In assessing whether uncertainty over income tax treatments exists, an entity may consider a number of indicators including, but not limited to, the following:
- Ambiguity in the drafting of relevant tax laws and related guidelines (such as ordinances, circulars and letters) and their interpretations
- Income tax practices that are generally applied by the taxation authorities in specific jurisdictions and situations
- Results of past examinations by taxation authorities on related issues
- Rulings and decisions from courts or other relevant authorities in addressing matters with a similar fact pattern
- Tax memoranda prepared by qualified in-house or external tax advisors
- The quality of available documentation to support a particular income tax treatment
In defining ‘uncertainty’, the entity only needs to consider whether a particular tax treatment is probable, rather than highly likely or certain, to be accepted by the taxation authorities. As explained in ‘Determination of tax positions‘ below, if the entity determines it is probable that a tax treatment will be accepted, then it will measure its income taxes on that basis. Only if the entity believes the likelihood of acceptance is not probable, would there be an uncertain tax treatment to be addressed by IFRIC 23.
When is the measurement of income tax probable?
Reference: IFRIC 23 10
If an entity concludes that it is probable that the taxation authority will accept an uncertain tax treatment, then it will measure all applicable taxes consistently with its income tax filings.
If an entity concludes that uncertainty over income tax treatments exists, it applies the guidance in IFRIC 23 5 which addresses:
- Whether to consider uncertain tax treatments separately (i.e. determine the unit of account),
- The assumptions it makes about the examination of tax treatments by taxation authorities,
- How it determines taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates (together referred to as ‘tax positions’) (i.e. ‘Determination of tax positions’),
- How it considers changes in facts and circumstances.
Determine the unit of account
One of the key aspects in the application of IFRIC 23 6 is to determine the unit of account. In practice, this might be an entire tax computation in a particular jurisdiction, each uncertain tax treatment separately, or a group of two or more uncertain tax treatments (e.g., all uncertain treatments in a particular tax jurisdiction, or all positions of a similar nature or relating to the same interpretation of tax legislation).
In determining which approach better predicts the resolution of the uncertainty, an entity might consider the following factors:
- How it prepares its income tax filings and supports tax treatments
- How the entity expects the taxation authority to make its examination and resolve issues that might arise from that examination
- The extent to which the outcomes of uncertain tax treatments are mutually dependent
- The resolution of similar tax issues by taxation authorities in prior years
Significant judgement may be required in the determination of the unit of account. In making the judgement, entities would need to consider the approach expected to be followed by the taxation authorities to resolve the uncertainty.
In general, interdependent tax positions (i.e., where the outcomes of uncertain tax treatments are mutually dependent) should be considered together.
The judgement required in the selection of a unit of account may be particularly challenging in groups of entities trading in various jurisdictions where the relevant tax laws or taxation authority treat similar elements differently.
Example: Unit of account
Entity A is part of a multinational group and provides intra-group loans to affiliates. It is funded through equity and deposits made by its parent. Whilst the entity can show that its interest margin earned on many loans is at an appropriate market rate, there are loans where the rate is open to challenge by the taxation authorities. However, Entity A determines that, across the loan portfolio as a whole, the existence of rates above and below a market comparator results in an overall interest margin that is within a reasonable range accepted by the taxation authorities.
Depending on the applicable tax law and practice in a specific jurisdiction, a taxation authority may accept a tax filing position on the basis of the overall interest margin if it is within a reasonable range. However, there might be other taxation authorities that would examine the interest rate separately for each loan receivable. In considering whether uncertain tax treatments should be considered separately for each loan receivable or combined with other loan receivables, Entity A should adopt the approach that better reflects the way the taxation authority would examine and resolve the issue.
Examination of tax treatments by taxation authorities
The Interpretation requires an entity to assume that the taxation authority can, and will, examine amounts it has a right to examine and have full knowledge of all related information when making those examinations. As such, IFRIC 23 requires an entity to assume a 100% detection risk. In making this decision, the Interpretations Committee noted that paragraphs 46 and 47 of IAS 12 require an entity to measure tax assets and liabilities based on tax laws that have been enacted or substantively enacted by the end of the reporting period.
