Winter 2011www.miamalta.org

Keeping UpTimes WITH THE

Interview with IAASB Chairman Prof. Arnold Schilder

Beyond Marks & Spencer

Integrity and Expertise

ECJ case law dealing with the freedom of establishment

Accounts Receivable Management

LOCAL NEWS

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Winter 2011

MIA ISSUES CPE PROGRAMME FOR THE PERIOD JANUARY TO JUNE 2011The Malta Institute of Accountants (MIA) has issued its Continuous Professional Education (CPE) Programme for the period January to June 2011. The programme offers participants high quality training, given by experts in the respective field, both in Core and Professional Competency areas.

The Programme can be viewed on the MIA website www.miamalta,org/Calendar.aspx and prospective participants can plan and book their CPE courses online 24x7. For more information one may contact Catherine Mallia Bonavia on 21323991 or cmbonavia@miamalta.org.

MIA ISSUES TWO TECHNICAL RELEASES ON AUDITOR REPORTINGThe MIA has issued two Technical Releases dealing with auditor reporting. Both pronouncements were issued by the MIA for public comment on 12 October 2010 and were recently issued as final.

The first of the two Technical Releases, AUDIT 02/10, deals with engagements to report on Undertaking Size Declarations prepared for the purposes of financing under the Training Aid Framework financed through the European Social Fund. The scope of the Technical Release is to lay down professional requirements, and provide guidance on the auditors professional responsibilities, when a Member undertakes such engagements.

The second Technical Release, AUDIT 03/10, deals with engagements to report on Form 4.7 Financial Statement submitted for public procurement tendering purposes. In fact the scope of AUDIT 03/10 is to lay down professional requirements with which Members shall comply when undertaking engagements to report on the Financial Statement form submitted by bidders as part of the selection criteria which must be satisfied when tendering for public procurement contracts with the Department of Contracts.

Both pronouncements are freely downloadable by MIA Members and Students from the Technical Releases e-library on the Members/Students area of the Institutes website.

MIA ISSUES GAPSE - IFRS FOR SMES COMPARATIVE ANALYSISThe MIA issued a technical publication entitled General Accounting Principles for Smaller Entities (GAPSE) and IFRS for SMEs: A comparative analysis.

The publication summarises the recognition, measurement and disclosure requirements set out in the Accountancy Profession (General Accounting Principles for Smaller Entities) Regulations, 2009 (GAPSE) and

compares these with the corresponding recognition, measurement and disclosure requirements in the IFRS for SMEs, with a view to identify any similarities and differences between the two standards.

The publication is freely downloadable by MIA Members and Students from the GAPSE e-library on the Members/Students area of the Institutes website.

MIA ENHANCES TECHNICAL DEPARTMENT, RECRUITS TECHNICAL OFFICERRitianne Cassar Soler has joined the Institutes Technical Department as a Technical Officer.

Ritianne holds a Bachelor of Accountancy (Honours) degree from the University of Malta and a Diploma in VAT Compliance from the Institute of Indirect Taxation (UK). Over the past years, she worked with established consultancy firms focusing on accounting, consultancy and tax related services, particularly in the international context. In May 2009, Ritianne was appointed Manager Finance of the National Agency responsible to regulate telecommunications in Malta.

BANIF BANK SIGNS A COOPERATION AGREEMENT WITH MIABanif Bank and the Malta Institute of Accountants have signed a collaboration agreement in relation to the 2010 Conference entitled The Accountant: evolving World evolving Role.

This collaboration agreement reaffirms our commitment to be an active player in the market and to support important initiatives that can add value to the local community. We believe that Banif can make a valid contribution at all levels of the economy from employees to professionals like accountants and auditors, commented Mr. Joaquim F. Silva Pinto, CEO of Banif Bank (Malta) plc in the presence of Mr. Bernard Scicluna, President of the Malta Institute of Accountants.

Banif Banks CEO, Mr. Joaquim F. Silva Pinto has also participated in one of the discussion panels which discussed the perception of accountants from the point of view of other professions.

MIA PUBLISHES COMMENT LETTER ON AUDIT POLICY GREEN PAPERThe MIA has published on its website the Institutes Comment Letter on the European Commissions Green Paper Audit Policy: Lessons from the Crisis which the Commission issued in October 2010.

The Institutes Comment Letter was filed with the European Commission on 7 December 2010.

&LocalUpdate MIANews

Autumn 2010LOCAL NEWS

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Winter 2011N

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AIADiane CauchiAdrian ChircopSharon CianguraSteven MarinelliReginald Meli Attard Andrew MifsudSean Vassallo

MIAChristine FrendoPaul McKenna

UPGRADES Nadia ArrigoJustin AxiaqGraziella CassarClint ChetcutiMariestell DalliFrancesca Ellul CastaldiEtienne FormosaChristabelle GauciRaymond GrechPauline McKayMaris MicallefKristina RaggioAngelo SaidPamela SalibaAlexie TabonePierre Vella

MIA 2010 CONFERENCE THE ACCOUNTANT: EVOLVING WORLD EVOLVING ROLE IN PICTURES

Winter 2011

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INTERVIEW

The International Auditing and Assurance Standards Board (IAASB),

the body which issues International Standards on Auditing (ISAs) that

set the global benchmark for external auditing, and which are applicable

in Malta through direct reference in our legislation, met in Malta with a

50-strong team at the invitation of the Malta institute of Accountants.

At the end of the week-long meeting MIA President Ben Scicluna and

Jonathan Dingli met with the Boards Chairman Prof. Arnold Schilder and

Technical Director James Gunn to discuss the completion of the Clarity Project and the effect this is expected to have on the quality and cost of an audit, as well as to acquire first hand

information on the main projects currently featuring on the Boards

agenda in particular its work on Compilation and Review engagements

which are being revised to assist practitioners in providing services to

SMes that may not be required to have their financial statements audited.

TIMESKEEPING UP WITH THE

INTERVIEW WITH IAASB CHAIRMAN PROF. ARNOLD SCHILDER

Photos: D. Aquilina

Winter 2011INTERVIEW

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The IAASB has just finalised a nearly five year long Clarity Project which resulted in 36 newly updated and clarified ISAs and a clarified International Standard on Quality Control. To what extent has this project enhanced the quality of the ISAs, and therefore audit quality?

