Week 6: Income Tax
Lecturer: Leonard Lau
ACCT5907 International Financial Statement Analysis
Term 1, 2024
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Topics and Key Learning Objectives
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1. Tax avoidance / evasion under attack
• Double Irish with Dutch sandwich
• Apple (AAPL) case study
2. Impact of Tax reform: USA Trump Tax Reform illustration
3. FREQ Earnings management: income tax expense
• IBM case study original
• IBM case study plus Trump tax reform
4. The accounting fundamentals for deferred tax
• Reconciling Income tax expense (ITE) with
• Current tax liability payable
• Deferred tax liability / asset
5. Deferred Tax Asset quality and Covid-19 impact
6. Tax base balance sheet: temporary or timing differences (not examinable)
• Other learning path available for Master of Prof Acc students taught in ACCT5942.
International tax avoidance / evasion under attack
Status quo of multinationals reported zero or minimal tax expenses in various jurisdictions might change
and making forecasting more uncertain
“… no, Apple does not use the Double Irish with Dutch associations and it never has”
https://www.smh.com.au/business/apple-australia-denies-double-irish-with-dutch-sandwich- tax-avoidance-20150419-1modsj.html
Australia’s response, a “google tax”
https://www.smh.com.au/business/the-economy/australia-now-officially-has-a-google-tax-diverted-profits-tax-laws-pass-parliament-20170328-gv83va.html
and aggressive enforcement
https://www.abc.net.au/news/2020-09-29/multinationals-tax-avoidance-ato-tax-office-disputes/12694162
Building fairer societies through global tax co-operation
https://www.youtube.com/watch?v=KEh2aYw546A&t=1s
5 key areas of OECD action to tackle Base Erosion and Profit Shifting (BEPS)
https://www.oecd.org/about/impact/ending-offshore-profit-shifting.htm
https://www.youtube.com/watch?v=imjo9-YP_wM&list=PLwJUf-surgy4vyyAX9kkY4UVxj85cYCnm
BEPS2.0: Pillar one and Pillar two: https://kpmg.com/xx/en/home/insights/2020/10/beps-2-0-pillar-one-and-pillar-two.html
Implications for Financial Statement Analysis:
• Future earnings may be substantially lower than current earnings affect valuation models
• FREQ predictability based on past earnings
• ADJUST Re-estimate probable effective tax rate and calculate forecast earnings,
e.g. instead of 0% or 5%, may be 30% (or your country’s statutory tax rate)
3 Jargons alert: Transfer Pricing Double-Irish Sandwich with a Dutch Sandwich Google Tax
BEPS Base Erosion and Profit Shirting
Apple impact
Apple aggressive tax structure to minimise taxes in the European market challenged by European Commission
Fiscal 2015 10-K just before: See Provision for Income Taxes (page 29):
https://www.sec.gov/Archives/edgar/data/320193/000119312515356351/0001193125-15- 356351-index.htm
See also their EX-21.1 from same filing, about their subsidiaries, where are they located?
“Provision for Income Taxes” (expense), see discussion:
• Effective tax rate being lower than 35%
• EU investigation: “The Company believes the European Commission’s assertions are without
merit. If the European Commission were to conclude against Ireland, the European Commission
could require Ireland to recover from the Company past taxes covering a period of up to 10
years reflective of the disallowed state aid.”
