 REPARIS Workshop “The relationship between corporate income tax reporting and annual accounts: Current Approach in Austria” Friedrich Roedler Partner - PricewaterhouseCoopers Vienna - March 14th 2006

PricewaterhouseCoopers Februar 2006 Slide 2 Financial Reporting - Background Austria is a “middle market economy” Few listed companies Bank debt as most important source of financing Historically main purpose of statutory Austrian GAAP financial statements: Determine disposable income (distributable profit for corporations)  protection of creditors Information to owners / shareholders / investors / public Austria

PricewaterhouseCoopers Februar 2006 Slide 3 Austrian GAAP IFRS required / allowed for consolidated accounts but not allowed for stand-alone financial statements Sources for Austrian GAAP Law – (§ 189 to 211 Commercial Code - “Handelsgesetzbuch” – “HGB”) Statements from the professional institutes (Chamber of Accountants, Institute of Auditors) Common practice and custom Austria

PricewaterhouseCoopers Februar 2006 Slide 4 Austrian GAAP Key principles of Austrian GAAP True and fair view “Prudence” vs “Fair View” -current assets: lower of cost or market -liabilities: higher of current value or repayment amount -no creation of hidden reserves (if reason for write-down does not exist any longer  write-up) -realisation / Imparity principle: gains: recognised when realised unrealised losses recognised -Current assets: write-down to market -Fixed assets: write-down if quasi-permanent impairment Austria

PricewaterhouseCoopers Februar 2006 Slide 5 Taxable Income Should reflect ability to pay  only realised profits should be taxed ! annualised profit on accruals basis Financial reporting (business accounting rules according to Austrian GAAP) as the starting point for determining taxable business income for corporations  “Dependency” between accounting income and taxable profit (“Massgeblichkeit”) similar to Germany Austria

PricewaterhouseCoopers Februar 2006 Slide 6 Legal Basis for Dependency between Financial Reporting and Corporate Income Tax Reporting Taxable trading income -Difference between net value of a company at the beginning and at the end of the fiscal year (income according to “tax balance sheet”) -adjusted by withdrawals (e.g. dividends) and contributions from shareholders Non-deductible expense / tax-exempt income § 5 (1) EStG (Income Tax Act): linkage between statutory financial reporting and income tax reporting: “dependency” (“Maßgeblichkeit”) Linkage applies to taxpayers (individuals, partnerships and corporations) registered in the companies register  obliged to keep books according to Austrian GAAP Austria

PricewaterhouseCoopers Februar 2006 Slide 7 “Formal” vs “General” Dependency (“Formelle” vs “Materielle” Maßgeblichkeit) Is taxable income to be determined based only on GAAP in general (“general” dependency) or also depending on the actual accounting choices made in the taxpayer’s statutory balance sheet (“formal” dependency)? Prevailing view: “formal” dependency -Simplification -´”Equal treatment” for fisc and taxpayer Austria

PricewaterhouseCoopers Februar 2006 Slide 8 Dependency Mandatory GAAP to be observed for tax purposes, e.g.: -Liabilities must be booked at the higher of current value or repayment amount -Imparity principle also valid for tax purposes Where GAAP allow for discretionary accounting treatment -Tax follows accounting treatment as applied by the taxpayer for accounting purposes -Deductions claimed from taxable income (e.g. valuation, depreciation, provisions, accruals, ………) only if booked in statutory accounts -…. unless tax law provides a mandatory rule

PricewaterhouseCoopers Februar 2006 Slide 9 Financial Reporting vs Tax Reporting mandatory rule tax rule prevails mandatory rulediscretionary ruletax follows financial accounting („general“ dependency) discretionary rule tax follows election made in financial reporting („formal“ dependency) discretionary rulemandatory ruletax rule prevails GAAP Tax Law Austria Tax Reporting

PricewaterhouseCoopers Februar 2006 Slide 10 „Formal“ Dependency Examples: Definition of acquisition cost / production cost Capitalisation of start-up cost and cost for major business expansion (§ 198 (3) HGB) write-off of current assets to market value Write-off of fixed assets due to permanent impairment of value Write-off of low-value assets Accruals

PricewaterhouseCoopers Februar 2006 Slide 11 Examples - “General” Dependency Capitalisation of self-created intangibles: Austria Sec 197(9) HGB: self-created intangibles must not be capitalized Sec 4 (1) EStG: intangibles may be capitalised only if acquired against compensation Self-created intangibles must not be capitalised for tax purposes

