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Enterprises in Albania must follow financial accounting & reporting rules aimed at providing investors with a true & fair view of the financial situation of the enterprise. These rules increase transparency & international comparability of the end results of an enterprise or a group, & are a strong step into the foreigner market. International Accounting Standards (IAS) & National Accounting Standards (NAS) are widely used by Multinational Enterprises (MNEs).

Financial accounting & reporting rules are rapidly shifting away from traditional legal concepts applied in commercial & fiscal laws. There is more. They are increasingly based closely on a fair presentation approach. The final results shown for financial purposes may differ considerably from the profits shown in the books of single enterprises or in the tax returns. MNEs therefore risk being confronted with unwarranted requests for tax profits adjustments or with the requirement that profits shown for financial purposes in a given country be taxable in that country. The national & international business community is of the view that it’s important for tax authorities & policy makers to understand the reasons why the end results shown in financial statements of an enterprise or a group differs from the taxable results of such enterprise or group.

Different approaches followed to determine taxable profits Some countries in Europe follow the concept of dependence in determining the taxable results. There is more. This means that the profits resulting from the commercial accounts are taken as the primary basis for tax assessment. OK. Subject to the relevant taxation rules, certain fiscal adjustments have to be made in order to calculate the taxable profits.

Other countries, in particular those with a common law tradition, follow the concept of independence. Two separate sets of rules are applied, one for the commercial results & another for tax purposes. So… Such countries do not rely heavily on commercial accounting rules for taxation, which may have as a consequence that the two systems differ considerably. Both systems have advantages & shortcomings. Right. With separate taxation rules, two sets of rules must be applied, which may increase the compliance burden for enterprises. It may also be easier to deviate for tax purposes from certain principles followed in commercial accounting. However, even when taxation is based closely on the commercial accounts, certain tax adjustments are unavoidable.

For the time being, it would be unrealistic to ask for a common approach in this respect. Each country is free to decide whether the determination of the taxable results should be based primarily on commercial accounts or derived from the application of a separate set of taxation rules. Countries have the right to follow different approaches with respect to the relationship between commercial & tax accounting (dependence/independence). Both approaches have advantages & shortcomings. However, in both cases, well-established principles of taxation must not actually be disregarded.

Differences between commercial accounting & capital market rules Commercial law prescribes how the financial results of a single enterprise are determined. These rules are often set out in specific accounting laws. Accounting & reporting rules are based closely on the principle of fair presentation & are mainly designed to increase transparency for investors. There is more. The standards must be applied consistently to the whole group. Sometimes, enterprises are given a choice with regard to the application of a given method or rule. The uniform application is examined by external auditors & is enforceable by supervisory bodies. So… Specific accounting & reporting standards for companies increase transparency & comparability, mainly for investors. A convergence of the principles governing existing accounting & reporting standards is desirable in order to increase comparability & to facilitate multiple listings. However, possible tax implications for companies, especially in countries relying on commercial accounts as primary basis for tax assessment, have to be kept in mind, & the convergence should not deteriorate the tax position of enterprises.

Different approaches & different purposes
Commercial, financial & taxation rules serve their own purposes and, as a consequence, differences in the end results should be fully expected & accepted.

? Commercial accounting rules are used to determine the commercial results of a single entity. They establish, in particular, whether a profit or a loss has resulted for a given period. The rules may form part of a country’s commercial or company law. They are intended to protect the rights of shareholders & creditors and, as a consequence, the prudence principle occupies an important place.

? Financial accounting & reporting rules are part of a country’s capital market regulations. There is more. Their objective is to give investors (and other stakeholders) a reliable and, as accurate as possible, picture of the financial situation of the economic entity (group) at a given moment (financial position, performance, cash flows). The guiding principle is “fair presentation” or “true & fair view”. Other important rules in this respect are “substance over form”, “market value measurement”, & – as a consequence of true & fair – the factual prohibition of hidden reserves.

? Taxation rules are used to determine taxable profits. There is more. Their objective is to define the tax liability of enterprises to the tax administration for a given year. The rules must be susceptible to compliance by taxpayers & control & enforcement by tax authorities. There is more. Taxation rules for companies are usually designed to preserve economic neutrality, so that business decisions are not unduly influenced by fiscal measures. The rules may also provide for non-fiscal objectives. There is more. Tax laws reflect general principles of taxation, such as non-discrimination or taxation according to economic capacity, but also practicalities, such as availability of funds for payment of the liability (realization), fairness between different categories of taxpayers (neutrality), the annual character of the liability (loss carryovers, standardized depreciations), long-term profitability (prudence, imparity, valuation below market value) & other such factors. By example, tax systems may prescribe special timing rules for the recognition (or deferral) of income, loss carryovers from other years & other rules peculiar to the field of taxation.

The approaches followed for the calculation of commercial, financial & taxation statements serve different purposes. Even though the respective rules are focused on the same general object (the results of a business entity in a given period), it’s important to understand that, under existing concepts, the rules applied in financial accounting & those applied for tax purposes should not actually be fully expected to be strictly comparable.

The good of interactions between accounting & taxation rules
As a result of demands by international capital markets (globalization), widely used accounting & reporting standards are expected to lead to a certain harmonization in the area of accounting & reporting. On the other hand, so long as each country imposes its own taxes, implementing its own tax policies, a similar degree of harmonization of taxation rules isn’t to be expected. At the same time, the more the rules used for financial accounting differ from those used in the field of taxation, & the more the end results of a group become transparent, the more obvious the differences that result from the application of the two sets of rules become. Tax authorities should not use the financial results of an entity (in the same country or in third countries) as a pretext for an adjustment of the taxable profits of an enterprise or to justify transfer pricing corrections. The rules applied for financial accounting & those used for tax purposes may differ considerably & may lead to results that can not reasonably be compared. Tax authorities & policy makers should accept that the underlying principles of financial accounting are not always compatible with basic principles & practices used in the field of taxation. From a tax policy perspective, it’s important that taxation rules are not undermined by an inappropriate extension of financial reporting requirements.

Internationally recognized accounting standards can be seen as a coherent set of rules for accounting & reporting that should give investors a “true & fair view” of the financial situation (balance sheet), performance (income statement) & changes in the financial position (cash flow) of an economic entity at a given moment.

In the field of taxation, some widely accepted principles clearly deviate from concepts used for financial accounting & reporting purposes. In addition, tax laws often provide for non-fiscal objectives, e.g. the granting of specific incentives (for R&D, for special reserves, to promote self-financing, to attract certain business activities, etc.). They may be designed to influence the behavior of enterprises by granting incentives or using disincentives (e.g. environmental taxes or relieves). Furthermore, a country’s taxation system is the result of a political decision-making process & therefore, in many cases, neither neutral for businesses nor fully internally consistent. Taxation & financial accounting rules serve different purposes, have different objectives & are based closely on different principles. Even though both sets of rules are used to measure the annual results of an enterprise, differences in the end results or in the methods applied have to be accepted. Financial accounting looks at the enterprise as an economic entity, whereas taxation is normally based closely on a separate entity approach.

Policy makers in the fields of taxation & accounting must be fully aware of these differences. There is more. Tax authorities must respect them & refrain from using companies’ financial results for tax adjustments.

By Eduart Gjokutaj

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