Faculty of Economy, Communication and IT

Faculty of Economy, Communication and IT

Elin Österberg

International harmonization and the connection between accounting

and taxation

International Financial Accounting

D-level thesis

Date/Term:Autumn 2009

Supervisor:Berndt Andersson

Table of contents

Concepts

How harmonization affects the connection between accounting and taxation

Accounting harmonization

The connection between accounting and taxation

The connection between accounting and taxation in Sweden

The future development of the connection between accounting and taxation

List of references

Concepts

ASBAccounting Standards Board

FASFinancial Accounting Standards

FASBFinancial Accounting Standards Board

IASInternational Accounting Standards

IASBInternational Accounting Standards Board

IFRSInternational Financial Reporting Standards

System of rules, regulated by IASB.

GAAPGeneral Accepted Accounting Principles

Recommendations, regulated by FASB. Even called the US GAAP.

”Swedish GAAP”“God redovisningssed”

VATValue Added Tax

IOSCOInternational Organization of Securities Commissions

CCCTBCommon Consolidated (EU) Corporate Tax Base

Swedish laws that occur in the thesis:

ILInkomstskattelagen, the Income Tax Act

ÅRLÅrsredovisningslagen, the Annual Accounts Act

RFRegeringsformen, the Swedish Constitution

How harmonization affects the connection between accounting and taxation

Today there are a lot of discussions about harmonization and if it is a good or bad thing to try to harmonize the world around different tasks and different areas. We all know that there are a lot of differences in the world, both between countries and groups of people. There are both good and bad aspects with these differences, the question is if it is better if we let these differences be, or if we shall harmonize the world around certain rules and standards. Another big question is how far we are willing to go in the process of harmonization, if we for example are willing to have the same rules and standards in the whole world, and maybe even the same currency and language? Are we better off with some differences, or shall we have the same systems in every part of the world?

In this text accounting harmonization will be discussed and how this affects the taxation in different countries. The taxation systems are very different in different countries, and the connection between accounting and taxation vary a lot. Therefore the process of harmonization will affect the taxation systems more or less in the countries. Examples from different countries will be given, but the main focus is on Sweden and the EU.

Accounting harmonization

Frost (1994) discusses the subject of accounting harmonization, which she claims is used loosely in the accounting literature, where it is referred to as narrowing the choice among alternative measurement methods. Another use of harmonization concerns the quantity and detail of information disclosed in the financial report (van der Tas 1992 referred in Frost 1994). Harmonization can also mean comparability and transparency of information, which is consistent with the EU accounting directives’ emphasis on the concept of the true and fair view (Walton 1993 referred in Frost 1994). Harmonization operates at many diverse levels, for example concepts, principles, standards, regulations and practice (Tay and Parker referred in Frost 1994). The fact that the harmonization expression is used this widely shows that it is a complicated subject with different meanings, which could lead to confusion in further discussions.

According to Sundgren et al. (2007) the work with the harmonization of the IFRS standards and the US GAAP implies that the companies which are listed on the dominated stock markets will use more similar accounting principles. An advantage of this is that it makes it easier to analyze and compare different companies, but a disadvantage is that similar rules for all companies do not need to be the best rule for every individual company. One of the goals with the changes in the standards has been to try to minimize the number of accounting principles, for to minimize the opportunities to “manipulate the profit” by using the methods or principles that are the most sufficient for the particular company.

The EU’s directives narrow the choice of accounting measurement principles (Frost 1994). Further on, Frost (1994) gives an example of the Fourth EU Directive, which does not address any key measurement issues such as those related to lease, pension liabilities, deferred taxation, foreign currency translation and new financial instruments. In addition to this, the concept of the true and fair view has been broadly viewed as basically a way for companies to use whatever accounting practices they prefer. The role of the true and fair view has therefore been viewed as largely a symbolic and political concept, rather than a practical one (Walton 1993 referred in Frost 1994). Each country within the EU translates the concepts in different ways (Frost 1994); they interpret the true and fair view in a context of their national culture, accounting tradition and national accounting standards (Alexander 1993 referred in Frost 1994). The national interpretations of the true and fair view, as well as the reporting incentives and the accounting rules and practices, are affected by different factors, such as differential tax structures, economic risks, legal systems and sources of capital (Frost 1994). So even with the broadly accepted principles, there are still some differences how the principles are translated and interpreted in different countries, which can cause trouble when it comes to comparing and investigating between countries.

