THERE is a basic misconception that taxation is based on financial accounts because tax computations are prepared based on the underlying figures provided. Let’s make it clear that the computation of income tax is based entirely on the Income Tax Act 1967 (ITA).
Many may not be aware that tax liability can be computed without referring to financial accounts because the ITA sets out step-by-step how gross income is recognised, deductions allowed, tax depreciation or capital allowances are computed on qualifying capital expenditure, and thereafter, any special deductions, reliefs, or rebates are provided.
When you compute your income tax liability, you have to follow step-by-step the income tax laws and regulations, and you will finally arrive at the correct tax liability. It is just that in practice, because the accounts contain the numbers and the information you require for the tax computation, reference is made to the accounts and the underlying transactions which have been recorded in the financial statements.
Purposes of accounting and taxation
The purpose of accounting is to provide interested parties information relevant to stewardship, control, and decision-making. The main purpose of taxation is to raise revenue for the government’s economic and social policy.
Has accounting seeped into taxation?
There are certain sectors or industries that require the taxation principles to be modified to provide taxpayers with a fairer means to settle their tax liabilities in alignment with the recognition of their income. A prime example will be taxpayers involved in long-term contracts, especially taxpayers in the property development or the construction industry where profits do not arise in one year but over a number of years.
There is a convergence between accounting and taxation where taxation rules have been specifically formulated within the powers of the Director General allowed in the ITA to recognise the profits over a period of time which is commonly referred to as a “percentage of completion”. The regulations for property developers and construction contracts that came out in 2007 allow the tax computation to be prepared in accordance with the accounting standard or practice applicable during the tax year.
Another example where the tax treatment has been punctuated with accounting principles is the adoption of accounting standards for the treatment of discounts or premiums in the issuance of bonds. Further examples would be the treatment of assets held for sale where the tax treatment is based on the generally accepted accounting principles, and the taxation of asset-backed securities.
What is the current situation?
In the past, accounting was solely based on historical information. However, currently, accounting is no longer entirely historical because principles such as fair value accounting which involves making impairment/revaluation adjustments, recognising right-of-use assets, etc, to ultimately reflect the current worth of the business enterprise.
When the tax accountants come in to prepare the tax computations, they have to unravel the accounts because for taxation purposes, the reliance is on the historical costs incurred and the income earned. There is a complete divergence between accounting and tax.
Tax largely relies on historical information subject to special rules aligned in accordance with the government’s fiscal policy. Accounting, however, is driven towards the economic needs of the business to show the true financial position on a current basis.
The mindset when dealing with taxation matters should be entirely separate from accounting because when you are managing tax risks and you are carrying out tax planning to save taxes, the thinking process is entirely influenced by different factors. Ultimately, you only need to pay the right amount of tax and therefore the mindset would be to ensure that you comply with the law fully but do not pay anything more.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
