FASB May Adopt IFRS for Tax Accounting

As the movement toward international accounting standards kicks into high gear, the Financial Accounting Standards Board may be planning to set aside certain portions of Generally Accepted Accounting Principles and simply adopt the international equivalent.

Such is apparently the case with accounting for income taxes, where FASB staff is advocating the wholesale replacement of Financial Accounting Standard No. 109, Accounting for Income Taxes, with its international counterpart, International Accounting Standard No. 12, Income Taxes.

FASB and the International Accounting Standards Board have been working on a joint project to converge FAS 109 and IAS 12 for some time. Now it seems FASB may just put U.S. wrapping paper on IAS 12 (as IASB plans to amend it; not in its current form), include that rule in U.S. GAAP, and call it a day.

Evans

“Now they’ve changed their direction,” says Chuck Evans, a partner at Grant Thornton. “The original idea was to amend FAS 109 so it would be converged with IAS 12. Now the approach is to completely adopt IAS 12 with some modifications to existing IAS 12.”

The United States has been under pressure for years to get with the program on international accounting rules, but the pace accelerated considerably when the European Union began requiring all EU companies to follow International Financial Reporting Standards in 2005. The Securities and Exchange Commission has already ruled that foreign companies filing under IFRS no longer need to reconcile their statements to U.S. GAAP. The Commission is widely expected to give domestic filers the choice of using IFRS rather than GAAP later this year.

FASB has been on a “convergence” path with IASB since the international board was formed in 2001. That work, however, has largely consisted of plucking away at joint projects with a goal of establishing accounting rules in IFRS and GAAP that are substantially comparable.

Now that the SEC talks about wholesale adoption of IFRS in U.S. capital markets, the urgency has given way to futility.

Gannon

“Standard setters are coming to the realization they just can’t get it all done in the next couple of years, so they have to pick and choose what to deal with in a short period of time,” says D.J. Gannon, a partner at Deloitte & Touche and leader of its IFRS Center of Excellence. “Now they’re talking about just adopting standards. If we’re using IFRS, there’s no need to converge the local standard any more. [Taxes] is one they can get done.”

The two boards have been working on revising their income tax rules since 2002 as part of their “short-term” convergence efforts. That category describes projects where the boards initially saw few differences in their rules and expected convergence to be a quick feat.

“Quick” and GAAP rulemaking, however, can rarely be uttered in the same sentence. Six years after starting the tax project, the two boards are just now preparing to issue their first drafts. FASB and IASB are expected to issue exposure drafts in 2008, with a goal of completing standards in 2009 to take effect in 2010.

DETAILS OF IAS 12

Below is an excerpt of IAS 12, Accounting for Taxes on Income.

Recognition of Deferred Tax Liabilities

The general principle in IAS 12 is that deferred tax liabilities should be recognized for all taxable temporary differences. There are 3 exceptions to the requirement to recognize a deferred tax liability, as follows:

liabilities arising from goodwill for which amortization is not deductible for tax purposes;

liabilities arising from the initial recognition of an asset/liability other than in a business combination which, at the time of the transaction, does not affect either the accounting or the taxable profit; and

liabilities arising from undistributed profits from investments where the enterprise is able to control the timing of the reversal of the difference and it is probable that the reversal will not occur in the foreseeable future.

Recognition of Deferred Tax Assets

A deferred tax asset should be recognized for deductible temporary differences, unused tax losses and unused tax credits to the extent that it is probable that taxable profit will be available against which the deductible temporary differences can be utilized, unless the deferred tax asset arises from:

negative goodwill which was treated as deferred income under IAS 22 Business Combinations; or

the initial recognition of an asset/liability other than in a business combination which, at the time of the transaction, does not affect the accounting or the taxable profit.

Deferred tax assets for deductible temporary differences arising from investments in subsidiaries, associates, branches and joint ventures should be recognized to the extent that it is probable that the temporary difference will reverse in the foreseeable future and that taxable profit will be available against which the temporary difference will be utilized.

The carrying amount of deferred tax assets should be reviewed at the end of each reporting period and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be utilized. Any such reduction should be subsequently reversed to the extent that it becomes probable that sufficient taxable profit will be available.

A deferred tax asset should be recognized for an unused tax loss carry forward or unused tax credit if, and only if, it is considered probable that there will be sufficient future taxable profit against which the loss or credit carry forwards can be utilized.

Source

International Accounting Standards Board.

Given the renewed urgency for allowing IFRS in the United States, FASB signaled to IASB in April that it would simply set aside FAS 109, take several amendments IASB is developing for IAS 12, and issue the whole thing as a proposed new standard on accounting for income taxes under U.S. GAAP.

Enter FIN 48

Unanswered, however, would be burning questions about how companies should then deal with Financial Interpretation No. 48 Accounting for Uncertainty in Income Taxes—the controversial and unpopular rule that says companies must disclose any uncertainty they have about tax positions they claim on financial reports. So far, FASB and IASB have a subtle, but distinct, difference of opinion about what companies should be required to report.

FASB has told IASB that accounting for uncertainty in income taxes is of “critical importance” in GAAP and must somehow be addressed in international rules. Observers like Gannon and Evans are curious to see how it will play out.

FIN 48 requires companies to assess all uncertain tax positions, determine which positions are “more likely than not” to hold up under a tax audit, then book a tax benefit only for those that meet that 51 percent threshold. For example, if a company is only 40 percent certain a position will hold up under audit, it would book no benefit at all in its financial statements.

In its current form, IAS 12 is silent on how companies should reflect uncertainty in their income taxes. IASB is working on a separate change to its existing standards, that would establish a probability-weighted average covering any expected outcome no matter how remote, Evans says. For example, a company only 40 percent certain about a given position would book a 40 percent benefit.

Immelman

“We don’t think the international standards are going to have something comparable to FIN 48, but everything we hear from FASB says they’re not going to do away with FIN 48” says Christina Immelman, managing director of tax services for auditing firm RSM McGladrey. That would leave a significant unresolved difference in GAAP and IFRS just when companies could get the opportunity to decide which accounting system to follow, she says. “It’s a very open item as to what is going to happen.”

Evans says the most contentious aspect of FIN 48 is not the measurement and recognition provisions, but the required disclosures. Companies have railed that the disclosures essentially give tax auditors a roadmap of where to look for trouble. “I’m not sure I’ve seen anything about disclosures in the international standards,” Evans says.

Dolinar

Aside from the FIN 48 question, accountants say other differences between IAS 12 and FAS 109 are small and should not lead to significant changes in future practice. “When you look at the standards together from a principles perspective, they’re very similar,” says James Dolinar of the auditing firm Crowe Chizek. “When you look at implementation, that’s where the differences lie.”

Dolinar worries that if FASB eliminates implementation guidance by adopting a more principles-based approach, the burden will fall to accounting firms to provide implementation guidance. “That’s going to lead to a lot more inconsistency problems,” he says. “When you research the firms’ views on implementing international standards, they’re not the same. If you get to the point where everyone is applying based on principles, you’re going to see a lot of diversity in actual practice.”