Uncertainty in income tax treatments – Int. 23 and Reportable Tax Position Schedules
In a world where a company’s tax payments (or lack thereof) are under increasing scrutiny, both the Australian Taxation Office (ATO) and the Australian Accounting Standard Board are now enforcing new reporting obligations that will see companies disclose their “uncertain” tax positions in their annual tax returns and financial statements. These obligations are addressed by the Reportable Tax Position Schedule (“RTPS”) for tax, and application of Interpretation 23 Uncertainty over Income Tax Treatments (“Int. 23”) for accounting.
Who is affected?
Int. 23 must be applied by all companies applying the recognition and measurement requirements of either Australian accounting standards or the International Financial Reporting Standards – including all entities reporting in accordance with the Corporations Act 2001.
The RTPS must be completed by public or foreign-owned companies whose annual turnover (either alone or in an economic group) exceeds AUD250M, as well as by companies that the ATO specifically contacts. Going forward, this self-assessment criteria will be expanded to include private companies – the ATO has indicated this will likely commence for the 30 June 2021 income year.
This alliance of accounting and tax disclosures has one common goal – to compel companies to explicitly quantify and record their risky tax positions.
This is in line with the ATO’s “Justified Trust” approach with taxpayers and the intensifying global demand for corporate transparency. These reporting requirements aim to provide a consistent framework for companies to account for and explain their uncertain tax positions so that regulators and the public can better understand the tax issues faced by reporters and identify outliers.
For income years beginning on or after 1 January 2019, companies will need to record their “uncertain” tax positions in their financial statements. This new Interpretation is a major conceptual extension to AASB 112 Income Taxes and requires the preparers of financial statements to consider the potential ramifications of tax accounting decisions, and potentially both record additional income tax expense and expand related disclosures. As it is directly related to AASB 112, its impact is limited to “income taxes” as defined in that standard – for most entities this is limited to income taxes, withholding taxes and transfer pricing adjustments.
This requirement applies to all companies who prepare financial statements applying the Australian accounting standards, including:
- All disclosing and public companies
- Large proprietary companies
- Companies limited by guarantee
- Registered managed investment schemes
- Small foreign owned companies
Specifically, Int. 23 requires companies to consider if they have applied any income tax treatments where there is potential uncertainty or where there is potential contention of that treatment by the tax authority (being the ATO and, ultimately, the courts). If the company concludes that it is probable (i.e. more than 50% likely) that said authorities would not accept that treatment, then it must quantify the potential exposure and record it in its calculation of current and deferred tax balances.
In making its assessment of the tax authority’s view, the company must assume that the tax authority will be privy to all related information applicable to all treatments. The practical implication of this is that where tax balances are adjusted as a result of Int. 23, the ATO could use this as an indicator to initiate their own tax audit procedures against the company.
It is likely that the application of Int. 23 will require an extension of companies’ internal tax risk and governance framework to address the additional accounting requirements, especially where Management and those charged with governance possess the appropriate documentation and the relevant tax expertise or skills to make reasonable judgements. This would also involve reviewing their documented consideration of any tax issues flagged by their external tax advisers during the year. For other, less sophisticated entities, it may be more appropriate to coordinate with tax advisors to develop and maintain reporting frameworks to assist entities in their reporting obligations.
Both of these approaches presume a company has a strong tax governance framework already in place whether performed internally or externally. Where this is lacking, companies will struggle with applying Int. 23 to a satisfactory level.
Reportable Tax Position Schedules
A reportable tax position is a contestable, and usually material, position taken by a company in respect of income tax. It’s important to note that “income tax” includes transfer pricing and other indirect tax positions adopted which have a flow-on impact to the company’s annual income tax liability. Such positions can include claiming a deduction or excluding an amount from assessment where the technical basis for doing so is ambiguous, or where the basis of calculating any income or expense claims has not been done in line with legislative requirements. These are required to be disclosed in the RTPS and lodged alongside the company’s annual income tax return form.
Within the RTPS, a company must disclose three categories of uncertain tax positions adopted – either in its income tax return, in its financial statements, or those that satisfy certain characteristics or arrangements that the ATO is currently targeting or considers high risk. The threshold for a reportable position is one that “is about as likely to be correct as incorrect, or is less likely to be correct than incorrect”. This term is similar to the “reasonably arguable position” threshold which requires detailed consideration of relevant authorities such as case law, tax legislation, ATO-issued guidance, and public rulings. Uncertain positions in the financial statements are those which can have a quantifiable impact or mismatch to the tax balances in a company or its related parties’ financial statements – and may reflect matters considered in the application of Int. 23. For the last category, companies must expressly explain why they do or don’t have any specific arrangements or transactions that the ATO has flagged as risky audit areas. These arrangements are set out in a comprehensive list of questions that the ATO will change annually.
The ATO’s stated purpose for the RTPS is to obtain clarity on the specific tax issues faced by corporate taxpayers who arguably have a significant impact on the Australian economy, identify weaknesses or ambiguity in existing tax law to be addressed, and map out trends in certain industries. While these outcomes are critical to ensure our tax system is robust and commercial, the immediate concern is that these companies are under the microscope of the ATO as said tax issues or trends have not yet been clarified or accepted.
Self-review of your current arrangements and tax positions is critical so as to identify and address any areas of uncertainty promptly, well before RTPS filing is required. All companies will have encountered tax issues that may have an element of uncertainty. The important thing is that these issues are considered – and ideally resolved – before any questions are raised by the ATO. For example, obtaining a private binding ruling, assessing the company’s risk profile in respect of that specific transaction in accordance with relevant ATO guidance or Practice Compliance Guidelines.