Journal of the Australasian Tax Teachers Association
|
|
Home
| Databases
| WorldLII
| Search
| Feedback
Journal of the Australasian Tax Teachers Association |
|
THE TAX AND ACCOUNTING INTERFACE
MICHAEL D’ASCENZO AND ANDREW ENGLAND[*]
ABSTRACT: Unlike some European countries,[1]Australia operates as an ‘Anglo-Saxon’ type system that has a disconnect rather than dependence between accounting and tax requirements. Notwithstanding repeated calls for a convergence of the tax and accounting treatments of income and expenses,[2]a comprehensive alignment seems a dim prospect given basic differences in purpose and policy, and practical realities.
I DIFFERENT PURPOSES OF TAX AND ACCOUNTING SYSTEMS
Tax and accounting systems exist for different reasons. The tax system, through tax laws, exists for the purpose of collecting revenue for the community and sometimes for encouraging or discouraging certain kinds of activities, and as a means of making transfer payments. The end result of an application of tax laws is usually that taxpayers are required to pay money to fund public spending. On the other hand, the accounting system, through accounting concepts and standards, exists for financial reporting reasons, for example, to help investors to make informed investment decisions.
This difference was summarised by the United States Supreme Court in Thor Power Tool Co v Commissioner:
The primary goal of financial accounting is to provide useful information to management, shareholders, creditors, and others properly interested; the major responsibility of the accountant is to protect these parties from being misled. The primary goal of the income tax system, in contrast, is the equitable collection of revenue; the major responsibility of the Inland Revenue Service is to protect the public fisc. Consistently [sic] with its goal and responsibilities, financial accounting has as its foundation the principle of conservatism, with its corollary that “possible errors in measurement [should] be in the direction of understatement rather than overstatement of net income and net assets.” In view of the Treasury’s markedly different goal and responsibilities, understatement of income is not destined to be its guiding light. Given this diversity, even contrariety, of objectives, any presumptive equivalence between tax and financial accounting would be unacceptable.[3]
With these different purposes in mind, it can be argued that rules governing the calculation of profit or loss for income tax purposes (taxable income or tax loss) are necessarily different to those governing the calculation of profit or loss for financial reporting purposes. It might be said, for example, that taxation rules require greater precision because they may result in the compulsory extraction of money from the taxpayer.[4]
In his overview of accounting and taxation in Europe, Hoogendoorn summarises the position as follows:[5]
|
INDEPENDENCE
|
DEPENDENCE
|
|
Czech Republic
|
Belgium
|
|
Denmark
|
Finland
|
|
Ireland
|
France
|
|
Netherlands
|
Germany
|
|
Norway
|
Italy
|
|
Poland
|
Sweden
|
|
United Kingdom
|
|
The countries with a strong link between accounting and taxation are listed under the heading ‘Dependence’, although legislation in 1996 removed the link for depreciation, inventory valuations, work in progress and warranty provisions in Sweden.
There has been a development towards more independence between accounting and taxation.[6]This development is linked to the transition to a market economy for some Eastern European countries, as well as to accounting harmonisation which interferes with the basic structure of dependence.
Some commentators argue that the link between taxation and accounting ‘pollutes’ the capability of financial reports to give a ‘true and fair’ view of the economic and financial situation of businesses.[7]The critics of the link say that ‘development of good accounting is hindered by tax concerns and the influence of the tax authorities who need consistent, well- specified and easy to verify rules instead of the more “true and fair” rules’.[8]
From a tax perspective, Johnson has argued against the Generally Accepted Accounting Principles (‘GAAP’) as a means of determining tax liability because, in many circumstances, corporations can under report their earnings without adverse non-tax consequences.[9]He argues that reported income as defined by GAAP is sufficiently ‘elastic’ that taxing income so defined would cause the reporting income to shrivel, which would both reduce tax revenue and also damage the pricing mechanisms of the capital markets. A problem raised by Artsberg is that in countries where there is a strong link between accounting and taxation, companies are often allowed to undervalue assets.[10]On the other hand, Artsberg also observes that for ‘practical reasons it is easier to work with only one accounting system, and it saves money for the companies to have only one system’.[11]
The Review of Business Taxation (‘the Ralph Review’) found that most of the Group 1 countries it examined had a basic approach to determining taxable income whereby the starting point was accounting practice based on statutory accounts.[12]The Ralph Review found that there were two essential differences in the treatment between countries. Firstly most Group 1 and Group 2 countries had explicit recognition of accounting principles (for example, section 446(a) of the United States Internal Revenue Code).[13]Secondly all these countries had variations from accounting standards in their tax provisions.[14]The extent of the adjustments necessary to reconcile the tax and accounting position varied considerably between the countries.
