IFRS 16, 17 and Tax Accounting – LEASES and INSURANCE REVENUE

The adoption of International Financial Reporting Standards (IFRS) continues to raise several questions and concerns especially regarding its impact on tax accounting. Accounting rules and tax rules are two concepts that serve different purposes. The relationship between tax accounting and financial accounting is important because the tax base for taxation is derived from accounting profit determined using generally accepted accounting principles based on accrual method as the starting point, subject to a few recognition rules for tax purposes. The use of GAAP is intended to ensure uniformity in financial statements and accounting methods, and to ensure that a taxpayer’s method of accounting for tax purposes clearly reflects the taxpayer’s income for a year of income. In the relationship between tax and financial accounting, tax legislation with provisions that specify tax accounting rules for many areas of financial accounting, takes precedence over financial accounting principles.

IFRS 16 – LEASES

The implementation of IFRS 16 effective January 2019, requires all leases, whether finance leases or operating leases (except for low value and short period hire), to be reported on the balance sheet of the lessee who has, substantially, all the economic benefits of the “use of an asset” associated with a lease. In other words, the person who benefits from the right to direct the use of the asset must place the asset on their balance sheet and therefore the off-balance sheet benefits of leasing will be eliminated. The new standard effectively removes the classification of any lease as an operating lease and requires all lessees to show a lease liability and a corresponding right-of-use asset for all leases. The treatment of leases, assets and liabilities for lessors remains generally the same i.e., the two categories of leases (operating and finance), and their recognition by the lessor are unchanged.

For income tax purposes, the tax law still maintains the classification of leases as either a finance lease or an operating lease, and only grants capital allowances on finance leases. Accordingly, the implementation of IFRS 16 will necessitate adjustments to be made in the tax computation since the tax law still recognises finance leases as the only basis for granting capital allowances to a lessee who uses a leased asset in the production of income included in gross income. The law does not recognize operating leases as an asset owned by the lessee, despite the new IFRS standard, which should qualify for capital allowance. Accordingly, the tax treatment of lease transactions remains the same, despite changes to accounting practices. This is because while a taxpayer’s method of accounting must conform to generally accepted accounting principles, specific provisions in the law which exist to the contrary take precedence based on the superiority of statutes doctrine.

IFRS 17 – INSURANCE REVENUE

IFRS 17 is a new accounting standard that applies to all insurance contracts regardless of the issuer, with implications not only on accounting and finance, but also taxes, policies, and processes. The standard became applicable for annual reporting periods beginning January 2023, and sets out principles for the recognition, measurement, presentation and disclosure of insurance contracts. It covers insurance and reinsurance contracts issued, insurance contracts held and investment contracts. The new reporting standard will allow insurance contracts to be compared across companies, contracts and industries. Under IFRS 4, different accounting policies were applied for each insurance contract, with no requirement for estimates to be updated. Consequently, it was difficult to determine the key drivers of profit.

Generally, IFRS 17 changes the measurement of corporate income from insurance contracts and appears to align insurance financial accounting to tax reporting by recognizing insurance premiums on a receipt basis. Under IFRS 4, insurance premium was accounted for on accrual basis. Going forward, this is critical in the computation of tax liabilities for short-term (general) insurance business since there will be no need to adjust accounting profit with the outstanding premium debtors or reinsurance creditors.

CONCLUSION

Where the tax rules follow generally accepted accounting principles, the tax rules do not automatically change when accounting practice changes. If follows, therefore, that whenever there is a change in IFRS, taxpayers are expected to use the new standards in their book keeping and financial reporting since the law requires them to apply accounting and financial reporting in accordance with generally accepted accounting principles. However, the tax rules for determination of taxable income do not change and appropriate adjustments to accounting profit or loss have to be made accordingly. Where the tax treatment of an item follows the accounting treatment, no adjustments are necessary. This does not, in my view, require simultaneous dual reporting for accounting and taxation purposes; or a modification to the tax laws to make the transition tax neutral. Instead, a number of adjustments should be made in the tax returns filed by a taxpayer to recognise and align changes in IFRS to the tax rules.

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