By Steven Marcy, BNA Staff Editor
Now is not the time for the International Accounting Standards Board to substantially revamp its income tax accounting standard, many accounting firms and businesses told the board in comment letters on its proposed revisions to International Accounting Standard 12, Income Tax.
Many of the 162 comments filed through Aug. 14 and examined by BNA said it is more urgent for the IASB to refine the guidance on fair value and on financial instruments that were at the heart of the financial crisis. The comment period closed July 31.
Besides the timing, some of the changes proposed in the exposure draft that the IASB issued March 31 are ill considered and impose more complexity and opacity, in contradiction of the goals of greater clarity and transparency.
Many commentators argued that they would welcome IASB rectifying some deficiencies in the current IAS 12—such as determining the manner of recovery of assets, issues over the initial recognition exception, measurement of uncertain tax positions, allocation of taxes within a single tax group—but that a comprehensive revision along the lines of the exposure draft is more trouble than it is worth.
Among other things, constituents said that if the revision does not result in greater convergence with U.S. generally accepted accounting principles, the changes are not helpful. The Financial Accounting Standards Board has suspended work on its parallel project, and has not decided how to proceed further. Previously, FASB had said it would issue the IASB's proposal for comment in the United States, but that was before the financial system meltdown.
The IASB proposed the revision to IAS 12 in March (5 APPR 314, 4/3/09). The revision would retain the temporary differences approach to accounting for income taxes, while removing several exceptions to that approach. At the time, IASB Chairman David Tweedie said the proposal is intended “to achieve clearer, more principles-based standards” that are also easier to understand and apply and result in more consistent reporting.
However, comments on the proposal made clear few believe the IASB achieved those objectives.
For example, Nissan Motor Co. Ltd., in a July 30 letter, objected to adoption of the exposure draft because “it does not achieve the IASB's goal of convergence with U.S. [generally accepted accounting principles], it does not improve financial reporting, it would be burdensome and costly to comply with, and the disclosures are excessive and intrusive.”
“We believe that IAS 12 should be retained until at least the Conceptual Framework is completed,” Nissan said, referring the project by IASB and FASB to update their differing overarching guidance on accounting standards.
Similarly, Royal Dutch Shell in a July 14 letter said it believes the proposed elimination of the initial recognition exception in the exposure draft would add rather than reduce complexity and that the proposal will not foster accounting standards convergence. “Our overall response to this exposure draft is therefore negative. We doubt that many preparers or users will welcome the proposals, and we must ask the [IASB] to reconsider its approach to this project.”
Nestle SA said in Aug. 10 comments that the proposed changes “will result in complexity and additional no-value-added work” that will be “less meaningful” and provide information of no real use to financial statement readers. “We therefore propose that the board should concentrate on making some short-term improvements to IAS 12 and have more comprehensive review of income taxes at a later date,” Nestle said.
Some commenters wanted the IASB to jettison its current approach for advice on better implementation of the current standard.
“We believe that any difficulties in applying the current standard would be better addressed by providing application and/or implementation guidance to the current requirements, rather than by the complete replacement of those requirements by the alternatives proposed in the exposure draft,” said Ernst & Young in a July 30 comment letter that was typical of sentiments voiced by many others.
Grant Thornton said July 10 it did not support the introduction of a new standard along the lines in the exposure draft. “We are not convinced that the proposals, taken as a whole, represent an overall improvement to IAS 12. We also believe that the proposals will fail to achieve the goals set by the Board” of greater transparency and congruence with other international standards, especially with U.S. generally accepted accounting principles.
KPMG Unit Raises Problems
KPMG IFRG Ltd, the United Kingdom unit of the global accounting firm, urged the IASB to call off the project.
“The [IASB] notes that it began work on this project to clarify aspects of IAS 12 and as part of its strategy of short-term convergence with U.S. GAAP,” the KPMG group said in a July 31 comment letter. “Since the inception of this project, significant new priorities have emerged for the Board; meanwhile the U.S. Financial Accounting Standards Board (FASB) has ceased to work on this project. Overall, we consider that the Board should suspend work on this project in its current form.”
KPMG IFRG said the IASB should suspend the project because it does not “represent a significant improvement in financial reporting.”