So it seems that the international experience in the interface between tax and accounting is not uniform. While many European countries have a closer link between tax and accounting than does Australia, the link is subject to specific legislation and tax concepts tend to predominate.[15]There are commentators who argue that the dominance of tax detracts from the purpose of accounts of providing a ‘true and fair’ view;[16]and there are commentators who argue that accounting standards are not sufficiently precise to form the basis of taxation.[17]
In relation to the United Kingdom, Lamb concludes:
Although many voices claim that greater tax conformity would reduce complexity, and thereby cost, it seems likely that the UK tax and accounting rule-making will continue to operate with relative autonomy. While the practices of tax and accounting profit measurement are undeniably interdependent, differences in profit calculations are inevitable as long as the rules remain out of phase and are expressed through independent institutions. [18]
A similar conclusion seems apt for the current position in Australia. Any substantial move towards convergence of tax and accounting treatments will require a meeting of minds between the accounting and tax professions and government.[19]
III CURRENT USE OF ACCOUNTING PRACTICE IN AUSTRALIAN INCOME TAX LAW
In Australia there is no systematic connection between the income tax law and accounting concepts or standards. However, the two interrelate in various ways.
A Timing of Recognition of Ordinary Income and General Deductions
In interpreting income tax law, particularly in relation to the timing of recognition of income and outgoings under the ordinary income and general deduction rules, the courts have sometimes drawn upon accounting practice. In determining when ordinary income is ‘derived’, the courts have drawn upon business conceptions and the principles and practices of accountancy.[20]Hill and Heerey JJ recently summarised the position as follows:
Perhaps the only relevance Ballarat Brewing has for the present case is that it adds to the quite substantial case law in which the High Court has made it clear that where the question at issue is the derivation of gross income that, being a matter for which the ITA Act makes no specific provision, the Court will have regard to the conceptions of business and the principles and practices of commercial accountancy. The case also makes it clear that the Court would be reluctant to apply to income tax a method of accounting which would produce a misleading result in the absence of a specific statutory provision which required that.Before turning to the accounting evidence in the present case it is important to note that while the earlier cases, such as Carden, Arthur Murray and Henderson, may be thought to have suggested that business and accounting principles are to be applied by the Court in determining questions of derivation, some later cases, for example the Australian Gas Light Company case in this Court have made the point that accounting principles are not determinative, although they may be persuasive.
Certainly where the question is whether a loss or outgoing is incurred for the purposes of s 51(1) it is clear that accounting principles are not determinative, cf Federal Commissioner of Taxation v James Flood Pty Ltd [1953] HCA 65; (1953) 88 CLR 492, Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616. Indeed, in the latter case Barwick CJ expressed the view that the “prudence and commercial propriety of such a course [accruing annual or long leave] has little bearing on the question whether there is present in the year of income a loss or outgoing within the meaning of s 51(1) where a jurisprudential analysis prevails over a commercial view, that accounting and business practice will not always be irrelevant and may indeed provide useful assistance to the Court: Coles Myer Finance Ltd v Federal Commissioner of Taxation [1993] HCA 29; (1992-3) 176 CLR 640 at 666 per Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ.
It is not necessary in the present case to decide if there is really a difference between the emphasis put on accounting practices in the early cases and the views expressed in the later cases. It suffices here to say that on either view of the law the business and accounting practices assist the Court in the working out of the principles behind the statutory language of “income derived”. [21]
In determining when losses or outgoings are ‘incurred’, sometimes the courts have tended towards approaches such as those found in accounting. For example, in Coles Myer Finance Ltd v Federal Commissioner of Taxation[22]the High Court referred to commercial and accounting principles in deciding that a deduction for discounts on certain debt instruments should be spread over two years (the period of the instruments).[23]
Another example of the courts drawing upon accounting principles is their recognition that unreported insurance claims are presently existing liabilities of an insurer and that the provisions a general insurer makes in its accounts for them are an allowable deduction if they represent a reasonable actuarial estimate.[24]The result is that provisions for ‘incurred but not reported’ claims are deductible, but provisions for events that have not yet occurred are not deductible.[25]
Nevertheless, the courts have made it clear that the interpretation of tax law ultimately involves a jurisprudential analysis of relevant provisions. For example, expenses are not necessarily recognised for income tax purposes at the same time as they are for accounting purposes[26]and the cost of trading stock must be ascertained from the meaning apparent from the statute rather than from accounting (although the two may well coincide).[27]
Hanlan and Nethercott have argued that:
the merits of comparability between accounting practice and taxation law have been recognised by academics, courts of law and governments ...[but] [w]hile Australian courts have endorsed the importance of accounting concepts, principles and practices, such factors are not determinative in reaching a decision. That is, accounting practice, while relevant must be used solely as an aid assisting in the interpretation of the Tax Act (1936) and (1977), and cannot be substituted for legal or jurisprudential analysis itself.[28]
On this basis the approach of the courts in interpreting the law will affect the extent of divergence between accounting and tax concepts. The less formalistic the approach to judicial interpretation, the more likely it is that the outcome will reflect the commercial substance of a matter.[29]
Another observation that can be made is that the doctrine of precedent applied in our system of law means that income tax law may not keep pace with developments in accounting concepts and standards. A court decision many years ago which drew upon accounting practice at that time may still represent the law now, even though the accounting practice upon which the decision was based may have changed.
