Approximation of tax accounting and bookkeeping in Draft Tax Code
Concerning harmonization of tax and financial accounting in the draft Tax Code
(update of the Legal Alert V dated August 4, 2010)
Numeration of Articles of the draft Tax Code of Ukraine is given in accordance with the version of the document dated 22 September 2010.
In the explanatory notes to the draft Tax Code it is said about “harmonization of tax and financial accounting” in the domain of corporate profit tax (Section ІІІ of the Tax Code). In addition to that the representatives of the Ministry of Finance of Ukraine announced in the interviews that taxpayers would have the opportunity to fill in corporate profit tax return based on the data of financial accounting. Herebelow we provide a brief review whether the announced shift towards “harmonization” was successful.
Given the declared “harmonization” of tax and financial accounting one would reasonably expect the following formula of assessment of tax base: “tax base is book profit considering the following adjustments…“. And then the list of adjustments to book profit would follow, if any would be considered necessary by the authors of the Tax Code.
However, in the Tax Code, suggested for discussion by the Cabinet of Ministers of Ukraine, another approach was taken: computation of taxable profit is regarded as separate and independent work, which means that data of financial accounting, in the same way as it is now, de facto are not considered to be the basis for completing tax reports.
One may agree with the Minister of Finance, that the Code indeed introduces into the tax accounting such principle of financial accounting as “accrual basis accounting and matching of revenues and expenses“: revenues should be matched against respective expenses and the difference received is subject to taxation. But what about other principles, among which “prudence” and “substance over form”, which are essentials of financial accounting?
In addition it is very unlikely that even implementation of the new term in the tax law “cost of goods, works, services”, despite its similarity to the one used in financial accounting, would give opportunity to use “the book cost” in tax accounting due to certain discrepancies, for example, in depreciation. However, we may conclude that the authors did not aim to achieve entire conformity between them, since in the explanatory notes to the draft Tax Code it is mentioned that “the structure of the expenses related to sale of … goods (services), … is similar to the one of the cost of goods sold…“. Comparable, but not identical or the same.
While reading the draft Tax Code one may have the impression, that the main objective of the authors of the Tax Code was considerable delay of the moment when expenses appear in tax return. Thus, under the guise of “harmonization of tax and financial accounting” the authors of the Tax Code at last managed to freeze in tax accounting those expenses which relate to “cost” of goods until the moment such goods are sold. While currently only material costs are blocked (by the mechanism set in clause 5.9.), after the Tax Code is adopted it will block also payroll related expenses along with social insurance expenses, services supplied by third parties, depreciation, lease … in other words everything that the tax authorities have striven for since the Law “On Corporate Profit Tax” in the version of 1997 became effective (let us recall their requirements that the value of “Finished products”, rather than the value of inventory, should be included into Calculation under clause 5.9). As to the fact that the authors of the Code eliminated taxation of advance payments and prepayments, this step is absolutely painless for the state budget: under effective rules the seller receiving advance payment increases its income while the buyer (making advance payment) increases deductable expenses, which is balanced at the state level.
As regards accounting of income, the authors of the Tax Code, as if “harmonizing” the moment when income should be recognised in tax accounting with the one in financial accounting, linked it to the date of transfer of title. Namely, in para. 137.1 of Article 137 of Section ІІІ “Corporate Profit Tax” it is said that: “income from sale of goods shall be recognised on the date of transfer of title to such goods to the buyer”.
At the same time it should be noted, that according to para. 8 of the Regulations (Standard) on Financial Accounting 15 “Revenue” (hereinafter – “RSFA 15”) revenue (proceeds) from sale of goods (products, other assets) should be recognised when all the following conditions have been satisfied:
- risks and rewards of ownership of the products (goods, other assets) are transferred to the buyer;
- the enterprise retains neither managerial involvement nor effective control over the products (goods, other assets) sold;
- the amount of revenue can be measured reliably;
- it is probable that the economic benefits associated with the transaction will flow to the enterprise and the costs incurred in respect of the transaction can be measured reliably.
As we can see from the cited provision of RSFA 15, recognition of revenue in financial accounting depends on several criteria, and none of such criteria mentions the transfer of title. It looks like the authors of the Tax Code decided to simplify the provisions of RSFA 15 in the Tax Code. But is this approach reasonable?
As it was mentioned above, one of the conditions for recognising of revenue is the transfer to the buyer of “risks and rewards of ownership of the products (goods, other assets)“. Is this condition equal to “transfer to the buyer of title to such goods”, mentioned in the draft Tax Code?
Surely, on certain occasions transfer of risks and rewards of ownership takes place simultaneously with the transfer of title. However, para. 1 of Article 668 of the Civil Code of Ukraine stipulates that the risk of accidental loss of or accidental damage to the goods shall pass to the buyer at the moment the goods are delivered to the buyer, unless otherwise is stipulated by the contract or by the law.
At the same time the moment of delivery of goods should be determined considering part 2 of Article 334 and Article 664 of the Civil Code of Ukraine. In particular part 2 of Article 334 of the Civil Code of Ukraine provides that “the goods shall be deemed delivered upon handing them over to the purchaser or carrier, communication organisation etc. for dispatching, transmission to the purchaser of goods, where the seller is not bound to deliver the goods. Handing over of the bill of lading or other document controlling the disposition of the goods shall be equal to delivery of goods”.
Article 664 of the Civil Code of Ukraine states that: “The obligation of the seller to deliver the goods to the buyer consists:
- in handing the goods over to the buyer, if the contract provides for such obligation;
- in placing the goods at the buyer’s disposal, if the goods shall be delivered at a particular place where the goods are placed.
The purchase-sale contract may provide for another moment at which the obligation of the seller to deliver the goods shall be deemed fulfilled.
