Narrowing the Gap between Tax Law and Accounting
Chaudhary, Humayun Rashid
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Accounting income and taxable income are both designed to capture the economic activities of an entity based on their own rules and assumptions. Despite all the differences in reporting objectives and measurement methods, accounting income forms the starting point for determining taxable income. This suggests that much of accountants use of consistency and matching principles flows through to the legal measure of taxable income. This thesis argues that the principles in some select areas of financial reporting can be sanctioned more explicitly and enacted into the Income Tax Act (ITA) in determining the taxable income of corporations. It also recommends a new reporting schedule that requires taxpayers to disclose greater reconciliation between accounting and taxable incomes in a limited number of areas subject to any statutory or legal provisions to the contrary. The booktax income gap can be divided into two components: a conceptual gap in computing income or profit and a second gap arising from policy-based deductions and/or aggressive tax planning. The conceptual gap is mostly due to different rules for the calculation of income based on section 9 of the ITA and case law in contrast to the rules for calculating book income based on accounting principles, such as International Financial Reporting Standards (IFRS). The second type of gap arises due to policy-based deductions in the ITA that may allow for more or less generous deductions or write-offs compared to accounting rules. This gap can also be caused by aggressive tax planning. This thesis contributes to the literature by exploring economic, accounting, and legal definitions of income in a setting with more recent business transactions. It estimates the gap between accounting income and taxable income based on the historical data of Canadian companies and the reasons why they may have diverged in recent years. It also argues why narrowing the gaps may be desirable at least in some select areas. While this study was being conducted, the federal government introduced an elective mark-to-market regime for derivatives an illustration of one of this dissertations recommendations.