The COVID-19 pandemic is having a tremendous impact on the world’s economy. Many businesses are struggling to stay afloat and doing whatever they can right now to rationalize costs and preserve any cash surpluses they have in order to bridge future cash flow needs. Around the world, governments are stepping in to try and limit the impact of the pandemic by providing financial support in numerous ways from direct cash payments through to the deferral of tax payments.
This sets out four key areas of your tax provision that could be affected by the impacts of COVID-19. More specifically we focus on how government support in the form of tax incentives and tax relief might change previous assessments that were made applying IAS 12 ‘Income Taxes’ (IAS 12).
Recognition of deferred tax assets
For many entities, deferred tax assets can be recognized for non-capital losses, but only when supported by convincing evidence that future taxable profit exists. This requirement is set out more fully in IAS 12.35-36.
Entities that have been considerably impacted by COVID-19 should reassess any deferred tax assets previously recognized. No matter whether it is interim or annual financial statements being prepared, one of the greatest challenges for reporting entities will be providing compelling evidence to support the profitability assumptions that have been made into the future.
Expected manner of reversal
Under IAS 12.51, taxable and deductible temporary differences are required to be measured using the rates at which these differences are expected to reverse. Often, the relevant rate is the general corporate income tax rate applicable to the profit of the entity. Business rationalization may be an inevitable consequence of COVID-19, which could alter the composition of existing temporary differences as well as the way those temporary differences reverse.
Interim reporting – effective tax rate
IAS 34.30(a), requires the use of the so called, effective tax rate (ETR) method, as the most appropriate depiction of a reporting issuer’s tax provision on a quarterly basis. The ETR method uses the weighted average annual ETR and applies this to the pre-tax income of the interim period. The ETR should be computed on the basis of the tax rates that have been enacted or substantively enacted at the end of the interim reporting period and that will apply at the end of the annual reporting period. In other words, expected changes in tax rates or tax laws, as a result of government measures to support entities affected by COVID-19 should not be anticipated when computing the ETR.
The logic being that in the normal course of business, entities are taxed based on their annual income, which encompasses the activity of an annual reporting period (all quarters of a year) and not the activity of one specific quarter. Absent significant uncertainty, a projected effective tax rate should be a reasonable approximation of an annual tax rate.
With COVID-19 and the existing uncertainty as to when global economies will begin to recover, coupled with various government support and incentives that are being announced daily with the administration of the programs not yet finalised, it may be difficult to demonstrate that a reliable estimate of the annual tax rate can be made using the ETR. Furthermore, the composition of taxable income could be highly uncertain as a result of government programs.
. IAS 34 in general, requires anticipated tax credits and benefits, relating to a one-off event be recognized in the interim period in which they are anticipated to be received. This requirement may further complicate the ability to derive a reasonable ETR.
We are here to help
Preparers of financial statements will need to be agile and responsive as the situation unfolds. Having access to experts, insights and accurate information as quickly as possible is critical – but your resources may be stretched at this time.
We can support you as you navigate through accounting for the impacts of COVID-19 on your business. Now more than ever the need for reporting entities and their auditor or accounting advisor to work closely together is essential, so if you would like to discuss any of the points raised, please contact us.