Deferred taxes related to foreign interest – what you should consider under IAS 12

These consequences are:

• The existence of undistributed profits of subsidiaries, branches, associates and joint ventures;
• Differences in foreign exchange rates when a parent and its subsidiary are based in different countries; and
• A reduction in the book value of an investment (the application of the accounting method of fair value under IFRS 9 may result in a reduction of the book value of an investment)

From an International Financial Reporting Standards (IFRS) perspective, particularly International Accounting Standard (IAS)-12 – Income Taxes -, these items may cause a difference between the book value (either individual or consolidated) of the investment and its tax base (typically the original cost of the equity).

This temporary difference is known as outside basis and is given in the tax jurisdiction of the parent company, for example, in case of having a distribution of profits from a foreign investment, a tax liability should arise for the parent entity.

Even so, IAS -12 includes some cases by which the tax liability may not be recognised by the parent entity when:

• the parent or investor is able to control the timing of the reversal of the temporary difference; and
• it is probable that the temporary difference will not be reversed in the near future.

In this regard, a detailed analysis is required by all consolidation levels in a group to conclude if the parent entity must recognise a tax liability for outside basis in its financial statements.

Taking this into account, different perspectives may be found between US-GAAP [Generally Accepted Accounting Principles] and IFRS when the outside basis is analysed. For instance:

From a US-GAAP perspective, the outside basis is focused on undistributed profits, and the only exception to recognising a deferred tax liability in the parent company is to demonstrate a higher income tax rate in the foreign country where the subsidiary (which distributes the profit) is located. A full tax credit for the income tax paid abroad may be applied by the parent company therefore.

From an IFRS perspective a deeper analysis must be done to conclude if the outside basis may cause a deferred tax asset or a deferred tax liability. Some items under analysis are, in the case of a deferred tax liability to demonstrate:

• that the parent company has effective control of the dividends policy upon the subsidiaries; and
• the dividends will not be distributed in the foreseeable future.

In the case of a deferred tax asset:

• to demonstrate http://bit.ly/15sL2oFenough taxable income in future years.

In the case of having a deferred tax asset related to outside temporary differences, further analysis must be done to come to a conclusion regarding its recognition in the financial statements. This analysis includes basically the ability of the parent entity to generate future taxable income.

Lessons

• The outside basis conclusion may be different from a US-GAAP perspective concerning IFRS –IAS-12.
• This analysis should be made from bottom to top of all consolidation levels to have full documentation regarding foreign interest, including full control in the parent company upon undistributed dividends in all subsidiaries, and joint ventures.

José Abraján (jose.abrajan@mx.ey.com), Senior Manager – Tax Accounting, EY Mexico

Guadalupe García (guadalupe.garcia@mx.ey.com), Senior – Tax Accounting, EY Mexico

Gustavo Gómez (gustavo.gomez@mx.ey.com), Partner – Corporate Taxes, EY Mexico

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