Elimination of intragroup profit (2)

H, an entity taxed at 34%, has a subsidiary S, which is taxed at 30%. On 15 December 2013 S sells inventory with a cost of €100,000 to H for €120,000, giving rise to a taxable profit of €20,000 and tax at 30% of €6,000. If H were preparing consolidated financial statements for the year ended 31 December 2013, the profit made by S on the sale to H would be eliminated.

In this case, the consolidated financial statements would record current tax paid by S of €6,000 and a deferred tax asset measured at H’s effective tax rate of 34% of €6,800, giving rise to the following entry:

DR

CR

Current tax (profit or loss)

6,000

Current tax (balance sheet)

6,000

Deferred tax (balance sheet)

6,800

Deferred tax (profit or loss)

6,800

In this case there is a net €800 tax credit to profit or loss (current tax charge €6,000 less deferred tax credit €6,800). This reflects the fact that, by transferring the inventory from one tax jurisdiction to another with a higher tax rate, the group has put itself in the position of being able to claim a tax deduction for the inventory of €800 (i.e. €20,000 at the tax rate differential of 4%) in excess of that which would have been available had the inventory been sold by S, rather than H, to the ultimate third party customer.