CHAPTER 16:

Corporate
Income Tax

Prepared by
Shannon Butler, CPA,
CA
Carleton University
© 2017 MCGRAW-HILL EDUCATION LIMITED
 Introduction
• Income tax expense usually differs from income tax paid in a
year; the outcome is that deferred income tax must be
recognized on the statement of financial position (SFP),
resulting from interperiod income tax allocation.
•Many individual assets and liabilities have different accounting
treatment as compared to their tax treatment; their accounting
carrying value differs from their tax basis.
•This chapter will cover the method of accounting for income
tax.

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 Income Tax Provision vs. Expense

Provision for income tax: the expense (or recovery) of income

tax charged to the income statement.
• IFRS does not apply the word “provision” to an income tax expense
or recovery but the term is used in practice.
• It is used to encompass both income tax expense and income tax
recovery
• In this textbook, to avoid confusion between the expense item and
the tax liability, “income tax expense” will typically be used even
when the expense is a credit (recovery of previously paid income
taxes)

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 Interperiod Tax Allocation-
Introduction
Interperiod tax Allocation - allocating tax expense to an
appropriate year, irrespective of when it is actually paid

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Differences Between Taxable and
Accounting Income
The difference between taxable income and accounting income
arises from permanent differences and temporary differences
Permanent differences: items of revenue, expense, gains, or
losses enter the computation of either taxable income or pre-tax
accounting income but never enter into the computation of the
other
• Non-reversing

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Differences Between Taxable and
Accounting Income
Examples of permanent differences:
• Dividends received by Canadian corporation from other
taxable Canadian corporations
• Equity in earnings of significantly influenced associate
companies
• 50% of capital gains
• Golf club dues
• 50% of meals and entertainment expenses
• Interest and penalties on taxes
• Political contributions

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Differences Between Taxable and
Accounting Income
Temporary differences: arise when the tax basis of an asset or
liability differs from its accounting value
Originates in the period in which it first enters the computation
of either the pre-tax accounting income or taxable income; and
reverses in a subsequent period when item enters into the
computation of the other measure.

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 Differences Between Taxable and
Accounting Income
A few Examples of Temporary differences:
• Depreciation for accounting purposes; CCA for tax
• Amortization of capitalized development costs for accounting;
immediate deduction for tax
• Writedown of inventories, investments and capital assets; loss
recognized when realized for tax purposes
• Bad debt expenses recognized in year of sale for accounting; tax
deductible when uncollectible
• Fair value increases for investment properties or biological assets;
gain taxable only when property is sold
• Estimates for warranty costs;

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Conceptual Issues in Interperiod
Tax Allocation
Three basic underlying policy issues:
• the extent of the allocation;
• the measurement method; and
• discounting

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Conceptual Issues in Interperiod
Tax Allocation

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 Extent of Allocation
Extent of allocation → the range of temporary differences that
give rise to deferred income tax.
Two basic options are:
Taxes payable method: no allocation
Comprehensive tax allocation method: full allocation

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 Extent of Allocation
The taxes payable method (the flow-through method): the
amount of taxes assessed in each year is the income tax
expense for that year
• i.e. income tax expense = current income tax
• Permitted under ASPE only
Comprehensive tax allocation method: the tax effects of all
temporary differences are allocated, regardless of the timing or
likelihood of their reversal
• i.e. income tax expense = current income tax + tax on changes
in temporary differences

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 Measurement Method
Liability method: records the future tax impacts by using the
tax rate that will be in effect in the year of reversal
IFRS and ASPE require use of the liability method
The future tax impact is recorded on the SFP as a liability, and is
updated as the tax rate changes are enacted
• The effect of changes in enacted rates is reported in the net
earnings.

