Technical Advisory: Fair Value Adjustments (IAS 40 & IFRS 9) vs. Taxable Gross Income
This document outlines the accounting treatment of fair value adjustments under International Financial Reporting Standards (IFRS) and contrasts it with the tax treatment under the Zimbabwean Income Tax Act [Chapter 23:06] and Capital Gains Tax Act [Chapter 23:01].
1. The Core Conflict: Accounting Profit vs. Taxable Gross Income
The objective of financial reporting under IFRS is to present a “true and fair view” of an entity’s economic reality, which includes recognizing unrealized changes in asset values (Fair Value Adjustments).
Conversely, the tax system in Zimbabwe operates on the realization principle. Under Section 8(1) of the Income Tax Act [Chapter 23:06], “Gross Income” is defined as:
…the total amount, in cash or otherwise, received by or accrued to or in favour of a person in any year of assessment from a source within or deemed to be within Zimbabwe, excluding receipts or accruals of a capital nature.
Why Fair Value Adjustments (FVAs) are Excluded from Gross Income:
- No “Accrual” has Occurred: For tax purposes, an income “accrues” only when the taxpayer becomes unconditionally entitled to receive it (Lategan v CIR). An unrealized fair value gain is a paper-based, hypothetical movement; no legal right to receive cash from a third party has arisen.
- Capital Nature: FVAs on long-term assets (like investment properties) are capital in nature. Under Section 8(1), capital receipts and accruals are explicitly excluded from Gross Income (unless they fall under specific deeming provisions).
2. IAS 40 – Investment Property
Under IAS 40, investment property (property held to earn rentals, capital appreciation, or both) can be subsequently measured using either the Cost Model or the Fair Value Model.
A. Accounting Treatment (Fair Value Model)
If an entity adopts the Fair Value Model:
- The property is revalued to market value at each reporting date.
- Any resulting gain or loss is recognized directly in the Statement of Profit or Loss (P&L).
- No depreciation is charged on the property.
B. Tax Treatment (ZIMRA)
- Unrealized Gains/Losses: ZIMRA does not recognize unrealized fair value gains as part of Gross Income, nor does it allow unrealized fair value losses as a deduction.
- Capital Allowances: Even if an entity does not depreciate the property for accounting purposes, it may still claim Capital Allowances (e.g., Commercial Building Allowance at 2.5% per annum on historical cost) for tax purposes, provided the property is used for the purposes of trade (e.g., commercial letting).
- Tax Computation Adjustment:
- Unrealized Fair Value Gains must be deducted from accounting profit.
- Unrealized Fair Value Losses must be added back to accounting profit.
- Disposal (Realization): When the property is eventually sold, the transaction is subject to the Capital Gains Tax Act [Chapter\ 23:01] (taxed at 20% of the capital gain, or 5% if acquired before 22 February 2019, subject to inflation-adjusted allowance calculations).
3. IFRS 9 – Financial Instruments
IFRS 9 governs the classification and measurement of financial assets and liabilities. The mismatch between IFRS 9 fair value adjustments and tax rules is common in treasury and investment portfolios.
A. Classification & Accounting Treatment
Financial assets are classified into three primary categories, each with distinct fair value treatment:
- Amortized Cost: Measured at amortized cost; no fair value adjustments.
- Fair Value Through Profit or Loss (FVTPL): Fair value movements are recognized directly in the P&L.
- Fair Value Through Other Comprehensive Income (FVTOCI): Fair value movements are recognized in Other Comprehensive Income (OCI) and accumulated in equity.
Additionally, IFRS 9 introduces the Expected Credit Loss (ECL) framework, which requires recognizing provisions for future bad debts based on forward-looking credit risk.
B. Tax Treatment (ZIMRA)
- FVTPL Gains/Losses: Unrealized gains are non-taxable (deducted in tax computation); unrealized losses are non-deductible (added back). Tax is only triggered upon the actual disposal/redemption of the financial instrument (realization).
- FVTOCI Gains/Losses: Because these movements bypass the P&L and go directly to OCI, they do not affect Accounting Profit Before Tax. However, they are also ignored for tax purposes until realized.
- Expected Credit Loss (ECL) Provisions:
- Under Section 15(2)(g) of the Income Tax Act, ZIMRA only permits deductions for debts that are proved to have become bad and have been actually written off during the tax year.
- General provisions, portfolio provisions, and forward-looking ECL adjustments under IFRS 9 are strictly non-deductible and must be added back in the tax computation.
4. Deferred Tax Implications (IAS 12)
Because accounting values incorporate fair value adjustments while tax bases do not, substantial temporary differences arise. These must be accounted for under IAS 12 (Income Taxes).
The formula for a temporary difference is:
Temporary Difference = Carrying Amount – Tax BaseThe resulting Deferred Tax Liability (DTL) or Deferred Tax Asset (DTA) is calculated as:
DTL or DTA = Temporary Difference times Effective Tax Rate
Applying IAS 12 to IAS 40 and IFRS 9:
| Standard | Accounting Scenario | Carrying Amount vs. Tax Base | Tax Rate Applied | Balance Sheet Impact |
| IAS 40 | Fair Value Gain recognized in P&L | Carrying Amount > Tax Base (Historical Cost less tax allowances) | Capital Gains Tax Rate (typically 20%) | Deferred Tax Liability (DTL) created; deferred tax expense charged to P&L. |
| IAS 40 | Fair Value Loss recognized in P&L | Carrying Amount < Tax Base | Capital Gains Tax Rate (typically 20%) | Deferred Tax Asset (DTA) created (subject to probability of future capital gains). |
| IFRS 9 | FVTPL Fair Value Gain | Carrying Amount > Tax Base (Amortized Cost / Purchase Cost) | Corporate Income Tax Rate (typically 25.75% including AIDS levy) | Deferred Tax Liability (DTL) created; deferred tax expense charged to P&L. |
| IFRS 9 | FVTOCI Fair Value Gain | Carrying Amount > Tax Base | Corporate Income Tax Rate or CGT Rate (depending on asset type) | Deferred Tax Liability (DTL) created; deferred tax charge recognized directly in OCI/Equity. |
| IFRS 9 | Expected Credit Loss (ECL) Provision | Carrying Amount of Debtors < Tax Base of Debtors | Corporate Income Tax Rate (25.75%) | Deferred Tax Asset (DTA) created; deferred tax credit recognized in P&L. |
5. Summary Reference Matrix
| Feature | IAS 40 (Investment Property) | IFRS 9 (Financial Instruments – FVTPL) | IFRS 9 (Expected Credit Losses) |
| Accounting Treatment | Gains/losses to P&L | Gains/losses to P&L | Impairment expense to P&L |
| Affects Accounting Profit? | Yes | Yes | Yes |
| Included in Taxable Gross Income? | No (Unrealized/Capital) | No (Unrealized) | No (Provisions are non-deductible) |
| Tax Return Adjustment | Deduct fair value gains
Add back fair value losses |
Deduct fair value gains
Add back fair value losses |
Add back ECL impairment expense
Deduct actual debts written off |
| When is Tax Triggered? | Upon sale of property (Capital Gains Tax) | Upon sale/redemption of asset (Income/Capital Gains Tax) | When specific debts are legally written off |
| Deferred Tax Account | Deferred Tax Liability (at CGT rate) | Deferred Tax Liability (at Corporate Tax rate) | Deferred Tax Asset (at Corporate Tax rate) |
