An entity must analyze the deferred tax in the investment property from two perspectives:
The first perspective is presented when the company can’t measure the fair value in the subsequent measurement of an investment property reliably.
Therefore, the entity chooses the cost model as its accounting policy.
And the other perspective occurs when an entity can reliably determine fair value on subsequent measurement of an investment property.
Deferred tax when fair value cannot be reliably estimated.
IAS 40, specifically in paragraph 30, establishes that when an entity cannot reliably measure the fair value of an investment property, it must use the cost model.
Now, what does it mean that an entity chooses the cost model?
The choice of the cost model or the fair value model may imply a significant change in the calculation of the deferred tax.
Before explaining theoretically and with a practical example the repercussions of deferred tax on investment properties using the cost model, it is essential to define what deferred tax is.
Deferred tax is the value that an entity expects to recover in the future due to the temporary differences arising between an accounting base and a tax base.
When we refer to the use of the cost model, we refer to the temporary differences presented between the accounting base and the tax base of an investment property due to the use of different useful lives tax and accounting.
For example, an entity acquires a warehouse to lease to third parties.
The entity cannot reliably measure the asset’s fair value.
Therefore, the entity chooses the cost model as its accounting policy and depreciates the asset based on a useful accounting life of 50 years, according to IAS 16.
On the other hand, the maximum tax period that an entity can depreciate an investment property is 30 years in the company’s jurisdiction.
As the years go by, the accounting carrying amount and the tax carrying amount will be different.
This results in a temporary difference that causes a deferred tax.
It is essential to say that from an accounting point of view, investment properties are not depreciated as long as the entity can reliably measure the fair value; however, this is not the case.
Practical example 1: Tax deferred investment properties:
In year 1, an entity acquires a warehouse for 1,000,000, with a useful life of 50 years.
The company uses this asset to obtain income as an operating lease.
The entity cannot reliably establish the fair value of the investment property and therefore chooses the cost model as its accounting policy for subsequent measurement.
Under the tax regulations in the jurisdiction where the entity operates, buildings are depreciated based on a useful life of 30 years.
The current tax rate for year 1 is 34%, while for year 2, it is 42%.
The profit and loss statement from the accounting and tax point of view is shown below:
As you can see, the fiscal income statement is different from the income statement in IFRS.
This difference occurs because the useful life calculated to obtain fiscal depreciation is different from the one calculated for accounting effects.
The deferred tax calculation is shown below:
The calculation of the carrying amount for year one is obtained by dividing the historical cost of the asset over a useful life of 50 years.
This results in a monthly depreciation of 20,000, which means an accounting carrying amount for year 1 of 980,000.
In the same way, the same procedure is carried out for tax purposes.
But based on a useful life of 30 years.
This is equivalent to a monthly depreciation of 33,000 and a carrying amount of 966,667.
Therefore, the temporary difference for year 1 is 13,333.
That is, a deferred tax liability of 4,533 (13,333 * 34%).
Remember that if the accounting base is greater than the tax base, it is a temporary taxable difference, and it must be accounted for as a liability.
However, if, on the contrary, the accounting base is less than the tax base, it is a temporary deductible difference, and it should be accounted for as an asset.
For year 2, the temporary difference is 26,667.
This is equivalent to a deferred tax liability of 11,200.
To determine the deferred tax expense in year 2, we must deduct the initial balance of the liability recognized in year 1.
This results in a deferred tax expense in year 2 of 6,667 (11,200 – 4,553).
The reconciliation of the deferred tax is as follows.
In this way, the reconciliation begins with the current fiscal tax expense for years 1 and 2.
The entity must add the expense for temporary differences for each year to this value.
That is, for year 1, the tax expense deferred is 13,333 (x34 %) = 4,533 and for year 2 it is the difference between the deferred tax between years 1 and 2, better said: 11,200 – 4,533 = 6,667.
On the other hand, within the reconciliation, it’s necessary to consider the increase in the tax rate from 34% to 42%
This effect is calculated based on the temporary difference from the previous year.
In other words, 13,333 multiplied by the difference between the tax rates from one year to another, which is equivalent to 8% (42% – 34%)
This operation results in an income due to an increase in the tax rate equal to 1,067.
In summary, the tax expense of 36,400, plus the expense of the period of 6,667, less the adjustment for the increase in rates of 1,067, should be equal to the expense for accounting income tax (100,000 * 42%) = 42,000.
Calculation of the effective tax rate:
It’s necessary to start from the tax rate applied each year.
To this percentage, you must add the tax effect of the expenses that are not deductible to calculate the taxable profit.
In this example, there are no such expenses.
On the other side, we must also deduct the increase in the rate from one year to another.
The sum of the items mentioned above must equal the effective rate.
The effective rate is determined using the following formula:
Effective rate: Current tax + deferred tax / Accounting profit
Then, for year 1, the effective rate is 34% of current tax + the expenses that are not deductible when calculating the taxable profit, equal to zero.
And the effect on the increase in the rate is also zero for year 1.
This results in an effective tax rate of 34%.
This percentage must equal to the current tax of (29,467 + 4,533) / 100,000 = 34%.
We repeat the same procedure for year 2 as follows:
Applicable tax rate of 42% plus expenses that are not deductible and the effect of the tax rate increase in both years.
In this way, the tax rate of 42%, the expenses that are not deductible when calculating the taxable profit equal to zero, plus the effect of the increase in the rate equivalent to 1.1% (1,067 / 100,000) is equal to 43.07%.
To check this operation the effective rate percentage of 43.07% must be equal to (36,400 + 6,667) / 100,000 = 43.07%
Deferred tax when the fair value can be reliably estimated.
The other scenario related to deferred tax on investment properties occurs when an entity can measure the fair value reliably of these assets.
In most jurisdictions, the increase in the fair value of an investment property is not taken into account in calculating the tax base of these assets.
In this second scenario, under the tax regulations, the temporary differences will arise as a consequence of the difference between the tax base and the accounting base product of the depreciation and the valuations of the assets; let’s look at the following practical example.
Practical example 2: Tax deferred investment properties:
An entity acquires a building for 1,000,000.
Its useful fiscal life is 30 years, and the company maintains the asset to obtain capital gains.
At the end of year 1, the fair value of the investment property is 1,300,000, and in year 2, the fair value is 1,500,000.
The tax rate for year 1 is 34%, and for year 2, it is 43%.
The fiscal and accounting income statement is shown below:
Under paragraph 35 of IAS 40, should recognize changes in fair value in profit and loss.
The deferred tax calculation is as follows:
The reconciliation of the deferred tax and the reconciliation of the effective rate is as follows.