Facts
East is a private entity, and it has recently acquired two 100% owned subsidiaries, West and North. West and North are themselves private entities. East has a business plan whereby in a few years it is going to acquire a stock exchange listing for its shares and capital. East acquired West on July 1, 20X3. When East acquired West, it had unused tax losses. On July 1, 20X3, it seemed that West would have sufficient taxable profit in the future to realize the deferred tax asset created by these losses. However, subsequent events have shown that the future taxable profit will not be sufficient to realize all of the unused tax losses.
West has made a general impairment charge of $4 million against its total accounts receivable. West gets tax relief on impairment of specific accounts receivable. Because of the current economic situation, West feels that impairment charges will increase in the future.
West has investments that are valued at fair value in the balance sheet and any gain or loss is taken to the income statement. The gains and losses become taxable when the investments are sold.
East acquired North on July 1, 20X3, for $10 million, when the fair value of the net assets was $8 million. The tax base of the net assets acquired was $7 million. Any impairment loss on goodwill is not allowed as a deduction in determining taxable profit.
During the current year, North has sold goods to East of $10 million. North has made a profit of 20% on the selling price on the transaction. East has $5 million worth of these goods recorded in its balance sheet at the current year end.
The directors of East have decided that during the period up to the date they intend to list the shares of the entity, they will realize the earnings of the subsidiary, North, through dividend payments. Tax is payable on any remittance of dividends to the holding entity. In the current year no dividends have been declared or paid.
Taxation is payable for listed entities at 40% and for private entities at 35% in the jurisdiction.
Required
Prepare a memorandum that sets out the deferred tax implications of the above information for the East Group.