Tax Accounting Implications on
Conversion to IFRS
Carolyn Engel, CA
Deloitte & Touche LLP
Canadian Tax Foundation
Calgary Young Practitioners
March 9, 2010
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Presentation Overview
• Adoption and Framework of IFRS
• CRA Response
• IAS 12: Key Canadian GAAP vs IFRS Differences
• Selected Oil & Gas Issues
• Recent Developments
• Questions & Answers
1
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Adoption of IFRS
January 1st, 2010 :
Transition Date
Opening balance sheet date if
PAE does not early adopt IFRS
before the final deadline (Jan 1
1,
2011).
January 1st, 2011 :
Conversion
Adoption is required for fiscal
years beginning on or after
January 1, 2011
First date of converted
comparative f/s (assuming only
one year of comparative
statements presented)
Jan. 1
2010
Jan 1.
2011
Dec. 31
2011
Year Ended December 31, 2010 :
December 31, 2011:
Quantitative disclosure , if available, of
impact of conversion to IFRS in MD&A
(assuming no early adoption)
First audited financial
statements in compliance
with IFRS
2
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Authoritative References
International Accounting Standards
• IAS 12 – Income Taxes
• The International Accounts Standards Board (IASB) is an independent body that
issues International Financial Reporting Standards (IFRS)
– Formed in 2001; adopted all of the International Accounting Standards (IAS)
issued by its predecessor body, the International Accounting Standards
Committee (IASC)
• The International Financial Reporting Interpretations Committee (IFRIC) is a
committee that assists the IASB.
– Replaced the Standing Interpretations Committee (SIC)
– Analogous with the Emerging Issues Committee (EIC)
• The IAS 12 Exposure Draft (“ED”) released in March 2009 was widely criticized
and therefore, the IASB voted in late 2009 to defer work on the ED.
3
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Framework
Common conceptual foundation (IAS 12 and CICA Section 3465)
• Both standards are based on the balance sheet approach.
– Recognition of deferred tax assets and liabilities for temporary
differences, for operating loss and tax credit carryforwards
• Differences mostly in the details.
4
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First -Time Adoption of IFRS
• IAS 12 must be applied retroactively
• N
No special
i l exemptions
ti
available
il bl under
d IFRS 1 ffor iincome
taxes
• General principles of IFRS 1 should be applied on first-time
adoption:
– Recognize all deferred tax assets and liabilities that
should be recognized in accordance with IAS 12;
– Do not recognize deferred tax assets and liabilities for
which IAS 12 does not permit recognition;
5
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First -Time Adoption of IFRS
• “New” temporary differences may arise as a result of
changes in accounting standards
• Measurement of deferred taxes on transition follows the
measurement of other assets and liabilities. Therefore, the
various other adjustments made under IFRS 1 affect the
measurement of deferred tax on transition.
• Effect of changes generally recorded to opening retained
earnings
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CRA Response
CRA website dedicated to the impact of IFRS:
– http://www.cra-arc.gc.ca/tx/bsnss/tpcs/frs/menu-eng.html
Content:
• IFRS Advisory Committee on Tax Administration
• Publicly accountable enterprises
• Impact on taxable income
• Transfer pricing and conversion
• Books and records guidance
7
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Tax Authorities vs. IFRS
Recent Developments:
• 2010 “Table Ronde – APFF”:
Question 49:
• For an affiliate of a Canadian public corporation, will F/S prepared in
accordance to IFRS be acceptable with regards to a 5907(2.1) ITR
election?
Response:
p
• With respect to the surplus accounts of foreign affiliates, the CRA
would allow the F/S to be prepared in accordance to IFRS only if, by
doing so, the F/S are prepared in accordance with the laws of the
country where the foreign affiliate resides.
