Provision in accounting vs. provision in taxation
Newsletter - March 2015
On 23 December 2013 the Conseil d’Etat (the highest administrative court) found in a ruling (“SAS Foncière du Rond-Point”) that a provision recorded in a company’s accounts should, except for certain exceptions, reduce the taxable earnings. Hence, the principle of there being a connection between accounting and taxation was reaffirmed.
Definition of a provision for accounting purposes
A provision is defined by the National Accounting Code Standards (“PCG”) (Article 321-5): It is a liability whose due date or amount is not specified exactly. This means that it is a likely charge that the company shall be required to incur. Provisions must be distinguished from amortisation:
– Provisions are recorded on the liabilities side of the balance sheet (item 15); they are intended to cover contingencies or charges;
– An amortisation item is recorded as a deduction from an asset item of the balance sheet; it is intended to convey the loss of value of an asset item (an inventory item or a receivable, for instance).
Recognition of a provision
The provision must be recorded to take account of contingencies and losses that occurred during the financial year (Article 513-4 of the PCG). When events that occurred or are occurring make it likely that the contingency or charge – whose circumstances have been clearly specified – will occur, the provision must be recognised (Article R.123-179 of the French Commercial Code).
The trigger event must exist on the balance sheet date and must be appraised at that date.
In taxation terms, provisions are allocated in order to deal with contingencies or charges that are clearly defined and that are likely to occur as a result of events in process (at the balance sheet date). They are deductible on the provision that they were actually recognised in the accounting entries of the financial year (Article 39-1(5) of the General Taxation Code). The definition for taxation purposes makes it possible to use the available information until the balance sheet date, so as to determine the provision’s value.
What the Conseil d’Etat case law contributes
Case law had on several occasions accepted that a provision recognised in the accounts could be reconsolidated back for the purposes of determining the earnings figure for taxation purposes of the year in which it was allocated, and then deducted from the taxable earnings figure of the subsequent year (this is implied by the decision of the Paris Administrative Court of 2 February 2010). Therefore, it seemed possible for a company to record a provision in year N without deducting it from the taxable earnings figure in that same year N, thus treating the provision differently for accounting purposes and for tax purposes.
However, in its decision of 23 December 2013, the Conseil d’Etat found that the company that recognises a provision in respect of a particular financial year is required to deduct it from its taxable earnings figure for that same financial year, thus imposing a strict application of the principle of the connection between accounting and taxation, as defined in Article 38-quater of Appendix III of the General Taxation Code.
The consequences of the accounting and taxation rules being aligned
The principle of the accounting and taxation rules being in alignment on the matter of provisions must therefore be applied, unless special rules arising out of tax law prevent it. Therefore, the taxation authority would be entitled to assess the reversal of a provision for taxation even if such reversal was not deducted for tax purposes when it was allocated, since it met the criteria for deduction in taxation terms. However, to tax a reversal of a provision, that provision is required to exist on the opening tax balance sheet for the financial year in which it was reversed.
Two prospective situations may be deduced from the application of the mechanism of intangibility of the opening balance sheet and of the Conseil d’Etat case law:
– if the reversal of provision occurs in respect of the first financial year that is not outside the statute of limitations, the taxation authority should not be entitled to tax its reversal as exhibited in the accounts, since the rule of the intangibility of the opening balance sheet of the first financial year that is not outside the statute of limitations prevents the provision from being recorded in that balance sheet earlier;
– if the reversal of provision occurs in respect of a subsequent financial year, the taxation authority would be entitled to tax its reversal as exhibited in the accounts. However, pursuant to the theory of symmetrical corrections, the company would be entitled to obtain an abatement in respect of the first financial year that is not outside the statute of limitations, unless the deduction was omitted deliberately.
To summarise, a company does not therefore lay itself open to being assessed for taxation in respect of the reversal of a provision unless it deliberated refrained from deducting such provision while the tax conditions of such deduction were fulfilled.
We are entirely available if you have any further queries about the issues discussed in this newsletter or about any other accounting, tax, social security or law related topic.