Midyear Tax Planning Letter To Our Clients and Friends: Although this year is only about half over, we’ve already had one new tax law (a really big one), and more might be on the way (maybe not so big). Despite confusion created by never-ending legislative changes, the current federal income tax environment is still quite favorable. Now is the time to take advantage of the tax breaks that Congress has provided before they disappear. This letter presents just a few key tax planning ideas to consider this summer while you have time to think. Some of the ideas may apply to you, some to family members, and others to your business. Here goes.
Cash in on First-time Homebuyer Credit
Legislation enacted in 2008 created a temporary tax credit for so-called first-time homebuyers (basically, taxpayers who haven’t owned a principal residence in the last three years). Stimulus legislation enacted earlier this year extended the credit provision to cover qualified home purchases between 1/1/09 and 11/30/09 and made the maximum credit amounts a bit more generous. More importantly, the stimulus legislation also deleted a previous requirement to repay the credit over 15 years. For a qualified principal residence purchase between 1/1/09 and 11/30/09, the maximum credit equals the lesser of: (1) 10% of the purchase price of a principal residence, (2) $8,000, or (3) $4,000 for those who use married filing separate status. The credit can be used to offset your entire federal income tax bill, including any Alternative Minimum Tax (AMT). The credit is also refundable. After your tax bill has been reduced to zero, you are allowed to collect any leftover credit amount in cash.
Beware: The credit is phased out (reduced or completely eliminated) if your Modified Adjusted Gross Income (MAGI) is too high. Contact us for details about that and other qualification rules that are not covered here.
Collect Tax Breaks for Buying New Vehicle
Thanks to the following tax breaks that won’t be around forever and a buyer’s market, now might be a very good time to purchase a new vehicle.
Sales Tax Deduction. Stimulus legislation passed earlier this year created a new federal income tax deduction for state and local sales and excise taxes paid on new (not used) vehicles that are purchased (not leased) between 2/17/09 and 12/31/09. The write-off is limited to the amount of taxes on the first $49,500 of purchase price. You can claim the break whether you itemize or not, and it’s allowed even if you owe the AMT. An IRS spokesperson recently confirmed that you can claim the deduction on as many vehicles as you care to buy within the designated time frame. Qualifying vehicles include almost all passenger autos, pickups, and SUVs, as well as motorcycles and RVs. However, a phase-out rule can reduce or completely eliminate the break for higher-income taxpayers. Contact us for details.
Hybrid Vehicle Credit. A federal income tax credit is allowed for buying (not leasing) a qualifying new (not used) hybrid vehicle. The credit can be used to offset your 2009 federal income tax bill even if you owe the AMT, and high income won’t disqualify you. Credits for most qualifying vehicles range from around $1,500 to $3,000. However, credits are phased out once the manufacturer has sold over 60,000 hybrids in the U.S. Credits for Toyota and Lexus hybrids disappeared after 2007, and credits for Honda hybrids vanished after 2008. Credits for Ford and Mercury hybrids are being phased out right now. You’ll get a bigger credit for buying a Ford or Mercury hybrid before October 1. So far, full credits are still allowed for hybrids made by Chrysler, GM, Mazda, and Nissan.
Lean-burn Diesel Vehicle Credit. A federal income tax credit is also granted for buying (not leasing) a new (not used) qualifying lean-burn diesel vehicle. The credit will offset your 2009 federal income tax bill even if you owe the AMT and regardless of how high your income might be. Lean-burn diesel credits are subject to the same phase-out rule as hybrid credits. So, they will be reduced and eventually disallowed after a manufacturer has sold 60,000 units (not an issue so far). Right now, you can find Audi, BMW, Mercedes, and Volkswagen diesels that qualify. Credits range from $900 to $1,800.
Leverage Standard Deduction by Bunching Deductible Expenditures
Are your 2009 itemized deductions likely to be just under, or just over, the standard deduction amount? If so, consider the strategy of bunching together expenditures for itemized deduction items every other year, while claiming the standard deduction in the intervening years. The 2009 standard deduction for married joint filers is $11,400; the magic number for single filers is $5,700; it’s $8,350 for heads of households. Examples of deductible items that can be bunched together every other year to lower your taxes include the interest due with your January home mortgage payment, charitable contributions, and state income and property tax payments. But, watch out for AMT as state income and property taxes are but deductible for AMT purposes.
Take Advantage of Generous But Temporary Business Tax Breaks
Several favorable business tax provisions have a limited shelf life that may dictate taking action between now and year-end. They include the following.
Bigger Section 179 Deduction. Your business may be able to take advantage of the temporarily increased Section 179 deduction. Under the Section 179 deduction privilege, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions. For tax years beginning in 2009, the maximum Section 179 deduction is $250,000 (same as last year). For tax years beginning in 2010, however, the maximum deduction is scheduled to drop back to about $130,000 (depending on the inflation adjustment). Various limitations apply to the Section 179 deduction privilege, so please contact us if you want more information.
