IAS 12 Scope and Deferred Tax Concept
IAS 12 applies to all entities and requires recognition of deferred tax assets/liabilities for temporary differences between book values (IFRS) and tax bases (local tax rules).
Why deferred tax exists: Tax authorities use different rules than IFRS. A transaction might be a £10m asset on the balance sheet but have a £0 tax base, creating a temporary difference. When the asset is eventually used/disposed, the difference reverses and affects future tax cash flows.
Temporary Differences: Book vs Tax
Example 1: Depreciation Timing
| Item | Book (IFRS) | Tax Law |
|---|---|---|
| Equipment cost | £100,000 | £100,000 |
| Year 1 depreciation | £10,000 (10-year) | £20,000 (accelerated) |
| Temporary difference (end Year 1) | £90,000 (book) | £80,000 (tax) |
| Difference: £10,000 (DTL at 20% tax = £2,000) | ||
Example 2: Warranty Provisions
- Book (IAS 37): Recognize £50,000 warranty provision (expected future claims)
- Tax: No deduction until claim is paid (future year)
- Temporary difference: £50,000 (deductible when paid →’ DTA)
Deferred Tax Assets vs Liabilities
Deferred Tax Liability (DTL)
When book value > tax base. Tax will increase when the difference reverses.
- Accelerated tax depreciation (tax deducted faster than book)
- Fair value revaluation (book increase not deductible)
- Goodwill (tax non-deductible, book carries forward)
Deferred Tax Asset (DTA)
When book value < tax base. Tax will decrease (or loss is deducted) when the difference reverses.
- Provisions recognized (book) but deducted at payment (tax)
- Unused tax losses (deductible in future years)
- Deductible temporary differences
Deferred Tax Calculation Step-by-Step
Step 1: Identify All Temporary Differences
Compare book values to tax bases across the balance sheet.
Step 2: Calculate Net Deferred Tax Position
Step 3: Assess whether the deferred tax asset is recoverable
A deferred tax asset is recognised only to the extent it is probable that future taxable profit will be available against which the deductible difference or loss can be used (IAS 12.24 and 12.34). Under IFRS this is a limit on recognition, not a provision against a recognised asset.
Step 4: Measure at the rate expected on reversal
IAS 12.47 requires the rates enacted or substantively enacted by the reporting date that are expected to apply when the asset is realised or the liability settled. Substantive enactment matters in the UK: a Finance Bill rate is generally treated as substantively enacted once it has passed the House of Commons third reading, which can fall in a different reporting period from Royal Assent. Never discount deferred tax balances (IAS 12.53).
Recognition: the "probable" test, and why IFRS has no valuation allowance
When to recognise a deferred tax asset
Recognise a deferred tax asset for deductible temporary differences and unused tax losses to the extent that it is probable taxable profit will be available to use them (IAS 12.24, 12.34).
The evidence bar where there is a history of losses
IAS 12.35 hardens the test once an entity has been loss-making. The existence of unused tax losses is itself "strong evidence" that future taxable profit may not arise, so a deferred tax asset on those losses is recognised only to the extent the entity has sufficient taxable temporary differences with the same tax authority, or other convincing evidence. Management forecasts on their own rarely clear that bar, because they are the least verifiable evidence available and are being weighed against the most objective negative indicator there is.
Where a deferred tax asset is recognised in an entity that made a loss in the current or preceding period, IAS 12.82 requires the amount and the nature of the evidence supporting it to be disclosed. That disclosure is where auditors start.
The mechanics on both sides, including worked journals and the ASC 740 evidence-weighting rules, are set out in Recoverability of Deferred Tax Assets: IAS 12 vs ASC 740.
Example: loss-making subsidiary
- Unused tax losses: £10m, available indefinitely under local law
- Potential deferred tax asset: £10m × 20% = £2m
- Assessment: loss-making for five years, no reversing taxable temporary differences with the same tax authority, no contracted backlog, no credible turnaround plan
- IAS 12 treatment: the convincing-evidence test in IAS 12.35 is not met, so nothing is recognised. No asset is booked and no allowance is booked, because there is no asset to allow against.
