IAS 12 Income Taxes: Accounting for Current and Deferred Tax

IAS 12, the IFRS standard on income taxes, tells you how to account for two things in your financial statements: the tax you owe or are owed for the current period, and the tax consequences that sit inside your balance sheet and will surface in future periods. It covers all domestic and foreign taxes based on taxable profits, including withholding taxes a subsidiary or associate pays on distributions to the reporting entity.¹ The guiding principle is that the tax effects of a transaction belong in the same period as the transaction itself.

Current Tax

Current tax is the income tax payable or recoverable on the taxable profit or loss of the current period. Unpaid amounts for the current or any prior period sit on the balance sheet as a liability. Any excess already paid sits as an asset.²

You measure current tax using rates and laws enacted or substantively enacted by the end of the reporting period. “Substantively enacted” matters where a government has announced a new rate and the remaining legislative steps are a formality; you use the new rate once its approval is effectively assured, not once the final signature lands.¹

Loss Carrybacks and Carryforwards

When a company reports a tax loss and local law allows it to carry that loss back and recover tax paid in an earlier year, IAS 12 requires the expected refund to be recognized as an asset immediately. The prior-year tax was actually paid and the law entitles the company to it back, so the benefit is treated as effectively certain.²

Carryforwards are treated more cautiously. Unused tax losses and credits can support a deferred tax asset only to the extent that future taxable profit is probable. A startup that has never produced a profit faces a much higher bar than an established company with a short downturn. At each reporting date, previously unrecognized losses must be reassessed and any newly probable amount brought onto the balance sheet.²

Temporary Differences: The Core of Deferred Tax

Almost everything else in IAS 12 flows from one comparison: the carrying amount of an asset or liability under normal accounting rules versus its tax base, meaning the amount the tax authority attributes to that same item. Where the two figures differ, you have a temporary difference, and that difference will eventually reverse and change how much tax you pay.

Taxable Temporary Differences

A taxable temporary difference will produce higher taxable income in a future period. The classic case is accelerated tax depreciation. A machine carries at 100,000 in the financial statements but has a tax base of 70,000 because the tax authority allowed faster write-offs. The 30,000 gap means the company has already claimed tax deductions it hasn’t yet matched with accounting expense. As the carrying amount is recovered through use or sale, taxable income will exceed accounting profit, and additional tax will fall due.

Deductible Temporary Differences

A deductible temporary difference works the other way: it will reduce taxable income in a future period. Warranty provisions are the textbook example. The company recognizes a 50,000 warranty liability, but the tax authority won’t allow a deduction until cash is actually spent. Carrying amount is 50,000; tax base is zero. When the repairs are paid for, the tax deduction will exceed the accounting expense in that period, lowering that period’s tax.

Recognizing Deferred Tax Liabilities

IAS 12 requires a deferred tax liability for virtually every taxable temporary difference. If the balance sheet already reflects transactions that will increase future tax payments, the standard’s view is that the obligation belongs on the balance sheet now.² Only a few narrow exceptions apply.

Goodwill

In many jurisdictions goodwill is not deductible for tax purposes, so its tax base is zero from day one. The gap between its carrying amount and zero is technically a taxable temporary difference, but IAS 12 prohibits recognizing a deferred tax liability on it. Goodwill is calculated as a residual in a business combination, and recognizing deferred tax on it would increase that residual, which would increase goodwill again, and so on. The standard cuts the loop by simply barring recognition. Any later impairment of goodwill still relates to that initial recognition and stays unrecognized. Where local tax law allows goodwill to be amortized for tax purposes and the tax base then changes over time, deferred tax on the subsequent movements is recognized.²

The Narrowed Initial Recognition Exception

IAS 12 has long exempted entities from recognizing deferred tax when an asset or liability was first recorded in a transaction that was not a business combination and affected neither accounting profit nor taxable profit. A 2021 amendment narrowed this exemption. Transactions that create equal and offsetting taxable and deductible temporary differences on initial recognition, such as leases (a right-of-use asset and a lease liability) and decommissioning obligations (a provision and a corresponding asset component), no longer qualify. Both a deferred tax asset and a deferred tax liability must be recognized from day one. The amendment took effect for reporting periods beginning on or after January 1, 2023.³

Recognizing Deferred Tax Assets

Deferred tax assets are treated more conservatively. An entity recognizes one only to the extent that it is probable future taxable profit will be available against which the deductible temporary difference, unused loss, or unused credit can be used. “Probable” under IFRS is generally read as more likely than not, meaning a greater than 50% chance the profit will materialize.²

This forces real discipline. If a company has 100,000 in deductible differences but can only demonstrate that 40,000 of future taxable profit is probable, the deferred tax asset is based on 40,000. The remaining 60,000 stays off the balance sheet until circumstances change.

