Changeover from Canadian Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS) and/or private enterprise GAAP and its impact on taxable income

As you know, Canadian GAAP is being replaced as the required accounting standard for financial reporting in Canada. Effective January 1, 2011 IFRS will now be the new accounting standard for public enterprises.  The Canadian Institute of Chartered Accountants (“CICA”) has created a useful guide for users of financial reports in order to assist in interpreting the consequences as a result of the IFRS convergence.

Private enterprises will have the ability to use so-called private enterprise GAAP rather than IFRS as their new accounting standard.  For further information on this please see a good report published by the Accounting Standards Board of Canada.

Regular readers of our blog know that Moodys LLP Tax Advisors does not engage in any accounting services whatsoever.  Notwithstanding, many of our clients have questioned us as to what the conversion to IFRS or private enterprise GAAP will mean as it relates to their tax affairs.  Specifically, will the calculation of taxable income for enterprises that use IFRS or the new private enterprise GAAP be negatively impacted?  Overly simplified, it is our firm’s view that the conversion to IFRS or private enterprise GAAP should generally not have any negative impact on the computation of taxable income as compared to prior years.  This is because the Income Tax Act (the “Act”) does not mandate that GAAP accounting profits be used in the first instance to compute taxable income (or, simply, to calculate profit for tax purposes).  GAAP is not the law.  In addition, the Supreme Court of Canada, in the leading case of Canderel, has made it clear that a taxpayer’s goal, in seeking to ascertain profit (for tax purposes) is to obtain an accurate picture of the taxpayer’s profit for purposes of section 3 of the Act for the given year.   The Supreme Court stated in Canderel that a taxpayer is free to adopt any method to compute profit which is not inconsistent with:

a) the provisions of the Act;
b) established case law principles; and
c) well accepted business principles.

Practically speaking, IFRS and private enterprise GAAP (and current GAAP) may be a good starting point to compute an accurate picture of profit.  However, other methods are certainly available and may not be inconsistent with computations of profit used for tax purposes prior to the mandatory adoption of IFRS or private enterprise GAAP.1  What will be necessary, however, is to understand the detailed differences in computing accounting profits under current GAAP vs.  IFRS and/or private enterprise GAAP.   Such differences may be a required adjustment in order to get back to the method of computing tax tax profits as was used in prior years.

To illustrate, let us assume that a corporate taxpayer currently uses Canadian GAAP as its starting point to compute profit for tax purposes. While the Act will require many adjustments to the profit calculation (given that the Act contains very specific rules for how certain matters must be treated), IFRS and/or private enterprise GAAP may change the computation of accounting profits for 2011 forward.  As an example, what may have been previously expensed in the accounting financial statements of a taxpayer may now be capitalized (and therefore not expensed) pursuant to IFRS and/or private enterprise GAAP.  To the extent that the now capitalized item for accounting purposes would be more appropriate as a deduction (and was previously deducted in prior years when computing tax profits) such an adjustment will need to be made to the tax profit calculation which is consistent with the principles of Canderel.  Accordingly, tax practitioners will need to be very aware of the detailed differences between current GAAP and IFRS and/or private enterprise GAAP starting in 2011.

The CRA has published a number of publications which appear on their website.  Specifically, they have commented on the impact of IFRS on taxable income.  In addition, they have published a technical news document – Income Tax Technical News #42 dated May 31, 2010 – which provides useful information on this subject.

The tax professionals at Moodys LLP would be pleased to comment on your own specific issues regarding this topic.  Please feel free to contact any one of our tax professionals.

1. To be clear, it is only mandatory for public enterprises to use IFRS as their accounting standard.  For private enterprises, if there is no need to use GAAP when preparing financial statements (for example, the users of the financial statements have determined that there is no need to use GAAP) then private enterprise GAAP need not be used.