SEC Proposal to Move from U.S. GAAP to IFRS Has Significant Tax Implications

On November 14, 2008, the U.S. Securities and Exchange Commission released its much anticipated proposal to allow U.S. companies to use International Financial Reporting Standards (IFRS) instead of U.S. generally accepted accounting principles (U.S. GAAP). The proposal follows on the heels of the G-20 summit, which endorsed the move to one global accounting standard-setter in the near term.

As proposed, the SEC could mandate U.S. companies to report under IFRS as early as 2014 if key milestones are met in the roadmap. Certain issuers may be able to file financial statements under IFRS beginning in 2010. The proposal would also require a company, in the year of mandated compliance, to provide three previous years' audited financial statements as if the statements had been prepared under IFRS.

The consequences of the move to IFRS not only will affect financial reporting, the move also could have a significant impact on the U.S. companies' taxes. The significant tax implications include:

Tax treatment of LIFO inventories, since LIFO is not permitted;
Potential for earlier recognition of income from advance payments; and
Book-tax differences for research and development costs.

The changes will not go unnoticed by the IRS and Congress. We expect either one or both to react with further guidance to decrease the IRS's administrative burden in answering the windfall of requests to change accounting methods or to capitalize on the revenue increases that would result from companies converting from LIFO to another inventory method.

LIFO followers must change their inventory method

IFRS, as issued by the IASB, does not permit the use of last-in first-out cost-flow assumption. Companies that now use this method will have to:

Request permission to change to an alternative method (e.g., first-in first-out or weighted average); and
If applicable, make a Sec. 481(a) adjustment to recognize income over a four-year period.

Due to a conformity requirement in the Internal Revenue Code, a company may not use the LIFO accounting method for tax purposes if it does not do so for financial reporting purposes. To change methods, the taxpayer must restate its opening inventory as if it had used the new method all along; but if the new balance is higher than it would have been under LIFO, the company must recognize income over a four-year period in accordance with Sec. 481(a). This may present a cash-flow problem for companies because though they would recognize income, they may not have the cash on hand to cover the tax.

Potential for Earlier Recognition of Income From Advanced Payments

For tax purposes, advanced payments are generally recognized upon receipt. However, if the company employs one of the conformity exceptions allowing for deferral of advanced payments in accordance with its financial reporting method, the company may have to request permission to change its method. Under U.S. GAAP and IFRS generally, a company recognizes advance payments when the buyer has the risks and rewards of the ownership. However, the recognition criteria for revenue is more principles-based under IFRS. As such, the company will have to decide how it is going to approach the recognition of revenue. If the application means that income will be reported earlier under IFRS than would have been under U.S. GAAP, the taxpayer also may then be reporting the income earlier for tax purposes.

Change in Tax Treatment of Research & Development Costs or More Book-Tax Differences

Though the Sec. 174 tax treatment is separate from the accounting treatment, a change in the accounting may significantly altered to the book-tax differences of U.S. companies. Under Sec. 174, the taxpayer may chose to either capitalize or expense research and development costs. Under U.S. GAAP, most companies expense both research and development costs. IFRS, however, requires research costs to be expensed and development costs to be capitalized. If a company chooses to change its tax treatment to align with the accounting treatment, the company will have to request permission from the IRS. If the company does not change its tax treatment, the company will have to make changes to track its book-tax differences.