This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to the International Accounting Standards Board on 31 July 2009:
Dear Sir,
Exposure Draft (ED/2009/2): Income Tax
We are pleased to have the opportunity to comment on the above exposure draft issued by the International Accounting Standards Board (IASB), on behalf of BDO International. Our detailed comments are set out in the attached appendices.
We welcome the IASB’s proposal to develop a new standard on income taxes as the existing IAS 12 is unnecessarily complicated being more of a collection of rules, rather than a clear principles based standard. However, we are concerned that the ED may not represent a sufficient improvement to the existing guidance in IAS 12 to justify a change in approach. Our significant reservations include in particular:
- The objective of US GAAP convergence will not be achieved. The project on Income Taxes was originally a joint project with the FASB, characterised as a short-term convergence project. However, we note that the FASB has deferred any decision on whether to undertake projects that would eliminate differences in the accounting for tax by adopting the IFRS (paragraph IN5 of the ED). As a result the proposals in the ED differ from applicable US GAAP. In addition we are not convinced that the objective of convergence with US GAAP will improve financial reporting as the provisions taken from FAS 109 are rules-based and affected by the US tax jurisdiction and environment.
- The ED fails to improve the current guidance overall as it replaces one set of rules with a different set of rules, rather than seeking to identify a principles-based approach. Whilst it eliminates some of the complexity of the current standard, in doing it creates a number of new issues, increasing complexity and reducing understandability.
In consequence, in our view the IASB should not proceed with the project. Instead, we believe that the IASB should develop a proposal which provides a more robust and fundamental approach to the issues of tax accounting. We are aware that the ASB (Accounting Standards Board) and the GASB (German Accounting Standards Board) are jointly leading a project on “Accounting for corporate income tax”, as part of the Pro-active Accounting Activities in Europe (PAAinE) initiative and suggest that the IASB might consider their proposals in the development of an improved ED. We acknowledge that, despite our view to the contrary, the IASB may wish to proceed with its proposals as set out in the ED. We have therefore set out our responses to the detailed questions in the ED together with some additional comments in the attached appendices. We consider that in particular, the approach for uncertain tax positions should be considered further and clarified.
We hope that our comments and suggestions are helpful despite our reservations regarding the proposals. Should you wish to discuss any of the points we have raised please contact Andrew Buchanan at +44 (0)20 7893 3300 or Tracey-Lee Massey at +32 2 778 0130.
Yours faithfully,
BDO Global Coordination B.V.
APPENDIX 1
Question 1 - Definitions of tax basis and temporary difference
The exposure draft proposes changes to the definition of tax basis so that the tax basis does not depend on management’s intentions relating to the recovery or settlement of an asset or liability. It also proposes changes to the definition of a temporary difference to exclude differences that are not expected to affect taxable profit. (See paragraphs BC17–BC23 of the Basis for Conclusions.)
Do you agree with the proposals? Why or why not?
We do not agree with the proposed changes to the definition of tax basis. We believe that the value of assets to an entity will regularly be recovered through use, rather than through a sales transaction. Therefore, using a sales approach as the only method for the determination of the tax basis of assets will result in deferred tax balances that will be different from the actual cash flows that are likely to arise from the recovery of an asset and therefore do not represent relevant financial information for the user. A similar issue arises with respect to the definition of the tax basis of a liability.
Of particular importance is the inconsistency of the ED with respect to management expectations. For instance the ED states that the determination of the tax basis does not depend on managements expectations regarding the recovery of the asset, but acknowledges the role of management expectations with respect to the initial threshold of the recognition and the measurement of deferred tax assets and liabilities. In addition the proposal set out in the ED would continue an existing difference between IFRS and US GAAP as US GAAP does not currently define the tax basis.
We doubt that it is possible to achieve the principle of reflecting the tax consequences of transactions when there is a requirement to determine the tax basis as being on a sale basis, as this precludes the expected tax consequences of a transaction from being reported. Consequently, management’s intention relating to the recovery or settlement of an asset or liability with respect to the definition of tax basis might provide more relevant financial information. If it is considered that management intention is not an appropriate basis, we would suggest an alternative approach. Such an alternative approach might be based on a principle of the “highest and best use” of an asset/liability by market participants (which is the approach considered in the ED Fair Value Measurement) as this could be viewed as being a more principles-based starting point for the definition of the tax basis. This might also increase consistency within IFRS.
We agree with the proposal that temporary differences exclude differences that are not expected to affect taxable profit.
