Income Taxes and Foreign Currency Translation
IAS 12 uses the balance sheet approach: recognise deferred tax on temporary differences between the carrying amount and tax base of assets and liabilities, using the tax rates expected to apply when the difference reverses. Deferred tax liabilities arise for taxable temporary differences; deferred tax assets for deductible temporary differences and unused tax losses, recognised only where it is probable that taxable profit will be available. Candidates must know the initial recognition exceptions (goodwill, and the initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting nor taxable profit), the treatment of revaluations (deferred tax taken to OCI), and the offsetting rules. IAS 21 covers functional currency, presentation currency and foreign operations: monetary items are retranslated at closing rate with differences in P&L, non-monetary items at historical rate, and translation of a foreign operation uses closing rate for assets and liabilities, average rate for income and expenses, with differences in OCI.
Traps
Common traps include the distinction between temporary differences and permanent differences, the recognition of deferred tax on undistributed profits of subsidiaries (with the exception where the parent controls the timing and reversal is not probable), and the treatment of tax base where an asset is revalued. Watch for hyperinflation (IAS 29) and the recycling of foreign currency translation reserves on disposal of a foreign operation.
Worked example / rule of thumb
An asset costs $100,000, has tax depreciation claimed of $40,000 and accounting depreciation of $20,000, so carrying amount $80,000 and tax base $60,000. The taxable temporary difference is $20,000; at a 30% rate the deferred tax liability is $6,000. Rule of thumb: carrying amount greater than tax base = taxable temporary difference = deferred tax liability.