Entities may find themselves in a position where they had tax losses due to the weak economic conditions, even before the COVID-19 pandemic. In many instances the effect of the lockdown and resulting regulations have exacerbated this. In addition, some normally profitable entities have become loss-making, even if only temporarily so.

Deferred tax is an accounting measure that reflects the future tax consequences of recovery or settlement of the carrying amounts of an entity’s assets and liabilities. One particular item that is taken into account in this balance is the effect of tax losses that an entity carries forward. 

The recognition of deferred tax assets for tax losses is normally a contentious matter. It is likely to be subject to even greater scrutiny in the current conditions. This article provides a recap of the key considerations that are relevant to determine whether a deferred tax asset can be recognised for tax losses or not.

Deferred tax assets

A deferred tax asset reflects income tax that an entity can recover in future tax periods. Such a deferred tax asset can arise from deductible temporary differences that reflect deductions already reflected in P&L for accounting purposes but which the tax laws will only permit in a future period. This may, for example, be expenses that relate to provisions recognised for accounting purposes but that are only deductible for tax purposes once the expense materialises. The future recovery of income tax may however also result from the fact that an entity carries forward a tax loss that can be utilised in future to reduce taxable income.

An entity can only recognise a deferred tax asset to the extent that it is probable that there will be sufficient taxable profits available against which the deductions can be utilised in future tax periods. The existence of taxable temporary differences (i.e. differences that will result in taxable amounts in future) can be an indication of probable future taxable profits, provided that the taxable temporary differences are of an appropriate type and are expected to reverse in an appropriate tax period that the deductions can be utilised against it. In the absence of sufficient taxable temporary differences, the recognition of the deferred tax asset depends on the probability of future taxable profits and tax planning opportunities. This assessment will depends on the facts and circumstances of each entity.

Tax losses and loss-making entities

The same principles that apply to any deferred tax asset are relevant when this asset relates to unused tax losses. However, the fact that an entity has a history of recent losses that resulted in the unused tax losses could, in itself, be a strong indication that there may not be sufficient taxable profits in future to utilise the tax losses. 

In addition to assessing the availability of taxable temporary differences, probability of future profits and tax planning opportunities, the cause of the tax losses should be investigated. If the losses resulted from an identifiable cause that is unlikely to recur, this could provide grounds to support a view that it is probable that an entity may have taxable profits in future despite the existence of losses. In the context of the COVID-19 pandemic, it could be difficult to anticipate whether this can be viewed as a non-recurring loss-event or not. This assessment is likely to also vary between industries.

When an entity has suffered losses in the current or prior reporting periods and recognises a deferred tax asset in excess of the amount of taxable temporary differences that are expected to reverse, this implies that the utilisation of this asset is dependent on the probability of future taxable profits. In these circumstances, the entity is required to provide additional disclosure about the nature of the evidence that supports the recognition of the deferred tax asset.