- Balance sheet: £nil. The £10m of losses is disclosed as an unrecognised deferred tax asset under IAS 12.81(e), with the expiry dates of any that are time-limited.
- If the same facts were reported under ASC 740: a £2m gross deferred tax asset and a £2m valuation allowance, netting to £nil. Same balance sheet, two extra numbers in the note.
Tax Rate Changes
When the government changes the tax rate, remeasure all deferred tax balances at the new rate and recognize the adjustment in P&L or OCI (depending on whether the item was a P&L or OCI transaction).
Worked Example: Rate Increase
- Existing DTL (at 19%): £10m
- Tax rate enacted to change to 25%: New rate applies to future reversals
- Remeasured DTL (at 25%): £10m / 19% × 25% = £13.16m
- P&L adjustment: £3.16m (tax expense increase, hit P&L as "Impact of tax rate change")
Worked Example: Manufacturing Company Deferred Tax
Balance Sheet as at 31 Dec 2025
| Item | Book Value (£m) | Tax Base (£m) | Temp Diff (£m) |
|---|---|---|---|
| PP&E | 100 | 70 | 30 (DTL) |
| Inventory | 50 | 50 | — (none) |
| Warranty provision | (20) | — (0) | 20 (DTA) |
| Unused tax loss carried forward (not a temporary difference; recognised under IAS 12.34) | — | 15 | 15 (DTA) |
| Net temporary differences: DTL £30m − DTA £35m = DTA £5m (net) | |||
Deferred Tax Calculation (Tax Rate 19%)
- Gross DTL: £30m × 19% = £5.7m
- Gross DTA (warranty + loss): £35m × 19% = £6.65m
- Net DTA before valuation: £6.65m − £5.7m = £0.95m
Recoverability assessment
The £5.7m of taxable temporary differences on PP&E reverse against the same tax authority, which under IAS 12.28 is on its own sufficient support for £5.7m of the deferred tax asset without relying on any forecast. The remaining £0.95m rests on future trading profit, and the company is profitable with a five-year plan showing continued profit. Both parts are recognised in full. No allowance arises, because IFRS has no such mechanism.
Balance Sheet Presentation
- Deferred tax asset (non-current): £0.95m
- Deferred tax liability (non-current): £0 (netted)
What this looks like in a filed set of IFRS accounts
An earlier version of this page carried a worked example attributed to a named UK aerospace group, including a "valuation allowance" figure. That example has been removed. It was wrong twice over: the figures were not traceable to the filed accounts, and a UK group reporting under UK-adopted IFRS cannot present a valuation allowance, because IAS 12 has no such concept. It is left flagged here rather than quietly deleted, because the error is instructive.
What you will actually find in the tax note of a large IFRS filer with a history of losses is a different shape:
- A single net deferred tax asset or liability on the face of the balance sheet, offset only where IAS 12.74 permits (a legally enforceable right to set off current tax, same taxable entity or same tax authority).
- A note analysing the recognised deferred tax by category of temporary difference, with the movement in the year split between profit or loss, other comprehensive income and acquisitions (IAS 12.81(g)).
- A separate line for unrecognised deferred tax assets under IAS 12.81(e), with the expiry dates of any losses that are time-limited. That number is what a US reader would recognise as the valuation allowance, but it is disclosure only. It never appears as a balance.
- Where an asset has been recognised despite a loss in the current or preceding period, a specific statement of the supporting evidence under IAS 12.82.
To see it for yourself, take any FTSE 100 annual report, go to the deferred tax note, and find the unrecognised losses line. The gap between recognised and unrecognised is the judgement the audit committee spent the most time on.
The initial recognition exemption, and what changed in 2023
IAS 12.15 and 12.24 contain an exemption: no deferred tax is recognised on the initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting profit nor taxable profit. It exists to stop entities grossing up the cost of an asset for a tax effect at the moment of purchase.
