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The Importance Of Differences Between Taxation And Accounting Rules
Companies in Albania must comply with financial accounting and reporting rules aimed at providing investors with a true and fair view of the company’s financial condition. These rules increase the transparency and international comparability of the company’s or group’s results and are a strong step in 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 used in commercial and tax law. They are increasingly based on a fair presentation approach. The results shown for financial purposes can be quite different from the profits shown in the books of individual companies or in tax returns. Multinational companies therefore run the risk of facing unjustified demands for adjustments to taxable profits or the requirement that profits shown for financial purposes in a particular country are taxable in that country.
The national and international business community considers it important that tax authorities and policy makers understand the reasons why the results shown in the financial statements of a company or group differ from the taxable results of such company or group.
Different approaches have been used in determining taxable profit
Some countries in Europe follow the dependency concept when determining taxable results. This means that the profit derived from commercial accounts is taken into account as the primary basis for tax assessment. Subject to the relevant tax rules, certain tax adjustments must be made 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 one for tax purposes. Such countries do not rely heavily on commercial accounting rules for taxation, which can make the two systems quite different.
Both systems have advantages and disadvantages. Separate tax rules require two sets of rules to be applied, which can increase the compliance burden for businesses. For tax purposes, it may also be easier to depart from certain principles of commercial accounting. Even if taxation is based on commercial invoices, some tax adjustments are unavoidable.
For now, it would be unrealistic to demand a common approach in this regard. Each country is free to decide whether the determination of taxable results should be based primarily on commercial accounts or whether it should result from the application of a separate set of tax rules.
Countries are entitled to 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 neglected.
Differences between commercial accounting and capital market rules
The Economic Act prescribes how the financial results of an individual company are determined. These rules are often laid down in specific accounting laws. Accounting and reporting rules are based on the principle of fair presentation and are primarily intended to increase transparency for investors. The standards should be applied consistently across the group. Sometimes companies have a choice about using a particular method or rule. The unified application is reviewed by external auditors and enforced by supervisory authorities. Specific accounting and reporting standards for companies increase transparency and comparability, especially for investors. Convergence of principles governing existing accounting and reporting standards is desirable to increase comparability and facilitate multiple listings. However, the potential tax implications for businesses should be taken into account, particularly in countries that rely on commercial invoices as the primary basis for tax assessment, and convergence should not worsen the tax position of businesses.
Different approaches and different purposes
Commercial, financial and tax rules serve their purposes, so differences in results should be expected and accepted.
o Commercial accounting rules are used to determine the commercial results of an individual entity. In particular, they determine whether a profit or loss has occurred in a certain period. The rules can be part of national commercial law or company law. They are intended to protect the rights of shareholders and creditors, which is why the precautionary principle occupies an important place.
o The rules on financial accounting and reporting are part of the state capital market regulations. Their goal is to provide investors (and other stakeholders) with a reliable and as accurate as possible picture of the financial condition of the economic entity (group) at a given moment (financial position, performance, cash flows). The guiding principle is “fair representation” or “true and fair view”. Other important rules in this regard are “substance over form”, “measurement of market value” and – as a true and fair corollary – the actual prohibition of hidden reserves.
o Taxation rules are used to determine taxable profit. Their goal is to define the tax liability of companies to the tax administration for an individual year. The rules must be amenable to compliance by taxpayers and control and enforcement by tax authorities. Business tax rules are usually designed to maintain economic neutrality so that fiscal measures do not unduly influence business decisions. The rules may also set non-fiscal targets. Tax laws reflect the general principles of taxation, such as non-discrimination or taxation according to economic ability, as well as practical aspects such as the availability of funds to pay the liability (realization), fairness between different categories of taxpayers (neutrality), the annual nature of the liability (loss carry-forwards, standardized depreciation), long-term profitability (prudence, impropriety, valuation below market value) and other similar factors. For example, tax systems may prescribe specific timing rules for the recognition (or deferral) of income, loss carryforwards from other years, and other rules specific to the area of taxation.
The approaches used to calculate business, financial and tax statements serve different purposes. Although the relevant rules are focused on the same general objective (the results of the business entity in a certain period), it is important to understand that according to the existing concepts, the rules used in financial accounting and those used for tax purposes should not expected to be strictly comparable.
Advantage of interaction between accounting and tax rules
Due to the demands of international capital markets (globalization), widely used accounting and reporting standards should result in a certain harmonization in the field of accounting and reporting. On the other hand, as long as each country imposes its own taxes and implements its own tax policy, a similar level of harmonization of tax rules cannot be expected. At the same time, the more the rules used for financial accounting differ from those used in the tax field, and the more transparent the results of the group become, the more obvious the differences arising from the application of the two sets of rules. to become Tax authorities should not use the entity’s financial results (in the same country or in third countries) as a pretext to adjust the company’s taxable profit or to justify transfer pricing adjustments.
The rules used for financial accounting and those used for tax purposes can be quite different and can lead to results that cannot be reasonably compared. Tax authorities and policy makers should accept that the fundamental principles of financial accounting are not always compatible with the basic principles and practices used in taxation. From a tax policy perspective, it is important that tax rules are not undermined by an inappropriate extension of financial reporting requirements.
Internationally recognized accounting standards can be understood as a coherent set of rules for accounting and reporting that should give investors a “true and fair view” of the financial position (balance sheet), performance (income statement) and changes in the financial position (cash flow) of an economic of the subject at a given moment.
In the area of taxation, some generally accepted principles clearly deviate from the concepts used for financial accounting and reporting purposes. In addition, tax laws often provide for non-fiscal objectives, e.g. allocation of special incentives (for research and development, for special reserves, to encourage self-financing, to attract certain business activities, etc.). They can be designed to influence the behavior of companies 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 financial results of companies for tax corrections.
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