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Oct. 20 — Companies that fail to disclose the amount of uncertain tax provisions in their financial statements when these are subject to risk are set to be challenged over their inadequate reporting by the U.K.'s regulator.
The warning was issued in a report published Oct. 21 by the Financial Reporting Council following its review of 33 annual reports among the FTSE 350—the top 350 companies listed on the main market of the London Stock Exchange—in which company reports were pulled up for poor articulation of the way they account for tax uncertainties.
“Descriptions of tax-related significant judgments and estimation uncertainties were often bland and not sufficiently specific to the company’s circumstances.
“Companies should articulate better how they account for material tax uncertainties by explaining the bases for recognition and measurement, and we expect more companies to disclose the amount of tax provisions than do so presently ,” the FRC said.
The FRC said that while many of companies—pre-warned as to the regulator’s focus on their tax reporting—explained how they accounted for tax uncertainties, the FRC said their descriptions “were expressed in general terms in the absence of any specific requirement setting out how tax uncertainties should be reflected” in relation to income tax.
While FTSE 250 companies among the top 350 responded proactively to the warning over the scrutiny of the tax reporting element of their accounts by improving their disclosures. The FRC found marked improvement in the quality of information that companies provided in relation to effective tax rate reconciliations, greater visibility of factors including structuring which affected the tax charge and its sustainability.
However, the FTSE 100 fell short.
“It was disappointing that no FTSE 100 company subject to the review stood out as a role model in their reporting of tax,” the FRC said in its report.
“Companies need to respond to increasing stakeholder scrutiny of their tax strategies, including where they pay tax, and consider carefully whether they are sustainable, ensuring that any material risks to which they give rise are clearly described in the report and accounts,” the FRC said.
The issue relating to disclosure of uncertainties in relation to income tax has now been referred to the International Accounting Standards Board, which is expected to issue a clarification on the matter to help companies improve the quality of their reporting.
Of the companies sampled that had identified uncertain tax provisions involving significant judgments and estimates, only 45 percent quantified the provisions, the FRC said.
The FRC said that “clarity about significant risk of short-term adjustment to uncertain tax provisions” is both valuable to investors—the ultimate users of the accounts—and a requirement of international accounting standards.
The area of uncertain tax provisions is now in scope for the FRC’s audit monitoring activities for 2016/2017 annual reports.
Tax has become a particular area of focus for a broad range of stakeholders. The U.K.'s Finance Act 2016 introduces a requirement for larger listed companies to publish a separate tax strategy annually on their website.
Increasing public focus on companies’ tax arrangements and the risk arising from high-risk tax planning also drove the regulator to look more closely into the area.
The FRC’s review of tax reporting within company reports came as a result of concerns identified in previous years, with issues highlighted over annual reports failing to include information of particular interest to investors “such as the discussion of effective tax rates,” the FRC said in its report.
Paul George, FRC executive director of corporate governance and reporting, said the regulator would write to companies with concerns if there are disclosures that are not in annual accounts, when they should be.
“What we are trying to do is improve behavior in advance. Companies never like receiving a letter so they try to get it right the first time,” said George.
He said the FRC made a conscious decision to highlight good practice in its report—Michael Page International plc and Tate & Lyle PLC were singled out for model tax disclosures.
“We didn’t find a FTSE 100 that we could hold up,” he said, adding that the FRC has discussed findings that have emerged with the Hundred Group, which represents finance directors and heads of tax among the U.K.'s top 100 companies.
Senior Deloitte U.K. accounting technical partner Veronica Poole said the FRC’s report was positive due to its emphasis on clarity and quality of disclosures at a time when tax transparency has become a very important matter with a high amount of public interest.
“Companies need to explain what makes their tax rate, and explain uncertainties in these amounts, not simply follow requirements to provide a reconciliation on the effective tax rate. There is so little understanding out there around some of these numbers,” said said.
The report also brings “considerably more focus in the board’s minds on transparency of tax contribution, the rates and uncertainty with those amounts, she said.
“What the FRC is saying is companies need to step back and ask whether they are being clear and explaining enough about their effective tax rate and contribution,” Poole said.
She also highlighted that the timing of the report—in the fourth quarter when multinationals are putting together their skeleton accounts in preparation for their year-end reports—is especially crucial.
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