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IAS 12: Key Canadian GAAP vs. IFRS
Differences
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The Initial Recognition Exception (“IRE”)
IAS 12
CICA Section 3465
Deferred tax liability/asset is recognized,
unless deferred tax liability/asset
y
arises
from:
Future tax liability/asset is recognized for
temporary
p
y differences on the acquisition
q
of
assets in a transaction other than a business
combination.
• The initial recognition of goodwill, or
• The initial recognition of an asset or
liability in a transaction that is not a
business combination, and at the time
of the transaction, affects neither
accounting profit nor taxable profit.
Future tax liability is recognized, unless
future tax liability arises from:
• The initial recognition of goodwill that is
not deductible for income tax purposes.
Reversal of the asset or liability will create a “permanent”
difference that will impact the effective rate.
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Initial Recognition Exception (“IRE”)
1. Non business combination acquisition
AcquisitionCo
TargetCo
Undeveloped Oil &
Gas Assets
• Under IAS 12.15 you do not record deferred taxes on any
differences between book and tax basis.
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Initial Recognition Exception (“IRE”)
2. Asset Retirement Obligations
Dr. Asset
$100
$150
Cr. Liability
12
$100
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Initial Recognition Exception (“IRE”)
3. Capitalized Stock Based Compensation
– Under IFRS the stock based compensation should follow
the employee and can therefore be recorded as an
expense or capital.
– For Canadian tax purposes stock based compensation is
normally not deductible.
– Amounts capitalized to PP&E will result in a book
difference that can not be recorded pursuant to IAS 12.15.
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Initial Recognition Exception (“IRE”)
4. Discount on Certain Obligations
- Initial recognition exemption should apply where
an instrument is issued at a discount, and only ½
of the discount may be deducted pursuant to ITA
20(1)(f).
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Compound Financial Instruments
IAS 12
CICA Section 3465
Per IAS 32, the issuer of a compound
financial instrument ((i.e.,, convertible
debenture) classifies the liability component
as a liability an the equity component as
equity. Where the tax base of the liability
component on initial recognition is equal to
the sum of the components, a taxable
temporary difference should arise.
Prohibits recognition of future income taxes
where the enterprise
p
is able to settle the
instrument in accordance with its terms,
either through settlement on maturity or
conversion, without the incidence of tax.
The deferred tax is charged directly to the
carrying amount of the equity component.
Subsequent changes in the deferred tax
liability are recognized in profits or loss as
deferred tax expense (income).
The tax basis of the liability component is
considered to be the same as its carrying
amount and there is no temporary
difference.
The IRE should not apply to certain compound financial
instruments.
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Transfer of Assets in the
Consolidated Group
IAS 12
CICA Section 3465
Deferred taxes are recognized in the
consolidated financial statements for
temporary differences resulting from
unrealized profits from intergroup
transactions.
Prohibits recognition of future income taxes
in the consolidated financial statements for
any temporary differences arising from the
transfer of the assets within the
consolidated group.
The taxes paid/payable by the seller are
recognized as prepaid taxes.
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Inter-Company Sales - Example
UK Parent
Company
CanCo
USCo
Hong Kong Co.
China
Suppliers
Sales price - $15
Product Cost - $10
•
•
•
•
17
Assume no transfer pricing issues
Canco’s deferred tax asset: $5 x 30% = $1.50
Hong Kong Co’s current tax expense - $5 x 16.5% = $0.83
Accounting issues revolve around whether one is dealing with
non-consolidated financial statements of Canco (including
accounting policies on related party transactions) VS.
consolidated financial statements of the UK Parent Company
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Recognition of Deferred Tax Asset
IAS 12
CICA Section 3465
A deferred tax asset is recognized only to
the extent that it is probable that taxable
profits will be available against which the
deductible temporary differences can be
utilized.
A future income tax asset is recognized to
the extent that it is more likely than not to
be realized.
realized
The term “probable” is not defined in the
standard.
In practice, the IAS 37.23 definition of
“probable as being “more likely than not” is
used.
