The new 137-country agreement to overhaul global taxation could step up pressure on some groups that had nothing to do with it—the panels that set corporate accounting rules.
The agreement uses a company’s income as measured under accounting rules, which is often different from its taxable income, as a key component of determining its tax bills. That could inject tax concerns into how accounting rules are set, some observers fear, and interfere with the goal of giving investors clear, unslanted information about companies’ finances.
In the worst-case scenario, they fear, politicians and governments will regularly pressure the private-sector bodies that set accounting rules to shape the rules on behalf of companies that have the politicians’ ear, in ways that would lower the companies’ taxes.
“That’s not what the point of this is,” said Sandy Peters, head of financial reporting policy for the CFA Institute, which represents chartered financial analysts and advocates on investors’ behalf. “You’re going to change who wants to influence what that numerical measure looks like.”
Using accounting income to set tax revenue “would be an additional pressure, there’s no doubt, on our mission and what we do,” said Rich Jones, the chairman of the Financial Accounting Standards Board, which sets the accounting rules for U.S. companies, at a meeting in November. (Jones was speaking about a similar U.S. proposal for a tax on “book income,” but a FASB spokeswoman said “some of the same concerns could arise” over the OECD agreement.)
At the International Accounting Standards Board, which sets accounting rules for most countries outside the U.S., companies are “active participants” in the process and their input is welcome, said a spokesperson for the IFRS Foundation, which oversees the IASB.
Accounting Income, Tax Rates
The global tax pact uses accounting income in two respects: For companies that will see some taxable profits reallocated from one country to another under the agreement, that determination is based on accounting income. And the calculation of a company’s effective tax rates in each nation, to see if they’re over the agreement’s 15% global minimum rate, uses accounting income, too. Accounting income will be subject to some adjustments, yet to be ironed out.
Accounting income is calculated relatively consistently across countries. In contrast, taxable income can vary from one country to the next because of factors like timing differences—differences in how countries treat deferred revenue, or the carrying forward of losses—as well as different tax rules on items like employee stock options and fines and penalties.
The tax agreement needs “a standardized measure of profit” as a basis for reallocation, and international accounting rules are “a useful and pragmatic reference point,” the Organization for Economic Cooperation and Development said in 2020 in a preliminary “blueprint” document as the OECD and negotiators worldwide worked on the pact. The U.S.’s accounting rules are separate from what most other countries use, but some of its rules align with the international rules.
But the process of setting accounting rules is supposed to be independent, free of any concerns other than defining what the numbers on a company’s financial statements look like. When other concerns intervene, accounting observers say, the rules can get bent out of shape, and interfere with the independence of the FASB and IASB.
Taxation and other policy concerns are ”not their reason for being,” said Dennis Beresford, a former FASB chairman. “They’re not supposed to be the group that picks the winners and losers in the economy.”
Linking taxation and financial accounting is “a bad idea,” said Stephen Zeff, a Rice University accounting professor. He said they have different aims—one to raise money to finance government programs and influence economic behavior, one to provide investors with useful financial information.
“These two sets of aims are incompatible. The quality of financial reporting is bound to suffer,” Zeff said.
Risk to Independence
Government officials have tried to intervene in the rule-setting process before when they don’t like the results, and sometimes it doesn’t end well. In the 1990s, for instance, political pressure prevented the FASB from revamping the accounting for employee stock options—a lack of action that later fueled the Enron scandal.
In 2009, Congress pressured the FASB into softening its rules for banks on valuing their investments, in the wake of the global financial crisis. In 2020, Congress allowed banks to hold off on adopting a new FASB-enacted way of recording loan losses, because of the Covid-19 pandemic.
“We did not want to have the accounting drive a company’s decisions,” said Russell Golden, another former FASB chairman. If that happens, “I think there’s a greater risk and greater pressure to independent standard-setting.”
That kind of politicization could even lead to political scrutiny of the views of every new appointee to the accounting boards, as well as the bodies that oversee them and advise them, said R. Harold Schroeder, a former FASB member. “Who gets appointed to the board, who are the trustees overseeing the process? All of that becomes fair game.”
Not everyone sees the tax agreement’s reliance on accounting income as a negative, however. Companies will want their accounting income to be higher and their taxable income to be lower, so folding those incentives together could “induce greater truth-telling” by companies, said Karthik Ramanna, a University of Oxford professor of business and public policy.
—With assistance from Michael Kapoor, Nicola White, and Hamza Ali.