PricewaterhouseCoopers cautioned in a new report that serious tax issues stemming from a shift to international financial reporting standards make it vital for corporate tax executives to “be part of the IFRS conversion process at a very early stage.”
Titled “IFRS: The Right Move toward Convergence,” the report does indeed promise that moving to international standards is “both inevitable and advantageous” for U.S.-based multinational companies. “IFRS will enhance comparability and transparency, which will be beneficial to all stakeholders,” it says, pointing to cost efficiencies and fewer rules and exceptions that will “reduce complexity and the risk of errors.” However, it lists several tax-related areas of major concern.
Adopting IFRS “involves a fundamental change in the framework of how U.S. companies measure pre-tax income and the principles governing accounting for income taxes,” starting with effective tax rate and extending to “a myriad of tax method-of-accounting considerations.”
The report, prepared by PwC tax practice tax-accounting services leaders both in the U.S. and Europe, calls attention to international tax planning, state and local taxes, and transfer pricing determinations as central areas for revision, making the involvement of tax professionals “important at every stage of the IFRS conversion process.”
In foreign cash taxes, for example, the change from existing generally accepted accounting principles to IFRS will alter the “starting point in determining taxable income for tax filing purposes.” Differences between IFRS and GAAP “include the accounting for revenue, leases, asset impairments, classification and measurement of financial instruments, hedging activity, and stock-based compensation, to name a few,” the report says.
Since U.S. taxes do not necessarily reflect the “book” accounting method, IFRS conversion requires “an analysis of each new accounting policy for its related tax implications,” including whether it “is permissible or advisable to conform the related tax method of accounting to the new book accounting method.” Often, the consent of the Internal Revenue Service commissioner in the U.S. is needed before a change in method is made, PwC notes.
For companies now using the last-in, first-out method of inventory valuation, “IFRS also is a major tax issue,” since international standards do not allow the use of LIFO, “and the tax law does not permit the use of LIFO unless the method is used for financial reporting purposes.” Unless there is new legislation, U.S. companies now using LIFO “will face a tax cost with a change to IFRS for financial reporting,” according to the report.
And all these considerations come even before companies begin to consider using fair-value measurement — one of the areas that has received the most attention among executives discussing convergence. “For example, under IFRS companies can elect to measure property, plant equipment, and investment property at fair value, and certain financial instruments may be required to be carried at fair value,” the report says. “These measurement concepts could have a significant impact on debt-to-equity and other balance sheet ratios, resulting in limitations on interest deductibility.”
Look for additional impact in cash repatriation, among other areas. “The impact of these various international tax considerations will vary by company and by industry,” PwC cautions. So to keep ahead in tax and treasury strategy, it is important for corporate tax executives to “gain insight into the potential pre-tax implications of IFRS,” even if convergence for external reporting doesn’t come right away.
Also mentioned are difference in international and GAAP approaches to accounting for uncertain tax positions, where the International Accounting Standards Board currently does not intend to adopt a standard similar to Federal Accounting Standard No. 48. Under IFRS “a liability for tax uncertainties is based on the amount of taxes expected to be paid to the tax authorities,” and the FIN 48 two-step process for recognition and measurement is not specified.
Finally, the PwC report lists potential changes in companies’ overall state and local tax positions that may result from convergence, with balance sheet changes affecting net worth and franchise and property taxes. It points out that compensation and benefit plans will have to be revised. And it discusses how existing systems and processes and controls in the tax departments of U.S. multinationals “have been primarily designed to deliver information to meet the financial statement reporting requirements of U.S. GAAP, along with various tax compliance and reporting requirements.”
PwC envisions a timetable in which IFRS could be made mandatory by 2013 to 2014, with early-adoption options being available as early as next year.