Tax Reporting Insights When Moving from US GAAP to IFRS
Businesses are increasingly adopting IFRS, and the conversion from US GAAP poses unique tax considerations
A version of this article first appeared in Bloomberg Tax.
Businesses today are increasingly expanding their global presence to reap the benefits of operating as multinational enterprises. As a result, tax, accounting teams, and finance leaders are placing greater emphasis on the financial reporting implications of this evolution. One popular financial reporting evolution is the adoption of International Financial Reporting Standards (IFRS). For businesses that have traditionally followed the US Generally Accepted Accounting Principles (GAAP), the transition to IFRS can be challenging, especially in terms of tax considerations.
US GAAP and IFRS tax-related reporting differences include tax expense recognition, cross-border intra-group transfers, and financial statement disclosure requirements. When considering a conversion to IFRS, management can better understand the IFRS and GAAP through early discussions with their tax teams and advisors. Here are several key considerations that may arise:
Addressing Deferred Taxes and the “Backwards-Tracing” Principle
Deferred tax assets or liabilities arise when there are timing differences in income or expense items between financial statements and tax calculations. One common timing difference involves the depreciation of fixed assets. Financial statements often recognize depreciation on a straight-line basis, while tax regulations allow for accelerated depreciation on certain types of fixed assets. This disparity in depreciation timing leads to differences in tax deductions and financial statement expenses, resulting in deferred tax assets or liabilities.
Under IFRS standards, changes to deferred taxes originally recorded in equity must be matched with the initial recognition upon reversal. For example, if a deferred tax asset (or liability) was established for unrealized gains or losses and initially recorded in Other Comprehensive Income, any subsequent reversal of these gains (or losses) should not be considered a tax expense but should be recognized through Other Comprehensive Income, a component of equity.
Disclosing “Unused Losses” on Financial Statements
Deferred tax assets are typically accounted for when an expense recognized in financial statements will be realized for tax purposes in a future period. Under US GAAP, deferred tax assets are offset by a valuation allowance to reduce the measurement to the expected realizable amount. In contrast, IFRS requires only net deferred tax liabilities to be reflected on the balance sheet, with unrealizable deferred tax assets disclosed in a footnote as “unused losses.” Although a full tax provision calculation and valuation allowance analysis are still necessary under IFRS, the presentation differs significantly from US GAAP.
Under US GAAP, all deferred tax assets are reported in the Income Tax footnote, while unrealizable amounts are identified through a valuation allowance account. In IFRS financial statements, unrealizable deferred tax assets are excluded from the balance sheet, with separate disclosure of unrealizable assets and potential future benefits.
Recognizing the Right Tax Basis on Intra-group Transfers
For many businesses today, intra-group transfers of assets or inventory create tax benefits of depreciation and amortization. IFRS requires the recognition of deferred taxes for the buyer and the current tax impact for the seller when such transfers result in a step up in tax basis. This treatment differs from the deferral rules outlined in US GAAP. For instance, under IFRS, if an intangible asset is acquired in a stock acquisition with no resulting tax basis and subsequently purchased in an “asset acquisition,” the acquiring entity would have the tax basis in the newly acquired asset. tax basis in the newly acquired asset.
Considering Deferred Taxes Related to Investments in Subsidiaries (Outside Basis Deferred)
IFRS requires the recognition of a deferred tax liability for investments in foreign subsidiaries or corporate joint ventures unless (1) the entity has control over the reversal of the temporary difference, and (2) it is more likely than not that the temporary difference will not reverse in the foreseeable future. The recognition exception under IFRS applies solely to foreign subsidiaries and joint ventures that are deemed to be essentially permanent in duration. This treatment marks a difference from US GAAP recognition principles whereby an entity would not recognize a deferred tax liability if the foreign subsidiary or joint venture is deemed to be permanent in nature.
Staying Consistent with Hybrid Income Taxes
As US businesses face state and local taxes, net worth, capital, or gross receipts taxes are now seen as “hybrid taxes” under ASU 2019-12. An example is the Texas Gross Margin tax, which uses a modified gross receipts calculation rather than federal taxable income.
According to US GAAP, if a hybrid tax combines income-based and non-income-based calculations, the income-based portion is treated as income tax, while the difference is considered non-income or above-the-line tax. IFRS lacks specific guidance on hybrid taxes but requires consistent recognition.
Under IFRS, one approach designates a tax based on a non-income gross amount as a minimum non-income tax and treats the incremental amount as income tax expense. For instance, if non-income tax is calculated using gross receipts at the applicable rate, it is presented as an above-the-line tax. If the income tax calculation exceeds the previous amount during provisioning, it becomes income tax expense.
IFRS also allows recognizing a minimum income tax based on net income less expenses, with any excess reported as non-income tax. This approach aligns with US GAAP principles under ASU 2019-12.
Comparing Tax Rate Disclosure Approaches
For US GAAP, the effective tax rate reconciliation is presented using the statutory tax rate of the parent company. Under IFRS, the effective tax rate reconciliation can be based on the applicable tax rate or the weighted average tax rate applicable to the profits of the consolidated entities. While the first approach aligns more closely with US GAAP reporting, facilitating a smoother transition, the second approach, which requires additional considerations and input from the tax team and advisors, can also be commonly used.
As businesses evolve their financial reporting to reflect their global expansion, tax reporting must also adapt. When planning a conversion from US GAAP to IFRS, it is crucial for management to involve the tax function during the early stages. Taking a proactive approach allows leaders to understand potential changes in tax reporting and disclosures, integrate tax reporting into the business, and effectively communicate any presentation changes and disclosed effective tax rates to investors.