On the main enhancements to the standards from the Clarity Project I would characterise them in three points.

First, the Clarity Project has certainly enhanced the readability and structure of the ISAs. Before the Clarity Project, the requirements and guidance of an ISA were intermingled, with the guidance found in between paragraphs specifying requirements. So an ISA seemed pretty much like a long story, which had to be read till the end to be understood. The feedback we received from the users of the ISAs (in particular the SMP community) showed that it was difficult to get a grasp of all the requirements that are expected of them. Users said they wanted an effective tool - they need to know what the requirements are (and in that regard they said it would be helpful if all the requirements are put in one place) and to be able to source relevant application material in an effective way. And thats how weve actually structured the clarified ISAs because thats how they are used.

Secondly, the Project has enhanced clarity with respect to responsibilities. Our new conventions now help from both an inspection point of view, but equally important from a practitioner point of view, in that they clarify what is exactly required of the auditor. We heard from different stakeholders (regulators, practitioners) that the old standards had ambiguity. The Clarity Project looked at those ambiguous conventions and the new standards are now more precise in the specification of requirements. We also identified that one area that we would like to highlight in our standards are considerations specific to audits of smaller entities. The previous standards did not have those within the text of the standards, leaving users to look elsewhere for that. So we included in the application material of the Clarity standards those specific considerations that deal with audits of SMEs.

The third change or enhancement to the standards really goes to the substance of the standards. Weve not only redrafted the standards but weve also revised about half of them, which resulted in having stronger ISAs on a number of key areas in the audit such as: Reporting: what the auditor says in the auditors report and when communicating with those charged with governance or management. Audit of financial statement areas that typically require significant management judgement: accounting estimates; fair value estimates; identification and disclosure of related parties. Risk assessment when an organisation uses other entities (service organisations). Audit evidence, in areas such as external confirmations and written representations, and when using the work of others such as experts and component auditors in the case of group audits. ISA 200 and a number of other ISAs strengthen provisions on professional judgement and professional scepticism.

So all in all there are a number of areas which have been revised which strengthen the quality of the standards and thereby the quality of audits.

Moving on to your second question the impact the Clarity

Project is expected to have on audit quality - we cannot enough bring that message to the outside world. The clarity ISAs have been very proactive in addressing the critical questions that now lure on one hand from the crisis on the other hand from recent audit inspections.

We have already seen what the new ISAs point to: its about communications, its about estimates, its about risk assessment and typically judgmental issues, and its about quality audit evidence. These areas have been explicitly addressed in the revised ISAs. We now have stronger standards, for example, on estimates and fair values, and two standards on communication including a new one on communication of internal control deficiencies.

It is argued in certain quarters that requirements have increased by over 50% as a result of the Clarity project. Has there been any impact assessment on how much more time will you need to conduct an audit in accordance with the clarity ISAs?

One cannot here but refer to the impact study that the EC commissioned from the University of Duisberg-Essen entitled Evaluation of the possible adoption of International Standards of Auditing (ISAs) in the EU in which they have addressed the issue of cost-benefit. And their conclusion was clear - benefits outweighed the costs by far.

Of course there is a learning curve to climb in the beginning because a practitioner needs to invest time and resources in understanding the revised and redrafted ISAs. However, the end result should be very rewarding. Theres a clear conclusion in the Duisberg-Essen study that adoption of the clarified ISA through the EU would contribute to the credibility and quality of financial statements and to audit quality in the EU, and to a greater acceptance of audit reports outside of their home jurisdictions within and outside of the EU.

So were pretty confident that therell be a net impact of benefits over cost.

Moreover its been noted that while theres an increase in the requirements overall, and that increase in requirements will have an impact on the cost of audits, those requirements are scalable in relation to the size and complexity of the audited entity. In fact what we are hearing from members around the Board that are small practitioners is that if you carefully think about how to approach your audit, the impact will probably not be that significant particularly for micro entities - the less complex the audit, the simpler it is, and the less requirements will be applicable to that audit. So careful thinking and planning together with effective engagement management minimises the time required to do an effective audit. Having said that I guess the test has to be the application of the standards by the practitioners in practice; only through that exercise will we know the true impact of the Clarified ISAs.

We have also learned from our implementation monitoring projects that it makes a lot of difference whether smaller practitioners are being helped by their member bodies and institutes and by fellow SMPs, and whether they are making use of any training material.

With over 600 requirements, is it possible to do an affordable audit?

Yes. This was the very first issue that I have been confronted

Winter 2011

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INTERVIEWwith soon after I took chairmanship of the Board. I remember I gave my first presentation at the SMP Committee Forum in Berlin in front of a rather sceptical audience of German practitioners who could not come to grips with the fact that such a big book could also be applied for small audits. I was then able to quote many of the Considerations Specific to SMEs now included in the Clarity ISAs and we had a resulting debate. Of course I cannot say that I convinced everybody but they started opening up for recognising that there is a lot of special attention in the ISAs for SMEs.

We had further discussion on the issue, which was then followed up by the IAASB staff with the publication of a staff Q&A on the proportionality of the ISAs, which I believe to be a very important publication. I really need to mention here my fellow board member Phil Cowperthwaite who is an SMP himself he is one of the two partners in a small firm in Canada and Phil is advocating very strongly that while every practitioner should have an understanding of the ISAs, one should ask the question which of those 600 requirements is typically relevant for my practice? And Phil has sorted that out for his own practice and estimates that one third will hardly be applicable anyhow: for example, group audits, using the work of internal audit, service organisations, etc.

Another one third of the requirements may or may not be applicable, depending on your clients, the complexity of the audit, etc. So you need to know that there is a standard on using the work of an expert, and how to audit fair values, but those standards may not always be applicable. Then of course there are the main requirements thats in the ISA 200, risk assessments, communications, etc. If you have that understanding, you know what to do.

