Current issues in tax accounting_TIA Paper

Current Issues in Accounting
for Income Tax
Ronen Vexier
Partner
PricewaterhouseCoopers
February 2008
Taxation Institute of Australia
23rd
National Convention
12 to 15 March 2008-02-21
Adelaide Convention Centre, South Australia
PRICEWATERHOUSECWPERS

Introduction
The aim of this paper is to discuss current issues in accounting for income taxes in Australla and to look
ahead to understand the impact of a Iooming change.
1 seek to highlight some of the major practical challenges facing those responsible for preparing and
auditing this aspect of financial reporting; and lt is fair to say that these challenges are, generally, quite
significant. Corporates and advisors alike have been grappling with the technical and practical issues for
some time, with varying degrees of success. There are obviously several reasons for this. However, in
my view the key reason is that this area is the (un)happy coincidence of two formerly discrete disciplines
which is yet to fully emerge as a stand alone specialisation.
Accounting for income tax is now sufficiently complex and significant that lt requires its own
specialisation, with a sufficient understanding of tax and accounting to be able to ask the right questions
and make the rightjudgment calls. A good appreciation of systems and processes is also required to
enable a seamless interaction between the tax and accounting functions in an organisation.
In addition to the current challenges, as we look out to the horizon we can see a major change coming.
The latest product of the global convergence of the two major sets of accounting standards, International
Accounting Standards and US Standards, could result in some fundamental changes in the way
Australian entities account for income taxes. This paper considers some of the business impacts of
these changes, likely to be contained in the revised lAS 121.
The revised lAS 12 will hopefully alleviate some of the challenges currently experienced in relation to tax
accounting but lt will also introduce new rules, new procedures and new levels of analysis and
processing. Of course, there will also be the trials and tribulation of transition.
References in this paper to relevant accounting guidance are as follows:
AASB 112 Australian Accounting Standard AASB 112 Income Taxes
UIG 1052 Urgent Issues Group Interpretation 1052 Tax Consolidation Accounting
FAS 109 US Financial Accounting Standards Board Statement No. 109 Accounting for
Income Taxes
lAS 12 (revised) Proposed revised International Accounting Standard lAS 12 (as distinctfrom the
current lAS 12)
EIN 48 FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes
IASB International Accounting Standards Board
AIFRS Australian equivalents of International Financial Reporting Standards
AASB 112 and UIG 1052 have applied in Australla since 1 January 2005. FAS 109 has applied for
USGAAP purposes sinGe 1991 and FIN 48 was effective for reporting periods beginning after 15
December 2006.
1
The views in this paper are those of the author and do not necessarily represent the views of PricewaterhouseCoopers nor any other
person or body. The author thanks David Romans, a Partner of Corporate Tax PricewaterhouseCoopers Melbourne, Alistair Hutson, a
Director of Corporate Tax PricewaterhouseCoopers Adelaide and Belinda Harrison, a Senior Manager of the Corporate Compliance team
PricewaterhouseCoopers Melbourne, for their assistance in preparing the content of this paper.
Current Issues in Accounting for Income Tax

Introduction
In relation to the proposed revised lAS and the content and timing of its adoption in Australia, we are
currently waiting to see the Exposure Draft and we are expecting lt to be published shortly. The
commentary provided in this paper in relation to expected content of the revised lAS is drawn from
project update reports issued by the IASB in relation to the convergence project and its tentative
conclusions contained therein.
The commencement date of lAS 12 (revised) is as yet unknown. However, based on current
expectations and guidance from the IASB, lAS 12 (revised) may have application in Australia for
reporting periods commencing as early as 1 JuIy 2009.
c
0
ii PricewaterhouseCoopers

Contents
Introduction
1 Current issues in accounting for income tax 2
1.1 Taxbase 2
1.1.1 AASBII2 2
1.1.2 lAS 12 (revised) 4
1.2 Initial recognition exemption 5
1 .3 Recognition of DTAs 6
1 .4 Allocation of tax between entities 7
1 .5 Balance sheet disclosures 7
1 .6 Other issues 8
1.6.1 Distributing entities 8
1.6.2 Investments 8
1 .6.3 Allocation of tax to profit or
equity 8
1.6.4 Differences between FAS 109
and lAS 12 (revised) —
continued divergence 8
2 Dealing with uncertain tax positions 9
2.1 Uncertain tax positions pursuant to
AASBI12 9
2.2 Uncertain tax positions pursuant to EIN
48 — recognition 9
2.3 Uncertain tax positions pursuant to EIN
Q
48 — measurement 10
2.4 Uncertain tax positions pursuant to lAS
12 (revised) 10
Conclusion 13
Current ssues in Accounting for Income Tax

