Deferred Tax Fair Value Adjustment for Investment Property

Introduction

Investment properties are often measured at fair value under International Financial Reporting Standards (IFRS 13) and IAS 40. However, fair value adjustments can have tax implications, particularly regarding deferred taxes. When a company revalues its investment property, any increase in value may create a deferred tax liability (DTL), while a decrease may lead to a deferred tax asset (DTA).

This article explains:

• The concept of deferred tax in fair value adjustments
• The calculation process
• Examples with step-by-step computations
• The impact on financial statements

Understanding Deferred Tax in Fair Value Adjustments

Deferred tax arises due to temporary differences between accounting and tax treatment of assets. Investment properties under fair value accounting create such temporary differences because:

• Accounting basis: Properties are revalued at fair value each reporting period.
• Tax basis: Tax authorities may require properties to be carried at historical cost or subject to different depreciation rules.

This results in a deferred tax liability or asset, which is calculated using the corporate tax rate applicable to future gains or losses.

Formula for Deferred Tax Liability/Asset

The deferred tax effect of a fair value adjustment is calculated as:

Deferred \ Tax = Temporary \ Difference \times Tax \ Rate

Where:

• Temporary Difference = Fair Value of Investment Property – Tax Base
• Tax Rate = Applicable corporate tax rate (e.g., 25%)

Example Calculation

Scenario 1: Fair Value Increase (Deferred Tax Liability)

A company owns an investment property with:

• Original cost = $500,000
• Current fair value = $800,000
• Tax base (net of depreciation) = $450,000
• Corporate tax rate = 25%

Step 1: Determine the Temporary Difference

Temporary \ Difference = Fair \ Value - Tax \ Base

= 800,000 - 450,000 = 350,000

Step 2: Compute the Deferred Tax Liability

DTL = 350,000 \times 0.25 = 87,500

The company will recognize an $87,500 deferred tax liability in its financial statements.

Scenario 2: Fair Value Decrease (Deferred Tax Asset)

If the fair value drops to $400,000, the new calculation is:

Step 1: Determine the Temporary Difference

Temporary \ Difference = 400,000 - 450,000 = -50,000

Step 2: Compute the Deferred Tax Asset

DTA = -50,000 \times 0.25 = -12,500

Since the company now has a deferred tax asset of $12,500, it can offset future taxable income.

Impact on Financial Statements

• Income Statement: The deferred tax expense or benefit is recorded under tax expense.
• Balance Sheet: Deferred tax liabilities appear under non-current liabilities, while deferred tax assets appear under non-current assets.
• Statement of Cash Flows: Non-cash deferred tax movements are adjusted in operating cash flows.

Conclusion

Deferred tax adjustments for fair value changes in investment properties play a crucial role in financial reporting. Investors and financial analysts must consider these adjustments when evaluating a company’s financial health, as they directly impact net profit and asset valuations.