Many transfer pricing issues will arise from a conversion to IFRS.

Summary: Between 2014 and 2016, depending on the type of company, US companies will be required to adopt International Financial Reporting Standards (IFRS). The transition has implications for risk management, regulatory, tax and IT functions. Proper communication channels will enable companies to avoid many of the problems inherent in conversion.

The US Securities and Exchange Commission (SEC) reaffirmed its commitment to International Financial Reporting Standards (IFRS) in a statement published on 24 February 2010. The transition to IFRS raises many tax questions for issuers faced with the prospect of incorporating IFRS into their US financial reporting systems.

Your tax directors and transfer pricing professional must understand the impact of IFRS conversion on their entire company so that they can address potential issues in a timely manner. These are tax issues to consider in anticipation of IFRS adoption.

SEC Roadmap for conversion

In November 2008, the SEC issued a proposed Roadmap for conversion to IFRS by US-listed companies. According to this Roadmap, US companies would be required to start filing under the new standards between 2014 and 2016, depending on the type of company.

SEC Chief Accountant Jim Kroeker suggested that if IFRS were to be incorporated into the US financial reporting system, it would happen no earlier than 2015, with the goal of providing US issuers adequate time to make the transition. Today, more than 100 countries have either adopted or are on target to adopt IFRS. Companies listed in the European Union were required to file financial statements using IFRS beginning in 2005.

IFRS conversion costs: to allocate or not to allocate

Among the first issues faced by companies that adopted IFRS in Europe was how to treat, from a transfer pricing perspective, the significant costs associated with conversion. Companies can treat these costs differently, depending on the facts and circumstances surrounding their respective processes.

Direct conversion costs would normally be considered shareholder costs, that is, a head-office expense that would be unallocable to affiliates. However, depending on the scope and breadth of the conversion, this may not necessarily be the case.

If a company completely overhauls its systems (e.g., the adoption of Enterprise Resource Planning) as part of the IFRS conversion process, some of these costs may be allocable to affiliates that receive a benefit from the upgrades. Similarly, the existence of centers of excellence (e.g., foreign affiliates specialized in derivatives accounting) may require sharing the expenses of the related conversion processes and an allocation of the financial burden across the organization.

Consider the potential company-wide implications and create a clear strategy before undertaking any conversion project. It’s critical to involve the tax department in the project management to analyze and address potential tax implications, including transfer pricing implications.

Globalization is challenging multinational companies to find innovative transfer pricing solutions

Transfer pricing analyses rely heavily on financial accounting data. Financial statement information does not necessarily impact the basis of an opinion or the choice of, but it can affect the basis on which third-party comparables data are prepared.

• Comparability of data is of critical importance in preparing transfer pricing documentation. Although it is possible to use comparables with different accounting standards, Treasury Reg. §1.482-1(d) (2) requires the consideration of adjustments to increase reliability. The use of accounting information prepared under different standards could result in the incorrect conclusion that a comparable’s arm’s length transaction is not in fact comparable.
• Profit-based transfer pricing methods, including the transactional net margin method (TNMM) under the OECD Guidelines and the comparable profits method (CPM) under Treasury Reg. Section 1.482, rely on financial statement data. A global shift in accounting standards will have a strong influence on the comparability of companies’ accounting data across reporting jurisdictions.
• The profit-split, is a transfer pricing method commonly used in the financial services industry. If an allocation key used for the attribution of profits is derived from accounting-based data, results may differ if different accounting standards were used.
• If some group members adopt IFRS for regulatory or local accounting purposes, it will be necessary to convert the results using a single accounting standard. These are among the considerations that should be discussed prior to the implementation of any new post-conversion systems.
• Conversely, some transaction-based methods — such as the comparable uncontrolled services price method (CUSP) under Section 482 and the comparable uncontrolled price method (CUP) under OECD — are unlikely to be impacted by conversion because the amount benchmarked is not subject to accounting treatment. The prices or percentages charged are often captured in an agreement or contract, mitigating the role of possible differences in revenue/cost recognition under different accounting regimes.
• Conversion could impact both technical and practical transfer pricing matters. For example, a revamped accounting system could affect where and how data is sourced for transfer pricing analyses. If new systems are implemented for a shift to IFRS, transfer pricing professionals should try to take advantage of the opportunity to improve the access and availability of critical data needed for transfer pricing analysis. If there have been issues capturing necessary information in the past, participation in the planning and implementation of a new system could address many of these problems.

IFRS impact on revenue recognition and accounting standards

• Implications for previously recognized income

  Subject to certain exemptions, companies that elect to adopt the financial reporting standards of the International Accounting Standards Board (IASB) are required to retrospectively apply, to all periods presented, the international standards that exist as of the company’s adoption of IFRS, as if those standards had always been in effect.

  Consequently, differences between US GAAP and IFRS generally result in first-time adoption adjustments to the financial statements. For example, timing differences between US GAAP and IFRS could impact how previously recorded transactions must be recorded on Day 1 and into the future.

• Implications for revenue recognition

  Regarding revenue recognition, there is significantly less detail in the International Accounting Standards (IAS) framework than in US GAAP, which is very prescriptive and often provides guidance for specific industries.

  This reduction in guidance will increase the subjectivity of how transactions are treated, thereby reducing comparability. As IFRS adoption increases around the world, additional guidance should become available to address some of these concerns.

Income previously recognized under local GAAP that would not have yet been recognized under IFRS may require certain adjustments. If, for example, IFRS required a slower recognition of revenue for a transaction than US GAAP, too much revenue may have already been recognized. This amount would have already been allocated to foreign affiliates. Treatment of this could reasonably be addressed in one of two ways:

• First, by immediately aligning the company with IFRS, retained earnings would be reduced and the previously recognized revenue would be re-recognized through earnings as IFRS deems appropriate. This creates a problem from a transfer pricing perspective because it would require companies to withdraw previously recognized earnings from other jurisdictions.
• Second, the company could maintain its US GAAP methodology for existing transactions and make necessary changes as required by IFRS on future transactions. This would require no retroactive adjustment. It would, however, require the maintenance of separate records, systems and processes, one for US GAAP (for existing transactions) and one for IFRS (for new transactions).