Question 2 - Definitions of tax credit and investment tax credit
The exposure draft would introduce definitions of tax credit and investment tax credit. (See paragraph BC24 of the Basis for Conclusions.) Do you agree with the proposed definitions? Why or why not?
We welcome the definitions of tax credits and investment tax credits, as there is currently no guidance under IFRS. However, it would be helpful if the Board could provide additional guidance regarding the accounting consequences.
Question 3 - Initial recognition exception
The exposure draft proposes eliminating the initial recognition exception in IAS 12. Instead, it introduces proposals for the initial measurement of assets and liabilities that have tax bases different from their initial carrying amounts. Such assets and liabilities are disaggregated into (a) an asset or liability excluding entity-specific tax effects and (b) any entity-specific tax advantage or disadvantage. The former is recognised in accordance with applicable standards and a deferred tax asset or liability is recognised for any temporary difference between the resulting carrying amount and the tax basis. Outside a business combination or a transaction that affects accounting or taxable profit, any difference between the consideration paid or received and the total amount of the acquired assets and liabilities (including deferred tax) would be classified as an allowance or premium and recognised in comprehensive income in proportion to changes in the related deferred tax asset or liability. In a business combination, any such difference would affect goodwill. (See paragraphs BC25–BC35 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
Despite the fact that we support Board’s intention to eliminate the initial recognition exception, we believe that the proposals in the ED (which are aimed at eliminating the exception) are, due to the proposals for the initial measurement, overly complex and will not achieve this aim.
We are not convinced that the new standard on Income Tax should retain any initial recognition exception at all, even in respect of goodwill. Therefore, we suggest that paragraph 21 of the ED is deleted.
As goodwill is defined as an asset and not only as a residual there is from a principles-based perspective no argument for an exception regarding the recognition of deferred tax effects where there are differences that are expected to affect taxable profit.
We disagree with an exception for temporary differences that arise on foreign subsidiaries and joint ventures (please refer to our response in relation to question 4).
The disaggregation of assets and liabilities with respect to entity-specific tax advantages and disadvantages taking into account the perspective of a market participant may cause significant difficulties in practice, in particular in the determination who the relevant market participant might be. To address some of the difficulties, we suggest that reference might be made to the definition of market participants as set out in the ED for Fair Value Measurements. In addition the application guidance should provide additional guidance on the entity-specific tax effects.
Question 4 - Investments in subsidiaries, branches, associates and joint ventures
IAS 12 includes an exception to the temporary difference approach for some investments in subsidiaries, branches, associates and joint ventures based on whether an entity controls the timing of the reversal of the temporary difference and the probability of it reversing in the foreseeable future. The exposure draft would replace these requirements with the requirements in SFAS 109 and APB Opinion 23 Accounting for Income Taxes—Special Areas pertaining to the difference between the tax basis and the financial reporting carrying amount for an investment in a foreign subsidiary or joint venture that is essentially permanent in duration. Deferred tax assets and liabilities for temporary differences related to such investments are not recognised. Temporary differences associated with branches would be treated in the same way as temporary differences associated with investments in subsidiaries. The exception in IAS 12 relating to investments in associates would be removed.
The Board proposes this exception from the temporary difference approach because the Board understands that it would often not be possible to measure reliably the deferred tax asset or liability arising from such temporary differences. (See paragraphs BC39–BC44 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not? Do you agree that it is often not possible to measure reliably the deferred tax asset or liability arising from temporary differences relating to an investment in a foreign subsidiary or joint venture that is essentially permanent in duration? Should the Board select a different way to define the type of investments for which this is the case? If so, how should it define them?
We do not agree with the proposal. In our view, it would be appropriate to require the recognition of deferred taxes with respect to all temporary differences. If it is not possible reliably to measure deferred tax assets or liabilities from temporary differences of foreign subsidiaries and joint ventures this could be addressed through an impracticability exemption, in a similar way to restatements for changes in accounting policies in IAS 8. This would result in a consistent treatment of domestic and foreign entities of a group.
The justification for the exemption does not only apply to foreign but also to domestic entities. The exemption in paragraph B5 of the ED should only apply if the determination of deferred taxes is impracticable. If it is impracticable to determine deferred taxes reliably disclosure of that fact should be required.
Question 5 - Valuation allowances
The exposure draft proposes a change to the approach to the recognition of deferred tax assets. IAS 12 requires a one-step recognition approach of recognising a deferred tax asset to the extent that its realisation is probable. The exposure draft proposes instead that deferred tax assets should be recognised in full and an offsetting valuation allowance recognised so that the net carrying amount equals the highest amount that is more likely than not to be realisable against taxable profit. (See paragraphs BC52–BC55 of the Basis for Conclusions.)