Reference IFRIC 23 8
In some jurisdictions, examination by taxation authorities is subject to a time limit, sometimes referred to as a statute of limitations. In others, examination by taxation authorities might not be subject to a statute of limitations, which means the authorities can examine the amounts at any time in the future.
The threshold for reflecting the effects of uncertainty is whether it is probable that the taxation authority will accept an uncertain tax treatment. In other words, the recognition of uncertainty is not determined based on whether a taxation authority examines a tax treatment. One rationale suggested is that, in jurisdictions with no statute of limitations, there could be a point in time after which it becomes increasingly probable that the taxation authority would accept a tax treatment, simply because so much time has elapsed. Although the entity may, in such situations, conclude that it has become probable that the taxation authority would accept a tax treatment, it should consider the requirements in paragraph 13 of the Interpretation as discussed in ‘Changes in facts and circumstances’ below.
Determination of tax positions
If an entity concludes that uncertainty exists in its tax treatment, it has to consider whether it is probable that the taxation authority will accept such tax treatment (or group of uncertain tax treatments if it has been determined that they should be considered together, as discussed in ‘Determine unit of account’).
The threshold in IFRIC 23 is ‘probable’. This is consistent with other principles in IAS 12, for example, the ‘expected amount’ approach in paragraphs 46 and 47 to the measurement of tax, and paragraph 24 of IAS 12, which requires the recognition of deferred tax assets to the extent that it is probable that an entity will be able to use deductible temporary differences against future taxable profit.
Reference IFRIC 23 9
The following table provides an overview of the approach taken in IFRIC 23 to assess how uncertain tax treatments are measured:
How likely is it that the tax treatment will be accepted?
Measurement in line with income tax filings (i.e., no uncertain tax treatments), see IFRIC 23 10
Measure tax amounts using the method that provides better prediction of resolution
An entity may need to apply judgement in concluding whether it is probable that a particular uncertain tax treatment will be acceptable to the taxation authority. An entity may consider the following:
- Past experience related to similar tax treatments
- Legal advice or case law related to other entities
- Practice guidelines published by the taxation authorities that are applicable for the specific case
- The entity obtains a pre-clearance from the taxation authority on an uncertain tax treatment
An entity has a transfer pricing position that it considers to be vulnerable to challenge by a tax authority. It claims a deduction worth 100 of tax in its tax return for the expense. It currently accounts for UTPs using the most likely outcome method. The table below shows the position for the additional amount it expects to pay to the tax authorities over and above the amount presented in its filed tax return under its current method and the expected value method.
|Estimated additional liability||Probability||Estimate of expected value|
Using the most likely outcome method, the entity would record a provision for 40. Under the Interpretation, the entity might observe that the outcomes are widely dispersed, and as a result conclude that the expected value method is more appropriate. Accordingly it would include a provision for 65, to reflect the effect of the uncertainty.
Changes in facts and circumstances Uncertainty in income tax measurement
The Interpretation recognises that entities make judgements and estimates in considering uncertainty over tax treatments based on the available information at the time and that the information available can change over time. IFRIC 23 requires an entity to reassess those judgements and estimates if:
- The facts and circumstances on which the judgement or estimate was based change, or
- New information that affects the judgement or estimate is available
Reference IFRIC 23 13 – 14
The challenge for entities is to determine what represents a change in facts and circumstances that should result in a need to reassess judgements and estimates previously made by the entity.
The Application Guidance in Appendix A to the Interpretation provides the following examples:
- Examinations or actions by a taxation authority. For example:
- Agreement or disagreement by the taxation authority with the tax treatment or a similar tax treatment used by the entity
- Information that the taxation authority has agreed or disagreed with a similar tax treatment used by another entity
- Information about the amount received or paid to settle a similar tax treatment
- Changes in rules established by a taxation authority Uncertainty in income tax measurement
- The expiry of a taxation authority’s right to examine or re-examine a tax treatment
An uncertain tax treatment is resolved when the treatment is accepted or rejected by the taxation authorities. The Interpretation does not discuss the manner of acceptance (i.e., implicit or explicit) of an uncertain tax treatment by the taxation authorities. In practice, a taxation authority might accept a tax return without commenting explicitly on any particular treatment in it. Alternatively, it might raise some questions in an examination of a tax return. Unless such clearance is provided explicitly, it is not always clear if a taxation authority has accepted an uncertain tax treatment.
