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Financial reporting of tax positions – square pegs and round holes

The recent IFRS proposals to address uncertain tax positions in financial statements marks another chapter in the long-running saga of standard-setters striving to meet stakeholder demands for more transparency on an entity's tax position through its financial reports.

The proposals are a creditable second attempt by the international standard-setter to allow entities to evaluate and present within their financial statements, a "most probable" scenario for uncertain tax positions. However, the pace of legislative change affecting taxation combined with the significant and varied interpretation of tax laws is likely to present some challenges to companies attempting to estimate the right tax position.

Tax accounting within financial statements by listed and other large corporates often features on the target list of many national corporate regulators who have responsibility for the quality of financial reporting. If the latest proposals in respect of uncertain tax positions become effective, entities will have their work cut out in ensuring they document the process detailing a rigorous probability assessment for each uncertain tax position. There is also the possibility that the relevant amounts and disclosures will provide a roadmap to national tax agencies on where to focus their efforts when examining the tax affairs of entities.

Unquestionably, tax agencies have the right to closely examine tax disclosures in financial statements, and in fact, in most jurisdictions have the right of access to detailed information that goes far beyond what's disclosed in the financial statements. But with these new proposals, entities will be required to take a position and potentially defend why they chose that position if the ultimate position transpires differently.

The pace of legislative change affecting taxation has been breathtaking in the last few years, and it has not stopped with national law makers either. Tax base erosion and profit shifting by multinationals have been the catalyst for recent actions by the Organisation for Economic Cooperation and Development (OECD) and G20 countries. Many individual jurisdictions, including Australia, have taken the lead and introduced specific anti-avoidance rules for multinational entities. Taken collectively, these actions and measures are likely to result in some significant uncertain tax positions for certain multinational enterprises.

Documentation an entity produces to support its tax positions will also have to be sufficiently robust to satisfy external scrutiny by the entity's auditors. Facilitating better and timely communication between the entity's tax advisors and external auditors is likely to be beneficial.

Determining a tax position can be complex, lengthy and involve examinations by and negotiations with, multiple authorities including tax agencies and the courts. There is some concern that the requirement for an entity to predict the outcome of an uncertain tax position could put an entity in the unenviable position of defending its prediction, particularly when the final outcome is different. It is essential that the terminology in the final pronouncement is unequivocal in its message; the determination by the entity is based on its evaluation of the circumstances, taking into account all relevant and available evidence at the period end.

Alex Malley is chief executive of CPA Australia

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