IFRS update October 2005 - Tax

Nothing is likely to get those in business more steamed up than tax. and January’s introduction of IAS12 has done little to cool this.

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The standard has already achieved infamy, being dubbed a ‘killer for reserves’ and has added significant baggage to some companies’ balance sheets. As with many standards that have only just bitten here, it is already under review. The jury is out as to whether the proposed changes will benefit the UK.

The standard is already deeply unpopular with the business community. It halts the discounting of deferred tax liabilities, forcing companies to recognise future tax liabilities on any potential changes to their assets.

According to the IASB, it is designed to force companies to ask the question: ‘If I sold this asset today for the amount reported on the balance sheet would I owe taxes?’ And here lies the problem.

If firms revalue their assets or subsidiaries they have to put the relevant deferred tax liability on their balance sheet, even if in reality this would only have a cash impact if it was sold. This can create huge volatility and artificially distort balance sheets if assets are significantly re-valued.

‘It’s a rubbish standard and is having a big impact. We have a stack of clients where there will be big deferred tax liabilities,’ says Ken Wild, global head of IFRS at Deloitte. He says companies must anticipate the impact and communicate with the market ‘sooner rather than later.

Gillian Wild, tax director at PwC, agrees. ‘Deferred tax is one of the most underestimated complexities within international standards and of the Q&A sessions we have held, it is the most frequently asked about issue,’ she says.

‘The issue has been a rollercoaster and changes in UK tax legislation over t he past 12 months haven’t helped. It has created added complexity, extra cost and time and has been another burden to companies.’

Due to the added uncertainty that the review brings, Gillian Wild advises companies that to avoid embarrassment when reporting they should ‘understand the numbers’ and be clear whether deferred tax will become real liabilities.

Supermarket giant Sainsbury’s has already reported a £495m deferred tax deficit on its restated group consolidated accounts for 2004, while Cadbury Schweppes was hit with a £711m deferred tax expense for the first time, helping to reduce its assets from £3bn to £2.3bn.

Media group Reed Elsevier, while on track to meet its growth targets after reporting first-half profits of £395m, saw its earnings per share reduced from 7.5p to 5.1p due to its deferred tax liabilities.

It isn’t all bad news. Marconi, which has been struggling after failing to land a multi-million pound contract with BT, is thought to be more attractive to potential buyers due to its £800m in deferred tax credits.

The IASB believes the standard makes tax more transparent and closes potential routes for avoidance. But the ICAEW has warned that the impact of deferred tax will act as a disincentive for companies to adopt IFRS for consolidated accounts.

Instead, more are likely to use UK GAAP for subsidiaries and IFRS for parent companies, effectively producing two sets of books. Chris Jackson, director of restructuring services at PwC, says that listed companies paying dividends need to ‘plan how to transfer profits from subsidiaries to the parent company’.

The IASB is working on a short-term convergence project between IAS12 and the US standard FAS109 with the FASB. There are indications that it may redraft IAS12 and simplify it to ease it into UK tax practice.

But the board will have to overcome severe scepticism in the industry. Caroline Beer, senior IFRS manager at the ICAEW says convergence projects so far have not been in keeping with UK principles and have moved standards to a more rigid US rules based system.

But Peter Holgate, accounting technical partner at PwC, believes any convergence could go one step further, leading to even greater deferred tax liabilities for companies and that it could even result in some having to account for more than they actually have to pay.

Business should be paying careful attention to any proposed changes from the standard setters as there could be even more taxing times ahead for UK plc.

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