“The incremental changes to current practice proposed in the [exposure draft] do not respond to an overarching concern about current financial reporting, do not introduce a significant new principle or concept, and will not introduce a step-change improvement in the information provided to users of financial statements,” the KPMG group said. “Some proposals will introduce additional complexity, for example, the proposals regarding initial recognition and the allocation of current and deferred tax to components of comprehensive income and equity.”
“Additionally,” KPMG IFRG said “we believe that some proposals will reduce the relevance of income tax accounting, for example, the proposal to introduce a rule that the tax base of an asset be measured by reference to the tax consequences of selling an item even if an entity plans to use the asset in its business which may have significantly different tax consequences.”
KPMG IFRG said the income tax project “may distract the board from other more pressing matters” such as a revamp in conjunction with FASB on fnancial instruments, and divert resources from other needed projects, KPMG said.
The proposal also does not guarantee full convergence with the FASB, and its implementation costs might be underestimated, KPMG IFRG said. While some areas of income tax accounting need improvement, these can be accomplished through the board's annual update process rather than a completely separate project, the accounting firm unit said.
Not only is the income tax overhaul unnecessary, it is also flawed in many respects, KPMG IFRG said.
KPMG IFRG said the proposal's redefinition of a tax basis could lead to artificial accounting that does not accurately reflect an entity's expected future cash flows. The firm also said the proposal for separate definitions of tax credits and investment tax credits lacks clarity in applying them even to “relatively simple tax benefits.”
KPMG, in comments also echoed by others, said it disagreed with the proposal's decision to:
• temporarily distinguish between certain types of investments;
• provide overly detailed guidance on the need for valuation allowances;
• impose probability-weighted assessments about the outcome of uncertain tax positions that require assessing a multiplicity of outcomes, which runs the risk of creating still more uncertainty; and
• requiring the assessment of what would be an historical “substantively enacted” tax rate.
Deloitte, PwC Comments
Deloitte Touche Tomaiatsu in its July 31 comments doubted the constituents who would use the new standards would favor them.
Among other things, Deloitte said the proposal would “produce outcomes that are inconsistent” with the conceptual framework. The proposed changes also “would not be representationally faithful of the economic substance of the underlying tax consequence expected,” Deloitte said, and would be “difficult to rationally explain.”
PricewaterhouseCoopers, in July 31 comments, objected on a number of fronts.
It said the proposed revisions for recognizing share based payment added complexity and volatility. Instead of recognizing part of share based payment in income and the other part of it received by the individual in equity, the whole thing should be recognized in income, the firm said. “The requirement to track the expected tax benefit by reference to individual awards and allocate a portion to the income statement and a portion to equity in each accounting period adds complexity without significantly improving the financial reporting,” the firm said. It also “creates volatility in both net income and net equity.”
Problems with Deferred Tax Model
PwC also recommended a complete rethinking and overhaul of the deferred tax model to eliminate its complexity and the fact that many of the transactions conducted under the current system fail to reflect actual economic activity. PwC did not, however, recommend the course or elements that this reform should undertake.
PwC also said the IASB should alter its definition of tax credits to include only those that are payable because the tax burdens exceeds the total amount of the credit. Tax credits that exceed the amount of the liability and are therefore “refundable,” should be defined as government grants.
Initial Recognition Issues
Many commenters had problems with the proposed revision to the initial recognition exception, saying they were just far too complex.
The IASB decided that it needed to end the provision that deferred taxes should not be recognized on what were only temporary differences on some assets and liability positions, Ernst & Young explained in an April analysis of the proposals. Not recognizing the deferred taxes in those situations could no longer be justified conceptually because it failed to capture the true economic reasons behind such transactions. “Accordingly, the ‘initial recognition exception is abolished, with deferred tax being recognized on all temporary differences, whenever they arise, except that a deferred tax liability is not recognized on the initial recognition of goodwill,” E&Y said in April.
“We strongly disagree with the (initial recognition exception) proposals,” InterContinental Hotels Group said. “Our view is that the methodology is too complex for purposes of the limited circumstances in which it would be expected to apply in the context of consolidated financial statements, without providing material added value to users of the financial statements.”
