The world of accounting standards is an always changing place, as both the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) continue to add and adapt standards to meet today’s accounting needs. Currently over 120 countries follow International Financial Reporting Standards (IFRS). As that number continues to grow it raises the question of how American based companies that follow General Accepted Accounting Principles (GAAP) are going to compare their books, to the books of companies that follow IFRS. While the major areas of IFRS and GAAP are similar, there are several areas where the two differ. One of those areas in which they differ is in how they deal with income taxes.
Uncertain Tax Positions
Under GAAP, tax benefits cannot be recognized in the financial statements unless it is more likely that the benefit will be sustained through an audit. The company recording the benefit must assume that the benefit will be examined by a taxing authority that has full knowledge of all relevant information. The company must also assume that it will be resolved in the court of last resort. If these steps are not met, no benefit may be recognized. If these steps are met, then the company may recognize the tax benefit at a portion of what they expect to be realized.
Currently IFRS has no guidelines on accounting for uncertain tax positions. However the recognition and measurement criteria found in IAS 37 of IFRS calls for the recognition of liabilities of uncertain timing and amount, if it is more likely to result in an outflow of assets. This standard can be tied to the reporting of uncertain tax positions, as they may result in such a liability.
When using GAAP, companies record taxes from the share-based compensation expense reported on the financial statements. This is done so that changes in the stock price do not affect the deferred tax asset that is already reported in the company’s financial statements.
Under IFRS deferred taxes are calculated by the tax deduction from the share-based payments in each period. When done this way, a change in the stock price does affect the tax asset. This means that an adjustment to the deferred tax asset account is required at the end of each period.
Tax Consequences of Intercompany Sales
When a company makes an intercompany sale between different tax jurisdictions under GAAP they must use the seller’s tax rate to avoid intercompany profit on the sale. The tax from the sale may be deferred upon consolidation and does not have to be reported until the item is sold to a separate entity unrelated to the company.
When a company makes an intercompany sale using IFRS it creates a difference in the book value of the asset and its tax base. Therefore, if the intercompany entities operate in different tax jurisdictions or different tax rates they must use the rate that is most likely to reverse the difference. This usually ends up being the buyers tax rate.
Recognition of Deferred Tax Assets
Under GAAP, deferred tax assets are recognized in full. They are later reduced with a valuation allowance, only if it is more likely that a portion of the deferred tax asset will not be realized. The allowance will then lower the deferred tax asset to the portion of the deferred tax asset that will be realized.
Deferred tax assets are only recognized under IFRS when it is probable that they will be realized. IFRS does not allow for the use of a valuation allowance when handling deferred tax assets.
Undistributed Earnings on Investments
With GAAP deferred taxes are recognized on undistributed earnings in relation to domestic subsidiaries or a domestic joint venture that occurred after 1992. No deferred tax is recognized on undistributed earnings in deals with foreign subsidiaries or foreign joint ventures if the investments are permanent.
IFRS deals with undisturbed earnings in a very similar fashion to GAAP. The recognition of deferred taxes is required on undisturbed earnings. The key difference between the two is that when using IFRS, recognition of deferred taxes is required on both foreign and domestic investments.
These are just some of the ways GAAP differs from IFRS when it comes to income tax reporting. As the use of IFRS continues to grow throughout the world, we may see these two sets of standards merge in order to make comparing financial statements from companies all over the world easier.