Income tax balances – Bringing certainty to uncertainty

By its very nature, income tax law is subject to a range of varied interpretations. As a result, reporting entities and their auditors may, in certain cases, be uncertain about whether a position adopted in the entity’s tax return would ultimately be sustained. Further, given the diverse risk profiles of companies, and in the absence of specific guidance on how to account for uncertain tax positions, significant disparity in how companies recognise and measure tax benefits recorded in their financial statements has arisen over a period of time. 

Bringing certainty to uncertainty

In response to this widespread diversity in practice for the recognition and measurement of uncertain tax positions, IFRIC 23 Uncertainty over Income Tax Treatments (implemented in Australia as AASB Interpretation 23 or ‘the Interpretation’) was issued in July 2017, and applies to annual reporting periods beginning on or after 1 January 2019.

The Interpretation brings new obligations with respect to the consideration of uncertain tax positions during financial statement audits. US companies have been subject to similar rules for a number of years by having to apply FIN 48.

What does IFRIC 23 require?

IFRIC 23 sets out the requirements for accounting for uncertain tax positions as follows:

  • If an entity concludes that it is probable the tax authorities will accept a tax position, no additional action is required. Tax balances will be calculated under the existing accounting standard.
  • If an entity concludes that it is not probable the tax authorities will accept a tax position – it is required to use the ‘most likely amount’ or ‘expected value’ in determining its tax balances. Any variation between the ‘most likely amount/expected value’ and the amount recorded in the financial statements will also need to be recognised in the financial statements.

Please refer to our July 2017 Accounting News article for more information.

Most likely amount Expected value
The single most likely amount in a range of possible outcomes   The sum of the probability-weighted amounts in a range of possible outcomes

Assume that a tax audit will be conducted

Most importantly, the Interpretation requires calculation of the current tax liability and deferred tax balances in the financial statements as if the tax authorities were going to perform a tax audit, and the tax authorities knew all the facts and circumstances about your tax position. 

There is no allowance permitted for detection risk, or for the revenue authority’s view of materiality.

Common impact areas

The Interpretation is likely to have a significant impact on the quantum of income tax liabilities subject to judgemental areas, particularly in respect of any technical area where a position has been taken and the ATO has issued a Tax Alert or Practical Compliance Guideline that would characterise the position as high risk.

“Transfer pricing is likely to be a key area of focus for multinational reporting entities, particularly in light of the inherent uncertainty triggered by recent base erosion and profit sharing (BEPS) changes. The Interpretation further reinforces the need for entities to prepare for their first financial statement audit under the new rules to ensure they have sufficient documentation to identify and support their transfer pricing positions, because without such documentation, it will be very difficult for companies to conclude that their intercompany dealings are ‘probably’ going to be accepted by a tax authority.”

Zara Ritchie, BDO’s Global Transfer Pricing Leader

What can we expect?

The Interpretation is not likely to be welcomed by preparers of financial statements because it will require the preparation of a register of uncertain tax positions, documentation of positions adopted and the recognition of higher current tax liabilities at an earlier date. Currently there is divergent practice in respect of tax provisions, with many companies taking an optimistic view and factoring in the probability having a tax audit, as well as the outcome, rather than accounting for the ‘worst case’ scenario where a successful ATO challenge is likely.

“I expect the ATO to be very enthusiastic about this development. It has been agitating for some time for entities to be required to report tax uncertainties in their financial statements and now it will have both new financial statement disclosures as well as the new lowered threshold in respect of the Reportable Tax Position Schedule. This will give the ATO a roadmap to focus its audit activity. Reporting entities will need to ensure that all of their tax positions are appropriately researched and documented to avoid being caught by the Interpretation and mitigate the risk of having to make unwanted financial statement disclosures.”

Michael Smith, Partner, Transfer Pricing

How can BDO assist?

Our experts have in-depth experience in the introduction and application of similar accounting requirements and recommend that you consider engaging an advisor who can both provide you with a clear road map to meet your obligations under the Interpretation and best represent your interests in an audit scenario. Please contact a member of BDO’s IFRS Advisory team or Transfer Pricing team if you require assistance.