taxable and deductible

differences

► Separate rules for deferred

tax assets and liability

SOCPA IFRS


First time adoption IFRS 1 requirements


First time adoption issues

► The basic principle - financial statements should be restated as if IAS

12 had always been in force.

► In practice, it might be difficult to simulate the judgments that would

have been made at these earlier dates.

► Retrospective application is required.

► Deferred tax should be restated, based on conditions as they were

perceived at the time of the earlier financial statements

► Subsequent changes in tax rates should not be considered; only rates

that had been enacted at the time can be used.

► Estimates should be consistent with those that were made at the time

under previous GAAP, unless it can be shown that they were wrong at

the time.


IAS 12 disclosures


Disclosure requirements

Ordinary activites - The tax expense (or income) related to profit or loss from

ordinary activities (should be presented on the face of the income statement).

Equity related taxes - The aggregate current and deferred tax relating to items

charged or credited to equity.

Other comprehensive income - The amount of income tax relating to each

component of other comprehensive income.

Discontinued operations - The tax expense related to the gain or loss on

discontinuance and the results from ordinary activities of the discontinued

operation in each year presented

Tax expense and adjustments - The major components of tax expense, such

as current tax expense and adjustments to current tax of prior periods.

Temporary differences reversals - The deferred tax expense relating to the

origination or reversal of temporary differences and changes in tax rates or to the

imposition of new taxes


Disclosure requirements (continued)

► Analyse each of the major components of tax expense. The list is not

comprehensive but just example for the sake of training:

Reduction of taxes - The amount of benefit from a previously unrecognized tax loss, tax

credit or temporary difference of a prior period that is used to reduce either current or

deferred tax expense.

Write-down - The write-down (or its reversal) of a deferred tax asset.

Explanation of changes - A description of changes in the applicable tax rates compared to

the previous accounting period

Reconciliation - A numerical reconciliation between tax expense and the product of

accounting profit multiplied by the applicable tax rate(s); or a numerical reconciliation

between the average effective tax rate and the applicable tax rate(s).

Deductible temporary differences - The amount (and expiry date, if any) of deductible

temporary differences, unused tax losses, and unused tax credits for which no deferred tax

asset is recognised in the statement of financial position

Specific investments - The aggregate amount of temporary differences associated with

investments in subsidiaries, branches, associates, and joint arrangements, for which no

deferred tax liabilities have been recognised


More disclosures

Charged/credited to equity - The current and deferred tax relating to items that are

charged or credited to equity and the amount of income tax relating to each component of

other comprehensive income.

Statement of financial position - For each type of temporary difference, the amount of

the deferred tax assets and liabilities recognised in the statement of financial position (this

disclosure is also required for each type of unused tax losses and unused tax credits)

Statement of income - For each type of temporary difference, the amount of the deferred

tax income or expense recognized in profit or loss, if this information is not evident from the

movement in the statement of financial position amounts (this disclosure is also required for

each type of unused tax losses and unused tax credits)

Future taxable profits - The amount of a deferred tax asset and the nature of the

evidence supporting its recognition, when its utilization depends on future taxable profits

exceeding those arising from the reversal of existing taxable temporary differences, and the

entity has made a taxable loss in either the current or preceding period in the relevant tax

jurisdiction (this disclosure is required when deferred tax assets are recognized in reliance

on future accounting profits, despite the existence of recent losses).

Dividends - Any tax consequences of dividends proposed after the reporting date but not

provided for


More disclosures (continued)

Business combination – If a business combination in which the entity is the acquirer

causes a change in the amount recognized for its pre-acquisition deferred tax asset, the

amount of that change; and if the deferred tax benefits acquired in a business combination

are not recognized at the acquisition date but are recognized after the acquisition date, a

description of the event or change in circumstances that caused the deferred tax benefits to

be recognized.

Retained/distributed profits - When there are different tax consequences if profits are

retained or distributed, the nature of the potential tax consequences that would arise from a

payment of dividends to shareholders (this should quantify the amounts, when the

consequences are practicably determinable, or otherwise disclose whether there are any

consequences that are not practicably determinable).

Illustrative disclosures:


Amendment in SOCPA standard for zakat


Why change?!

► Saudi Arabia’s move towards IFRS reporting framework

from 2017

► 2017 for Listed entities and 2018 for others

► Under IFRS there is a Tax accounting standard (IAS 12)

but no Zakat standard

► SOCPA has amended its existing Zakat accounting

standard and formally adopted it on 19 September 2016


What’s new?

► Zakat expense for pertinent period shall be presented as a

separate item in the income statement

► Previously:

► 100% GCC owned entities – Zakat expense presented in the

statement of income

► Mixed entities – Zakat and income tax expense presented in the

statement of changes in equity

► The amended standard is applicable for financial periods

beginning from 1 January 2017


Basis of change

► SOCPA found difference in presentation of zakat, between

the 100% GCC owned entities and the mixed entities as

inconsistent with the legitimate Islamic advisories (Fatwa),

government directives and accounting principles, on the

following basis:

► A lot of Islamic advisories consider Zakat as an expense for the

entity.