Question 5A
Do you agree with the recognition of a deferred tax asset in full and an offsetting valuation allowance? Why or why not?
We support a two step approach regarding the recognition of deferred tax assets, which will enhance the ability of users of financial statements to understand the information in relation to the tax position of the entity, i.e. in step one to provide information with respect to all potential deferred tax assets and in step two to provide information regarding the valuation allowance, if any.
We note that this two step approach would converge IFRS with US GAAP in this respect.
Question 5B
Do you agree that the net amount to be recognised should be the highest amount that is more likely than not to be realisable against future taxable profit? Why or why not?
We agree with the proposal, but suggest that guidance is included to clarify the concept to avoid different interpretations in practice. Paragraphs 83-89 of the Framework note that an asset should be recognised when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. In most cases “probable” is interpreted within IFRS as being “more likely than not” (e.g. paragraph 23 of IAS 37). However, we believe there might be different interpretations in practice in respect of the proposals in the ED. In addition we understand that under US GAAP probable and more likely than not are interpreted differently. This again reinforces the need for guidance to clarify what is meant by more likely than not in this context.
Question 6 - Assessing the need for a valuation allowance
Question 6A
The exposure draft incorporates guidance from SFAS 109 on assessing the need for a valuation allowance. (See paragraph BC56 of the Basis for Conclusions.) Do you agree with the proposed guidance? Why or why not?
We agree with the proposal. The guidance is extensive but is likely to improve comparability regarding the recognition of deferred tax assets by different reporting entities.
Question 6B
The exposure draft adds a requirement on the cost of implementing a tax strategy to realise a deferred tax asset. (See paragraph BC56 of the Basis for Conclusions.) Do you agree with the proposed requirement? Why or why not?
We agree with the proposal as the cost of implementing a tax strategy is an integral part of the overall assessment.
Question 7 - Uncertain tax positions
IAS 12 is silent on how to account for uncertainty over whether the tax authority will accept the amounts reported to it. The exposure draft proposes that current and deferred tax assets and liabilities should be measured at the probability-weighted average of all possible outcomes, assuming that the tax authority examines the amounts reported to it by the entity and has full knowledge of all relevant information. (See paragraphs BC57–BC63 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
Although conceptually we can see that the proposal has merit, we do not agree. Instead, the amount provided for an uncertain tax position should be the most likely amount, rather than probability weighted. If this latter approach is followed, then the tax provision will almost never be equal to the actual amount paid. We note that a ‘most likely amount’ approach would be consistent with the approach set out in the Discussion Paper for leases, where there are options to extend the lease term. It would also be more consistent with the 'more likely than not' approach taken in FIN 48.
However, we suggest that the disclosure requirements are considered carefully to address the concerns that arise, in particular where there may be a dispute between an entity and its tax authority. The tax authority may not have full knowledge of all relevant information and (depending on local laws and regulations) the entity may not necessarily be required to provide that information to the tax authority. The disclosures currently required under paragraphs 97 and 125 of IAS 1 have proved to be sufficient to address the needs of users of financial statements (excluding tax authorities).
Question 8 - Enacted or substantively enacted rate
IAS 12 requires an entity to measure deferred tax assets and liabilities using the tax rates enacted or substantively enacted by the reporting date. The exposure draft proposes to clarify that substantive enactment is achieved when future events required by the enactment process historically have not affected the outcome and are unlikely to do so. (See paragraphs BC64–BC66 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
We agree with the proposal.
Question 9 - Sale rate or use rate
When different rates apply to different ways in which an entity may recover the carrying amount of an asset, IAS 12 requires deferred tax assets and liabilities to be measured using the rate that is consistent with the expected manner of recovery. The exposure draft proposes that the rate should be consistent with the deductions that determine the tax basis, ie the deductions that are available on sale of the asset. If those deductions are available only on sale of the asset, then the entity should use the sale rate. If the same deductions are also available on using the asset, the entity should use the rate consistent with the expected manner of recovery of the asset. (See paragraphs BC67–BC73 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
We do not agree with the proposal as it will create an inconsistency with respect to the determination of the tax basis and the measurement of any deferred tax asset/liability (as described in our response to question 1). As noted in our response to that question, we would advocate an approach based on the expected manner of recovery or realisation of assets and liabilities, with a potential alternative of basing the calculation on the “highest and best use” of an asset/liability by market participants.
