IAS 12 Deferred Tax Assets, Liabilities, Recognition and Worked Examples

IAS 12 Deferred Tax Assets, Liabilities, Recognition and Worked Examples

By Sai Manikanta Pedamallu (ACCA, CMA US, CSCA US, CGMA, ACMA, Dip IFRS, M.Com, MBA, MA)

Lead Instructor, Global Fin X | www.globalfinx.in/manikanta

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IAS 12 is deliberately asymmetric, and understanding that asymmetry is the key to the entire standard. A deferred tax liability is recognised for every taxable temporary difference, with three narrow exceptions, and no assessment of whether the entity will actually be in a position to pay it. A deferred tax asset is recognised only to the extent it is probable that future taxable profit will be available to use it against.

The reasoning is straightforward prudence: an obligation to pay more tax in future is recognised regardless of circumstances, while a right to pay less tax in future is only worth recognising if there will actually be tax to reduce. A company with no realistic prospect of future profits has no meaningful asset in its accumulated tax losses, whatever the tax law technically permits it to carry forward.

Post 62 covered the tax base concept and how temporary differences arise. This post covers what happens next: the recognition tests, the measurement mechanics, and the worked calculations that Dip IFRS examines most heavily.

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Deferred Tax Liabilities: Recognised Almost Universally

A deferred tax liability is recognised for all taxable temporary differences, except in three specific circumstances:

The initial recognition of goodwill. Recognising deferred tax on goodwill at acquisition would itself increase goodwill, which would then generate further deferred tax, in a circular sequence the IASB chose to break by prohibiting recognition entirely.

The initial recognition exemption. Where an asset or liability is initially recognised in a transaction that is not a business combination, does not affect accounting or taxable profit at the time, and does not give rise to equal taxable and deductible temporary differences. The 2021 narrowing of this exemption, covered in Post 62, removed leases and decommissioning provisions from its scope.

Investments in subsidiaries, branches, associates and joint arrangements, where the parent or investor can control the timing of the reversal of the temporary difference and it is probable the difference will not reverse in the foreseeable future.

Outside these three, there is no probability test, no assessment of recoverability, and no judgment about future profitability. If a taxable temporary difference exists, the liability is recognised.

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Deferred Tax Assets: The Recognition Hierarchy

A deferred tax asset is recognised for all deductible temporary differences to the extent that it is probable taxable profit will be available against which the deductible temporary difference can be utilised.

The assessment follows a specific sequence, and working through it in order matters because the first step is objective while the second is judgment-heavy.

Step One: Sufficient Taxable Temporary Differences

The first test is whether the entity has sufficient taxable temporary differences (deferred tax liabilities) relating to the same taxation authority and the same taxable entity, that are expected to reverse in the same period as the deductible temporary difference, or in periods into which the tax loss can be carried back or forward.

Where such taxable temporary differences exist and are sufficient, the deferred tax asset is recognised without needing any forecast of future profitability at all. The reversal of the existing taxable temporary difference will itself generate the taxable profit against which the deductible difference is used. This is an objective test based on balances already on the balance sheet.

Three conditions must align: same taxation authority, same taxable entity, and reversal in the appropriate period. A deferred tax liability in an Indian subsidiary cannot support a deferred tax asset in a Singapore subsidiary, since they face different taxation authorities and are different taxable entities.

Step Two: Probable Future Taxable Profit

Where taxable temporary differences are insufficient, the entity must assess whether it is probable that sufficient future taxable profit will arise, of the appropriate type, in the same periods as the reversal of the deductible temporary differences, in the same taxable entity, and under the same taxation authority.

The "appropriate type" qualifier matters in jurisdictions that ring-fence categories of income. A capital loss that can only be set against future capital gains cannot be supported by expected future trading profits. In India, this is directly relevant: unabsorbed capital losses can only be offset against capital gains, and losses from speculative business can only be set against speculative business income.

The Exclusion That Prevents Circular Reasoning

An entity's estimate of future taxable profit for this purpose excludes tax deductions resulting from the reversal of the deductible temporary differences themselves. This clarification, introduced by the 2016 amendment, prevents an obviously circular argument: the deferred tax asset cannot be justified by the very deduction it represents.

The same amendment also clarified that the estimate of future taxable profit may include amounts from recovering assets for more than their carrying amounts, where there is sufficient evidence that this is probable. A company holding land at historical cost well below its current market value can factor the expected taxable gain on eventual disposal into its assessment.

