Full explanation
Overview
Two million euros of profit, taxed at twenty-five percent. The real bill is twelve thousand five hundred less — and it is not a mistake.
IAS 12 is Income Taxes — and it is two standards in one. Current tax: what you actually owe this year. Deferred tax: what today's numbers commit you to owing later. Part one is the mechanics of both, ending on a full worked example. Part two covers where deferred tax actually comes from, industry by industry, and what is changing right now.
What you actually owe this year
Current tax is the amount actually payable to, or recoverable from, the tax authority for the period. If it is unpaid at year end, it is a current tax liability. If you have overpaid, it is a current tax asset. There is no judgement here — it is arithmetic on the tax return, not an estimate.
The same enactment test
Current tax is measured using tax rates and tax laws enacted, or substantively enacted, by the end of the reporting period — the same enactment test deferred tax uses. And if a loss can be carried BACK to recover tax already paid in an earlier period, that recovery is itself a current tax asset, recognised in the loss-making year, not the year the refund arrives.
Carrying amount vs tax base
Deferred tax starts with two numbers on the same asset or liability: its carrying amount in your accounts, and its tax base — what the tax authority will let you deduct against it in future. The gap between them is a temporary difference. A TAXABLE temporary difference means you will pay more tax later; a DEDUCTIBLE one means you will pay less.
One rule, two directions
IAS 12 treats those two directions completely differently. A deferred tax liability is recognised for almost every taxable temporary difference, full stop. A deferred tax asset is recognised only to the extent it is PROBABLE that future taxable profit will actually be available to use it. Same standard, one asymmetric test — prudence built directly into the recognition rule.
Two exceptions sit right at the start of that rule — and one of them just changed.
The initial-recognition exemption
The initial recognition exemption: no deferred tax at all where a transaction is not a business combination and, at the time, affects neither your accounting profit nor your taxable profit. And a permanent exception on top of it — a deferred tax liability is NEVER recognised on the initial recognition of goodwill itself.
The exemption got narrower
But that exemption was narrowed. Since the first of January twenty twenty-three, it no longer applies where a single transaction creates EQUAL and offsetting taxable and deductible differences at the start — the classic case being a lease liability and its right-of-use asset, or a decommissioning provision and the asset it relates to. You now recognise the deferred tax asset AND liability gross, even though the net effect on day one is zero.
Two conditions, both required
Investments in subsidiaries, associates and joint ventures carry their own version of this. A deferred tax liability on the parent's share of undistributed profits IS recognised — unless the parent controls the timing of any reversal AND it is probable that reversal will not happen in the foreseeable future. Two conditions, both required, before you can avoid it.
Recognition decides whether a number exists at all. Measurement decides how big it is — and which rate to use is its own judgement.
The rate you'll actually face
Deferred tax is measured at the rate expected to apply when the asset is realised or the liability settled — using rates enacted or substantively enacted by year end. And deferred tax is never discounted to present value, even though settlement can be years away.
One rebuttable presumption
The rate and the tax base you use must match HOW you expect to recover the asset — through use, or through sale — because some jurisdictions tax the two differently. IAS 12 goes further for one specific case: an investment property held at fair value under IAS 40 is PRESUMED to be recovered through sale, unless it is depreciable and held to consume its benefits over time. That presumption alone can change which tax rate applies.
Tax follows the item
One more principle before the numbers: tax follows the item it relates to. Tax on something recognised in profit or loss is recognised in profit or loss. Tax on something recognised in other comprehensive income — or directly in equity — is recognised there too. The tax entry never travels to a different statement than the transaction that caused it.
Enough principles. Let's put real numbers through all of it, start to finish.
€1,900,000 taxable
Meridian Limited: accounting profit before tax, two million euros. To get to taxable profit, add back three hundred thousand of accounting depreciation, since it is not itself deductible; deduct five hundred thousand of tax depreciation, the amount actually allowed; add back one hundred and fifty thousand of warranty costs accrued but not yet paid; and deduct fifty thousand of non-taxable government grant income. Taxable profit: one million, nine hundred thousand. Current tax at twenty-five percent: four hundred and seventy-five thousand euros.
€50,000 liability, €37,500 asset
Now deferred tax, on the same two items. The equipment's carrying amount now sits two hundred thousand above its tax base, because tax depreciation ran ahead of accounting depreciation — a taxable temporary difference, giving a deferred tax liability of fifty thousand. The warranty provision has a tax base of zero, since none of it is deductible until paid — the full one hundred and fifty thousand is a deductible temporary difference, giving a deferred tax asset of thirty-seven thousand five hundred.
Put the two together, and the number should tie out exactly to the accounting profit times the tax rate — minus whatever doesn't belong in tax at all.
Exactly €12,500 apart
Current tax, four hundred and seventy-five thousand. Net deferred tax expense — the fifty thousand liability less the thirty-seven thousand five hundred asset — twelve thousand five hundred. Total tax expense: four hundred and eighty-seven thousand five hundred. At the standard rate, two million times twenty-five percent should give five hundred thousand. The gap is exactly twelve thousand five hundred — the tax effect of that fifty-thousand-euro non-taxable grant. Nothing else moves the total; every temporary difference washes out through deferred tax by construction. Effective tax rate: twenty-four point three eight percent.
Every euro traceable to a paragraph
Meridian's actual statement. Profit before tax: two million. Current tax: four hundred and seventy-five thousand. Deferred tax: twelve thousand five hundred. Total tax expense: four hundred and eighty-seven thousand five hundred. Profit for the period: one million, five hundred and twelve thousand five hundred. Every euro traceable to a paragraph — and to the reconciliation that proves it.