The effect of international financial reporting standards on current tax planning strategy
Following increasing pressure around the globe to harmonize accounting standards, the US is making the transition from the Generally Accepted Accounting Practices (GAAP) to the International Financial Reporting Standards (IFRS). The most immediate impact of the adoption of the IFRS is how the current tax reporting and planning strategy has changed. This is because most tax methods are based on the US GAAP and the shift to IFRS will also require key changes in the tax planning strategy. This essay will explain the effect that the implementation of IFRS has had and will continue to have on tax planning strategy.
One tax planning strategy that has been affected by the IFRS is the current inventory method used across the country. Under the US GAAP, most entities use the last in first out (LIFO) method to determine their net income and the amount of taxes owed. However, a shift from GAAP to IFRS will make the inventory method obsolete and taxes will no longer be determined using the method. According to Gray and Ehoff (2014), the LIFO method had a major loophole in terms of determining tax liability in that it was using outdated information leading to low net income reporting.
In contrast, IFRS shifts the focus to the balance sheet whereby entities will be forced to disclose and use the most relevant financial information. With the IFRS, the reporting of inventory and taxes liable will be more transparent and the taxes that entities pay will increase. In the short term, the US might have trouble letting go of the LIFO inventory method. However, in the long term, full transition to IFRS is unavoidable and so a more transparent method will need to be used (Brüggemann, Hitz & Sellhorn, 2013).
Another tax planning strategy that is being affected and will continue to be affected by the IFRS is the tax basis. In both US GAAP and IFRS, the common income tax principle that is used is that there is a difference between the carrying amount and the tax basis of items and assets (IFRS Foundation, 2017). However, the tax basis of assets differs between GAAP and IFRS and this could significantly influence the amount of taxes to remit. According to the US GAAP, the tax basis is defined by the tax law at the state and national level. However, with the adoption of the IFRS, the tax basis will be dictated by the amount that will be deducted for tax purposes.
Subsequently, while accounting for income taxes, entities will be required to disclose how they will settle the value of the item and this is what will form the tax basis. This tax planning strategy touches on how entities will be required to account for income taxes. With the US GAAP, entities were not required to disclose how they would recover the value of the asset but with IFRS, companies will be forced to part with more money in terms of taxes. In the short term, this will have no significant impact on the carrying amount but in the long term, companies will be required to pay more taxes than they are used to because the new tax basis requires them to (Braga, 2017).
Entities should also be concerned about the adoption of the IFRS and how it would impact their current tax planning strategy in terms of the reconciliation of the real and the expected tax rates. According to the US GAAP, when it comes to calculating the amount of taxes to remit, public companies are required to use the domestic federal rate on their net income. However, non-public companies are not required to disclose the amounts to which they are applying the rates. Still, the real and expected tax rates change completely when the IFRS is fully adopted (Bernard, 2008).
Public companies that use IFRS are calculating their expected taxes expense by using the specified tax rate to their entire incomes and also disclose the whole amount that they are using the rate on. Every entity that will adopt IFRS will also be required to do the same. By being required to disclose how they compute the tax rate on the income, there will be transparency and accuracy when determining the amount of taxes to pay in the short term and in the long run. However, in the short term, this transparency might slow the process of transitioning from the US GAAP to the IFRS (Hanlon & Heitzman, 2010).
In summary, the shift to IFRS is inevitable and the fact that the US has made the plan to make the full transition from US GAAP to the IFRS means that sooner or later, all entities will be required to use IFRS. The new accounting principles will significantly impact how entities calculate and report taxes and as discussed above, many tax planning strategies will be affected. For instance, companies will no longer be using the last in first out (LIFO) inventory method to determine the amount of taxes to pay. In addition, the IFR has introduced a completely different tax basis. In addition, the IFR has reconciled both the expected and the actual tax rates for more accuracy.