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The Convincing Evidence Standard

IAS 12 contains an explicit and pointed warning: the existence of unused tax losses is strong evidence that future taxable profit may not be available.

Where an entity has a history of recent losses, it recognises a deferred tax asset arising from unused tax losses or tax credits only to the extent that it has sufficient taxable temporary differences, or there is convincing other evidence that sufficient taxable profit will be available.

This is a genuinely higher hurdle than the ordinary "probable" test, and it is deliberately so. A company that has lost money for three consecutive years and is projecting a sharp return to profitability needs more than a board-approved budget to support a material deferred tax asset.

What constitutes convincing evidence in practice: a specific, identifiable event that has changed the entity's circumstances (a major contract won, a loss-making division disposed of, a restructuring completed with quantified cost savings already realised); demonstrable improvement in recent results within the loss period; the existence of taxable temporary differences that will reverse; and forecasts that have historically proved reliable rather than persistently optimistic.

What does not constitute convincing evidence: a management forecast projecting recovery with no identifiable change in circumstances driving it; reliance on the same assumptions that produced forecasts already proved wrong in prior years; and reliance on tax planning strategies the entity has not committed to and does not expect to implement.

Why This Matters Particularly in India Right Now

KPMG's Accounting and Auditing Update in August 2025 observed directly that companies with a recent history of losses have recognised material deferred tax assets, sometimes over a prolonged number of years, without sufficient evidence supporting their expectation that taxable profit will be available in future periods. The observation echoes the European Securities and Markets Authority's public statement on IAS 12, which set out considerations for assessing the availability of future taxable profits and the existence of convincing evidence, and which is relevant to entities reporting under IFRS regardless of jurisdiction.

This is a live audit and regulatory focus area, not a theoretical concern. Where an entity has recognised a deferred tax asset for unused tax losses and has incurred a tax loss in the current or preceding period in the same tax jurisdiction, IAS 12 imposes additional disclosure requirements specifically to expose this position: the amount of the asset and the nature of the evidence supporting its recognition.

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Tax Planning Opportunities

An entity may take tax planning opportunities into account when assessing whether future taxable profit will be available, but only where the entity actually expects to adopt them. A theoretically available restructuring that management has no intention of executing cannot support a deferred tax asset.

The distinction is between actions the entity has decided to take and actions it could hypothetically take. Auditors test this specifically, since a tax planning strategy invoked purely to support a deferred tax asset, with no corresponding board decision or implementation plan, is a recognised audit finding.

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Worked Example 1: Deferred Tax Liability from Accelerated Depreciation

An Indian manufacturing company purchases plant for Rs. 100 crore on 1 April 2025. Book depreciation under Ind AS 16 is straight-line over 10 years. Tax depreciation is 40% on a reducing balance basis. The applicable tax rate is 25.17% (Section 115BAA regime).

The pattern is worth understanding rather than just calculating. The temporary difference builds in the early years, while tax depreciation exceeds book depreciation, peaks around Year 3, and then reverses as tax depreciation on the shrinking reducing balance falls below the constant straight-line book charge. The deferred tax liability follows the same trajectory: a charge to profit or loss while the difference builds, then a credit as it unwinds.

By the end of the asset's life, assuming full write-off under both bases, the cumulative temporary difference returns to nil and the deferred tax liability is fully released. This is the defining characteristic of a temporary difference: it reverses.

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Worked Example 2: Deferred Tax Asset on Carried-Forward Losses

An Indian company has accumulated unabsorbed business losses of Rs. 25 crore as at 31 March 2026. The applicable tax rate is 25.17%. Under the Income-tax Act framework, business losses may be carried forward for eight assessment years, while unabsorbed depreciation may be carried forward indefinitely.

The potential deferred tax asset is Rs. 25 crore x 25.17% = Rs. 6.29 crore. Whether it can be recognised depends entirely on the assessment.

Scenario A: The company has taxable temporary differences of Rs. 30 crore reversing within the carry-forward window.

The first test is satisfied objectively. The reversal of the taxable temporary differences will generate Rs. 30 crore of taxable profit, sufficient to absorb the Rs. 25 crore of losses. The full deferred tax asset of Rs. 6.29 crore is recognised, with no forecast of trading profitability required.

Scenario B: The company has minimal taxable temporary differences, has been profitable historically, and this loss arose from a one-off event (a major litigation settlement) that will not recur. Forecasts show taxable profits of Rs. 10 crore annually from FY27.