A valuation allowance may be used to
reduce the future tax assets to the extent
they are more likely than not to be realized.
The concept of valuation allowance is not
used in IAS 12.
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Investment Tax Credits (“ITCs”)
IAS
CICA
IFRS treatment of ITCs is uncertain.
Under CGAAP, accounted for under s.
3805 of the CICA HB.
ITCs are nott specifically
ITC
ifi ll defined
d fi d in
i
IAS 12; no specific guidance
provided under IFRS.
Treatment of ITCs under IAS 20
(i.e. Accounting for Government
Grants and Disclosure of
Government Assistance) also
possible alternative.
19
Treated using cost reduction
approach and recognized when
company incurs qualifying
expenditures and when there is
reasonable assurance that the
credits will be realized.
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Acquisition of Tax Benefits (Loss Co.)
IAS 12
This area is not addressed in IAS 12.
Current view is that the deferred credit is
not recorded under IAS. Instead the credit
is recorded to the income statement.
CICA Section 3465
EIC 110 “Accounting for Acquired Future
Tax Benefits in Certain Purchase
Transactions that are not Business
Combinations” provides guidance:
• acquired future tax benefits should be
recorded as future tax assets
Dr.
FITA
Cr.
Deferred credit
Cr
Cr.
Cash
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Uncertain Tax Positions
IAS
Uncertain tax positions (“UTPs”) are not
specifically addressed in IAS 12
View A:
UTPs are within the scope of IAS 12:
Current tax assets and liabilities are measured
based on the expected amount paid to (or
recovered from) the tax authorities
CICA
Uncertain tax positions generally
accounted for as contingencies under
CICA 3290 Contingencies, though
some variety in practice exists.
View B:
IAS 37 is relevant because provision is recorded
for a UTP that gives rise to “a liability of uncertain
timing or amount”
21
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Uncertain Tax Positions (cont’d)
• Presume 100% likelihood of detection by the tax authorities
– Presume that the tax authorities have all the relevant
information
• Under either view you still need to determine the quantum
of the reserve – various possible methods to determine
– Need to consider binary versus non-binary issues.
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Uncertain tax positions - Example
Possible Outcome ($)
Probability (%)
Probability Weighted
$100
$
5%
$5
$
$80
30%
$24
$60
20%
$12
$40
15%
$6
$20
20%
$4
$0
10%
$0
100%
$51
• $51 is the probability weighted outcome (reserve of $49)
• $80 is the most probable outcome (reserve of $20)
• FIN 48 - $60 has a cumulative probability > 50% (reserve of $40)
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Outside basis differences on
subsidiaries and joint ventures
IAS 12
Taxable temporary differences relating to
investments in subsidiaries,
subsidiaries branches,
branches
associates* and interests in JV’s is not
recognized if:
– Investor able to control timing of reversal of
temporary difference; and,
CICA Section 3465
Essentially the same exception exists under
Canadian GAAP
GAAP, but not for equity accounted
investees.
EIC 106 addresses measurement of deferred
taxes related to investments in equity
accounted investees.
– It is probable that temporary difference
will not reverse in foreseeable future.
Deductible temporary differences recognized
only to extent it is probable that:
– Temporary differences will reverse in
foreseeable future; and
– Taxable profit will be available against which
temporary difference can be utilized.
* i.e., equity accounted investees
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Disclosure Requirements
• IAS 12.7: The tax base of an asset is the amount that will be
deductible for tax purposes against any taxable economic
benefits that will flow to an entity when it recovers the carrying
amount of the asset. If those economic benefits will not be
taxable, the tax base of the asset is equal to its carrying amount.
• IAS 12.81(f): The aggregate amount of temporary differences
associated with investments in subsidiaries, branches and
associates and interest in jjoint ventures,, for which deferred tax
liability have not been recognized shall be disclosed separately.
