Clarifying tax reporting – a worthwhile challenge

The Institute of Chartered Accountants of England and Wales have issued the latest in a series of “Audit Insights” documents, this one focused on “Improving annual reports of listed companies.”

Some of the content covers matters addressed on this blog several times in the past, for example in commenting on materiality and disclosure overload, and some of it is specific to its UK environment. But it caught my attention for a section focusing on whether tax reporting is understandable, which isn’t something I’d considered in much detail. Here in part is how it sets out the issue:

  • “From what we see some boards are taking transparency very seriously, with increased disclosure of what taxes are paid and where, and we support this trend where it plays a meaningful role in explaining a company’s approach to taxation. But too many companies either continue to overwhelm users with tax detail that they find difficult to understand or are reluctant to disclose more information than is necessary. Where information is disclosed, the language used is shrouded in technical tax and accounting jargon that is not well understood by the public.
  • Tax transparency is a difficult challenge for corporate reporting. It is an emotive subject with a high level of public and political interest, fuelled by statements in the media that large corporates have lost their moral compass through aggressive tax planning. Customers have demonstrated they will change their buying choices if they believe a business is not paying its fair tax. Many employees also want to know that they are working for an organization with a strong ethical stance towards social responsibility, including paying fair amounts of tax, while investors want to understand the reputational and tax risks their investments face. The demand for greater tax transparency and, in particular, for multinational entities such as multinational companies to publicly disclose their country-by-country (CbC) tax data is strong. There is also a perception that it will help prevent aggressive tax avoidance.
  • In our experience most multinational companies are open to disclose more tax information where it is not competitively damaging. However, the extent of transparency – what should be disclosed and to whom – is difficult to judge…”

Building on these observations, the document sets out some recommendations for preparers:

  • Review the adequacy of your taxation disclosures, particularly within the strategic report. Ensure that stakeholders can fairly assess the taxation risks facing your business, the board’s approach to tax planning and its governance approach to tax, together with an overview of how this has translated to tax payments made to the jurisdictions in which your group operates. This narrative explanation will create a platform from which the board can be held accountable. Consider the best place to include this information and whether any of it, regulations permitting, could safely be included on the company’s website with short summary narratives in the annual report.
  • In determining the adequacy of disclosures, consider the following key questions.
  • – Have you adequately explained significant variances in the effective tax rate between countries, particularly where the effective tax rate differs notably from the base rate?
  • – Are there any apparent contradictions between the CbC data presented in the financial statements and the narrative description of your tax approach? Such contradictions should be resolved through additional narrative disclosure if necessary.
  • – Will stakeholders and external commentators fairly understand your approach to tax planning and tax governance?

This all seems very well-considered. By repeatedly focusing on measures such as EBITDA, entities often seem to invite stakeholders to all but ignore their tax expense, as if it were an act-of-God-type appropriation beyond rationally engaging with. At other times, as noted, the whole disclosure just seems like a morass of technicalities. It’s common to come across opinions that users don’t understand IFRS deferred tax accounting and that the whole thing should just be junked. I’ve always thought that’s not really the point though, that deferred tax accounting doesn’t exist to be meaningful in itself, but rather to eliminate the misleading fluctuations in the reported tax rate that would occur if it didn’t exist. Because of that, this is an area of financial reporting where focusing on the numbers is a particularly ineffective way of understanding the underlying strategy and substance.

Preoccupation with taxes pushes individuals and entities into strange strategic and ethical contortions – manifested for example by how a North American entity might through  “inversion” seek to artificially re-establish itself elsewhere, even if it has no better idea for what to do with the funds it thereby saves other than to accumulate them in perpetuity. Investors might disdain such manoeuvres, or regard them as a rational exercise of fiduciary duty to stakeholders, or a bit of both. An individual entity’s financial report can’t set out to define the entire complex playing field of actions and perceptions in this area. But it can surely try to explain what game the entity is trying to play…

The opinions expressed are solely those of the author

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