The second test applies. Expected taxable profit over the eight-year carry-forward window is Rs. 80 crore, comfortably exceeding the Rs. 25 crore of losses. The one-off nature of the loss, combined with a demonstrable history of profitability, supports the forecast. The full deferred tax asset is recognised.

Scenario C: The company has incurred losses in each of the last three years, has minimal taxable temporary differences, and forecasts a return to Rs. 10 crore annual profits from FY27 based on a planned turnaround.

The convincing evidence standard applies, and a board-approved turnaround plan alone will not satisfy it. If the company can point to a specific, completed change (a loss-making segment already disposed of, a major contract already signed, cost reductions already implemented and visible in recent quarters), partial or full recognition may be supportable. Absent such evidence, the deferred tax asset should not be recognised, or should be recognised only to the extent supported by whatever taxable temporary differences do exist.

Scenario C is where practice most frequently diverges from the standard, and where audit challenge concentrates.

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Worked Example 3: Revaluation and the OCI Allocation

A company revalues land upward from a carrying amount of Rs. 40 crore to Rs. 65 crore. The tax base remains at Rs. 40 crore, since the revaluation is ignored for tax purposes. The rate applicable to the expected manner of recovery (sale, taxed as a capital gain) is 23.30%.

Taxable temporary difference: Rs. 65 crore less Rs. 40 crore = Rs. 25 crore

Deferred tax liability: Rs. 25 crore x 23.30% = Rs. 5.83 crore

Because the revaluation surplus is recognised in other comprehensive income under IAS 16, the related deferred tax liability is also recognised in OCI, not in profit or loss. The revaluation surplus presented in OCI is therefore the net amount: Rs. 25 crore less Rs. 5.83 crore = Rs. 19.17 crore.

Note the rate used: the capital gains rate applicable to the expected manner of recovery, not the ordinary corporate rate. This is the measurement principle from Post 62 applied in practice, and it is a frequent exam point.

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Reassessment at Every Reporting Date

Deferred tax assets are not recognised once and left alone. At each reporting date, an entity reassesses unrecognised deferred tax assets and recognises a previously unrecognised asset to the extent it has become probable that future taxable profit will allow recovery. An improvement in trading conditions, a newly signed contract, or the emergence of taxable temporary differences can each trigger recognition of an asset previously written off.

The reverse also applies. The carrying amount of a recognised deferred tax asset is reduced to the extent it is no longer probable that sufficient taxable profit will be available. A company that recognised a deferred tax asset on the strength of a forecast that has since deteriorated must write it down, with the charge going to profit or loss (or OCI or equity, following the item).

This reassessment obligation makes deferred tax assets one of the more volatile items on a balance sheet during periods of business stress, and one of the areas where a deterioration in outlook produces a compounding effect: profits fall, and the deferred tax asset supporting the balance sheet is written down at the same time.

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Presentation and Offsetting

Deferred tax assets and liabilities are always classified as non-current in the statement of financial position, regardless of when the underlying temporary differences are expected to reverse. IAS 1 is explicit on this point, and it is one of the simplest rules in the standard to get wrong.

Offsetting is permitted only where the entity has a legally enforceable right to set off current tax assets against current tax liabilities, and the deferred tax assets and liabilities relate to income taxes levied by the same taxation authority on either the same taxable entity, or different taxable entities that intend either to settle current tax amounts on a net basis or to realise the assets and settle the liabilities simultaneously.

For Indian groups, this generally means offsetting within a single legal entity is appropriate, while offsetting across separate group companies is not, since each Indian company is separately assessed and there is no group taxation regime permitting consolidated returns.

Current tax and deferred tax are presented as separate components of tax expense in the statement of profit and loss, and the standard requires a reconciliation between the tax expense and the product of accounting profit multiplied by the applicable tax rate, explaining the reasons for the difference.

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Ind AS 12 vs IAS 12: Recognition and Measurement

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What Big 4 Auditors Focus On

Deferred tax asset recognition where there is a loss history. This is the single highest-risk area in IAS 12 auditing, and it is an active regulatory focus. Auditors test whether the convincing evidence standard has genuinely been met, specifically whether management has identified a concrete change in circumstances rather than simply forecasting recovery. Prior-year forecast accuracy is tested directly: if last year's forecast predicted profit and the entity made a loss, this year's forecast requires substantially more support.

The step-one test performed properly before moving to forecasts. Auditors verify that the entity has first assessed whether sufficient taxable temporary differences exist, with matching taxation authority, taxable entity, and reversal period, before relying on future profit forecasts. Skipping to forecasts when an objective test was available understates the quality of the analysis.

