2.4 Deferred tax is a subject all of its own and is covered in chapter 3. In brief, the deferred tax balances in the Last Accounts or Completion Accounts typically represent the net of both assets and liabilities. Some years ago deferred tax balances were not recognised in financial statements if they represented an asset in net terms as this was considered to be imprudent. However, it is now standard practice under both UK GAAP and IFRS to recognise deferred tax assets if it is more likely than not that they will be recovered. It is therefore important that the drafting of the tax covenant should make allowance for the prospect of the deferred taxation being an overall asset rather than a liability.
2.5
The above drafting provides for the three expected circumstances:
(a)
there may be a net deferred tax liability in the Completion Accounts;
(b) the deferred tax liabilities may have been cancelled by deferred tax assets but a net deferred tax asset has not been recognised in the Completion Accounts;
(c)
there may be a net deferred tax asset in the Completion Accounts.
2.6 As a reminder of the material covered in chapter 3, we can provide details of some of the matters which give rise to assets in the deferred tax account. The taxed values of each of the following five examples are deferred tax assets: 2.6.1 if a company has made trading losses in earlier years, then the tax value of these losses is a deferred tax asset as the losses can be used to cover future profits from the same trade, without time limit, under the provisions of Section 393, ICTA. A similar provision deals with losses in respect of rental income, under the provisions of Section 392A, ICTA. However, the asset would only be recognised if it reduced a deferred tax liability or if it was more likely than not that the losses would be utilised; 2.6.2 if a company has plant, machinery, vehicles or other assets on which capital allowances are available, then the tax value of the balances on the various capital allowance pools are deferred tax assets: they represent tax allowances which will be available in the future years by reference to the past capital expenditure; 2.6.3 if a company has made a provision for bad debts which is a general provision rather than a specific provision (for example by providing for 75% of all balances over 90 days old), then it has a charge in its profit and loss account but has not received a tax deduction for this charge. This position is reversed in the future at the option of the Company - either by the provision being released, or by it being made specific (in other words the existing provision is allocated to stated old balances which can be considered as potentially bad debts; at this point the provision changes from a general to a specific provision and it is then deductible for tax purposes); 2.6.4 if other provisions are made for costs which do not meet the requirements of Financial Reporting Standard 12 (“FRS 12”) for recognition, then there is similarly a charge without a tax deduction. For example a provision is made in the accounts for repair costs to be incurred in the future or for redundancy liabilities which have not yet been
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