Adjustments From Operating Activities Of Statement Of Cash Flows The Importance Of Differences Between Taxation And Accounting Rules

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The Importance Of Differences Between Taxation And Accounting Rules

Enterprises in Albania must comply with financial accounting and reporting regulations aimed at providing investors with a true and fair view of the enterprise’s financial situation. These regulations increase transparency and international comparability of enterprise or group results and have a strong foothold in foreign markets. International Accounting Standards (IAS) and National Accounting Standards (NAS) are widely used by multinational enterprises (MNEs).

Financial accounting and reporting regulations are quickly moving away from traditional legal concepts applied in commercial and financial laws. They are mostly based on fair presentation approach. The results shown for financial purposes can be quite different from the profits shown in the books or tax returns of single enterprises. MNEs therefore face excessive requests for adjustments to tax profits or the requirement that profits shown for economic purposes in a given country be taxable in that country.

The national and international business community believes that it is important for tax authorities and policy makers to understand the reasons why the results shown in the financial statements of an enterprise or group differ from the taxable results of such enterprise or group.

Various methods are adopted to determine the taxable profit

Some countries in Europe follow the concept of dependency to determine the taxable effect. This means that the profit from business accounts is taken as the primary basis for tax assessment. Subject to the relevant taxation rules, certain financial adjustments have to be made to calculate the taxable profit.

Other countries, especially those with common law traditions, adhere to the concept of liberty. Two separate sets of rules are applied, one for business consequences and the other for tax purposes. Such countries do not rely heavily on professional accounting rules for taxation, which can result in significant differences between the two systems.

Both systems have advantages and disadvantages. Along with separate taxation rules, two sets of rules must be applied, which can increase the compliance burden for enterprises. It can also be easy to deviate for tax purposes from certain principles followed in professional accounting. However, even if taxation is based on business accounts, some tax adjustments are inevitable.

For the time being, it would be unreasonable to ask for a general approach in this regard. Each country is free to decide whether the determination of taxable results should be based primarily on business accounts or through the application of a separate set of taxation rules.

Countries are entitled to follow different approaches regarding the relationship between business and tax accounting (dependency/independence). Both methods have advantages and disadvantages. However, in both cases, the well-established principles of taxation should not be ignored.

Differences between commercial accounting and capital market regulations

Commercial law prescribes how the financial results of a single enterprise are determined. These rules are often set out in specific accounting laws. Accounting and reporting rules are based on the principle of fair presentation and are primarily designed to increase transparency for investors. Standards must be applied consistently across the group. Sometimes, enterprises are given a choice regarding the application of a given method or rule. Uniform application is audited by external auditors and can be enforced by supervisory bodies. Specific accounting and reporting standards for companies primarily increase transparency and comparability for investors. Convergence of principles governing existing accounting and reporting standards is desirable to enhance comparability and facilitate multiple listings. However, the potential tax implications for companies, especially in countries that rely on business accounts as the primary basis for tax assessment, have to be kept in mind and convergence should not worsen the tax position of enterprises.

Different perspectives and different motives

Commercial, financial and taxation rules serve their own purposes and consequently, differences in outcomes should be expected and accepted.

o Business accounting rules are used to determine the business results of an entity. They determine whether there has been a profit or loss for a particular period. Regulations may be part of the commercial or company law of the country. They are intended to protect the rights of shareholders and creditors and consequently, the prudential principle occupies an important place.

o Financial accounting and reporting rules are part of the country’s capital market rules. Their goal is to provide investors (and other stakeholders) with a reliable and as accurate as possible, a picture of the financial situation (financial position, performance, cash flow) of an economic entity (group) at a given moment. The guiding principle is “fair presentation” or “true and fair view”. Other important rules in this context are “form over substance”, “market value measurement”, and – as a true and fair consequence – the factual prohibition on hidden stocks.

o Taxation rules are used to determine taxable profit. Their objective is to define the tax liability of an enterprise to the tax administration for a year. Rules should be sensitive to compliance by taxpayers and control and enforcement by tax authorities. Taxation rules for companies are generally designed to maintain fiscal neutrality, so that business decisions are not unduly influenced by fiscal measures. Regulations may also provide for non-financial objectives. Tax laws reflect general principles of taxation, such as non-discrimination or taxation according to financial ability, but also practicalities, such as availability of funds for payment of liability (recovery), fairness (neutrality) between different categories of taxpayers, nature of annual liability (loss carrying, standard depreciation), long-term profitability (prudence, ambiguity, valuation below market value) and other such factors. For example, a tax system may prescribe specific timing rules for recognizing (or deferring) income, other years of losses, and other rules related to the area of ​​taxation.

The approaches adopted for computation of commercial, financial and taxation statements serve various purposes. Although the relevant rules focus on the same general object (the results of a business entity in a given period), it is important to understand that, under existing concepts, the rules applied in financial accounting and the rules applied for tax purposes are not the same. A strict comparison is expected.

Better interaction between accounting and taxation rules

As a result of the demands of international capital markets (globalization), widely used accounting and reporting standards are expected to lead to certain harmonization in the field of accounting and reporting. On the other hand, as long as each country imposes its own taxes, implements its own tax policies, there is not expected to be an equal degree of harmonization in taxation rules. At the same time, the rules used for financial accounting will be different from the rules used in the field of taxation, and the more transparent the results of the group, the more obvious the differences resulting from the application of the two rules. Tax authorities should not use the financial results of an entity (in the same country or in third countries) to justify adjustments to the taxable profits of the enterprise or transfer pricing adjustments.

The rules applied for financial accounting and the rules used for tax purposes may differ significantly and result in results that may not be reasonably comparable. Tax authorities and policy makers must recognize that the basic principles of financial accounting are not always consistent with the basic principles and practices used in the field of taxation. From a tax policy perspective, it is important that taxation rules are not weakened by an undue expansion of financial reporting requirements.

Internationally accepted accounting standards can be seen as a consistent set of rules for accounting and reporting that give investors a “true and fair view” of financial position (balance sheet), performance (income statement) and changes in financial position (cash flow). The flow of an economic entity at a given moment.

In the area of ​​taxation, some widely accepted principles clearly deviate from the concepts used for financial accounting and reporting purposes. In addition, tax laws often provide for non-economic purposes, e.g. Specific incentives (for R&D, for special reserve funds, to encourage self-financing, to attract specific business activities, etc.). They can be designed to influence the behavior of enterprises by using incentives or disincentives (eg environmental taxes or reliefs). Furthermore, a country’s taxation system is the result of political decision-making processes and therefore, in many cases, is neither neutral nor fully internally consistent for businesses.

Taxation and financial accounting rules serve different purposes, have different objectives and are based on different principles. Although both sets of rules are used to calculate the annual results of an enterprise, differences in the results or the methods applied should be accepted. Financial accounting views the enterprise as an economic entity, while taxation is generally based on a separate entity approach.

Policymakers in taxation and accounting need to be aware of these differences. Tax authorities should respect them and refrain from using financial results of companies for tax adjustments.

By Eduart GJOKUTAJ

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