An entity may consider the following to determine whether a taxation authority has implicitly or explicitly accepted an uncertain tax treatment:
- The tax treatment is explicitly mentioned in a report issued by the taxation authorities following an examination
- The treatment was specifically discussed with the taxation authorities (e.g., during an on-site examination) and the taxation authorities verbally agreed with the approach, or
- The treatment was specifically highlighted in the income tax filings, but not subsequently queried by the taxation authorities in their examination
Paragraph A3 of IFRIC 23 clarifies that the absence of agreement or disagreement by a taxation authority with a tax treatment, in isolation, is unlikely to constitute a change in facts and circumstances or new information that affects the judgements and estimates required by this Interpretation. In such situations, an entity has to consider other available facts and circumstances before concluding that a reassessment of the judgements and estimates is required. Uncertainty in income tax measurement
Upon reassessment, if an entity concludes that the judgements and/or estimates have changed, the entity will reflect that change prospectively in accordance with IAS 8 as a change in accounting estimate. Uncertainty in income tax measurement
When facts and circumstances change after the reporting period and before the financial statements are authorised for issue, the entity must apply IAS 10 Events after the Reporting Period to determine whether a change that occurs after the reporting period is an adjusting or non-adjusting event. Uncertainty in income tax measurement
Example: Change in facts and circumstances
Entity A claimed a tax-deduction for a particular expense item. In the prior year, Entity A had concluded that it was probable that the taxation authority would accept the tax deduction. However, during the current year, Entity A is alerted by its tax advisor that another company in the jurisdiction with a similar issue was denied a tax deduction in a ruling by the Supreme Court. The recent court ruling is considered a change in facts and circumstances. As a result, Entity A has to reassess the uncertain tax treatment, taking into account the recent Supreme Court decision.
Example: Explicit and implicit acceptance
Entity B paid interest at a mutually agreed rate of 10% to an affiliated foreign company. However, the taxation authorities in Entity B’s jurisdiction normally only accept interest rates that are based on LIBOR plus a margin (which is significantly lower than 10%). Entity B made a statement in its corporate income tax return that it performed a transfer pricing study that substantiates the arm’s length nature of the 10% interest rate. Upon request, it could provide this documentation to the taxation authorities. The taxation authority may accept the tax treatment either implicitly or explicitly as described below:
Example: Events after the reporting date
Entity C had claimed a tax deduction for a particular expense item in its tax return related to the financial year ending 31 December 2018. However, for the purpose of recognising current and deferred taxes in that year, Entity C had concluded that it is not probable that the taxation authorities will accept the tax deduction. Accordingly, Entity C had recognised an additional tax liability relating to the uncertainty.
In February 2020, before the approval of the financial statements for the year ending 31 December 2019, Entity C receives the final tax assessment for 2018. The tax assessment confirms the full deductibility of the expense item. The confirmation of tax deduction received after the reporting period and prior to authorisation of the financial statements for 2019 is considered as an adjusting event after the reporting period. Accordingly, the additional tax liability that was recognised in 2018 relating to the uncertainty is released in the 2019 period.
Entity B claimed a tax-deduction pertaining to interest expense on a loan granted by an affiliated company, amounting to CU 500,000 in its tax return related to the financial statements for the year ending 31 December 2018. However, for the purposes of recognising current and deferred taxes for that year, Entity B had concluded that the taxation authorities will only accept a deduction of CU 100,000.
In March 2020, before the approval of the financial statements for the year ending 31 December 2019, Entity B learns from its tax advisor that the taxation authorities have confirmed that they will accept, on a retrospective basis, another method of determining interest rate at arm’s length that would lead to a tax deduction of CU 300,000 in year 2018.
In this example, it appears that the taxation authorities have issued a new guideline on deductibility of interest expenses relating to a loan from an affiliated company. Accordingly, in contrast to Scenario A above, the information received in March 2020 is considered as a non-adjusting event after the reporting period for the 2019 financial statements.