No.

2009-11 10 April 2009

Hot Topic
Update on major accounting and auditing activities

IASB issues Exposure Draft on Income Tax

Contents Overview ............................................... 1 Summary of proposed changes to IAS 12 ............................................... 1 Differences between IFRS and U.S. GAAP ............................................. 2 Next steps ............................................. 3

Overview
On 31 March 2009, the International Accounting Standards Board (IASB) issued an Exposure Draft, Income Tax (the Exposure Draft) which, if adopted, would replace International Accounting Standard 12, Income Taxes (IAS 12). The objectives of the IASBs project on income taxes are to 1) satisfy requests to clarify various aspects of IAS 12 and 2) reduce the existing differences between IAS 12 and FASB Statement No. 109, Accounting for Income Taxes (Statement 109). The project on income taxes was originally a joint project with the Financial Accounting Standards Board (FASB). In August 2008, the FASB announced it was indefinitely suspending its deliberations on the income tax project. While the FASB does not have any current plans to amend Statement 109, it plans to solicit feedback on the IASBs Exposure Draft through an Invitation to Comment because of the possibility that some or all US public companies may be permitted or required to adopt IFRS at some future date pursuant to the Securities and Exchange Commissions Roadmap. Based on the feedback received on the Invitation to Comment, the FASB is expected to decide whether to add a project to its

agenda that could result in the adoption in the US of the IASBs revised standard on accounting for income taxes. Because the possibility exists that US companies may have to apply the IASBs revised standard on accounting for income taxes in the future, it is important for interested parties to understand the IASBs Exposure Draft and to monitor future developments. We encourage interested parties to provide comments to the IASB that will assist in the development of a high quality accounting standard. Comments are due to the IASB by 31 July 2009. In addition, we encourage constituents to provide feedback to the FASB on its Invitation to Comment when it is issued. A copy of the Exposure Draft can be obtained from the IASBs website at www.IASB.org.

Summary of proposed changes to IAS 12

The accompanying Supplement to IFRS Outlook publication, ED Income Tax A proposal to replace IAS 12, provides a summary of the changes to the accounting for income taxes proposed in the IASBs Exposure Draft, including a more detailed discussion of the most important changes to IAS 12.

IASB issues Exposure Draft on Income Tax

Differences between IFRS and U.S. GAAP

The accounting for income taxes under IFRS and U.S. GAAP are broadly similar because IAS 12 and Statement 109 share the same principles. Despite the similarities, several differences currently exist between IFRS and U.S. GAAP. One of the IASBs primary objectives of the project on income taxes was to reduce the existing differences between IAS 12 and Statement 109. Accordingly, many of the changes to IAS 12 proposed in the Exposure Draft, if adopted, will result in convergence between IFRS and U.S. GAAP. If the Exposure Draft is adopted as currently drafted, the following differences between IFRS and U.S. GAAP will be substantially eliminated as IFRS would be consistent with current practice under U.S. GAAP:

Many differences between IFRS and U.S. GAAP accounting for income taxes will remain if the Exposure Draft is adopted as currently drafted, including:

Accounting for uncertain tax positions U.S. GAAP requires a two-step process that separates the recognition criteria from measurement. A benefit is recognized when it is more likely than not to be sustained based on the technical merits of the position (excluding any consideration of detection risk). The amount of the benefit to be recognized is based on the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement. The IASBs Exposure Draft proposes a one-step process whereby uncertain tax positions are measured using the probability-weighted average amounts of possible outcomes, assuming the tax authorities have full knowledge of all relevant information and will examine the issues. The proposed model does not have a threshold for determining whether an uncertain tax position should be recognized (other than materiality).

transferred between entities in different tax jurisdictions that remain within the consolidated group. IFRS requires taxes paid on intercompany profits to be recognized as incurred and requires deferred taxes to be recognized on basis differences of assets transferred between entities in different tax jurisdictions that remain within the consolidated group.

Treatment of temporary differences that arise on the initial recognition of assets acquired or liabilities assumed outside of a business combination (e.g., an asset acquisition) Under U.S. GAAP, deferred taxes are recognized for temporary differences arising on the initial recognition of assets acquired or liabilities assumed outside of a business combination. For example, if the amount paid for an asset differs from its tax basis, the consideration paid is allocated between the asset and deferred tax using a simultaneous equation approach. Under the model proposed in the IASBs Exposure Draft, the asset acquired will be valued under the respective IFRS recognition guidance and deferred tax will be recognized for the temporary difference between this amount and the tax basis of the asset. The difference between the consideration paid and the total recognized amounts (i.e., the aggregate of amounts recognized for the asset and the deferred tax) represents a premium or allowance that will be recorded as an offsetting adjustment to the deferred tax amount recognized.

