Illustrative examples (INT1052_06-05_COMPdec21_01-22)

These examples are a simplified illustration of the ongoing tax consolidation accounting required by the Interpretation, both with and without a tax funding arrangement between the entities.  Other methods may equally comply with the requirements of the Interpretation.  For simplicity, the examples assume that all current and deferred tax amounts are recognised as part of tax expense (income).  Paragraph 58 of Accounting Standard AASB 112 Income Taxes may require the recognition of tax amounts directly in equity or as part of the initial accounting for a business combination.

Any contribution by the head entity to a subsidiary upon assuming the subsidiary’s current tax liability and tax losses/credits is recognised in the example journal entries by the head entity as “investment in subsidiary” and by the subsidiary as “other contributed equity”.  This is illustrative only as the Interpretation does not prescribe which accounts are to be adjusted for tax-consolidation contributions by or distributions to equity participants.  Similarly, the treatment of a distribution by the subsidiary to the head entity in Example 4 is only illustrative.

The journal entries shown in the examples include the usual consolidation eliminations, such as inter-entity receivables and payables and equity contributions and investments.  The group outcome shown in the examples reflects only tax relating to the subsidiary or subsidiaries.  The examples do not illustrate taxes recognised by the head entity in relation to its own transactions, events and balances.

In this example, no tax funding arrangements have been established and there are no transactions between entities in the tax-consolidated group. The subsidiary’s initial tax accounting is based on a systematic and rational method consistent with the broad principles of AASB 112, as required by the Interpretation. For the purpose of this simple illustration of specific tax consolidation adjustments, it is not necessary to identify the specific method adopted for the initial recognition of income taxes for the period by the subsidiary.

In this case there are no transactions between entities in the tax-consolidated group, other than those required under a tax funding arrangement. The journal entries illustrate a tax funding arrangement under which the intercompany charge equals the current tax liability of the subsidiary, resulting in neither a contribution by the head entity to the subsidiary nor a distribution by the subsidiary to the head entity.

In this case there are no transactions between entities in the tax-consolidated group, other than those required under a tax funding arrangement. The journal entries illustrate a tax funding arrangement under which the intercompany charge is less than the current tax liability of the subsidiary, resulting in a contribution by the head entity to the subsidiary.

If the intercompany charge under the tax funding arrangement instead exceeded the subsidiary’s current tax liability, the excess would be a distribution by the subsidiary to the head entity.

The subsidiary in this example has incurred unused tax losses of $100,000 during the reporting period.  The head entity expects to recover the tax losses in full.  Based on the “stand-alone taxpayer” income tax recognition method adopted by the subsidiary, it has no current tax liability but initially recognises a deferred tax asset of $18,000 arising from these losses ($60,000 losses × tax rate 30%); that is, only part of the potential tax loss asset can be recognised by the subsidiary in its particular circumstances.  There is no tax funding arrangement between the entities, resulting in a distribution by the subsidiary to the head entity.

The consolidation adjustment above is in generic terms, and in practice would reflect the accounts in which the distribution was recognised.  For example, if the subsidiary recognised the distribution to the head entity as a reduction in retained earnings, and the head entity recognised the distribution as revenue, then the consolidation adjustment would reverse those entries to give the results from the group’s perspective.  As another example, the distribution may have been recognised by the subsidiary as a reduction in reserves and by the head entity as a reduction in its investment account.  The consolidation adjustment then would reverse those entries.  The accounting adopted for the distribution does not affect the group tax outcome.

In future reporting periods, the subsidiary’s measurement of current and deferred taxes does not take into account the $40,000 of unused tax losses remaining from the $100,000 tax loss.  As the tax loss is assumed by the head entity at the end of the period, it is then regarded as no longer available to the subsidiary.  The subsidiary’s accounting is also unaffected if the head entity is required in a later period to derecognise part or all of its tax-loss deferred tax asset due to the recognition requirements in AASB 112 ceasing to be met.