Question 10 - Distributed or undistributed rate
IAS 12 prohibits the recognition of tax effects of distributions before the distribution is recognised. The exposure draft proposes that the measurement of tax assets and liabilities should include the effect of expected future distributions, based on the entity’s past practices and expectations of future distributions. (See paragraphs BC74–BC81 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
We agree with the proposal as it will provide a fair presentation of the overall expected cash outflows of an entity. To assist in avoiding different interpretations in practice we suggest that detailed application guidance is included, covering how the effect of expected future distributions should be measured.
Question 11 - Deductions that do not form part of a tax basis
An entity may expect to receive tax deductions in the future that do not form part of a tax basis. SFAS 109 gives examples of ‘special deductions’ available in the US and requires that ‘the tax benefit of special deductions ordinarily is recognized no earlier than the year in which those special deductions are deductible on the tax return’. SFAS 109 is silent on the treatment of other deductions that do not form part of a tax basis.
IAS 12 is silent on the treatment of tax deductions that do not form part of a tax basis and the exposure draft proposes no change. (See paragraphs BC82–BC88 of the Basis for Conclusions.) Do you agree that the exposure draft should be silent on the treatment of tax deductions that do not form part of a tax basis? If not, what requirements do you propose, and why?
We agree with the proposal to exclude “special deductions”.
Question 12 - Tax based on two or more systems
In some jurisdictions, an entity may be required to pay tax based on one of two or more tax systems, for example, when an entity is required to pay the greater of the normal corporate income tax and a minimum amount. The exposure draft proposes that an entity should consider any interaction between tax systems when measuring deferred tax assets and liabilities. (See paragraph BC89 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
We agree with the proposal. An entity should consider any interaction between different tax systems when measuring deferred tax assets/liabilities.
Question 13 - Allocation of tax to components of comprehensive income and equity
IAS 12 and SFAS 109 require the tax effects of items recognised outside continuing operations during the current year to be allocated outside continuing operations. IAS 12 and SFAS 109 differ, however, with respect to the allocation of tax related to an item that was recognised outside continuing operations in a prior year. Such items may arise from changes in the effect of uncertainty over the amounts reported to the tax authorities, changes in assessments of recovery of deferred tax assets or changes in tax rates, laws, or the taxable status of the entity. IAS 12 requires the allocation of such tax outside continuing operations, whereas SFAS 109 requires allocation to continuing operations, with specified exceptions. The IAS 12 approach is sometimes described as requiring backwards tracing and the SFAS 109 approach as prohibiting backwards tracing. The exposure draft proposes adopting the requirements in SFAS 109 on the allocation of tax to components of comprehensive income and equity. (See paragraphs BC90–BC96 of the Basis for Conclusions.)
Question 13A
Do you agree with the proposed approach? Why or why not?
The exposure draft deals with allocation of tax to components of comprehensive income and equity in paragraphs 29–34. The Board intends those paragraphs to be consistent with the requirements expressed in SFAS 109.
We do not agree with the proposed requirements and do not consider that the elimination of “backwards tracing” will result in an improvement in financial reporting. In addition, the proposed requirements on the allocation of tax to components and comprehensive income and equity are overly prescriptive and add significant complexity.
We believe that the current requirements regarding backwards tracing and tax allocation should be retained.
Question 13B
Would those paragraphs produce results that are materially different from those produced under the SFAS 109 requirements? If so, would the results provide more or less useful information than that produced under SFAS 109? Why?
The exposure draft also sets out an approach based on the IAS 12 requirements with some amendments. (See paragraph BC97 of the Basis for Conclusions.)
As noted above, we believe that backwards tracing should be retained as it provides more useful information.
Question 13C
Do you think such an approach would give more useful information than the approach proposed in paragraphs 29–34? Can it be applied consistently in the tax jurisdictions with which you are familiar? Why or why not?
We do not consider that the proposed approach would provide more useful information.
Question 13D
Would the proposed additions to the approach based on the IAS 12 requirements help achieve a more consistent application of that approach? Why or why not?
We do not believe that the proposed additions will result in the achievement of a more consistent approach.
Question 14 - Allocation of current and deferred taxes within a group that files a consolidated tax return
IAS 12 is silent on the allocation of income tax to entities within a group that files a consolidated tax return. The exposure draft proposes that a systematic and rational methodology should be used to allocate the portion of the current and deferred income tax expense for the consolidated entity to the separate or individual financial statements of the group members. (See paragraph BC100 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
We agree with the proposal.
