Revisiting accounting for levies

SUITS THE C-SUITE By Meynard A. Bonoen

First Published in Business World (07/28/2014)

PAYING THE government certain amounts primarily due to legislation is often customary or necessary in conducting a business.

In our current business environment where compliance with legislation is paramount, businesses are compelled to pay and settle these obligations. Failure to comply with these obligations has implications ranging from imposition of penalties to revocation of licenses or business permits.

When governments or public authorities impose levies on business entities, other than impositions for income taxes and fines or other penalties, it is not always clear when the obligation to pay arises, and, consequently, when such obligation should be recognized in financial statements.

This has resulted in differences in the timing of recognition among companies. In May 2013, the IFRS Interpretations Committee issued IFRIC 21, Levies, to address this issue. The interpretation clarifies when liabilities for levies should be recognized in the financial statements.

IFRIC 21 defines a levy as “an outflow of resources (embodying economic benefits) that is imposed by governments (including government agencies and similar bodies whether local, national or international) on entities in accordance with legislation (i.e., laws and/or regulations).”

At first glance, this new definition appears broad and may cover all kinds of payments to governments by virtue of legislation. IFRIC 21, however, limits its scope and coverage to exclude payments that are within the scope of other accounting standards (such as income taxes covered by International Accounting Standards (IAS) 12, Income Taxes and service concession agreements covered by IFRIC 12, Service Concession Arrangements), fines and other penalties imposed for breaches of legislation; and contractual payments made to governments for the acquisition of an asset or rendering of a service. Moreover, application is not required for liabilities that arise from emission trading schemes.

It should also be noted that payments other than those explicitly called a “levy” may likewise be covered by IFRIC 21. The nature — more than the designation — of the payment is the better qualifier to determine whether the obligation is within the scope of IFRIC 21.

Businesses should consider and reassess all payments imposed by governments pursuant to legislation as many of these are not explicitly identified as levies. Legislation is not always clear on the nature of the payment and the activity that gives rise to the obligation. Sound business judgment in determining whether a payment is in the scope of IFRIC 21 must be exercised. This entails evaluation of each type of payment on its own merits and according to the legal requirements.

Some examples of payments that may be within the scope of IFRIC 21 (although specific facts and circumstances should be carefully analyzed) are real property taxes, local business taxes, and capital-based taxes. These could also include certain fees, concessions, or contributions imposed on industries which are regulated by the government such as in banking, insurance, telecommunications, power and utilities, among others. Careful assessment, however, should be made to ensure that such payments are not covered by the scope exclusions described above.

The appropriate point of recognition should then be established once a levy or payment is assessed to be covered by IFRIC 21. The obligating event, which triggers the payment or binds the business to pay the levy as required by legislation, should be identified. This is crucial as it dictates the timing and measurement of liability recognition. It determines whether to recognize the liability over a period of time or at a point in time.

For an obligating event that occurs over a period, IFRIC 21 requires that the liability to pay a levy be recognized progressively. If the generation of revenue over a period is the obligating event, for instance, the entity recognizes the corresponding liability as the said entity generates the revenue. This is because at any point in that period, the entity has the present obligation to pay a levy on revenues generated to date.

Some levies, however, need to be recognized as an obligation arising at a point in time. An example is a levy that is triggered in full as soon as the entity generates revenues in one period, based on revenues from a previous period. In this case, the liability is recognized in full as soon as the entity generates revenue in the current period. Generation of revenue in the previous period is necessary, but not sufficient, to create a present obligation.

The same rule applies to an obligation to pay a levy once a minimum threshold is reached (such as minimum amount of revenue or sales generated or outputs produced). In this case, the liability is recognized only when that minimum activity threshold is reached. No obligation should be recognized prior to reaching the threshold regardless of how certain the entity is of reaching that threshold.

In sum, a liability to pay a levy to a government should be recognized only when an obligating event has occurred.

As indicated in the EY publication, titled “Accounting for Levies”: “IFRIC 21 clarifies that neither a constructive nor a present obligation arises as a result of being economically compelled to continue operating, or from any implication of an intention and ability to continue operations in the future.” The same principles must be consistently applied even for interim reporting.

IFRIC 21 is applicable for annual periods beginning on or after Jan. 1, 2014, and requires retrospective application. Hence, it is imperative that entities start assessing its impact on their financial reporting. An inventory of payments covered by the interpretation should be made, and an assessment should be done whether the new guidance on point of recognition would change current accounting practice. By taking a closer look at IFRIC 21 and scrutinizing which types of payments to government are within its scope and would be impacted by the clarified guidance, companies are better positioned to produce more accurate financial statements. Ultimately, when reporting is up to par, risks can be reduced and decisions are better informed.

Meynard A. Bonoen is a Senior Director of SGV & Co.

This article 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.