– Accounting: possible contingent liability
https://www.newstalk.com/news/european-commission-to-appeal-apple-tax-ruling-from-eu-court-1081656
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Jargons alert: Statutory tax rate Effective tax rate Undistributed foreign earnings Repatriation of foreign earnings
Local vs foreign tax Deferred tax assets and liabilities valuation change
Impact of Tax reform: a USA Trump Tax Reform illustration
Broad implications: Lower statutory tax rate outlook, deferred tax assets/liabilities valuation change, tax incentives for
capex, tax disincentive for over-leverage, and possible increase in repatriation of foreign earnings
Tax Cuts and Jobs Act 2017 (for presentation just focus on Company related tax)
https://www.investopedia.com/taxes/trumps-tax-reform-plan-explained/
“Foreign Earnings”: one time cash repatriation tax of profits in overseas subsidiaries of
8%-15.5%
 less borrowing for dividends, buybacks, lower leverage
“Corporate Tax Rate”: (fed) tax 21% (v. 35%)  ↑earnings
“Immediate Expensing”: of short-lived capital investment (v. depreciation) ↑capex, ↓CFI
“Net Operating Losses”: 90%, 80% after 2022 (v. no cap)
“Interest”: net interest deduction 30% EBIT (v. no cap)  less borrowing? for buybacks?  less FREQ
EPS management?
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Lesson from Trump’s tax reform (immediate implications)
Cash repatriation

‘Thanks To Tax Cuts, Companies' Overseas Profits Now Flooding Back To U.S.’
https://www.investors.com/politics/editorials/overseas-profits-return/
Tax rate reductions may have upfront FREQ asset quality implications
‘Citigroup’s $20 Billion Write-Down Would Be Just the Ticket’
https://www.nytimes.com/2017/12/07/business/dealbook/citigroup-taxes.html
(Both Citibank articles to for a single presentation. Use on UNSW Library Proquest if paywall blocked)
‘Citi is dropping after warning the Senate GOP tax bill could cost it $20 billion’ (with market reaction chart)
https://markets.businessinsider.com/news/stocks/citi-stock-price-falls-after-warning-the-gop-tax-bill-could-cost-20-billion-2017-12-
1010435679?op=1#
Relevant reference: Textbook Chapter 9, Section 3.3 Changes in Income Tax Rates
Depends on net position of deferred tax assets and liabilities: Citigroup had net deferred tax
assets because of past tax losses (from GFC) carried forward.
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Jargons alert: Repatriation of foreign earnings Deferred Tax Assets write-down
USA Biden’s Tax Plan and post-Trump presidency updates
Biden’s Tax Plan: What’s Enacted, What’s Proposed (Apr 2021)
For presentation focus on corporate tax changes only
https://www.investopedia.com/explaining-biden-s-tax-plan-5080766#
Several tax proposals included in Biden’s FY23 budget (Apr 2022)
For presentation focus on corporate tax changes in the main article; optional to extend to the “read the full alert” section
https://www.ey.com/en_us/tax/several-tax-proposals-included-in-biden-s-fy23-budget
Global Corporate Minimum Tax: What it is, How it Works (Feb 2023)
What Is the US Position on the OECD Proposal for a Global Corporate Minimum Tax?
https://www.investopedia.com/global-corporate-minimum-tax-5192149
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EY: How we entered an era of permanent tax uncertainty (Apr 2022)
https://www.ey.com/en_us/tax/how-we-entered-an-era-of-permanent-tax-uncertainty
FREQ Earnings management: income tax expense
An IBM illustration: Managing the profit after tax (PAT) reported earnings by tax expense line
IBM 4Q 2013 earnings announcement MD&A
https://www.sec.gov/Archives/edgar/data/51143/000110465914003343/a14-3591_18k.htm
https://www.sec.gov/Archives/edgar/data/51143/000104746914001302/a2217495zex-13.Htm
INFER (if you cannot get the zerohedge article the analysis below in bullet points would be sufficient)
https://bambooinnovator.com/2014/01/22/ibm-asian-revenues-crash-adjusted-earnings-beat-on-tax-rate-fudge-debt-rises-20-to-fund-stock-buybacks/
• Compare income tax expense (11.2%) effective tax rate with previous quarter YoY