1 Current issues in accounting for income tax
1.1 Taxbase
1.11 AASB 112
AASB 112 requires the adoption of a balance sheet approach in accounting and reporting for deferred
income taxes. Yes, lt‘s true! Despite the state of denial still lived in by many entities required to prepare
tax accounting calculations and disclosures, the balance sheet approach has been required by AASB
112 since 2005.
The basic principles of AASB 112 are ta account for the current and future tax cansequences of:
transactions and other events of the current periad that are recognised in the entity‘s financial
reports
ii the future recovery of the carrying amount of assets ar, in the case of liabilities, the future
settlement of their carrying amount.
The main building block ofthe balance sheetapproach in AASB 112 isthe concept of tax base, whereby
deferred tax is recognised as the difference between an asset or liability‘s tax base and its carrying
amount an the balance sheet.
There are two possible tax bases: tax written down value (WDV) and capital gains tax (CGT) base.
Unfartunately, there is much controversy around which base is the right one in same cases and a proper
analysis of this question requires an understanding of both the relevant accounting requirements and the
relevant income tax law.
Broadly, the tax base of an asset as determined pursuant to AASB 112 can vary depending on the
expected ‘method of recovery‘ of the asset, whether by use or by sale. The answer to this question for
same assets is relatively simple and without controversy. For example, the expected method of recovery
for depreciable fixed assets is generally use and thus the tax base for such assets is generally their tax
WDV. The expected methad of recovery for infinite life assets such as land is assumed to be sale and
thus the tax base for such assets is their CGT cost base. CGT cost base is generally determined for an
asset an acquisitian, although subsequent events can affect the value af that cost base during the life of
the asset.
Where cantroversy arises is in the context of indefinite life assets, or finite life assets that are not
depreciable for tax purposes. Examples of indefinite life assets include mining rights and brands without
a defined effective life. Examples of finite life assets include brands that are viewed 10 have a finite life
over which the brand may be amortised.
There are twa schaols of thought an the appropriate tax base in this case and na definitive guidance2:
One option is to use a tax base ascertained by the actual intent of management, i.e. if the asset is
held for sale use CGT cast base, atherwise use tax WDV. A cansequence af this alternative is that
a Deferred Tax Liability (DTL) will often arise an assets held for use which are typically not tax
depreciable, such as intangibles, brands and custamer contracts.
2
Some guidance in relation to land is provided in the interpretation issued by the Standard Interpretations Committee, SIC 21.
2 PricewaterhouseCoopers

Current issues in accounting for income tax
Intangibles, for example, may have a finite life for accounting purposes but not be depreciable for
tax purposes (for example finite life brands). Although the accounting life may end, say, within 10
years, this does not trigger a tax disposal.
Should an entity take the position that an asset is held for sale, and therefore use CGT cost base
as the tax base, lt is possible that no (or only a minimal) DTL will be required to be recognised
because the tax base and carrying amount may be of similar value.
ii The second option is to assume an asset is held for sale (and therefore use CGT base) in some
circumstances, irrespective of management‘s actual intent.
Unfortunately, given the uncertainty surrounding these issues, what we have seen is a divergence of
positions taken across potentially similar circumstances. lt is important to note that these differences can
impact on current year earnings:
Where CGT cost base is used, and that base is greater than the accounting base, it is quite likely
that the Deferred Tax Asset (DTA) prima facie arising will not be booked. Accordingly, the current
year accounting depreciation charge or impairment will create a DTA which is written-off via
income tax expense. Alternatively, where tax WDV is used and the asset is not tax depreciable, a
DTL will arise. Any accounting depreciation or impairment will be added back to increase the tax
provision and also reduce the DTL, with no net impact on the income statement.
ii Where CGT base is used and the asset is subsequently impaired, it is likely pursuant to AASB 112
that a “doubly whammy“ could arise to the income statement. The ‘first whammy‘ is the impairment
itself. However, the impairment may also result in a change as to how the asset is viewed and may
change it from being an indefinite life asset to a definite life asset, and thus from being held for
sale to being held for use. The ‘second whammy‘ arises from this change in status and the
consequent change in tax base from CGT to tax WDV (often zero). The resultant DTL is required
to be recognised via tax expense.
There are also significant challenges within organisations, especially global organisations which have
grown by acquisition, to ensure a uniform approach to this issue. The systems and process challenges
required to make this an effective and efficient exercise are not to be underestimated.
The foregoing has caused some consternation and discussion in the profession and amongst those
entities affected by the recognition of such DTLs. This consequence of applying AASB 112 has been
particularly controversial because the DTLs have:
often been of a significant value
ii have required an understanding of both accounting and tax in order to properly unravel the
standard‘s requirements
iii arisen in a new AIFRS environment where additional intangibles were required to be recognised
on the balance sheet
iv arisen pursuant to the new tax accounting standard and were not previously required to be
recognised under the preceding standard that applied the income statement method.
The adoption in Australla ofAASB 112 and the balance sheet method has introduced uncertaintyfor
taxpayers as to the correct tax base to be used when calculating deferred tax balances. This has caused
a divergence in treatment between taxpayers and also unexpected, and often undesirable,
consequential impacts to the income statement.
PricewaterhouseCoopers 3