Having obtained that understanding and knowledge of what to use and when, according to Phil the next step is for one to organise his or her practice in a very efficient manner, including using software for documentation, etc. And then it is possible to do an audit in accordance with the Clarified ISAs but nonetheless in a very cost effective manner.

Is it possible to conduct a full ISA compliant audit without the use of audit software?

Yes of course, but thats more a cost efficiency question. I think it would be difficult and inefficient to carry out an audit by going through all the ISA requirements without the use of audit software, but nonetheless it is doable. Audit software would definitely increase audit efficiency and cost effectiveness and we know of several initiatives around the world being undertaken to develop audit software in accordance with the Clarified ISAs.

Having said that, this is not directly related to the Clarity Project. How efficient was it to carry out a paper audit with no methodology and no software under the old standards? So this was, is, and will remain a cost efficiency question. I think in todays world to do an efficient audit it is imperative to invest in tools and software. So it is not really a question of whether you can comply with the Clarified ISAs without the use of audit software, but rather one underscoring the importance of software in todays world.

Many countries are introducing audit exemptions thereby exempting certain entities from having an audit requirement. Is this an indication of perhaps the audit becoming less universally relevant?

I believe the pressure for audit exemptions is coming from a different direction, which is reduction of administrative burdens for smaller entities. So thats where the discussion started. The next question, however, is for who is an audit useful? And that is the subject of ongoing discussions.

You would certainly agree that an audit is extremely relevant to public interest entities with public shareholders who need independent assurance on the financial information presented to them. Following from that, legislators have themselves asked the question whether it is necessary to mandate an audit for privately held companies, and arguably the decision to have an audit or not for such entities should be left to the shareholders discretion. So its not a question about the value of an audit its more about not burdening smaller entities that have private shareholders.

But on the other hand many ask whether such companies could then benefit from having a different and lower level of assurance then an audit provides. And in fact such companies tend to go for alternative assurance services.

And thats actually what kept us quite busy in Malta as we are revising two of our existing standards on review engagements and compilation engagements, which could be used by practitioners in providing services to SMEs that may not be required, or do not elect, to have their financial statements audited. Following these revisions we will also look into further issues and standards for other engagements such as agreed upon procedures.

In fact those two projects took a considerable amount of time during our meeting this week. We had for instance a very good discussion one of them quite difficult on what is limited assurance compared to reasonable assurance. On the other hand we also covered a lot of ground on the compilation engagements project. I must say we had both a fascinating and exhausting discussion. Ultimately we were successful in approving an exposure draft by the end of the week.

As you said the Board was busy this week working on the revision of the review and compilation engagements standards. Is that one step back from the position that an audit is an audit?

No definitely not. The revision of these standards is not conveying that message. The outlook there is that every audit needs to be a high quality audit and therefore in conformity with the clarity ISAs.

In fact we have already seen that ISAs are scalable to the size and complexity of the audit at hand and ones professional judgement comes into play when planning and carrying out the audit. So an audit is an audit does not mean that you have to do it all the time in the same way. If that were to be true, you could fully understand small practitioners concerns that ISAs cannot be applied proportionately to SME audits as they would have to do the same level and amount of work irrespective of whether one is auditing a local hardware store or carrying out an international audit. And thats obviously non-sense.

So, within the audit arena, the professional already differentiates his or her audits by making decisions and judgements on what needs to be done on the particular audit at hand: the extent of understanding of the client, the complexity of the nature of the client, risk assessments for

Winter 2011INTERVIEWfurther procedures that need to be carried out. And that ties in to the other issue of documentation; an auditor needs to have appropriate documentation about significant judgements made during the audit, but does not need documentation about every detail - the audit is not a mechanistic approach. Its basically having sufficient documentation that would enable an independent reviewer (i.e. an experienced professional rather than someone who doesnt know anything about audit) to understand the nature, timing and extent of the audit procedures performed, the results of those procedures and the audit evidence obtained, and significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions.

As a former practitioner I could say its most beneficial to the practitioners themselves to have such documentation available; unfortunately there are always cases in which you can get in trouble or your client has a problem, like going concern, taxes, whatever. And at that point such documentation would be extremely handy. In the case of small entities it usually takes no more than an hour or two just to sit down and to write it.

What drove the IAASB to put the review and compilation projects on the agenda?

Id probably say we were listening. As we came out of our Clarity Project, after having spent 4 or 5 years focussing solely on audit, we thought it was due time for us to place attention on those circumstances where an entitys financial reporting need is not going to be met by the audit; where the audit is not what is needed in the circumstances. Certainly audit is not the only offering that the profession can provide in terms of assisting SMEs in their financial reporting needs.

Weve always had a compilation standard. But the message to the IAASB as it set out on its new strategy was to explore standards for further services, other than an audit, which

practitioners can provide to help meet the financial reporting needs of SMEs. It was not self-serving in the sense of promoting more services but the Board was trying to respond to a need. We were in fact charged with sort of an ambitious task: explore the types of engagements that will help meet those needs and design standards to ensure those engagements are conducted with quality and the public interest in mind.

And we reflected and we carefully considered what would be the best approach. We contemplated starting with a clean white sheet of paper - completely exploring all the different possibilities, different engagements, different combinations of engagements. We asked whether we should create something new, or whether we should go down to where market practice exists? What we heard at the time is that a lot of countries, a lot of jurisdictions, were asking absolutely the same questions: how do we create a project that will help service our needs? And after quite a bit of research but before we went into this project we issued a consultation paper to really understand what the international environment is with respect to reviews. Finally we thought how best can we get to the market as quickly as possible and identified some standards that would help deliver services to meet the needs.

We came down to the fact that since we have two existing standards that are used in a number of jurisdictions, it may be more efficient to start off with a platform that we understand. In fact we detected a number of areas which are currently being revised in those standards to see if we could further meet the markets needs. Once were through the revision of the review and compilation standards, were planning to make an assessment to identify whether there are any remaining needs. That I think will help us focus on what the new engagement standards might be. Without that it would be shooting darts against the wall and hopefully you hit the need; I think our approach is logical and likely to move us forward faster towards getting a product which people can understand.

