International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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one standard should be applied for all interest and penalties on taxes in all jurisdictions.
Instead, an entity should make a determination of the nature of the particular interest
and penalties in question based on its understanding of the operation of the specific tax
law and the way in which the charge or credit is calculated.
The following factors are relevant in determining whether an item is in scope of IAS 12,
although we believe that no particular order should be applied and that no single factor
is conclusive:
• whether there is a predominant local consensus in evidence or specific guidance
issued locally by regulators as to the nature of interest and penalties applied to a
specific tax in the relevant tax jurisdiction. Where a treatment may not otherwise be
clear, entities often refer to local practice in determining whether a tax is an income
tax; whether legislation has been substantively enacted; and in the treatment of
investment tax credits. Determining whether interest and penalties are part of
income tax requires careful consideration of the local legislation and hence entities
would usually defer to local consensus where it exists. Since the judgement depends
on the circumstances of the particular tax laws in a particular country, it should be
accepted that an international group could encounter different conclusions in
relation to interest and penalties arising in different jurisdictions. In particular, we
would normally not expect a conclusion based on local consensus to be reversed in
a subsequent consolidation by an overseas parent;
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• whether the amounts are clearly identifiable. Does the tax legislation have specific
rules and requirements that allow an entity to identify the amounts that are to be
regarded as ‘interest’ and as ‘penalties’? That is, if an entity pays a single lump sum
to settle existing tax positions, it would only identify interest and penalty
components to the extent that communications from the tax authorities and/or tax
legislation allow the entity to identify such components. An entity would not
bifurcate such a single payment to identify notional interest and penalty amounts
as this would be too judgemental;
• the degree to which the entity believes it is certain that interest and penalties will be
applied. In some cases an entity might decide to wait until a tax enquiry is concluded
before settling an expected obligation. In others, the entity could be confident of
recovering an overpayment of tax, with interest added to the expected refund. In these
circumstances, it could be argued that interest and penalties result from an entity’s
conscious decision not to pay earlier the taxes due or to secure the later receipt of
interest. Hence, those interest and penalties might be regarded as not directly related
to taxable income, but rather the result of the entity’s financing decisions;
• whether the amount is based on net taxable profit. As noted at 4.1 above, IAS 12 only
applies to income taxes, which are based on ‘taxable profits’. However, in many
jurisdictions income tax legislation contains elements that, when looked at in
isolation, are not strictly based on a notion of taxable profits. Examples include tax
exempt amounts, deductibility caps and super-deductions for certain eligible
expenditure. As a practical matter it is normally not considered helpful or necessary
to account for such elements as a separate unit of account, unless not doing so would
significantly misrepresent the underlying substance of the arrangements; and
• whether the interest rate applied by the tax authorities reflects current market
assessments of the time value of money. If the applied rate clearly reflects the time
value of money, it should be treated as interest. If the rate is largely punitive, the interest
should be considered together with penalties. However, it would not be sensible to
attempt to identify a notional time value component as this would be too judgemental.
Where the amounts involved are material, it will be appropriate for the entity to
consider whether the judgements made and the amounts involved should be disclosed
in accordance with the requirements of paragraph 122 of IAS 1.
4.5
Effectively tax-free entities
In a number of jurisdictions, certain classes of entity are exempt from income tax, and
accordingly are not within the scope of IAS 12.
However, a more common, and more complex, situation is that tax legislation has the
effect that certain classes of entities, whilst not formally designated as ‘tax-free’ in law, are
nevertheless exempt from tax provided that they meet certain conditions that, in practice,
they are almost certain to meet. A common example is that, in many jurisdictions,
investment vehicles pay no tax, provided that they distribute all, or a minimum percentage,
of their earnings to investors.
Accounting for the tax affairs of such entities raises a number of challenges, as discussed
further at 8.5.1 below.
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5 CURRENT
TAX
Current tax is the amount of income taxes payable (recoverable) in respect of the
taxable profit (tax loss) for a period. [IAS 12.5].
Current tax for current and prior periods should, to the extent unpaid, be recognised as
a liability. If the amount already paid in respect of current and prior periods exceeds
the amount due for those periods, the excess should be recognised as an asset. [IAS 12.12].