The exemption used to be read as covering leases and decommissioning provisions, because each gives rise to an asset and a liability at the same moment. Practice was inconsistent, with some entities recognising deferred tax on both sides and others on neither. The IASB amended IAS 12 in May 2021 to settle it, effective for annual periods beginning on or after 1 January 2023: the exemption does not apply to a transaction that gives rise to equal and offsetting taxable and deductible temporary differences.
The practical effect is that a lessee recognises a deferred tax liability on the right-of-use asset and a deferred tax asset on the lease liability, rather than nothing. They are usually similar in size, so the net balance sheet effect is small, but they are measured separately, they unwind at different rates, and the deferred tax asset is subject to the recoverability test in the normal way. The same reasoning applies to decommissioning and restoration provisions with a matching asset. Any material written before 2023 that tells you leases fall inside the initial recognition exemption is describing superseded guidance.
Pillar Two: the exception you must not miss
The OECD's Pillar Two rules impose a 15% global minimum effective tax rate on in-scope groups, broadly those with consolidated revenue of €750m or more in at least two of the previous four years. The UK implemented them as the Multinational Top-up Tax and Domestic Top-up Tax in the Finance (No. 2) Act 2023, applying to accounting periods beginning on or after 31 December 2023.
The accounting question this raised was awkward. Pillar Two top-up taxes are income taxes within the scope of IAS 12, which on the face of it would require every affected group to compute deferred tax on them across every jurisdiction it operates in. The IASB judged that impractical and amended IAS 12 in May 2023 with two provisions:
- A mandatory temporary exception (IAS 12.4A) from recognising and disclosing deferred tax assets and liabilities related to Pillar Two income taxes. It is not an option. An entity that recognises Pillar Two deferred tax is not complying with IAS 12.
- Targeted disclosures instead. IAS 12.88A requires the fact that the exception has been applied to be disclosed. IAS 12.88B requires current tax expense related to Pillar Two to be disclosed separately once the legislation is in effect. IAS 12.88C and 88D require, for periods after enactment but before the rules take effect, known or reasonably estimable information about the entity's exposure.
If your group is under the €750m threshold this does not apply to you. If it is over, and the tax note is silent on Pillar Two, that is a disclosure deficiency rather than an oversight.
Audit Red Flags and Common Errors
Red Flag 1: Deferred tax asset left unrecognised without support
Finding: the company has £20m of unused tax losses, none recognised, but the five-year plan shows a clear path to profitability and there are reversing taxable temporary differences with the same tax authority.
Auditor action: non-recognition is a judgement that has to be evidenced in both directions. Reversing taxable temporary differences under IAS 12.28 are the strongest support and do not depend on the forecast at all, so if they exist and have been ignored, recognition is required to that extent. Watch also for the reverse incentive: an entity that wants to smooth future tax charges has a motive to under-recognise now and release later. IAS 12.56 requires the assessment to be revisited every reporting date in both directions.
Red Flag 2: DTL Not Remeasured After Tax Rate Change
Finding: Tax rate increases from 19% to 25% effective next year; DTL not remeasured.
Auditor action: Require remeasurement; P&L impact of 6%+ rate increase is significant.
Red Flag 3: Tax Loss Carryforward Not Assessed
Finding: £50m tax loss carryforward not evaluated for DTA recognition due to ownership change restrictions (Section 382 in the US, or similar rules in other jurisdictions).
Auditor action: Assess whether loss is available; if restricted, no DTA (or partial).
Red Flag 4: Tax on items outside profit or loss not backward-traced
Finding: a PP&E revaluation is recognised in other comprehensive income but the related deferred tax is charged to profit or loss.
Auditor action: IAS 12.61A requires tax to follow the item it relates to. Tax on something recognised in OCI goes to OCI; tax on something recognised directly in equity goes to equity. This is backward tracing, and IFRS requires it even where the tracing is difficult, which is a genuine difference from ASC 740's intraperiod allocation. Reclassify. Note that "SORIE" stood for the statement of recognised income and expense, an IAS 1 statement abolished in 2009, not the statement of other comprehensive income; the analysis is unchanged but the label is retired. Detail in IAS 12 deferred tax on OCI and equity items.
