Adoption of International Financial Reporting Standards (IFRS) from this year has created much confusion in the business circles because of the government’s delay in effecting amendments to the tax laws to remove discrepancies between the island’s tax laws and some of the criteria laid down by the IFRSs.
Although Sri Lankan firms were to fully adopt IFRSs starting from the January 1, 2012, even after lapse of six months authorities are yet to iron out the differences between the island’s tax legislation and some of the income and expenditure criteria of IFRSs among other issues, which affect the banking and the financial institutions the most, financial sources said.
“Sri Lanka Bank’s Association is to meet the Ministry of Finance and Planning within the next two weeks with the proposals to change the current tax legislation and we have also received a positive response from Dr P B Jayasundara, so hopefully all companies will be able to make their tax payments under a new tax legislation,” said the president of the association, Upali De Silva.
This situation arose mainly because of the rule based approach to accounting standards in IFRSs which value the financial assets under fair value, a valuation which is close to the market values of such assets. This is different to Sri Lankan Accounting Standards which followed mostly a principle based approach under which assets were valued according to historical cost accounting.
Under the tax proposals of the Budget Speech 2012, it was suggested that necessary adjustments to the respective tax laws would be made after studying the tax implications of financial statements prepared under IFRS. However, so far the authorities have failed to introduce any amendments to the law.
Sujeewa Rajapakse, the President of the national accounting standards setter, Institute of Chartered Accountants of Sri Lanka, while agreeing that there was an inconsistency added they were still discussing the issue with the Inland Revenue Department. He said there is a proposal for all entities to have two sets of Financial Statements – one to be prepared based on the IFRSs and other to satisfy the Revenue Authority of the country.
Meanwhile, the senior partner at Gajma and Company and one of Sri Lanka’s foremost tax specialists, N R Gajendran dismissed the idea of amending the tax legislation of a country to fall in line with IFRSs as ridiculous on the grounds that the legislation was based on the legal form while accounting was based on its commercial substance.
“There are basically three financials that have to be removed in order to bring the financial statements based on IFRSs to be in line with the tax legislation. You have to remove mere book entries which do not involve transactions, re-classification of assets, liabilities, income, expenses & equity and finally the unrealized gains and losses arising as a result of Fair Valuation,” he said.
Financial statements prepared based on IFRSs recognize revenue when the total risks and rewards are transferred from the seller to the buyer whereas the tax legislation considers the transfer of the legal ownership. “ Further, according to the IAS 32 and the IAS 39 Financial Instruments, impairment and fair valuation of the financial assets and the liabilities amount to unrecognized gains and even losses distorting the true business performance of the firm,” he added.
“Therefore, this might lead to banks and financial institutions carrying large amounts of financial assets which do not have a fundamental substance compared with other entities ending up paying higher taxes and sometimes no taxes at all. So, fundamentally, if there are any considerations on alignment of tax legislation and the IFRSs, they should remove any financial which has no transaction which amounts to unrecognized gains and losses and artificial recognition of certain financials,” he suggested.
Meanwhile, the Managing Partner of KPMG Sri Lanka, Reyaz Mihular speaking to The Nation Gain said that the non-alignment of tax legislation with that of IFRSs was not an issue faced only by Sri Lanka and it was natural in any country in their first full year of adoption. “In the United Kingdom too they faced similar issues and they managed to make some adjustments to their IFRS accounts in respect of Fair Value adjustments to get them aligned. Of course, you cannot expect a smooth flow of operation during the first one or two years,” he added.
The Deputy Commissioner General of Tax Policy at Inland Revenue too accepted the fact that they would have to encounter major problems at the end of the year when making adjustments unless certain areas of the law were amended. “Major problem arises because of the basis of valuation because of the fair valuation. Not only the Income Tax Law, certain areas of the other laws such as VAT, VAT on financial services, etc. will also have to be adjusted and we will soon make necessary adjustments after consultation with the stakeholders,” he said.