How deferred tax on undistributed foreign earnings is recognized under IAS 12 and ASC 740

Graziano Stefanelli
7 minutes ago
5 min read

When subsidiaries or joint ventures operate abroad, profits may remain undistributed indefinitely. These retained earnings often carry potential tax consequences—such as withholding taxes, repatriation taxes, or other transfer restrictions. IFRS (IAS 12) and US GAAP (ASC 740) both require companies to assess whether a deferred tax liability (DTL) should be recognized for these potential future taxes. The key difference lies in how the indefinite reinvestment assertion is applied and documented.

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Why undistributed foreign earnings create deferred tax exposures

When a parent owns a foreign subsidiary, its share of the subsidiary’s post-acquisition profits may ultimately be repatriated as dividends. At that moment, the parent could face:

Withholding tax in the subsidiary’s jurisdiction.
Additional domestic tax if repatriation reduces available foreign tax credits.
Currency translation and remittance costs.

The accounting question is whether these potential taxes are probable obligations (requiring recognition) or contingent on future management decisions (thus disclosed only).

Example:A parent in France owns 100% of a US subsidiary. The US subsidiary has retained earnings of €50,000,000. A 5% withholding tax would apply upon dividend distribution. The parent must decide whether to recognize a DTL for €2,500,000 or assert that earnings will be indefinitely reinvested in the US operation.

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IFRS approach — IAS 12.39 to IAS 12.45

1. Basic principle

A deferred tax liability must be recognized for taxable temporary differences arising from investments in subsidiaries, branches, associates, and joint arrangements, except when:

The parent can control the timing of the reversal of the temporary difference, and
It is probable that the temporary difference will not reverse in the foreseeable future.

2. Control test

The parent controls the timing if it can prevent distribution of profits (for example, through control of the board or dividend policy).
If local regulations or covenants restrict repatriation, the temporary difference may be considered not expected to reverse.

3. Measurement

If a DTL is recognized, it is based on the expected tax rate on distribution (including withholding tax) applicable in the foreign jurisdiction at the reporting date.

Example (continuing):If the parent intends to repatriate 40% of the subsidiary’s earnings (€20,000,000) and the withholding tax rate is 5%:

Deferred tax liability = 20,000,000 × 5% = €1,000,000.

4. Disclosure

If the parent does not recognize a DTL because profits are indefinitely reinvested, IAS 12.82A requires disclosure of:

The aggregate amount of temporary differences relating to such investments, and
The unrecognized DTL if it is practicably determinable.

Example note (IFRS):

The Group has not recognized deferred tax liabilities of €9.6 million in respect of undistributed earnings of foreign subsidiaries amounting to €192 million, as such profits are indefinitely reinvested.

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US GAAP approach — ASC 740-30-25

1. Recognition threshold

ASC 740 requires recognition of deferred taxes on temporary differences related to investments in foreign subsidiaries unless the entity can demonstrate that undistributed earnings will be indefinitely reinvested (known as the indefinite reinvestment assertion).

2. Indefinite reinvestment assertion

A DTL is not recognized if:

The company intends and is able to indefinitely reinvest the earnings abroad.
The assertion is supported by specific evidence (strategic plans, funding needs, cash flow forecasts).

If these conditions are met, no deferred tax is recorded.

3. Recognition and measurement

If the assertion cannot be supported, recognize a DTL for the incremental tax that would arise upon repatriation—typically withholding tax or differential domestic tax.

Example (continuing):If management cannot demonstrate indefinite reinvestment, record:

Dr Income Tax Expense 2,500,000
Cr Deferred Tax Liability 2,500,000

4. Disclosure

Even when the indefinite reinvestment assertion is applied, ASC 740-30-50-2 requires disclosure of:

The cumulative amount of unremitted earnings, and
The unrecognized DTL or a statement that it is not practicable to estimate.

Example note (US GAAP):

At December 31, 2025, unremitted earnings of foreign subsidiaries totaled $300 million. Deferred income taxes have not been recognized on these earnings as management intends to indefinitely reinvest them outside the United States. The unrecognized deferred tax liability on these earnings is approximately $12 million.

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Comparative framework — IAS 12 vs ASC 740

Topic	IFRS (IAS 12)	US GAAP (ASC 740)
Recognition rule	Recognize DTL unless reversal is not probable and timing is controlled	Recognize DTL unless indefinite reinvestment assertion is supported
Control assessment	Parent must control dividend policy and repatriation	Intent and ability must be demonstrable and documented
Measurement	Expected tax rate on distribution (withholding or remittance tax)	Incremental tax on repatriation (withholding + residual domestic tax)
Disclosure	Disclose unrecognized temporary differences and potential DTL	Disclose unremitted earnings and unrecognized DTL (or not practicable)
Reversal / change in plan	Recognize DTL in period when plan to distribute changes	Same; record current-period tax expense for new DTL
Deferred tax asset	Possible if losses of foreign subsidiary expected to be recovered through distribution	Possible in limited cases (rare)

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Worked example — partial repatriation scenario

Facts:

Subsidiary retained earnings: €80,000,000.
50% intended to be distributed next year (withholding tax 10%).
Parent controls distribution.

IFRS computation:Deferred tax liability = 80,000,000 × 50% × 10% = €4,000,000.

Entry:

Dr Income Tax Expense 4,000,000
Cr Deferred Tax Liability 4,000,000

US GAAP computation:If indefinite reinvestment assertion applied to the remaining 50%, recognize only the €4,000,000 DTL for the portion planned for distribution.

If the assertion is withdrawn later, recognize additional DTL when plan changes.

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Journal entries summary

IFRS (IAS 12):

Recognize DTL when reversal probable:
- Dr Income Tax Expense xx
- Cr Deferred Tax Liability xx
Derecognize when indefinite reinvestment becomes probable:
- Dr Deferred Tax Liability xx
- Cr Income Tax Expense xx

US GAAP (ASC 740):

Recognize DTL when indefinite reinvestment assertion not supported:
- Dr Tax Expense xx
- Cr Deferred Tax Liability xx
Reverse if assertion subsequently established:
- Dr Deferred Tax Liability xx
- Cr Tax Benefit xx

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Impact on financial performance and ratios

Effective tax rate (ETR): Deferral under the indefinite reinvestment policy lowers ETR temporarily.
Equity: DTL recognition reduces retained earnings.
Cash flow: No immediate cash outflow; the impact is deferred until dividends occur.
Comparability: Cross-border groups using different frameworks may report divergent ETRs solely due to reinvestment assertions.

Analysts should adjust for unrecognized deferred taxes on foreign earnings to estimate a company’s sustainable effective tax rate.

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Operational considerations

Maintain an inventory of unremitted earnings by subsidiary and jurisdiction.
Document intent and ability for indefinite reinvestment with management approvals and cash flow projections.
Periodically reassess the assertion, especially when liquidity, capital structure, or regulatory conditions change.
Coordinate with treasury and tax departments to track withholding rates and treaty effects.
Ensure consistent disclosure wording across IFRS and US GAAP reporters in dual-filing environments.

Accurate recognition and disclosure of deferred tax on undistributed foreign earnings demonstrate disciplined tax governance and transparency in cross-border profit management.

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DATA STUDIOS

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