The fast changing world of corporate taxation.

• Author: Cherecwich, Paul, Jr.

Information technology is having a broad effect on almost every facet of human life. It affects what business is done and how it is done. Future historians will refer to this period as the information era, because information technology is profoundly affecting every profession and business.

The effect of information technology on the accounting profession was addressed by Robert K. Elliott in his article entitled "The Third Wave Breaks on the Shores of Accounting," which was published in the June 1992 issue of Accounting Horizons. Mr. Elliott describes the information era as a third wave of wealth creation, following the agricultural era and the industrial era. His article discusses how accounting has evolved to meet the needs of the first and second waves, and he posits several ideas on how accounting can and must be modified to meet the needs of the third wave -- the information era. He notes, for example, that merely recording assets was good enough for the agricultural era. For the industrial era, double-entry bookkeeping evolved to record the changes in wealth through the creation of income and funds flow statements. Mr. Elliott suggests that the information era will require new methods of accounting that measure not just the change in wealth, but the rate of change in wealth.

Information technology also has a direct effect on the world of corporate taxation. This article addresses that effect at three levels. First, tax policy will be addressed, using illustrations consistent with the thoughts put forth by Mr. Elliott. Second, the role of the corporate tax manager in the third-wave world is discussed. Finally, the effect of information technology on the in-house corporate tax practitioner who functions as a member of the tax department staff will be addressed.

Tax Policy and Wealth Creation

Tax policy appears to follow the waves of wealth creation, but with a considerable lag effect. The first wave of wealth creation was in the agricultural era, when accounting focused on the balance sheet. Tax policy also focused on the balance sheet, in that taxes were payable by property owners. The classic tax in our system was the old English property tax, payable with respect to landed property. Inheritance taxes and estate taxes, though not technically imposed on property but rather on the transfer of property, also have a long history.

As the industrial era began, and double-entry bookkeeping was introduced to record changes in wealth, tax policy followed suit with the imposition of an income tax. Thus, we saw the focus shift from wealth taxation to taxation of the change in wealth as measured by income recognized in a period.

The challenge we face today is that a simple tax on income cannot keep up with the third wave of wealth creation that we find in the information era. The evolution of tax policy is woefully behind the times. To illustrate this point, consider three examples: (i) issues involving capitalization as opposed to expensing; (ii) research and the creation of intangible property; and (iii) the consequences of business globalization.

Capitalization versus Expensing

Once upon a time, it was easy to determine whether an expenditure was capital in nature. If the expenditure created an asset with a useful life of more than one year, it was capital in nature; otherwise, it constituted a current expense. By not allowing an immediate deduction for a capital expenditure, it was believed by tax policymakers that income would be more clearly reflected.

Mr. Elliot explains that, in today's business environment, all members of the workforce -- even the blue collar laborers of yesterday -- are becoming "knowledge workers." These knowledge workers require training in, and new ways of doing things with, information technology.

One of those new ways of doing things is found in the manufacturing world, where the concepts of just-in-time inventory, cellular manufacturing, etc., are taking hold. Workers require training in statistical process control, decision-making, blueprint reading, multiple task skills, etc. Thus, information technology is taking hold of the manufacturing floor and blue collar workers are becoming knowledge workers.

What does the Internal Revenue Service think of all this? The agency's view (as expressed in a private letter ruling) is that training and other costs associated with establishing a just-in-time manufacturing operation are capital costs, not ongoing costs of doing business. The IRS theorizes that expenditures intended to put information technology to use on the factory floor create an intangible asset with a useful life of more than one year. Those involved in manufacturing, of course, take the view that as information technology enters our lives and our businesses, the cost of using information technology is an ordinary cost of doing business. They believe that income is more clearly reflected if information technology expenditures can be currently expensed.

Numerous other examples illustrate the tension between evolving business practices in the information era and the attempt to deal with those practices through an outmoded tax policy that is rooted in industrial era concepts of what constitutes a clear reflection of income. Unless tax policy is changed in the manner to be suggested later in this article, conflict and complexity will increase.

Research and the Creation of Intangible Property

Once upon a time, it was easy to identify research. It was what those people wearing white coats did back there in the laboratory. But in the information...