IFRS implications for income taxes.

• Author: Rood, Joan
• Position: INTERNATIONAL TAX - International Financial Reporting Standards

TRANSITIONING TO IFRS WILL HAVE A NOTICEABLE EFFECT ON CORPORATE TAXES, DUE TO THE INTERTWINED RELATIONSHIP OF THE TAX RULES AND REGULATIONS EMBEDDED IN U. S. GAAP.

Recognizing that U.S. companies compete for capital in a global marketplace, in late August the U.S. Securities and Exchange Commission moved to allow some large companies to begin using International Financial Reporting Standards as early as next year.

Then, if certain milestones are met, a decision will be made on moving to require certain U.S. companies to use it by 2014 and all to do so by 2016.

The commission voted unanimously to propose for comment a roadmap for conversion, with eventual adoption. This transition will not only impact financial statement preparers, it also will have a noticeable effect on tax professionals, due to the intertwined relationship of the tax rules and regulations embedded in U.S. generally accepted accounting principles.

The following addresses several projected implications that a transition to IFRS may have on tax rules and regulations.

Tax Treatment of LIFO Inventories

The most profound and best-known effect that IFRS will probably have on U.S. tax law concerns the treatment of inventories. Upon adopting IFRS, a company using the last-in, first-out (LIFO) cost-flow assumption for determining its cost of goods sold for tax purposes will likely have to request permission from the Internal Revenue Service to change to an alternative method--such as the first-in, first-out (FIFO) method or the weighted average method.

That's because IFRS does not permit a company to use LIFO for financial reporting purposes. In addition, the tax code prohibits firms from using LIFO for tax purposes if they don't for financial reporting purposes under a provision known as the "LIFO conformity rule."

If a company changes its accounting method from LIFO to something else, it must restate opening inventory in the year of the change as if it had used the new method in prior periods. If the new opening inventory balance is greater than what it would have been under LIFO, the firm must recognize the difference as income over the following four years through a Sec. 481(a) adjustment to eliminate any income distortion from changing inventory methods.

This adjustment essentially represents the cumulative tax benefit the company obtained by using LIFO. For many companies, the Sec. 481(a) adjustment will be substantial, because the beginning inventory amount under LIFO includes purchases from many years earlier. Thus, the company's adjustments would be very large and would result in "phantom" taxable income over the spread period.

This taxable income from the Sec. 481(a) adjustment is phantom income in the sense that there is no current economic gain to the company. Instead the income reflects the tax benefits that the firm received by using the LIFO method instead of the new method. Conversely, if a company has a negative Sec. 481(a) adjustment, likely due to the effects of deflation on its...