B Specific Statutory Intervention
Over the years, many specific statutory rules or regimes have been inserted into the income tax law that produce results similar to those found in accounting. One example is the alteration of the derivation point for income from deferred interest securities (Division 16E of Part III of the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’)).
However, the statutory rules usually provide their own set of detailed rules for the valuation and timing of recognition of amounts. (See, for example, the Capital Gains Tax (‘CGT’) event and cost base rules in Divisions 104, 110 and 112 of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997)’.)
Sometimes, specific statutory rules directly refer to accounting concepts or standards. For example, Division 240 of the ITAA 1997 provides, in some circumstances, for the apportionment, according to generally accepted accounting principles, between income years of ‘notional interest’ payable by a hirer under a hire purchase agreement.[30]The ‘notional interest’ itself is, however, not worked out according to those accounting principles.
Another significant example of the reference in statutory rules to accounting concepts and standards is to be found in the new consolidation regime’s provisions for working out the tax cost setting amount of the assets of an entity joining a consolidated group.[31]Step 2 of the calculation requires the addition of amounts for liabilities recognised by the joining entity in accordance with accounting concepts or standards of the Australian Accounting Standards Board.[32]
However, this use of an accounting concept and valuation of liabilities points up the potential hazards of using a hybrid of specific tax and accounting rules. The ‘step 2’ calculation requires a provision to reconcile the timing differences that can arise between when a liability (expense) is recognised for tax purposes and when it is recognised for accounting purposes.[33]To illustrate, assume the following facts:
Subco joins Headco in a consolidated group in Year 2. The cost base of Headco’s shares in Subco is $50. Subco has one asset (land) with a cost base to Subco of $50 and a $50 provision in its accounts, from Year 1, for employee’s leave (recognised as a liability for accounting purposes). The market value of the land at the time of consolidation is $100.The allocable cost amount for Subco is $100 ($50 cost base of shares plus $50 accounting liability). This means that, without more, the cost base of the land to Headco would become $100. This means that if the land was immediately sold for its market value ($100) there would be no capital gain assessable to Headco. The effect of this would be to recognise, for tax purposes, the provision for leave entitlements at a point before it should be recognised for those purposes and might, in fact, lead to a double deduction for them.[34]
To overcome this problem, a provision is required to extract the result that arises from using an inconsistent accounting concept in the cost setting process (section 705-80). Under that provision, Headco would have to calculate the allocable cost amount on the assumption that the provision for leave had been recognised for income tax purposes at the same time it is recognised for accounting purposes. On this assumption, Subco would have incurred a tax loss of $50 in Year 1 (on the assumption that it had no income and no other expenses in that year).
However, this deemed tax loss is then subtracted from the allocable cost amount (section 705- 100). Therefore, on this assumption, the allocable cost amount would be $50 ($50 cost base of shares plus $50 accounting liability less $50 deemed tax loss).
Under section 705-80, the amount added for the accounting liability is decreased by the difference between what it would have been with the assumption created by section 705-80 and what it is without that assumption (in this case $50).
This all means that the cost base of the land to Headco is actually $50, so that if it was sold immediately after consolidation a $50 capital gain would be assessable. A deduction for the $50 leave entitlements would then arise subsequently when the liability for them was incurred.
This example illustrates that many provisions in the income tax law are interrelated, and unless they all operate on the same basis (for example, accounting principles), the mix of accounting and jurisprudential approaches can lead to greater complexity than if it were designed on one basis alone. Care is required to ensure the coherence of the law in a way that minimises this complexity and the associated compliance costs.
IV DEVELOPMENT OF THE TAX BASE IS CONSISTENT WITH CURRENT ACCOUNTING CONCEPTS
The statutory intervention in the income tax law since the tax reform of 1985 has created an income tax base that has crept closer to the conceptual basis of accounting. That conceptual basis, found in Statement of Accounting Concept (‘SAC’) 4, emphasises assets and liabilities as the basis for determining profit or loss.[35]
Income tax law increasingly recognises asset based notions (for example, ITAA 1936 Division 16E). Possible policy reforms in the area of the taxation of financial arrangements might continue this trend. However, the convergence so far as the recognition of assets is concerned is piecemeal rather than systematic or consistent.
In addition, while there have been some recent developments (for example, debt forgiveness rules),[36]the income tax law still struggles to recognise liabilities in a systematic way. This could be seen as the cause of problems like those that arose in Federal Commissioner of Taxation v Orica Ltd.[37]
Nevertheless, the removal of accelerated depreciation is the most obvious recent example of bringing accounting income and taxable income closer together.[38]
V ACCOUNTING AND THE PRACTICAL CALCULATION OF TAXABLE INCOME
There is a practical interdependence between accounting and taxation. Many business taxpayers calculate their taxable income or tax loss in practice by reconciling from their accounting profit or loss. The key observation here is that accounting records and calculations are a vital part of the practical application and administration of the income tax system, even for those taxpayers who do not have to comply with accounting standards.
