The general principle in IAS 12 is that entities should measure deferred tax using the tax bases and tax rates that are consistent with the manner in which the entity expects to recover or settle the carrying amount of the item. For assets, the carrying amount of an asset is normally recovered through use, or sale, or use and sale. The distinction between recovery through use and sale is important since, in some jurisdictions, different rates might apply for income (recovery through use) and capital gains (recovery through sale). However, for investment property carried at fair value, there is a rebuttable presumption that recovery will be entirely through sale, even where the entity earns rentals from the property prior to its sale. [IAS 12 para 51C].
In order to rebut this presumption, investment property must be depreciable and held as part of a business model whose objective is to consume substantially all of the economic benefits embodied in the property through use over time. An investment property might not qualify for tax depreciation, and no part of the property’s cost is deductible against taxable rental income. Instead, the cost of the property (uplifted by an allowance for inflation, where applicable) is allowed as a deduction against sales proceeds for the purpose of computing any taxable gain arising on sale. [IAS 12 para 51C].
Deferred tax for investment properties carried at fair value should generally be measured using the tax base and rate that are consistent with recovery entirely through sale, and using capital gains tax rules (or other rules regarding the tax consequences of sale, such as rules designed to claw back any tax depreciation previously claimed in respect of the asset). If the presumption is rebutted, deferred tax should be measured reflecting the tax consequences of the expected manner of recovery.
The presumption also applies where investment property is acquired in a business combination and the acquirer later uses fair value to measure the investment property. [IAS 12 para 51D].
The freehold land component of an investment property can be recovered only through sale.
Example – Deferred tax on investment property at fair value: clawback of tax depreciation and 0% capital gains tax | |
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Background At 31 December 20X3, the fair value of the investment property is C120. The tax written-down value is C88 (that is, the accumulated tax depreciation is C12). The tax legislation in jurisdiction X is as follows:
What would the deferred tax liability be in each of the following scenarios?
Solution
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C | |
At 31 December 20X3 | |
Carrying amount at fair value | 120 |
Tax base | (88) |
Taxable temporary difference | 32 |
Clawback of tax depreciation below cost (C100-C88 =C12 at 30%) | 3.60 |
Fair value in excess of cost (C120 = C100 =C20) at 0% | |
Deferred tax liability | 3.60 |
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C | |
At 31 December 20X3 | |
Carrying amount at fair value | 120 |
Tax base | (88) |
Taxable temporary difference | 32 |
Deferred tax liability at 30% | 9.60 |
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Example – Deferred tax on investment property at fair value: clawback of tax depreciation and capital gains tax | |||
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Background The tax legislation in jurisdiction Y is as follows:
What would the deferred tax liability be in each of the following scenarios?
Solution
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Taxable (deductible) temporary difference | Tax rate | DTL/(DTA) | |
Tax depreciation clawback | 40 | 30% | 12 |
Capital losses (fair valueof C50less purchase priceof C100) | (50) | 15% | (7.50) |
The tax relief on capital losses can only be utilised if there are sufficient capital gains to offset the loss. As such, the deferred tax asset can only be recognised if the criteria in paragraph 24 of IAS 12 are met. Note that, in line with paragraph 74 of IAS 12, the deferred tax liability and deferred tax asset cannot be offset in this case, since jurisdiction Y only allows capital losses to be offset against capital gains.
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Example – Deferred tax on investment property at fair value: no tax depreciation with capital gains tax |
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Background Management expects to use the property for 10 years, to generate rental income, and to dispose of the property at the end of year 10. The property’s residual value at the end of 10 years is estimated to be C20. The fair value of the property is C60 at 31 December 20X0. The tax legislation in jurisdiction Z is as follows:
What is the deferred tax liability on initial recognition and at the end of year 1? Solution At the end of year 1, the fair value of the investment property has increased to C60, with no change in the tax base on disposal. There is a taxable temporary difference of C10. Entity C would recognise a deferred tax liability of C4 (C10 × 40%) at the end of year 1. |
