INSIGHT: IFRIC 23 Requirements and the Nigerian Tax Authorities’ Revenue Drive

The advent of technology and its continuous advancement has led to the emergence of sophisticated business models and ease of expansion for most businesses. Whilst tax authorities in several countries continue to play catch up, the emerging business models are leading to uncertain tax positions (UTPs) for companies, especially as some tax laws did not contemplate these business models.

Prior to June 2017, companies were only required to evaluate the facts of their tax position and its underlying impact, before deciding whether to apply International Accounting Standard (IAS) 12 or IAS 37. The question of which standard to apply was based on the specific circumstances of such companies, i.e. whether the tax position could be ascertained as at the end of the accounting year or was contingent upon other events.

For some uncertain tax positions, companies mostly applied IAS 37 on the entirety of the underlying tax effect, after appropriate consultations with tax consultants on the likelihood of a potential exposure. The resulting provision that might be booked or disclosed in the company’s financial statement would be dependent on the outcome of the assessments of the probability of the treatment resulting in a tax liability. Where the probability was higher than 10% but less than 50%, a contingent liability would exist, and a disclosure made in the company’s financial statement. However, where the probability of occurrence was greater than 50%, such company was required to book a provision in its financial statement.

These provisions, which would reduce a company’s profit and ultimately the dividend payable to shareholders, were disallowed for income tax purposes, as required by the extant tax laws. Nonetheless, companies could track the provisions to ensure that the tax treatment is updated (where necessary).

Every business aims to create value for its shareholders while meeting its financial obligations as and when due. However, in certain instances, where no provisions nor disclosures were made about UTPs in a company’s accounts, such companies could become insolvent and be forced into liquidation, as a result of their inability to meet their obligations, after being served additional tax assessments arising from the UTPs several years later.

Furthermore, in evaluating UTPs, the ambiguous tax provisions and the fact that the tax laws did not envisage some of the transactions that gave rise to them, leave a gap on the clear interpretations and implementation of the tax laws in this regard. Also, the continuous delay in receiving clarifications when sought from tax authorities and judgments from the tax appeal tribunal or federal courts on tax disputes further broadened the horizon for more aggressive positions to be explored to the benefit of businesses, even when there were contrary positions by the tax authorities. Thus, these different treatments by companies and tax authorities developed into a tax asset or liability (depending on the outcome), which might remain undisclosed to relevant stakeholders due to non-availability of guidance for the accounting treatment of uncertain or disputed tax positions.

To close this identified gap, the International Financial Reporting Interpretations Committee (IFRIC), in June 2017, issued IFRIC 23 to be applied to reporting periods beginning on or after January 1, 2019 (early adoption was permitted). IFRIC 23 addresses the issue of recognition and measurement of income tax liabilities (or assets) when there is an uncertain tax treatment by a reporting entity. An uncertain tax treatment, as highlighted by the standard, is any tax position where there is ambiguity over whether the approach adopted by a company will be accepted by the tax authority.

Many Nigerian and multinational companies had hitherto alleged that the relevant tax authorities (RTAs) (i.e. both state and federal—charged with the administration of taxes in Nigeria) were more focused on revenue generation drive, to the detriment of business continuity and survival. Thus, the consensus is that the disclosures prescribed by IFRIC 23 may lead to additional tax revenue expectations by the RTAs, without full recourse to the basis for such disclosures.

This article therefore discusses the presumptive conflict between the requirements of IFRIC 23 and the revenue generation drive of the relevant tax authorities and how to create a balance between the two.

Overview of IFRIC 23

IFRIC 23 answers the question surrounding the circumstances where it is appropriate for entities to recognize a current tax asset or liability in respect of an uncertain tax position, disputed tax payment or treatment and how to measure any such recognition.

The interpretation requires an entity to do the following:

• Consider each uncertain income tax treatment separately (most likely amount method) or together with other uncertain tax treatments (expected values method) based on which approach better predicts the resolution of the uncertainty.
• Assume that the tax authority will review amounts reported and will have full knowledge of relevant information during its review.
• Where an entity concludes that it is probable that the tax authority will accept its uncertain tax treatment, it will compute its income tax returns consistent with that treatment.
• Where an entity concludes that it is not probable that the tax authority will accept its uncertain tax treatment, it should use the most likely amount (the single most likely amount in a range of possible outcome) or expected values (the sum of the probability weighted amounts in a range of possible outcomes) acceptable by the tax authorities in computing its income tax returns.

The entity’s decision will be based on its prediction of the resolution of the UTP. However, where there is a change in the facts and circumstances regarding the UTP, a second review of estimates and judgments is required to ascertain whether the change will affect the initial decision.

Generally, when a UTP is established, an entity will be required to disclose:

• judgments made in determining the taxable profit (or loss), tax bases, unused tax losses, unused tax credits and tax rates applying IAS 1—Presentation of Financial Statements; and
• information about the assumptions and estimates made in determining the taxable profit (or loss), tax bases, unused tax losses, unused tax credits and tax rates applying IAS 1.