At every reporting date, management reassesses both recognized and unrecognized amounts. A major long-term contract might now provide enough evidence to bring a previously unrecognized asset onto the balance sheet. If profitability prospects dim instead, the carrying amount of a recognized deferred tax asset must be written down. Auditors pay close attention here because the judgment is significant.

Measuring Deferred Tax

Deferred tax assets and liabilities are measured using the tax rates expected to apply when the asset is realized or the liability is settled, based on laws enacted or substantively enacted by the end of the reporting period. If legislation has raised the corporate rate from 20% to 24% starting next year, deferred taxes that will reverse next year are measured at 24%.²

No Discounting

One rule surprises people coming from other areas of financial reporting: deferred tax is never discounted to present value. A deferred tax liability that will not reverse for 15 years appears at the same nominal amount as one reversing next quarter. Discounting would require scheduling exactly when each temporary difference reverses, which the standard treats as impractical and too subjective to be reliable.

Expected Manner of Recovery

Measurement must reflect how the entity actually expects to recover or settle each item, because different recovery methods can attract different tax rates. Selling an asset might be taxed at a capital gains rate while using it produces deductions against income taxed at the ordinary rate. The entity applies the rate that matches its expected behavior.²

For investment property measured at fair value, IAS 12 sets a rebuttable presumption that the carrying amount will be recovered through sale. The tax rate applicable to disposal is used unless the entity can demonstrate the property will be recovered through use, for example by renting it out indefinitely. The presumption exists to reduce judgment and improve comparability across entities holding similar properties.⁴

Where the Tax Effect Is Recognized

Not all tax effects flow through profit or loss. IAS 12 requires the tax to follow the underlying transaction. Tax on an item recognized in other comprehensive income goes to other comprehensive income. Tax on an item recognized directly in equity goes to equity.² Common examples include revaluations of property, plant and equipment (other comprehensive income) and prior-period error corrections applied retrospectively (retained earnings). Tax effects arising from business combinations receive their own treatment and do not pass through profit or loss.

Share-Based Payments

When employees are paid in shares or options, the tax authority may allow a deduction based on the share price at exercise rather than the accounting expense recognized over the vesting period. That creates a deductible temporary difference whose value moves with the share price. Under IAS 12, the deferred tax asset is measured using the share price at the reporting date when the future deduction depends on that price.⁵

Where the tax deduction exceeds the cumulative accounting expense, the excess tax benefit is recognized directly in equity, on the basis that it relates to the equity instrument rather than to employee compensation. If the tax deduction is less than or equal to the cumulative expense, the entire tax effect stays in profit or loss.⁵

Dividends

Some tax jurisdictions apply different tax consequences depending on whether profits are distributed or retained. IAS 12 requires entities to recognize the income tax effects of dividends when the liability to pay the dividend is recognized, not when it is declared or proposed. The tax follows the same recognition path as the profits that produced the dividend: profits originally recorded in profit or loss carry their tax to profit or loss. Withholding tax paid to authorities on behalf of shareholders is charged directly to equity as part of the dividend.²

Uncertain Tax Treatments

IFRIC 23, effective since January 1, 2019, fills a gap IAS 12 left open: how to measure your tax position when you are not sure the tax authority will agree with it.⁶

The starting assumption is aggressive. IFRIC 23 requires you to assume the tax authority will examine the position and will have full knowledge of all relevant information. No detection risk discount. From there, ask whether it is probable the authority will accept your treatment. If yes, measure tax consistently with what you filed. If not, measure the uncertainty using whichever method better predicts the outcome: the most likely amount, which suits binary situations, or the expected value, which suits a range of possible outcomes.⁶

