Over the past few years, in order to comply with the growing movement toward consistent international reporting on financial statements, many companies have begun the transition to International Financial Reporting Standards (IFRS). While making this change, there are many factors that corporations need to consider. One of the major features of IFRS reporting is that it does not permit the use of LIFO (last-in, first-out) for inventory valuation.
This change affects tax reporting as well as financial reporting. Code Section 1.472-2(e) states that if a taxpayer elects to use LIFO for federal income tax purposes, it must prove to the IRS that is uses no method other than LIFO in its determination of income, profit, or loss. In addition, all statements given to either shareholders, partners, beneficiaries, or creditors must conform to this LIFO requirement or include explanatory language as to the lack of conformity. If these LIFO conformity rules are violated, the taxpayer may be forced to discontinue the use of LIFO.
The IRS recently examined a case where the LIFO conformity rules and IFRS standards came into conflict. This issue will become more relevant as IFRS and generally accepted accounting principles (GAAP) convergence becomes a reality in the next few years. This case revolves around a taxpayer that became a wholly owned subsidiary of ABC, which files a consolidated tax return. The taxpayer had used GAAP in the past, but was required to switch to IFRS. Despite the fact that IFRS do not allow the LIFO method, the taxpayer continued to use it for tax reporting purposes. When the company gave financials to its parent company, it provided an IFRS balance sheet. The taxpayer then gave these documents to a lending institution. So while the taxpayer was prohibited by IFRS from using LIFO, LIFO conformity rules state that a taxpayer cannot use an inventory method other than LIFO if it has already elected to use LIFO.
The IRS concluded that this company violated the three LIFO conformity rules. First of all, it used an inventory method other than LIFO to calculate income. Secondly, these financial statements were then used for a letter of credit, which is deemed "for credit purposes." And finally, this company failed to provide supplementary or explanatory information.
This case provides an example of how IFRS can violate the tax code. Consequently, while making the transition to IFRS, business owners must be conscious of the tax consequences of this transition.
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