50% First-year Bonus Depreciation. Above and beyond the bumped-up Section 179 deduction, your business can also claim first-year bonus depreciation equal to 50% of the cost of most new (not used) equipment and software acquired and placed in service by December 31 of this year. The first-year bonus depreciation break is scheduled to expire at year-end unless Congress takes further action. Contact us if you want more details about this generous, but temporary, tax break.
Longer Carryback Period for Net Operating Losses (NOLs). Stimulus legislation passed earlier this year allows qualifying small and medium-sized businesses to carry back Net Operating Losses (NOLs) generated in tax years beginning or ending in 2008 for up to five years (versus the two-year carryback rule that usually applies). Therefore, if your qualifying business uses a fiscal tax year (say one ending in October), you may still have time to take actions that will create or increase an NOL for the current tax year. That NOL can then be carried back for up to five years to recover taxes paid in those years.
Note: 50% first-year bonus depreciation deductions for qualifying assets placed in service between now and December 31 can create or increase an NOL. However, Section 179 deductions cannot. Please contact us for details on the interaction between asset additions and NOLs.
Conclusion
As we said at the beginning, this letter is intended to give you just a few ideas to get you thinking about tax planning moves for the rest of this year. Please don’t hesitate to contact us if you want more details or would like to schedule a tax planning strategy session. We are at your service!
Best regards,
TRM Services Team
+1 561 568 7115 or daniel@dnerasmus.com
Wednesday, August 26, 2009
Wednesday, August 19, 2009
IRS defeats Textron over accrual work papers
By a 3-2 majority, the US Court of Appeals for the First Circuit ruled on Thursday that the Internal Revenue Service (IRS) can see tax accrual work papers prepared by Textron, an aerospace and defence company, to back up calculations made for its audited financial statements...
IRS defeats Textron over tax accrual work papers
International Tax Review
By a 3-2 majority, the US Court of Appeals for the First Circuit ruled on Thursday that the Internal Revenue Service (IRS) can see tax accrual work papers prepared by Textron, an aerospace and defence company, to back up calculations made for its audited financial statements.
The IRS had appealed a district court judgement, confirmed subsequently by the first circuit, that the papers, which related to sale-in lease-out (Silo) transactions, were privileged. The US tax authorities consider Silo transactions to be potential abusive tax shelters. Textron argued the papers had been prepared in case there was litigation and so qualified for attorney-client privilege.
"The work product privilege is aimed at protecting work done for litigation, not in preparing financial statements," Judge Michael Boudin wrote, in the majority opinion. "Textron's work papers were prepared to support financial filings and gain auditor approval; the compulsion of the securities laws and auditing requirements assure that they will be carefully prepared, in their present form, even though not protected; and IRS access serves the legitimate, and important, function of detecting and disallowing abusive tax shelters."
Judge Juan Torruella, who dissented along with Judge Kermit Lipez, wrote: "This court should accept the district court's factual conclusion that Textron created these documents for the purpose of assessing its chances of prevailing in potential litigation over its tax return in order to assess risks and reserve funds. Under these facts, work-product protection should apply."
The court remanded the case for further proceedings.
The majority came up with the right verdict, said Linda Beale, a professor at Wayne State University.
"This is an important decision and one that was correctly decided," she blogged at ataxingmatter. "It is time the courts recognized the boundaries to work-product protection. Tax accrual workpapers do not merit protection. Textron should hand over the workpapers and determine to engage in less aggressive tax planning in the future."
Adler Pollock & Sheehan and Steptoe & Johnson represented Textron.
IRS defeats Textron over tax accrual work papers
International Tax Review
By a 3-2 majority, the US Court of Appeals for the First Circuit ruled on Thursday that the Internal Revenue Service (IRS) can see tax accrual work papers prepared by Textron, an aerospace and defence company, to back up calculations made for its audited financial statements.
The IRS had appealed a district court judgement, confirmed subsequently by the first circuit, that the papers, which related to sale-in lease-out (Silo) transactions, were privileged. The US tax authorities consider Silo transactions to be potential abusive tax shelters. Textron argued the papers had been prepared in case there was litigation and so qualified for attorney-client privilege.
"The work product privilege is aimed at protecting work done for litigation, not in preparing financial statements," Judge Michael Boudin wrote, in the majority opinion. "Textron's work papers were prepared to support financial filings and gain auditor approval; the compulsion of the securities laws and auditing requirements assure that they will be carefully prepared, in their present form, even though not protected; and IRS access serves the legitimate, and important, function of detecting and disallowing abusive tax shelters."
Judge Juan Torruella, who dissented along with Judge Kermit Lipez, wrote: "This court should accept the district court's factual conclusion that Textron created these documents for the purpose of assessing its chances of prevailing in potential litigation over its tax return in order to assess risks and reserve funds. Under these facts, work-product protection should apply."