Definitions of tax basis, temporary difference, tax credit and investment tax credit Accounting for deferred taxes related to investments in foreign subsidiaries and foreign corporate joint ventures Accounting for deferred tax liabilities related to investments in domestic subsidiaries and domestic corporate joint ventures Approach to recognizing and assessing the realizability of deferred tax assets Allocation of income taxes to items charged or credited directly to other comprehensive income and equity Allocation of income taxes to entities in a consolidated tax group when an entity within that group prepares separate financial statements Treatment of alternative minimum tax systems Classification of deferred taxes on the balance sheet

Accounting for deferred tax assets related to investments in domestic subsidiaries and domestic corporate joint ventures Under U.S. GAAP, deferred tax assets are recognized for deductible temporary differences on the outside basis of investments in domestic subsidiaries and corporate joint ventures that are essentially permanent in duration only if it is apparent that the temporary difference will reverse in the foreseeable future. As proposed in the IASBs Exposure Draft, recognition of deferred tax assets for outside-basis differences will be required. Accounting for the tax effects of intercompany transfers of non-monetary assets U.S. GAAP requires taxes paid on intercompany profits to be deferred and prohibits the recognition of deferred taxes on basis differences of assets

In addition to the differences described above, IFRS would continue to differ from U.S. GAAP in other aspects of accounting for income taxes, such as the:

Measurement of deferred taxes on foreign non-monetary assets Tax rate applied to undistributed profits of subsidiaries Use of substantively enacted versus enacted tax laws and rates

Hot Topic No. 2009-11, 10 April 2009

IASB issues Exposure Draft on Income Tax

Treatment of special deductions and investment tax credits Accounting for the tax effects of sharebased payments Accounting for the tax effects of leveraged leases

Next steps
The IASB plans to review the feedback provided by constituents and will determine whether to make revisions to the proposed standard. The IASB has a goal of issuing a final standard in 2010. The FASB is expected to issue an Invitation to Comment in the second quarter of 2009 that includes the IASBs Exposure Draft. Based on the feedback received, the FASB is expected to decide whether to add a project to its agenda that could result in the FASB adopting the IASBs revised standard on accounting for income taxes.

Certain of the remaining differences between U.S. GAAP and IFRS would have been eliminated under the FASBs tentative conclusions before it decided to cease its efforts on the project. Further discussion of the differences between IFRS and U.S. GAAP that will be eliminated and those that will remain if the Exposure Draft, as currently drafted, becomes a final standard is provided in the Basis for Conclusions on the Exposure Draft.

Attachment Supplement to IFRS Outlook: ED Income Tax A proposal to replace IAS 12

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Issue 36 / April 2009

Supplement to IFRS outlook

ED Income Tax A proposal to replace IAS 12

Background
On 31 March 2009 the International Accounting Standards Board (IASB) published an Exposure Draft (ED) of an International Financial Reporting Standard (IFRS) intended to replace IAS 12 Income Taxes. Comments are invited, to be received by 31 July 2009. The IASBs income taxes project was originally a joint project with the US Financial Accounting Standards Board (FASB), undertaken as part of the IASBs and FASBs short-term convergence project aimed at eliminating differences between US GAAP and IFRS. Accounting for income taxes seemed an ideal topic for convergence. IAS 12 is based on the temporary difference approach developed by the FASB and used in the US standard FAS 109. However, the project proceeded rather slowly and the FASB announced last year that it had suspended indenitely its deliberations on the income taxes project. The FASB has indicated that it will solicit input from US constituents by issuing an Invitation to Comment containing the IASBs ED. It will then decide whether to undertake a project that would eliminate differences in the accounting for income taxes by adopting the proposed new IFRS.

Main changes
The ED covers the following areas. We consider the proposals in italics as the most important changes from IAS 12, and address them in more detail below. Denitions of tax basis and temporary difference Exceptions to the temporary difference approach (elimination of the initial recognition exception) Measurement of deferred tax assets and liabilities Recognition of deferred tax assets Allocation of tax to components of comprehensive income or equity Balance sheet classication Uncertain tax positions Denitions of tax credit and investment tax credit Other miscellaneous changes Disclosures Transitional and rst-time adoption provisions

Denition of tax basis and temporary difference IAS 12 currently requires the tax base of an asset or liability to reect the manner in which the entity expects to recover the asset (or settle the liability). This effectively makes deferred tax a function of management intent, which the IASB has striven to eliminate from other areas of nancial reporting. The ED proposes replacing the term tax base with tax basis, dened in the ED as the measurement, under applicable substantively enacted tax law, of an asset, liability or other item. The tax basis of an asset is determined by the tax consequences of selling it for its carrying amount at the reporting date. The tax basis of a liability is determined by the tax consequences of settling it for its carrying amount at the reporting date. At present, a temporary difference is simply the difference between the carrying amount of an item and its tax base. The ED redenes a temporary difference as the difference between the carrying amount of an item and its tax basis that the entity expects will affect taxable prot when the carrying amount of the related asset or liability is recovered or settled (or, in the case of items other than assets or liabilities, will affect taxable prot in the future). In effect, this means that in some cases, the entitys expectations determine the measurement of deferred tax, so that the IASB has not been able to remove management intent from the picture entirely. Exceptions to the temporary difference approach IAS 12 currently provides that deferred tax should not be recognised on some temporary differences arising on the initial recognition of assets and liabilities. This initial recognition exception (or IRE) as it has become generally known can appear