The subsidiary in this example has incurred unused tax losses of $100,000 during the reporting period.  The head entity expects to recover the tax losses in full.  Based on the “stand-alone taxpayer” income tax recognition method adopted by the subsidiary, it has no current tax liability but initially recognises a deferred tax asset of $18,000 arising from these losses ($60,000 losses × tax rate 30%); that is, only part of the potential tax loss asset can be recognised by the subsidiary in its particular circumstances.  The tax funding arrangement with the head entity is based on the subsidiary’s current tax liability (asset) and the tax losses that the head entity expects to recover.

In this scenario, the head entity recognises a contribution to the subsidiary as it will pay more under the tax funding arrangement for the assumption of tax losses than the subsidiary can recognise initially as a deferred tax asset.  The head entity then also recognises the additional deferred tax asset, as appropriate in relation to the tax position of the tax-consolidated group, giving rise to tax income for the head entity.  The outcome is that the group recognises tax income of $30,000 arising in relation to the subsidiary.  This comprises the tax income of $18,000 initially recognised by the subsidiary, adjusted for the additional $12,000 deferred tax asset relating to the subsidiary’s losses that is recognised by the head entity.

As in Example 4, in future reporting periods the subsidiary’s measurement of current and deferred taxes does not take into account the $40,000 of unused tax losses remaining from the $100,000 tax loss.  As the tax loss is assumed by the head entity at the end of the period, it is then regarded as no longer available to the subsidiary.  The subsidiary’s accounting is also unaffected if the head entity is required in a later period to derecognise part or all of its tax-loss deferred tax asset due to the recognition requirements in AASB 112 ceasing to be met.

The subsidiary in this example has incurred unused tax losses of $100,000 during the reporting period.  The head entity expects to recover the tax losses in full.  Based on the “separate taxpayer within group” income tax recognition method adopted by the subsidiary, it has no current tax liability and initially recognises a deferred tax asset of $30,000 arising from these losses ($100,000 losses × tax rate 30%); that is, the whole of the potential tax loss asset is recognised by the subsidiary.  This is so even if in its own circumstances the subsidiary expected to recover only $60,000 of the tax losses.  The tax funding arrangement with the head entity is based on the subsidiary’s current tax liability (asset) and the tax-loss deferred tax asset recognised by the subsidiary.

No contribution by or distribution to equity participants is recognised in this case as the tax funding arrangement amount equals the tax amounts recognised by the subsidiary that are assumed by the head entity.  Despite the application of a different method for the initial recognition of income tax by the subsidiary, and a different basis for the tax funding arrangement between the entities, the group outcome is the same as in Examples 4 and 5.

As in Examples 4 and 5, if the subsidiary in this case had not been able to recognise a deferred tax asset in relation to all of its tax losses arising during the reporting period, in future periods the subsidiary’s measurement of current and deferred taxes would not take into account the remaining unused tax losses.  As the tax loss is assumed by the head entity at the end of the period, it is then regarded as no longer available to the subsidiary.  The subsidiary’s accounting is also unaffected if the head entity is required in a later period to derecognise part or all of its tax-loss deferred tax asset due to the recognition requirements in AASB 112 ceasing to be met.

In this example the head entity H has two subsidiaries A and B in the tax-consolidated group.  The subsidiaries measure tax amounts for their separate financial statements on a “stand-alone taxpayer” basis, as allowed by the Interpretation.  There is no tax funding arrangement between the entities.  In year 1, subsidiary A sells inventory purchased for $1,000 from an external party to subsidiary B for $1,500 cash.  By the end of year 1, subsidiary B has not sold the inventory outside the group.  In year 2, subsidiary B sells the inventory to a party outside the group for $1,800 cash.

