Making IFRIC agenda decisions mandatory

Speaker 1:
Hello and welcome to the CPA Australia Podcast, your weekly source for business, leadership and public practise accounting information.

Ram Subramanian:
Hello and welcome. I'm Ram Subramanian, Policy Adviser in Reporting at CPA Australia. Joining us for this podcast is Siva Sivanantham, Director National Financial Reporting Advisory at Grant Thornton Australia.

Ram Subramanian:
The IFRS interpretations committee issued an interpretation clarifying the accounting treatment for uncertainties in income taxes. The Australian Accounting Standards Board has issued the same interpretation in July as AASB interpretation 23. Siva is here to talk to us about the accounting requirements arising from this interpretation and some of the practical implications.

Ram Subramanian:
Welcome, Siva.

Siva Sivanantham:
Thank you, Ram. Pleasure to be here.

Ram Subramanian:
Thank you. Many of our listeners will appreciate the difference between Australian Accounting Standards and Australian Accounting Interpretations but for those listeners who may not, could you please explain the distinction between accounting standards and accounting interpretations and how these are applicable when preparing financial statements?

Siva Sivanantham:
Yeah, sure. Well internationally, we've got the International Accounting Standards Board also known as the IASB which issues international financial reporting standards, which we call IFRS. They've also got another body within their structure which is called IFRS Interpretations Committee. The IFRS Interpretations Committee develops interpretations on technical accounting issues, which are then ultimately issued by the IASB. Once issued by the IASB, both the interpretations and standards are part of the infrastructure and have the same authority.

Siva Sivanantham:
In the Australian context, we have the Australian Accounting Standards Board, the AASB, is responsible for issuing accounting standards and also accounting interpretations. We used to have another body called Urgent Issues Group many years ago but that ceased to exist some time ago. It's now the AASB's role to issue both accounting standards and accounting interpretations.

Siva Sivanantham:
Accounting standards have the force of law. Accounting Interpretations also have mandatory status by virtue of [inaudible 00:02:40] accounting standards called AASB 1048 Interpretation of Standards. Basically, what AASB 1048 does is it actually gives interpretations mandatory applicability when you apply Australian Accounting Standards.

Ram Subramanian:
Thank you for that. AASB Interpretation 23 or IFRIC Interpretation 23 has been developed to clarify the accounting for uncertain tax positions when accounting for income taxes under AASB 112 or IAS 12, which is the international equivalent, the IFRS equivalent. Could you throw some light on the reasons behind why the IFRS Interpretations Committee considered it necessary to develop this Interpretation?

Siva Sivanantham:
Well this project started a couple of years ago when the IFRS Interpretations Committee received a query asking when it is appropriate to recognise current excesses if tax law requires an entity to make a payment in respect of a disputed tax treatment and in that specific case, the entity was actually planning to appeal that tax ruling. Now, I'll be discussing this issue later on. The Committee noted that there would be similar questions arising with respect to other circumstances where there are uncertainties with respect to income tax treatments. The Committee decided that the Interpretation should address all the accounting for income tax uncertainties that relate to application of IS12 or AASB112. Now, the Committee published a draught Interpretation back in October 2015. It received 61 comment letters. Following the re-deliberation of those comment letters and the proposals, the Interpretation was finally issued by the AASB in June 2017.

Ram Subramanian:
Thank you. Quite a popular topic then, 61 comment letters. When considering the requirements of this Interpretation, do entities have to consider uncertainties surrounding only income taxes, or does this affect uncertainties surrounding other taxes as well? For example, GSD?

Siva Sivanantham:
Good question. The Interpretation here, Interpretation 23 is really an Interpretation of IS12 or AASB112. In other words, the requirements of this Interpretation add to and complement the requirements in IS12 and AASB112. Now, the Interpretations Committee actually discussed the possibility of broadening the scope. But, the Committee decided against it on the basis that it was concerned that a broader scope might create conflicts within other accounting standards.

Ram Subramanian:
Okay, so the scope is basically only to do with income taxes.

Siva Sivanantham:
Exactly.

Ram Subramanian:
When should an entity consider that a tax treatment is uncertain? In other words, what do we mean by the word 'uncertainties' in this context? The context of this Interpretation? Could you give an example or two of when such a situation may arise for a tax-paying entity.

Siva Sivanantham:
An uncertain tax treatment is pretty much any tax treatment adopted by the entity where there is uncertainty as to whether the tax authority will accept that treatment. For example, an entity's decision to not include an item of income in taxable income. Or, an entity's decision to include an item of expense as a deduction could be good examples here if there is uncertainty as to whether those treatments would be accepted by the tax authority.

Siva Sivanantham:
Now, a couple of other things I wanted to note here. In the Australian context, there is a question around what is the appropriate tax authority. For example, is it just the ATO or is it also including the courts? Now, the general view in the accounting community is that it includes both the ATO and also the courts because in some cases entities actually appeal against ATO's decisions and go to the court. In that case, the court is the ultimate authority that makes a ruling.

