14 August 2009 Short Fin48 Ppt Presentation

FIN 48 in SA? PROPOSED EXPOSURE DRAFT ED/2009/2

Presented by:

Marius van Blerk & Daniel Erasmus

INTRODUCTION

• The Exposure Draft dealing with Income Tax was published for public comment on 31 March 2009 by the International Accounting Standard Board (“the Board”).

• Comments on question 7 and 16 in the Exposure Draft.

• The Nature & Value of Tax Risk• Internal factors

• Quality of tax staff• How well you know the facts in your business• How effectively/efficiently you manage the tax risk (75%)

• External factors• Tax laws changing;• SARS Audits

• Survey Results• 83% not 100% tax compliant (72% success rate SARS audits)• 79% have no documented tax strategy• 55% tax managers DO NOT communicate regularly with other

managers• 43% did not think their source info was 100% reliable• 66% - 79% had not undergone VAT/PAYE audits in the last 2

yearswww.TaxRiskManagement.com

COMMENT ON QUESTION 7

• Comment on question 7 states as follows:

Question 7 – Uncertain tax positions

IAS 12 was silent on how to account for uncertainty over whether the tax authority will accept the amounts reported to it. The exposure draft proposes that current and deferred tax assets and liabilities should be measured at the probability-weighted average of all possible outcomes, assuming that the tax authority examines the amounts reported to it by the entity and has full knowledge of all relevant information. (See paragraphs BC57 – BC63 of the Basis for Conclusions.)

Do you agree with the proposals? Why or why not?”

www.TaxRiskManagement.com

COMMENT ON QUESTION 7 Cont…

• The evaluation of a tax situation for FIN 48 purposes is based on a two-step process:

o The first step is recognition: which is a 50% or greater likelihood based on the technical merits of the tax situation;

o All facts circumstances consideredo Presume examination by Tax Authoritieso Take into account all relevant precedents & practices

o The second step is measurement: measured to determine the amount of benefit to recognize on financial statements.


COMMENT ON QUESTION 7 Cont…

• In addition to taking into account the benefit that a particular tax issue will create for a particular business, interest and penalties must also be computed in addition to the tax liability, where required by the relevant tax legislation.

• A tax liability will cease to be a liability during the first interim period in which any one of the following three requirements exist:

o the more likely than not recognition threshold is met by the reporting date;o the tax issue is settled through negotiation or litigation;o the statue of limitations for the Revenue Service (prescription) to examine a tax

issue has expired, unless there has been fraud, misrepresentation or non-disclosure by the taxpayer.


DISCLOSURE IS TOO ONEROUS

• The Exposure Draft suggests that all amounts affecting current and deferred tax assets and liabilities must be considered and taken into account irrespective of the amount concerned and irrespective of the likelihood of a dispute.

• There is no recognition threshold applicable to the disclosure.

• In addition, all possible outcomes should be included in the analysis of the amount.

• A simple example illustrating the amount of work involved for one item affecting the tax liability is as follows:

Assume a deduction giving rise to a tax benefit of R1 million is claimed.

A probability should be attached to all possible outcomes assuming the tax authority examines the amounts reported and has full knowledge of all relevant information. No possible outcomes should be ignored in the measurement.


DISCLOSURE IS TOO ONEROUS Cont…

Possible Outcomes Probability Risk in R

Tax benefit claimed is not challenged by the tax authority 50% 0 Tax benefit claimed is challenged by the tax authority and the taxpayer wins the matter 20% 0 Tax benefit claimed is challenged by the tax authority and the tax authority wins the matter 20% 200 000 Tax benefit claimed is challenged by the tax authority and the matter is settled 50/50 5% 25 000 Tax benefit claimed is challenged by the tax authority and the matter is settled 70/30 in favour of the tax authority 5% 35 000

100% 260 000


DISCLOSURE IS TOO ONEROUS Cont…

• This could be a onerous task for the following reasons:

o There is no threshold as in the application of FIN 48. The number of items in respect of which the analysis should be done is numerous. With no threshold, it means every single item having a tax effect should be considered. This goes against the principle of materiality employed during an audit process.

o The number of possibilities to include in the analysis is endless.

o The liability is contingent and it should be recognised even where the possibility of realizing is remote. This goes against general accepted accounting practice.

o A tax dispute takes time to run its course and this impact on the accuracy of the disclosed contingent liability.

o The effect that prescription may have is difficult to take into account. Nothing is said about applying the statue of limitations which is expressly provided for in FIN 48.


TAX AUTHORITIES TAKE ADVANTAGE OF THE DISCLOSURE

• With FIN 48 in the USA, the increase in tax accrual working papers was a major concern for USA taxpayers - tax authority could exploit the situation.

• Then the US v. Textron CA No., 06-198T (“Textron”) judgment, a US case concerning the disclosure of working papers during an audit, was in favour of the taxpayer and the IRS agreed to exercise restraint in line with the judgment.

• The judgment is not binding on tax authorities world-wide. There is no guarantee that tax authorities worldwide will exercise a similar restraint.