The court remanded the case for further proceedings.
The majority came up with the right verdict, said Linda Beale, a professor at Wayne State University.
"This is an important decision and one that was correctly decided," she blogged at ataxingmatter. "It is time the courts recognized the boundaries to work-product protection. Tax accrual workpapers do not merit protection. Textron should hand over the workpapers and determine to engage in less aggressive tax planning in the future."
Adler Pollock & Sheehan and Steptoe & Johnson represented Textron.
Worldwide - Alarm over new company tax weapon
A NEW accounting standard will be added to the South African Revenue Service’s (SARS) armoury to collect taxes from companies . Companies will be required to account for all tax uncertainties in their financial statements, giving tax authorities the power to seize audit working papers. Tax analysts said at the weekend if the draft accounting standard were to be implemented in its current form, SARS “will use it without shame and unequivocally against taxpayers” to boost revenue collections.
Alarm over new company tax weapon
SANCHIA TEMKIN
Published: 2009/08/17 06:39:06 AM
A NEW accounting standard will be added to the South African Revenue Service’s (SARS) armoury to collect taxes from companies .
Companies will be required to account for all tax uncertainties in their financial statements, giving tax authorities the power to seize audit working papers.
Tax analysts said at the weekend if the draft accounting standard were to be implemented in its current form, SARS “will use it without shame and unequivocally against taxpayers” to boost revenue collections.
The International Accounting Standards Board recently released an exposure draft (ED 2009/2) on income taxes. The proposed accounting standard is intended to replace the existing standard on accounting for income tax (IAS12). Companies will be required to accurately reflect their liability for tax annually according to the exposure draft .
Marius van Blerck, group tax director at Standard bank , said the proposed accounting standard would apply to dozens of tax systems internationally. Van Blerck was speaking at a workshop on Friday hosted by the International Tax Institute in Johannesburg.
He pointed out a number of problematic provisions with the proposed accounting standard.
It requires tax assets and liabilities to be measured by using a probability-weighted average of all possible outcomes. This relates to all tax issues and not just disputes.
“It (the methodology) assumes disaggregation.” It assumed that it was possible to make accurate assumptions about the outcome of potential and actual disputes, on a case by case basis (instead of an aggregated basis), he said.
“I t requires extraordinary foresight (on the part of auditors).”
The most serious issue was that the exposure draft required companies to make disclosure of this information in their annual financial statements.
It was uncertain whether the authorities would accept the amounts presented to them, he said. Globally, tax authorities are under immense pressure to collect revenue and had initiated a number of steps against large companies to boost collections.
SARS was 12,2% (R20bn) behind on revenue collection, gross domestic product shrank 6,4% in the past quarter, and unemployment in the economy was growing.
Daniel Erasmus, chairman and CEO of TRM Services, said the disclosure element would confer more power on tax authorities.
The requirements could undermine a taxpayer’s due process rights by allowing tax authorities direct access to information that should be legally privileged.
“SARS would be able to ask for the working audit papers of a company — they would be able to seize a company’s documents.”
Erasmus said in the future companies would have to separate the responsibilities of audit partners and tax advisers by way of a tax risk-management programme.
Van Blerck expected the international accounting board to revise the exposure draft after a wide range of responses .
temkins@bdfm.co.za
Alarm over new company tax weapon
SANCHIA TEMKIN
Published: 2009/08/17 06:39:06 AM
A NEW accounting standard will be added to the South African Revenue Service’s (SARS) armoury to collect taxes from companies .
Companies will be required to account for all tax uncertainties in their financial statements, giving tax authorities the power to seize audit working papers.
Tax analysts said at the weekend if the draft accounting standard were to be implemented in its current form, SARS “will use it without shame and unequivocally against taxpayers” to boost revenue collections.
The International Accounting Standards Board recently released an exposure draft (ED 2009/2) on income taxes. The proposed accounting standard is intended to replace the existing standard on accounting for income tax (IAS12). Companies will be required to accurately reflect their liability for tax annually according to the exposure draft .
Marius van Blerck, group tax director at Standard bank , said the proposed accounting standard would apply to dozens of tax systems internationally. Van Blerck was speaking at a workshop on Friday hosted by the International Tax Institute in Johannesburg.
He pointed out a number of problematic provisions with the proposed accounting standard.
It requires tax assets and liabilities to be measured by using a probability-weighted average of all possible outcomes. This relates to all tax issues and not just disputes.
“It (the methodology) assumes disaggregation.” It assumed that it was possible to make accurate assumptions about the outcome of potential and actual disputes, on a case by case basis (instead of an aggregated basis), he said.
“I t requires extraordinary foresight (on the part of auditors).”
The most serious issue was that the exposure draft required companies to make disclosure of this information in their annual financial statements.
It was uncertain whether the authorities would accept the amounts presented to them, he said. Globally, tax authorities are under immense pressure to collect revenue and had initiated a number of steps against large companies to boost collections.
SARS was 12,2% (R20bn) behind on revenue collection, gross domestic product shrank 6,4% in the past quarter, and unemployment in the economy was growing.
Daniel Erasmus, chairman and CEO of TRM Services, said the disclosure element would confer more power on tax authorities.
The requirements could undermine a taxpayer’s due process rights by allowing tax authorities direct access to information that should be legally privileged.
“SARS would be able to ask for the working audit papers of a company — they would be able to seize a company’s documents.”
Erasmus said in the future companies would have to separate the responsibilities of audit partners and tax advisers by way of a tax risk-management programme.
Van Blerck expected the international accounting board to revise the exposure draft after a wide range of responses .
temkins@bdfm.co.za
Friday, August 14, 2009
Nature & Value of Tax Risk - Additional Notes to the FIN 48 in SA seminar
IFRS have issued a draft income tax statement proposing the introduction of a process to determine tax liabilities more onerous than FIN 48. Is South Africa prepared? Here are some useful tips on making preparation for future more onerous tax positions...
Nature and value of tax risk
Tax risk is something you acquire by simply doing business. You choose to be exposed to it the moment you attempt to generate income. You can of course influence the extent of the tax risk, but the final value of tax risk is ultimately determined by internal and external factors to your business. You will determine the extent by how effective and efficient your management of tax risk is.
The quality of tax risk can range between a negative monetary and bad reputational exposure, to a positive ability to identify opportunities to reduce tax exposure, increasing the ability to procure greater profits. The internal factors that influence this are:
- the quality of your tax compliance staff and/or advice;
- how well you know the facts in your business that might drive tax exposure – this is the information you access “above the ledger line” on an inverted triangle. The apex is the accurate determination of taxable income. The "ledger line" appears half way between the base and apex of the triangle – it is difficult to believe, but the size of the area between that line and the base of the triangle is 75% area of the whole triangle. The area between the line and the apex only makes up 25% of the total area. It is this part of the taxpayer’s overall tax risk that is usually accounted for in tax compliance. The other 75% goes undetected until there is an audit by a Tax Authority – or a structured tax risk management plan is put into place;
- how effectively and efficiently you manage the “above the ledger line” information (the 75% undetected or uncovered area) that may cause tax exposure.
The external factors, in summary, are:
- the regular practical processing of new tax legislation and regulations that may impact on your business;
- being targeted by a Revenue Authority for a tax audit.
Unfortunately for most businesses, they do not care to manage the “above the ledger line” information (that 75% portion), until they have been forced to do so by an adversarial Tax Authority tax audit, threatening to expose them to exorbitant back-taxes not previously provided for.
Internationally, there is an increase in targeted business tax audits by specially organized Tax Authority task teams – showing increased improvements in tax exposures by taxpayers. Why is this? Take a look at the results of a recent tax risk survey:
- 83% of survey participants (taxpayers) stated they knew they were not 100% tax compliant;
COMMENT: SARS had a 72% success rate on its 69 000 tax audits in 2008;
- 79% do not have a documented tax strategy;
- 55% tax compliance managers do not communicate with the rest of the business to double-check the accuracy of “above the ledger account” information;
- 43% did not think their tax compliance information is from a 100% reliable source;
- Between 66% - 79% had not undergone tax audits by the Tax Authority in the last 2 years;
- 43% did not know whether or not tax issues and risks are discussed at board level.
Various conclusions can be drawn from these survey results. Any Tax Authority responsible for administering tax compliance amongst these taxpayers would be virtually guaranteed of arrear taxes, penalties and interest.
Over 200 taxpayers have participated in the survey.
A properly orchestrated tax risk management plan, as advocated in the book “7 Habitual Tax Mistakes” in conjunction with the retainer program offered by www.tax-Radar.com will go a long way towards managing and controlling previously undetected and unknown tax risks in any taxpayer business.
Nature and value of tax risk
Tax risk is something you acquire by simply doing business. You choose to be exposed to it the moment you attempt to generate income. You can of course influence the extent of the tax risk, but the final value of tax risk is ultimately determined by internal and external factors to your business. You will determine the extent by how effective and efficient your management of tax risk is.
The quality of tax risk can range between a negative monetary and bad reputational exposure, to a positive ability to identify opportunities to reduce tax exposure, increasing the ability to procure greater profits. The internal factors that influence this are:
- the quality of your tax compliance staff and/or advice;
- how well you know the facts in your business that might drive tax exposure – this is the information you access “above the ledger line” on an inverted triangle. The apex is the accurate determination of taxable income. The "ledger line" appears half way between the base and apex of the triangle – it is difficult to believe, but the size of the area between that line and the base of the triangle is 75% area of the whole triangle. The area between the line and the apex only makes up 25% of the total area. It is this part of the taxpayer’s overall tax risk that is usually accounted for in tax compliance. The other 75% goes undetected until there is an audit by a Tax Authority – or a structured tax risk management plan is put into place;
- how effectively and efficiently you manage the “above the ledger line” information (the 75% undetected or uncovered area) that may cause tax exposure.