The different aspects that cause the variation between the national accounting in different countries and the international accountingare for example cultural, environmental, economical, legal and political differences, which also have been briefly mentioned above. Differences in the definition of the national GAAP also affect the accounting systems in different countries (Alexander et al. 2009). EvenFagerström[1]discusses this subject and the fact that the same words are used in different ways in different countries and languages, which could be very problematic and cause a lot of misunderstandings in adiscussion about a certain subject or area. Fagerström illustrates this with a quote:

“Before accounting can be recognized as a language it must develop apositive system of communicating ideas and a sound means of expressingits symbolic doctrine. Many errors and much confusion in accounting are aresult of the misapprehension of the language; and one means of correctingthis

fault lies in a better understanding of a common mode of expression.”

(Avery 1953, p.83 referred by Fagerström)

Fagerström[2] also claims that some expressions only exist in one language, because the particular expression or word has no translation in other languages. This could of course create big problems and difficulties, which can be hard to overcome.

Besides the different languages, there are also differences within languages.An example of this is the different forms of one language, where English is a very distinct example. The IASB uses a mixture of the UK and US English, but in the Fourth EU Directive the UKterms are used (Alexander et al. 2009).This mixture of terms could easily cause trouble for those who are not familiar with which language these terms comes from. In other words it is essential to know which language that is used, since the terms have different meanings in different languages.

The different expressions in countries lead to different logics and ways to view accounting. The approaches may be different, but they all try to describe the same problem. These differences between languages needs to be remembered when it comes to discussions and co operations between countries and people with different backgrounds.

Olsson[3] gives some examples of the GAAP and how it is translated into to different countries, there is the US GAAP (FASB), the Swedish GAAP and the True and fair view in the UK. The US GAAP includes about 150 FAS, which are very detailed and covers totally several thousand pages. In the UK it is the ASB who issues the standards and in Sweden it is the National Accounting Board (Bokföringsnämnden; BFN) who issues the standards, with consultation from different bodies that also produce accounting standards. In condition to these differences there are also international standards and regulations that every country has to adopt. In the EU the member countries are bound by the IAS-regulation and the standards of the IAS/IFRS are interpreted into binding law. This affects the auditing and the auditors a lot, some big auditions firms even have their own resources who work with the interpretation of the IAS/IFRS. Alexander et al. (2009) claims that, according to academic researches, even when all countries have complied with the same GAAP or IAS/IFRS, there will still be national influences and differences that affect the quality of financial reporting. With this in mind, one can question how necessary it really is to implement the same standards and rules all over the world. One important task is the question about whether the benefits of accounting harmonization really cover the costs and time that come from the implementation.

The connection between accounting and taxation

During the years there have been many comparisons between countries when it comes to the connection between accounting and taxation. Countries with a strong connection between accounting and taxation can see the harmonization of accounting standards as a more difficult task than countries with a weaker connection, since they have to have the taxation rules in mind when they implement the international accounting standards. The implementation can therefore take more time in countries with a strong connection between accounting and taxation, and the cost will most likely also be higher in those countries.

Alexander et al. (2009) gives the countries Sweden, Norway, Germany, France, Belgium and Italy as examples of countries which have a strong connection between accounting and taxation. But in Denmark, UK, Ireland, The Netherlands, CzechRepublic and Poland the connection is much weaker. The connection or relationship can also vary over time, an example of this is Spain, which had a strong connection between accounting and taxation for a long time, but has moved towards a weaker and weaker connection after the reform of 1989.According to Olsson[4], this is happening today in Germany, which now is moving towards a disconnection between accounting and taxation. The case inSweden will be discussed later in this text.

It is also important to remember that the “strong connection” between accounting and taxation can occur in different ways in different countries. According to the SOU 2008:80, a lot of comparisons have been done in the attempt of classifying countries according to their connection between accounting and taxation. In Denmark there is no purely principal connection, the solution has instead been concise laws of periodization of incomes and expenses, which are complemented by prescriptions, legal standpoints and so on. In the UK they have a fundamental general connection. However, they also have a number of particular taxation rules, which means that the connection only get a practical meaning in some certain areas.In Norway, which is a country with a strong connection according to Alexander et al. above, there has earlier been a legal connection between accounting and taxation. This is though not the fact anymore; instead of the legal connection they now have relatively concise laws of taxation, which have their starting point in the principle of realization.

The connection between accounting and taxation in Sweden

Sweden is one of the countries with a strong connection between accounting and taxation. The connection has been quite strong for a long time, which has resulted in some particular features, such as untaxed reserves (Artsberg 1996).