• The degree of disclosure in terms of the Exposure Draft is not clear, ie detailed workings as opposed to a consolidated number.

• SARS audits will now focus their investigations on annual financial statement (“AFS”) tax disclosures. This will create far greater exposures, even in remote situations, which otherwise may never have materialized into a dispute or controversy.

• Trigger tax audits without any “friendly” disclosure or settlement process available, as is the case in the USA with FIN 48.


THE MEANING OF “MATERIAL”

• What is “material” for accounting purposes?

• Exposure Draft. “Material” is not defined. IASB have made certain findings on “relevance”. Is relevance material? If we assume it is, the IASB state:

“To be relevant, information must be capable of making a difference in the economic decisions of users by helping them evaluate the effect of the past and the present events on future net cash flows…or confirm or correct previous evaluations…Also, the information must be available when the users need it…”.

• This means that any tax uncertainty after it has been through the compulsory internal tax review process (in that the information is available, and will influence future cash flows based on a probability analysis) could be material, as it satisfies all these criteria.


ATTORNEY / CLIENT PRIVILEGE

• In many respects this disclosure requirement undermines the attorney/client privilege taxpayers are entitled to.

• See the Textron case. It still remains to be decided whether Textron waived confidentiality when it gave its internal documents to the auditors.

• With the Exposure Draft, it can be anticipated that SARS will argue that the internal documents given to the auditor will form part of their working papers and will not be subject to attorney/client privilege.

• This will lead taxpayers to have to implement measures where any tax risk review documentation is not exposed to auditors, but kept in their possession of their qualified attorney in anticipation that this information may realistically be the subject of tax litigation with SARS, because it is anticipated that SARS will actively pursue any disclosures for the reasons stated above, leading to potential litigation.


CONSTITUTIONAL ISSUES

• Section 33 of the South African Constitution states that no person can be compelled to give self incriminating evidence. Self incrimination includes being exposed to punitive penalties.

• The Companies Act at section 285A read with 440FF, states that widely held companies must comply with generally excepted accounting standards in the preparation of their financial statements. This means that if the relevant taxpayers do not comply with the standard, the Companies Act imposes an administrative penalty, and if the transgression is not remedied, a criminal penalty on the offending party. It is therefore compulsory for widely held companies to comply with the Exposure Draft.

• SARS will be able to access this information in one of two ways:

o By approaching a third party auditor to present its working papers, in which case SARS is at liberty to pursue any administrative or criminal actions against the taxpayer; or

o By approaching the taxpayer direct, and invoking the compulsory information machinery of the Income Tax Act, where the taxpayer may be able to rely on a ‘self incrimination’ defence, that entitles the taxpayer to any punitive penalty immunity, because the taxpayer was compelled to give the evidence to SARS.


CONSTITUTIONAL ISSUES Cont…

• The dichotomy of these two scenarios exposes the unfairness and uncertainty that will arise in the future.

• The ‘hardliner’ defence in terms of the Income Tax Act will be that the party refusing to give the information to SARS, can “show good cause” why they refuse SARS’ request, because:

o the opinions expressed in working papers are not information in the narrow sense, pertaining to a specific transaction at the time of its execution – but opinion or conjecture, a view formed, after the fact; or

o the taxpayer would be able to raise the ‘self-incrimination’ reason as “good cause”.

• However, both are unlikely to be followed as a defence by most.


SUGGESTED ALTERNATIVE APPROACH

• We suggest the following alternative approach:

o We suggest that a threshold for recognising the liability should apply in line with FIN 48. This will make the disclosure less onerous.

o We suggest that disclosure in the AFS should be minimal to avoid exploitation by the tax authorities.

• Procedures should be implemented where the tax accrual working papers for tax uncertainties are regarded as subject to attorney/client privilege. This will be difficult to impose on the legislatures of various governments.


QUESTION 16 – CLASSIFICATION OF INTEREST AND PENALTIES

The Facts

•The Board decided to follow FIN 48 in that the classification of interest and penalties payable to tax authorities is a matter of accounting policy choice that should be disclosed.

•Disclosure of the amount of interest and penalties is not required unless the amount is material in terms of paragraph 97 of IAS 1.

Invitation to Comment

•We hereby comment on question 16 which states as follows:

“IAS 12 is silent on the classification of interest and penalties. The exposure draft proposes that the classification of interest and penalties should be a matter of accounting policy choice to be applied consistently and that the policy chosen should be disclosed. (See paragraph BC103 of the Basis of Conclusions.)

Do you agree with the proposals? Why or why not?


SUGGESTED ALTERNATIVE APPROACH

• History in the USA shows that with FIN 48, about 42% of companies surveyed understated the interest and penalties component. The precise basis as to how this must apply, with reference to the probability theory, must be carefully spelt out to ensure proper compliance.

• What is stated with reference to Question 7 is repeated here, as well, and in particular in relation to what is ‘material’ enough to be disclosed.


FIN 48 in SA? PROPOSED EXPOSURE DRAFT ED/2009/2

Thank you


14 August 2009 Short Fin48 Ppt Presentation

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