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Winter 2011 INTERVIEWNow with the clarity project over and done with, and with the review and compilation engagements at a fairly advanced stage, are there any other projects on the Boards agenda for the next two to three years?

First we need to follow-up on the implementation of the Clarified ISAs. The standards are complete as far as lets say their production is concerned. But are they being implemented consistently in practice? Weve spent a lot of time already providing support. For example there are a number of video modules and implementation material available on the IAASB website.

Review and compilation engagement standards are also expected to take a considerable amount of time before we are at the finish line. Assurance on sustainability reports will also feature on the Boards agenda: what kind of assurance should be given, what kind of work effort should be done, and what should be emphasised in the practitioners report.

Then the Board will have to deal with the more explorative projects that will have an effect on the future of the profession and on our future. These include auditor reporting, audit quality, auditing financial statement disclosures, etc.

Most definitely the Board will have an enticing and equally challenging agenda for the years 2012 2014. I am pretty sure that, as we were ahead of the curve when kicking off our Clarity Project before the global crises, the Board will keep its leading edge in the development of high quality auditing and assurance standards that will be needed not only by todays but also by tomorrows companies in meeting their financial reporting needs.

Winter 2011 FEATURE

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INTRODUCTION

Various management systems and methodologies have been developed to address the multitude of issues facing organisations from one decade to another. At the on sought of technological and industrial developments, numerous books have been written full of advice and suggestions about how to manage one business issue or another. For the benefit of the readers, whom I appreciate, are constantly bombarded with information from a multitude of sources, this two-part article seeks to condense much management thinking and effectively organise diverse insights in a practical manner.

As the first decade of the twenty-first century comes to an end, contemporary management thinking has been profoundly reshaped by the conviction that developing necessary skills to manage organisational knowledge effectively is a prerequisite for sustainable competitive success.

INDUSTRIAL AGE COMPETITION VS INFORMATION AGE COMPETITION

Companies are in the midst of a revolutionary transformation. Industrial age competition is shifting to information age competition. In the industrial age, technology mattered, but, ultimately, success accrued to companies that could embed the new technology into physical assets that offered efficient, mass production of standard projects. During the industrial age, multinationals such as General Motors, DuPont, Matsushita, and General Electric developed an integrating device such as the Return on Investment metric to facilitate and monitor efficient allocations of financial and physical capital .

An overarching financial objective such as return-on-capital-employed (ROCE) or Return on Investment (ROI) could direct a companys internal capital to its most productive use whilst monitoring the efficiency by which operating divisions used financial and physical capital to create value for shareholders.

By the mid-twentieth century, multidivisional firms were using the budget as the centrepiece of their management systems. In the 1990s, companies had extended the financial framework to embrace financial metrics that correlated better with shareholder value, leading to economic value added (EVA) and value-based management metrics. Today these principles are firmly entrenched in most industries.

Whilst the ROI calculation of dividing net income by assets employed ignores a capital charge, EVA adjusts accounting net profit to factor in an explicit capital charge by applying a business-specific and perhaps even an asset-specific cost of capital. Businesses that are earning above their risk-adjusted cost of capital are considered to be creating shareholder value, whereas businesses earning less than their cost of capital are destroying shareholder value. EVA addresses the defect in a pure accounting income calculation that ignores the cost of assets employed to generate accounting profits.

The emergence of the information era, however, in the last decades of the twentieth century, made obsolete many of the fundamental assumptions of industrial age competition. It is very unlikely that todays best financial frameworks capture all the dynamics of performance in todays knowledge-based competition.

The impact of the information era is even more revolutionary for service organisations than for manufacturing companies. Many service organisations, especially those in the transportation, utility, communication, financial, and health care industries, existed for decades in comfortable, non-competitive environments. They had little freedom in entering new businesses and in pricing their output. In return, government regulators protected these companies from potentially more efficient or more innovative competitors, and set prices at a level that provided adequate returns on their investment and cost base. Clearly, the past two decades have witnessed major deregulatory and privatisation initiatives for service companies throughout the world as information technology created the seeds of destruction of industrial-era regulated service companies.

Sustainable competitive advantage is no longer gained by merely deploying new technology into physical assets rapidly and by managing financial assets and liabilities. To steer todays organisations toward excellent future outcomes it is vital to obtain an accurate understanding of: a) the complex competitive environment; b) the organisations goals; and c) the methods available for attaining those goals.

ORGANISATIONAL MANAGEMENT IN A COMPETITIVE ENVIRONMENT AND THE ORGANISATIONS GOALS

An initial step is to obtain an understanding of the cyclical process of organisational management in a competitive environment. The four-stage process shown in Diagram 1 starts off from the early stages of formulating strategy all the way through monitoring and control of operational plans.

Diagram 1: The four-stage organisational management process

To start off with, the unique and sustainable way by which organisations create value is through their strategies. This is true for any type of organisation be it large or small, manufacturing or service, mature or rapid-growth, public or private, for-profit or not-for profit. Strategic business planning sets the overall direction for the future that integrates organisations processes, people and technology into concrete, achievable business goals. When strategy is being formulated, accounting information is the basis for financial analysis which is one aspect of the process of evaluating strategic alternatives.

TRANSFORMING MANAGEMENT SYSTEMSAND ACCOUNTING FUNCTIONS

TO MEET THE CHALLENGESOF INFORMATION AGE COMPETITION

By: Anita AloisioPart 1

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Winter 2011 FEATURE

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Strategies that are not financially feasible or that do not yield adequate financial returns cannot be appropriate strategies.

There three different strategies used by organisations to differentiate themselves in the market place are: i. Product leadership. ii. Customer intimacy. iii. Operational excellence. Organisations following a product leadership strategy must excel at the functionality, features, and performance of their product or service. Organisations following a customer intimacy strategy will stress the quality of their relationships with customers and the completeness of the solution offered to customers. Organisations following an operational excellence strategy need to excel at measures of competitive price, customer-perceived quality, and lead-time and on-time delivery for purchasing.

At stage 2, organisations today need a language for linking vision with strategic business planning. The building blocks are in communicating strategy, managing roll-out and gaining feedback about the strategy. The overarching mission of the organisation provides the starting point; it defines why the organisation exits or how a business unit fits within a boarder corporate architecture. Ultimately, success comes from having strategy become everyones everyday job.