Appropriate type of taxable profit. Where losses are ring-fenced (capital losses, speculative business losses), auditors test whether the forecast profit is of the type that can actually absorb them, rather than aggregate profit of any description.

Rate applied to the expected manner of recovery. For revalued assets and investments, auditors test whether the capital gains rate or the ordinary rate has been correctly applied based on how the entity expects to recover the carrying amount.

Follow-the-item allocation for revaluations and remeasurements. Auditors verify that deferred tax on items recognised in OCI has been recognised in OCI, producing a net OCI presentation, rather than being routed through profit or loss.

Tax planning strategies invoked without commitment. Where a deferred tax asset relies on a tax planning opportunity, auditors seek evidence of board approval and an implementation plan, not merely a technical possibility.

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Dip IFRS Exam Angle

This is one of the most reliably examined areas in the entire Dip IFRS syllabus, and it is calculation-heavy.

Most tested areas:

Building a multi-year deferred tax schedule from accelerated depreciation, calculating the temporary difference and the deferred tax balance at each year end, and deriving the movement to profit or loss as the difference between opening and closing balances.

Assessing whether a deferred tax asset on carried-forward losses can be recognised, applying the two-step test in order and identifying whether the convincing evidence standard applies.

Calculating deferred tax on a revaluation and allocating it correctly to OCI, presenting the revaluation surplus net of the related deferred tax.

Identifying which of the three DTL exceptions applies in a given scenario.

Common traps:

Applying a probability test to a deferred tax liability. There is no such test; DTLs are recognised for all taxable temporary differences outside the three exceptions.

Including the reversal of the deductible temporary difference itself as a source of future taxable profit supporting its own recognition.

Classifying deferred tax as current where the underlying difference reverses within twelve months. Deferred tax is always non-current.

Using the ordinary corporate rate for a revalued asset expected to be recovered through sale in a jurisdiction with a distinct capital gains rate.

Routing deferred tax on a revaluation surplus through profit or loss instead of OCI.

Offsetting deferred tax assets and liabilities across different taxable entities without the required conditions being met.

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FAQ

Why is there no recoverability test for deferred tax liabilities?

Because a taxable temporary difference will produce a taxable amount in future regardless of the entity's circumstances. There is no question of "recovering" a liability; it will simply become payable when the difference reverses. The asymmetry with deferred tax assets is deliberate prudence.

Can a deferred tax asset be recognised for tax losses if the entity has never been profitable?

Only where sufficient taxable temporary differences exist to absorb the losses, or where genuinely convincing evidence of a specific change in circumstances exists. An entity that has never been profitable and can point to no identifiable change faces a very high bar, and in most such cases recognition is not appropriate.

How is the eight-year carry-forward period in India factored into the assessment?

The forecast of future taxable profit must fall within the period the losses remain available. Profits expected in year ten cannot support losses that expire in year eight. Where losses expire progressively, the assessment needs to be performed by loss vintage rather than in aggregate.

Does unabsorbed depreciation get treated differently from business losses in India?

Yes, and it matters for the assessment. Unabsorbed depreciation may be carried forward indefinitely, so the recognition assessment is not constrained by an expiry window in the way it is for business losses limited to eight assessment years.

If a deferred tax asset was written down in a prior year and circumstances have improved, can it be reinstated?

Yes. IAS 12 requires reassessment at each reporting date, and a previously unrecognised or written-down deferred tax asset is recognised to the extent it has become probable that future taxable profit will permit recovery.

Why is deferred tax always non-current when the underlying difference might reverse next year?

IAS 1 specifically requires this classification for deferred tax balances, as a presentational simplification. Attempting to split deferred tax between current and non-current would require detailed reversal scheduling that IAS 12 otherwise deliberately avoids requiring.

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Enroll with Global Fin X

Deferred tax recognition is where IAS 12 stops being mechanical and becomes genuinely judgment-driven, particularly for the deferred tax asset assessment that regulators and auditors are actively scrutinising. Our programme covers the complete IAS 12 series with detailed lectures, multi-year worked schedules at current Indian tax rates, the recognition assessment framework, exam-style MCQs, and a dedicated LMS for working professionals.

Enroll Now: Dip IFRS Programme

Faculty profile: www.globalfinx.in/manikanta

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This is Post 63 of the Global Fin X IFRS Series. Previous: IAS 12: Current Tax, Deferred Tax and Temporary Differences. Next: Post 64: IAS 12 vs Ind AS 12: Treatment of MAT Credit and Other Differences.