Taxation and Representation

The first international accounting standard to be adopted by the United States may well be the one dealing with tax. But rulemakers first will have to decide how to explain uncertainty to investors.

For the first time since 1775, American taxes soon may be determined by people far away in London, England. But don’t break out your squirrel guns and start dumping tea just yet — we’re only talking about accounting.

In an effort to speed the convergence of American and international accounting, rulemakers at the Financial Accounting Standards Board are considering making no further tweaks to U.S. rules for tax accounting. Instead, they may simply toss out those rules in favor of the international financial reporting standard, which rulemakers in London are also modifying in an ongoing effort to reduce differences between the two systems.

“If ultimately convergence is going to be on IFRS,” said FASB member George Batavick during a recent Webcast, “why not just go ahead and adopt their standard lock, stock, and barrel?”

Were FASB to adopt the IAS 12 standard, it would be the first time an international financial reporting standard with the “IAS” designation found its way directly into the U.S. GAAP hierarchy — a significant step on the path to moving the United States to full adoption of IFRS. But there is a major stumbling block in the way: how to represent on the financial statements the possibility that the government will challenge a company’s taxes.

“One problem is [IASB] does not have a FIN 48 standard and they are not interested in having the same sort of model we have,” said Batavick.

FIN 48 is a piece of guidance that tells companies in the United States how to account for uncertainty in tax positions. It went into effect for most companies at the beginning of last year, despite howls of protest and requests for delays from corporations. FIN 48 requires companies to include specific information regarding potential tax liabilities — information that was previously tucked in with other potential liabilities.

Much of the protest was sparked by fear that the new rule would provide the IRS and other taxing authorities with an audit roadmap. Indeed, some critics said FIN 48 breaks from accounting norms because it requires companies to assume the item in question will be audited and does not allow them to factor in the probability of not being audited or having the item in question go unnoticed by government auditors.

However, under the U.S. rule, companies must record a liability only if they determine that their tax position is “more likely than not” to be disallowed. “Our system is more of an ‘all-or-nothing’ approach,” explains tax expert Robert Willens of Robert Willens LLC.

IFRS, by contrast, does not have a recognition threshold. Instead, it seems likely that the IASB will require companies to factor the potential uncertainty of a tax position, no matter how small, into the amount of taxes reported on the financial statement. How that liability is likely to be measured also differs from U.S. standards. Although IASB has not issued a specific proposal related to uncertainty in tax, “the board has reconfirmed that it wants to continue with the approach of doing probability weighted expected outcome,” said IASB senior project manager Anne McGeachin during a recent KPMG Webcast that looked at the impact that adoption of IFRS would have on U.S. tax practices.

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