Accounting reports constitute one of the important ways that strategy gets communicated throughout the organisation. Good accounting reports in this early stage of the process are thus reports that focus attention on those factors that are critical to the success of the strategy adopted.

At stage 3, strategy needs to be translated to operational terms. Michael Porter describes the foundation of strategy as the activities in which an organisation elects to excel: Ultimately, all differences between companies in cost or price derive from the hundreds of activities required to create, produce, sell, and deliver their products or services. Differentiation arises from both the choice of activities to be undertaken and how they are performed .

It follows then that specific tactics as well as processes and systems must be developed in support of the overall strategy. Financial analysis is one of the key elements in deciding which tactical programs are most likely to be effective in helping an organisation meet its strategic objectives. At a tactical level, the critical issue is to understand what the key value and cost drivers are.

Organisations can benefit considerably if management has a detailed understanding of the value creation processes within the organisation itself and the wider value network. An important factor to consider is that costs and value creation are spread unevenly across the activities in the value chain and value network. So some activities are more crucial to value (or cost) creation than others but this will vary with the type of business and with the circumstances in which it is operating.

Diagram 2 gives some examples of key cost and value drivers that vary in line with strategic considerations dependent on the source.

Key cost and value drivers may change over time. For example, during the introduction of a new product the key factor may be establishing sales volume. Once the product is established in the market place, prices and unit cost may be more important. During decline, improving cash flow through stock and debtor reduction may be essential to support the introduction of the next generation of products. At stage 4, controls must be developed and introduced to monitor the success of the implementation steps and continuously align the organisation to strategy to succeed in meeting the strategic objectives. Rather than having managing control systems, contemporary thinking calls for a paradigm shift towards the implementation of strategic

management performance systems that look beyond financial measures and concentrate on factors that create economic value.

The extent to which managers are able to control items of cost and value creation will vary with context. For example, in commodity markets price is externally determined so managing for value must concentrate on other items, mainly operating costs and the supply chain. At divisional level in both the private and public sectors the cost of capital may be determined at the corporate level. So divisional managers must focus on controlling other cost drivers and value creating measures. In the public sector there is a growing need to deliver best value within financial limits.

METHODS FOR ATTAINING ORGANISATIONAL GOALS

Traditionally, vision, strategy, and resource allocation flowed down from the top. Ability to execute strategy was given more importance than the quality of the strategy itself and good vision. Exclusive reliance on financial indicators promoted short-term behaviour that sacrificed long-term value creation for short-term performance.

Recognising the limitations of managing only with financial numbers, many organisations attempted to transform themselves to compete successfully and concentrate on other factors apart from pure financial measures, by turning to a variety of improvement and reengineering initiatives, amongst which:

During the 1980s and 1990s, organisations adopted quality as their central rallying cry and organising framework. But quality alone was insufficient, as were the pure financial measures the quality programs hoped to replace. Beyond financial and quality measures, some organisations have emphasised customer focus, implementing programs to build market-focused organisations and establishing customer relationship management systems. Others have opted for core competencies or reengineering of fundamental business processes. Still others have emphasised strategic human resources management, showing how motivated, skilled employees can create economic value, or have deployed information technology for competitive advantage.

But many of these improvement programmes were introduced as separate independent initiatives, fragmented and many a time not in alignment with the organisations strategic direction nor designed to achieve specific financial and economic outcomes. Each of these perspectives financial, quality, customers, capabilities, processes, people and systems is important and can play a role in creating value in organisations. But each represents only one component in the network of management activities and processes that must be performed to generate superior, sustainable performance.

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2Diagram 2: Identifying key cost drivers and considerations for value creation

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To focus on and manage only one of these perspectives encourages sub optimisation at the expense of broader organisational goals. It is not unthinkable that an organisation may have made significant investment in an area that wasnt its core competency and later the newly developed capability was outsourced. Such reengineering initiatives turned out to be counter-productive, wasteful and stole resources from other strategic projects.

It is not surprising therefore, that key stakeholders and sponsors may be sceptical about further investment in management systems and management may find it difficult to garner the level of support needed in terms of money and resources. Despite this situation, it is recognised that breakthroughs in performance require major change, and that includes changes in the measurement and management systems of an organisation.

The key to successful implementation is to become more strategic in prioritising efforts for performance improvement. Although strategic success cant be achieved through a set of rules and priorities which apply in equal measure to all organisations at all times, there are three broad common issues facing organisations of all types.

Diagram 3: Common issues facing organisationsFirstly, managing for value, whether this is concerned with creating

value for shareholders or ensuring the best use of public money is an important consideration. Seeking to strike a balance between business and financial risk is the second consideration. Finance managers need to ensure that the nature of the funding of strategic development is aligned to the type of strategy being followed and vice versa. Thirdly, financial expectations of stakeholders will vary both between different stakeholders and in relation to different strategies. This should influence managers in both strategy development and implementation.

The determinants of value creation are also governed by three key drivers as illustrated in Diagram 4.

Diagram 4: The determinants of value creationFunds from operations are clearly a major contributor to value creation.

In the long term, this concerns the extent to which the organisation is operating profitably. A thorough understanding of the detailed cost structures of businesses is crucial since it varies considerably from sector to sector and hence the relative importance of specific cost items. For example, service organisations are generally more human

resource intensive than manufacturing underlining the importance of salary structures. On the other hand, retailers are concerned with stock turnover and sales volume per square metre, reflecting two major drivers.

The extent to which assets and working capital are being stretched is also a key consideration. Highly competitive organisations develop competences in supporting much higher levels of business from the same asset base than others. The mix of capital in the business between debt and equity will determine the cost of capital and also the financial risk.

The issues facing the public sector are very similar. The problem for most public sector managers is that their financial responsibilities are usually confined to managing their budget. They will usually be doing this with little understanding of the other financial issues, normally managed by the corporate financial function. There is a real need for managers to be much more familiar with the impact of their day-to-day management decisions on the wider financial health of the organisation.

