University of Economics, Prague. IFRS and Corporate Income Tax in Small Open Economy. David Procházka

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1 University of Economics, Prague Faculty of Finance and Accounting Department of Financial Accounting and Auditing IFRS and Corporate Income Tax in Small Open Economy David Procházka Department of Financial Accounting and Auditing Faculty of Finance and Accounting University of Economics, Prague W. Churchill Sq. 4 Prague, Czech Republic Web: <prochazd@vse.cz>

2 Agenda Paper s agenda Models of linkage between taxation and accounting systems Specifics of financial reporting regulation in the Czech Republic Specifics of income tax regulation in the Czech Republic Switching to IFRS as a tax base in the Czech Republic - opportunities, risks, advantages, disadvantages - empirical evidence Slide 2/16

3 Accounting taxation models 1 Accounting taxation models There are different approaches how to design the mutual relation of accounting and taxation systems Theoretically, three models can be identified: - Model I: absolutely separate systems - Model II: fully dependent systems (with either leading role of accounting, or leading role of taxation) - Model III: hybrid systems (partially dependent) With regard to the IFRS adoption across Europe (and world), it arises a question whether IFRS shall be allowed IFRS to be a tax base under real-life taxation systems Slide 3/16

4 Accounting taxation models Fig. 1: Alternative systems of taxation in connection to regulatory framework of financial reporting Taxation: IFRS Consolidated FS: IFRS Individual FS: IFRS Individual FS: Local GAAP Individual FS: Choice Taxes-Accounting Independent Taxation: Local GAAP Taxation: Local GAAP Taxation: IFRS Taxation: Local GAAP Slide 4/16

5 Specifics in the Czech Republic 2 Regulation of financial reporting and taxation in the Czech Republic 2.1 Adoption of the IFRS in the Czech Republic Regulation (EC) 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the application of international accounting standards Act on accounting requires a mandatory application of the IFRS in: - consolidated financial statements of companies listed on EU capital markets (see Regulation) - individual financial statements of those publicly traded companies In addition, Act on accounting enables a voluntary application of the IFRS in: - consolidated financial statements of non-listed companies - individual financial statements of non-listed companies, which are subject of IFRS consolidation (change in force from 2011) Slide 5/16

6 Specifics in the Czech Republic Fig. 2: Individual financial statements according to the Czech accounting legislation (from 2011) O n l y I F R S CAS + IFRS or only IFRS O n l y C A S Slide 6/16

7 Specifics in the Czech Republic 2.2 Corporate income tax in the Czech Republic Pursuant 23, article 2 of Act on income taxes the determining of the tax base is based on the accounting income, always without the influence of international accounting standards... A taxpayer, who prepares its statutory financial statements in accordance with International Accounting Standards, as approved by the European Union, shall determine its accounting income for the purposes of this Act with reference to specific legal act Act on accounting is the specific legal act Listed companies and voluntary adopters are supposed to maintain additional evidence based on CAS just for tax purposes Tax officers have to be aware about all differences between IFRS and CAS Typology of differences: - transactions occurring only in IFRS statements - transactions occurring both in IFRS and CAS statements, however differently classified and/or Slide 7/16

8 Specifics in the Czech Republic measured - transactions occurring both in IFRS and CAS statements, with the same classification and measurement - transactions occurring only in CAS statements Current status levies prohibitive expenses on companies with no obvious benefits either for tax authorities or national economy => allowing IFRS to be relevant for tax base seems to be smart solution What about the impacts of possible shift to IFRS? => Empirical evidence Slide 8/16

9 Empirical evidence 3 Empirical evidence Empirical evidence performed for year 2010 and 2011, available data on: - total corporate income tax (CIT) collection by state - financial statements from entities with IFRS as statutory accounts Listed companies (total 28 observation in sample): - 46 issuers on PSE - 33 have legal and tax domicile in the CR; remaining 13 with domicile abroad (however 6 originally in the CR have moved to tax paradises ) - additional 5 companies excluded (reason in the paper) Voluntary adopters: - only two companies used the option to apply IFRS in their statutory individual FS voluntarily 4 questions need to be resolved to quantify effects of potential shift Slide 9/16

10 Empirical evidence 3.1 Question 1 Q1: Is the topic relevant at all? Is the corporate income tax an important source of tax revenues? Tab. 1: Share of corporate income taxes on total tax revenues and gross domestic product Year Tax rate 41% 39% 39% 35% 35% 31% 31% 31% 31% CIT (millions CZK) Share on tax revenue (%) 12,3% 9,4% 10,6% 9,8% 10,8% 9,8% 11,4% 12,0% 12,5% Share on GDP (%) 4,4% 3,2% 3,7% 3,3% 3,7% 3,3% 3,9% 4,2% 4,4% Year Tax rate 28% 26% 24% 24% 21% 20% 19% 19% CIT (millions CZK) Share on tax revenue (%) 12,3% 12,2% 13,1% 13,1% 12,3% 10,6% 10,1% 9,8% Share on GDP (%) 4,4% 4,3% 4,6% 4,7% 4,2% 3,5% 3,4% 3,4% Steep reduction in tax rate (from 41 % in year 1995 to 19 % in year 2011) Relative share of corporate income tax on total tax revenues (including social security) remains stable; 11.3 % on (arithmetic) average. Slide 10/16

