Question

BhL Ltd has always adhered to good Human Resource policies. Its policies include awarding its employees long service leave payments as well as redundancy payments in the event that there is a retrenchment. This has resulted in the creation of Deferred Tax Assets. Recently BhL Ltd has had tough trading conditions and has had to stream line its operations. Due to this it has retrenched some of its work force and has had to pay out the long service leave and retrenchment benefits. The long service leave and retrenchment payments has been claimed as a deduction from its current tax liability. Due to these large payouts, BhL Ltd reported a tax loss in the current period. You are asked to consider whether BhL Ltd can continue to raise a deferred tax asset in the current period in relation to the long service leave and redundancy payments.

Answer 1

Answer:

For tax purposes, long service leave liabilities and retrenchment liabilities can only be claimed as tax deductions when a cash payment is made. For accounting purposes, these expenses are recognised on an accrual basis. This therefore creates a timing difference between the carrying amount of the liability for accounting purposes and the tax base of zero, as the deduction is only available for the long service and retrenchment liabilities when it is paid in the future. The timing difference thus creates a deferred tax asset.

Paragraph 24 of AASB 112/IAS 12 specifies that a deferred tax asset can be recognised ‘to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised’.

When there are insufficient taxable temporary differences for the entity to use against the deductible temporary differences, a deferred tax asset can be recognised only to the extent that it is probable that the entity will have enough taxable income in the same period as the reversal of the deductible temporary difference or recovery of a tax loss, or tax planning opportunities are available to the entity that will create taxable income in appropriate periods.

All available evidence, both positive and negative, must be evaluated before determining whether to recognise a deferred tax asset. In evaluating whether the entity will have sufficient taxable income in future periods, paragraph 29 states that the entity must ignore the taxable amounts arising from deductible temporary differences expected to originate in future periods, because the deferred tax asset from future deductible temporary differences will itself require future taxable income in order to be used.

If, based on an assessment of the evidence, it is not probable that sufficient future taxable income will exist, then a deferred tax asset can be recognised only to the extent that it can be recovered against the future taxable income available.

Based on these requirements, there are doubts about the legitimacy of the deferred tax assets recognised by BhL Ltd as BhL Ltd might not be able to show evidence that it will be able to generate future taxable income.