Income taxes – give to Caesar, but what about the IASB?

Some say the tax return is ‘the easy bit’. Deferred tax accounting continues to cause heartburn years after the transition to IFRS. In addition, a newfound angst surrounding uncertain tax positions is emerging

Background

The IASB began its current project in 2002, supposedly to finalise a new standard on accounting for income taxes in time for IFRS to be applied widely for the first time in 2005. The project morphed into a joint project with the Financial Accounting Standards Board (FASB) to streamline, improve and converge deferred tax accounting. An exposure draft was issued by the IASB in March 2009, after the FASB withdrew from the project.

The basis of the approach under the existing IAS 12/AASB 112 Income Taxes and the equivalent United States pronouncements is a ‘balance sheet’ approach. By comparing the carrying amounts of assets and liabilities with their equivalent tax values, the outcome is sometimes surprisingly the ‘right’ answer. But not always. Debate rages over whether the exceptions to recognition of taxes should be applied in areas such as leases and decommissioning liabilities, there is uncertainty where multiple tax consequences arise (such as ‘revenue’ and ‘capital’ consequences of buildings and intangible assets) and even as to what is an ‘income tax’ is in the first place.

But the greatest derision is kept for ‘uncertain tax positions’ – what they are and how they should be accounted for in practice. This impacts the measurement of both current and deferred taxes and is the crucial sticking point in this project.

The uncertain tax position concept

There is nothing certain in life but death and taxes. Well, maybe. When it comes to taxes, there is little in an average tax return for which companies and their advisers could confidently put their hands on their hearts and say is 100% certain of being sustained on investigation by the Australian Tax Office (or other relevant taxing authority). Common areas of greater uncertainty include transfer pricing, tax losses, formation of tax-consolidated groups, research and development – but even straightforward areas such as depreciation can be fraught with uncertainties.

The debate from an accounting perspective is how to take the uncertainty in account when reporting the impact of taxes on the financial statements. Many entities in Australia currently ‘put their heads in the sand, and fully reflect at face value all deductions claimed and other positions taken in the tax return – so long as the amount is more likely than not of being sustained.

In the United States, the issue is tackled from another perspective: no matter what position is taken in the actual tax return, the financial statements can only reflect the possible outcome that has a greater than 50% chance of being sustained on investigation by the taxing authority. Any difference between the tax return and the accounting amount is recognised as a liability, effectively the amount the entity owes for tax on investigation.

The IASB in March 2009 took a wider approach, proposing that all tax amounts would be measured on a weighted probability approach (a popular concept at the IASB, also arising in proposals for provisions and leasing, amongst others). An entity would need to determine every possible outcome of every tax position, assign probabilities to each outcome and then determine the accounting amount recognised using a mechanical mathematical calculation. The number produced from this process would rarely actually reflect the amount ultimately settled on in subsequent negotiations. And the number effectively requires the wisdom of the highest court in the land to determine in the first place.

This area is obviously ripe with commercial difficulty and is a touch point of discord with companies – the problem extends beyond a mere conceptual accounting issue and into a commercial risk with accounting and disclosure creating a ‘roadmap’ for tax authorities. It has been suggested that differences in the approaches between the IASB and FASB was one of the causes of the FASB backing away from the joint project – it had already been through a battle with its constituents on its existing requirements, why should it go back with another approach so soon afterwards?

The current state of play

Constituent comment on the IASB’s proposals was overwhelming negative. The weighted probability approach to uncertain tax positions received a disproportionate share of criticism, as did the proposed ‘simplification’ of the deferred tax calculation methodology.

As a key remaining plank in the agreed convergence process between IFRS and US-GAAP, the IASB and FASB discussed constituent comment on the IASB’s exposure draft at a joint meeting in October 2009. It was effectively agreed to abandon the proposals in the IASB’s ED in favour of a short-term project. The IASB subsequently confirmed this approach and is currently working on a list of issues with the existing IAS 12/AASB 112 – including uncertain tax positions where the current United States approach would have to be considered a slight favourite for the win in the conceptual argument. The original deadline of a new or revised standard applying no later than 2013 (and perhaps earlier) remains.

Dealing with tax is hard enough. Uncertainty around accounting doesn’t make it any easier. Tax returns tend to be ‘open’ for review for a number of years, meaning that positions taken in current and future tax years may fall within the scope of any new requirements.

The key message is this: whilst there is no need to panic quite yet, taxpayers need to think strategically when dealing with current tax issues. No one is suggesting a full-blown weighted probability analysis is needed for every single tax uncertainty an entity faces. However, high-level consideration of uncertain tax positions now will allow better planning for future financial reporting. The lessons learned from this high-level review can be developed into a more strategic approach to uncertain tax positions going forward – from a need to consider the proposals in major transactions and tax events, to developing a tax risk management policy on the spectrum of tax planning.

Learn more

• Deloitte press release ‘’ Deloitte welcomes rethink of accounting for income taxes, but warns against complacency’
• Joint Accounting and Tax alert ‘ IASB’s income tax proposals – taxing times ahead’
• IAS Plus Update Newsletter ‘Exposure draft on income tax’ (PDF 103kb)
• IAS Plus project page