Finally, certainty on uncertainty is coming...
On 21 October 2015, the International Accounting Standards Board (IASB) published Draft IFRIC Interpretation 2015/1 Uncertainty over Income Tax Treatments. The Draft Interpretation has been released in response to widespread diversity in practice on recognition and measurement of tax assets and liability where there is uncertainty in the application of the tax law (in the absence of specific guidance in IAS 12: Income Taxes).
By its very nature, income tax law is subject to significant and varied interpretation. As a result, reporting entities (and their directors) may be, in certain cases, 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, it is to be expected that there be significant disparity in how companies recognise and measure tax benefits recorded in their financial statements. The IASB believes that introducing uniformity through this Interpretation will help to increase comparability and transparency in financial reporting of income tax positions.
After almost 10 years in the wilderness since the introduction of IFRS in Australia it is pleasing to see that the reporting requirements for uncertain tax positions are finally being clarified. However, there are a number of definitional areas that will require further clarification in the final Interpretation.
The Interpretation sets out suggested requirements around 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 Standard.
- If an entity concludes that it is not probable the tax authorities will accept a tax positions – 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 accounts will need to be adjusted.
The calculation of ‘expected value’ through a weighted average probability calculation is perhaps the most significant departure from what is currently done in respect of A-IFRS tax effect accounting. Where the ‘expected value’ method is adopted, entities will need to consider a documented process detailing a rigorous probability assessment for each relevant tax position.
The Interpretation further states that entities are able to consider positions separately, or as a group, depending on which approach provides better predictions as to the resolution of the uncertainty. Common tax positions that may be able to be grouped include research and development claims and transfer pricing positions. As both the determination of a ‘permanent establishment’ and the transfer pricing policies of entities constitute tax positions, entities may need to undertake a significant body of work to ensure that the positions adopted are supportable.
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 BEPS changes. The Interpretation further reinforces the need for entities to keep up-to-date transfer pricing documentation 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.
The introduction of these requirements is also likely to add significant complexity in business combinations. Entities will need to appropriately address uncertain tax positions when assessing the tax risk attached to a potential acquisition and make their own assessment as to the nature of the tax position once the acquisition is complete. The interaction with relevant guarantee and indemnification clauses in sale agreements will also need to be considered.
A devil in the detail of the Interpretation is the requirement to assume that the tax authority will review the position and has full knowledge of all relevant information. There is no allowance permitted for detection risk or for the revenue authority’s view of materiality (which is at odds with what revenue authorities may require in complying with tax laws).
BDO expects the ATO to be very excited by this development. It has been agitating for some time for entities to be required to report tax uncertainties in their financial statements. This is not surprising, as it 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 inadvertently caught by this new Interpretation.
The draft Interpretation is open for comment until 16 January 2016. If you would like your views to be incorporated into BDO’s submission please contact BDO Tax Partner Jason de Boer or your local BDO representative.