The benefit relating to a tax loss that can be carried back to recover current tax of a
previous period should be recognised as an asset. When a tax loss is used to recover
current tax of a previous period, an entity recognises the benefit as an asset in the period
in which the tax loss occurs because it is probable that the benefit will flow to the entity
and the benefit can be reliably measured. [IAS 12.13-14].
Current tax should be measured at the amount expected to be paid to or recovered
from the tax authorities by reference to tax rates and laws that have been enacted or
substantively enacted by the end of the reporting period. [IAS 12.46].
5.1
Enacted or substantively enacted tax legislation
IAS 12 requires current tax to be measured using tax rates or laws enacted ‘or
substantively enacted’ at the end of the reporting period. [IAS 12.46]. The standard
comments that, in some jurisdictions, announcements of tax rates (and tax laws) by the
government have the substantive effect of actual enactment, which may follow the
announcement by a period of several months. In these circumstances, tax assets and
liabilities are measured using the announced tax rate (and tax laws). [IAS 12.48].
IAS 12 gives no guidance as to how this requirement is to be interpreted in different
jurisdictions. In most jurisdictions, however, a consensus has emerged as to the meaning
of ‘substantive enactment’ for that jurisdiction (see 5.1.1 below). Nevertheless,
apparently similar legislative processes in different jurisdictions may give rise to
different treatments under IAS 12. For example, in most jurisdictions, tax legislation
requires the formal approval of the head of state in order to beco
me law. However, in
some jurisdictions the head of state has real executive power (and could potentially not
approve the legislation), whereas in others the head of state has a more ceremonial role
(and cannot practically fail to approve the legislation).
The general principle tends to be that in those jurisdictions where the head of state has
executive power, legislation is not substantively enacted until actually approved by the
head of state. Where, however, the head of state’s powers are more ceremonial,
substantive enactment is generally regarded as occurring at the stage of the legislative
process where no further amendment is possible.
5.1.1
Meaning of substantive enactment in various jurisdictions
The following table summarises the meaning of ‘substantive enactment’ in various
jurisdictions as generally understood in those jurisdictions.6
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Country
Point of substantive enactment
United Kingdom
A Finance Bill has been passed by the House of Commons and is
awaiting only passage through the House of Lords and Royal Assent.
Alternatively, a resolution having statutory effect has been passed under
the Provisional Collection of Taxes Act 1968.
Canada
If there is a majority government, substantive enactment generally occurs
with respect to proposed amendments to the Federal Income Tax Act
when detailed draft legislation has been tabled for first reading in
Parliament. If there is a minority government, proposed amendments to
the Federal Income Tax Act would not normally be considered to be
substantively enacted until the proposals have passed the third reading in
the House of Commons.
Australia
The Bill has passed through both Houses of Parliament (but before
Royal Assent).
France
Signature of the legislation by the executive.
Germany
The Bundestag and Bundesrat pass the legislation.
Japan
The Diet passes the legislation.
United States
The legislation is signed by the President or there is a successful override
vote by both houses of Congress.
South Africa
Changes in tax rates not inextricably linked to other changes in tax law are
substantively enacted when announced in the Minister of Finance’s Budget
statement. Other changes in tax rates and tax laws are substantively enacted
when approved by Parliament and signed by the President.
5.1.2
Changes to tax rates and laws enacted before the reporting date
Current tax should be measured at the amount expected to be paid to or recovered
from the tax authorities by reference to tax rates and laws that have been enacted, or
substantively enacted, by the end of the reporting period. [IAS 12.46]. Accordingly, the
effects of changes in tax rates and laws on current tax balances are required to be
recognised in the period in which the legislation is substantively enacted. There is no
relief from this requirement under IAS 12, even in circumstances when complex
legislation is substantively enacted shortly before the end of an annual or interim
reporting period. In cases where the effective date of any rate changes is not the first
day of the entity’s annual reporting period, current tax would be calculated by applying
a blended rate to the taxable profits for the year.
Where complex legislation is enacted shortly before the end of the period, entities
might encounter two distinct sources of uncertainty:
• uncertainty about the requirements of the law, which may give rise to uncertain
tax treatments as defined by IFRIC 23 and discussed at 5.2 and 9 below; and
• uncertainties arising from incomplete information because entities may not have
all the data required to process the effects of the changes in tax laws.
