Income taxes: Top 10 differences between IFRS and US GAAP

Like IFRS, income tax related to items recognized outside profit or loss in the current period is itself recognized outside profit or loss.

Unlike IFRS, subsequent changes are generally recognized in profit or loss – i.e. backwards-tracing is not permitted.

However, the FASB recently provided companies the option to reclassify tax effects stranded in accumulated OCI as a result of the tax reform to retained earnings.¹

Typical items requiring backwards-tracing include: actuarial gains and losses on employee benefit liabilities, cash flow hedge reserves, and available-for-sale reserves. This is because these items are recorded in OCI.

Dual reporters need to implement a process to monitor subsequent changes of items initially recognized outside profit or loss to keep track of and record this difference.

IFRS does not currently include specific guidance on income tax exposures. The general provisions of IAS 12 apply.

IFRIC 23² will reduce diversity in practice, but may create new differences between IFRS and US GAAP.

In summary, the key test is whether it is more likely than not that the taxing authority (having full knowledge) will accept the company’s tax treatment as reported in the income tax filing.

• If yes, the company records the same amount in the financial statements as in its tax return.
• If no, the company reflects the effect of the uncertainty using the method it expects will better predict resolution of the uncertainty (most likely or expected amount).

IFRIC 23 is effective for annual reporting periods beginning on or after January 1, 2019. See our November 2017 IFRS Perspectives Newsletter for further discussion.

Unlike IFRS, US GAAP has specific guidance on the accounting for uncertainty in income taxes (income tax exposures).

Unlike IFRS, the benefits of uncertainty in income taxes are recognized only if it is more likely than not that the tax positions are sustainable based on their technical merits.

Unlike IFRS, for tax positions that are more likely than not of being sustained, the largest amount of tax benefit that is greater than 50 percent likely of being realized on settlement is recognized.

Given its complexity and scale and the speed at which it was passed, the tax reform creates many unknowns that may eventually result in income tax exposures.

In the meantime, IFRS preparers will make their best estimates in recording the tax effects of tax reform.

Deferred tax is recognized for the step-up in tax bases as a result of an intra-group transfer of assets between jurisdictions.

Additionally, the current tax effects for the seller are recognized in the current tax provision.

Unlike IFRS, the current tax effects for the seller are deferred and deferred tax is not recognized for the step-up in tax bases for the buyer as a result of an intra-group transfer of assets between jurisdictions.

ASU 2016-16³ eliminates this difference, with the exception of transfers of inventory.

Deferred tax is not recognized with respect to investments in subsidiaries (both foreign and domestic) if certain criteria are met.

These criteria primarily focus on whether the investor is able to control the timing of the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future (usually 12 to 18 months).

Like IFRS, deferred tax is not recognized with respect to investments in foreign subsidiaries if certain criteria are met; however, these criteria differ from IFRS, which may give rise to differences from IFRS.

Like IFRS, whether the investor is able to control the timing of the reversal of the temporary difference is one criterion. However, unlike IFRS undistributed earnings further need to be reinvested indefinitely or can be distributed on a tax-free basis in order for a company not to record deferred taxes on taxable temporary differences related to investments in certain foreign subsidiaries.

Other exceptions apply to domestic subsidiaries.

Dual reporters need to perform separate analyses under IFRS and US GAAP.

For US GAAP, the analysis requires sufficient documentation that the ‘indefinite reversal criteria’ are met. This requires a robust process involving people not only from within, but also outside the tax department.

The income tax expense recognized in each interim period is based on the best estimate of the weighted-average annual rate expected for the full year applied to the pre-tax income of the interim period.

If a change in tax rate is enacted or substantively enacted in an interim period, an entity may recognize the effect of the change immediately in the interim period in which the change occurs. However, another acceptable approach is to spread the effect of a change in the tax rate over the remainder of the annual reporting period via an adjustment to the estimated annual effective income tax rate.

Like IFRS, the income tax expense recognized in each interim period is based on the best estimate of the effective tax rate expected to be applicable for the full year applied to the pre-tax income of the interim period.

Unlike IFRS, if a change in a tax rate is enacted in an interim period, then the effect of the change is required to be recognized in income from continuing operations immediately in the interim period of enactment. The entity would then typically evaluate and adjust the estimated annual effective tax rate for the change and apply any resultant change prospectively. This is true unless the change in tax rate is administratively effective retrospectively to the beginning of the fiscal year.

Because IFRS allows for alternative acceptable approaches, dual reporters may align their IFRS accounting with US GAAP. That is unless a policy has been established in the past or has been set by the parent (IFRS group reporting).

Fiscal year-end companies may face further challenges because the change in tax rate brought by the tax reform is administratively effective at the beginning of the tax payer’s fiscal year (i.e. retrospectively).

A deferred tax asset or liability is not recognized if:

• it arises from the initial recognition of an asset or liability in a transaction that is not a business combination; and
• at the time of the transaction it affects neither accounting profit nor taxable profit.

The exemption applies, for example, if a company buys equipment whose cost will not be fully deductible for tax purposes.

This difference requires dual reporters to establish a process to identify and quantify the difference for each reporting period.

Deferred tax assets recognized for share-based payment arrangements are adjusted each period to reflect the amount of tax deduction that the entity would claim if the awards were tax-deductible in the current period based on the current market price of the shares.

If the amount of a tax deduction (or estimated future tax deduction) for a share-based payment transaction exceeds the amount of the related cumulative remuneration expense, the excess is recognized directly in equity (e.g. additional paid-in capital).

IFRS does not specifically address the situation in which the amount of the tax deduction is less than the related cumulative remuneration expense. In our view, such tax deficiencies should be recognized as income tax expense.

Unlike IFRS, temporary differences related to share-based payment arrangements are based on the amount of compensation cost that is recognized in profit or loss without any adjustment for the entity's current share price until the tax benefit is realized.

The difference between the deduction for tax purposes and the compensation cost recognized in the financial statements creates an excess tax benefit or tax deficiency. Unlike IFRS, entities record all excess tax benefits (tax deficiencies) as an income tax benefit (expense) in profit or loss in the period in which the tax deduction arises.

IFRS does not specifically address the accounting for interest and penalties related to income taxes. However, the accounting is not an accounting policy choice.

If interest and penalties are considered income taxes, then any associated uncertainties are accounted for under IAS 12. Conversely, if IAS 12 is not applied, then IAS 37⁴ applies to that amount.

Unlike IFRS, US GAAP specifically addresses the accounting for interest and penalties related to income taxes.

Interest on an underpayment of income tax is recognized when interest would begin accruing under the provisions of the tax law.

Penalties are recognized when a tax position does not meet the minimum statutory threshold to avoid payment of penalties.

A company has an accounting policy choice to classify interest and penalties as either income taxes or as a component of pretax income (loss).

In practice, some of the principles in accounting for uncertainty in income taxes are also applied to measure the amount of interest and penalties to accrue.

It appears that a company may choose an accounting policy, to be applied consistently, whether to discount long-term tax assets and payables (that are not part of a negotiated settlement with the tax authorities).

Examples related to the tax reform are the long-term transition tax payable on deemed repatriated earnings and the current tax asset associated with a refundable Alternative Minimum Tax (AMT) credit carryforward.

More resources

To understand the Act itself, KPMG Report on New Tax Law – Analysis and observations

KPMG’s IFRS Q&As, including discussion of the differences between IFRS and US GAAP, Tax reform in the United States – IFRS

KPMG’s US GAAP Q&As, Tax reform – Supplement to KPMG’s Handbook, Accounting for Income Taxes

KPMG’s dedicated website on US tax reform: kpmg.com/us/tax-reform