More importantly, due to the inter linkages and intertwined complexities of todays economy, organisations have to move away from management systems linked exclusively to financial frameworks. New opportunities for creating value are shifting from managing tangible assets to managing knowledge based strategies that deploy an organisations intangible assets.

Navigating to a more competitive, technological, and capability-driven future cannot be accomplished merely by monitoring and controlling financial measures of past performance. Realistically, however, it is difficult to place a reliable financial value or measure on an organisations value-creating activities from its intangible assets.

Undeniably, these are the very assets and capabilities that are critical for success in todays and tomorrows competitive environment: process capabilities; employee skills, competencies and motivation and flexibility of employees; customer loyalty and relationships; data bases and information technologies; efficient and responsive operating processes, innovation in products and services and systems as well as political, regulatory, and societal approval.

In the 1990s, the groundbreaking work of Kaplan and Norton brought to managements attention the need to measure performance in a more holistic way. Therefore, organisations have to replace any narrow or specific focus with a comprehensive view in which strategy becomes a continual and participative process and the heart of management systems. Kaplan and Norton came up with four perspectives for strategic mapping and a balanced scorecard was emerging as a possible solution to the performance measurement problem. Parmenter recently increased the four perspectives to six.

The balanced Scorecard provides a new framework to describe a strategy by linking intangible and tangible assets in value creating activities. The old adage what gets measured gets done is still true. Although, the scorecard does not attempt to value an organisations intangible assets, it measures these assets, but in units other than euros.

The scorecard allows innovative organisations to build a new kind of management systems having three distinct dimensions: 1. Making strategy the central organisational agenda through effective communication2. Creating incredible focus through a continual process of aligning resources and activities to strategy3. Organising logic and architecture to establish linkages across business units, shared services and individual employees

The Balanced Scorecard seeks to translate a business units mission and strategy into tangible objectives and measures. The measures represent a balance between external measures for shareholders and customers, and internal measures of critical business processes, innovation and

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About the authorAnita Aloisio heads Nexia BTs advisory services department. Anita is a restructuring specialist with broad experience in cost-modeling and the development and implementation of strategic management systems. Anita obtained an Executive Masters in Business Administration from ENPC in Paris and the University of Edinburgh Business School in 2002. She also holds a degree in Accountancy from the University of Malta. Anita holds a practicing audit warrant and is a Fellow of the Malta Institute of Accountants. In 1995, Anita was awarded the CIMA prize for the best dissertation in Management Accounting. Prior to joining Nexia, Anita held a number of senior management and advisory positions, in the private as well as the public sector and for several years was also heavily involved in the communications industry.

Part 2 of this feature will be carried in the forthcoming (Spring 2011) issue of the Accountant.

References1 A. D. Chandler, Jr., The Visible Hand: The Managerial Revolution in American Business , Cambridge, Mass.:Harvard University Press, 1997and T. H. Johnson and R. S. Kaplan, Relevance Lost: The Rise and Fall of Management Accounting, Boston: Harvard Business School Press, 19872 M. Treacy and F. Wiersema, The Discipline of Market Leaders: Choose your customers, Narrow your focus, Dominate your Market, Reading, MA: Addison-Wesley, 19953 M. Porter, What is strategy? Harvard Business Review, Nov/December 19964 Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action, Boston: Harvard Busiess School Press, 19965 Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes, Boston: Harvard Business School Press, 2004.6 David Parmenter, Developing, Implementing and Using Winning Key Performance Indicators, New Jersey: John Wiley & Sons, Inc., 20077 M. Porter, What is strategy?, Harvard Business Review, Nov/Dec 1996

learning and growth. For instance a customer focused strategy can be executed by decentralising the organisation into market-facing business units where each business unit is held accountable for its profitability and central staff functions are restructured into shared service groups.

The measures are balanced between the outcome measures the results from past efforts and the measures that drive future performance. And the scorecard is balanced between objective, easily quantified outcome measures and subjective, somewhat judgmental, performance drivers of the outcome measures.

Whilst retaining an emphasis on achieving financial objectives, the scorecard measures organisational performance across the following six balanced perspectives:

The objectives and measures of the scorecard are derived from an organisations vision and strategy. It enables companies to track financial results while simultaneously monitoring progress in building the capabilities and acquiring the intangible assets they need for future growth.

Rather than assessing financial performance just by measuring asset utilisation or simple cost reduction ratios, one of the principal contributions of the Balanced Scorecard is to highlight the opportunities for driving financial performance through two basic strategies: growth and productivity. The revenue growth strategy focuses on developing new sources of revenue and profitability. On the other hand, the productivity strategy focuses on cost reduction and efficiency by focusing on the efficient execution of operational activities in support of existing customers. Organisations that are in early-stage start-up mode or see opportunity for extremely rapid growth will emphasise objectives and measures from the revenue growth strategy.

The next perspective that needs to be considered is the customer segment or niche market that the organisation chooses to serve. Deciding which target group of customers, varieties, and needs the company should serve is fundamental to developing a strategy. But so is deciding not to serve other customers or needs and not to offer certain features or services .

Connecting a companys internal processes to improved outcomes with customers is the value proposition delivered to the customer. The value proposition describes the unique mix of product, service, price, relationship, and image that the provider offers its customers.

Porter claims that activities are the basic units of competitive advantage. The art of developing a successful and sustainable strategy is ensuring alignment between an organisations internal activities and its customer value proposition. The value proposition determines the market segments to which the strategy is targeted and how the organisation will differentiate itself, in the targeted segments, relative to the competition.

Learning and growth initiatives are the ultimate drivers of strategic outcomes - they are the true starting point for any long-term, sustainable change. This perspective defines the intangible assets that are needed to enable organisational activities and customer relationships to be performed at ever-higher levels of performance.

Managers and individuals lower down in organisations usually control resources and competences that are crucial in enabling strategic success and also likely to be the most knowledgeable about changes in parts of the business environment with which they interface. Cognisant of this fact, contemporary management thinking encourages execution that flows back from the front lines and back office whilst management directs efforts to implement, innovate, provide feedback and stimulate learning across the entire organisation.

