Tax loss carry forwards in excess of current year expected profits
An entity that reports half-yearly has unutilised operating losses of 75,000 for income tax purposes at the start of the current financial year for which no deferred tax asset has been recognised. At the end of its first interim period, the entity reports a profit before tax of 25,000 and expects to earn a profit of 20,000 before tax in the second half of the year. The entity reassesses the likelihood of generating sufficient profits to utilise its carried forward tax losses and determines that the IAS 12 recognition criteria for a deferred tax asset are satisfied for the full amount of 75,000. Excluding the effect of utilising losses carried forward, the estimated average annual income tax rate is the same as the enacted or substantially enacted rate of 40%.
As at the end of the current financial year the entity expects to have unutilised losses of 30,000 (75,000 carried forward less current year pre-tax profits of 45,000). Using the enacted rate of 40%, a deferred tax asset of 12,000 is recognised at year-end. How is this deferred tax asset recognised in the interim reporting periods?
Approach 1
Under the first approach, the estimate of the average annual effective tax rate includes only those carried forward losses expected to be utilised in the current financial year and a separate deferred tax asset is recognised for those carried forward losses now expected to be utilised in future annual reporting periods.
In the fact pattern above, using 45,000 of the carried forward tax losses gives an average effective annual tax rate of nil, as follows: