Globally adopted, the International Financial Reporting Standards (IFRS) were developed as a set of principle-based standards for a consistent approach to financial reporting. One of its principles, known as International Financial Reporting Interpretations Committee 23 or IFRIC 23 for short, entitled Uncertainty over Income Tax Treatments, was issued in May 2017 as a guide to recognize and account for uncertain income tax treatments. It covers annual reporting periods beginning on or after 1 January, 2019.
For entities operating on a calendar year basis, compliance with IFRIC 23 is a must for the financial statements that will be issued in the next few months. Thus, accountants and those who prepare financial statements should be aware of the tax treatments/practices that may be covered by IFRIC 23.
Walking down the tax memory lane, let us take a closer look at the requirements of IFRIC 23.
Setting the boundaries of uncertainty for recognition purposes
IFRIC 23 presents challenges, especially for large entities, as there is a need to account for a lot of tax treatments. It does not help that Philippine tax laws, rules, and regulations are riddled with numerous uncertainties. Therefore, it is vital to identify which tax treatment/practice is covered by IFRIC 23.
Income Tax only
Foremost, IFRIC 23, being an interpretation of International Accounting Standard 12 (IAS 12), covers solely income tax treatments; other taxes are governed by separate accounting standards, as applicable (e.g., IAS 37 on Provisions, Contingent Liabilities, and Contingent Assets). The interpretation is to be applied in the “determination of taxable profit (tax loss), tax bases, unused tax losses, unused tax credits, and tax rates” relative to uncertainties in income tax treatment.
IFRIC 23 defines an “uncertain tax treatment” as any tax treatment, where there is uncertainty over whether the relevant taxation authority will accept the tax treatment under tax law. The dilemma may happen when the acceptability of a particular tax treatment is unclear or ambiguous until resolved in the future. Taxation authority refers to the body or bodies that decide whether tax treatments are acceptable under tax law. It may include a court.
In the Philippine context, an uncertain tax treatment may stem from conflicting provisions in the Tax Code or issuances from the Bureau of Internal Revenue (BIR). It may also arise from conflicting court decisions, which can only be clarified by a decision of a higher-level court.
After establishing which tax treatments are uncertain, entities need to reflect them in the financial statements.
Uncertainty in measuring income tax-related accounts
IFRIC 23 provides that an entity shall consider each uncertain tax treatment, depending on which approach better predicts the resolution of the uncertainty. In doing so, an entity shall assume that a taxation authority has a right to examine the treatments and has full knowledge of all related information when making those examinations (thus, implying a high detection risk). As such, the likelihood of a tax treatment being questioned by the BIR is irrelevant for IFRIC 23 purposes. Instead, assessing the probability of acceptance will primarily be based upon the technical merits and legal bases used by management in electing a tax treatment.
If an entity considers that the taxation authority will probably accept an uncertain tax treatment, it shall apply the tax treatment in its income tax filings, as if no uncertainty exists. This tax approach shall be used to determine the taxable profit (tax loss), tax bases, unused tax losses, unused tax credits, and tax rates.
Otherwise, the entity shall reflect the effect of the uncertainty by using either of two methods. Depending on which one could best predict the resolution of such uncertainty, it may apply either (1) the most likely amount method (appropriate for possible outcomes that are binary); or (2) the expected value method (the sum of the probability-weighted amounts in a range of possible outcomes).
In the Philippines, the first method may be more applicable since, generally, the BIR will either assess deficiency taxes at full amount or none at all.
Considered separately or together with other uncertainties
IFRIC 23 also provides guidance on whether an entity should consider each uncertain tax treatment separately or together with other uncertainties. The decision should be based on which approach better predicts the resolution of the uncertainty by considering: (a) how the entity calculates its income tax and supports tax treatments; or (b) how the entity expects the taxation authority to make its examination and resolve issues that might arise from that examination.
Note that in most cases, the BIR and the courts generally consider the cumulative impact of the findings in quantifying the assessed amount.
Initial application and change in facts and circumstances
On initial application, an entity may apply IFRIC 23 either: (a) retrospectively by applying IAS 8 on Accounting Policies, Changes in Accounting Estimates and Errors, if possible without the use of hindsight; or (b) retrospectively with the cumulative effect of initial application as an adjustment to the opening balance of retained earnings (or other component of equity, as appropriate).
Any change in facts and circumstances must be reflected as such as a change in accounting estimate (i.e., prospectively).
A change occurs if the facts and circumstances on which the judgment or estimate was based become different, or when new information affects the judgment or estimate (e.g., the expiration of the tax authority’s right to examine). Hence, a judgment or estimate must be reassessed to determine any changes that may develop.
In my next article, we shall take a closer look at how the provisions of IFRIC 23 apply in actual practice. I will also discuss some key considerations that must be made as an entity adopts IFRIC 23.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Tax Manager, PwC Philippines
Tel: +63 (2) 8845 2728 loc. 3170