1.1.2 lAS 12 (revised)
The definition ofthe tax base of an asset is expected to change under lAS 12 (revised). Tax base will be
determined by reference to the CGT cost base, ie an assumed method of recovery by sale, in the
absence of evidence to the contrary. This will bring tax base in line with the concepts of FAS 109 and will
remove the challenge offen presented by AASB 112 in identifying the appropriate tax base for certain
assets, in particular intangibles, and avoiding the consequential impacts to the balance sheet and to tax
expense.
The introduction ofa revised lAS 12 in Australia will also likely see us follow the FAS 109 requirement
for gross DTAs to be fully recognised before offset (where relevant) by a valuatian allowance. This
requirement will further emphasise the importance of identifying and calculating the tax base of assets
and liabilities held by an entity, in order to properly quantify all deferred tax balances even if a taxpayer
is in a lass position.
This change will benefit those entities with assets that have a CGT coSt base but no tax written down
value, such as brands or trademarks that are indefinite life assets and customer contracts.
lfa DTL has been recognised pursuantto AASB 112, on transition to lAS 12 (revised)the tax base will
change from tax written down value to CGT cost base. Although we are not yet aware as to the
transitional provisions to be introduced by the IASB, it is not unreasonable to expect that the DTL will not
be released to the income statement but should be recognised to retained earnings an adoption ofthe
new accounting standard. This change in the balance sheet is then likely to have fiow an effects in
relation to tax attributes that are determined by reference to the financial statements, such as thin
capitalisation and tax consolidation. This will require changes to the calculations of such attributes going
forward, but will also potentially require the reopening of calculations already performed.
The impact an thin capitalisation in particular could be a significant issue. The thin capitalisation regime
imposes a limit an the ability of multinational corporations to gear their Australian operations. The regime
operates by reference to the balance sheet, and relevantly has regard to liabilities other than debt, such
as DTLs. Accordingly, to the extent that DTL‘s are reduced as companies are able to use CGT base as
their tax base, this should improve companies‘ thin capitalisation position. This would provide same
much needed relieffollowing the generally adverse impact an thin capitalisation of the AIFRS transition.
Under lAS 12 (revised), many entities will find themselves in a position where tax base (now equal to the
CGT cost base) exceeds the book carrying amount. This results in a prima facie DTA, subject to an
assessment of the need for a valuation allowance. CGT cost base may exceed the carrying amaunt
where there is an upward reset of tax base under tax consolidation but na equivalent increase in the
carrying amaunt. The accaunting depreciation of the asset may also give rise ta this position. Where a
DTA does not satisfy the recaverability criteria, and must be reduced by a valuation allowance, a non
temporary difference impact an tax expense will arise as and when accaunting depreciation is expensed
and added-back for tax provision purpases.
Companies will need ta formally assess the future recoverability of DTA‘s and consider relevant
disclosures. Therefore, understanding CGT cost bases in the context af lAS 12 (revised) is likely to
reveal information gaps in entities‘ CGT recordkeeping. Entities will be required ta have calculated, and
ta keep track af, the CGT cost base of all of their CGT assets. Far those assets deemed held for sale,
CGT cast base has not always been a priority and campanies have offen taken the view that, as na DTA
could be booked, there was no need to know the CGT cast base until the asset was sold. For example,
the entity may not have determined the market value CGT cost base pursuantto Division 149 which
deems pre-CGT assets to become post-CGT assets as a result of a majority change in ownership. This
position will not be sustainable under lAS 12 (revised) given the need ta disclose grass DTA‘s and any
valuation allawances separately (see below).

