“The uncertainty of accounting for uncertain tax positions” by Noel P. Rabaja (March 29, 2010)
SUITS THE C-SUITE By Noel P. Rabaja
Business World (03/29/2010)
This column recently discussed the increasing need for tax governance and why corporations should pay more attention to tax risk management.
Tax governance is now in focus, as we see increased enforcement activity by the Bureau of Internal Revenue (BIR), and certain developments in accounting may soon require application of special rules on accounting for and disclosure of uncertain tax positions in financial statements.
The Philippines fully adopted the International Financial Reporting Standards (IFRS) in 2005 which include, among others, the International Accounting Standards 12, Income Taxes (IAS 12).
There have been proposals to align IFRS and US GAAP. Under US GAAP, entities are required to account for their uncertain tax positions, pursuant to FASB Interpretation No. (FIN) 48. Thus, the special rules on accounting for uncertain tax positions are not entirely new to some entities since some Philippine companies such as the material subsidiaries and affiliates of US SEC-listed companies already do apply FIN 48 in their US GAAP reporting.
Currently, IAS 12 has no explicit provision on how to account for uncertainty over whether authorities will accept the tax positions taken by an entity. An entity may have taken a position in a previously filed return or is expected to take a position in a future return which can result in a permanent reduction of taxes (permanent differences), a deferral of taxes (temporary differences), or a change in the expected realizability of deferred tax assets (tax planning strategies).
In March last year, the International Accounting Standards Board (IASB) published an Exposure Draft (ED) of a new standard that would have replaced IAS 12. However, this was set aside in October.
While the IASB has yet to come out again with the proposed limited amendments to IAS 12, provisions on uncertain tax positions had already been included in the IFRS for Small and Medium-sized Entities (SMEs) which became effective last Jan. 1.
There are similarities in the manner by which uncertain tax positions are required to be accounted for in the IFRS for SMEs and that proposed in the ED. If this is any indication of the future amendments to IAS 12, it is likely that the IASB may propose amendments to the rules on accounting for uncertain tax positions similar to those provided in the ED.
Entities in the Philippines need to be prepared for this eventuality.
Should any such proposal be adopted, the following guidelines and requirements on recognition, measurement and disclosure will have to be observed and considered:
An entity with an uncertain tax position should stand ready to pay tax, the amount of which is uncertain. No probability threshold should be applied to the recognition of the “stand-ready” liability. This means that an entity needs to look at, and measure, all its uncertain tax positions.
An entity is to use the probability weighted average amounts of possible outcomes, assuming the tax authorities will examine the amounts reported to them, and have full knowledge of all relevant information. In other words, “detection risk” should not be taken into account by the entity.
The ED proposes that entities should disclose information about the major sources of estimation uncertainties relating to tax effects to enable users to assess the possible financial effects of such uncertainties and their timing.
We have observed that the US GAAP and the ED still contain many differences in accounting for income taxes. For example, under the US GAAP, a benefit is recognized when it is more likely than not to be sustained based on the technical merits of the position (excluding any consideration of detection risk). The amount of the benefit to be recognized is based on the largest amount of tax benefit that has more than 50% likelihood of being realized upon ultimate settlement of the uncertainty. In contrast, the ED does not have a threshold in determining whether an uncertain tax position should be recognized (other than materiality).
There will be significant implications if and when rules on accounting for uncertain tax positions (similar to the ED) are adopted in the Philippines. For one, lack of clarity on the proper income tax treatment of certain transactions can easily lead to a number of uncertain tax positions for an entity. This is one major factor in the Philippine setting that our local regulators should consider before deciding to adopt any proposed amendment to IAS 12. If uncertain tax positions are measured using the probability weighted average amounts of possible outcomes as provided in the ED, it is possible for an entity not to be able to recognize the entire tax benefit of a position even if it is highly probable of being sustained for as long as there is more than zero probability that a different outcome may arise from a settlement of the uncertainty.
There is also a concern that the financial statements may become very transparent with respect to tax exposures, causing reluctance by some entities to disclose and accrue provisions for uncertain tax positions. The problem is that non-accrual of provisions for uncertain tax positions could engender material misstatements in financial statements.
In addition, this may entail significant amount of work on the part of the affected entities.
First of all, an affected entity will need to identify all its uncertain tax positions (at least those that are material), evaluate the different possible outcomes of a settlement, and the probability for each of the outcomes.
Secondly, the rules proposed in the ED are not simple and will require a good grasp of both accounting and tax rules.
Thirdly, there will be a need for the entity to establish processes and controls to ensure that it will be able to consider all material uncertain tax positions, changes and/or settlements relating to them, and new uncertain tax positions that may arise in the future.
Lastly, the company will have to assess the potential impact of the proposed amendment on its financial statements, its policies on tax compliance, its tax planning strategies, and other aspects of operations.
As part of its tax risk management process, the entity must prepare for the uncertainty that the accounting for uncertain tax positions may bring, if and when it is adopted in the Philippines.
(Noel P. Rabaja is a Tax partner of SGV & Co.)
This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.