Income Taxes Part 1 PDF

Income Tax  Is income tax an expense? Most say it is, others argue that income tax is a distribution of income, just as dividends are. Perhaps the strongest argument for treating income tax as an expense is that the government provides service to a business entity by implementing rules and...

Income Tax  Is income tax an expense? Most say it is, others argue that income tax is a distribution of income, just as dividends are. Perhaps the strongest argument for treating income tax as an expense is that the government provides service to a business entity by implementing rules and regulations, thus contributing to the orderly conduct of business, allowing an entity to function smoothly. Nature cost of doing business, therefore, require recognition in the same period as the related income. Two types of income or profit are reported: taxable income is reported to taxing authority for imposition of income taxes; whereas for financial reporting purposes, profit is measured in accordance with the financial reporting standards. lAS 12, Income Taxes Issue: how to account for the current and future tax consequences of the future recovery (settlement) of the carrying amount of assets liabilities) that are recognized in an enterprises statement of financial position and transactions and other events of the current period that are recognized in an enterprise's financial statements. The fundamental principle is the recognition of deferred tax liability (or asset) by enterprises arising from the differences between tax base of assets and liabilities and their carrying amounts in the statement of financial position >>> In the statement of financial position, the effect of income taxes is recognized either as current tax liabilities (or current tax assets) or deferred tax liabilities (or deferred tax assets). CURRENT TAX LIABILITIES AND CURRENT TAX ASSETS Income tax for current and prior periods should, to the extent unpaid, be recognized as a liability. If the amount already paid in respect of the current and prior periods exceeds the amount due for those periods, the excess should be recognized as an asset. Current tax liabilities (or current tax assets) are computed based on taxable profit (or tax loss) determined in accordance with the rules established by the taxation authorities. PH National Internal Revenue Code (NIRC) and other Bureau of Internal Revenue (BIR) regulations The revenues recognized for tax purposes are termed as taxable revenues while the expenses allowed to be deducted therefrom are called allowed deductions or deductible expenses. The resulting net amount is the taxable income (or loss). The applicable income tax rate is then applied to this taxable income to determine the income taxes currently payable. Example Total taxable revenues during 2022 of ABC Company were P5,000,000 while allowed deductions were P3,800,000. The taxable income is P1,200,000. If the income tax rate is 30%, then the company's current tax is P360,000. If the company remitted no income taxes yet pertaining to the year 2022 to the BIR, the entry to recognize the current income tax is Income Tax Expense – Current 360,000 Income Tax Payable 360,000 The income tax payable is presented as a current liability on December 31, 2022 statement of financial position. ACCOUNTING PROFIT AND TAXABLE PROFIT Accounting profit is pre-tax profit computed based on the the accounting standards and the definition, recognition and measurement criteria in the Conceptual Framework. Accounting profit (or financial income) is sometimes called pre-tax financial income. Differences exist between accounting income and taxable income 1. permanent differences (non-temporary differences) and 2. temporary differences. Permanent differences are revenue and expense items recorded for accounting purposes because they meet the recognition criteria in the Conceptual Framework and the accounting standards but they are never included in the computation of taxable profit, because the revenue items are non-taxable and the expense items are non- deductible. Permanent differences are of two types: 1. non-taxable revenue; and 2. non-deductible expenses. NON-TAXABLE OR TAX-EXEMPT REVENUES Revenues that have been included in financial income but will never be included in taxable income are called non-taxable revenues. Examples of non-taxable or tax-exempt revenues are: gain from settlement of life insurance of officers and employees where the corporation is the named beneficiary dividend revenue received by a domestic corporation or non-resident corporation from a domestic corporation gains that are already subjected to final withholding tax, such as capital gains and taxes withheld on bank deposits. NON-DEDUCTIBLE EXPENSES Expenses that are deducted from accounting revenues (to arrive at accounting profit) but will never be allowed to be deducted from taxable revenues (to arrive at taxable income) are called non- deductible expenses fines and penalties for violation of law charitable contributions in excess of tax limitation insurance premiums for life insurance of officers, where the corporation is the designated beneficiary. RECONCILIATION When reconciling accounting profit to taxable income, non- taxable revenues are to be deducted from accounting income and non- deductible expenses are to be added back to accounting income. DEFERRED TAX LIABILITIES AND DEFERRED TAX ASSETS An enterprise shall recognize in its statement of financial position any deferred tax liability or deferred tax asset, in addition to current tax liability or current tax asset. Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of (a) deductible temporary differences, (b) the carryforward of unused tax losses, and (c) the carryforward of unused tax credits. TEMPORARY DIFFERENCES From a statement of financial position (or balance sheet) perspective, a temporary difference is the difference between the carrying amount of an asset or liability in the statement of financial position and its tax base. From an income statement perspective, a temporary difference occurs when a revenue or expense is included in financial profit in one period but reported for tax purposes in another period. Temporary differences may be either (par. 5, IAS12 Income Taxes) (a) taxable temporary differences (also called future taxable amount) or (b) deductible temporary differences (also called future deductible amount). TAXABLE TEMPORARY DIFFERENCE From a statement of financial position perspective, when the carrying value of an asset exceeds its tax base or when the carrying value of the liability is less than its tax base, the temporary difference is a taxable temporary difference. From an income statement perspective, when a temporary difference results in accounting profit being more than taxable profit, the temporary difference is a taxable temporary difference.