11 Empirical evidence 3.2 Question 2 Q2: Are entities with statutory IFRS statements significant in terms of income taxes? Tab. 2: Share of corporate income taxes by IFRS entities on total corporate taxes collected CIT IFRS entities (millions CZK) CIT all entities(millions CZK) Share (%) 16,5% 17,8% The share is about 17 %, which is not decisive However, a rapid growth of number of companies reporting under IFRS can occur, if it is favourable: - listed companies control 334 Czech subsidiaries - estimates of the total number of entities in question differ ranging from 2,000 to 200,000 companies (which is 40 % of all registered companies in the CR) Slide 11/16

12 Empirical evidence 3.3 Question 3 Q3: If IFRS are allowed for income tax calculation, which level of income shall be used? Should it be Profit & loss or Total comprehensive income? Tab. 3: Amount of other comprehensive income (relatively to comprehensive income) Company FI OCI 2011 % OCI 2010 % CETELEM ČR, a.s. yes -22,86% -74,32% Czech Property Investments, a.s. no -17,42% -0,90% ČEZ, a.s. no -26,38% 13,22% Česká pojišťovna a.s. yes -98,00% -10,85% Česká spořitelna, a.s. yes -21,47% -19,39% Československá obchodní banka, a. s. yes -98,12% 7,60% Dalkia Česká republika, a.s. no -26,16% -7,98% Energoaqua, a.s. no -28,92% -6,56% GREENVALE, a.s. no 0,00% 0,00% Hypoteční banka, a.s. yes -23,64% -24,01% Raiffeisenbank a.s. yes -28,29% -27,35% UniCredit Bank Czech Republic, a.s. yes 59,42% -54,29% Komerční banka, a.s. yes 34,10% -12,91% Sberbank CZ, a.s. yes -15,33% -6,69% Wüstenrot hypoteční banka a.s. yes -527,17% 0,00% Slide 12/16

13 Empirical evidence Company FI OCI 2011 % OCI 2010 % ISTROKAPITAL CZ a.s. yes 0,00% 0,00% Jáchymov Property Management, a.s. no 0,00% 0,00% Philip Morris ČR a.s. no 0,00% 0,00% Pražské služby, a.s. no 0,00% 0,00% Severomoravská plynárenská, a.s. no 0,00% 0,00% Severomoravské vodovody a kanalizace Ostrava a.s. no 0,00% 0,00% SPOLEK PRO CHEM.A HUT.VÝR.,a.s no 0,00% 0,00% Telefónica Czech Republic, a.s. no 0,00% 0,00% TOMA, a.s. no -0,39% -0,75% UNIPETROL, a.s. no 0,00% 0,00% Východočeská plynárenská,a.s. no 0,00% 0,00% VET ASSETS a.s. no 0,00% 0,00% Wüstenrot - stavební spořitelna a.s. yes 0,00% 0,00% Škoda AUTO a.s. no -51,56% -6,90% Tamero invest no 0,00% N/A In 2011, other comprehensive income is zero (with no items) in 14 out of 30 cases In 2010, a similar situation happened in 14 out of 29 cases OCI significant also by non-financial entities (including two biggest Czech companies) Slide 13/16

14 Empirical evidence 3.4 Question 4 Q4: Are any important differences in profit & loss between Czech GAAP and IFRS? Solution to be found yet; several suggestions of future research Firstly, a model of generalised equations, which will encompass benefits and costs for each interested party under current situation compared to conditions after switch to IFRS: - expanding the theoretical models - starting point for a regression analysis on real data Secondly, a qualitative analysis of differences between IFRS and Czech GAAP: - current Act on income tax is not ready for the switch - many of differences (PwC study about 80 pages) may drop out from the scope of the Act - different structure of CI statement under IFRS and Czech income statement => how to ensure equal access to all taxpayers? Slide 14/16

15 Empirical evidence Thirdly, an empirical model proposed by Spengel et al. (2012) approach in the individualised version suggested by Roggeman et al. (2013): - data unavailability for the CR => very rough and imprecise assumptions, which will impair findings significantly Fourthly, a quantitative analysis of differences between Czech GAAP and IFRS profit & loss figures actually reported by Czech companies, which could be done as follows: - by analysing publicly available financial statements for the period of the first implementation of IFRS - by extracting needed data from tax returns in periods following the first implementation Slide 15/16

16 Conclusions Conclusions A quantitative analysis on companies level is inevitable Data are available only for the period before transition to the IFRS There might to one-time effects from transition => longer time-series is needed => data not available publicly (tax returns are not published) Inspiration in other countries (Slovakia) on practical level => reference point for future research, too Slide 16/16

University of Economics, Prague. IFRS as a Basis for Corporate Income Tax in Small Open Economy. David Procházka

University of Economics, Prague Faculty of Finance and Accounting Department of Financial Accounting and Auditing IFRS as a Basis for Corporate Income Tax in Small Open Economy David Procházka Department