(25.5%), or to longer time-series (next slide)
• Check 10-K Note N (p.121) for reasons? Main reason foreign differential: maybe tax avoidance (e.g. Double Irish)
• Check other previous 10-Ks: no serious discussion of reconciliation in 2012 (2012 10-K p.121, DrW checked but you do
not have to for this course)
ADJUST use the previous period’s effective tax rate as benchmark
• IBMtax.xlsx, also worksheet for 2015Q1 to match article in Lecture02
A note on proper accounting terminology and practitioner’s ambiguity (also previously mentioned in Lecture02)
• Income tax expense  vs. “Provision for income taxes” “Allowance” (contra: asset CR) vs. “Provision” (liability CR)
• Allowance for doubtful debts  vs. Provision for doubtful debts
• Net income (profit) vs. net income (profit) after tax (redundant)
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Jargons alert: Effective tax rate: current period vs prior period Statutory tax rate Double-Irish arrangement
Prior period average effective tax rate Provision vs Allowance vs Expense
IBM plus Trump tax reform 4Q & Full 20178
IBM 4Q 2017 earnings announcement MD&A
https://www.sec.gov/Archives/edgar/data/51143/000110465918002862/a18-3308_1ex99d1.htm
https://talkmarkets.com/content/us-markets/ibm-beats-thanks-to-record-low-tax- rate?post=162984
FREQ 1 persistence: one-time tax expense from US Tax Cuts & Jobs Act
INFER 1: What was the reason this time? 10K p.44, 122
• What was continuing ops effective tax rate? 49.5% - 48%=1.5%
• What was the main reason? 48% rate: U.S. Tax Cuts and JobsAct
ADJUST 1
• Do you adjust for one-off? What would it have been without? 1.5%
FREQ 2 earnings management: from lower income tax expense
INFER 2: What was the effective tax rate after adjusting for FREQ 1?
• 49.5% - 48%=1.5%
• Compare with time-series (IBMtax.xlsx)
• Rebounds in 2014 (some reversal?)
• But decline continues in 2015, 2016 (as low as 3.6%)
• Snowballing? Because no major reversal of effective tax rate
• Compare with peers (eg Apple ~ 26%, which includes offshore tax avoidance, without which would be higher)
ADJUST 2
• Choose an effective tax rate: recalculate net income
• You need to actually do the calculation if the numbers are available
Opportunity to flush out tax expense not recognised (snowballed) in prior years camouflaged as part of one-off Trump tax reform related
The accounting fundamentals for deferred tax
Accounting profit and taxable income is subject to different rules/basis
• Deferred tax is an Accrual
Accounting accrues the tax incidence
• Gap between accrued accounting tax expense and tax law’s tax expense  DTA/L (accrual)
• Compare accounting base and tax base
But book-tax equivalence accounting would limit incentive to manage earnings
• Same accounting and tax basis
• Accrued accounting Income tax expense = Income tax paid
• No DTA/L on the balance sheet
• Very few (none?) countries these days
• Companies from book-tax countries reported low profits
– E.g. Daimler when first cross-listed on NYSE (1990s) reported low profits under German
Accounting Standard, but high profits under US GAAP
FREQ earnings management because do not have to worry about paying more tax
• Time shifting technique: push tax expense in to future
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Jargons alert: Accrued Accounting Tax Expense = Current + Deferred Tax Expenses Current Tax Liability (CTL) Deferred Tax Liability (DTL)
Deferred Tax Asset (DTA) Book-Tax Equivalence accounting
Reconciling ITE with CTL/ DTL
Can the change in income tax expense (ITE) be explained? Normally,
• ITE/L = CTE/L + DTE/L
• Note: DTE/L = Net ∆DTA/L= (∆DTL - ∆DTA)
To reduce ITE
• ITE ↓ = CTL ↓ + DTL ↓ + missing? Push into future
• Remember: earnings can be managed by time shifting expenses
• In this case: neglect to recognise it (not in books)
So in future we may see (e.g. next slide Qantas TOP)
• ITE = CTL + DTL + Prior period Adj
But sometimes, changes through equity makes it hard to reconcile (e.g. next
slide Qantas BOTTOM)
• ITE/L = CTE/L + DTE/L + Prior period Adj + ∆Equity
