Subject 3. Determining the Tax Base of Assets and Liabilities

The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

The Tax Base of an Asset

An asset's tax base is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the asset's carrying amount. It is the amount that would be tax deductible if the asset was sold on the balance sheet date.

For example, a firm has total accounts receivable of $100,000. At the end of the year, management recognized a specific doubtful debt division of $3,000 for financial reporting. However, provisions for doubtful debts are not allowed for tax purposes in the firm's tax jurisdiction. A tax deduction is received when the receivable is written off as bad debt.

The carrying amount of the accounts receivable becomes $97,000. The tax base of the asset still remains $100,000. The firm has a deductible temporary difference of $3,000. Management should recognize a deferred tax asset in respect to the deductible temporary difference.

If the economic benefit will not be taxable, the tax base of the asset will be equal to the carrying amount of the asset. An example is dividends receivable from a subsidiary. If it is not taxable, the tax base and the carrying amount of the dividends receivable are equal.

The Tax Base of a Liability

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes with respect to that liability in future periods.

  • An unearned revenue item is treated as a liability for financial reporting but tax authorities often recognize it as taxable income. The tax base of such a liability is the carrying amount less any amount of the revenue that will not be taxable in the future. Examples are prepaid rent, prepaid subscriptions, etc.
  • If an item has already been expensed, then its tax base and carrying amount are both zero. One example is interest paid on long-term loans.

Example

At the beginning of the year a firm received a lump sum of $5 million for rent from a lessee. The rent was for the use of an office building for the next 5 years. Local tax authorities require 70% of rent received in advance to be taxable income.

At the end of the year, $4 million should be treated as a liability for financial reporting purposes. That's the carrying amount. The tax base of the liability is $1.2 million (30% of $4 million) and $2.8 million should be treated as taxable income.

Changes in Income Tax Rates

When tax rates change, the deferred tax liability or asset has to be adjusted immediately to the new amount that is now expected, based upon the new expected tax consequences. The effect of this change in estimate will be included in the income from continuing operations.

The effect of an income tax rate increase:

  • It raises deferred tax liabilities and thus increases tax expense.
  • It raises deferred tax assets and thus decreases tax expense.
  • If deferred tax liabilities exceed deferred tax assets, the net effect is to increase tax expense, and vice versa.

User Contributed Comments 12

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kalps: TO the extent that deferred taxes are not a liability they are part of shareholders equity. Should be discounted to PV where appropriate
kalps: You should be able to judge from the evidence of current and recent past to see if the allowance is required to reduce the deferred tax asset.
thekapila: DTA - need valuation aloowance if relaizability is more.
DTL -can be treates as equity id realizability is less.
sanyukta: god compplicated literature!!
boddunah: tax code is complicated.
rocyang: ok, everyone, this topic really got me. The common explaination I found for tax base is "the assessed amount of an asset, cash flow, etc" that is subject for taxation. While the defination for tax base of an asset here says it is the amount that will be deductible for tax purpose. Where does the difference come from?
MXMX: Anyone can help me to explain why income tax rate decreases will decrease the DTA? thanks
swisha: @MXMX - you have DTA when your taxable income is higher than your pretax income. So when you decrease the tax rate then your taxable income will decrease MORE than your pretax income percentage-wise. This reduces the difference between the pretax income and taxable income causing a decrease in the DTA.
johntan1979: rocyang, I agree with you. I'm going to stick with the "amount deductible" definition, since the example in the previous notes "2. Deferred tax assets and liabilities" supports this definition.

The example given above (accounts receivable) makes no sense to me. How can the whole value, $100,000 be the tax base (deductible amount???

What a headache! :(
Naoual: complicated literature, especially for non english native speakers
dirdeb: rocyang / johntan. Agree with the confusion that implies "deductible amount" in TBA defintion. I will try to clarify it with my approximative English:
- rocyang, you can keep your common explanation of "amount subject to taxation". It's still working for me and reinforces comprehension.
- johntan: why "amount deductible"? Today, all the amount is subject to tax but it will be deductible in the future as the benefit of asset is realised (With Asset decreasing, tax base will go in the same direction, but not at the same time, it's an amount potentially deductible in tax purposes).

It's easier to explain with a long-lived asset depreciation example than a receivables account example (because depreciation is an obvious expense reducing the taxable income):
If there is a temporary difference: depreciation is not already considered by tax authorities, TBA is still "higher" than in Financial information, so it's an "amount deductible", like that tricky definition tells. ;-)
pigletin: if dividend is not taxable, why on earth it has tax base?