25
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Reversal of Outside Basis Differences
Canadian Parent
Corporation
External
E
t
l
Lenders
Can Holdco 1
Dividend
•Deductible
Ded ctible per ITA 113?
•Withholding tax?
US Holdco
UK Opco
Can Holdco 2
Can Opco
US Opco
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Foreign Currency vs. Tax Currency
IAS 12
IAS 12 requires recognition of a
deferred tax asset/liability for temporary
differences that arise on translation of
non-monetary assets that are
remeasured from the local currency to
the functional currency using historical
rates and results from changes in
exchange rates and indexing for income
tax purposes.
CICA Section 3465
A future tax asset or liability should not
be recognized for a temporary
difference arising on translating nonmonetary assets or liabilities of
integrated foreign operations.
Is the tax currency different than the functional currency?
27
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Foreign Currency Transition Example
• A Canadian parent’s US subsidiary has been determined to
have a functional currency that is Canadian dollars.
H
However,
it iis required
i d tto fil
file itits US ttax returns
t
iin US d
dollar
ll
terms.
• A taxable temporary difference may emerge due solely to
foreign exchange movements on the tax pools
– May impact the effective tax rate.
– Under Canadian GAAP, no future tax would be recoded
for this temporary difference.
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Substantively Enacted Tax Rates
IAS 12
CICA Section 3465
IAS 12 requires assets/liabilities to
be measured based on rates/laws
that have been “enacted or
substantively enacted” by the
balance sheet date.
EIC 111 “Determination
Determination of
Substantively Enacted Tax Rates”
provides guidance on conditions
evidencing the substantive
enactment in Canadian specific
context.
The extent to which the remaining
procedures or processes are
perfunctory is viewed as a the point
substantive
b t ti enactment
t
t occurs
29
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Substantively Enacted Tax Rates
– Factors to consider
• The legal system and related procedures or processes necessary
f enactment
for
t
t off the
th tax
t law
l
change;
h
• The nature and extent of the remaining procedures or processes;
• The extent to which the remaining procedures or processes are
perfunctory; and
• The timing of the remaining procedures and processes
30
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Distributed versus Undistributed Rate
of Income Tax
IAS 12.52A
CICA Section 3465
•In some jurisdictions, income taxes
are payable at a high or lower rate if
part or all of the net profit or retained
earnings is paid out as a dividend.
No concept of dual rates
•In these situations, current and
deferred tax assets and liabilities
are measured at the tax rate
applicable to the undistributed
profits.
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Distributed versus Undistributed Tax Rate
MFT Example:
39% vs. 2
25%
%
Mutual
Fund
Trust
GP
CanOpco
32
Operating
LP
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Distributed versus Undistributed Tax Rate
(cont’d)
• Is a REIT also subject to this dual rate concept or does a
REIT only have one rate (ie. 39%) and can eliminate this if
they pay distributions.
33
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Backwards Tracing
IAS 12
CICA Section 3465
IAS 12 allocates to equity any current-year
deferred taxes on items that are related to
an item charged to equity in a prior year
(backwards tracing).
When income taxes are being recognized (or
de-recognized)
g
) in a subsequent
q
p
period,, they
y
are charged to the income statement and
not to equity.
(e.g., share issue costs)
34
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Interest and Penalties
IAS 12
CICA Section 3465
•IAS 12 restricts what is included in tax Does not address interest and
expense. Interest and penalties are not penalties.
included in this definition and should be
included either in interest expense or
operating expenses.
•Repealed exposure draft contemplated
given companies the option to record
above or below the line.
35
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Selected Oil & Gas Issues
• Flow Through Shares
• Petroleum Revenue Tax
36
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Flow Through Shares (“FTS”)
• There is no specific guidance under IFRS regarding FTS
– EIC 146 is no longer a source of GAAP
• Under IFRS, the share issuance proceeds must be
bifurcated between the liability (i.e., premium) and equity
components.