Accounting profit is the difference between revenue and expenses. Revenue is the ‘inflows or other enhancements, or savings in outflows, of future economic benefits in the form of increases in [net] assets ... other than those relating to contributions by owners’.[39] Expenses are the ‘consumptions or losses of future economic benefits in the form of reductions in [net] assets...other than those relating to distributions to owners’.[40]Thus, accounting profit (or income) is based on assets and liabilities, in particular the change in an entity’s net position (to the extent that it does not result from contributions by, or distributions to, owners).
The profit and loss statement is a way of displaying the sources of that change in net assets (for example, retail sales or debt defeasance). In this way, the profit and loss statement explains how an entity’s balance sheet at the start of the year comes to look like its balance sheet at the end (putting aside dealings with owners in their capacity as owners); it explains the movement of accounting values.
Under the income tax law, taxable income is the difference between assessable income and deductions (section 4-15 of the ITAA 1997). Assessable income is comprised of ordinary income and statutory income (section 6-5 and 6-10 of the ITAA 1997). Deductions are comprised of general deductions and specific deductions (sections 8-1 and 8-5 of the ITAA 1997).
This scheme explains taxable income but taxpayers often do not work out their taxable income by directly computing assessable income less deductions. In many cases they work off their accounts and make reconciliations for tax purposes. Also, they do not usually keep an ongoing set of tax accounts with accounts called ordinary income, statutory income, general deductions and specific deductions. Nevertheless, their taxable income, once computed, must be explicable on the bases of the scheme used in the income tax law.
Therefore, there is a distinction to be drawn between the concepts that work together to result in taxable income and its practical derivation.
VI RECONCILING ACCOUNTING PROFIT TO TAXABLE INCOME
Basically, accounting profit does not equal taxable income because:
∞ it includes items that are not included in assessable income under the income tax law, or which are not deductible under the income tax law;
∞ of the items that should be included, it may use different amounts than would be included as assessable income or as an allowable deduction under the income tax law; and
∞ it omits certain items, whether as income or as an expense or outgoing.
So, a reconciliation is needed because accounting profit takes into account different items and may use different amounts. The process is a series of increasing and decreasing adjustments. Importantly, it is accounting profit that is in practice modified to get to taxable income. This means that any adjustments relate to the items set out in the profit and loss account or statement.
Increasing adjustments under the income tax law may result from:
∞ an accounting expense that is not an allowable deduction, for example an expense that:
- is not a ‘loss or outgoing’, such as an income tax expense;
- is not ‘incurred’, such as provisions for leave;
- is ‘capital’ in nature, such as expenses in building plant; or
- is expressly denied deductibility, such as entertainment expenses;
∞ an accounting expense that is an allowable deduction, but the expense is more than the deduction;
∞ assessable income that is not accounting revenue, for example a notional or deemed amount, such as the amount by which franked dividends are grossed up; and
∞ assessable income that is accounting revenue, but the income is more than the revenue.
Decreasing adjustments under the income tax law may be made for:
∞ an allowable deduction that is not an accounting expense, for example carry forward tax losses;
∞ an allowable deduction that is an accounting expense, but the deduction is more than the expense;
∞ accounting revenue that is not assessable income, for example some upward asset revaluations; and
∞ accounting revenue that is assessable income, but the revenue is more than the assessable income.
There are frequently calls for reform to the tax law to reduce the gap between tax and accounting. It is almost a perennial issue. Calls for reform of this kind are increasingly a response to the complexity of the current income tax laws, both in terms of their policy and their structure and drafting. Another reason given is that compliance costs would fall because of a reduced need to maintain duplicate records and, most importantly, less need to follow duplicate processes in calculating profit or loss.
One of the major reforms often put forward is that taxable income or tax loss should equal, or at least be formally based upon, accounting profit or loss. This approach was touted again as recently as August late 2002.[41]However, there are many difficulties with the approach.[42]
∞ Accounting profit is calculated for a different purpose.
∞ Accounting profit can be used as a starting point, but it cannot provide the end result unless radical changes to tax policy can be contemplated (for example, current tax policy is that not all accounting provisions should be recognised for tax purposes).
∞ Most taxpayers do not at present need to comply with accounting standards.
∞ Accounting is moving away from determining profit on a realisation basis. For example, equity accounting may require companies to count towards their accounting profits income earned by entities over which they have a significant influence, causing capacity to pay difficulties if taxable income was based on accounting profits.[43]
∞ Applying the concept of materiality in a tax system is at the expense of fairness. As Gammie has argued, it ‘would be inappropriate if the materiality concept were to permit the taxpayer to be the sole judge of whether a particular treatment of a transaction in the accounts should be adopted in computing the final tax liability’.[44]
∞ Accounting is not as certain. (SAC) 4 requires assets and liabilities to be recognised if it is “probable” that the future economic benefits will eventuate or that the future sacrifice of economic benefits will be required. ‘Probable’ is interpreted to mean a greater than 50 per cent likelihood.[45]This certainty threshold could be one of the clearer differences between accounting and taxation.
∞ Accounting brings losses forward. The matching process of recognising expenses by associating costs incurred with revenues recognised, along with the principle of conservatism, explains the difference in treatment of bad debts between accounting and tax practice.