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Approach to Income Tax
Questions

1. Calculate taxable income and income taxes payable

2. Determine the change in deferred income tax accounts
3. Combine income tax payable with the change in deferred
income tax accounts to determine tax expense for the year

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Step 1: Calculate Taxable Income
and Income Taxes Payable
1. Adjust accounting income for temporary and permanent
differences. Then multiply taxable income by the current tax rate
to obtain income tax payable.
Item Adjustment to
accounting income
Expense deducted on SCI, but not tax deductible Add back
(depreciation, fines)
Revenue on SCI, but not taxable (dividend Deduct
revenue)
Expense not on SCI but allowable for tax Subtract
purposes (CCA)
Taxable revenue not on SCI Add

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Step 2: Determine the Change in
Deferred Income Tax
1. Calculate the required closing balance in deferred income
tax from each source of temporary difference.
2. Compare to the existing balance.
3. Calculate the change required.

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 Determining the Accounting Basis

The related SFP account is the accounting basis for the item
giving rise to a temporary difference:
Examples:
• Depreciation and amortization differences – use the
carrying value of NBV of tangible and intangible assets.
• Warranty expense difference – use the balance in warranty
provision.

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Determining the Accounting Basis

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 Determining the Tax Basis
• For monetary assets (i.e. receivables), the tax basis of a
taxable asset is its accounting carrying value less any amount
that will be added to taxable income in future periods.
• For non-monetary assets , the tax basis is the tax-deductible
amount less all amounts already deducted in determining
taxable income of the current and prior periods

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 Determining the Tax Basis
• For monetary liabilities, the tax basis is its accounting carrying
value less any amount that will be deductible for income tax
in future periods.

• For non-monetary liabilities, the tax basis is its carrying

amounts less any amount that will not be taxable in future
periods.

• Note: permanent differences - tax basis is equal to its

accounting basis

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 Step 3: Determine Income Tax
Expense for the Year
The last step is to combine the calculation of tax payable with
the change in the deferred income tax accounts to produce tax
expense. This is summarized in a journal entry:

• A credit to tax payable, from step 1;

• A debit or credit to deferred income tax asset/liability from
step 2; and
• A debit to tax expense, to balance

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 SFP Elements
• Deferred Income Tax Liabilities are created when tax paid is less
than accounting accrual-based expense.
• Created when:
• revenue is recognized on the books but is not taxable until a
later period;
• tax expense deductions precede accounting expense
deductions
• CCA results in a higher expense than depreciation

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 SFP Elements
• Deferred Income Tax Assets - created when tax is effectively
prepaid:
• Created when:
• tax on revenue is paid before the revenue is reflected on the
books
• Example – unearned revenue, but deposits are taxable on
receipt
• accounting expense deductions precede tax expense
deductions

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 SFP Elements

Deferred Asset Recognition Limit

• Deferred income tax assets on the balance sheet can be
recognized

Netting
• The deferred income taxes relating to all temporary
differences are lumped together and netted as a single
amount if for the same taxable company and the same taxing
government.

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 Disclosure: General
Recommendations
General disclosure requirements of the components for income tax
expense:
1. The amount of income tax expense on continuing operations
reported separately in income statement;
2. The amount of income tax expense attributable to current
taxes and deferred income taxes, either on the face of income
statement or in the notes.
3. Discontinued operations and each component of OCI are
reported net of income tax, and the amounts of income tax
expense that relate to each item should be disclosed. Also,
any income tax relating to capital transactions should be
disclosed.

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 Disclosure: General
Recommendations

4. The change in deferred income tax due to (1) changes in

temporary differences and (2) tax rate changes (or imposition
of new taxes) should be disclosed in the notes.

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 Disclosure:
Reconciliation of Effective Tax
Rates
Effective tax rate =
Total income tax expense / Net earnings from continuing
operations before tax

• Must reconcile the statutory rate to the effective tax rate

• Reconciliation may be in dollars or percentages

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 Disclosure:
Reconciliation of Effective Tax
Rates
Two general categories of causes for variations in the effective
tax rate:
• Permanent differences, which cause items of income and/or
expense to be reported in accounting income that are not
included in taxable income, and
• Differences in tax rates, due to:
• different tax rates in different tax jurisdictions,
• special taxes levied (and tax reductions permitted) by taxation
authorities
• changes in tax rates relating to temporary differences that will
reverse in future periods

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 Short-Cut Approach
Where tax rates have not changed, use the following short-cut
approach:
1. Calculate taxable income and income tax payable.
2. Determine the change in deferred income tax through a direct
calculation.
Change in deferred income tax = temporary difference
during the year X tax rate
3. Combine the income tax payable with the change in deferred
income tax to determine tax expense for the year.

