A Case For Convergence
of Income Tax Laws with
IAS/IFRS
ASIA - PACIFIC TAX CONFERENCE
March 18, 2006, Karachi
Mujahid Eshai
F.C.A.
CONVERGENCE (cont’d.)

Convergence is the act or fact of coming together or near

Tax laws have always been the sacred domain of
Governments.

Through these laws Governments all over have provided
incentives for Investment in industry, Commerce and
business while laying down the rules for collection of
Revenues for its administrative and Public Interest
Infrastructural, Social, Educational and Economic
Programs.

As long as Protectionism was the buzz word the
approaches developed were for the local industry etc.
whilst not foregoing the Government’s need for funds.

Investments across borders were relatively small and not
driven by economic motives alone.
CONVERGENCE (cont’d.)

Alongside this approach particularly in new born states
was a desire to succeed at all cost and through any
means.

A need to record the transactions or keep the books also
emerged followed by a need mandatory or otherwise to
undertake audits.

Tax laws framed were thus detailed rules of what
constituted proper books and how various transactions
would be verified or dealt with or accepted as valid
business sources of income or expenditure.

Obviously the first need was to meet the Tax
requirements. Accordingly books and records were
maintained to meet these requirements.
CONVERGENCE (cont’d.)

The emerging economies were also becoming large Cash
Economies with increasing issues relating to
documentation of underlying transactions.

A Quote from the 3rd report of the Australian Tax Office
Task Force on Cash Economy is relevant: “A key issue for
many small business operators is their ability to
understand and meet their taxation obligations.
Businesses in high risk cash economy industries display a
common range of basic problems.
1. poor record keeping
2. poor cash flow management
3. Inaccurate invoicing procedures
4. poor national tax number usage practices
These problems generally arise due to a lack of
understanding rather than a deliberate intention not to
comply.”
CONVERGENCE (cont’d.)

The Tax laws used to, until quite recently, talk of
“Whatever accounting method employed.”

Commercial Accounting on the other hand only advocated
two methods viz., Cash and Accruals.

The two methods now stand recognized explicitly.

The Income Tax Ordinance now also by virtue of Rule
32(2) in Part-III recognizes the existence of International
Accounting Standards - A giant leap forward.

However, in my opinion, the IAS/IFRS usage and
application with reference to the preparation of Financial
Statements should be made a part of the Ordinance.
CONVERGENCE (Cont’d.)

It is therefore, in my opinion, no longer necessary
for the Income Tax law to explain how the
transactions should be recorded and treated in the
Books of Accounts and presented and disclosed in
the Financial Statements.

Indeed, only if any accounting treatment, as
specified in the Accounting Standards, is not in
accordance with the policies or there is additional
information required in respect thereof or a differing
treatment or a fiscal incentive given should there be
a cause for detailing.

The Accounting Standards along with their
interpretations issued by IASB are sufficient and
revised on a regular basis.
CONVERGENCE (cont’d.)

•
Convergence does not imply complete oneness.
There is room for departure.
The departures could be due to any one or a
combination of the following:
1. Public Policy
2.Transfer Pricing
3. Structural Reasons
4. Avoidance
5. Tax neutrality
6. Capital items
7. Fiscal incentives
8. Symmetry
9. Realisablity &Tax Capacity
10. “True Reflection”
CONVERGENCE (cont’d.)



For example, Fines and Penalties will not be
allowed as a permissible expense for tax purposes
as these are a result of a public policy .
Tax holidays may be deemed necessary in certain
areas or activities with the objective of achieving
industrial or economic growth as part of Public
Policy.
Accelerated or additional Depreciation as a fiscal
incentive may be allowed.
CONVERGENCE (cont’d.)

Accounting Standards are generally not concerned with
these issues. They may and do suggest consequential
preferred treatment or lay down the principles for situations
resulting from such departures.

Timing and/or temporary differences resulting in deferred
tax assets and liabilities is an example.

IAS 12 (INCOME TAXES) deals with the subject in detail. It
now talks of a ‘TAX BASE’ (that is determining a tax value)
for assets and liabilities which may cause the creation of a
statement of assets and liabilities based upon this concept
for the purposes of calculating the deferred tax liabilities to
be reflected in the Financial Statements.

As such separate tax computations, based on the results
declared in the Financial Statements prepared in accordance
with the IAS, will continue to be required.
CONVERGENCE (cont’d.)