Subsidiary A recognises tax expense of $150 (profit of $500 × tax rate 30%) in relation to its sale of inventory to subsidiary B, even though the transaction is ignored under the tax consolidation system as it is a transaction between entities in the tax-consolidated group.  Subsidiary B recognises no tax as it has not yet sold the inventory purchased from subsidiary A, and the taxable temporary difference for its inventory (carrying amount of $1,500 but tax base of $1,000) is not recognised under the AASB 112 exception concerning the initial recognition of an asset or liability in certain circumstances.  The head entity and the group recognise no tax in relation to subsidiary A’s profitable sale, since no external sale has occurred.  The relevant journal entries:

The second consolidation adjustment journal entry eliminates the $150 recognised by subsidiary A as a contribution by the head entity via an adjustment of tax expense (income), since the head entity has not recognised any tax-related contribution to the subsidiary.  The outcome is that the group does not recognise any tax expense in relation to subsidiary A (or B) or any equity contributions between the subsidiaries and the head entity.  (The inventory is recognised at $1,000 by the group.)

Subsidiary B sells the inventory in year 2 for a profit of $300, realising a profit for the group of $800.  As an external sale has occurred, this profit is assessable to the head entity in relation to the tax-consolidated group.  Subsidiaries A and B continue to recognise their own tax balances based on the stand-alone taxpayer method.  There are no entries for subsidiary A in year 2 relating to the inventory.  The journal entries for the other entities in the group:

In this case, subsidiary B recognises a tax expense of $240 even though its accounting profit on the sale of the inventory is only $300.  This is because the tax base of the inventory from the perspective of the group is $1,000, being the original cost to subsidiary A when purchased from an external party.  Even under the stand-alone taxpayer approach to measuring the subsidiary’s taxes, tax values are based on those of the tax-consolidated group, as no other tax values are available.  The tax expense of $240 recognised by subsidiary B in year 2 is not divided between the various subsidiaries that held the inventory within the group.  Subsidiary A’s tax expense of $150 in year 1 (which was eliminated on consolidation) is not revised.

If there was a tax funding arrangement between the entities, the intercompany amounts arising under the arrangement would affect the amounts recognised as equity contributions or distributions.  A tax funding arrangement does not alter the tax expense (income) recognised by an entity.

The facts are the same as set out in Example 7 (see paragraph IE17), except that the subsidiaries A and B measure tax amounts for their separate financial statements on a “separate taxpayer within group” basis, as allowed by the Interpretation.  Thus, in this example there is no tax funding arrangement between the entities; in year 1, subsidiary A sells inventory costing $1,000 to subsidiary B for $1,500 cash; and in year 2, subsidiary B sells that inventory to a party outside the group for $1,800 cash.

Subsidiary A does not recognise any tax expense in relation to its sale of inventory to subsidiary B, since the transaction is ignored under the tax consolidation system as it is a transaction between entities in the tax-consolidated group.  Subsidiary B recognises no tax as it has not yet sold the inventory purchased from subsidiary A, and the taxable temporary difference for its inventory (carrying amount of $1,500 but tax base of $1,000) is not recognised under the AASB 112 exception concerning the initial recognition of an asset or liability in certain circumstances.  The head entity and the group recognise no tax in relation to subsidiary A’s profitable sale, since no external sale has occurred.

Thus there are no tax-related journal entries in year 1 concerning the intragroup sale of inventory.  The inventory-related journal entries are the same as shown for Example 7 in year 1.

Subsidiary B sells the inventory in year 2 for a profit of $300, realising a profit for the group of $800.  As an external sale has occurred, this profit is assessable to the head entity in relation to the tax-consolidated group.  The inventory-related journal entries are the same as shown for Example 7 in year 2.  The tax-related journal entries:

The group outcomes are the same under both Examples 7 and 8, illustrating that the method adopted for subsidiaries’ initial tax recognition for a period does not affect the accounting results for the tax-consolidated group.  However, the different income tax allocation methods can result in different reporting in the separate financial statements of the subsidiaries, as indicated for subsidiary A.  Subsidiary B has the same result under both Examples because in each case the same tax base applied to the intragroup inventory that it sold during year 2.