This comment letter, which reflects the views of the international BDO network of independent member firms, was sent by BDO IFR Advisory Limited to the International Accounting Standards Board on 12 November 2010.
A copy of the exposure draft is attached at the foot of this page.
Dear Sir
IASB Exposure Draft ED/2010/11: Deferred Tax: Recovery of Underlying Assets, Proposed amendment to IAS 12
We are pleased to comment on the above exposure draft (the ED). Following consultation, this letter summarises the views of the BDO network.
While we would not normally be in favour of the introduction of an exception to a principle, we acknowledge that the issue that is proposed to be addressed does give rise to diversity in practice, and causes difficulties in a number of jurisdictions. Consequently, we agree that the proposed amendment to IAS 12 should be made. However, we believe that the amendment should be as narrow as possible, being restricted to investment property accounted for in accordance with the fair value model in IAS 40. Even though they might be revalued, items of property, plant and equipment, and intangible assets with a limited economic life, which are depreciable will have a residual value meaning that the determination of the expected manner of recovery of the carrying amount is less difficult and subjective than for those assets which are either not depreciated or have an indefinite useful life. We note that this is consistent with the Board’s discussion at paragraph BC 12 of the Basis for Conclusions.
We also note that in a number of jurisdictions to which the amendment would be relevant, a number of investment property companies have historically held investment property assets for the whole of their economic lives, recovering their carrying value through use. It would be appropriate for the test of whether the presumption should be rebutted to include consideration of past practice, with a departure from that practice for the purposes of the deferred tax calculation being permitted only where there has been a clear change of business model.
Our responses to the specific questions included in the ED are set out in the attached Appendix.
We hope that our comment and suggestions are helpful. If you would like to discuss any of them, please contact Andrew Buchanan at +44 (0)20 7893 3300.
Yours faithfully
BDO IFR Advisory Limited
Appendix
Question 1 – Exception to the measurement principle
The Board proposes an exception to the principle in IAS 12 that the measurement of deferred tax liabilities and deferred tax assets should reflect the tax consequences that would follow from the manner in which the entity expects to recover or settle the carrying amount of its assets and liabilities. The proposed exception would apply when specified underlying assets are remeasured or revalued at fair value.
Do you agree that this exception should apply when the specified underlying assets are remeasured or revalued at fair value?
Why or why not?
We agree with the proposal to include an exception to the principle. Although we would not generally be in favour of exceptions, we acknowledge that the proposed amendment would address a specific aspect where there are application issues and diversity in practice.
Question 2 – Scope of the exception
The Board identified that the expected manner of recovery of some underlying assets that are remeasured or revalued at fair value may be difficult and subjective to determine when deferred tax liabilities or deferred tax assets arise from:
a) Investment property that is measured using the fair value model in IAS 40;
b) Property, plant and equipment or intangible assets measured using the revaluation model in IAS 16 or IAS 38;
c) Investment property, property, plant and equipment or intangible assets initially measured at fair value in a business combination if the entity uses the fair value or revaluation model when subsequently measuring the underlying asset; and
d) Other underlying assets or liabilities that are measured at fair value or on a revaluation basis.
The Board proposes that the scope of the exception should include the underlying assets decribed in a), b) and c), but not those assets or liabilities described in d).
We disagree with the proposed scope. Our understanding is that the issue that was brought to the Board’s attention was in respect of investment property that is revalued to fair value. As the proposed amendments are an exception to the principle in IAS 12, as outlined in question 1, we believe that the scope should be as narrow as possible.
Although items of property plant and equipment, and intangible assets, are permitted to the revalued to fair value at each reporting date, the carrying amounts are still typically depreciated or amortised to a residual value. We note from paragraph BC12 that the Board believes that:
‘...the determination of the expected manner of recovery of assets using the cost model in IAS 40 is less difficult and less subjective than when the fair value model is applied. This is because there is a general presumption that the asset’s carrying amount is recovered by use to the extent of the depreciable amount and by sale to the extent of the residual value.’
We see no reason why depreciable assets should be subject to a different treatment simply because they have been remeasured to fair value. Consequently, we believe that the scope of the amendment should be limited to investment property accounted for in accordance with the fair value model and revalued intangible assets with an indefinite useful life.
Question 3 – Measurement basis used in the exception
The Board proposes that, when the exception applies, deferred tax liabilities and deferred tax assets should be measured by applying a rebuttable presumption that the carrying amount of the underlying asset will be recovered entirely through sale. This presumption would be rebutted only when an entity has clear evidence that it will consume the asset’s economic benefits throughout its economic life.
Do you agree with the rebuttable presumption that the carrying amount of the underlying asset will be recovered entirely through sale when the exception applies?
Why or why not? If not, what measurement basis do you propose and why?
Our understanding of the Board’s intention is that the presumption should apply, unless there is clear evidence that an entity will hold the asset for the whole of its economic life and, in consequence, consume all of its economic benefits through use. The drafting of the final sentence in paragraph 51B is not entirely clear, as questions might arise in respect of what ‘throughout its economic life’ means; the text might be clarified.
In addition, an entity might have evidence that it will recover part of the carrying value of the asset through use and part through sale. In such circumstances, it would be appropriate for the deferred tax calculation to be split between the two elements.
Consequently, the final sentence in paragraph 51B might be redrafted to read
‘However, if an entity has clear evidence that it will hold the asset for either an identifiable part, or all, of its economic life and, in consequence, recover the related identifiable part, or all, of the carrying amount through use, this presumption is rebutted and the requirements of paragraphs 51 and 51A shall be followed.’
We also have some concerns that the presumption might not be rebutted when it is appropriate to do so. For example, an entity in a jurisidiction to which the amendments may be relevant might, throughout its trading history, have held investment property assets for their entire economic life, meaning that their carrying values have consistently been recovered through use. It would be appropriate for there to be a requirement for past practice to be taken into account, with the presumption being rebutted in the circumstances described in this paragraph unless there is a demonstrable change in the entity’s business model.
We note that the proposed approach would normally require the land element of an investment property to be dealt with separately from the building element (other than, for example, where both the land and building are leasehold with the same lease periods). It would be helpful for the revised standard to be explicit on this point.
Question 4 – Transition
The Board proposes that the amendments should apply retrospectively. This requirement includes retrospective restatement of all deferred tax liabilities or deferred tax assets within the scope of the proposed amendments, including those that were initially recognised in a business combination.
Do you agree with the retrospective application of the proposed amendments to IAS 12 to all deferred tax liabilities or deferred tax assets, including those that were recognised in a business combination?
Why or why not? If not, what transition method do you propose and why?
We agree with the proposed transitional arrangements.
Question 5 – Other comments
Do you have any other comments on the proposals?
We have no other comments on the proposals.