There is a further challenge for those assets previously viewed for tax purposes as a pool of intangibles
on acquisition. In particular, some entities took this position as a short Gut in performing their tax
consolidations exercise. Entities may now be required to separately identify and attribute a separate
CGT cost base to each asset3. This is similar to the experience on transition to AIFRS where entities
have been required to prepare their balance sheets disclosing separately identifiable intangible assets
beyond goodwill. In practice, this separation may not be required if the accounting and tax treatment is
ultimately the same for each asset within the pool and thus separate identification would not change the
result.
The proposed adoption in Australia of lAS 12 (revised) should remove much ofthe uncertainty currently
experienced by taxpayers in identifying the correct tax base to be used when calculating deferred tax
balances. However, the default to using CGT cost base will in itseif introduce challenges as taxpayer‘s
current recordkeeping may not include the information required to caiculate the correct tax base. On the
good news front, the adverse impact on thin capitalisation calculations of DTLs recognised pursuant to
AASB 112 should be diminished on transition to IASI2.
1.2 Initial recognition exemption
If a temporary difference arises on acquisition of an asset or assumption of a liability, depending on the
nature of the transaction that gave rise to the difference, AASB 112 does not permit recognition of any
resulting DTA or DTL. This exemption only applies to transactions which:
• are not business combinations
• at the time of the transaction, affect neither accounting profit nor taxable income.
Examples of temporary differences to which this exemption has applied are luxury cars, buildings subject
to the building write-off fortax purposes, exploration licences and in some cases, finance leases.
In contrast to AASB 112, FAS 109 does not contain this exemption and Australia has been lucky enough
to avoid (other than in relation to business combinations) the need to perform the iterative caiculation
required in the US. Briefly, this involves the booking of the prima facie deferred balance on acquisition,
which requires a recalculation of the related asset (or liability), and therefore a change in the deferred
balance and so on.
In contrastto AASB 112, but consistentwith FAS 109, lAS 12 (revised) will not contain an initial
recognition exemption and thus we are to be exposed to this more complicated method of tax accounting
on initial recognition. lAS 12 (revised) will require entities to recognise more DTAs and DTLs that arise
on acquisition of assets and assumptions of liabilities.
In particular in relation to assets, the recognition ofa DTL and a possible corresponding increase in the
value of the underlying asset may raise a question as to recoverability of the asset and whether this
increase in value needs to be impaired. Alternatively, there may be an argument to amortise the
increase in value or view it as an acquisition adjustment. This aspect of the application of the revised lAS
12 remains uncertain.
This apparent increase in the complexity of tax accounting under lAS 12 (revised) will be, fortunately, in
some way mitigated by the proposed change in lAS 12 (revised) to a held for sale assumption in relation
to tax base. This should, in part, reduce the impact of the removal ofthe initial recognition exemption.
3
Note that there is still some uncertainty as to whether a DTA would be required if the asset has not been attributed a separate value in
the balance sheet.
Pricewaterhousecoopers 5