Moreover, investing in, managing, and exploiting the knowledge of every employee whilst maintaining employee satisfaction has become critical to the success of information age companies. Both the development of unique resources and core competences in parts of an organisation may provide the springboard from which new strategies are developed.

The second and final part of this article to be shown in the next (Spring 2011) issue of the Accountant will address the process to build a scorecard; give practical examples of aligning objectives and measures to organisational strategies and strategic maps; propose methods for evaluating accounting functions whilst tests for evaluating investments in technological change to meet the challenges of the information age will be explored.

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Marks &SpencerBy: Jeanette Calleja Borg

People have described him as a very meticulous person, seeking perfection and accuracy topped up with a very short temper. He believes that playing basketball releases a lot of

tension and energy. When the inevitable happens and I stop playing, I believe that it will have serious repercussions on my patience.

BEYOND

ECJ CASE LAW DEALING WITH THE FREEDOM OF ESTABLISHMENT

that the Court has initially confirmed already accepted ECJ doctrine. In paragraph 312 the Court underscored that Member States should abide by the freedom of establishment and in no way should they hinder companies from establishing their business in another Member State.

The Court however went further by imposing some restrictions and criteria that need to be met by the subsidiaries before relief for their losses may be claimed by the parent company in its host state. The Court felt it necessary to create these restrictions so as to safe guard against the possibility of double non taxation of income. The Court held that such restriction could be justified if it was necessary to preserve the balanced allocation of taxing powers between Member States, if the restriction was a means of preventing double deduction of losses and if it safeguarded against tax avoidance. These three criteria needed to be all present together and the restriction must be proportionate. In Marks and Spencer the Court upheld that the UK rules present at the time were not proportionate to the objective being pursued.

ECJ CASE LAW IN RELATION TO INTRA-GROUP TRANSFER OF LOSSES IN EU MULTINATIONAL COMPANIES

Following the Marks and Spencer Case the ECJ has decided on two other cases in relation to cross-border transfer of losses between groups of companies, these being the case of Socit Papillion3 and that of X Holding4.

The circumstances in the X Holding case were very similar to that of Marks and Spencer given that the case related to a Dutch company and its Belgian subsidiary. Opposingly in the Socit Papillion case the Court from the very beginning stressed that the question referred by the Conseil dEtat (Administrative French Supreme Court) did not relate to the tax consolidation of the intermediate holding, the Dutch company, itself, but of the lower-tier subsidiaries. It is only in the X Holding case that there is a situation of cross-border consolidation.

In both cases the Court held that the relevant French and Dutch regimes were in breach of the freedom of establishment. The Court however did not accept the French justification that the French regime was in place to preserve the balanced allocation of taxing powers. The Court contended that unlike the issue in Marks and Spencer this case concerned the taking into account of losses recorded within a single Member State. Moreover the Court emphasised that the restriction exceeded what was necessary to achieve the coherence of the French tax system, i.e. the Court found the restrictions present in the French regime as being disproportionate. The French authorities also argued that by allowing tax consolidation in this circumstance there was a risk of double deduction. The ECJ however argues that there were other means to prevent this double deduction, such as requesting the necessary information from the tax payer, or the French tax

INTRODUCTION

In the absence of direct tax harmonisation rules, the European Court of Justice (ECJ) has been deciding on a number of cases in relation to cross-border activities by groups of companies. This article will discuss a selection of ECJ Court cases dealing with the principle of the Freedom of Establishment in relation to cross-border surrendering of losses between Groups of Companies, including permanent establishments, as well as cases dealing with deductibility of expenses/ charges incurred by parent companies in relation to their shareholdings in cross-border subsidiaries. Furthermore, the ECJs approach in adopting the principles developed in Marks and Spencer1 will be examined.

THE ECJS DECISION IN MARKS AND SPENCER

In Marks and Spencer the court argued that it is discriminatory and against the freedom of establishment to restrict group loss relief of non-resident subsidiaries, when it is available to groups of companies wholly resident in the UK. When one reads the ECJ decision in Marks & Spencer it is immediately apparent

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authorities could utilise mutual assistance procedures to verify such information.

Contrary to the decisions in Marks and Spencer and Socit Papillion, the Court ruled in favour of the Dutch authorities in X Holding. The residing argument was the fact that the Dutch fiscal unity allows the parent company the liberty to decide which subsidiaries to include or exclude from the fiscal unity. The Court referred to Marks and Spencer (paragraph 46) and held that giving the companies the option to choose in which Member State their losses would be deducted would seriously undermine the balanced allocation of the Members States to impose taxes.5 The Court thus found the Dutch tax regime restriction proportionate in order to safeguard the balanced allocation of taxing powers.

While in Socit Papillion the Court held that it was contrary to the freedom of establishment to refuse the deduction of losses from a group subsidiary, even if these were held through a company not resident in France, in X Holding the court acknowledged that it was contrary to the freedom of establishment to restrict the inclusion in the fiscal unity of a non-resident subsidiary, but this restriction could be justified in order to protect the Member States taxing powers. In the latter case the Court has applied the argumentations brought forward in Marks and Spencer to accept the concept of the balanced allocation of taxing powers to satisfy the proportionality test. The Court seems to be implying that the concept of balanced allocation of taxing powers, even though this has never been properly defined, is now enough to satisfy the test of proportionality.

ECJ CASE LAW IN RELATION TO SURRENDERING OF LOSSES BETWEEN COMPANIES AND PERMANENT ESTABLISHMENTS

The ECJ rulings dealing with losses of permanent establishments (PE) to date have shown a trend in Court decisions in relation to loss relief. The Court is perceived to accept the following circumstances as justifiable reasons under community law for which loss relief can be disallowed:

1. Restricting relief to losses from third countries is not against the principle of freedom of establishment; 2. When the country where the PE is established allows for the carry forward of losses against future profits.

Point one above was established in Stahlwerk6, where the Court decided that when third countries are involved the principle of freedom of establishment cannot be invoked. In Stahlwerk, a German company had two loss-making permanent establishments in the United States. Germany refused the deduction of the US losses from the profits taxable in Germany. This was only accepted as a justification by the Court since the US is not a Member State.

