Larissa Nechaeva
Before the mid-1990s, all Russian enterprises calculate only taxable profits. This figure was reported in financial statements and was useful primarily for tax authorities. Following changes made to the Government Resolution #552 on 1 July 1995, the profit determined for tax purposes was officially separated from the one determined for financial reporting purposes. However, the tax orientation of Russian financial statements has not been fully eliminated either officially or in practice.
Depreciation charges across the whole of Russia are in practice still recognized in financial statements using «tax» rules (i.e. statutory norms) despite the fact that, in accordance with PBU#6 «Accounting for Fixed Assets», enterprises can choose other economically sound calculation techniques. The tax treatment prevails because expenses other than those approved under statutory rules are not recognized for tax purposes. Accountants are reluctant to perform double calculations of depreciation charges under the excuse that the calculations are technically complex and statutory requirements are inconsistent (so far, the Resolution #552 requires enterprises to include depreciation charges in the cost of goods/services at statutory rates without specifying that this is done for tax purposes).
It should be noted that, for different reasons, Western companies also perform two separate calculations of:
- accounting profit which is the net profit or loss for a period before deducting tax expense that is recognized in the financial statements;
- taxable profit which is the profit for a period, determined in accordance with the rules established by taxation authorities, upon which income taxes are payable.
Depreciation of fixed assets is not an exception in these calculations. Depreciation charges are also calculated twice for the purpose of: 1) determining accounting profit and 2) determining taxable profit. In addition, the tax consequences arising from the differences between the accounting profit and taxable profit are also calculated. These tax consequences are recognized in financial statements as:
- deferred tax liabilities which are the amounts of income taxes payable in future periods; and
- deferred tax assets which are the amounts of income taxes recoverable in future periods.
The accounting treatment for tax consequences is prescribed in IAS 12, Income Taxes. This Standard provides examples that illustrate the calculations of tax consequences arising from the so-called «temporary differences» between the carrying amount of an asset or liability in the balance sheet and its tax base. The differences are called temporary because they reverse over time, i.e. their nature is temporary. Under IAS 12, temporary differences are broken down into:
- taxable temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods; and
- deductible temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods.
For example, if an accelerated depreciation method is used in the determination of the taxable profit, there is a taxable temporary difference that results in a deferred tax liability. This means that in future periods the enterprise will not be able to deduct the amount of this difference from the taxable profit and, accordingly, cannot use it in calculating its income tax. The example is given below to illustrate the calculation of the deferred tax liability
Example – A new machine is purchased on 1 January 2001 for $100,000. The company uses the straight-line depreciation method with an estimated equipment life of 5 years and a zero residual value. The accelerated depreciation method is used for tax purposes. Annual charges, assuming accelerated depreciation, are 33.33%. The income tax rate is 35%. The deferred tax liability at the beginning of the year is zero. The deferred tax liability on 31 December 2001 is calculated as follows:
In cases where depreciation for tax purposes is calculated at lower rates than the rates used for financial reporting purposes, the deductible temporary difference results in the deferred tax asset. This means that in the future the enterprise will deduct the amount of this difference from the taxable profit and, accordingly, from the income tax.
The Government Resolution #552 has established procedures for determining taxable profits in Russia. These procedures are different from those in Western countries. For example, US enterprises may use the cash basis of accounting for taxable profits, i.e. some revenues and expenses may be recognized when cash is received or paid. Consequently, items such as prepaid expenses, prepaid rent, prepaid subscription fees and installments are included in the determination of the taxable profit for the period. In contrast, for tax purposes, in Russia, there are specific rules to determine recognition of these elements:
- revenues are recognized as cash is paid or goods are shipped (services are rendered);
- expenses incurred by the enterprise are adjusted using statutory limits, rules and standards.
So, under the Russian tax system, prepaid expenses are not deductible from the taxable profit until they are accrued. Such a tax system cannot be considered progressive and favorable for economic growth. It should be noted that any prepayment is associated with a certain risk. Therefore, if an enterprise assumes this risk for economic purposes, this should be taken into account for tax purposes.
The move to IAS is necessary in Russia. However, international experience should also be used in the tax area. Some steps have already been made to improve the Russian tax system. The taxable profit has been separated from the accounting profit, tax assessment and payment procedures are getting easier and a new Russian Tax Code has been adopted. The Standard on Tax Settlements is to be adopted under the Accounting Standards Implementation Plan developed in accordance with the Russian Government Resolution #283, dated 6 March 1998, «On Approval of the Accounting Reform Program towards International Accounting Standards». This standard has not yet been implemented in Russia. However, it should be noted that the accounting treatment for tax consequences prescribed in IAS 12 is suitable for any tax system, including a Russian one. It should be implemented promptly, as it would allow the user of financial statements to receive more useful information.
Larissa Nechaeva is a Technical Manager at ICAR. She can be contacted by e-mail: larissa@icar.ru.