The truth is that Corporate Income Tax Accounting has become increasingly difficult and complex.
Over the last few years, new regulations have been included that complicate corporate tax settlement, such as the limitation on the deduction of financial expenses or the improvement in the capitalisation reserve.
In this article we are going to talk about the basics.
In many cases the accounting of corporate income tax as an expense does not coincide with the tax that is finally paid.
See why this situation occurs and how this tax is accounted for.
Corporate Income Tax Settlement
Accounting-taxation differences
Calculation of Corporate Income Tax (IS)
The taxable base for corporate income tax (IS) is calculated on the basis of the accounting result, to which a series of corrections are applied to adapt it to the special features established by tax regulations.
The basic corporate income tax settlement scheme is as follows:
| Accounting result |
| + / – Off-balance-sheet adjustments and reductions |
| = Previous taxable income |
| – Offsetting of tax loss carryforwards |
| = Taxable income |
| x Tax rate |
| = Full tax liability |
| – Allowances and deductions |
| = Net amount |
| – Withholdings, payments on account and fractioned payments |
| = Differential quota |
| + Loss on incentives in previous years + Interest on arrears |
| = Net amount to be paid or refunded |
Extra-accounting corporate income tax adjustments
Off-balance-sheet adjustments reflect the differences between accounting and tax rules, and may be permanent or temporary:
Permanent adjustments
These reflect differences that do not affect the tax base in any subsequent tax period.
For example, when a company receives a fine, it can book it as an expense, but the tax rules state that this expense is not deductible(and will not be deductible in the future).
Temporary adjustments
These arise mainly from differences in accounting and tax criteria in the timing of the recognition of income and expenses.
For example, a company may recognise a customer impairment expense when it receives an unpaid receivable, but this impairment is not deductible for tax purposes if at least six months have not elapsed since the due date.
Reversal of entries
These temporary adjustments have an impact on future years.
Continuing with the example, if at year-end six months have not yet elapsed since maturity, the expense recorded will not be deductible and a positive off-balance sheet adjustment will have to be made.
In the following year, once the six months have elapsed, an adjustment of the opposite sign can be made, so that in the computation of both years, the accounting and tax results coincide.
The following table summarises some examples of temporary and permanent adjustments, both positive and negative:
Permanent | Temporary | |
+ | For non-deductible expenses | Impairment due to unpaid debts of less than six months. |
– | For exempt income (dividends) | Tax incentives for accelerated depreciation. |
Accounting adjustment data
Once all the items that generate off-balance sheet adjustments have been identified, as well as the applicable reductions, allowances and deductions, the computable IS expense at 31 December can be calculated.
Let’s look at an example for a company with a positive accounting result of 100,000 euros, which has identified the following items:
- It has recorded an expense of 300 euros fora traffic fine, and an income of 20,000 for dividends received.
- It has recorded an expense for unpaid debts of 3,250 euros (due in October 2024).
- The company can apply accelerated and unrestricted depreciation (in addition to the depreciation already booked) in the amount of €12,000.
- It can apply a reduction for capitalisation reserves of 9,000 euros, and is also entitled to a reduction for the equalisation reserve, as it is a small company (turnover of less than 10 million euros).
- Finally, it is entitled to a deduction of 2,000 euros for hiring disabled people.
Example of Corporate Income Tax Accounting
With these data, the corporate income tax settlement will be as follows:
| Accounting result | 100.000 |
| + Permanent fine adjustment | + 300 |
| – Permanent adjustment exempted dividends 95%. | – 19.000 |
| – Permanent adjustment capitalisation reserve | – 9.000 |
| Subtotal | 71.700 |
| + Temporary adjustment for unpaid debts | + 3.250 |
| – Temporary adjustment accelerated depreciation | – 12.000 |
| Subtotal | 62.950 |
| – Temporary adjustment for equalisation reserve | – 6.295 |
| 6,295 = Taxable income | 56.655 |
| x 25 % = Full amount | 14.164 |
| – Allowances and deductions | – 2.000 |
| = Liquid quota | 12.164 |
The capitalisation and equalisation reserves have special calculation rules.
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Accounting for corporation tax
Corporate Income Tax Accounting should reflect two items
At 31 December
On the other hand, the tax accounting should reflect:
- On the one hand, the amount to be paid when presenting the settlement for the year;
- And on the other hand, the deferred tax, which is the one derived from temporary differences (that generate a higher or lower payment in the future).
In the case of the example, the accounting entry will be as follows:
Concept | Debit | Credit |
Current tax expense | 15.925 | – |
Deferred tax assets | 812 | – |
Deferred tax liabilities | – | 4.573 |
H.P. creditor, tax to be paid | – | 12.164 |
The tax payable does not match the expense recognised, precisely as a result of the temporary adjustments.
Explanation why the accounting entry does not match the corporate income tax
See where each of the above amounts comes from:
- The current tax expense is the result of applying 25% to the accounting result (23% in the case of micro-SMEs) reduced by permanent differences, reducing the result with the deductions applicable in the quota (which are a definitive tax saving, and not a mere tax deferral).
- The deferred tax asset is the result of applying 25% (or 23%) on the temporary adjustment derived from the unpaid tax. As this expense will be deductible in the following year (when six months will have elapsed since the due date), it will result in a lower tax payment at that time.
- Deferred tax liabilities correspond to 25% (or 23%) of the negative temporary adjustments (equalisation reserve and accelerated depreciation), and will result in higher future tax payments.
To ensure that deferred tax assets and liabilities are correctly reversed in subsequent years, they should be accounted for separately on a transaction-by-transaction basis.
And if the corporate tax base is negative?
It is also accounted for
If the tax base for the year is negative, the company is entitled to offset it against future profits.
Something similar happens with deductions: as there is no positive taxable income, they cannot be applied, but the law allows them to be applied in the future, when profits are made.
Therefore, if the company expects to make a profit in the future:
- If the company expects to make profits in the future, it can book 25% (or 23%) of the negative tax base as a deferred tax asset (since, when it offsets the negative base against future positive bases, it will pay less tax).
- In addition, 100% of unused deductions that can be used in the future can be counted as a deferred tax asset.
- Deferred tax assets and liabilities arising from the temporary adjustments you have made must also be taken into account as described above.
Remember that tax losses can be offset against future profits with no time limit.
Deductions not applied due to insufficient tax liability can generally be applied within 15 or 18 years of their generation.
In conclusion
Discrepancies arise when certain income and expenses that are recorded are not taken into account when calculating the corporate income tax base, or are recorded for tax purposes in periods other than those in which they are recorded for accounting purposes.