∞ Concessions that are currently available to taxpayers could be removed (or limited). As Tran observes: ‘Alignment of tax rules with (generally accepted accounting practice) means that the government has to use means other than the income tax system to achieve its policy objective.’[46]
∞ The international harmonisation of accounting standards may influence the tax base (or itself may be at risk).
∞ The accounting profession may be placed under added pressure. Auditors of company accounts may assume greater responsibility if accounting profit is used to measure taxable income. This may increase audit fees given the expanded work schedule and greater liability exposure.[47]
Notwithstanding the prospect of potentially lower compliance costs, consequences of any such an alignment might also include:
∞ higher taxable incomes (it has been said that reported accounting profits are usually higher than taxable incomes)[48]or lower taxable income if accounting income is sufficiently elastic that taxing it would cause it to diminish;[49]
∞ a threat to tax concessions for particular industries or that encourage investment in certain areas of the economy;
∞ possible tax avoidance issues, because of less precision in accounting standards (for example, in the area of financial transactions), and because accounting standards do not require transactions to be measured on an arm’s length basis; and
∞ the dependence of tax outcomes on accounting standards established independently of government.
So, while there have been significant developments consistent with accounting concepts (for example, removal of accelerated depreciation), the bottom line is that the practical realities make a comprehensive alignment of tax and accounting difficult, and the potential benefits speculative.
The rationalisation of tax and accounting systems was addressed by the Review of Business Taxation (often referred to as the ‘Ralph Review’ after its chair, John Ralph). The Review recommended that appropriate regard be had to accounting principles in the development of the Australian Tax Code (recommendation 4.23) and that work be undertaken with tax and accounting professionals to identify differences between tax and accounting with a view to better aligning them (recommendation 4.24).[50]
It would have to be said that there has been little progress on these issues in the development of legislation post the Review. This might have something to do with the fact that the recommendations of the Review were designed as an integrated package but only some recommendations have actually been implemented. It may also be a reflection of the adoption of other priorities.
A Tax Value Method
The Tax Value Method (‘TVM’) proposed by the Review of Business Taxation was a fundamental reform aimed at simplifying the income tax statute.[51]It was not aimed at aligning tax and accounting outcomes (tax policy prevented that). However, it was based explicitly on the same conceptual framework that now underlies accounting. That conceptual framework, found in SAC 4, emphasises assets and liabilities as the basis for determining profit or loss. Similarly, TVM was intended to be based on the changing tax values of assets and liabilities.[52]
The experience with the development of the TVM highlights the realities associated with adopting accounting outcomes as tax outcomes.
An aim of TVM was to align, at the conceptual level, accounting concepts and tax concepts. It was understood by those developing TVM (initially the Review of Business Taxation and then the Tax Board’s legislative group) that, while consistent with accounting at this conceptual level, TVM could never be the same as accounting. This reflected fundamental differences between the policy underlying accounting recognition and valuation criteria and the tax policy governing which gains or losses should be taken into account for tax purposes. This meant that, at the level of detail, TVM was different to accounting in many areas (just as the current income tax law is different, recognising policy differences) for example:
∞ The recognition criteria for TVM were often different to the recognition criteria for accounting. For example, provisions for employee’s leave while recognised in accounting were not recognised in TVM, reflecting tax policy. [53]
∞ In income tax, gains and losses are largely recognised on a realisation basis, most assets had a tax value based on cost under TVM even though for accounting purposes their value may have reflected a market valuation.
Some commentators criticised TVM for this. But given tax policy constraints, an alignment of tax and accounting at the level of detail was never going to be possible.
The Commonwealth government’s decision not to proceed with the TVM followed a recommendation from the Board of Taxation.[54]The Board reported significant industry concern about the cost and uncertainty associated with the TVM, including the possibility of substantial transitional costs for tax advisers and business generally.
Apart from the costs and uncertainty that may have been inherent in the TVM proposal, the adjustments required in relation to the timing and values of assets and liabilities for practical and policy reasons show how difficult it is to achieve a complete alignment of tax and accounting concepts.
B Minimum Company Tax
As the Review of Business Taxation explained:
The motivation for an alternative minimum company tax (AMCT) springs from the fact that in some circumstances an entity’s taxable income may be significantly less than its accounting income. An AMCT would be levied on accounting income or an adjusted taxable income. There are many major components of accounting income which it would simply be inappropriate to subject to taxation. For example, many companies have substantial dividend income which has already been subject to company tax. Further foreign source income is included in accounting income but, if it has been subject to a comparable tax rate in the source country, it is not subject to Australian tax. [55]
The use of a minimum company tax as an alternative was considered by the Review as likely to result in additional complexity and costs to the extent that taxpayers would be required to undertake two calculations to determine which approach had to be applied.[56]The use of a minimum company tax based on accounting profits has been criticised as providing ‘an incentive for companies to manage their reported profits in order to avoid a potential tax liability’ which would ‘decrease the overall quality of financial reporting and reduce the efficiency of the capital markets’. [57]If, as is the case in those countries where the interface between tax and accounting is a dependent one, tax was based on accounting profits, the accounting standards would be subject to (and likely to be influenced by) legislative intervention.[58]In any event it is unlikely that Parliament would abdicate its responsibility for taxation matters to those responsible for setting accounting standards, in relation to the minimum company tax base.