The external factors, in summary, are:
- the regular practical processing of new tax legislation and regulations that may impact on your business;
- being targeted by a Revenue Authority for a tax audit.
Unfortunately for most businesses, they do not care to manage the “above the ledger line” information (that 75% portion), until they have been forced to do so by an adversarial Tax Authority tax audit, threatening to expose them to exorbitant back-taxes not previously provided for.
Internationally, there is an increase in targeted business tax audits by specially organized Tax Authority task teams – showing increased improvements in tax exposures by taxpayers. Why is this? Take a look at the results of a recent tax risk survey:
- 83% of survey participants (taxpayers) stated they knew they were not 100% tax compliant;
COMMENT: SARS had a 72% success rate on its 69 000 tax audits in 2008;
- 79% do not have a documented tax strategy;
- 55% tax compliance managers do not communicate with the rest of the business to double-check the accuracy of “above the ledger account” information;
- 43% did not think their tax compliance information is from a 100% reliable source;
- Between 66% - 79% had not undergone tax audits by the Tax Authority in the last 2 years;
- 43% did not know whether or not tax issues and risks are discussed at board level.
Various conclusions can be drawn from these survey results. Any Tax Authority responsible for administering tax compliance amongst these taxpayers would be virtually guaranteed of arrear taxes, penalties and interest.
Over 200 taxpayers have participated in the survey.
A properly orchestrated tax risk management plan, as advocated in the book “7 Habitual Tax Mistakes” in conjunction with the retainer program offered by www.tax-Radar.com will go a long way towards managing and controlling previously undetected and unknown tax risks in any taxpayer business.
Thursday, August 13, 2009
FIN 48 comes to SA? Are you ready with your tax risk management policies?
COMMENTS ON A PROPOSED NEW STANDARD ON INCOME TAX ACCOUNTING EXPOSURE DRAFT ED/2009/02 (“The Exposure Draft”) 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”). We hereby comment on question 7 and 16 as set out in the Exposure Draft.
COMMENTS ON A PROPOSED NEW STANDARD ON INCOME TAX ACCOUNTING EXPOSURE DRAFT ED/2009/02 (“The Exposure Draft”)
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”).
We hereby comment on question 7 and 16 as set out in the Exposure Draft.
QUESTION 7 - MEASUREMENT OF CURRENT AND DEFERRED TAX ASSETS AND LIABILITIES
1. The proposed standard retains the basic approach to accounting for income tax, known as the temporary difference approach which objective is to recognise now the future tax consequences of past events and transactions, rather than waiting until tax is payable.
2. The Board considered FIN 48 (Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109) issued by the FASB. FIN 48 requires an entity to recognise tax benefits it has claimed only if it is more likely than not that the tax authorities will accept the claim. If a tax benefit meets the recognition threshold, the amount recognised is the maximum amount that is more likely than not to be accepted by the tax authorities.
3. Applying that reasoning, the Board concluded that an entity has a liability to pay more tax if the tax authority does not accept the amounts submitted.
4. It is therefore proposed that the uncertainty be included in the measurement of tax assets and liabilities. That is done by measuring current and deferred tax assets and liabilities using the probability-weighted average of all possible outcomes theory (herein referred to as the probability theory).
5. The proposed wording of the above amendment in the Draft International Financial Reporting Standard X Income Tax is set out as follows under the heading “Measurement” at paragraph 26:
“Uncertainty about whether the tax authorities will accept the amounts reported to them by the entity affects the amount of current tax and deferred tax. An entity shall measure current and deferred tax assets and liabilities using the probability-weighted average amount of all the possible outcomes, assuming that the tax authorities will examine the amounts reported to them and have full knowledge of all relevant information. Changes in the probability-weighted average amount of all possible outcomes shall be based on new information, not a new interpretation by the entity of previously available information.”
6. There are no examples of applying the probability theory included in the Exposure Draft but the following is clarified:
6.1. In applying the probability theory to measure the tax assets and liabilities it is assumed that tax authorities will examine the amounts reported to them by the entity and have full knowledge of all relevant information (at “Measurement” para 26 of the Exposure Draft).
6.2. No possible outcomes are ignored in the measurement (at BC60 of the Basis for Conclusions).
6.3. The tax assets and liabilities are not discounted amounts (at BC60 of the Basis for Conclusions).
6.4. The Board does not intend entities to seek out additional information for the purposes of applying the measurement. Rather it proposes only that entities do not ignore any known information that would have a material effect on the amounts recognised (at BC63 of the Basis for Conclusions).
6.5. In contrast with FIN 48, the Board believes that the use of the probability theory without a recognition threshold provides more relevant information than an approach that uses a probability based recognition threshold.