► Some technical studies and related standards, conducted by

specialised boards, consider Zakat as an expense for the entity.

Quoted studies are of AAOIFI, Malaysian Accounting board and

IASB.

► In terms of regulations, the MCI has issued directives to

emphasize that zakat shall be taken from costs deductible from

gross profit to attain net profit rather than dividends.


SOCPA OPINION ON IMPACT OF ZAKAT AND INCOME TAX ON OWNERS’ EQUITY


Why opinion was issued

► For mixed entities, the owners may have the right to

decide internally to borne zakat or tax on individual basis

► Some of the owners in are not obligated to settle zakat.

Quoted examples are endowments and non-GCC

partners

► The question was raised to SOCPA, how to present the

impact of zakat and tax on owners’ equity.


Opinion

► An entity shall present the impact of zakat and income tax

on individual owners in the statement of changes in equity

► The entity shall disclose the following in the notes to the

financial statements:


Illustration of opinion

Example 1: Presentation and disclosure when Owners internally decide to

bear Zakat and Income tax expense

Assumptions:

Capital: SR 10 Million

Ownership: 50:50

Income before zakat and income tax: SR 1Million

Zakat on Saudi share: SR 80,000

Income tax on non-Saudi share: SR 100,000

10% of net profit is retained while 5% is distributed as dividends.

Statement of income

Saudi Riyals

Income before zakat and income tax 1,000,000

Zakat and income tax (note X) (180,000)

Net income for the period 820,000


Illustration of opinion (continued)


bear Zakat and Income tax expense (continued)

Note X to the financial statements

Statement of changes in equity

Elements of owners’ equity shall be classified into two categories according to

zakat or income tax as applicable. Net income, provisions and dividends of each

category shall be reflected in the proper fields of the table. The following is an

example of how to present statement of changes in equity for a mixed company

(format is variable according to elements of owners’ equity).

Total Saudi Foreigners

Income before Zakat and Income tax 1,000,000 500,000 500,000

Zakat (80,000) (80,000)

Income tax (100,000) (100,000)

Income after Zakat and Income tax 820,000 420,000 400,000




bear Zakat and Income tax expense (continued)

CapitalIncome Before Zakat and

Income tax

Zakat and

Income taxNet Income

Statutory Reserve (% of net

profit of each category of

owners)

Retained earnings

TotalSaudi

Share

Foreign

Share

Saudi

Share

Foreign

ShareTotal

Saudi

Share

Foreign

ShareTotal

Saudi

Portion

Foreign

PortionTotal

Saudi

Portion

Foreign

Portion

Balance

on 1

January

2015

10,000,000

Income

Before

Zakat/Tax

1,000,000 500,000 500,000 80,000 100,000 820,000 420,000 400,000 82,000 42,000 40,000 738,000 378,000 360,000

Dividends (500,000) (250,000) (250,000)

Balance

on 31 Dec

2015

10,000,000 82,000 42,000 40,000 238,000 128,000 110,000



Example 2: Presentation and disclosure when Owners do not internally

decide to bear Zakat and Income tax expense (i.e. mutually dividing net

profit after zakat/tax according to their ownership share)

Assumptions:

Capital: SR 10 Million

Ownership: 50:50

Income before zakat and income tax: SR 1Million

Zakat on Saudi share: SR 80,000

Income tax on non-Saudi share: SR 100,000

10% of net profit is retained while 5% is distributed as dividends.

Statement of income Saudi Riyals

Income before zakat and income tax 1,000,000

Zakat and income tax (note X) (180,000)

Net income for the period 820,000





profit after zakat/tax according to their ownership share) (Continued)

Note X to the financial statements

Statement of changes in equity

In this case, presentation of the statement is same as if the company is subject to

zakat only or income tax only. As such, no mutual decision by partners to bear

zakat or income tax. Therefore, the presentation is of a routine format as set out

below (format is variable according to elements of owners’ equity).

Total

Income before Zakat and Income tax 1,000,000

Zakat (80,000)

Income tax (100,000)

Income after Zakat and Income tax 820,000





profit after zakat/tax according to their ownership share) (Continued)

Capital

Statutory Reserve

(% of net profit)

Retained

earnings

Balance on 1 January 2015 10,000,000

Net income for the year 82,000 738,000

Dividends (500,000)

Balance on 31 December 2015 10,000,000 82,000 238,000


Questions?


Thank you

Questions & [email protected]

DisclaimerThe views expressed in this presentation are those of

the presenter. Official positions of the EY are determined only after extensive due process and deliberation.

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