PricewaterhouseCoopers Februar 2006 Slide 12 Examples – “Formal” Dependency Capitalisation of interest in production cost: Austria § 203(4) HGB: option to capitalise interest expense in production cost EStG: no tax rule Option to capitalise interest expense in production cost for tax purposes - dependency

PricewaterhouseCoopers Februar 2006 Slide 13 Example - No Dependency Austria Acquired goodwill: § 203(5) HGB: acquired goodwill may be capitalised and amortized over the expected period of use § 8(3) EStG: acquired goodwill must be capitalised and amortized over 15 years acquired goodwill must be capitalised and amortized over 15 years for tax purposes even if not capitalised for accounting purposes

PricewaterhouseCoopers Februar 2006 Slide 14 No Dependency Due to Mandatory Tax Rules Examples: Acquired goodwill Inventories: capitalisation of material and selling overhead cost Depreciation of fixed assets Accruals Correction of errors -GAAP financial reporting: current year -Tax: retroactive correction of prior years (opening balance sheet) Financial reporting year-end / fiscal year-end Austria

PricewaterhouseCoopers Februar 2006 Slide 15 “Reverse” Dependency - (“umgekehrte Maßgeblichkeit”) Valuation of Inventories: § 207 HGB: lower of cost or market principle for inventory § 6 Z 2 EStG: optional for tax but in fact mandatory due to general dependency § 208 (1) HGB: for financial accounting: obligatory write-up if reason for previous write-down ceases to exist § Sec 6 Z 2 EStG: for tax: “lower of cost or market” with optional write-up if reason for previous write-down not valid any longer § 208 (2) HGB: exemption from the obligation to write-up inventory if otherwise also an obligation to write-up for tax purposes Austria § 208 (2) HGB allows an exemption from from “true and fair view” principle for tax reasons !!!

PricewaterhouseCoopers Februar 2006 Slide 16 “Reverse” Dependency – Impact of Tax on Financial Reporting options allowed for tax purposes (valuation) must be exercised in accordance with statutory accounting (“formal” dependency) some tax benefits can be claimed only if also reflected in statutory financial accounts, e.g.: -Immediate write-off of low-value fixed assets tax has major impact on financial reporting Austria

PricewaterhouseCoopers Februar 2006 Slide 17 Accounting Choices Implicitly Impacted by Tax Examples: depreciation of fixed assets -period and methodology (financial: “consistent methodology”; tax: straight-line) -depreciation in 1st year (full or half year depreciation) purchase price allocation after an asset deal (e.g.:goodwill) inventory valuation (production cost, LIFO, ….) bad debt provisions accounting for lease contracts accruals for pensions choice of fiscal year-end Austria

PricewaterhouseCoopers Februar 2006 Slide 18 Impact of EU Law Austrian Commercial Code implements 4th Company Law Directive  Accounting rules have to be interpreted according to EU law Impact of ECJ case law on tax through dependency rules ? -ECJ can only interpret the relevant provisions of EU law -but not, how these accounting rules relate to Austrian tax law -ECJ can not rule how an accounting rule is interpreted for tax purposes VwGH : General tax principles override EU accounting directives EU Commission proposal for Common Consolidated Tax Base Austria

PricewaterhouseCoopers Februar 2006 Slide 19 Impact of IAS / IFRS IAS / IFRS obligatory for consolidated accounts Stand-alone accounts: Austrian GAAP; IAS / IFRS not allowed Convergence of Austrian GAAP – IAS ? IAS as “starting point” for taxable income (CCTB project of the EU Commission) ? Austria

PricewaterhouseCoopers Februar 2006 Slide 20 Impact of IAS / IFRS IAS / IFRS accounts not suitable for determining taxable income -private standard-setter for IFRS/IAS -tax courts to interpret IAS /IFRS ? -main purpose: information of investors -un-realised profits -subjective valuation of assets where no market value available -based on future expectations  uncertainty & subjectivity -judgemental (e.g.: IAS 38: capitalisation of development cost; IAS 37: restructuring cost) Austria

PricewaterhouseCoopers Februar 2006 Slide 21 The Future of the “Dependency Principle” in Austria Expect increased divergence between financial and tax reporting businesses have become more complex -  need for more specific tax rules -  dependency does not lead to more simplicity ! broadening of tax base by disallowing certain accruals and provisions globalisation: convergence of local GAAP and IAS / IFRS IAS / IFRS not suited for tax purposes impact of dependency principle on quality of financial reporting and corporate governance Austria