• Because DTL of items via OCI (Equity) and not Income
⇒ Very difficult to check in this way
⇒ Best is to compare with previous effective tax rates, or peer companies
like we did on slide 7
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Jargons alert: ITE: Income Tax Expense CTL: Current Tax Liability DTL: Deferred Tax Liability DTA: Deferred Tax Asset
CTE: Current Tax Expense DTE: Deferred Tax Expense
Rule of thumb – P/L approach
Accounting ITE $10 = Tax Law ITE $10
Dr. Income Tax Expense 10
Cr. Current Tax Payable 10
(ITE 10 = CTE 10 + DTE 0)
Accounting ITE $8 < Tax Law ITE $10
Dr. Income Tax Expense 8
Cr. Current Tax Payable 10
Dr. Deferred Tax Asset/Liability 2
(ITE 8 = CTE 10 + DTE -2. Pay more now, less later)

Accounting ITE $10 > Tax Law ITE $8
Dr. Income Tax Expense 10
Cr. Current Tax Payable 8
Cr. Deferred Tax Asset/Liability 2
(ITE 10 = CTE 8 + DTE 2. Pay less now, more later. )
Reconciling ITE to CTL & DTL
Prior period adjustments in future
DTL recognised
directly in equity
(OCI) not income
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Covid-19 impact on deferred tax assets quality
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What is deferred tax asset?
https://www.investopedia.com/terms/d/deferredtaxasset.asp#
‘COVID-19 may impact projections of future taxable profits that are used to assess
the recoverability of deferred tax assets’ (KPMG)
https://home.kpmg/xx/en/home/insights/2020/03/covid-19-assets-1c.html
• of future taxable profits that are used to assess the recoverability of deferred
tax
‘Ten COVID-19 tax provisions surprises CFOs should prepare to address’ (EY)
https://www.ey.com/en_au/tax/income-tax-provision-and-covid-19-10-better-questions-cfos-should-be-asking
Tax base balance sheet: temporary or timing differences
(not examinable)
IAS12, para 10
• Where the tax base of an asset or liability is not
immediately apparent [if you do not understand],
it is helpful to consider [do not worry] the
fundamental principle upon which this Standard is
based: that an entity shall, with certain limited
exceptions, [this is an easier way to think about it]
recognise a deferred tax liability (asset) whenever
recovery or settlement of the carrying amount of an
asset or liability would make future tax payments
larger (smaller) than they would be if such recovery
or settlement were to have no tax consequences.
Pay more tax now (pay less tax in future)
=> Asset (DTA)
Pay less tax now (pay more tax in future)
=> Liability (DTL)
Not examinable
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Rule of thumb – Balance Sheet approach

Say: Accounting ITE $20 > Tax Law ITE $18
Dr. Income Tax Expense 20
Cr. Current Tax Payable 18
Cr. Deferred Tax Asset/Liability 2
(ITE 20 = CTE 18 + DTE 2. Pay less now, more later. )
Say tax rate = 25%
Tax Payable is 2 less than Tax Expense because of the timing difference =
2 / 25% = 8
E.g., Tax Law’s depreciation deduction is $8 higher than Accrued
Accounting depreciation expense. Higher deduction means pay less
tax. The current period difference, and the accumulated differences
would show when comparing the accounting vs tax base balance sheet
items relating to the timing difference.
Say, comparing the PPE carrying amount: Accounting based 100 (higher)
vs Tax based (lower) carrying amount 92. Difference of 8 due to
difference in accumulated depreciation. Hence DTL = (100-92) x 25% =
2. This will accumulate, and eventually decreased to zero when the
direction of the timing difference reversed.
Worldwide Tax Summaries online – PWC
non-examinable reference resource https://taxsummaries.pwc.com
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Self development activity on international
taxation:
https://taxsummaries.pwc.com
1) Look up on the tax rules overview on
Australia, China, USA, and Singapore
2) Review the respective country’s Overview
and the Significant Developments sections.
3) Click “Compare” and create a summarized
table comparing the above 4 countries tax
positions.
4) What are their Headline CIT rates,
corporate income tax return due date, and
VAT rates?