IAS 12 Fair Value Adjustments

7 Fair Value Adjustments

Differences arising from fair value adjustments, whether on acquisition or otherwise, are treated the same as any other taxable and deductible differences.

In simple terms, sales generally generate a tax charge. Revaluations (fair value adjustments) generate a deferred tax charge (an accrual for tax).

Differences arising from fair value adjustments examples:

EXAMPLE - Fair Value Adjustments i) financial instruments are carried at fair value, but no matching revaluation may be made for tax purposes.
	I/B	DR	CR
Financial instrument	B	100
Gain – fair value adjustment	I		100
Tax expense (deferred tax) @ 24%	I	24
Deferred tax liability	B		24
Revaluation of financial instrument

EXAMPLE - Deferred tax on available-for-sale equity investments An entity holds an available-for-sale investment, ie, shares in a listed company. The tax base of the shares is £500, which was the amount initially paid for the shares. The fair value of the shares at the year end is £1,000. At the balance sheet date, the entity expects to sell the shares in five years and receive dividends of £500 during this five-year period. Dividends are not expected to impair the carrying amount of the investment when paid. Dividends are non-taxable. Based on the current tax legislation, if the shares were sold after five years, capital gains tax at a rate of 10% would be payable on the excess of sales price over cost. How much deferred tax (if any) should the entity recognise at the balance sheet date? The principle in IAS 12 is that an entity should recognise deferred tax based on the expected manner of recovery of an asset or liability at the balance sheet date. The dividends are expected to be derived from the investee’s future earnings rather than from its existing resources at the balance sheet date. Given that there is no impairment expectation arising from the dividends, the entity does not expect the carrying amount at the balance sheet date to be recovered through future dividends but rather through sale. This is important since the expected manner of recovery will determine the deferred tax treatment. The carrying amount of £1,000 has a corresponding tax base of £500 on sale. There is a taxable temporary difference of £500 at the balance sheet date. The applicable tax rate is the capital gains rate of 10%. The entity should recognise a deferred tax liability of £50 relating to the shares.

EXAMPLE - Fair Value Adjustments  ii) revaluation of property, plant and equipment (IAS 16) to fair value, but no adjustment for is allowed for tax purposes.
	I/B	DR	CR
Revaluation of property, plant and equipment	B	700
Revaluation reserve-equity	B		700
Tax expense (deferred tax) @ 24% charged to equity	B	168
Deferred tax liability	B		168
Revaluation of property