The ATO’s focus is on administration. This includes the interpretation of the tax law as an inherent requirement of being able to administer the law.
In interpreting the income tax law, the ATO must be guided by the words used by the legislature and, to the extent allowed by the words used, will have regard to the legislative policy and compliance cost implications. Where different interpretations are properly open, the ATO will adopt a purposive interpretation that reflects the legislative policy (and preferably one which also minimises compliance costs). In other words the approach is ‘to make the law work in a constructive and positively directed fashion, tempered by a thoughtful awareness of its intrinsic limits’. [59]
Accordingly, the ATO has a preference for interpreting the law in accordance with accounting practice where that is consistent with the words used in their legislative context having regard to the legislation’s policy intent.
An example is the approach taken in Taxation Ruling TR 2002/20, ‘Income Tax’ Thin Capitalisation – Definition of assets and liabilities for the purposes of Division 820. In Division 820 the terms ‘assets’ and ‘liabilities’ are used in a regime for determining an acceptable mix of debt and equity for funding a business. The legislation relies on the valuation rules in the accounting standards to provide values of, amongst other things, assets and non-debt liabilities, but is silent as to whether the terms take an accounting or jurisprudential meaning. The regime uses as its benchmark whether an ‘arm’s length’ lender would lend to the borrower having regard, amongst other things, to the borrower’s assets and liabilities. It is in essence a commercial test, and the ruling takes the view that the accounting meaning is the ordinary meaning of these terms in the context of Division 820.[60]
In addition to its interpretative function, the ATO provides substantial assistance to taxpayers (for example, educational material and advice) to help them comply with the tax law. There is merit in pursuing approaches that help taxpayers understand where the tax approach is different to the accounting approach so that their process of reconciling from accounting profit or loss to taxable income or loss is made easier. This might be able to be pursued both at the level of ATO administration and assistance, and at the legislative drafting level (by Treasury and the Office of Parliamentary Counsel).
As a means of reducing compliance costs there is merit in using accounting concepts where they are aligned with the legislative intent, so as to get leverage out of taxpayers’ ‘natural accounting records or systems’.
Tran concluded that the ‘alignment of tax rules with accounting rules presupposes suitability of accounting rules to achieve the objectives and criteria of the income tax system. Unfortunately this is not the case’.[61]
Nevertheless the Review of Business Taxation recommended that divergent treatment of transactions in tax and accounting should be addressed if that difference is deemed to be inappropriate.[62]
Tax reform might be said to involve two aspects: (i) policy reform; and (ii) structural and drafting reform of the statute. The question of policy reform is of course a matter for government. The perspective of the latter is not necessarily to change policy but rather to reduce the unnecessary complexity that has arisen from the historical agglomeration of our income tax laws. Given the way in which taxable income and tax loss is computed in practice by many taxpayers (that is, by reconciling from accounting profit and loss), the real reform issue from this perspective is probably not whether accounting profit and loss should form the starting point for tax purposes. It already does this in practice to some extent. The real issue might be how to best structure and draft income tax law so as to use accounting concepts where it is sensible to do so, and to clearly identify where there are differences from accounting outcomes.
The way forward seems to be a careful and pragmatic review of the situations of divergence between accounting concepts and tax rules. As far as I know, as at 30 January 2003 such a review is not on the drawing board.
[*] Michael D’Ascenzo, BEc and LLB (ANU), Second Commissioner, Australian Taxation Office, and Andrew England, BA and LLB, Assistant Commissioner, Australian Taxation Office. This article is based on a paper delivered by the authors to the 15th annual conference of the Australasian Tax Teachers Association, Wollongong, 31 January – 1 February 2003. Note: The views expressed in this article are personal to the authors and should in no way be attributed to the ATO.
[1] See (1996) 5 The European Accounting Review 779: Supplement regarding the link between commercial accounting and tax accounting in 13 selected European countries.
[2] See, eg, Review of Business Taxation, A Tax System Redesigned: more certain, equitable and durable (1999) 204–5: Recommendation 4.24.
[3] [1979] USSC 16; 439 US 522 (1979) 542–3 (footnotes omitted).
By contrast the accounting rules in the Netherlands have been described as providing ‘a great deal of flexibility’: Martin N Hoogendoorn, ‘Accounting and taxation in the Netherlands’ (1996) 5 The European Accounting Review 871, 872. Similarly Harold Dubroff, M Connie Cahill and Michael D Norris, ‘Tax Accounting: The Relationship of Clear Reflection of Income to Generally Accepted Accounting Principles’ (1983) 47 Albany Law Review 345, 381: argue that ‘GAAP are receptive to a degree of estimation and a lack of precision which is incompatible with the process of identifying a particular amount of ascertainably “correct” income tax’.
Martin N Hoogendoorn, ‘Accounting and taxation in Europe – A comparative overview’ (1983) 47 The European Accounting Review 783, 786.