Siva Sivanantham:
Sorry, just one other thing I wanted to add and that relates to whether an entity needs to consider each uncertain tax treatment separately or together. Now, what the Interpretation says is that entities should use an approach that better predicts the resolution of the uncertainty and in doing that, need to consider how it prepares and supports the tax treatment and also how it expects the tax authority to make the examination and also resolve issues arising from the examination.

Ram Subramanian:
Thanks on that. The Interpretation says that an entity must assume that a taxation authority will examine the amounts it has a right to examine and have full knowledge of all related information. What does this mean in practical terms? For example, how does this criteria affect information held by the entity which is, say, subject to legal professional privilege?

Siva Sivanantham:
The Interpretation makes it very clear that entities are required to assume that the tax authority with the right to examine will examine the treatment and also will have the full knowledge of all related information when making those examinations. This, in practical terms, means that entities need to assume that the ATO will perform a tax audit with full knowledge of all the facts and circumstances about the entities tax position. Therefore, they should ignore both the probability of having a tax audit and also the detection risk when calculating the amount of tax owing where the tax treatment is uncertain.

Siva Sivanantham:
In terms of the information subject to professional privilege, my understanding is that this Interpretation doesn't affect that privilege in any way.

Ram Subramanian:
Thanks for that. If an entity concludes that it is probable that the taxation authority will accept a particular tax treatment, what does the Interpretation require the entity to do in this case?

Siva Sivanantham:
Probable means, really, that there's more than 50% chance of the tax authority accepting the uncertain tax position. Now, the Interpretation doesn't give much detail in terms of what probabilities or guidance around how we determine that we apply the general balance around probability. If an entity does conclude that it is probable that the taxation authority will accept a specific treatment, then the accounting for income taxes will be consistent with the tax treatment in the tax return. In other words, the income tax amounts used in the financial statements are measured consistently with the tax treatments used, or planned to be used, in the entity's tax return.

Ram Subramanian:
On the flip side, or conversely, if an entity concludes that it is not probable that a taxation authority will accept a particular tax treatment, what does an entity have to do under the requirements of this new Interpretation?

Siva Sivanantham:
The Interpretation says the entity in that case will need to reflect the effect of uncertainty in its income tax accounting in the period in which that determination is made. Where the entity concludes that it's not probable that the tax authority will accept a specific treatment, it will need to reflect that uncertainty in its income tax accounting in the period in which that determination is made. The effect of uncertainty is reflected using either of two methods. The first one is called the most likely amount method. The second one is called the expected value method. The entity is required to use whichever one better predicts the resolution of the uncertainty. These methods are pretty much the same as methods we use for variable consideration in the new manual standard IS15 or AASB15.

Siva Sivanantham:
Under the most likely amount method, the entity would work out the single most likely amount in a range of outcomes. This would be appropriate when there the possible outcomes are either binary or concentrated in one value. For example, you either get full deduction or zero deduction.

Siva Sivanantham:
The second method is called the expected value method which basically represents a sum of probability related amounts in a range of possible outcomes. This would be appropriate when there is a range of possible outcomes that are neither binary nor concentrated in one value. For example, if the deduction amount can be any amount within a range, that's when you would use the expected value method.

Ram Subramanian:
Okay, thank you for that. What should an entity do when there is a change in circumstances? They've already calculated and either decided that it's probable or not probable and accounted for it accordingly and, if there is a change in those circumstances, and it affects an original assessment it has previously made, what would an entity have to do in those circumstances?

Siva Sivanantham:
The Interpretation says judgements and estimates need to be re-assessed whenever there is a change in facts and circumstances or when we have new information coming through. Some examples of changes in facts and circumstances, or new information coming through, would include, for example, examinations or actions by a tax authority such as agreement or disagreement by the tax authority on similar treatments by the company or other companies; change in tax codes; expiry of the tax authority's right to examine. These would be examples of changes in circumstances or new information.

Siva Sivanantham:
The Interpretation makes it clear that in the absence of comment from the tax authority in isolation is unlikely to constitute a change in circumstances. In other words, if you don't hear anything from the tax office for some time, that doesn't necessarily mean you've got it right. In terms of accounting for this change, the change needs to be accounted for as a change in accounting estimate in accordance with IS8 or AASB108. In other words, this would be accounted for prospectively, rather than retrospectively.

Ram Subramanian:
So, no prior adjustment.

Siva Sivanantham:
Exactly.

Ram Subramanian:
There's a view that some new accounting requirements change the way in which entities conduct their business operations. The new lease accounting requirements under IFRS16 or AASB16 that comes into effect in the near future is one such example that is mentioned in this context. Some might say that this is a case of the tail wagging the dog. Do you think there is a similar risk with this Interpretation?

Siva Sivanantham:
There's no doubt that tax transparency is a very sensitive topic and I think this will certainly cause board rooms to rethink their approach on uncertain tax position. Particularly those with more aggressive tax treatments and those operating in more complex and multinational tax jurisdictions.