As noted in relation to the change to a held for sale assumption for tax base, the potential increase in
recognition of upfront DTAs and DTLs introduces flow on impacts to the calculation of tax attributes such
as thin capitalisation and tax consolidations.
New methods of accounting and identifying opening deferred tax will be required for those industries
regularly impacted, such as
• car fleet companies that carry luxury cars
• non depreciable exploration and mining or petroleum rights in the resources industry
• licences in the utilities sector
• entities that acquire buildings at a value different from the original construction cost
• entities that hold assets under some finance leases.
The initial recognition exemption contained within AASB 112 has simplified the process in Australia for
adopting the balance sheet method for tax accounting. Removal of this exemption in the proposed
revised lAS 12 will likely introduce additional work on acquisitions of assets and possibly the need for a
recalculation of tax attributes impacted by the new deferred tax balances that are likely to arise.
1.3 Recognition of DTAs
AASB 112 requires that DTLs be recognised for all taxable temporary differences, except where the
initial recognition exemption applies or in relation to goodwill.
In relation to deductible temporary differences, however, a DTA can only be recognised if lt 15 probable
that there will be sufficient taxable profit arising in the future against which the deductible temporary
differences can be utilised.
Even if not recognisable, many entities have been still required to disclose in their accounts the nature
and quantum of unrecognised DTAs. Notwithstanding this requirement, our experience is that many
entities have been reticent to spend time and resources on identifying and quantifying their DTAs. A
lower level of work has been performed in relation to such DTAs and entities have not always prepared a
detailed calculation of the prima facie DTA involved. As a consequence, other than knowing that the tax
base exceeds the carrying value, the DTA has not always been quantified and therefore the tax base
has not been accurately calculated.
cIn applying the recognition criteria for DTAs, lAS 12 (revised) will adopt the “valuation allowance“
concept as contained within FAS 109. In contrastto AASB 112, which only requires a disclosure in
statutory accounts for DTAs that do not satisfy the “probable“ recognition criteria, a valuation allowance
approach requires that the DTA be recognised at a gross level and then a valuation allowance be
recognised to bring the gross amount down to the proper amount to be recognised in the balance sheet.
Furthermore, FAS 109 is far more prescriptive than AASB 112 in relation to the evidence to be gathered
and weighed in order to support whether or not a valuation allowance is required. This suggests an
additional level of documentation tobe prepared in Australia under lAS 12 (revised).
Although this is essentially a disclosure issue, not impacting the income statement or balance sheet,
experience in relation to FAS 109 reviews suggests that the disclosures for valuation allowances, and
the consequential impact on first time recognition, mean that these disclosures are important and require
analysis beyond that currently required under AASB 112. They also require an analysis that balances
both accounting and tax knowledge, as tax knowledge 5 required to calculate the correct tax base but
accounting knowledge is required to apply the standard and to properly analyse future profitability when
determining the need for any valuation allowance.

The practical challenges of accurately determining tax base are not to be under estimated and are
discussed in more detail above.
1.4 Allocation of tax between entities
Currently, the rules governing the allocation of current and deferred tax between group entities is
governed bythe interaction between AASB 112 and UIG 1052. AASB 112 requiresthatthe currentand
deferred tax effect of an entity‘s transactions be first reflected in the entity itself and then current tax
balances and DTAs for losses are transferred to the head entity either via the intercompany account or
equity depending on the nature of the group‘s Tax Funding Agreement.
The revised lAS 12 will include the requirements for allocating tax between group entities, rather than
relying an a separate UIG. lt is expected thatthe relevant terms of lAS 12 (revised) will mirror those
contained in UIG 1052 and thus will not result in changes in application.
As noted above, there are a number af aspects of lAS 12 (revised) that may change the deferred tax
accounting for an entity. However, na changes are expected ta affect the accaunting for current fax and
therefore the allocation of current tax between graup entities should not see any change an transitian to
lAS 12 (revised).
However, ifthe deferred tax balances afa graup entity change an transitian ta lAS 12 (revised), far
example if a DTL previously recognised far a brand is no langer required to be recognised, we would
expect lAS 12 (revised) to require these changes to be booked atthe entity level.
lt is noted that certain aspects of UIG 1052 have presented same challenges to corporates and the
profession, in particular in relation to the determination of an acceptable method of allocating tax liability
across a graup. lt is hoped that lAS 12 (revised) will provide the opportunityto clarify much ofthe
uncertainty surrounding these issues.
1.5 Balance sheet disclosures
From 2005, AASB 112 introduced in Australia an additional level of detail in relation to the disclosure of
DTAs and DTLs. AASB 112 requires that the notes to the accounts refer to the amount af the DTA or
DTL for each type of temparary differences.
In practice this has meant that more time has been required ta identify and quantify individual DTAs and
DTLs and ta ensure a proper balance sheet approach is adopted to achieve this objective. Also,
although AASB 112 requires set off of DTAs and DTLs in many circumstances, this has not prevented
the need ta first identify and then quantify the DTAs and DTLs before then being offset.
lAS 12 (revised) will adopt the requirements in FAS 109 for entities ta split DTAs and DTLs an a current
and nan current basis4. This is a relatively simple analysis, as the split generally follows the character of
the asset ar liability giving rise ta the difference, but it does mean that process changes are required and
an appropriate level af detail in relation to each temporary difference is required.
AASB 101 in relation to presentation of financial statements currently requires this split, although not on the face of the balance sheet.

