Interpreting income tax disclosures

The following note was taken from the 2011 Annual Report of Tesco, a global UK-based grocery and discount retailing chain.

Required

(a) Based on this disclosure, which figure do you think was higher: taxable income reported under tax law, or pretax income reported under IFRS? How would you know? Does the magnitude and direction of this difference imply “conservative” accounting or “aggressive” accounting on the part of Tesco?

(b) What is meant by the term “origination and reversal of temporary differences?” What effect did the change in the UK corporate tax rate have on deferred income tax, and why?

(c) What would you expect to be the largest source of Tesco’s deferred income tax liability?

Recognized in the Group income statement

2011 £m

2010 £m

Current tax expense

UK corporation tax

694

566

Foreign tax

181

128

Adjustments in respect of prior years

(114)

(91)

761

603

Deferred income tax

Origination and reversal of temporary differences

148

110

Adjustments in respect of prior years

12

124

Change in tax rate

(57)

3

103

237

Total income tax expense

864

840

A number of changes to the UK corporation tax system were announced in the June 2010 Budget Statement. The Finance (No.2) Act 2010 included legislation to reduce the main rate of corporation tax from 28 to 27% from 1 April 2011. The proposed reduction from 28 to 27% was substantively enacted at the balance sheet date and has therefore been reflected in these Group financial statements.

In addition to the changes in rates of corporation tax disclosed above, a number of further changes to the UK corporation tax system were announced in the March 2011 UK Budget Statement. A resolution passed by Parliament on March 29, 2011 reduced the main rate of corporation tax to 26% from April 1, 2011. Legislation to reduce the main rate of corporation tax from 26 to 25% from April 1, 2012 is expected to be included in the Finance Act 2011. Further reductions to the main rate are proposed to reduce the rate by 1% per annum to 23% by April 1, 2014. None of these expected rate reductions had been substantively enacted at the balance sheet date and, therefore, are not reflected in these Group financial statements.

The effect of the changes enacted by Parliament on March 29, 2011 to reduce the corporation tax rate to 26%, with effect from April 1, 2011, is to reduce the deferred tax liability provided at the balance sheet date by £32m (£46m increase in profit and £14m decrease in the Group Statement of Comprehensive Income).

The effect of the changes expected to be enacted in the Finance Act 2011 to reduce the corporation tax rate from 26 to 25%, with effect from April 1, 2012, would be to reduce the deferred tax liability provided at the balance sheet date by a further £32m (£46m increase in profit and £14m decrease in the Group Statement of Comprehensive Income).

The proposed reductions of the main rate of corporation tax by 1% per year to 23% by April 1, 2014 are expected to be enacted separately each year. The overall effect of the further changes from 25 to 23%, if these applied to the deferred tax balance at the balance sheet date, would be to reduce the deferred tax liability by £66m (being £33m recognized in 2013 and £33m recognized in 2014).

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