Taxation and Regulatory Compliance
Taxation and Regulatory Compliance tests current and deferred tax, indirect tax mechanics, and the compliance obligations that affect financial reporting and penalties.
Tax base and deferred tax
- Current tax = taxable profit × tax rate. Taxable profit starts from accounting profit and adjusts for permanent and temporary differences.
- Permanent differences never reverse, such as fines and penalties that are not deductible. Temporary differences reverse over time and create deferred tax assets or liabilities under IAS 12.
- Measure deferred tax at the rate expected to apply when the difference reverses. Recognize a deferred tax asset only to the extent that taxable profit is probable.
- A deferred tax liability arises when tax depreciation exceeds accounting depreciation, because future taxable profit will be higher when accounting depreciation catches up.
Indirect tax and compliance
- VAT or GST is output tax on sales less input tax on eligible purchases. Record the net amount payable; do not treat recoverable input tax as an expense.
- Input tax is blocked for exempt supplies, non-business use, and many entertainment items.
- Transfer pricing must follow the arm's length principle, supported by contemporaneous documentation. Late filing and underpayment typically attract penalties and interest.
Worked example
Accounting profit is 500,000. Tax depreciation exceeds accounting depreciation by 60,000, and the tax rate is 25%. Taxable profit = 500,000 − 60,000 = 440,000. Current tax = 440,000 × 25% = 110,000. The 60,000 temporary difference creates a deferred tax liability of 60,000 × 25% = 15,000 because future taxable profit will be higher when the timing difference reverses. Total tax expense = 110,000 + 15,000 = 125,000. Reasoning: the difference is temporary, so current tax alone understates the total tax expense.
Traps that cost marks
- Treating a temporary difference as permanent and omitting deferred tax.
- Deducting fines, penalties, or non-deductible entertainment.
- Claiming input VAT on exempt activity or non-business expenditure.
- Applying the current tax rate to deferred tax when a different future rate is enacted.