somewhat arbitrary, but it is essentially a pragmatic solution to what were seen as inappropriate accounting consequences of the temporary difference approach in some circumstances. The EDs proposals in this area are complex. The IASB has concluded that the initial recognition exception could no longer be justied conceptually. On the other hand, it clearly wanted to avoid the accounting consequences which the exemption seeks to prevent. Accordingly, the initial recognition exception is abolished, with deferred tax being recognised on all temporary differences, whenever they arise, except that a deferred tax liability is not recognised on the initial recognition of goodwill. Where a temporary difference arises on the initial recognition of an asset or liability, the asset or liability should be disaggregated into: the asset or liability, excluding any entity-specic tax effects; and the entity-specic tax effects broadly, the extent to which the tax treatment of an item in the hands of the entity places the entity in a better or worse position than taxpayers as a whole. The former amount becomes the carrying amount of the asset or liability. Deferred tax is recognised on any temporary difference arising from this carrying amount. Where an asset or liability is recognised other than in a business combination or in a transaction that affects comprehensive income, equity or taxable prot, the entity also recognises a premium or allowance (the difference between the amount paid for an asset, or received for a liability, and its carrying amount together with any associated deferred tax asset or liability). Such a premium or allowance is offset against the deferred tax balance.

ED Income Tax: a proposal to replace IAS 12

The impact of this, in net terms, is that the former initial recognition exception is retained, in the sense that any deferred tax recognised on initial recognition of an asset or liability, other than in a business combination or a transaction that affects comprehensive income, equity or taxable prot, is immediately offset by a premium or allowance. Allocation of tax to components of comprehensive income or equity IFRS currently requires current tax and deferred tax to be charged or credited in other comprehensive income (OCI) or directly in equity if the tax relates to items that were credited or charged, whether in the current or previous period, in OCI or directly in equity. Subsequent changes to those amounts are also allocated to OCI or equity as applicable, a treatment commonly referred to as backward tracing. The ED proposes that any change to a tax asset or liability relating to an item accounted for in an earlier period should generally be recognised in prot or loss, without any backward tracing. However, the current requirement for backward tracing of share-based payment transactions is retained, (i.e., any tax deduction received in excess of the cumulative expense for an award is accounted for in equity). Unusually, the ED also presents for comment an alternative method of allocation based on the current standard, but with more specic guidance than in the current standard on the methodology of allocation between components. The IASB does not propose to adopt this alternative approach, but, nevertheless seeks commentators views on it. Uncertain tax positions Uncertain tax positions arise where there is an uncertainty as to the meaning of the law, the applicability of the law to a particular transaction, or both. IAS 12 does not explicitly address the recognition and

measurement of uncertain tax positions, although it notes that the principles of IAS 37 Provisions, Contingent Assets and Contingent Liabilities may be relevant to the disclosure of tax-related contingent assets and contingent liabilities. As a result, practice in this area has been varied. The ED proposes that entities measure uncertain tax positions on an expected outcome basis (i.e., at the probability weighed average of expected outcomes). The ED proposes that entities should disclose information about the major sources of estimation uncertainties relating to tax effects to enable users to assess the possible nancial effects of the estimation uncertainties and their timing (for example, the effects of unresolved disputes with the tax authorities), including: a description of the uncertainty; and an indication of its possible nancial effects on amounts recognised for taxes and the timing of those effects. These proposals, which greatly increase the disclosures required for what are typically sensitive issues, may prove one of the most contentious aspects of the ED. Transitional and rst-time adoption provisions Existing IFRS preparers are generally required to apply the proposed new standard retrospectively. However, the new requirements for the allocation of tax to components of prot or loss, OCI or equity must be applied prospectively from the date of the rst opening statement of nancial position. Where deferred tax has not been recognised on items due to the initial recognition exception, the new requirements that replace the initial recognition exception are applied as if the items concerned had been acquired for their carrying amounts outside a business combination at the date of the rst opening statement of nancial position.

Entities transitioning to IFRS are also generally required to apply the proposed new standard retrospectively. However, the new requirements for the allocation of tax to components of prot or loss, OCI or equity must be applied prospectively from the date of transition to IFRS. Moreover, entities with a transition date before the date on which any nal standard is issued may apply the current IAS 12 for periods presented that begin before that date. A rst-time adopter of IFRS may apply the new requirements that replace the initial recognition exception with full retrospective effect. Alternatively, it may disaggregate an asset or liability into an amount excluding any entity-specic tax effects and the entityspecic tax effects as at the date of transition to IFRS.

Business impact
The proposed amendments will affect virtually all tax-paying entities, given the pervasiveness and materiality of income tax items on the nancial statements. Entities will need to assess the effects of these amendments across the entire spectrum of their tax life cycle tax planning, tax provision, tax compliance and tax controversy. The proposals in the ED surrounding the accounting for and disclosure of uncertain tax positions may have far-reaching data gathering, documentation, and support implications to the entity as well as affect an entitys dealings with tax authorities worldwide.

ED Income Tax: a proposal to replace IAS 12

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