The goods shall be deemed to be placed at the buyer’s disposal provided that within the term set by the contract the goods, ready to be delivered, are placed at the due place and the buyer is informed about it. The goods ready to be delivered shall be properly identified for the purposes of this contract, in particular, by means of labelling.
2. If under the terms of the purchase-sale contract the seller is not bound to deliver goods at any particular place, obligation of the seller consists in handing the goods over to the carrier or communication organisation for transmission to the buyer”.
Considering the cited above provisions, the moment when goods are deemed to be delivered to the buyer, and, consequently, the moment of passing the risks might be determined in different ways. For example:
- if the contract provides for delivery by the seller of the goods to the warehouse of the buyer, the moment of delivery (and passing of risks of accidental loss of or accidental damage to the goods) is the moment when the goods are delivered to the buyer at the warehouse of the buyer;
- if the contract does not provide for the obligation of the seller to deliver goods at any particular place, the moment of delivery (and passing of risks) is the moment when the goods are handed over to the carrier;
- if the contract provides for other terms and conditions of delivery and passing of the risks, the moment of delivery and passing of risks should be determined depending on the conditions of the contract.
The rules discussed above are also in compliance with Incoterms 2000, where clause A.4 sets the conditions of delivery and specifies the moment when the goods are delivered to the buyer. Depending on the case the goods might be deemed to be delivered when the goods are placed at the disposal of the buyer at the warehouse of the seller (if, for example, the goods are delivered on EXW – seller’s warehouse terms), or when the goods are placed at the disposal of the buyer at the buyer’s warehouse (if, for example, the goods are delivered on DDP – buyer’s warehouse terms), or in other moment depending on terms of delivery. At the same time according to clauses A.5, B.5 of Incoterms 2000 under the general rule the risks pass from the seller to the buyer at the moment of delivery of goods to the buyer.
As we may see, neither the rules set in the Civil Code of Ukraine nor those in Incoterms 2000 associate the moment, when the risks pass, with the moment of transfer of title to goods. These moments might concur provided that it is directly stated in the contract.
We should also note that according to the International Accounting Standards (hereinafter – “IAS”) the fact, whether title to goods was transferred from the seller to the buyer or not, is irrelevant to condition (1), which is similar to the condition set by RSFA 15, discussed herein. In particular, in clause 15 of the IAS 18 “Revenue” (revised 1993) it is stated:
“In most cases, the transfer of the risks and rewards of ownership coincides with the transfer of the legal title or the passing of possession to the buyer. This is the case for most retail sales. In other cases, the transfer of risks and rewards of ownership occurs at a different time from the transfer of legal title or the passing of possession”.
We may see that the IAS do not associate recognition of revenue in financial accounting with the transfer of title either.
That means that even without discussing other conditions that should be satisfied for recognising book revenue, the first condition is not always met at the moment of transfer of title. Thus, in financial accounting revenue is not always recognised at the moment of transfer of title to the buyer.
It should be noted that at first glance one may conclude that recognition of income at the moment of transfer of title would facilitate tax accounting. Under such approach one should not determine the moment of shipment of goods, which is used as one of the events for the purposes of effective law. We would like to remind that this term is not defined in the Law “On Corporate Profit Tax”. Lack of definition of this term for the tax purposes brings about disputes with the tax authorities regarding the issues when shipment takes place for the purposes of this or that transaction and, therefore, when income should be recognised.
Under the approach taken in the draft Tax Code one should not analyze whether all of the 4 conditions for recognising book revenue are met in each particular case, which, to a certain extent, are evaluative, i.e. depend on subjective factor.
At the same time if income for tax purposes is recognised at the moment of transfer of title, harmonization of tax and financial accounting should not be declared so zealously, since it is far from being the truth. Apart from the said one should keep in mind that the discussed provision might be subject to misuse. Let us, for example, imagine the case when the goods have been supplied and are used by the client (for example, complex equipment), the client paid for such goods, while the contract provides that title to the goods shall be transferred after ten years…
The Tax Code contains also quite mysterious clause 137.4 of Article 137 of Section III “Corporate Profit Tax” which provides for one more date for recognising income:
“The date of receipt of income, which shall be accounted for the purposes of evaluation of tax base, shall be the reported period during which such income appeared, regardless actual receipt of funds (accrual method), determined considering the rules set in this clause and Article 159 of this Section”.
What should be understood as the event, when income appeared? Which of the events should be treated as prevailing: the date, when the title is transferred, or the date, when income appeared? The draft Tax Code does not answer these questions. We may only assume that clause 137.4. is the authorized version of Article 4 of the Law “On Accounting and Financial Reporting in Ukraine”, in particular of the paragraph clarifying the principle of “accrual basis accounting and matching of revenues and expenses”:
“Revenue and expenses shall be recognised in books and financial statements at the moment such revenue or expenses appear, regardless the date of receipt or payment of funds“.
However, unlike the cited Law, clause 134.4 of the draft Tax Code does not clarify the rule, but rather adds confusion.
It should be also noted, that the Tax Code (clause 180.1 of Article 180 of Section V “Value Added Tax”) uses the same principle for the purposes of recognising of VAT liabilities as is used currently in the effective law. Namely, VAT liabilities shall be recognised at the earlier of two events: “shipment” or “date of crediting of buyer’s funds to the bank account”.
Considering the above, why declare “harmonization” and “simplification” in the circumstances when instead of two events, provided for in the tax laws as effective, we will have at least three: shipment, crediting of funds to the bank account and transfer of title?Thus, one may unambiguously state, that for those bookkeepers, who adhere to the requirements of accounting standards (for the purposes of financial statements) and requirements of the Tax Code (for the purposes of tax reporting), less scope of work is not expected.
The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.
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