1.6 Otherissues
1.6.1 Distributing entities
Public entities for which the owners rather than the entities are liable for tax will now need to disclose the
net difference between tax bases.
This is likely to have a significant impact on specific industries, such as funds management and may
require a significant implementation effort to produce a comparison of carrying amount and tax base that
has not previously been required. When one considers the tight reporting timeframes and often disparate
reporting platforms which are features of some industries, the changes ahead are likely to require
significant lead time to successfully implement.
1.6.2 Investments
AASB 112 currently includes an exemption from recognition of a deferred tax liability for a taxable
temporary difference relating to Investments in subsidiaries, branches and associates and interest in C.joint ventures if the parent can control the timing of the reversal of the difference and it is probable that
the temporary difference will not reverse in the foreseeable future.
This exemption will be retained in lAS 12 (revised) butthe wording of FAS 109 will be adopted. lt is not
expected that this will result in any changes in practice.
1.6.3 Allocation oftax to profit or equity
AASB 112 requires that the tax effect of items credited or charged to equity during the year also be so
allocated to equity. Subsequent changes to those amounts are also required to be allocated to equity. In
contrast, FAS 109 requires that subsequent changes be allocated to the income statement, irrespective
ofwhere the original entry was recognised. Examples of items that are often recognised to equity, for
which a deferred tax balance may arise, are share based payments expense and hedging instruments.
The revised lAS proposes to adopt the intraperiod allocation requirements of FAS 109. This will thus
likely introduce further volatility to the income statement as taxpayers transition to the new tax
accounting standard.
1.6.4 Differences between FAS 109 and lAS 12 (revised) — continued
divergence
Notwithstanding the discussion in this paper regarding the convergence of many of the concepts
proposed for the revised lAS 12 with those currently contained in FAS 109, there will still be a number of
differences that will still require a reconciliation between US and Australian reporting in relation to
income taxes. However, the convergence project should achieve alignment of treatment for most major
tax to accounting adjustments, simplifying FAS 109 calculations going forward.

2 Dealing with uncertain tax positions
2.1 Uncertain tax positions pursuantto AASB 112
There is not a lot of guidance or constraint in the Australian accounting standards in relation to
accounting for uncertain tax positions. The only formal guidance in AASB 12 is the requirementthat
current and deferred tax be determined by reference to expected outcomes in relation to current tax law.
In relation to current tax, AASB 112 requires current tax be measured at the amount “expected to be
paid“ which requires an analysis of management‘s expectations as to the likely outcome of any tax
uncertainty. In relation to deferred tax, AASB 112 requires an analysis of management‘s expectations
regarding recoverylsettlement of assets/liabilities on the balance sheet at year end.
In dealing with uncertain tax positions, reference may also be made to AASB 137 and its requirements
to disclose amounts in relation to contingent liabilities and which may apply, although in unusual
circumstances, to a potential contingent tax liability. Reference to AASB 137 can only be made in
relation to disclosure purposes, and not in relation to measurement.
2.2 Uncertain tax positions pursuant to FIN 48 — recognition
USGAAP is far more prescriptive in relation to dealing with tax uncertainty and EIN 48 sets out the
requirements for recognition and measurement of uncertain tax positions. This is a recently introduced
requirement (from 1 January 2007) and lt was introduced with the objective of trying to alleviate the
disparities in recognition of uncertain positions that appeared to be arising between different entities.
EIN 48 requires that the financial effect of a tax position can only be recognised where it is “more likely
than not, based on the technical merits, that the position will be sustained upon examination“ (EIN 48,
para 6). Note that FIN 48 is phrased in terms of booking the benefit from a tax position - ie, whether the
tax provided should be reduced on the basis the uncertainty will be resolved in the company‘s favour.
Applying FIN 48 also requires thattaxpayers balance an understanding ofthe tax law requirements in
relation to the supportability of their position for tax law purposes, and the accounting standard
requirements in relation to the need to book a provision against the benefit claimed for that position.
There are some key assumptions to be made in making this assessment:
• more likely than not means a likelihood of more than 50 percent
• examination includes resolution of any appeals or litigation process
• the assessment shall consider the facts, circumstances and information available at the reporting
date
• it shall be assumed that the tax position will be examined by the relevant taxing authority, who will
have full knowledge of all relevant information
• the technical merits can include widely-known administrative practices of the relevant taxing
a uthority
• each tax position shall be considered in isolation, without consideration of the possibility of offset
or aggregation with other positions.
Provsions, Contingent Liabilities and Contingent Assets

