A closer look at IFRIC 23 and the challenges that lie ahead

(Second of two parts)

In last week’s article, we laid down the foundation of the International Financial Reporting Interpretations Committee 23 (IFRIC 23) by discussing the key requirements of recognizing uncertain income tax treatments. The initial application of a new accounting standard often poses questions and challenges. Today, we take a closer look at concrete applications of IFRIC 23, as well as the challenges and key considerations it entails.

Inherit challenges and considerations

Suppose an entity elects, as its tax practice moving forward, the deduction of expenses regardless if these were subjected to the corresponding withholding taxes. And based on the entity’s assessment, this tax practice is considered an uncertain tax treatment within the scope of IFRIC 23.

The Tax Code provides that a deduction be allowed if it is shown that the tax required to be withheld has been paid to the Bureau of Internal Revenue (BIR). However, under Revenue Regulations (RR) No. 6-2018 issued by the BIR, in case the tax was not withheld, a deduction will be allowed if the withholding agent pays the tax, including the applicable penalties due to the late payment, at the time of audit/investigation or reinvestigation/reconsideration.

Since the expenses may ultimately be allowed as deductions upon payment of the deficiency withholding taxes and penalties, this tax treatment could be interpreted as acceptable to the taxation authority. For consistency, the same tax treatment must be applied in valuing or measuring all related income tax accounts, including deferred taxes.

Recall that IFRIC 23 is to be applied retrospectively upon initial application — i.e., as if the tax treatment has been applied by the entity even in prior years. If the entity’s practice is to defer the deduction of outstanding accrued expenses until such time that they are subjected to withholding tax in the year of payment, the entity may need to quantify the potential restatement of accounts reported in prior years to comply with the transition requirement.

For an entity that has substantial outstanding year-end accruals, such potential restatement may be significant.

The entity may also need to consider amending previously filed returns so that the amounts reflected for tax purposes would be consistent with those reported in the financial statements. In a tax environment such as the Philippines, however, amendments restart the three-year prescriptive period for the BIR to assess deficiency taxes. Hence, the downside of an amendment is that it may expose an entity to certain risks, such as payment of interest and penalty.

With these implications, it may be paramount for an entity to evaluate the overall potential impact of IFRIC 23.

Note that income tax computation is a combination of tax treatments applied by an entity. As an evaluative measure, an entity may classify all of its tax treatments and identify which may be considered uncertain. Coordination among accounting, finance, tax, and legal functions is essential for a holistic and efficient assessment.

Intricacies and implocations of IFRIC 23 for financial institutions

There may also be industry-specific tax treatments within the scope of IFRIC 23. Thus, it may be advisable to also consider perspectives from an industry standpoint for additional guidance.

Take for instance the case of banks and other financial institutions (OFIs). Their taxation is different when compared to other types of taxpayers due to the promulgation of RR 4-2011.

While the BIR issued RR 4-2011 which required banks and OFIs to identify or allocate expenses between their income streams (i.e., tax-exempt, tax-paid or those subjected to final taxes and taxable, i.e., subject to regular corporate taxes), lack of clear guidance and/or illustrations as to its application gave rise to differing interpretations. Banks and OFIs, to a certain extent, had their distinct method of identifying and allocating expenses to compute for the taxable income subject to income tax.

Consequently, the BIR challenged the method employed by banks and OFIs by issuing tax assessments. Due to the industry-wide implications of RR 4-2011, several banks filed a petition for declaratory relief before the Regional Trial Court (RTC) in April 2015. For a time, the BIR was precluded from issuing tax assessments relating to RR 4-2011 due to a temporary restraining order on the enforcement of the regulations.

In May 2018, the RTC declared RR 4-2011 null and void for having been issued beyond the authority of the Secretary of Finance and the Commissioner of Internal Revenue. In response, the BIR elevated the case to the Supreme Court (SC), where the resolution remains pending to date.

Given the status, questions arise as banks and OFIs endeavor to adopt IFRIC 23. With the lingering issue on how the petition will be decided, should banks and OFIs consider their method of allocation of expenses an uncertain tax treatment? If it is, then the requirements of IFRIC 23 must be taken into account.

Taking the issue a step further, should they still comply with the provisions of RR 4-2011?

Suppose, as a matter of electing a tax position, the banks or OFIs stopped their allocation of expenses (i.e., all expenses were claimed as deductions against income subject to regular corporate taxes). First, there is a need to establish under tax law that it is probable that the BIR and tax courts (i.e., taxation authority) will accept its tax treatment of not allocating expenses.

Second, since IFRIC 23 requires retrospective application, banks or OFIs may be required to re-compute their income tax due and payable to value and measure the related tax accounts for the comparative periods presented in the 2019 financial statements. Compliance may pose a challenge, especially if the amount of the transition adjustment is significant. Lastly, the amendment of previously filed income tax returns may need to be considered with caution for potential penalty risks.

Admittedly, there may be other considerations and challenges not discussed here that could arise as entities endeavor to adopt IFRIC 23. Thus, it is necessary to assess the interpretation’s overall implications and address the issues early on.

While taxation is often criticized for its complexities, the thrill of life (in accounting and tax, at least) can ironically come from the uncertainties driven by the imperfect interactions between taxpayers, taxing authorities, and their environment.