Where an entity concludes that it is probable that a tax authority will accept an uncertain tax treatment, the entity shall determine whether to disclose the potential effect of the uncertainty as a tax-related contingency applying IAS 12.

Under IFRIC 23, the key test is whether it is probable (i.e. more likely than not) that the tax authority will accept a company’s tax treatment as reported in its income tax filing. If the answer is no, then the effect of the UTP is to be reflected using the method that will better predict the resolution of the issue. The two available methods are:

• the “most likely amount” method (being the single most likely amount in a range of possible outcomes); and
• the “expected value” method (i.e. the sum of the probability-weighted amounts in a range of possible outcomes).

For ease of reference, we have provided a simple illustration of the application of IFRIC 23 below:

Using the most likely amount method, the tax deduction to be used in computing the tax benefit in the financial statement would be 100,000 naira, because this outcome has the highest probability.

However, the spread of the probabilities shows three different percentages that are very close, thus making it difficult to conclude that a single outcome is most likely. Therefore, the expected value method better predicts the resolution of the UTP. On this basis, the tax deduction to be used in computing the tax benefit in the financial statement will be 65,500 naira, rather than 100,000 naira.

In 2006, the Financial Accounting Standards (FAS) Board issued the Interpretation 48 of FAS 109 known as FIN 48. FIN 48, “Accounting for Uncertainty in Income Taxes,” eliminates the inconsistency in accounting for UTPs in financial statements certified in accordance with U.S. Generally Accepted Accounting Principles (GAAP), hence mandating rules for recognition, de-recognition, measurement, and disclosure of all tax positions. In the opinion of the authors, IFRIC 23 and FIN 48 seek to address the same underlying issue of accounting for uncertain tax treatments and thus provide similar reporting requirements. However, unlike the FIN 48, the IFRIC does not include specific requirements for the treatment of interest and penalties, hence entities could either apply IAS 12 or IAS 37.

Nigerian Tax Authorities’ Revenue Generation Drive

In Nigeria, revenue from the sale of crude oil, which is the main source of the Federal government’s foreign exchange revenue, has been on the decline since 2014 (from $55.5 billion in 2014 to $18.04 billion in 2019). The petrodollar income is also highly susceptible to the vagaries of demand and supply in the international market; hence, it has proven to be an unstable source of forecast for the nation’s budgeting purposes. The various arms of government are therefore intently focusing on internally generated revenue from taxes and other statutory levies.

Tax revenue has been highlighted as one of the most dependable, sustainable and veritable sources of revenue in various countries. Consequently, the decline and instability of oil revenue has continued to place a mandate on the Nigerian tax authorities to increase revenue collection from tax, both at the state and federal levels. For instance, the Federal Inland Revenue Service (FIRS) has a 2020 revenue generation target of 8.5 trillion naira ($21.9 billion), (2019: 8.3 trillion naira). However, based on information available in the public domain, the FIRS only achieved 63% (5.26 trillion naira) of its revenue for 2019 financial year.

Thus, strategies are being introduced to increase the tax base, improve collection of tax, block loopholes in the tax law, prevent profit shifting, among others, while verifying taxpayers’ compliance status through regular tax audits/investigations. One such development is the recent enactment of the Finance Act, 2019 that has provided clarifications on some ambiguous tax provisions.

However, the twin shock (arising from the Covid-19 pandemic and the oil price shock in the first and second quarters of 2020) has intensified the need for sustainable revenue generation from taxes. Although the FIRS issued some palliative measures to ameliorate the impact of the pandemic on Nigerian businesses, they are mostly administrative and compliance in nature. Thus, taxpayers are expecting additional measures that provide some form of tax relief, especially as the pandemic has affected their business projections and cashflow. Nonetheless, there are still debatable tax provisions which may give rise to varying tax treatments between companies and tax authorities, thereby giving rise to UTPs for financial disclosure purposes as required by IFRIC 23.

According to the Organization for Economic Co-operation and Development (2006) , a tax audit is an examination of whether taxpayers have correctly assessed and reported their tax liability and fulfilled the related compliance obligations as and when due.

Prior to 1998, taxpayers in Nigeria (persons and corporations) were assessed to tax by the relevant tax authorities; a system known as government assessment. With the introduction of a self-assessment scheme into the Nigerian tax system in 1998, taxpayers are now required to file their tax returns independently. This practice informed the need for tax audits, to ensure that corporate taxpayers submit accurate information regarding their business income and expenses. It is the tax authorities’ belief that taxpayers are inherently disposed to reducing their tax liability, either through tax evasion or tax avoidance. Thus, the tax authorities carry out a periodic review of the taxpayers’ records to ensure that such practices are curbed to prevent undue reduction in government revenue.

Given the drive for the utmost revenue generation via taxation, and the reporting requirements of IFRIC 23, valid concerns are being raised on the vulnerability of taxpayers to excessive tax queries, desk reviews, audits and/or investigations as their information on these UTPs would be laid bare and readily available to the tax authorities once companies submit their annual tax returns.

