Tax Part 1

Quick reference

• 00:05 Time for taxing question.
• 00:07 They say there's only two things certain in life, death and taxes.
• 00:12 So what happens if the tax man dies?
• 00:17 Time for a slide you've not seen before.
• 00:20 Yes, how many times have we seen this now?
• 00:22 Building the model from a to b we are putting in the checks.
• 00:26 We've completed the operational section.
• 00:28 We've put through the working capital adjustments, put through the asset
• 00:32 adjustments, completed some of the financing, still some of that to go.
• 00:36 We're now at tax.
• 00:37 How it affects the financial statements.
• 00:41 And how it then affects the key outputs.
• 00:43 And how do we know we're there?
• 00:45 Well, we've been working our way through the P&L.
• 00:48 The smallest of the three financial statements conceptually.
• 00:50 We've systematically worked our way down here and we've now arrived at tax expense.
• 00:58 So let's look at tax.
• 01:02 Tax sort of goes hand in hand with accounting principles.
• 01:06 It determines the presentation of information in the financial statements,
• 01:10 partly.
• 01:11 You see, accounting principles are all about true and fair.
• 01:14 Everything's true and fair, whereas, quite frankly, tax isn't about true and
• 01:18 fair, it's about objectivity.
• 01:21 Pretty much all that you actually calculate from accounting principles is
• 01:24 the amount of tax expense.
• 01:26 And then you've got to look at the inter-reaction between the tax and
• 01:29 the accounting, because there's other laws in place.
• 01:32 We've got to look at tax payable, tax paid, deferred tax assets and liabilities.
• 01:37 Let me talk you through.
• 01:39 The key one to start off with is tax expense,
• 01:41 which is calculated based on accounting profit.
• 01:44 Basically you multiply the tax rate by the net profit before tax.
• 01:49 The only problem with this is that there are certain things that aren't allowable
• 01:53 or that should be included.
• 01:55 For example, if I don't pay my fine for
• 01:59 not paying tax last year I could get a penalty for that.
• 02:03 Now that would have to go through my PNL as a penalty for not paying my tax.
• 02:07 But it wouldn't be tax deductible.
• 02:09 Similarly, if I've got income coming in to overseas ventures that
• 02:13 doesn't get remitted back to the country I'm in, it could be
• 02:17 there is actually a treaty in place saying that you don't actually get taxed on that.
• 02:21 And again, this would be what we call a permanent difference.
• 02:25 This where there are things that will never reconcile between accounting and
• 02:28 taxation.
• 02:30 These things are now known as temporary differences under IFRS,
• 02:33 even though they last forever.
• 02:35 It's all a bit strange, really.
• 02:37 So, we have to adjust the net profit before tax,
• 02:39 first of all, to calculate what's call accounting taxable profit.
• 02:43 Which is adding back items that shouldn't have been deducted.
• 02:47 Business entertainment expenses is often one here.
• 02:50 And also deducting things that shouldn't have been included,
• 02:54 like certain types of revenue.
• 02:56 We then multiply this accounting taxable profit,
• 02:58 by the tax rate to determine the tax expense for the period.
• 03:03 Tax payable gets confused with all of these things here.
• 03:06 This is the amount of time it takes between actually paying it, and
• 03:11 when it becomes due.
• 03:12 This is on the balance sheet, and does not go into the income statement.
• 03:17 We have to get it calculated correctly and
• 03:21 too often I see tax payable as a line item in the P&L.
• 03:24 It's not, it's what's owed on the balance sheet.
• 03:29 Another issue is tax losses.
• 03:31 If I make a million dollars of losses this year and I have a tax rate of 30%,
• 03:36 that means that at the end of the year the tax authorities say, you poor thing.
• 03:40 You've made a loss.
• 03:42 30% of that is $300,000.
• 03:45 Here, have $300,000 for your troubles.
• 03:48 Don't think so.
• 03:50 Doesn't work like that.
• 03:51 What would happen is in the following year, in many territories,
• 03:55 you'd be able to carry it forward.
• 03:57 Let's say next year we made a $3 million profit.
• 04:00 At the same tax rate we would actually have to pay $3 million times 30% is
• 04:05 $900,000 tax.
• 04:08 But we've got a $1 million loss.
• 04:10 So $3 million less a million dollars is $2 million that we pay tax on,
• 04:15 times 30% is $600,000.
• 04:18 The actual amount of the value of the loss then, the tax effected value, so
• 04:22 to speak, is the difference between the two.
• 04:25 The $900,000 and the $600,000 which is $300,000
• 04:30 which is the same as multiplying the $1 million loss by 30%.
• 04:34 Now we put these losses, if we want to, on the balance sheet.
• 04:39 And these are called the tax effected amounts,
• 04:42 because this is what it's worth to us.
• 04:44 And the balance sheet used to be known as the net worth statement.
• 04:48 So it becomes an asset to be used in the future when we are able to
• 04:53 actually realize the tax loss.
• 04:55 Now you'll find in statutory accounts,
• 04:58 there are no tax losses recognized in the balance sheet.
• 05:01 And that's because the auditors of the statutory accounts have
• 05:04 to say it's true and fair.
• 05:05 And if they sign up that this is an actual asset in the balance sheet,
• 05:09 they're really saying, going forward,
• 05:11 they think there's possibly going to be a profit to offset this against.
• 05:15 And there have been case law precedents set where an individual or
• 05:20 a shareholder has taken the auditor to court because the company went bust.
• 05:25 And they were relying on these tax losses which never actually came to fruition.
• 05:29 So what we model and what happens in real life can be very different things.
• 05:35 We've still got more of the theory to go.
• 05:38 Let's have a look then at the idea of other types of deferred tax issues
• 05:43 in the next session.

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