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Finance Bill 2005 introduces tax measures to deal with the move to IFRS Back  
International Financial Reporting Standards (IFRS) gives rise to serious tax issues for companies in the financial services industry and it is welcome that the Finance Bill contains extensive provisions dealing with both the changeover to IFRS and the convergence of existing Irish GAAP with IFRS, writes JOHN O‚€ôLEARY. Further clarification of the tax issues arising will be available when the Revenue Commissioners issue a Statement of Practice on IFRS later this year.
The starting point for tax
The Finance Bill contains ‚€ėenabling‚€ô provisions in relation to the use of International Financial Reporting Standards (IFRS) accounts for tax purposes. As widely expected, the Bill provides that accounts prepared under IFRS will be an acceptable starting point for computing taxable trading profits. This means that profits reported in IFRS accounts will be taxable subject to any adjustment required under tax law. Accounts prepared under Irish GAAP will, of course, continue to be acceptable for tax purposes. This raises the prospect of companies with similar profiles having different levels of taxable profits as a result of adopting different accounting standards.

Transitional measures
The measurement and timing of recognition of income and expenses in the profit and loss account can be different under IFRS than under Irish GAAP. For banks, certain fee income is taken upfront under Irish GAAP which must be spread under IFRS. Furthermore, where premiums, discounts and fees are spread under Irish GAAP, a straight-line method is usually used whereas an effective-interest-rate method must be used under IFRS. For insurance companies, the deferral of acquisition costs under Irish GAAP will be substantially reduced on the move to IFRS due to the reclassification of certain insurance contracts. Consequently, the change to IFRS may mean that income/expenses previously recognised in the profit and loss account under Irish GAAP will again be recognised in a later profit and loss account under IFRS. Similarly, income/expenses that had not been recognised in an earlier profit and loss account under Irish GAAP may never be recognised. This is dealt with by way of prior year adjustments in the accounts for the year of changeover to IFRS. However, these prior year adjustments are not automatically taken into account for tax purposes and, instead, the Finance Bill introduces transitional measures to spread such adjustments over a five year period for tax purposes. These transitional measures are not necessarily tax neutral as they can result in a tax cashflow cost depending on the period over which income/expenses are recognised in the IFRS accounts.

Taxation of gains/losses on financial assets and liabilities
To date, gains and losses on financial assets and liabilities have, with certain exceptions, been included in taxable trading profits only when realised (the so called ‚€úrealisations basis). Going forward, fair value movements on financial assets and liabilities, which are reflected in the profit and loss account under IFRS, will be taxed.

Under IAS 39, there are a number of categories of financial assets and a different accounting treatment applies to each category. Trading book assets must be carried at fair value and fair value movements are reflected in the profit and loss account. Other assets (e.g. investment book assets) can fall into one of the following three categories:

1. Held to maturity investments which are accounted for at amortised cost;
2. Designated fair value assets which are fair valued in the profit and loss in the same way as trading book assets;
3. Available for sale (AFS) assets which are fair valued but fair value movements are taken to equity/reserves and released to the profit and loss account on disposal of the asset.
The accounting treatment adopted in practice will be driven by a number of commercial factors e.g. for banks, achieving an effective hedging strategy may be of particular importance. However, it is important that tax is factored into this decision as the accounting treatment adopted will impact on the timing of taxation of gains and losses e.g. if financial assets are designated as AFS, gains and losses will not become taxable until they are recognised in the profit and loss account on disposal of the asset i.e. the realisations basis is retained for such assets.

The realisations basis is also retained for companies that continue to prepare their accounts under Irish GAAP, until such time as a company changes to IFRS or adopts an accounting policy in line with IFRS. This will be of importance to many financial services companies and, in particular, companies operating in the general insurance sector.

There is also a specific anti-avoidance measure which is designed to prevent bed and breakfasting of financial assets and liabilities prior to adoption of IFRS in order to secure an immediate tax deduction for losses which would otherwise have been spread over five years by virtue of the transitional measures referred to above. The anti-avoidance provision is quite widely drawn and there is a risk that it will impact on genuine trading of financial assets and liabilities in the run up to the adoption of IFRS.

Bad debt provisions
Specific bad debt provisions charged in the profit and loss account under Irish GAAP are tax deductible. General bad debt provisions are not tax deductible.

Bad debt provisions charged in the profit and loss account under IFRS will be fully deductible for tax purposes.

On the transition to IFRS, some general bad debt provisions under Irish GAAP may be recategorised as specific under IFRS. A tax deduction will not become available for such amounts at the time of transition. However, a special measure is introduced to allow a deduction in future periods for such amounts if the bad debt provision falls below the level at the point of moving to IFRS. This special measure will not be of any benefit where there is a growing book of debts and the bad debt provision level is increasing

Securitisation companies
Securitisation companies (often referred to as Section 110 companies) are generally structured on the basis of tax neutrality. The adoption of IFRS by these companies may result in hedge ineffectiveness which can lead to timing mismatches between taxable profits and losses and ultimately a loss of tax neutrality. The Finance Bill provides a solution by allowing the taxable profits of such companies to be based on Irish GAAP as it existed at 31 December 2004. It is possible to elect out of this treatment but such an election is irrevocable. It remains to be seen if this solution will be sustainable on a long term basis for the securitisation industry.

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