Tax Accounting Services Tax Accounting Update Income Tax Accounting under IFRS — what is the status of the IASB’s income tax project? April 2010 / Issue 2 Pursuant to its objectives of clarifying and improving IAS 12 Income Taxes and reducing the difference between IAS 12 and the US Standard ASC 740 Incomes Taxes (formerly FAS 109), the IASB published an Exposure Draft (ED) to replace the existing standard on 31 March 2009. The proposals included in the ED were intended to more closely align IFRS and US GAAP and address some of the practical issues with the existing standard. Although the ED did not change the basic principles of tax accounting (i.e., balance sheet liability model), it proposed some significant changes to IAS 12 (for more information, please refer to our series of articles exploring the key changes released from April to June 2009 and available at www.pwc.com/usifrs/tax — IFRS tax publications section). The comment period ended on 31 July 2009. Respondents generally supported the two above mentioned objectives of the project. However, most of them considered that the ED failed to achieve these objectives and viewed many of the proposed changes in the ED not as improvements, but as an introduction of more complex rules. Overall, there was only very limited support for finalising the ED in its current form. Subsequent to the presentation of the comment letters by the IASB staff to the IASB Board in the October 2009 meeting with the FASB, both boards indicated that they would consider undertaking a fundamental review of accounting for income taxes at some time in the future. In the meantime, the IASB board asked their staff to undertake a limited scope project analysing the practical issues including: • Issues previously rejected by the IFRIC because they would be resolved by the Board’s income tax project • Particular practical concerns in practice raised by respondents (for more information, please refer to Staff Paper 8 — Income Tax project — Appendix B — List of practical issues on income tax issued in November 2009) • Amendments proposed in the ED and supported by respondents The IASB staff have conducted this analysis and presented their proposals on the way forward to the Board on 18 March 2010. The FASB has suspended its deliberations on the Income Taxes project and, together with the IASB, will consider undertaking a fundamental review of accounting for income taxes at some time in the future (consequently, there is no plan to issue amendments to ASC 740 Income Taxes at present). Recent developments Treatment of uncertain tax positions One of the areas of focus highlighted by the IASB staff paper presented to the Board in the October joint meeting with the FASB relates to uncertain tax positions. This was one of the convergence issues that respondents to the ED on Income Taxes suggested that the Board reconsider. The IASB staff have commented that having no specific requirements on uncertain tax positions is a substantial gap in IAS 12 that should be filled. However, they have recommended that this issue not be addressed until the amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets are finalised. This will allow the recognition and measurement requirements for uncertain tax positions in the scope of IAS 12 to be consistent with the general requirements for uncertain liabilities included in IAS 37. The IASB published a limited Exposure Draft of proposed amendments to IAS 37 on 5 January 2010 (please refer to our IFRS bulletin released in January 2010, summarising the proposals and available at www.pwc. com/ifrs — publications section — Straight Away). The IASB originally published an Exposure Draft to replace IAS 37 in June 2005. In the light of comments received on this ED and subsequent discussions, the Board has revised the proposals in the ED primarily to provide more guidance on applying the proposed measurement requirements. The comment period for the new January 2010 ED will end on 19 May 2010, with the new standard expected to be published in the third quarter of 2010. The new proposals require that the measurement of provisions should be the amount that an entity would rationally pay at the measurement date to be relieved of the liability. This amount is expressed in the ED as the lowest of: • The present value of the resources required to fulfil the obligation; • The amount the entity would have to pay the counterparty to cancel the obligation; and • The amount the entity would have to pay a third party to transfer the obligation to that third party. Appendix B to the ED provides comprehensive guidance on the expected present value technique: the estimate would take into account the expected outflows of resources, the time value of money and the risk that the actual outflows might ultimately differ from the expected outflows. Tax Accounting Update PricewaterhouseCoopers If the liability is to pay cash to a counterparty, the outflows would be the expected cash payments plus any associated costs. If the liability is to undertake a service at a future date, the outflows would be the amounts that an entity estimates it would pay a contractor at the future date to undertake the service on its behalf. Related tax accounting questions to consider From a tax accounting perspective, some questions come to mind in contemplating the practical application of the IASB’s proposed measurement of uncertain liabilities: 1) Does the proposed measurement guidance of uncertain liabilities apply to uncertain tax positions? The snapshot of IAS 37 revised by the IASB in January 2010 specifies that IAS 37 does not apply to items such as, among others, income tax liabilities because they are within the scope of other standards. It is possible that the proposed amendments to IAS 12 will be consistent with the final IAS 37 model. The final IAS 37 is likely to apply to uncertain tax positions related to non-income based taxes (i.e., related to taxes excluded from the scope of IAS 12 such as VAT and sales taxes). 