Dealing with uncertain tax positions
A key part of this assessment is determining the ‘unit of account“ for the tax position (FIN 48, para 5).
This effectively sets the parameters of the particular tax issue, so that the assessment only has regard to
facts and circumstances relevantto that issue. To highlightthe importance ofthis, FIN 48 provides the
example of claiming a Research and Development (R&D) concession in respect of a number of projects
- the question is whether the unit of account is the expenditure claimed, the individual projects, or the
R&D claim in total. In the example, the company decides that the individual project is the appropriate unit
of account, meaning that the more-Iikely-than-not threshold is examined for each project on its own
without regard for any negotiations or settlements that may occur in relation to any other project. The
decision as to the appropriate unit of account is based on the size of the matter, the level at which
Information is accumulated for the tax return, and the level at which the relevant taxing authority will
address the issues.
2.3 Uncertain tax positions pursuant to FIN 48 — measurement
Once it has been determined that an uncertain tax position meets the criteria for recognition, the amount
that is recognised is “the largest amount of tax benefit that is greater than 50% likely of being realised
upon ultimate settlement“ (EIN 48, para 8). Again, it is assumed that the relevant taxing authority has full
knowledge of all relevant information when estimating the likely settlement, and the assessment is made
using facts, circumstances and Information available at the reporting date.
EIN 48 contains the following illustrative example of the measurement test, where the outcome may
include possible settlements in the event of litigation - in relation to a tax position with benefits of $100.
Possible estimated outcome Individual probability of occurring (%) Cumulative probability of occurring (%)
$100 5 5
$80 25 30
$60 25 55
$50 20 75
$40 10 85
$20 10 95
0 5 100
In this example, as the $60 outcome is the largest amount of benefit with a greater than 50% likelihood
of being realised, it is the amount recognised.
2.4 Uncertain tax positions pursuantto lAS 12 (revised)
On introduction of lAS 12 (revised), Australla will move to the more prescriptive approach in relation to
uncertain tax positions and will be required to analyse all existing and future tax positions by reference to
a weighted average analysis. The requirements of lAS 12 (revised) will skip the recognition step
contained in EIN 48 and go straight to the measurement step that will be applied on a weighted average
basis.
In practice, this is likely to result in entities being required to raise more provisions for uncertain tax
positions than would be required in applying EIN 48. In applying the recognition step contained in EIN
48, many entities formed the view thatthe maximum benefit had at least 51% probability, necessitating
no provision to be booked at all as the largest amount more likely than not to be realised on settlement
equated to the fuIl value of the benefit.
lt important to note that a ‘provision for uncertain tax positions‘ is often a product of a broader risk
management process. In line with corporate governance developments, many entities have adopted a

more robust and comprehensive process to understand and monitor their tax risk profile. This process
can then be used to assess the appropriateness of a provision for uncertain tax positions. lt is quite
possible that on consideration ofthe information and analysis currently prepared by companies, the
accounting outcome will be quite different under lAS 12 (revised). Given that lAS 12 (revised) applies a
weighted average basis of recognition, any uncertain positions with possible outcomes assessed as less
than 50% likely (but still having some prospect of arising) which are not currentiy provided against, will
require a provision under lAS 12 (revised). In some cases, the Balance Sheet and retained earnings
impact can be significant, and corporates will be weil advised to understand this weil in advance so that
any transition is weil communicated. Additionai and potentialiy onerous disclosures may also be required
underthe revised lAS 12, as has been the experience in relation to EIN 48. As a consequence, as
appears to be a risk in the current F1N 48 environment in the US, these disclosures may provide
information to the Australian Taxation Office that may be used as an input to their review and audit
activity.
in addition, the introduction of lAS 12 (revised) may also be an opportune time for companies to revisit
their processes and systems in this area, to ensure they are sufficiently robust to support the provision
now iikeiy to be recognised.
lt is worth noting that the lAS 12 (revised) basis of recognising uncertain tax provisions is iikeiy to iead to
more voiatility in tax expense as companies reguiarly reassess their tax uncertainties in the face of
changing circumstances.
A specific chailenge in conducting a EIN 48 or lAS 12 (revised) analysis is determining the extent to
which Austraiian tax assessments are still open to amendment by the ATO. For the 2003/04 year of
income and earlier years, assessments had a 4 year amendment limit (extended in iimited cases). The
position is considerabiy more complex if the company has incurred tax losses. The complexity of these
ruies shouid not be underestimated in taking the fundamental first step in working out which uncertain
tax positions may still be disputed by the tax authorities.
Once the years in question have been identified, the next step is to examine the returns for those years
to identify uncertain tax positions. This process can be assisted by reviewing correspondence with tax
advisors, tax treatment of significant transactions, and any history of refund claims or amended
assessments.
Exampies of common areas of tax uncertainty are:
• tax loss recoupment tests
• reset of tax base on tax consolidations
• transferpricing
• positions adopted on specific transactions
• foreign exchange gains and iosses.
Measurement of the uncertain tax position relies on making an assessment of all the possible settiement
outcomes, and ranking their probabiiity. The risk of detection by the ATO is not factored into this
assessment. The probabiiity takes into account the iikelihood of reaching a settiement with the tax
authority, notjustthe pure technical meritofthe position.
FIN 48 and lAS 12 (revised) also require any interest and penaities to be accrued in respect of uncertain
tax positions. Interest is accrued at the appiicabie statutory rate of interest on the difference between the
tax position recorded in accordance with EIN 48 and lAS 12 (revised) and that adopted in the tax return.
In Australia, the determination of penalties is based on subjective factors, however companies will still
need to estimate the probability of each outcome for the purposes of measuring the position.