7. There is no definition of “material” as used in para BC63 and BC103 of the Exposure Draft Basis for Conclusions, explaining the New Standard on Income Tax.
Invitation to Comment
8. We hereby comment on question 7 which 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?”
9. To place into context the comparability FIN 48, we provide a short summary:
“FASB Number 109, in the past, contained no guidance on accounting for income tax assets and liabilities, resulting in businesses taking inconsistent positions. According to commentators on FIN 48:
“FIN 48 is an attempt to reconcile the inconsistencies by prescribing a consistent recognition threshold and measurement of tax assets and liabilities. It also gives taxpayers a clearly defined set of criteria to use when recognizing and measuring uncertain tax situations for financial statements, as well as specifying additional disclosures regarding the uncertainty.”
The evaluation of a tax situation for FIN 48 purposes is based on a two-step process:
· The first step is recognition: The business determines whether it is more likely than not (which is a 50% or greater likelihood) that a tax situation would be upheld on examination, including resolution of any ensuing litigation process, based on the technical merits of the tax situation;
· The second step is measurement: The tax situation that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize on financial statements.
In asserting the more likely than not standard, all the facts and circumstances are taken into account. Additionally, the taxpayer must presume that the tax situation will be examined by the Revenue Service with full knowledge of all the facts, technical merits of the relevant tax law and their applicability to the facts and circumstances of the tax situation. The taxpayer may take into account any past administrative practices and precedents of the Revenue Service in its dealings with the business, when those practices and precedents are widely understood.
Finally, each tax situation must be evaluated without consideration of the possibility of offset or addition to other tax issues. The appropriate timing of claiming the benefits of a tax issue is when it becomes clear that the tax issue has a more likely than not chance of being upheld. If a previous tax issue does not meet the more likely than not standard, then it shall be adjusted in the first period after the effective date of FIN 48 (1 January 2007).
A business must classify the liability associated with an unrecognized tax issue as a current Liability to the extent the business anticipates payment of cash within one year or the operating cycle, if longer. The liability for an unrecognized tax issue shall not be combined with deferred tax liabilities or assets.
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:
· the more likely than not recognition threshold is met by the reporting date;
· the tax issue is settled through negotiation or litigation;
· 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.”
10. We do not agree with the Exposure Draft proposal for the reasons set out below.
11. The Disclosure is too Onerous
11.1. The Exposure Draft seems to suggest 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.
11.2. We further understand that there is no recognition threshold applicable to the disclosure.
11.3. In addition, all possible outcomes should be included in the analysis of the amount.
11.4. 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.
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
11.5. This could be a onerous task for the following reasons:
11.5.1. 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.
11.5.2. The number of possibilities to include in the analysis is endless.
11.5.3. The liability is contingent and it should be recognised even where the possibility of realizing is remote. This goes against general accepted accounting practice.
11.5.4. A tax dispute takes time to run its course and this impact on the accuracy of the disclosed contingent liability. It could take up to two years after submitting a tax return that an item is queried and another year before an assessment is eventually issued. It could be settled in ADR after six months or if taken all the way to the Court of Appeal, it may take up to five years. During this time, the time value of money (which according to the Exposure Draft should be ignored) could play a significant role on the amount of the liability.
11.5.5. 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.
12. Tax Authorities will take Advantage of the Disclosure
12.1. After implementing FIN 48 in the USA, the increase in tax accrual working papers was a major concern for USA taxpayers because it created a responsibility for taxpayers to look at tax risks and at the same time an opportunity for the tax authority to exploit the situation.
12.2. Although the eventual outcome of 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.
12.3. The degree of disclosure in terms of the Exposure Draft is not clear, ie detailed workings as opposed to a consolidated number. The South African Revenue Service (“SARS”) is already querying details of tax provisions raised by companies. 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.
12.4. In addition, tax liability numbers on the AFS of high risk taxpayers will significantly increase after implementation of the standard. This will trigger tax audits for these taxpayers, without any “friendly” disclosure or settlement process available to taxpayers, as is the case in the USA with FIN 48. There are developed tax uncertainty processes given by the IRS setting out the settlement procedures. None is guaranteed to taxpayers in other jurisdictions.
13. The meaning of “material”
13.1. What is “material” for accounting purposes as contemplated in para BC63 and BC103 of the 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…”.
13.2. 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.
14. Attorney/Client Privilege
14.1. In many respects this disclosure requirement undermines the attorney/client privilege taxpayers are entitled to.
14.2. This issue was also considered in the Textron case. It still remains to be decided whether Textron waived confidentiality when it gave its internal documents to the auditors.
14.3. In the implementation of 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 priviledge. This will lead taxpayers to have to implement measures where any tax risk review documentation is not exposed to auditors, but kept in their posession 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.