Effect of Compliance with IFRIC 23 on Nigerian Companies

Tax uncertainty arises as a result of ambiguity in applying the tax laws to complex transactions not foreseen by the existing tax legislation. Complying with IFRIC 23 may be challenging for entities, especially multinationals, that operate in complex tax environments like Nigeria’s, as this will require them to make certain assumptions, estimates and significant judgments on UTPs. This may differ for similar UTPs in tax environments with unambiguous tax laws and short lead time for obtaining clarifications from the tax authorities. Before the introduction of IFRIC 23, companies’ shareholders, creditors and other users of financial statements previously had little or no information about UTPs and how they may affect the going concern of an entity. However, IFRIC 23 seeks to provide users of the financial statement with information on these UTPs. One of the users of financial statement is the relevant tax authorities, who may also be on the lookout for this new accounting disclosure.

Furthermore, prior to the adoption of IFRIC 23, companies could use asymmetric information advantage over the tax authorities to maintaiatively aggressive tax positions. These positions or tax treatments are only discovered by the tax authorities during a tax audit or a review of the companies’ tax returns and financial information. Typically, a full tax compliance audit exercise is conducted two or three years after the end of the accounting year being reviewed or audited. However, with the disclosure requirement of IFRIC 23, the tax authorities will now have readily available information on the existence of an uncertain tax treatment and may seek to probe these uncertainties immediately rather than wait for a tax audit or review exercise.

Thus, with the slow economic growth and high expectations from tax revenue generation, companies are anxious that the adoption of IFRIC 23 will expose their records to intense scrutiny and that tax authorities may take undue advantage by subjecting disclosures relating to UTPs to additional tax without putting such disclosures into context. Further, where the tax authorities probe UTPs during audits or desk reviews, it may result in increased open tax audits or investigation exercises. If the tax authority and taxpayer are unable to agree on the treatment of such UTPs, the issue may be referred to the court for a resolution and judgment. Court cases require time, resources and manpower of affected companies, their tax consultants and that of the tax authorities.

Planning Points

Based on the disclosure requirements of IFRIC 23, information on companies’ UTPs will now be readily available to all stakeholders—tax authorities, current and potential investors, financial institutions, regulatory authorities, etc. Therefore, the authors recommend that companies and tax authorities should take the following measures to mitigate the identified effect of complying with the IFRIC 23 disclosure requirements:

• Companies should proactively review their business agreements to ascertain whether there are any uncertain tax implications, before such contracts are executed. Where UTPs are identified, such companies should seek clarifications from tax advisers for resolutions that would be acceptable to the tax authorities before finalizing such agreements.
• To guide investment decisions, companies can seek clarifications from the tax authorities directly or through their tax advisers on the acceptability of any tax treatment arising from an identified UTP. However, such clarifications must be tested to ensure that they are in line with the provisions of the extant law. This is because the provisions of the law supersede any clarification that may be provided by the tax authorities.
• The relevant tax authorities should promptly issue circulars, newsletters, bulletins etc. to clarify gray areas of the tax laws and stating their stance on these areas.
• Speedy resolution of pending tax disputes or cases would further reduce the creation of UTPs, as companies can easily reference precedents when designing their business transactions and models.
• As business models are evolving, tax laws are constantly being amended and updated to adapt to these changes. Companies should, therefore, keep abreast of the changes and carry out a re-assessment of their business transactions and UTPs (when necessary).
• Tax dispute resolutions should be taken on the merits of each case. The tax authorities should not adopt a general approach when reviewing a company’s business transaction or IFRIC 23 disclosure.
• The tax authorities should seek to reduce the frequency of tax audits and focus on the speedy closure of ongoing audit exercises. This is because most companies have recurrent transactions on a yearly basis; thus, the holistic resolution of contentious issues raised by the tax authorities during an audit would aid in resolving UTPs in subsequent years.
• A risk-based approach to tax audits should be adopted by the tax authorities to target companies with high risk of non-compliance. This will better manage the resources available to the tax authorities and inspire confidence in compliant taxpayers to seek clarifications from the tax authorities where necessary.

Conclusion

The disclosure requirement of IFRIC 23 and revenue generation drive by the tax authorities have induced anticipation of increase tax burdens on companies, given the presumed antecedents of the tax authorities.

One of the strategic imperatives of the tax authorities is to generate revenue for the government through tax administration. This may drive their desire to review and audit every uncertain position reported in a company’s financial statement, thereby driving the development of the tax system and invariably tax compliance. In our view, a risk-based approach should be adopted to manage both companies’ and tax authorities’ costs, resources and manpower while encouraging the taxpayer’s compliance with the IFRS and tax laws.

Although UTPs cannot be completely eradicated, as tax laws will keep changing to adapt to business realities, it is our expectation that the Federal government of Nigeria continue the annual review of the provisions of the extant tax laws, in line with emerging business models, to minimize the instances of UTPs and also to align with global best tax practices.

Aminat Jegede is a Senior Manager, Judith Monye is a Senior Adviser and Adeola Akindele is an Experienced Staff Analyst, Tax, Regulatory and People Services, with KPMG in Nigeria.

The authors can be contacted at: aminat.jegede@ng.kpmg.com; judith.monye@ng.kpmg.com and adeola.akindele@ng.kpmg.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.