On transition to lAS 12 (revised), Australian entities will thus need to introduce a process whereby
ongoing transactions are analysed and provided for, and provisions in relation to ongoing positions are
released on settlement or closure. The type of processes that we have seen in relation to FIN 48 may
provide useful guidance to Australian entities as to how they should prepare for lAS 12 (revised).
Quarterly reviews would ensure regular consideration of these matters and timely identification of tax
issues on new transactions. This would allow for proper analysis of transactions on a timely basis and
the opportunity to seek independent advice to ensure the weighted average analysis can be done by
reference to complete and considered information and tax analysis.
Transition to lAS 12 (revised) may also see more volatility in the income statement as taxpayers
reassess their uncertain positions year to year and potentially increase or decrease provisions for tax.
Another major challenge for lAS 12 (revised), as experienced on introduction of FIN 48, is the gathering
and analysis of information. The introduction of FIN 48 has seen the development of various software
tools and spreadsheets distributed by US listed parent entities that allow the parent to gather and
consolidate information regarding uncertain positions around the world. Such information gathering tools
may now be required in an Australian context and may be useful to Australian entities with foreign
subsidiaries, which will also now need to introduce a process to be followed by the overseas subsidiaries
for (possibly) local purposes and for group reporting. Previous experience has shown such processes to
(work most efficiently with proper stakeholder engagement!
0

Conclusion
Asthe potential introduction of the revised lAS 12 looms, ourunderstanding of the currenttax
accounting issues being faced in Australia and in the US, and the proposed lAS 12 changes, suggests
that the key messages for entities preparing AIFRS financial statements can be summarised as follows:
• On transition, any changes to the tax accounting treatment of carried forward tax balances should
be reflected via retained earnings, with no adverse impact to the income statement. However,
entities should seek to understand and plan for the impact an the balance sheet of these changes
and the go forward impact an the income statement. Also, as experienced an transition to AIFRS,
entities will likely be required to recalculate their tax balance comparatives and thus perform an
additional level of work to create the required tax disclosures in the year of transition.
• Beyond transitian, entities can expect additional volatility in income tax expense given the regular
analysis and potential recalculation required for uncertain tax positians and for reassessment of
deferred balances an impairment of assets. Changes to deferred balances will have consequential
impacts an thin capitalisation and consalidatian calculations.
• Beyond the impact af transitian an the numbers, there will also be a need ta reengineer systems
and processes, and train staff, to ensure entities can gather the required information and have the
skills and tods ta analyse and present that Information in accordance with lAS 12 (revised).
• The expected changes contained in lAS 12 (revised) will require entities to update their CGT
registers and maintain a higher standard of documentation in relation to their CGT assets. Further
information requirements will arise to give entities the necessary understanding offuture recovery
and profitability ta allow a valuation allowance analysis. This will require a combination af tax and
accaunting skills.
• A rework and reinvigoration of the Australian accounting standard for income taxes, in particular ta
create greater alignment with US requirements, is a welcome objective. lt can be seen from the
foregoing however, that the anticipated improvements and convergence will also introduce
transition pains and patentially, some more weird and wonderful challenges for accauntants and
tax specialists alike. The need for a tax accounting specialisatian is never more apparent.
0
Ronen Vexler
March 2008
Disclaimer: This paper is not to be taken as a substitute for professional advice, Readers should make their own enquiries
in order to determine the accounting and taxation consequences of actual or proposed transactions.

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