Red Flag 5: Acquisition Not Deferred Taxed
Finding: Acquisition creates £50m of identifiable intangibles (non-deductible for tax). No DTL recognized on the fair value step-up.
Auditor action: Recognize DTL on intangible fair value adjustments; affects goodwill calculation and future tax expense.
Real-Life Case Study: Deferred Tax From Accelerated Capital Allowances
Scenario. A company buys equipment for £1m. Accounting depreciation is £100k/year (10 years); tax allowances are £250k/year (front-loaded). Tax rate 25%.
Year 1. Carrying amount £900k; tax base £750k. Taxable temporary difference £150k × 25% = £37.5k deferred tax liability. The tax bill is lower now but will be higher later, hence the liability.
Takeaway. Deferred tax is about temporary differences between carrying amount and tax base, not the current tax charge. The asset "reverses" over its life: total tax is unchanged, only the timing differs, which is exactly what the DTL captures.
Illustrative composite scenario for educational purposes. Figures are indicative and do not represent any specific company.
• IAS 12 Tax Loss Carryforwards: DTA Recognition & Utilization
• Recoverability of Deferred Tax Assets: IAS 12 vs ASC 740
• IAS 12 Tax Rate Changes: Remeasuring Deferred Tax Balances
• IAS 12 Deferred Tax on OCI: Recognizing Tax Effects in Other Comprehensive Income
• IAS 12 in M&A: Deferred Tax on Acquisition Fair Value Adjustments
Frequently Asked Questions
What is deferred tax, in plain terms?
It is the tax effect of the differences between the way something is measured in the accounts and the way the tax authority measures it. If an asset is written down faster for tax than for accounting, tax relief has been taken early and will not be available later. Deferred tax records that future consequence now, so the tax charge in the accounts matches the profit reported rather than the cheque written to HMRC this year.
Which differences create deferred tax and which do not?
Only temporary differences do, meaning differences that will reverse at some point. A permanent difference, such as a fine that is never deductible, never creates deferred tax because nothing reverses. IAS 12 works from the balance sheet: compare the carrying amount of each asset and liability with its tax base and provide on the difference.
When can a deferred tax asset be recognised?
Only to the extent that future taxable profit will probably be available to use it against. That is a forecasting judgement, and it is the single most challenged area in this standard. A history of recent losses is strong evidence against recognition, and it takes convincing evidence to overcome it. IFRS has no valuation allowance mechanism; that is a US GAAP concept under ASC 740, where the asset is recognised in full and then written down.
What is the initial recognition exemption?
Where an asset or liability is first recognised in a transaction that is not a business combination and affects neither accounting profit nor taxable profit, no deferred tax is recognised on the difference. The 2021 amendment narrowed it: for transactions like leases and decommissioning obligations, which give rise to equal and offsetting temporary differences on initial recognition, the exemption no longer applies and deferred tax is recognised on both sides.
How does Pillar Two affect the deferred tax numbers?
IAS 12 carries a mandatory exception: an entity does not recognise or disclose deferred tax on Pillar Two top-up taxes. The exception is not optional and the fact that it has been applied has to be disclosed, together with the current top-up tax expense. Anyone modelling Pillar Two into their deferred tax balances is applying the standard incorrectly.
Where does the deferred tax charge go, the income statement or equity?
It follows the item it relates to. Deferred tax on a revaluation reserve or a cash flow hedge goes to other comprehensive income, deferred tax on an item recognised directly in equity goes to equity, and everything else goes through profit or loss. Getting this wrong is a common error because the tax computation is prepared in one place and the accounting entry in another.
About the author
Usman Qureshi is a Chartered Certified Accountant (ACCA) working in audit and advisory. He writes the IFRS, FRS 102 and US GAAP guides published on this site. Membership is listed on the ACCA public register.