In Sweden there are a number of different angles of the connection between accounting and taxation. There is the material, formal, reversed and real connection, which are used in different situations. According to the material connection the calculation of taxable income from business is made according to the “bookkeeping principles” (bokföringsmässiga grunder), the base for business taxation is therefore the books. Incomes and costs are accounted for according to the GAAP, which also is the case for periodization. In a way the material connection is problematic and is therefore often the issue mainly discussed when it comes to discussions about a disconnection of accounting and taxation.[5] Later on in this text the question of disconnection will be further discussed.

The formal connection is a Swedish peculiarity, which is seen as a bit odd by other countries. According to the formal connection the tax law should correspond with the civil law accounting by using the same write-offs or depreciations, examples are depreciations according to accounting and periodization funds for a limited company. It covers a smaller area than the material, but together with the material it is the most important type of connection.[6]

When it comes to the reversed connection, the accounting is depending on the tax. It is the accounting standards that demand the tax law deviations to be shown in the books.An example of this is the 97 % rule (see chapter 17, 4 § IL), which is a specific rule in the Swedish tax law.[7]

The real connection is more of an administrative connection; the every day connection in the companies, at the accounting firms and at the Tax Authority (Skatteverket). In Swedenthis connection also covers the VAT.[8]

The history of the formal link between accounting and taxation in Sweden,which is described above, starts in 1928 (SillCn 1943; Thorell 1984, referred in Artsberg 1996) with the IL. Before this there had not been any clear rules about depreciation, which led to repeated disputes between companies and the Tax Authority. From 1910 the Tax Authority allowed depreciation to some extent, but these were not enough. At this time it was uncertain whether the tax legislation and accounting legislation should develop in the same or different directions. In 1929 the tax legislator took the decision to connect taxation to the commercial accounting rules. Because of the fact that the legislation with its compulsory character referred to the accruals concept, it spread faster in business practice than it would have done otherwise. Up to 1955 the differences between accounting legislation and taxation in Sweden were very small. At this time they became somewhat increased because of specific rules, which was formulated in the tax legislation. Considerable undervaluation was although still allowed in Sweden, using the justification of the principle of “smoothing the business cycle”, which was put forward by a number of the leading figures in education and business, and further on also accepted by both accounting law and tax law in Sweden (Artsberg 1996).

The common view is that the connection between accounting and taxation worked very well in Sweden in earlier days (Artsberg 1996). One of the reasons why the connection in Sweden has worked as well as it has is that the result concept traditionally has been ruled by creditor aspects. An important part in this is that no unrealized profits are allowed to affect the result and assets are normally not allowed to be valued above acquisition value (SOU 2008:80). The fact that the system in Sweden has worked well could be seen as one of the factors in favor of remaining the connection between accounting and taxation.

Since Sweden is a country that relies on legislation to a great extent, there is a need for court decisions to help interpret the legislation. “Good accounting practice” (Swedish GAAP, God redovisningssed) can never override the law and the court can never be restricted by private accounting rules, therefore the accounting practice and the accounting rules can only develop within the framework of the law (Thorell 1984;Norberg 1991 referred in Artsberg 1996). But in a practical way it is the large companies that stand for the actual development. They are the leaders when it comes to setting of new standards, because of the fact that there is not much guiding jurisprudence in this area in Sweden. This is a result of that a very few cases are brought up to the Supreme Administrative Court in Sweden (Regeringsrätten, the highest tax court), and almost none to the Supreme Court (Högsta domstolen, the highest civil court) (Artsberg 1996).

Business taxation in Sweden is depending on the Swedish GAAP in many ways. Ifa deviation from GAAP occurs in a company, this will most likely result in some kind of tax penalties according to the Swedish system. For there to bee a tax crime, an intent is necessary, which includes more than just a deviation from GAAP.[9] The connection between taxation and the Swedish GAAP has so far been retained. Apart from some changes in the rules regarding valuation of assets, which actually is a consequence of the approximation between the Swedish GAAP and IFRS, the opportunity to directly deduct costs for rebuilding commercial premises has been the only visible disconnection between financial accounting and taxation in the last years. Some steps have though been taken for to approximate Swedish GAAP according to the IFRS accounting. One of the most important things is that the Swedish Financial Accounting Standards Council (Redovisningsrådet; RR) has presented a new recommendation with the aim that a parent company should set up its single financial statement according to the IFRS as far as possible. But this is only possible to the extent that the recommendations in the IFRS do not interfere with the rules in the ÅRL, which are binding. It is for example not compatible with the ÅRL to evaluate assets at a market value, but it is possible according to the IFRS (Kirsch & Olsson 2008). The interference with the Swedish laws is a rather important issue in the process of harmonization. If we would fully adapt the IAS/IFRS, it would mean that we would have to change the Swedish laws, which as mentioned before would lead to high costs and a lot of effort.