Tuesday, November 30, 2010

On the need for improved deferred tax accounting

The Marks & Spencer story raises another issue: deferred tax. This is an item or items appearing in company accounts, but often only in slippery and elusive ways. Wikipedia says:
"Deferred tax is an accounting concept (also known as future income taxes), meaning a future tax liability or asset, resulting from temporary differences or timing differences between the accounting value of assets and liabilities and their value for tax purposes."
The name itself suggests, misleadingly, that this is tax to be paid some time in the future. In reality, deferred tax is frequently deferred forever: it becomes tax that is never paid. And there is usually very little disclosure about what really happens inside this strange category. A lot of deferred tax - trillions of dollars worldwide, most probably -- is sitting in tax havens right now. So it's something worth getting to grips with.

We will now draw out some key points from the Tax Research blog. First of all, it notes that companies are not required to make full disclosure of their deferred tax: neither what the reasons for it are, nor the country in which the deferred tax liability has arisen, nor whether the company will ever pay it.

"Given that deferred tax balances are frequently material on a company’s balance sheet it is extraordinary that so little information is disclosed with regard to these liabilities, particularly as many may be fictional."

Crucially, this allows companies to claim they are paying taxes close to the headline rate of tax - while in reality they are paying far less than this, and deferring the rest. This explains why in the Marks & Spencer story (we stress that M&S is far from unusual in this respect) the company can claim in its accounts that it has paying almost exactly the headline 28-30% tax rate, while in reality paying less than 19%. Click to enlarge the graph.

Tax Research thinks this whole set-up looks very ugly indeed:
"It is hard to escape the conclusion that the International Financial Reporting Standard requiring the provision of all deferred tax liabilities, whether or not there was any real possibility of the tax being paid, was little more than a deliberate public relations exercise designed to disguise tax avoidance. The deferral of tax is very often the aim of tax avoidance, complete cancellation of liability being much rarer. In this regard, it must be remembered that the International Accounting Standards Board is effectively controlled by the Big 4 firms of accountants and some of their largest clients; it is not, despite official sounding title, and government or international agency accountable to any international authority."
The solution, he says, is as follows:
1. All deferred tax liabilities should be disclosed by the country in which they arise;

2. All deferred tax provisions must be fully explained, with no “other” categories allowed;

3. The date of estimated settlement of liability should be declared for all deferred tax liabilities, and the date of realisation should be disclosed for all deferred tax assets. If settlement or realisation cannot be predicted within the coming ten years then the liability or asset in question should be considered contingent;

4. All tax reconciliations should be to the current tax liability, with an additional note explaining the composition difference between that current tax liability and the full tax charge including deferred tax;

5. All deferred tax movements, whether they be adjustments, or charges made through the Statement of Realised Gains and Losses, must be fully explained in the financial statements.
There are other deferred tax issues in addition to these, but addressing these issues would have significant impact on the way in which disclosure was made and address the problems noted in interpreting the accounts of Marks & Spencer.

The whole, occasionally slightly wonkish, post is here - and well worth reading.


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