EFIN2708 / EACC3708 IAS12 INCOME TAXES: LECTURE 2

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EFIN2708 / EACC3708
INCOME TAX
LECTURE 2: TAXABLE INCOME AND CURRENT TAX CALCULATIONS

UNIT-SPECIFIC LEARNING OUTCOMES

At the end of this lecture, you should be able to:

CONTENT MATERIAL

Relevant content material for Lecture 1:

• Introduction to IFRS: Chapter 7 Income taxes: Sections 3 and 4. With section 5 and 6, you can
focus on the two types of differences for purposes of this lecture. Do section 6 only up to
section 6.1 for now.
• A guide through IFRS: IAS 12 Income taxes (Included in your reader). Paragraphs 1-2, 5-6, 12.

Please ignore all references to the following, as these aspects fall outside the scope of the module:
• Unused tax losses, unused tax credits, assessed losses, unrecognized deferred tax assets.
• Deferred tax on revalued land
• Changes in tax rates

OVERVIEW AND LECTURE

Purpose and objective

The purpose and objective of this session are to give you a better understanding of how to calculate
the taxable income and current tax.

Background

From lecture 1 of the Income tax presentations, we have seen that you calculate taxable income
through adjusting the accounting profit (PBT) for the reporting period with certain items that are
treated differently for tax purposes. These different treatments give rise to permanent or temporary
differences.

“Permanent” differences:

The most common permanent differences are non-taxable and non-deductible differences. These
differences are explained in the financial statements and disclosed in the tax reconciliation under the
income tax expense note.

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EFIN2708 / EACC3708 IAS12 INCOME TAXES: LECTURE 2
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See below a summary with examples of these permanent differences:

Permanent Example(s) of item/transaction Accounting treatment Tax treatment Deferred tax

difference treatment
Non-taxable Dividend received (from SA Co.) Included in PBT (Other Exempt N/A
income)
Non-deductible Fines* Deducted for PBT (Other Not allowed N/A
expenses)

* Other examples of non-deductible expenses are:

„ Under more fines, penalties, interest on tax outstanding.

„ Expenditure incurred to earn exempt income.
„ Conditional expenditure, i.e., depending upon some future event.
„ Donations, unless made to a qualifying institution who issued an a18A cert. The expense will
be deductible, and there will there be no difference between the accounting and tax treatment
for the donation if an a18A certificate is received.

The effect of the permanent differences on the taxable Income calculation is as follow:

Profit before tax (PBT) Xx

Less: Non-taxable income (Dividend (x)
received)
Add: Non-deductible expense xx
Taxable income xx

Temporary differences:

IAS 12, paragraph 5, defines temporary differences as differences between the carrying amount of
an asset or liability in the Statement of financial position and its tax base. These differences are the
result of the different treatment of transactions for tax and accounting purposes, resulting in
different amounts recognized per period. Some of the more general differences in rules between
accounting and tax treatments are as follows:

Income:

„ Accounting treatment: HB CH7, s5, p176 HB Ch1, s4, p6

According to the Conceptual Framework, the financial performance of an entity should reflect
the concept of accrual accounting. Accrual accounting requires that transactions are recorded
for accounting purposes when they occur and not when the cash is received or paid. (p.7 &
p.166 in your textbook.)

„ Tax treatment:
Section 1 of the Income Tax Act (for a resident person) defines Gross income as the total amount,
in cash or otherwise, received by or accrued to a resident during a year of assessment, which is
not of a capital nature.”

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EFIN2708 / EACC3708 IAS12 INCOME TAXES: LECTURE 2
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The component of “received by or accrued to …” means that you are taxed on the earlier of the
date of receipt or accrual.

„ Example of difference:

Income received in advance:

Tax treatment: Money received in advance is recorded as income for tax purposes (earliest of
receipt or date of accrual).
Accounting treatment: The money received in advance will be treated as a liability “Income
received in advance” and will only be recognized as income when entitled to it.
Year 1 Dr Cr
Bank (SFP) XX
Income received in advance (SFP) XX
Year 2
Income received in advance (SFP) XX
Income (SPL) XX

Therefore, it is the same amount, but with different accounting and tax treatments due to a
timing “issue” between tax and accounting.

Expenses / Deductions:

„ Accounting treatment:
Similar as described under income above, the principle of accrual accounting applies.

„ Tax treatment:
According to the general deduction formula, most of the ordinary business expenses are
deductible for taxation purposes. Section 11 of the Income Tax Act permits a deduction of the
following from the taxable income: Expenditure and losses actually incurred, in the Republic,
during the year of assessment, in the production of the income, not of a capital nature (e.g.,
assets bought).

The deductibility of expenditure is not determined on a cash basis; that is, it is not necessary to
have paid the expense before the deduction can be claimed. However, the expense must be sure
or "actually incurred," which relates to being "paid" or "becoming liable for."

„ Examples of difference:

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EFIN2708 / EACC3708 IAS12 INCOME TAXES: LECTURE 2
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Other differences:

Allowance for credit losses:

„ Accounting treatment:
Movement in the allowance for credit losses is included in the calculation of profit before tax.
„ Tax treatment:
SARS only allow a certain percentage of the accounting allowance; the rest of the allowance will
only be permitted if the bad debt is written off in the future.
„ Examples of difference:
Work through Example 7.20 (p.177) in your textbook.

Capital allowances:
„ Accounting treatment:
From the textbook (p.205), it can be seen that depreciation of assets commences when the asset
is available for use and continues until it is derecognized, even if idle. The method of depreciation
an asset must reflect the pattern in which the asset’s benefits are consumed, i.e., straight line,
reducing balance, sum of digits, or production unit.
Depreciation is recognized in the profit or loss section of the Statement of profit or loss and other
comprehensive income unless it is included in the carrying amount of another asset, for example,
manufactured inventories.
„ Tax treatment:
The capital write-off period starts when the asset is taken into use. SARS prescribes various
write of periods and methods, e.g., allow a write off for research cost over three years on a
50/30/20 basis.
„ Examples of difference:
The tax effect on Property Plant and Equipment ('PPE') will be covered during the sessions on
PPE. However, basic PPE principles were already done last year.
Work through Example 7.1 (p.154) in your textbook.

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Summary
See the table below for an example of the effect of temporary differences on the taxable income
calculation:
Profit before tax (PBT) Xx

Non-taxable/exempt items: Xx

Temporary differences: Already taxed in the previous year.

Accrued amount of previous years income received in advance (Accounting) (x)
Income received in advance (Tax) xx Soonest of received or receivable.

Treatment the same, unless contingent

Accounting expense for accrued leave xx requirement.
Tax deduction for accrued holiday leave in the current year (x)
Soonest of paid or payable.

Prepaid expense (extra payment) (x)

Accounting expense for credit losses xx/(x) Reverse accounting entry and provide
Tax allowance for credit losses (x)/xx for % allowed by SARS.

Accounting Depreciation xx
Reverse accounting depreciation and
Tax allowance on PPE item (x) allow for tax allowance (Wear & Tear).

Taxable income xx

HOMEWORK

Homework questions and memos' are uploaded on Blackboard. Please do the questions, then mark
it and correct your work. Make notes on errors made and adjust your thinking pattern where
necessary.

1. Do Activity 1 and 2 (Document 3.1(a)).

2. Do Introductory question 1(a) – (d) (Document 3.2(a)).
3. Do Introductory question 2 (Document 3.3(a)). Please submit your own attempt as
Assignment 1 on blackboard before the end of day on 24 April.

Memo’s to these exercises will be uploaded as (b) documents, i.e. the memo for Activity 1&2 would
be document 3.1(b).

Thank you.

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