Taxing issues – are we missing a great opportunity?

Deferred tax is one of the least understood items on balance sheets. Its accounting is widely criticised as being too theoretical, too complex and not representing the economic effect of future tax cash flows. Some even argue that deferred tax is not a liability.

These criticisms might suggest that the IASB and FASB deferred tax standards, which are based on similar principles but are different in some details, should be reviewed afresh starting with a ‘blank piece of paper’.

Such fundamental challenges certainly imply that this approach is needed, so that the standard-setters can ask questions such as: is deferred tax a liability? How does it fit in with the Conceptual Framework? What information on taxes is useful to investors? Is the answer on balance sheet accounting or does it lie in note disclosure or elements of both?

Yet the IASB has recently issued proposals that do not address these fundamental questions. Indeed, the proposals seek to change IFRS so that it is nearer to the FASB rules, though not quite the same; a move towards harmonisation, without quite achieving it.

When the IASB first took deferred tax onto its agenda over six years ago, it was described as a ‘short-term convergence project’, with the aim of reducing differences between the IFRS and US rules. But the need for the IASB to remove differences between IFRS and US rules has arguably diminished since last year’s decision by the FASB to review its strategy for short-term convergence projects.

This creates an opportunity for the IASB to tackle some of the important questions that I have suggested above. If deferred tax is so extensively criticised, why tinker at the edges and, in some people’s eyes, add more complexity? Why not address some of those more important questions? As one of my colleagues expressed it recently in the pages of a UK accounting magazine, the IASB, in publishing these proposals, risks attracting the headline, ‘Large, incomprehensible number gets slightly bigger’.

A more holistic approach is that being taken by a recently-formed Anglo-German working party which, through the ‘Pro-active accounting initiative in Europe’, is considering more fundamental questions for the IASB. Yet the process is that the IASB’s current exposure draft may lead to a standard that will be in force for some period of time.

So the debate may be deferred and any change that might be agreed would not be reflected for a number of years – it could be at least until 2014. Perhaps, just in time for US adoption of IFRS, ironically enough. Some may say this is a missed opportunity.

As always, I would be interested in your thoughts, either by commenting here or by email.

Comments

[Attaullah Nihal Khan]

Although deferred tax is considered to be the least understood item on balance sheet however it is an integral element in ensuring accrual basis accounting for financial statements.
Deferred tax keeps a consistency in fair presentation of financial statements by adding a deferred tax liability (based on accrual base accounting) to a current tax liability purely based on cash base accounting.
With out deferred tax liability Our current tax liability would represent liability based on cash base accounting as opposed to accrual base accounting which is the basis of preparation of complete set of financial statements. Thus it will trnaslate into inconsistency within a set of financial statement.

[Rob Mackay]

The concept of deferred tax takes the level of accounting from the factual to the hypothetical. It has perforated the boundaries of the framework within which transactions were intended to be reported by effectively accounting for the consequences of transactions that are yet to occur. Has there ever been an instance of an analyst or other reader claiming that they have been misled by the misrepresentation of deferred tax in the balance sheet of an entity? The answer is probably a resounding NO. That has got to say something about where

[Sinqobile Nsele]

A statement of Deferred tax IAS 12 should not be scrapped, because it helps the preparers of financial statement to present fairly the potential tax consequence that will occur should the entity recovers fully its carrying amount of its net asset value at a certain point in time. Tax consideration for any investment decision is important as they affect the future cash flows that are used for any investment evaluation. Although they could be an argument that such the deferred tax balance in the balance sheet may not provide the user with the information s/he requires to ascertain the the tax consequence for the expected future cash flows. However, it could also be argued that users if given the tax rate can be able to assess the tax consequence by themselves or if not they can seek professional consultant on the tax matters.

Sinqobile
From:South Africa

[Muhammd Ali]

Dear Richard,

I fully endorsed your views that deferred tax is the least understood item of balance sheet with layer of complexities in computation and compounded by insufficient guidance.

IASB released its much-anticipated Exposure Draft of a standard to replace IAS 12, Income Taxes. Income taxes are a significant item for all reporting companies and any changes to how they are accounted for can have a fundamental impact on a company's balance sheet and income statement, as well as its disclosures.

PWC initiative in explaining the impact of new standard on their earnings and balance sheet no. through organization of web cast is really commendable and accompanied by series of publications.

The Exposure Draft proposes several changes to the current requirements of IAS 12, including new requirements for the accounting and disclosure of uncertain tax positions, and definitions of a "tax base" and a "temporary difference." Furthermore, the Exposure Draft proposes a change in the allocation of tax to components of profit or loss or equity (also known as "backward tracing") along with transitional and first-time adoption provisions.
The introduction of concept of discount or premium on tax position is incomprehensible and possibly create tension with the requirements of other IFRS with respect to initial recognition.
The proposed models only add further complexities in already the complex issue and exacerbates the problem. Currently effective IAS on income tax requires certain changes without undergoing complete make over.
Simplification of principles is the best solution but how one could get it is a matter of art.

I would be interested in your thoughts how new initial recognition issue will create tension with other ifrs for example IAS 16.

[Mike Abbots]

Because the Revenue work on a cash basis rather than an accruals basis, we have to have Deferred tax if only for consistency.

Unless the Revenue change to accurals or accounts are in effect cash flows, I doubt if this discussion will go away.

I have just completed the accounts of a medium sized telecom group where deferred tax is NOT an issue, and yet the auditors insisted that in order for the accounts to comply with IAS 12 over 4 pages of notes were taken up by this one note!

I totally agree with the previous comment that no one has asked any questions on this (probably 'no one' understands it!).

It is time it is scrapped.