Question

In some countries, tax legislation permits offsetting the tax losses of the company against the future tax profits.

For example, the tax loss not fully deducted in the year 1 can be carried forward and set off against the profits in the next three consecutive years.

However, when the company makes loss continuously in the consecutive years, can they be carried forward and should the deferred tax asset be recognized? How?
 

Answer

Good question and I agree that it may create some confusion.

The standard IAS 12 says in the paragraphs 24 and 34 that yes, you should recognize a deferred tax asset (DTA) for unused tax losses (or tax credits) carried forward, to the extent that it is probable that future taxable profits will be available.

To sum this up, before you recognize a DTA on unused tax losses, check if the following is met:

Does your tax legislation permit the tax deduction of the unused tax loss in the future years? What are the conditions?

For example, let’s say you generated a tax loss in the year 1 and the tax legislation permits offsetting 20% of that loss in each of the five consecutive years (years 2-6).

In this case – yes, provided you meet the second condition below, you can recognize DTA on unused tax loss.

If, however, imagine the situation when the tax legislation permits offsetting the tax loss in the consecutive years ONLY if you employ ten new people, or invest in the new technologies. Or, the tax legislation imposes the rules related to types of income against which you can utilize the tax loss.

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If you do not assume to pass through these restrictions, then do NOT recognize a DTA.

Do you assume sufficient future taxable profit against which the unused tax loss can be offset?

This part is a bit tricky.

The thing is that you do not necessarily need to generate sufficient taxable profits in the future.

The trick is to look at your current taxable temporary differences and see if they relate:

  • To the same taxation authority;
  • To the same taxable entity;
  • In the same period as the assumed utilization of tax loss carried forward.

Let’s say that you do not have any available taxable temporary differences and you assume the tax loss in the next 2 years, then profit in the year 3.

In this case, you can recognize DTA on unused tax losses only in the amount that you assume to utilize in the year 3.
 

Example

Imagine you generated a tax loss of CU 12 000 in the year 1.

The tax legislation permits offsetting this loss against future taxable profits in three consecutive years, at maximum amount of one third of that loss in a particular year, no other strings attached.

Thus, you can deduct CU 4 000 in each of the years 2, 3 and 4.

You have recognized taxable temporary differences amounting to CU 6 000 in total, assuming to reverse in the year 2.

Due to bad situation on the markets, you assume to generate further tax loss in the year 2 and 3, but the sufficient taxable profit in the year 4.

What DTA related to unused tax loss can you recognize in the year 1?

The first condition of the appropriate tax legislation is met. Just bear in mind you have three years to utilize that loss and you cannot utilize more than one third of it each year.

Let’s take a look at the second condition, year by year.

Year 2

Available taxable temporary differences amount to CU 6 000, reversible in the year 2.

In the same year, you can deduct one third of the loss of CU 4 000.

As the taxable temporary differences are greater than the tax loss, you can recognize a DTA on the tax loss of CU 4 000.

Year 3

You do not have any taxable temporary differences at the end of Year 1 to offset DTA.

Also, you do assume generating further tax loss.

As a result, you cannot recognize a DTA on the tax loss amounting to CU 4 000 that would have been offset in the year 3.

Year 4

Again, no taxable temporary differences reversible in the year 4 are currently in place, but you do reasonably assume to generate sufficient taxable profit.

So, you can recognize a DTA on the tax loss usable in the year 4 amounting to CU 4 000.

To sum up

You need to recognize a DTA on the tax loss amounting to CU 8 000 (year 2 and year 4).

The amount of DTA depends on the tax rates applicable in the future periods that are enacted.

Let’s say the tax rate is 20%, then the DTA amounts to CU 1 600 (20% of CU 8 000).
 

Final advice

From the above example you can see that the calculation of the deferred tax is not just the simple multiplication of the difference and rate.

You need to analyze properly IF and WHEN you can offset the DTA, period by period.

That means proper analysis of conditions and timing.

And, you need to think of any tax planning opportunities to turn the wheel in your favor, while compliant with relevant laws.