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The Importance Of Differences Between Taxation And Accounting Rules
Companies in Albania must follow financial accounting and reporting rules aimed at providing investors with a true and fair view of the company’s financial situation. These rules increase the transparency and international comparability of the company’s or group’s results and represent a strong step forward to the foreign market. International Accounting Standards (IAS) and National Accounting Standards (NAS) are widely used by multinational enterprises (MNEs).
Financial accounting and reporting rules are rapidly moving away from traditional legal concepts applied in commercial and fiscal law. They are increasingly based on a fair presentation approach. The results presented for financial purposes may differ significantly from the profits shown in the books of individual companies or in tax returns. MNEs therefore run the risk of facing unjustified demands for corporate tax reconciliation or a demand that profits presented for financial purposes in a particular 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 presented in the financial statements of a company or group differ from the taxable results of such company or group.
The following are different approaches to determining taxable profit
Some countries in Europe follow the concept of dependence in determining the taxable result. This means that the profit derived from business accounts is taken as the primary basis for withholding tax. In accordance with the relevant tax rules, certain fiscal adjustments must be made in order to calculate the taxable profit.
Other countries, especially those with a common law tradition, follow the concept of independence. Two separate sets of rules apply, one for commercial results and the other for tax purposes. Such countries do not rely heavily on commercial accounting rules for taxation, which can result in the two systems being significantly different.
Both systems have advantages and disadvantages. With separate taxation rules, two sets of rules must be applied, which can increase the compliance burden for businesses. It may also be easier for tax purposes to depart from certain principles followed in commercial accounting. However, even when taxation is based on business accounts, certain tax adjustments are unavoidable.
For now, it would be unrealistic to seek a common approach in this regard. Each country can freely decide whether the determination of taxable results will be primarily based on commercial accounts or whether it will be derived from the application of a separate set of tax rules.
Countries have the right to follow different approaches regarding the relationship between commercial and tax accounting (dependency/independence). Both approaches have advantages and disadvantages. However, in both cases well-established principles of taxation should not be ignored.
Differences between commercial accounting and capital market rules
The commercial law prescribes how the financial results of an individual company are determined. These rules are often specified in special accounting laws. Accounting and reporting rules are based on the principle of fair presentation and are mainly designed to increase transparency for investors. The standards must be applied consistently across the group. Sometimes companies are given a choice regarding the application of a particular method or rule. The single application is checked by external auditors and implemented by supervisory authorities. Special accounting and reporting standards for companies increase transparency and comparability, mainly for investors. Convergence of principles governing existing accounting and reporting standards is desirable to increase comparability and facilitate multiple listing. However, the possible tax implications for businesses should be kept in mind, especially in countries that rely on commercial accounts as the primary basis for tax deduction, and convergence should not worsen the tax position of businesses.
Different approaches and different purposes
Commercial, financial and tax rules serve their own purposes and, as a consequence, differences in results should be expected and accepted.
o Commercial accounting rules are used to determine the commercial results of an entity. They specifically determine whether a profit or loss was realized for a certain period. The rules may form part of the commercial or company law of the country. They are intended to protect the rights of shareholders and creditors and, as a consequence, the principle of prudence occupies an important place.
o Financial accounting and reporting rules are part of the country’s capital market regulations. Their goal is to give investors (and other stakeholders) a reliable and as accurate as possible picture of the financial situation of the economic entity (group) at a certain moment (financial situation, operations, cash flows). The guiding principle is “fair presentation” or “true and fair representation”. Other important rules in this sense are “substance before form”, “measurement of market value” and – as a consequence of truth and honesty – the factual prohibition of hidden reserves.
o Taxable rules are used to determine taxable profit. Their goal is to define the company’s tax liability to the tax administration for a specific year. The rules must be subject to compliance by taxpayers and control and enforcement by tax authorities. Taxation rules for businesses are usually designed to maintain economic neutrality, so that fiscal measures do not influence business decisions. The rules may also provide for non-fiscal objectives. Tax laws reflect the general principles of taxation, such as non-discrimination or taxation according to economic ability, but also practical aspects, such as the availability of funds to pay the obligation (realization), fairness between different categories of taxpayers (neutrality), the annual character of the obligation (loss carry-forwards , standardized depreciation), long-term profitability (prudence, inequality, valuation below market value) and other such factors. For example, tax systems may prescribe special timing rules for the recognition (or deferral) of income, carry-forwards of losses from other years, and other rules specific to the area of taxation.
The approaches used to calculate commercial, financial and tax reports serve different purposes. Although the respective rules are aimed at the same general objective (the results of a business entity in a certain period), it is important to understand that, according to existing concepts, the rules applied in financial accounting and those applied for tax purposes should not be expected to be strictly comparable.
The benefit of interaction between accounting and tax rules
As a result of the demands of international capital markets (globalization), it is expected that widely used accounting and reporting standards will lead to a 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 policy, we should not expect a similar degree of harmonization of tax rules. At the same time, the more the rules used for financial accounting differ from those used in the area of taxation and the more transparent the results of the group become, the more obvious are the differences arising from the application of the two sets of rules. become. Tax authorities should not use the entity’s financial results (in the same country or in third countries) as an excuse to adjust the company’s taxable profit or to justify transfer pricing adjustments.
The rules applied for financial accounting and those used for tax purposes may differ significantly and may lead to results that are not reasonably comparable. Tax authorities and policy makers should accept that the basic principles of financial accounting are not always compatible with the basic principles and practices used in the field of taxation. From a tax policy perspective, it is important that tax rules are not undermined by an inappropriate expansion of financial reporting requirements.
Internationally recognized accounting standards can be seen as a coherent set of rules for accounting and reporting that should give investors a “true and fair view” of the financial situation (balance sheet), performance (profit and loss account) and changes in the financial position (cash flow) of an economic entity at a certain 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-fiscal objectives, eg the allocation of special incentives (for research and development, for special reserves, for promoting self-financing, for attracting certain business activities, etc.). They can be designed to influence business behavior by providing incentives or using disincentives (eg environmental taxes or rebates). Furthermore, a country’s tax system is the result of a political decision-making process and is therefore, in many cases, neither business-neutral nor fully internally consistent.
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 measure a company’s annual results, differences in results or methods used must be accepted. Financial accounting looks at the business as an economic entity, while taxation is usually based on a separate entity approach.
Tax and accounting policy makers need to be aware of these differences. Tax authorities must respect them and refrain from using the company’s financial results for tax adjustments.
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