IFRIC 23 – Uncertainty on Income Tax Treatments – assessing the impact for investment funds
On 7 June 2017, the IFRS Interpretations Committee (IFRS IC) issued IFRIC 23, which clarifies how the recognition and measurement requirements of IAS 12 ‘Income taxes’ are applied where there is uncertainty over income tax treatments. This new interpretation is effective for annual periods beginning on or after January 1, 2019 with early adoption permitted. It is comparable but not identical to ASC 740-10 under US GAAP (formerly known as FIN 48).
IFRIC 23 was released following a question which was put to the IFRS Interpretations Committee regarding the circumstances in which it is appropriate for entities to recognise a current tax asset when tax law requires an entity to make a payment in respect of a disputed tax treatment. However, IFRIC 23 goes further than simply addressing this question and provides general guidance on when an entity should recognise a current or deferred tax asset in relation to any ‘uncertain tax treatment’, in addition to how to measure any such recognition.
IFRIC 23 addresses:
(i) whether an entity considers uncertain tax treatments separately;
(ii) the assumptions an entity makes about the examination of tax treatments by taxation authorities;
(iii) how an entity determines taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates; and
(iv) how an entity considers changes in fact and circumstances.
On application, full retrospective application is permitted or the requirements are applied by recognising the cumulative effect of initially applying them in retained earnings, or in other appropriate components of equity, at the start of the reporting period in which an entity first applies them, without adjusting comparative information.
The impact of this new standard on investment funds and the potential issues that may arise on transition are outlined below.
Impact on investment funds
IFRIC 23 clarifies how to apply the recognition and measurement requirements in respect of current and deferred tax which are outlined in IAS 12, relating to Income Taxes. In the context of an investment fund, it will therefore apply where to capital gains (realised and unrealised), interest income and dividend income.
This interpretation will place an obligation on investment managers to consider whether there is any ‘uncertain tax treatment’ in respect of any of the positions held by funds which it manages. Practically speaking, this will require an assessment to be completed of the following in respect of each investment position:
- whether there is any uncertainty in relation to whether the tax authorities in each investment jurisdiction will accept the tax treatment which has been adopted in respect of investment return; and
- whether it is probable that the relevant tax authority would accept such uncertain tax treatment.
An uncertain tax position could arise for an investment fund as certain foreign jurisdictions have domestic tax legislation that can impose a capital gains tax payment obligation and / or filing requirement, where a non-resident investor realises a gain on disposal of certain securities related to that foreign jurisdiction. Such a circumstance would likely result in an ‘uncertain tax treatment’ arising, which would give rise to the need to consider whether the tax authorities would accept such uncertain tax treatment – where the tax legislation of an investment jurisdiction imposes a tax payment and / or filing obligation on a non-resident investor, it will unlikely be possible to assert that the tax authorities of that jurisdiction would accept non-compliance by the non-resident investor. Where it is concluded that it is not probable that any tax authority will accept an uncertain tax treatment, there will be a requirement to reflect the impact of any uncertainty in determining taxable profit, tax bases, unused tax losses or tax rates. In the context of an investment fund, this will involve booking a provision, which will reduce the overall NAV.
Under IFRIC 23, any tax liability recorded as a result of any analysis may be theoretical only, as the likelihood of examination and enforcement may be remote. Therefore a liability may be recorded based on the tax legislation of an investment jurisdiction but may never be collected by the relevant tax authority. This will give rise to the ongoing need to monitor any provisions which are booked, to ensure such provisions are released once the statute of limitations expires in the investment jurisdiction.
In assessing the above, there is a requirement to assume that a taxation authority has the right to examine any amounts reported to it, will examine those amounts and will have full knowledge of all relevant information when doing so.
The need to consider investment jurisdiction tax treatment as a result of IFRIC 23 will likely present a new requirement for many investment managers. Therefore, it will be important that appropriate consideration is given to IFRIC 23, and a process is put in place to appropriately document any conclusions which have been reached to support the position adopted in the financial statements of each fund which is managed.
There are no new disclosure requirements under IFRIC 23 however in accordance with IAS 1, an entity must disclose any judgements or estimates made in assessing their uncertain tax treatment.
Considerations on transition
For investment funds which identify a tax liability upon the application of IFRIC 23, investment funds should consider the following:
- Given that the standard applies retrospectively, investment funds need to identify the cumulative effect of the standard which could go back to inception of the fund or the date which any tax legislation giving rise to ‘uncertain tax treatment’ came into effect in the relevant investment jurisdiction. If a tax liability is recognised in the current year, will it solely affect current investors?
- When a decision is made to terminate the investment fund which has accounted for tax liability in accordance with IFRIC 23 which has not been collected by the tax authority of an investment jurisdictions, the investment manager will need to make decisions on how to treat any historic accrual which has been booked (including whether to satisfy the technical obligation which gave rise to the ‘uncertain tax treatment’.