In general we are supportive of moves towards taxation being based more closely on financial accounts given the potential for simplification and reduction in the compliance burden which such a move might offer. However, in view of the current developments in accounting, specifically the introduction of International Financial Reporting Standards (under the IASB) and the general move towards fair value accounting with effect from 1 January 2005, we do not believe it would be appropriate for taxation to become more closely aligned with financial accounts at this time.
We have been heavily involved in discussions with the IASB and others concerning the new standards and in particular the proposed hedge accounting aspects in IAS 39. We are very concerned that because of the very restricted definition of hedge accounting in IAS 39 non-financial sector corporates will be required to reflect changes in the fair value of their derivative contracts held for hedging purposes directly in their profit & loss accounts, leading to considerable volatility in their financial results. These companies will then be faced with the choice of trying to explain the resultant volatility to the financial media and analysts or changing, or even eliminating, sensible commercial hedging activities. There is already evidence from the US of changes in the hedging behaviour of companies in response to FAS 133, and we believe this to be very regrettable. If the guidance notes to IAS39, when finalised, do not allow hedge accounting on internal contracts arising from hedging on a net basis, then hedge accounting will be more restricted under IAS compliant accounts (than US GAAP compliant accounts). Consequently, volatility arising in IAS compliant accounts would exceed volatility in US GAAP compliant accounts.
We are concerned that if taxation were also to be based on the fair value results of derivatives this would present an even more tangible and effective deterrent to sensible corporate hedging activities. We believe that every effort should be made to ensure that non-financial sector corporates are not taxed by reference to short term movements in the values of financial derivatives which are commercially held for the long term as part of a genuine commercial hedging policy.
Reference has been made to the fact that such derivatives are readily realisable and that therefore any argument based on inability to pay is flawed. However it is important to recognise that even though these derivatives are often readily realisable, they are being held for long term commercial purposes and therefore if taxation forces their premature sale this would amount to taxation having an undue influence on commercial behaviour.
The vast majority of financial derivatives held by non-financial sector corporates are held for hedging purposes even though they may not qualify for hedging treatment under the restrictive definition in IAS 39. We believe it is vital that profits and losses on such derivative contracts continue to be taxed on an accruals basis.