Fulvia Rocchi, ‘Accounting and taxation in Italy’ (1983) 47 The European Accounting Review 981, 987.
Kristina Artsberg, ‘The link between commercial accounting and tax accounting in Sweden’ (1983) 47 The European Accounting Review 795, 805.
Calvin H Johnson, ‘Using GAAP Instead of Tax Accounting is a Bad Idea’ (1999) 83(3) Tax Notes 425: TNT 74-119.
Review of Business Taxation, An International Perspective an information paper commissioned from Arthur Anderson Examining how other countries approach business taxation (1998) 5-6. The Group 1 countries were Canada, Chile, France, Germany, Ireland, Japan, Netherlands, New Zealand, Singapore, Sweden, Taiwan, United Kingdom and United States. They were chosen because, “they represent major world economies; or they are significant economic powers in the Asia Pacific region; or because of significant changes that have been made to their business tax systems in recent years.” ... “The countries making up Group 2 were chosen for various reasons. In some cases, certain broad features of the tax systems in those countries are of interest. This is particularly the case with the international dimension of the tax system or with the way in which the taxation of company and individual taxation is at least partially integrated. Countries have also been chosen because of the concessional way in which they treat certain types of income and the analysis attempts to put this treatment in some context by examining the treatment of business income,”
For example, in France there is ‘fiscal supremacy on some points such as the calculation of depreciation and provisions’: A Frydlender and D Pham, ‘Relationship between accounting and taxation in France’ (1983) 47 The European Accounting Review 845, 848. In Belgium ‘annual accounts ... are to a large extent tax-influenced’: Ann Jorissen and Luc Maes, ‘The principle of fiscal neutrality: the cornerstone of the relationship between financial reporting and taxation in Belgium’ (1983) 47 The European Accounting Review 915, 929.
See, eg, Fulvia Rocchi, ‘Accounting and taxation in Italy’ (1983) 47 The European Accounting Review 981, 987.
See, eg, Harold Dubroff, M Connie Cahill and Michael D Norris, ‘Tax Accounting: The Relationship of Clear Reflection of Income to Generally Accepted Accounting Principles’ (1983) 47 Albany Law Review 345, 381.
Margaret Lamb, ‘The relationship between accounting and taxation: The United Kingdom’ (1983) 47 The European Accounting Review 933, 947.
Note re Recommendation 4.24 of the Review of Business Taxation (1999) (above n 2) that the Australian Taxation Office work with the accounting and tax professions to identify differences between the accounting and taxation treatments of profits with a view to better aligning those treatments where the differences are inappropriate: With the shift of the responsibility for law design from 1 July 2002 from the ATO to Treasury (Commonwealth Treasurer, ‘Reforms to Community Consultation Processes and Agency Accountabilities in Tax Design’, Press Release No 022, 2 May 2002) Recommendation 4.24 is now a matter for Treasury.
Examples often cited are Commissioner of Taxation (SA) v Executor Trustee & Agency Co of South Australia [1938] HCA 69; (1938) 63 CLR 108 (Carden’s Case) 1 AITR 416, Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation [1965] HCA 58; (1965) 114 CLR 314 and J Rowe & Son Pty Ltd v Federal Commissioner of Taxation 71 ATC 4001).
BHP Billiton (Bass Strait) Pty Ltd v Commissioner of Taxation 2002 ATC 5169 (Hill & Heerey JJ, 20 December 2002) [66]–[69].
RACV Insurance Pty Ltd v Federal Commissioner of Taxation 74 ATC 4169; Commercial Union Assurance Company of Australia Limited v Federal Commissioner of Taxation 77 ATC 4186; ANZ Banking Group Ltd v Federal Commissioner of Taxation 94 ATC 4026, 4035–6; Federal Commissioner of Taxation v Mercantile Mutual Insurance (Workers Compensation) Ltd 99 ATC 4404.
See Taxation Ruling TR 97/15 ‘Income Tax: Conditional contracts: derivation of income; allowable deductions; trading stock on hand’ but cf Commissioner of Inland Revenue v Mitsubishi Motors New Zealand Ltd 95 ATC 4711.
Federal Commissioner of Taxation v James Flood Pty Ltd [1953] HCA 65; (1953) 88 CLR 492; Nilsen Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616, 81 ATC 4031.
Federal Commissioner of Taxation v St Hubert’s Island Pty Ltd [1912] HCA 78; (1978) 138 CLR 210, 78 ATC 4104, 4113; Philip Morris v Federal Commissioner of Taxation 79 ATC 4352, 4356–7.
Dean Hanlon and Les Nethercott, ‘Debt Defeasance: An Accounting/Taxation Interface’ (Paper presented at the Australasian Tax Teachers Association 14th Annual Conference, Manukau Business School, Auckland, New Zealand, 17–19 January 2002) 2.
