Accounting for the Tax Consolidation System

24 February 2003

Mr Keith Alfredson
Chairman
Urgent Issues Group
PO Box 204
COLLINS STREET WEST VIC 8007

Dear Keith

Accounting for the Tax Consolidation System

The Group of 100 (G100) is concerned about the practical implications of the current direction of the Urgent Issues Group (UIG) in relation to accounting for income taxes in light of the tax consolidation system.

Apart from the technical issues associated with the implementation of tax consolidation the practical consequences are a major concern because of the confluence of a number of factors. The G100 suggests that when addressing tax consolidation issues the UIG should be cognisant of the fact that the 1989 standard will soon be replaced by the 1999 standard, either in its own right or as IAS 12 “Income Taxes” as adopted by the AASB. With the impending take up of IASB standards and the foreshadowed requirements of IFRS 1 “First-time Adoption of International Financial Reporting Standards” companies will need to restate comparative information for one year and in some cases for two years. To achieve this in an orderly fashion companies will need to maintain two sets of tax accounting records: one set reflecting the requirements of the 1989 standard and a second set reflecting the requirements of the 1999/IAS 12 standard. We believe that in view of the confluence of these factors and the desirability of avoiding unnecessary duplication of record keeping and effort, the adoption of a pragmatic approach to the implementation of tax consolidation is justified.

Some members have indicated that the current approach does not reflect the way in which businesses are considering the implementation of the tax consolidation system, takes no account of the present environment regarding tax-effect accounting and adoption of IASB standards, will impose onerous record-keeping requirements on Australian companies, and leads to potential inconsistencies in treatment between the requirements of the two Abstracts dealing with this issue.

Further information about each of these aspects is set out below:

Economic and Commercial Reality

UIG Abstract 39 “Effect of Proposed Tax Consolidation Legislation on Deferred Tax Balances” (UIG 39) and Abstract 52 “Income Tax Accounting under the Tax Consolidation System” (UIG 52) strongly suggest that the impact of resetting tax values on a subsidiary entering into a tax consolidated group are to be treated as permanent differences when applying Accounting Standards AASB 1020 and AAS 3 “Accounting for Income Tax (Tax-effect Accounting)” (1989 Standards). Furthermore, UIG 39 as explained in Appendix 3, requires deferred tax assets to be written down to the extent that the recognition criteria for such assets are not satisfied.

The impact of these requirements is that the majority of entities implementing tax consolidation under the 1989 Standards will recognise an income tax expense, resulting from the write down of deferred tax assets.

The structure and nature of the tax consolidation system is such that it provides substantial benefits to groups of entities that choose to implement it. Whilst many entities will lose at least some of the benefits of tax losses in existence before implementation, in the vast majority of cases this impact will be offset by greater benefits flowing from increased asset values leading to higher tax depreciation and other benefits resulting from the resetting of asset tax values.

It is incongruous that the accounting for the impacts of these changes results in an entity initially reporting a worse financial performance when the substance of the arrangements is that the entity has a significantly improved tax position. Any benefits arising from the implementation of tax consolidation are effectively deferred and may only be recognised over a period of time.

We believe that the 1989 standards reflect the requirements of a tax system at that time and are not necessarily consistent with recent developments in Australian tax legislation. The standards do not envisage a major change in tax legislation such as the tax consolidation system. The G100 believes that the strict application of the definitions of “permanent” and “timing” differences is not appropriate when accounting for the consequences of tax consolidation. This has effectively been acknowledged by the UIG in UIG 52 in respect of the head entity recognising deferred taxes that arise from the tax status of the assets and liabilities of a tax-consolidated subsidiary.

Onerous Record Keeping Requirements

The impact of treating reset tax values as permanent differences under the 1989 standards gives rise to onerous and unnecessary record keeping requirements. Entities in a tax-consolidated group will be required to maintain their original tax depreciation schedule and other tax records so that the reversal of pre-consolidation deferred tax balances can be calculated on an on-going basis and will also need to maintain records of reset tax values for the preparation of the consolidated tax return.

These record-keeping requirements will continue to be required of an entity that leaves tax-consolidated group. One interpretation of the UIG’s current proposals is that the original tax records will need to be carried forward and updated by the entity leaving the group, even though the whole tax basis of the controlled entity was reset from being part of a tax consolidated group. In addition, those records would serve no purpose in the preparation of the entity’s tax return.

Furthermore, the requirement of UIG 52 to measure deferred tax balances on the basis of the carrying amounts in the subsidiary, rather than the consolidated carrying amounts, creates additional record keeping and calculation requirements. Two calculations must be performed, even though the amounts recognised in the parent entity are adjusted on consolidation

We believe that the UIG could help reduce these unnecessary record-keeping requirements by reconsidering the requirements of UIG 52 in the context of the confluence of accounting and taxation requirements.

Potential Conflict Between UIG 39 and UIG 52

Some members have drawn attention to a potential conflict between the requirements of UIG 39 and UIG 52. UIG 39 requires the assessment of deferred tax assets on an “aggregate” basis, taking into consideration whether an aggregate reduction in asset tax values is expected under the tax consolidation system. It is suggested that this approach may be inconsistent with the requirement that the impacts of the resetting of tax values should be treated as permanent differences as implied in UIG 52 and elsewhere in UIG 39. This arises because the existence of an “offsetting” permanent difference is considered in the assessment of a carried forward deferred tax asset. Those expressing this view note that an aggregate reduction in asset tax values ordinarily leads to a higher taxable income in future reporting periods (as tax deductions arising from the assets will be lower), meaning that it would be easier to support the carrying amount of deferred tax assets in this circumstance.

Early Adoption of the 1999 Standards

The G100 does not believe that an acceptable resolution of these issues is for entities to adopt revised Accounting Standards AASB 1020 and AAS 3 “Income Taxes” (1999 Standards) early. The adoption of the 1999 standards will require substantial effort, impose further calculation, training and system burdens on entities that would need to be considered in conjunction with the implementation of the tax consolidation system and the implications of adoption of IASB standards in 2005. In addition the Australian Accounting Standards Board (AASB) has acknowledged the difficulties surrounding the implementation of the 1999 Standards by twice deferring the application date of these Standards.

Where entities do not early-adopt the 1999 standards, the impacts of the tax consolidation system will result in adjustments (normally an income tax benefit) being recognised directly in opening retained earnings when the standards are adopted.

Recommendations

The UIG has acknowledged that the strict application of the 1989 Standards is not appropriate in respect of the tax consolidations system, and the G100 therefore urges the UIG to reconsider the consensus in both UIG 52 and UIG 39 in light of the consequences discussed above.

The G100’s preferred approach when applying the 1989 Standards is that on implementation of the tax consolidation system accounting for income taxes in the head entity should be based on the consolidated carrying amounts of assets and liabilities and related reset tax values. In these circumstances we believe a pragmatic approach would be to treat any resulting differences as timing differences. This approach would result in the recognition of an income tax expense or benefit on initial implementation of the tax consolidation system.

This approach recognises the unique circumstances surrounding the tax consolidation system, and would produce an outcome that is conceptually closer to the 1999 Standards.

Yours sincerely

John V. Stanhope
National President