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IFRS conversion: Taxing times ahead
January, 27th 2010

The increasing attractiveness of the European and Asian capital markets has prompted emerging economies like-Brazil , China, India, and Russia to converge their existing accounting standards to International Financial Reporting Standards (IFRS).

Over 100 countries have now adopted or permitted IFRS or have based their local Generally Accepted Accounting Principles (GAAP) on the principles of IFRS.

In 2007, the Institute of Chartered Accountants of India (ICAI) announced its intention to have full convergence with IFRS from 1 April 2011.

The momentum towards convergence has since gathered steam. Surprisingly , the stakeholders have given the tax impact of conversion of Indian GAAP financial statements to IFRS financial statements little or no importance.

It will be a grave mistake to presume convergence as a mere technical accounting exercise. Conversion to IFRS could have a significant impact on all aspects of the tax lifecycleplanning , provision, compliance and controversy (as well as the people, process, and technology matters for the tax department).

It could also have a combined impact on various accounting policies and change the way accounting income is determined. This, in turn, would alter the face of the balance sheet.

The IFRS lays more emphasis on the balance-sheet disclosures than the profit & loss account, as International Accounting Standards Board (IASB), the body responsible to develop IFRS, favours fair value accounting over historical accounting. This could mean greater volatility of results.

For tax purposes, the potential problem with fair value accounting is that it gives rise to the recognition of unrealised profits and losses. The question is whether these profits should form the starting point to calculate taxable profits where no specific tax rule currently exists to the contrary.

The difficulty for companies would arise when unrealised profits & losses on account of fair value accounting are brought to tax without the company having the cash to pay for it.

For instance, real estate companies would have to take a re-look at their construction agreements for the purposes of revenue recognition. Under IFRS, a company would be able to recognise revenue with reference to stage of completion, if and only if, the agreement transfers control to the buyer, as well as the significant risks and rewards of the ownership of the work.

But the guidance note and accounting standards issued under Indian GAAP considers it appropriate to recognise revenues once there is a legally 
enforceable agreement for sale and other conditions for recognition of revenue are met.

Similarly, in the absence of any specific guidance on the treatment of Foreign Currency Convertible Bond (FCCB) under Indian GAAP, most companies adjust the redemption premium to the securities premium account. Consequently, there is no or little charge to the income statement.

As per the recent exposure draft (ED) issued by IASB, FCCB may not meet the basic loan feature criterion for measurement at the amortized cost due to the conversion cost. Consequently, the ED will require the whole of the FCCB including the conversion option to be measured at fair value through the income statement .

Such a dichotomy will impact the accounting income being disclosed by the company. As a result, IFRS conversion would change the effective tax rates of companies that is calculated upon the ratio of income tax expense to pretax income.

On adoption of IFRS, companies will prepare the accounts as if IFRS always applied . Normally, when there is a change in the accounting policy, a prior year adjustment arises in the year of change. On adoption of IFRS, there will be a wholesale restatement of the entire accounts, and as a result no prior adjustments will be shown.

IFRS 1 deals with first time adoption of IFRS. If the changes due to conversion to IFRS are made from retrospective effect, it needs to be seen whether revenue that is recognised in previous years and is already offered to tax would be de-recognised .

Will revenue authorities accept such deferment of income for subsequent years? Would revision income for prior years be accepted? What would be the treatment of the income offered and taxes paid for previous years?

While the effect will vary between companies and industries and go beyond changes to accounting results, it is safe to say that for many companies, an IFRS conversion will affect cash taxes and change effective tax rates. It will also involve reassessment of unrecognized tax benefits, affect compensation and benefit plans, raise issues related to tax return accounting methods and affect tax provision and compliance processes

To conclude, companies need to start identifying the differences that will arise and consider what the potential tax implications maybe. With the deadline fast approaching , IFRS conversion should be taken as an opportunity to align the tax provisioning and reporting processes.

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