Question 15 - Classification of deferred tax assets and liabilities
The exposure draft proposes the classification of deferred tax assets and liabilities as current or non-current, based on the financial statement classification of the related non-tax asset or liability. (See paragraphs BC101 and BC102 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
In principle, we agree with the proposal and note that it would align the requirements of IFRS with those of US GAAP, but are of the view that the classification requirements should be included in IAS 1, such that there is no need for individual standards to include guidance on this type of presentation issue.
Question 16 - Classification of interest and penalties
IAS 12 is silent on the classification of interest and penalties. The exposure draft proposes that the classification of interest and penalties should be a matter of accounting policy choice to be applied consistently and that the policy chosen should be disclosed. (See paragraph BC103 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
We agree with the proposal to allow an accounting policy choice.
Question 17 – Disclosures
The exposure draft proposes additional disclosures to make financial statements more informative. (See paragraphs BC104–BC109 of the Basis for Conclusions.) Do you agree with the proposals? Why or why not?
The Board also considered possible additional disclosures relating to unremitted foreign earnings. It decided not to propose any additional disclosure requirements. (See paragraph BC110 of the Basis of Conclusions.) Do you have any specific suggestions for useful incremental disclosures on this matter? If so, please provide them.
We disagree with the proposed disclosure requirements. The existing disclosure requirements of the current standard are already extensive and we support the IASB in its review of the usefulness of current requirements. However, the proposals of the ED bring even more complexity increasing the risk of “information overflow” which may not benefit users of financial statements.
In particular, we disagree with the disclosure requirements regarding
- major sources of uncertainties relating to tax (paragraph 41b, 41e and 49), please see our response to question 7.
- a detailed roll-forward tracing of deferred tax assets and deferred tax liabilities for each type of temporary difference and for each type of unused tax losses and tax credits and taxes recognised in OCI and equity (paragraph 46b).
- transfers of assets and liabilities within a consolidated group between tax jurisdictions with different tax rates
- In our view these further disclosure requirements will provide only limited additional value for users, but will increase complexity. We believe that IAS 1 adequately addresses the disclosure requirements about major sources of uncertainty, therefore no additional disclosure requirements for deferred tax are needed.
Question 18 - Effective date and transition Paragraphs 50–52 of the exposure draft set out the proposed transition for entities that use IFRSs, and paragraph C2 sets out the proposed transition for first-time adopters. (See paragraphs BC111–BC120 of the Basis for Conclusions.) Do you agree with these proposals? Why or why not?
We agree with the transitional rules as proposed.
APPENDIX 2 - ADDITIONAL COMMENTS
Structure of the ED
The guidance regarding the accounting for current and deferred tax is included within the proposed Standard itself, the Application Guidance and the Basis for Conclusions. Some of the key definitions are included in the proposed Standard and are duplicated in the Application Guidance. We suggest that the structure of any standard based on the proposals is revisited and simplified such that the key guidance and definitions are included within the standard itself.
Reference to specific tax jurisdictions
The ED refers in paragraphs B26 and BC 66 to the US tax jurisdiction. The reference to a specific tax jurisdiction conflicts with a principles-based approach. We suggest that the references are deleted.
Discounting of deferred taxes
The ED carries forward the requirement of the current guidance that deferred taxes are not discounted. We would raise two observations:
- In its January 2009 meeting the IASB discussed reasons for not providing guidance on the discounting of current taxes (Agenda Paper 19 - Ballot draft sweep issue - discounting current tax, IASB Meeting, January 2009). However, the IFRIC previously noted that its general view was that current taxes payable should be discounted as far as the time value of money is material (IFRIC Update, June 2004). Therefore, we suggest that the IASB might reconsider the requirement that deferred taxes should not be discounted.
- The current guidance on the measurement of deferred taxes justifies the approach of not discounting by referring to impracticability and complexity (paragraph 54 of IAS 12). However, while the ED carries this requirement forward, it does not explain why. We would welcome a fuller discussion of the importance of the role of discounting, in particular in relation to valuation allowances for deferred tax assets resulting from unused tax loss carry-forwards.
1 BDO International is a world wide network of public accounting firms, called BDO Member Firms, serving international clients. Each BDO Member Firm is an independent legal entity in its own country. The network is coordinated by BDO Global Coordination B.V., incorporated in the Netherlands, with an office in Brussels, Belgium, where the International Executive Office is located.
Exposure Draft ED/2009/2 of March 2009: Income Tax, Comments due by 31 July 2009:
ED-2009-2 Income Tax.pdf