15. Constitutional issues
15.1. Section 33 of the South African Constitution states that no person can be compelled to give self incrimenating evidence. Self incrimination includes being exposed to punitive penalties.
15.2. The Companies Act at section 285A read with 440FF, states that widely held companies must comply with generally excepted accounting standards in the preperation 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.
15.3. SARS will be able to access this information in one of two ways:
15.3.1. By approacing 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
15.3.2. By approaching the taxpayer direct, and invoking the compulsary information machinery of the Income Tax Act, where the taxpayer may be able to rely on a ‘self incrimination’ defence, that enititles the taxpayer to any punitive penalty immunity, because the taxpayer was compelled to give the evidence to SARS.
15.4. The dicotomy of these two scenarios exposes the unfairness and uncertainty that will arise in the future.
15.5. 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:
15.5.1. 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
15.5.2. 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
16. We suggest the following alternative approach:
16.1. We suggest that a threshold for recognising the liability should apply in line with FIN 48. This will make the disclosure less onerous.
16.2. We suggest that disclosure in the AFS should be minimal to avoid exploitation by the tax authorities.
16.3. 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
17. 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.
18. 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
19. 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
20. 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 thoery, 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.
COMMENTS ON A PROPOSED NEW STANDARD ON INCOME TAX ACCOUNTING EXPOSURE DRAFT ED/2009/02 (“The Exposure Draft”)
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”).
We hereby comment on question 7 and 16 as set out in the Exposure Draft.
QUESTION 7 - MEASUREMENT OF CURRENT AND DEFERRED TAX ASSETS AND LIABILITIES
1. The proposed standard retains the basic approach to accounting for income tax, known as the temporary difference approach which objective is to recognise now the future tax consequences of past events and transactions, rather than waiting until tax is payable.
2. The Board considered FIN 48 (Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109) issued by the FASB. FIN 48 requires an entity to recognise tax benefits it has claimed only if it is more likely than not that the tax authorities will accept the claim. If a tax benefit meets the recognition threshold, the amount recognised is the maximum amount that is more likely than not to be accepted by the tax authorities.
3. Applying that reasoning, the Board concluded that an entity has a liability to pay more tax if the tax authority does not accept the amounts submitted.
4. It is therefore proposed that the uncertainty be included in the measurement of tax assets and liabilities. That is done by measuring current and deferred tax assets and liabilities using the probability-weighted average of all possible outcomes theory (herein referred to as the probability theory).
5. The proposed wording of the above amendment in the Draft International Financial Reporting Standard X Income Tax is set out as follows under the heading “Measurement” at paragraph 26:
“Uncertainty about whether the tax authorities will accept the amounts reported to them by the entity affects the amount of current tax and deferred tax. An entity shall measure current and deferred tax assets and liabilities using the probability-weighted average amount of all the possible outcomes, assuming that the tax authorities will examine the amounts reported to them and have full knowledge of all relevant information. Changes in the probability-weighted average amount of all possible outcomes shall be based on new information, not a new interpretation by the entity of previously available information.”
6. There are no examples of applying the probability theory included in the Exposure Draft but the following is clarified:
6.1. In applying the probability theory to measure the tax assets and liabilities it is assumed that tax authorities will examine the amounts reported to them by the entity and have full knowledge of all relevant information (at “Measurement” para 26 of the Exposure Draft).
6.2. No possible outcomes are ignored in the measurement (at BC60 of the Basis for Conclusions).
6.3. The tax assets and liabilities are not discounted amounts (at BC60 of the Basis for Conclusions).
6.4. The Board does not intend entities to seek out additional information for the purposes of applying the measurement. Rather it proposes only that entities do not ignore any known information that would have a material effect on the amounts recognised (at BC63 of the Basis for Conclusions).
6.5. In contrast with FIN 48, the Board believes that the use of the probability theory without a recognition threshold provides more relevant information than an approach that uses a probability based recognition threshold.
7. There is no definition of “material” as used in para BC63 and BC103 of the Exposure Draft Basis for Conclusions, explaining the New Standard on Income Tax.
Invitation to Comment
8. We hereby comment on question 7 which 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?”
9. To place into context the comparability FIN 48, we provide a short summary:
“FASB Number 109, in the past, contained no guidance on accounting for income tax assets and liabilities, resulting in businesses taking inconsistent positions. According to commentators on FIN 48:
“FIN 48 is an attempt to reconcile the inconsistencies by prescribing a consistent recognition threshold and measurement of tax assets and liabilities. It also gives taxpayers a clearly defined set of criteria to use when recognizing and measuring uncertain tax situations for financial statements, as well as specifying additional disclosures regarding the uncertainty.”
The evaluation of a tax situation for FIN 48 purposes is based on a two-step process:
· The first step is recognition: The business determines whether it is more likely than not (which is a 50% or greater likelihood) that a tax situation would be upheld on examination, including resolution of any ensuing litigation process, based on the technical merits of the tax situation;
· The second step is measurement: The tax situation that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize on financial statements.