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It is not necessary for entities to have a complete understanding of every aspect of the
new tax law to arrive at reasonable estimates, and provided that entities make every
effort to obtain and take into account all the information they could reasonably be
expected to obtain up to the date when the financial statements for the period are
authorised for issue, subsequent changes to those estimates would not be regarded as a
prior period error under IAS 8. [IAS 8.5]. We expect that only in rare circumstances
would it not be possible to determine a reasonable estimate. However, these
uncertainties may require additional disclosure in the financial statements. IAS 1
requires entities to disclose information about major sources of estimation uncertainty
at the end of the reporting period that have a significant risk of resulting in a material
adjustment to the carrying amounts of assets and liabilities within the next financial year
(see Chapter 3 at 5.2.1). [IAS 1.125-129].
Whilst the effect of changes in tax laws enacted after the end of the reporting period
are not taken into account (see 5.1.3 below), information and events that occur between
the end of the reporting period and the date when the financial statements are
authorised for issue are adjusting events after the reporting period if they provide
evidence of conditions that existed as at the reporting date. [IAS 10.3]. Updated tax
calculations, collection of additional data, clarifications issued by the tax authorities and
gaining more experience with the tax legislation before the authorisation of the
financial statements should be treated as adjusting events if they pertain to the position
at the balance sheet date. Events that are indicative of conditions that arose after the
reporting period should be treated as non-adjusting events. Judgement needs to be
applied in determining whether technical corrections and regulatory guidance issued
after year-end are to be considered adjusting events.
Where the effect of changes in the applicable tax rates compared to the previous
accounting period are material, an explanation of those effects is required to be
provided in the notes to the financial statements (see 14.1 below). [IAS 12.81(d)].
5.1.3
Changes to tax rates and laws enacted after the reporting date
The requirement for substantive enactment by the end of the reporting period is quite
clear in the literature. IAS 10 – Events after the Reporting Period – identifies the
enactment or announcement of a change in tax rates and laws after the end of the
reporting period as an example of a non-adjusting event. [IAS 10.22(h)]. For example, an
entity with a reporting period ending on 31 December issuing its financial statements on
20 April the following year would measure its tax assets and liabilities by reference to
tax rates and laws enacted or substantively enacted as at 31 December even if these had
changed significantly before 20 April and even if those changes had retrospective
effect. However, in these circumstances the entity would have to disclose the nature of
those changes and provide an estimate of the financial effect of those changes if the
impact is expected to be significant (see 14.2 below). [IAS 10.21].
5.1.4
Implications of the decision by the UK to
withdraw from the EU
On 29 March 2017, the UK Government started the legal process of negotiating a
withdrawal by the UK from the European Union (EU). Under the provisions of the
relevant laws and treaties, the UK will leave the EU by 29 March 2019, unless either a
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deal is reached at an earlier date, or the negotiation period is extended by unanimous
consent of the European Council. Until that date, the UK remains a member of the EU
and all laws and regulations continue to apply on that basis. After that date, the UK will
cease to be a member of the EU and will acquire ‘third country’ status, the terms of
which will be defined in a new arrangement that, at the time of writing this Chapter, is
still being negotiated.
Tax legislation in EU member states and other countries contains tax exemptions and
tax reliefs (e.g. withholding tax and merger relief) that depend on whether or not one
or more of the entities involved are EU domiciled. Once the UK leaves the EU, these
exemptions and reliefs may no longer apply to transactions between UK entities and
entities in those EU member states and other countries. In those cases, additional tax
liabilities may crystallise. At the time of writing, it is still uncertain whether any of
these exemptions and reliefs will apply to the UK when it ceases to be a member state.
A transitional period to December 2020 during which the status quo is maintained,
has been proposed but is itself dependent on an overall agreement being concluded
between the EU and the UK. Other scenarios of ‘no deal’ or a rejection of any
proposed agreement by the UK and other national parliaments is still a possibility at
this stage.
Accordingly, the withdrawal process by the UK raises significant uncertainty about how
the existing tax legislation in the UK and in other countries will apply after the UK
ceases to be a member of the EU. It has also raised uncertainty about the future tax
status of entities, which may lead to changes in the accounting treatment.