In practice, two views are being taken:
A. No deferred taxes should be recognized
B. UGAAP policy should be employed
37
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View A: No Deferred Tax Recognized
• Pursuant to ITA 66(12.61), the qualifying expenditures are
deemed never to have been incurred, hence creating a
temporary
p
y difference.
• The IRE is applicable and no deferred tax liability should be
recognized.
• The premium is released to income at the time the
qualifying expenditures are incurred.
incurred
38
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View A: Example
Share Issuance Proceeds: $1,000,000
Premium Liability: $150,000
On Issuance:
Dr. Cash
Cr. Premium Liability
Cr. Share Capital
$1,000,000
$150,000
$850,000
As Qualifying Expenditures are Incurred:
Dr. PPE
Dr. Premium Liability
Cr. Cash
Cr. Other Income
39
$1,000,000
$150,000
$1,000,000
$150,000
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View B: UGAAP Policy
• The incurrence of the expenditures and subsequent
renouncement is analogous to a debit and subsequent
credit to the tax p
pool. The IRE should not apply.
pp y
• This view is consistent with the FASB/SEC position
articulated by the FASB staff in Appendix A of the
November 2004 US SEC publication “International Financial
Reporting and Disclosure Issues in the Division of
Corporate Finance.”
Finance.
• When is “renouncement”?
40
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View B: Example
On Issuance:
Dr. Cash
Cr. Premium Liability
Cr Share Capital
Cr.
$1,000,000
$150,000
$850,000
$850 000
On Renouncement:
Dr. Premium Liability
Dr. DIT Expense
Cr. Deferred Tax Liability
$150,000
$100,000
As Expenditures Incurred:
Dr. PPE
Cr. Cash
$1,000,000
41
$250,000
$1,000,000
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Petroleum Revenue Tax (“PRT”)
• In some jurisdictions (i.e., UK and Aus) PRT is charged on
companies involved in the extraction of oil and gas. PRT is
determined on the basis of revenue from extraction
activities, less certain deductions of “allowable expenditure.”
In arriving at corporate taxable income, any PRT paid is
considered a deduction for purposes of the corporate
income tax regime.
income tax
tax” to be accounted for in accordance
• Is PRT an “income
with IAS 12?
42
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Recent Developments
• In the March 2010 Board meeting, the Board decided that the scope of the project should
be to consider the following practice issues:
1. Uncertain tax positions, but only after the revision of IAS 37 is finalized
2 Deferred tax on property remeasured at fair value
2.
• The Board also decided to introduce the following proposals that were generally supported
by respondents to the exposure draft issued in March 2009:
1. The introduction of an initial step to consider whether the recovery of an asset or
settlement of liability will affect taxable profit
2. The recognition of a deferred tax asset in full and an offsetting valuation allowance to
the extent necessary
3 Guidance
3.
G id
on assessing
i th
the need
d ffor a valuation
l ti allowance
ll
4. Guidance on substantive enactment
5. The allocation of current and deferred taxes within a group that files a consolidated tax
return
In addition, the Board suggested adding to the project the issue of what tax rate should be
applied (distributed vs. undistributed rate) for entities such as real estate investment trusts.
43
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Recent Developments (Cont’d)
Exposure Draft (September 2010)- Deferred Tax: Recovery of Underlying Assets
• The proposals would introduce a presumption that, for the assets noted below, an
asset is recovered entirely through sale unless the entity has clear evidence that
recovery will occur in another manner.
– Investment properties (when an entity applies the fair value model in IAS 40),
– PP&E or intangible assets (when an entity applies the revaluation model in IAS 16
or IAS 38)
• The ED was open for comment until November 9, 2010
• On December 3rd, 2010
• The Board voted almost unanimously (all but 1 member) to adopt a narrow scope
exception limited only to investment property measured using IAS 40
40.
• This amendment to IAS 12 would be effective January 1, 2012 with early adoption
permitted and applied retrospectively.
44
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Questions & Answers
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