Aidan Walsh Director Corporate Tax Services

1. Lack of local tax law expertise or failure to engage local tax law expertise resulting in the incorrect assumption of reduced tax expense associated with restructuring charges in various foreign locations in 2004 and 2003;

2. Inadequate knowledge and application of the provisions of SFAS No. 109 [accounting for income taxes – including deferred taxes] by tax personnel resulting in errors in the accounting for income taxes;

3. Lack of clarity in roles and responsibilities with the global tax organizations related to income tax accounting;

4. Insufficient or ineffective review and approval practices within the global tax and finance organizations resulting in the errors not being prevented or detected in a timely manner; and

5. Lack of processes to effectively reconcile the income tax general ledger accounts to supporting detail and adequate verification of data used in computations.

The Conversion from Irish GAAP to IFRS
With effect for accounting periods beginning on or after 1 January 2005, the consolidated financial statements of all EU entities listed on a regulated market must be prepared according to adopted IFRS.

Obviously, the conversion from one accounting standard to another will result in changes to the accounting treatment of certain matters. These changes in accounting treatments will have consequent changes to the current and deferred tax implications of the matters involved.

Some areas are more likely to result in conversion adjustments. Significant accounting differences between GAAP and IFRS include:

• the increased use of fair value measurement and amortised cost, particularly in the financial services sector and for financial instruments such as interest rate hedges;
• greater use of discounting;
• more recognition of specific types of intangibles;
• the treatment of actuarial differences on defined benefit pension schemes;
• the recognition of share options granted to, and other share-based payments made to, employees as an expense of the employer;
• prohibition from using the closing rate to translate the results of a foreign operation;
• prescriptive rules in relation to the determination of functional currency;
• new rules for accounting for foreign exchange forward contracts;
• splitting certain bonds into debt and equity components;
• acceleration or deferral of income due to new income recognition rules;
  

The starting point in preparing an Irish corporation tax computation and for the tax computation in many other jurisdictions (but not all!) is the accounts of a company prepared under the ordinary principles of commercial accounting. Therefore, any change to these principles (for the entity’s accounts – changes at the consolidated level may not have a current tax effect) is going to have a current tax impact and a consequent deferred tax effect. Finally, any legislative changes dealing with conversion are also going to have both a current and deferred tax effect.

Cross-border elements make this problem even worse. For example, one of the conversion issues for many companies is changes to the treatment of intangibles and the amortisation of intangibles e.g. goodwill. In Ireland there is, in most cases, no tax deduction for the amortisation of intangibles. However, in other jurisdictions, for example the UK, there may be a tax deduction.

Therefore, on conversion the accounting treatment of the intangibles may change, this will have consequent current and deferred tax implications but, while the accounting treatment will be the same in different countries for intangibles under IFRS (that being one of the purposes of implementing IFRS), the tax treatment in various countries may be different and, so, the deferred tax treatment of intangibles may be different. Or the tax treatment will be the same but the tax rate may be different or the rate of amortisation allowed is different and, so, again the deferred tax consequences may be different. This is one of the big risks for groups: the complications that flow from the different tax treatment and different tax rates in different countries of the same item.

The tax department in any group needs to understand, at some level, the accounting treatment of these differences and the accountants need to understand, to a greater extent than ever before, the tax issues.

The conversion from FRS 19 [deferred tax] to IAS 12 [accounting for taxes on income].

On top of all that, the conversion to preparing deferred tax under FRS 19 to preparing it under IAS 12 will have further consequences for the deferred tax implications of certain matters. IAS 12 requires a company to recognise a deferred tax liability or, subject to certain conditions, a deferred tax asset for all temporary differences, with certain exceptions. Temporary differences are differences between the tax base of an asset or liability and its carrying amount in the balance sheet. (FRS 19 took a timing difference approach to deferred tax.)

IAS 12 requires that deferred tax assets should be recognised when it is probable that taxable profits will be available against which deferred tax assets can be utilised; these recognition criteria are not significantly different to FRS 19.

The main differences, as detailed in FRS 19 itself, are:

• Revaluation of non-monetary assets.
  
  IAS 12 requires that the deferred tax asset or liability is accounted for even if the company does not intend to dispose of the asset or rollover relief is available.
  
• Sale of assets where gain has been or might be rolled over into replacement assets.
  
• Fair value adjustments (except for non-deductible goodwill).
  

  IAS 12 requires that the deferred tax asset or liability is accounted for even if the company does not intend to dispose of the asset or rollover relief is available.
  

• Unremitted earnings of associates and, possibly, subsidiaries, joint ventures and branches. Generally, IAS requires that deferred tax should be provided on such unremitted earnings. However, IAS 12 prohibits the recognition of such a deferred tax liability to the extent that the investor is able to 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.

  For investment in subsidiaries and joint ventures this would likely mean no provision for deferred tax on unremitted earnings. However, it may be necessary to consider deferred tax on unremitted earnings of associates as the investor may not have control over dividend policy.

• Unrealised intra-group profit (such as on stock) is calculated at the buyer's rate of tax (it is the seller’s rate under FRS 19).
• Exchange differences on consolidation of non-monetary assets.

These changes, particularly having to provide for deferred tax liabilities or assets, where previously only a disclosure was required, have caused and are causing real problems for companies. For example, deferred capital gains on rolled over assets may have been claimed by a company in the past. Irish rollover relief for capital gains tax has been in existence since the 1970s, in other countries it may have existed for longer. The company may not have adequate records going back as far as a particular disposal and rollover claim.

Conclusion:
The problem can only be described as complex. The conversion to IFRS not only changes the way that companies account for different items, the way the tax is accounted for on those items and the current real tax charge resulting from those items but also many areas, such as rollover relief claims, will now require deferred tax provisions and, thus, a much greater degree of record keeping and process management than may, hitherto, have been the case in many companies.

In a previous article I said that changes in the commercial environment required new skills from tax advisers and finance professionals. The conversion to IFRS throws the need for certain of these new skills into a sharp light. In the next article we will look at some of the new skills and techniques that might be useful in dealing with the conversion to IFRS and the financial reporting tax risks that result.

¹ Finance Magazine May 2005
² Control Weakness Disclosure Alert which was recently published by the Corporate Executive Board
³ www.kodak.com/US/en/corp/annualReport04
⁴ Finance Magazine April 2005

Aidan Walsh is a tax director in Ernst & Young specialising in tax risk management. The opinions expressed in this article are the author’s own. The material in this article is provided for general information purposes only and does not constitute professional advice. It is necessarily in a condensed form. Readers are advised to seek professional advice with regard to their particular factual situation before taking any decision or course of action.

© Copyright 2005 Ernst & Young


This article was first published in Finance Dublin – July 2005