PwC also said the proposals lack clarity. “We suggest that illustrative examples explaining how the proposed model should be applied to complex situations would be helpful if the board decides to retain the proposed model,” PwC said.
PwC said the examples should explain:
• “the interaction between the discount or premium and a valuation allowance”;
• “the accounting when the tax deduction available to a market participant that purchases the asset outright (rather than in a corporate shell) differs from the tax basis obtained by the entity,” and;
• “the accounting when the consideration given for the asset is not equal to the fair value of the asset.”
Convergence Goal Undermined
The InterContinental Hotels Group also said July 31 it “would question whether the exposure draft makes significant advances towards” convergence.
“In particular we consider that several of the proposals adopt a methodology based on the existing US GAAP standard FAS 109 (Accounting Standards Codification 740), in circumstances where we believe that the existing IAS 12 methodology or another approach would produce greater benefits for readers of the financial statements whilst also avoiding a substantially increased burden of compliance.”
More Uncertainty to Uncertain Tax Positions
Differences between the IAS 12 proposal and Financial Accounting Standards Board's Accounting Standards Codification 740-10 (Financial Accounting Interpretation 48, Accounting for Uncertainty in Income Tax) on uncertain tax positions also generated criticism.
The IAS 12 proposal would create a “probability-weighted expected outcome approach” to accounting for an uncertain tax postion. Under it, whatever the probability of tax position not being upheld, a reserve equal to that probability must be created on the books. For instance, a 60 percent chance of a position not being sustained would trigger the creation of a reserve equal to 60 percent of the value of the asserted benefit to cover the eventuality of its being disallowed. This could create one of the biggest problems for preparers, PwC said in an April 17 webcast on the issue (5 APPR 415, 5/1/09).
Many commenters said the IAS proposed approach would require the calculation of too many outcomes, each of which would have only a remote chance of occurring.
IHG said it “strongly” disagrees with the IAS 12 uncertain-tax proposal. “Our primary concern is that the proposed methodology would result in the recognition of liabilities for items which are considered to be remote, or indeed some level of benefit for items which are highly unlikely to materialize. The proposed methodology, which does not adopt the two-stage recognition and measurement approach of FIN 48, therefore introduces a burden of quantifying many more positions than under both the current standard and FIN 48.”
“For this reason we would recommend the introduction of a reasonable threshold to eliminate any requirement to assess outcomes in respect of highly certain or highly uncertain items, or alternatively the retention of the current methodology which permits an alternative 'best estimate' approach,” IHG said.
Tax Executives Institute said Aug. 7 the probability-weighted approach “would be difficult to interpret and apply consistently. Assigning a probability to each possible position would require filers to speculate about what position a tax authority will take and how the authority will support that position. Because the tax law is by no means black and white, many issues, such as transfer pricing, can yield multiple outcomes.”
“Assigning a probability to each possible outcome and then weighing each outcome using that probability would force issuers to include even the most unlikely outcomes in their calculations, often resulting in [uncertain tax position] reserves being overstated,” TEI said. “Furthermore, because the approach does not permit an entity to reserve for an amount representing actual settlement outcomes, it would by definition always be an incorrect estimate.”
“TEI believes the approach of FIN 48 is preferable because it does not require a company to estimate probabilities on positions that have a remote possibility of materializing,” the organization's comments said. “Further, the absence of a recognition threshold (as proposed in the Exposure Draft) would result in potential inaccuracies by requiring companies to recognize tax benefits that are highly uncertain or even for those for which no or only meager authority exists.”
While PwC said the IASB should offer guidance on accounting for uncertain tax positions, which the current standard lacks, it also said the basis for that accounting should reflect the likelihood of an obligation being paid or a tax payment being recovered. Remote contingencies should be ignored, PwC said.
Withdraw and Rethink
Overall, the bottom line consensus is that the IASB should withdraw the IAS 12 proposed changes and give it a thorough rethink.
“On balance, we are concerned about continuing developing the income tax standard on the basis of this [exposure draft],” the Federation of European Accountants said in its July 28 comments. “We suggest postponing the project to a future date at which time a more fundamental rethinking of accounting for income tax can be carried out rather than developing short-term solutions to improve IAS 12.”
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