In asserting the more likely than not standard, all the facts and circumstances are taken into account. Additionally, the taxpayer must presume that the tax situation will be examined by the Revenue Service with full knowledge of all the facts, technical merits of the relevant tax law and their applicability to the facts and circumstances of the tax situation. The taxpayer may take into account any past administrative practices and precedents of the Revenue Service in its dealings with the business, when those practices and precedents are widely understood.
Finally, each tax situation must be evaluated without consideration of the possibility of offset or addition to other tax issues. The appropriate timing of claiming the benefits of a tax issue is when it becomes clear that the tax issue has a more likely than not chance of being upheld. If a previous tax issue does not meet the more likely than not standard, then it shall be adjusted in the first period after the effective date of FIN 48 (1 January 2007).
A business must classify the liability associated with an unrecognized tax issue as a current Liability to the extent the business anticipates payment of cash within one year or the operating cycle, if longer. The liability for an unrecognized tax issue shall not be combined with deferred tax liabilities or assets.
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:
· the more likely than not recognition threshold is met by the reporting date;
· the tax issue is settled through negotiation or litigation;
· 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.”
10. We do not agree with the Exposure Draft proposal for the reasons set out below.
11. The Disclosure is too Onerous
11.1. The Exposure Draft seems to suggest 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.
11.2. We further understand that there is no recognition threshold applicable to the disclosure.
11.3. In addition, all possible outcomes should be included in the analysis of the amount.
11.4. 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.
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
11.5. This could be a onerous task for the following reasons:
11.5.1. 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.
11.5.2. The number of possibilities to include in the analysis is endless.
11.5.3. The liability is contingent and it should be recognised even where the possibility of realizing is remote. This goes against general accepted accounting practice.
11.5.4. A tax dispute takes time to run its course and this impact on the accuracy of the disclosed contingent liability. It could take up to two years after submitting a tax return that an item is queried and another year before an assessment is eventually issued. It could be settled in ADR after six months or if taken all the way to the Court of Appeal, it may take up to five years. During this time, the time value of money (which according to the Exposure Draft should be ignored) could play a significant role on the amount of the liability.
11.5.5. 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.
12. Tax Authorities will take Advantage of the Disclosure
12.1. After implementing FIN 48 in the USA, the increase in tax accrual working papers was a major concern for USA taxpayers because it created a responsibility for taxpayers to look at tax risks and at the same time an opportunity for the tax authority to exploit the situation.
12.2. Although the eventual outcome of 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.
12.3. The degree of disclosure in terms of the Exposure Draft is not clear, ie detailed workings as opposed to a consolidated number. The South African Revenue Service (“SARS”) is already querying details of tax provisions raised by companies. 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.
12.4. In addition, tax liability numbers on the AFS of high risk taxpayers will significantly increase after implementation of the standard. This will trigger tax audits for these taxpayers, without any “friendly” disclosure or settlement process available to taxpayers, as is the case in the USA with FIN 48. There are developed tax uncertainty processes given by the IRS setting out the settlement procedures. None is guaranteed to taxpayers in other jurisdictions.
13. The meaning of “material”
13.1. What is “material” for accounting purposes as contemplated in para BC63 and BC103 of the 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…”.
13.2. 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.
14. Attorney/Client Privilege
14.1. In many respects this disclosure requirement undermines the attorney/client privilege taxpayers are entitled to.
14.2. This issue was also considered in the Textron case. It still remains to be decided whether Textron waived confidentiality when it gave its internal documents to the auditors.
14.3. In the implementation of 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 priviledge. This will lead taxpayers to have to implement measures where any tax risk review documentation is not exposed to auditors, but kept in their posession 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.
15. Constitutional issues
15.1. Section 33 of the South African Constitution states that no person can be compelled to give self incrimenating evidence. Self incrimination includes being exposed to punitive penalties.
15.2. The Companies Act at section 285A read with 440FF, states that widely held companies must comply with generally excepted accounting standards in the preperation 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.
15.3. SARS will be able to access this information in one of two ways:
15.3.1. By approacing 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
15.3.2. By approaching the taxpayer direct, and invoking the compulsary information machinery of the Income Tax Act, where the taxpayer may be able to rely on a ‘self incrimination’ defence, that enititles the taxpayer to any punitive penalty immunity, because the taxpayer was compelled to give the evidence to SARS.
15.4. The dicotomy of these two scenarios exposes the unfairness and uncertainty that will arise in the future.
15.5. 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:
15.5.1. 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
15.5.2. 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
16. We suggest the following alternative approach:
16.1. We suggest that a threshold for recognising the liability should apply in line with FIN 48. This will make the disclosure less onerous.
16.2. We suggest that disclosure in the AFS should be minimal to avoid exploitation by the tax authorities.
16.3. 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
17. 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.
18. 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
19. 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
20. 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 thoery, 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.
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