In certain countries, the tax rate applied to a company’s tax return reporting i
ID: 2408551 • Letter: I
Question
In certain countries, the tax rate applied to a company’s tax return reporting income depends upon whether the profits for the period are distributed or undistributed. Amounts are initially taxed at the higher rate, but a tax credit is received when the profits are distributed. Therefore, companies need to determine the rate (distributed vs. the undistributed tax rate).
Global Multinational Corporation (Global) is a U.S. company that owns and operates 100% of a consolidated subsidiary in a foreign jurisdiction where income taxes are payable at a higher rate on undistributed profits than on distributed earnings. For the year ending December 31, Year 1, Global’s foreign subsidiaries taxable income is $150,000. Global’s foreign subsidiary also has net taxable temporary differences amounting to $50,000 for the year, thus creating the need for a deferred tax liability on the balance sheet. The tax rate on distributed profits is 40%, and the tax rate on undistributed profits is 50%; the difference results in a credit if profits are distributed in the future. At the date of the balance sheet, no distributions have been proposed or declared. On March 31, Year 2, Global’s foreign consolidated subsidiary distributes dividends of $75,000.
Instructions:
Obtain and review the accounting and related measurement guidance related to anticipated tax credits in IAS12, Income Taxes, and in Sections 25 and 30 of ASC740-10, Income Taxes-Overall. Document the relevant portions of the IFRS and US GAAP related to the accounting that Global must follow for the above series of transactions.
Provide the required journal entries for both Year 1 and Year 2 under both the US GAAP and IFRS for each respective date where you are provided information in the above scenario. In your explanation for each journal entry, make sure you document the basis for each journal entry amount. In other words, how did you obtain the figures? In addition, provide a detailed explanation for each respective journal entry with the appropriate Reference(s) to IAS12 and ASC 740-10, respectively.
Explanation / Answer
Under U.S. GAAP, ASC 740 is the primary source of guidance on accounting for income taxes.
Under IFRSs, IAS 12, Income Taxes, is the primary source of guidance on accounting for income taxes.
In general, the income tax accounting frameworks under both U.S. GAAP and IFRSs consist of the same basic principle concerning the basis of deferred tax assets and liabilities: the recognition of temporary differences between the carrying amount and tax basis of assets and liabilities in the financial statements.
The table below summarizes these differences and is followed by a detailed explanation of each difference.1
Subject U.S. GAAP IFRSs
Classification of deferred tax assets and liabilities Classification is split between current and noncurrent components on the basis of either (1) the underlying asset or liability or (2) the expected reversal of items not related to an asset or liability. There is no split between current and noncurrent. All deferred tax assets and liabilities are classified as noncurrent.
Recognition of deferred tax assets Deferred tax assets are recognized in full and then reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be recognized. No valuation allowance concerning deferred tax assets. Deferred tax assets are only recognized if it is probable (more likely than not) that they will be used.
Tax rate for measuring deferred tax assets and liabilities Enacted tax rates are used. Enacted or "substantively" enacted tax rates are used.
Uncertain tax positions ASC 740 prescribes a two-step recognition and measurement approach to determining the amount of tax benefit to recognize in the financial statements. IAS 12 does not specifically address the accounting for tax uncertainties. The recognition and measurement provisions of IAS 37 are relevant because an uncertain tax position may give rise to a liability of uncertain timing and amount. Recognition is based on whether it is probable that an outflow of economic resources will occur. Probable is defined as more likely than not. Measurement is based on the entity's best estimate of the amount of the tax benefit.
Tax consequences of intercompany sales Tax expense from intercompany sales is deferred until the related asset is sold or disposed of, and no deferred taxes are recognized for the purchaser's change in tax basis. Tax expense from intercompany sales is recognized, and the buyer's tax rate is used to recognize deferred taxes for the change in tax basis.
Deferred taxes on foreign nonmonetary assets/liabilities remeasured from local currency to functional currency No deferred tax is recognized on the remeasurement from local currency to functional currency. Deferred tax is recognized on the remeasurement from local currency to functional currency.
Other exceptions to the basic principle that deferred tax is recognized for all temporary differences
(1) Leveraged lease exemption — no deferred tax is recognized under ASC 740. See ASC 840-30 for information about the tax consequences of leveraged leases.
(2) No similar exception under U.S. GAAP.
(1) No similar exception under IFRSs.
(2) "Initial recognition" exemption — deferred tax is not recognized for taxable or deductible temporary differences that arise from the initial recognition of an asset or liability in a transaction that (a) is not a business combination and (b) at the time of the transaction does not affect accounting profit or taxable profit. Changes in this unrecognized deferred tax asset or liability are not subsequently recognized.
Special deductions (special deductions provide tax benefits under specific tax jurisdictions for unique indus
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