Sir Anthony Mason, ‘Future Directions in Australian Law’ [1987] MonashULawRw 6; (1987) 13 Monash University Law Review 149 has observed that ‘purposivism is more attractive because it emphasises substance over form’; but cf R C Allerdice, ‘The Swinging Pendulum: Judicial Trends in the Interpretation of Revenue Statutes’ [1996] UNSWLawJl 10; (1996) 19(1) UNSW Law Journal 162, 163. Note also the comments of G T Pagone in ‘Taxation Update: Anti-avoidance Provisions’ (2002) 31 Australian Tax Review 241–52 (particularly 251) on recent judicial interpretations of Part IVA.
Income Tax Assessment Act 1997 (Cth) s 240-60(2).
Income Tax Assessment Act 1997 (Cth) div 705. See, in particular, s 705-60.
Income Tax Assessment Act 1997 (Cth) ss 705-70 – 705-80.
Income Tax Assessment Act 1997 (Cth) s 705-80.
Such provisions are not incurred until there is a present liability to pay the employees (Nilsen Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616; 81 ATC 4031).
Australian Accounting Standards Board, SAC 4 Definition and Recognition of the Elements of Financial Statements 3/95 (1995) (‘SAC 4’) prepared by the Public Sector Accounting Standards Board (‘PSASB’) of the Australian Accounting Research Foundation (‘AARF’), and Australian Accounting Standards Board (‘AASB’), issued by AARF for the Institute of Chartered Accountants in Australia (‘ICAA’) and the Australian Society of Certified Practising Accountants (‘ASCPA’) and by the AASB. Avail as a pdf file via the AASB website <http://www.aasb.com.au/public_docs/concept_statements/SAC4_3-95.pdf> 5 June 2005.
Income Tax Assessment Act 1936 (Cth) sch 2C.
98 ATC 4494 [1998] HCA 33; (1998), 39 ATR 66.
New Business Tax System (Capital Allowances Act) 1999 (Cth).
See Brian Toohey, ‘Tax reform? Turn 8,500 pages and weep’ Australian Financial Review, 17–18 August 2002, 49.
See (September 2001) ‘TVM - why make the change?’ (Paper prepared by the TVM Legislation Group and ATO for the Board of Taxation), see <http://www.taxboard.gov.au/content/Tax_Value_Method/tvm_legpapers/index.asp>
Review of Business Taxation (1999), above n 2, 284.
Malcom Gammie, ‘TVM and the relationship between taxation and commercial accounting methods’ (Paper presented at the ATAX/Board of Taxation TVM Conference, Sydney, 23–24 July 2001) 19.
Jayne Godfrey, Allan Hodgson, Scott Holmes and Vernon Kam, Accounting Theory (2nd ed, 1994) 368.
Alfred Tran, ‘Relationship of Tax and Financial Accounting Rules, An Empirical Study of the Alignment Issue’ (doctorial thesis submitted at the Australian National University, 1997) 34.
See above n 15. Recommendation 4.23 is also now a matter for Treasury, and the Office of Parliamentary Counsel.
The advantage sought from TVM in adopting the conceptional basis of accounting was to provide a uniform structural platform for drafting tax law. As an example, the simplified capital gains tax rules in the TVM legislation released by the Board of Taxation in March 2002 reduced 40 CGT events to a maximum of 8, and reduced the size of the law by over 70%.
Review of Business Taxation (1999), above n 2, 38, 155.
See Commonwealth Treasurer, ‘Government Decides Against the Tax Value Method’, Media Release No 048, 28 August 2002; Board of Taxation, ’Evaluation of the Tax Value Method : a Report to the Treasurer and Minister for Revenue and Assistant Treasurer ’ (July 2002) avail <http://www.taxboard.gov.au/content/Tax_Value_Method/tvm_recommend/index.asp> 5 June 2005.
Review of Business Taxation (1999), above n 2, 52.
Ibid 285. See also Johnson, above n 9.
For example, in Finland ‘Tax laws have had a strong influence on accounting practice’ (Marko Järvenpää, ‘Taxation and financial accounting in Finland’ (1996) 5 European Accounting Review 899, 911), and in Germany ‘differences between the financial statements and the tax accounts may arise from specific tax rules that always supersede commercial rules’ (Dieter Pfaff and Thomas Schröer, ‘The relationship between financial and tax accounting in Germany – the authoritativeness and reverse authoritativeness principle’ (1996) 5 European Accounting Review 963, 969).
J Scott Wilkie, ‘Looking Forward into the Past: Financial Innovation and the Basic Limits of Income Tax’ (1995) 43(5) Canadian Tax Journal 1147, 1166.
There is an alternative view that the definition of ‘assets’ and ‘liabilities’ takes a traditional legal meaning. Some support for this view may be gained from the Explanatory Memorandum. However, this view is less apt for what is intended to be an ‘arm’s length’ commercial test, and imposes higher compliance costs. It would require companies to determine assets and liabilities using jurisprudential concepts and then value the assets and liabilities so determined having regard to commercial standards.
Recommendation 4.24 of A Tax System Redesigned (1999), above n 2.
AustLII:
Copyright Policy
|
Disclaimers
|
Privacy Policy
|
Feedback
URL: http://www.austlii.edu.au/au/journals/JlATaxTA/2005/2.html