Ram Subramanian:
Thank you. Which entities in Australia are going to be affected by this new Interpretation and from when? When should entities start preparing for the requirements in this Interpretation?

Siva Sivanantham:
Interpretation 23 is an Interpretation of the recognition and measurement requirements in IS12 or AASB112 and the exclusion requirements in IS1 or AASB101 presentation of financial statements. Any entity that applies these standards will be impacted. The expected impact is quite widespread. All entities, in practical terms, all entities preparing general purpose financial statements and those in Australia preparing special purpose financial statements under cooperation set, or those other special purpose financial statements that are non-cooperation set, but elect to comply with recognition and measurement requirements, they will need to carefully consider the impact of this Interpretation. Now, the Interpretation is effective on first of January 2019 and early application is permitted.

Siva Sivanantham:
In terms of transition, similar to the approach on the new Revenues and Leases Standards we've got 2 options here. The first one is full retrospective approach, in accordance with IS8 or AASB108 but that's only allowed if it's possible without the use of hindsight. The second approach which is likely to be the most popular one is a limited retrospective approach. Under this approach, the cumulative effect of initial application of the Interpretation is recognised as an adjustment to the opening return to earnings. There is no need to restate the comparatives under this case. For entities with a December year end, your date of initial application would be first of January 2019. For entities with a June year end, your date of initial application would be first of July 2019.

Siva Sivanantham:
Under the modified retrospective approach, the adjustment is made as of the date of initial application. That's why the date of initial application is quite significant here. While 2019 might sound like a long way away, it's only 14 months away. Plus, it's a very sensitive and complex area for many entities so it's quite important that entities start reviewing their current approaches against the requirements in the Interpretation as soon as possible pretty much. As we all know and as you already flagged, Ram, the new leasing standard is also coming into effect in 2019, so it's going to be a busy period for entities. So, that's why we need to start thinking about this Interpretation early.

Ram Subramanian:
The Australian Taxation Office, the ATO, already has requirements for certain entities to disclose their reportable tax positions. This requires large businesses to disclose their most contestable and material tax positions to the ATO. The ATO has also indicated this requirement will extend to all businesses and economic groups with turnover more than 250 million dollars for income years ending on or after 30th of June 2018. Do you see any differences between the ATO requirement and Interpretation 23?

Siva Sivanantham:
I think there are two key difference here, Ram. The first one is a size difference. The ATO requirement only applies to collectively larger businesses whereas Interpretation 23 applies to all entities that prepare general purpose financial statements. Also, those that prepare special purpose but comply with recognition and measurement. I think the requirements in the Interpretation is likely to apply to more entities than those captured by the ATO requirements.

Siva Sivanantham:
The second difference I see is that the ATO requirement is more focused on the disclosure whereas the requirement in the Interpretation also focuses on recognition and measurement as well as disclosures. That's the second difference. At the end of the of day, all these measures whether from a pure tax perspective for from an accounting perspective are all part of the broader push for increasing tax transparency. These initiatives along with recent Australian legislation requiring significant global entities to prepare general purpose financial statements and lodge with ATO for example, they all complement each other and they work together to help promote tax transparency.

Ram Subramanian:
Thank you. Siva, you just mentioned that under the tax transparency measures that are being put together, the requirement to lodge general purpose financial statements with the ATO which is coming into play very soon, or it's already in play in fact. Can you just very briefly tell us what's involved here?

Siva Sivanantham:
This all started with the legislation passed by the Parliament back in December 2015. Then, that legislation was quite brave in terms of some of the finer details. What it tried to actually do was to get these so-called significant global entities, which are, essentially, entities that are part of a bigger global group, say one billion or more global income. If the entity is part of it or if it is a head entity within that group, then you are required to lodge general purpose financial statement with ATO. Some of these entities may not be lodging those financial statements at the moment or they might just be doing special purpose.

Siva Sivanantham:
What this was intended was getting these entities to prepare and lodge general purpose statements with ATO. The ATO would then give those financial statements to ASIC and then ASIC would put them on public records. There was no requirement to audit these financial statements. This requirement came into effect for income years ending 30th of June 2017 so it is already effective. The Australian Taxation Office has recently, earlier this month, or late last month, issued it's near final guidance in terms of how some of the finer details of how the legislation needs to be applied. Some of those requirements are quite complex, which I think we plan to cover in a more detailed podcast later on so that's probably enough for the time being, Ram.

Ram Subramanian:
Thank you very much, Siva. As Siva pointed out, we are planning to have a separate podcast on this topic very soon, so watch this space. And, thank you, Siva, for joining us today and explaining very clearly what the requirements in IFRIC Interpretation 23 or AASB Interpretation 23.

Siva Sivanantham:
Thank you, Ram.

Ram Subramanian:
For those listeners who are interested in reading more material on this topic, there is a link to the AASB Interpretation 23 itself on the same page on which this podcast resides. There is also a link to the technical alert issued by Grand Thornton, Australia if people want to read some of the impact that this Interpretation will have on financial statement preparers. Thank you.

Speaker 1:
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