2) If the proposed guidance of uncertain liabilities applies to uncertain tax positions, how would it apply? The proposed amendments to IAS 37 require that the provision for uncertain liabilities would take into account the expected outflows of resources, the time value of money and the risk that the actual outflows might ultimately differ from the expected ones. A tax liability is an obligation to pay cash to a counterparty, so the outflows would be the expected cash payments plus any associated costs. How would the IAS 37 model apply to uncertain tax positions? Would they be considered to be the best estimate of the amount to pay after negotiation with the Tax Authorities or would they be assessed based on the present value technique specified in the ED of IAS 37 replacement (i.e., a probability-weighted average of the present value of the expected cash payments for all the possible outcomes)? At present this is not clear and does not clarify concerns of respondents to the ED of IFRS replacing IAS 12 on the uncertain tax positions issue. April 2010 / Issue 2 2 Next steps The comment period for responses to the ED of proposed amendments to IAS 37 ends on 19 May 2010. We encourage companies to consider the implications of the proposal and provide the IASB with comments. Deferred taxes on investment property revaluation gains When a company measures an investment property at fair value under the fair value model in IAS 40, this creates a temporary difference, unless the remeasurement at fair value also results in an equal adjustment to the tax base of the asset at the same time (a similar temporary difference arises from revaluation of an asset under other IFRSs). Under IAS 12, the company must determine how it expects to recover the carrying amount of the property, as that expectation determines the tax base of the asset and the applicable tax rate to apply to any temporary difference that exists. For example, if a company has measured a property at fair value and expects to recover its carrying amount through future rental receipts, it would have to determine the tax base and the applicable tax rate that apply to the rental receipts and provide deferred tax on the resulting temporary difference using that income tax rate regardless of whether there would be any tax payable on a sale of the property. However, many companies in jurisdictions where there is no capital gains tax on sale of properties argue that no deferred tax liabilities should be recognised in such situations, regardless of the expectation of the manner of recovery. Similarly, where gains on sale of the property are tax free but there is a tax on the claw back of previously claimed tax depreciation for the property, many companies argue that a deferred tax liability should be recognised only for the claw-back portion. To address this issue, the ISAB staff proposed a new exception under IAS 12. Broadly, the new exception would exempt entities from recognising deferred tax for temporary differences arising from remeasurement of assets and liabilities at a fair value to the extent that a market participant acquiring the asset or assuming the liability for the fair value would have the same temporary differences. Tax Accounting Update PricewaterhouseCoopers However, the Board rejected the staff’s proposed solution to the accounting for deferred tax on investment properties and suggested a simpler, broader exemption for investment property measured at fair value under IAS 40, based on the lower of tax consequences of sale or use. Other matters At their meeting on 18 March 2010 the Board endorsed the IASB staff’s proposal that the scope of the limited scope project to amend IAS12 Income Taxes should focus on resolving the problems in practice under the standard, without changing the fundamental approach under IAS, and preferably without increasing divergence from US GAAP (i.e. ASC 740). In addition to tackling uncertain tax positions and deferred tax an investment property revaluations, the Board agreed that the scope of the project should include the introduction of the proposals in the ED Income Tax on: (i) the introduction of an initial step to consider whether the recovery of an asset or settlement of liability will affect taxable profit; (ii) the recognition of a deferred tax asset in full and an offsetting valuation allowance to the extent necessary; (iii) guidance on assessing the need for a valuation allowance; (iv) guidance on the meaning of substantive enactment; and (v) the allocation of current and deferred taxes within a group that a consolidated tax return. In addition, the Board indicated that it would explore the possibility of resolving the issue of the tax effect of dividends by entities, such as real estate investment trusts and co-operative societies. The staff will outline proposals on the above issues to Board meetings starting in the third quarter of 2010. We will monitor progress on these issues and update readers of further developments in due course. Please note the above is for information purposes only and should not be relied on as final advice. April 2010 / Issue 2 3 Contacts PricewaterhouseCoopers’ Tax Accounting Services group is a global network of tax professionals providing tax accounting services, technical knowledge and support. If you would like to discuss any issues with respect to tax accounting please contact your Tax engagement partner, Assurance engagement team, or one of the specialists below. Hong Kong Shanghai Singapore Guy Ellis — Tax Partner +852 2289 3600 guy.ellis@hk.pwc.com Terry Tam — Tax Partner +86 21 2323 1555 terry.sy.tam@cn.pwc.com Paul Cornelius — Tax Partner +65 6236 3718 paul.cornelius@sg.pwc.com Suzanne Wat — Tax Partner +852 2289 3002 suzanne.wat@hk.pwc.com pwchk.com This publication has been prepared by PricewaterhouseCoopers for general guidance on matters of interest only, and is not intended to provide specific advice on any matter, nor is it intended to be comprehensive. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers firms do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. 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