Judgments and estimates must be reassessed when facts change or new information appears, and the effect of any change is treated as a change in accounting estimate under IAS 8.⁶

Presentation and Offsetting

Tax items sit separately from other balance-sheet lines. Current tax appears with current assets or current liabilities. Deferred tax is classified as non-current. The tax expense or income related to ordinary activities appears in the statement of profit or loss and other comprehensive income.²

A current tax asset can be offset against a current tax liability only when the entity has a legally enforceable right to set off the amounts and intends either to settle on a net basis or to realize the asset and settle the liability at the same time. In practice, that means the taxes must be levied by the same authority on the same taxable entity.

Deferred tax offsetting works on similar principles and extends slightly further. Deferred tax assets can be offset against deferred tax liabilities only where the entity has a legally enforceable right to offset current tax amounts and the deferred items relate to taxes levied by the same authority on either the same entity or different entities that intend to settle on a net basis in each future period where significant deferred tax amounts are expected to reverse.² Netting amounts that shouldn’t be netted overstates liquidity; failing to offset when permitted clutters the balance sheet.

Disclosures

IAS 12 requires substantial transparency, designed to let readers see why the tax charge differs from what accounting profit multiplied by the headline rate would suggest.

The centerpiece is the tax rate reconciliation: a numerical reconciliation between the tax expense and the product of accounting profit and the applicable tax rate, with the applicable rate disclosed and explained. The reconciliation breaks out items such as non-deductible expenses, the effect of rate changes on opening deferred tax balances, and income taxed at different rates.²

Beyond the reconciliation, entities must disclose the amount and any expiry date of deductible temporary differences, unused tax losses, and unused tax credits for which no deferred tax asset has been recognized. Where a recognized deferred tax asset depends on future profits beyond existing taxable temporary differences and the entity has recently reported a loss in that jurisdiction, the supporting evidence for recognition must be explained. Entities also disclose the aggregate temporary differences associated with investments in subsidiaries, branches, associates, and joint arrangements where no deferred tax liability has been recognized, along with deferred tax balances by type of temporary difference and by unused loss or credit, the tax expense relating to discontinued operations, and the income tax effects of dividends proposed or declared after the reporting period but before the financial statements were authorized for issue.²

Recent Amendments

Two recent changes matter most for current reporting.

Single Transaction Amendment

Before the 2021 amendment described earlier, the initial recognition exception meant that many entities did not recognize deferred tax on lease liabilities and right-of-use assets or on decommissioning provisions and their corresponding assets, and practice varied widely. The amendment removed the exception for transactions where equal taxable and deductible temporary differences arise simultaneously, requiring both a deferred tax asset and liability from the start. Entities transitioning to the new rule recognized the cumulative effect as an adjustment to retained earnings at the beginning of the earliest comparative period presented. It took effect for reporting periods beginning on or after January 1, 2023.³

Pillar Two

The OECD’s Pillar Two framework introduced a global minimum tax of 15% for large multinational groups. In May 2023, the IASB amended IAS 12 to introduce a mandatory temporary exception: entities do not recognize deferred tax assets or liabilities arising from Pillar Two income taxes. The complexity of the calculations and the still-evolving state of national implementing legislation made normal deferred tax treatment impractical. Targeted disclosures were added so users of financial statements can still understand an entity’s exposure to Pillar Two taxes.¹

Other changes worth flagging include a 2016 amendment clarifying deferred tax recognition for unrealized losses on debt instruments measured at fair value and a December 2010 amendment addressing investment properties measured at fair value. IFRS 18, issued in April 2024, also makes consequential amendments to IAS 12’s presentation requirements that entities will need to integrate as that standard takes effect.¹

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IFRS Foundation. IAS 12 Income Taxes
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IFRS Foundation. IAS 12 Income Taxes
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IFRS Foundation. IAS 12 Income Taxes
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IFRS Foundation. IAS 12 Rebuttable Presumption – Manner of Recovery of Investment Property
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IFRS Foundation. IAS 12 Income Taxes
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IFRS Foundation. IFRIC 23 Uncertainty over Income Tax Treatments