Temporary difference = difference between tax base and
carrying amount. Will result in tax or deduction when sold
or settled.
Accrue deferred tax liability for nearly all taxable
temporary differences. (Partial provision and deferral
method prohibited.)
Accrue deferred tax asset for nearly all deductible
temporary differences if it is probable a tax benefit will be
realised.
Note: Tax assets will be recognised more often than
before.
 Accrue unused tax losses and tax credits if it is
probable that they will be realised. Review and reduce
if appropriate.
 Use tax rates expected at settlement.
 Non-deductible goodwill: no deferred tax.
 Un remitted earnings of subsidiaries and associates:
Do not accrue tax.
 Capital gains: Accrue tax at expected rate.
CONVERGENCE (Cont’d.)
Do not "gross up" government grants or other
assets or liabilities whose initial recognition
differs from initial tax base.
 Disclosures: components of tax expense, tax on
equity items, reconciliation of tax expense and
tax paid; balance sheet items.
IAS 12 does away with the old income statement
approach of timing differences and instead looks at
balance sheet approach of temporary differences. If
there's a difference between an asset's tax base
versus its booked carrying amount, you must
provide for deferred taxes on the difference.


CONVERGENCE (cont’d.)





In my opinion, the tax authorities in Pakistan need
to pay due attention to IAS 39 and 32.
IAS 39 has major implications for the economy and
all those involved with it.
Position papers need to be prepared keeping the
economic environment in view and discussed in a
transparent manner with all concerned.
Derivatives, their accounting and an equitable tax
treatment needs consideration.
Hedge accounting, forward contracts are issues that
need to be examined with clear cut, unambiguous
pronouncements thereon.
CONVERGENCE (cont’d.)

Fair value accounting of assets and liabilities with
resulting intangibles and their treatment for tax
purposes requires study and alignment.

Companies Ordinance Section 237 (1) states:
“There shall be attached to the financial statements
of a holding company having a subsidiary or
subsidiaries, at the end of the financial year at
which the holding company’s financial statements
are made out, consolidated financial statements of
the group presented as those of a single enterprise
and such consolidated financial statements shall
comply with the disclosure requirements of Fourth
schedule and International Accounting Standards as
are notified under subsection (3) of section 234
CONVERGENCE (cont’d.)

IAS 27-Consolidated And
Separate Financial StatementsPARA 22 states “…In order that
the consolidated financial
statements present financial
statement about the group as
that of a single economic
entity…”
CONVERGENCE (cont’d.)

The two have the same objective - A financial
picture as a single entity.

Therefore at least where the group holding
company is also listed publicly and has wholly
owned subsidiaries a case for treatment as a single
taxed entity can be considered.

Relevance of Consolidated accounts, fair value
measurement and equity accounting does not exist
in our tax law. Fair Market value as defined in the
Tax Ordinance only relates to acquisition or disposal
of Fixed Assets and other transactions such as
perquisites, house rent etc.
CONVERGENCE (cont’d.)

Section 59(B) of the IT Ordinance suggests a
proportionate set-off of losses to a controlling share of
75% or more. particularly as a controlling interest is
defined as in excess of 50% by both Companies
Ordinance and the IAS.

As far as Equity method of accounting is concerned this is
not recognized in the tax law and the issue has been
referred to in my paper.
CONVERGENCE (cont’d.)

I would only like to state that there is
a dire need to re-examine our tax
laws in the light of the changes in the
Corporate world and the underlying
principles. The time is ripe to move
from a pure, classical revenue
oriented approach to a principle
based approach.
CONVERGENCE (cont’d.)

Perhaps a beginning can be made by re-defining
and separating Corporate Tax Policies for Listed
Companies who have to prepare their accounts in
accordance with the IFRS/IAS, from individuals and
other non-listed and privately owned entities. The
LTU/MTU were a second step, in my opinion.

Harmonization of the tax base by using and
accepting the global accounting standards will
eliminate the plethora of frivolous time wasting
appeals against assessments.

Assessments should not be subjective but based on
hard evidence or departure from laid down
principles.

A 100% convergence is not possible nor desirable.
CONVERGENCE (Cont’d.)
Going a step further, both accountants and tax
practitioners, especially in India, have often been
heard pining for a complete harmony between tax
provisions and accounting diktats enshrined in
accounting standards though sceptics as well as
some fiscal experts dismiss this out of hand, as an
idle romanticism.
 The truth, however, is that there is a case for
bringing about harmony to the extent possible
between tax provisions and accounting tenets not
only in the interest of simplification but also to quell
the need for tax on book profits which is not only
retrograde in nature but also reflective of the
confused state of mind of the Government.
Quote from Article by S. Murlidharan in Daily
Business Line dated 16/8/2001

CONVERGENCE (THE END)
THANK YOU!