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 Statement of Cash Flows
• The statement of cash flows will only include the amounts of taxes
actually paid or received for the year
• If indirect approach is used:
• If start with net earnings, add back income tax expense and
deduct income taxes paid.
• If start with earnings before taxes, show income taxes paid as
separate item

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 Is deferred income tax a liability?
• Does the deferred income tax liability represent an existing
obligation?
• The government does not consider the amount as owing, so is
not an existing obligation.
• The reality of having to pay out cash in the future as the
temporary differences reverse depends on the joint occurrence
of two conditions:
• The asset basis of the temporary difference must shrink
before there can be a net reversal, and
• The company must be earning taxable income while the net
reversals occur

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 Accounting Standards for
Private Enterprises
• Private enterprises may elect to use either the taxes payable
method or the comprehensive allocation method.
• If use taxes payable method, intraperiod allocation still required as
follows:
• Earnings from continuing operations;
• Discontinued operations;
• Gains and losses recorded directly in retained earnings;
• Capital transactions recorded directly in share capital.

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 Accounting Standards for
Private Enterprises
• CPA Canada Handbook, Part II (ASPE), uses the term future
income tax instead of deferred income tax. There is no
requirement to use that particular terminology - the two terms
are used interchangeably.
• ASPE requires companies to classify deferred/future income tax
liabilities and assets as either current or long-term.
• There is less disclosure required for private enterprises. In the
accounting policies note, a company should disclose the fact that
it is using the taxes payable method.
• The company should reconcile its income tax expense to the
average statutory income tax rate – similar to that described for
public companies.
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 Appendix 1: Conceptual issues
in Interperiod Tax Allocation
• Three policy issues that must be established in accounting
standards with respect to accounting for income tax are the
extent of allocation, the measurement method, and the
possibility of discounting deferred tax balances.
• Comprehensive tax allocation method → all temporary
differences give rise to deferred income tax.
• Taxes payable method → no deferred tax is recognized.
• Deferred tax balances can be measured at the rate of
accumulation, referred to as the deferral method, or the tax rate
expected to be in effect when the deferred tax amount reverses,
which is called the liability method.

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 Appendix 2: The Investment
Tax Credit
• Tax credit –a direct dollar for dollar offset against income
taxes that otherwise would be payable
• Amount not affected by the company’s tax rate
• Investment tax credits (ITC) are available in Canada for:
• qualifying research and experimental development
expenditures; and
• specified types of expenditures for capital investments

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 Appendix 2: The Investment
Tax Credit
• Qualifying expenditures can vary on three dimensions:
1. Type of expenditure;
2. Type of corporation; and
3. Geographic region

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 Appendix 2: The Investment
Tax Credit
• Accounting Treatment:
There are two possible approaches to accounting for the ITC:
1. The flow-through approach → the ITC is reported as a direct
reduction in the income tax expense for the year; or
2. The cost-reduction approach → the ITC is deducted from the
expenditures that give rise to the ITC; the benefit of the ITC is
thereby allocated to the years in which the expenditures are
recognized as expenses.

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 Appendix 2: The Investment
Tax Credit - Disclosure
• The notes should disclose the following:
• The accounting policy and the method of presentation in the
financial statements;
• The nature and extent of ITCs (and any government grants);
and
• Any unfulfilled conditions or contingencies.

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 END OF CHAPTER 16:
Corporate Income Tax
Summary → The amount of taxable income often differs from
the amount of pre-tax net income reported for accounting
purposes. The difference between taxable income and
accounting income arises from two types of sources:
permanent differences and temporary differences. The
objective of comprehensive interperiod income tax allocation
(liability method) is to recognize the income tax effect of every
item when that item is recognized in accounting earnings.
The alternative to comprehensive allocation is the taxes
payable method, which is a choice allowed under ASPE but
not permitted under IFRS.

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