Tax Base of a Company’s Assets and Liabilities

An asset’s tax base is the amount that will be deductible for tax purposes in future periods once the economic benefits of the asset have been realized and a company can recover its carrying amount. If the economic benefit will not be taxable, the asset’s tax base will be equal to its carrying amount.

A liability’s tax base is the carrying amount of the liability less any amounts that will be deductible in the future for tax purposes. Whenever revenue is received in advance, the tax base of this liability is the carrying amount less any amount of the revenue that will not be taxable in the future.

Calculation of the Tax Base for an Asset

Calculation of an asset’s tax base is best demonstrated through an example.

Assume that the pieces of information below relate to a company.

• Dividends receivable – Dividends receivable of $100,000 are reported on the company’s balance sheet. Dividends, however, are not taxable.
• Development costs – Development costs of $2 million are capitalized during the year, with $400,000 of this amount being amortized during the year. For tax purposes, amortization of 25% is allowed.
• Research costs – Research costs of $400,000 are incurred, and are all expensed in the current fiscal year for financial reporting purposes. Tax legislation however requires research costs to be expensed over a 4-year period rather than all in one year.
• Accounts receivable – Accounts receivable of $1,100,000 is reported, net of a provision of $100,000 for doubtful debt. The tax legislation allows a deduction of 25% of the gross amount of accounts receivable for doubtful debt.

The tax base for each of these assets is determined as follows:

Dividends Receivable:

carrying amount = tax base = $100,000; and

dividends are not taxable, therefore carrying amount = tax base.

Development Costs:

carrying amount = $2,000,000 – $400,000 = $1,600,000;

development costs are assumed to generate future economic benefits; and

the amortization allowed by tax legislation > amortization accounted for based on accounting rules. Therefore, carrying amount > tax base.

Research Costs:

carrying amount = $0 since the full amount is expensed for financial reporting purposes;

tax base = ($400,000 – $400,000/4) = $300,000;

research costs are assumed to generate future economic benefits; and

Tax base > carrying amount

Accounts Receivable:

based on the existing tax legislation, a greater amount of provision is allowed in the current fiscal year than would be the case under accounting principles; and therefore

tax base < carrying amount.

Calculation of the Tax Base for a Liability

Calculation of a liability’s tax base is also best demonstrated through an example:

Assume that the information given below relates to a company.

• Donations – Donations of $40,000 were made in the current fiscal year. Whereas the donations were expensed for financial reporting purposes, they are not tax-deductible based on the applicable tax legislation.
• Interest received in advance – Interest of $25,000 was received in advance. This interest is taxed because the applicable tax legislation recognizes that the interest accrues to the company (part of taxable income) on the date of receipt.
• Rent received in advance – $3.5 million is recognized for rent received in advance from a lessee for a rental office  space. Rent received in advance will be deferred for accounting purposes but will be taxed on a cash basis.
• Loan – A long-term loan of $750,000 was obtained during the current fiscal year. Interest is charged at 11.5% per annum and is payable at the end of each fiscal year.

The tax base for each of these liabilities is determined as illustrated below.

Donations:

carrying amount = tax base = $0; and

the donation of $40,000 was immediately expensed. Therefore, the carrying amount is $0. Also, since tax legislation does not allow donations to be deducted for tax purposes, tax base = carrying amount.

Interest Received:

carrying amount = $25,000;

tax base = $25,000 – $25,000 = $0; and

since the full amount of interest received is included in taxable income in the current fiscal year, the tax base is $25,000 – $25,000 = $0.

Rent Received:

carrying amount = $3,500,000;

tax base = $3,500,000- $3,500,000= $0; and

since the full amount of interest received is included in taxable income in the current fiscal year, the tax base is $3,500,000 – $3,500,000 = $0.

Loan:

carrying amount of loan capital = tax base = $750,000;

tax base of Interest on loan = $0; and

loan repayment has no tax implications. Interest paid is included in the calculation of taxable income as well as accounting income.

Question

Which of the following statements is the least accurate?

1. If the economic benefit of an asset is not taxable, its tax base will be less than its carrying amount.
2. The tax base of a liability is the carrying amount of the liability less any amounts that will be deductible for tax purposes in the future.
3. The tax base of an asset is the amount that will be deductible for tax purposes as an expense in the calculation of taxable income as the company expenses the tax basis of the asset.

Solution

The correct answer is A.

If the economic benefit of an asset is not taxable, its tax base will be equal to, not less than, its carrying amount.

Options B and C are correct statements.