The Lidl7 and Krankenheim8 cases give rise to point two above. The deciding factor in the Lidl case was that Luxembourg allowed for the carry forward of losses by the PE that could be used against future profits. In this case a German company was denied the deduction of losses from a permanent establishment in Luxembourg on the grounds that, according to the Luxembourg-German double taxation convention (DTC), income from such a permanent establishment is not subject to taxation in Germany. The Court first stressed that a Member State cannot impose a measure which restricts the freedom of establishment where a non-resident subsidiary has exhausted all possibilities to offset, carry forward or carry back the losses incurred in the Member State where it is situated. When the resident parent company demonstrates to the national tax authorities that those

conditions are fulfilled, it is contrary to the freedom of establishment to preclude the possibility for the parent company to deduct from its taxable profits the losses incurred by its foreign subsidiary.

Luxembourgs tax legislation, however, provides that a company can carry forward its losses. In this case, Lidl Belgium benefited from such a carry-forward in a subsequent year when its permanent establishment generated profits. Accordingly, Lidl Belgium did not demonstrate that the conditions for establishing the situation in which a measure constituting a restriction on the freedom of establishment goes beyond what is necessary to attain legitimate objectives recognised by EC law were satisfied. Therefore, the tax regime at issue was considered not to be in breach of the freedom of establishment.

On the other hand in the Krankenheim case, the ECJ ruled in favour of the country by allowing reintegration of losses of the PE being previously deducted against the income of the parent, when the PE makes a profit. The deciding factor in this case was that Austria did not allow for the carry forward of losses. In this case the ECJ held that when a permanent establishment makes a profit, a Member State may provide for a tax re-integration of any losses which were previously incurred by the permanent establishment and which were taken into account by the parent company situated in a different Member State when calculating tax due on its income. This is only acceptable when the state, where the permanent establishment is situated, does not confer any right to carry forward losses incurred by a permanent establishment whose parent company is situated in a different Member State, and where, under a convention for the prevention of double taxation between the two states concerned, the income of such an entity is exonerated from taxation in the state in which the parent company has its seat.

The deciding factor for PEs seems to be whether carry forward of losses is allowed. This factor is determined by the PEs Member States tax legislation and not on the tax legislation of the Member State where the parent is established, even though this latter Member State is expected to provide relief for the losses incurred by the PE. In practice this does not allow for a fixed set of rules as the Member State where the parent company is established would need to look at the legislation of the Member State where the PE is resident. This creates an administrative burden which is very hard to maintain in practice.

The availability of rules allowing for the carry forward of losses seems to be crux of the Courts decision. One may argue that harmonisation of rules in relation to carry forward of losses might provide the solution. If the PE is considered by all Member States as an extension of the parent company in another state, thus implying that its profits/losses all belong to the parent company, then it would be logical to tax all profits or give relief to losses in the Member State where the parent company is resident. When sustaining that the PE is an extension of the parent company one is stating that the PE cannot exist without the parent company and therefore it is not a physical entity on its own but must be considered as an integral part of the parent company. It follows from this argument that the Member State where the PE is resident cannot tax the PE as it has no taxing rights over the parent company.

Member States might argue that the PE is earning source income in their country and thus they have a right to tax that source income. It is evident that a more focused and clear direction still needs to be provided in order to assist multinationals with their strategic and tax planning.

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CASES DEALING WITH DEDUCTIBILITY OF EXPENSES AND CHARGES INCURRED BY PARENT COMPANIES IN RELATION TO SHAREHOLDINGS IN CROSS-BORDER SUBSIDIARIES

Following the decision on the landmark case of Marks and Spencer in February 2006 the ECJ decided on the Keller9 case. Here the ECJ held that non-deductibility of expenses related to exempt dividends from a second-tier subsidiary located in another EU Member State under the old imputation system is incompatible with the freedom of establishment. In the Keller case the parent company tried to deduct the interest on loans raised to acquire its immediate subsidiary together with other administrative expenses. The German tax authorities disallowed such a deduction, as the expenses mentioned had an immediate and economic connection with tax-exempt income received from the second-tier subsidiary.

The Rewe Zentralfinaz10 case is similar to the Keller case since it also deals with a Member State, Germany, disallowing deductibility of expenses. In this case Rewe Zentralfinanz, a German resident company was the sole shareholder of a Dutch holding company, which in turn had subsidiaries in other EU Member States. Rewe Zentralfinaz depreciated at market value, the going concern book value, of its participation in the Dutch company. The German tax authorities however, denied such a write-down as a deduction for tax purposes as the German tax rules restrict depreciation of holdings in non-resident subsidiaries. This case was referred to the ECJ and the Court held that this denial of immediate deduction for passive participation violated EC law.

More recently in the Deutsche Shell case, the ECJ held that it is contrary to the freedom of establishment for a Member State to deny a head office the possibility to deduct a currency loss resulting from the repatriation of the start-up capital of its permanent establishment situated in another Member State, as such a loss can never, by its very nature, be taken into account in the Member State of the permanent establishment.

In this case a German company with an Italian PE suffers currency losses with regards to the depreciation in the value of the start-up capital. This currency loss was not deductible under German law since it was deemed to be an expense directly attributable to the PE income which was exempt under German law. The Court held that while there was no duty of harmonisation in that a Member State is not expected to draw up its tax rules on the basis of those of another Member State, in order to ensure that there are no disparities in any circumstances11, in this case the tax disadvantage related to a specific operational factor which could only be taken into consideration by the German tax authorities. The ECJ refused the German tax authorities arguments on the grounds of cohesion of the tax system, balanced allocation of taxing powers and double deduction and ruled in favour of the company.

In all of the above mentioned cases (Keller, Rewe Zentralfinanz and Deutsche Shell) the ECJ ruled in favour of the company making the claim and held that a Member State should allow deductibility of expenses as a result of a direct or indirect subsidiary even when the expenses arise as a result of activities in another Member State.

On the other hand in OY AA12 the ECJ held that it is permissible for a Member State to allow a resident subsidiary to deduct a transfer of profits made under the intra-group financial transfer system only when the receiving parent company is resident in the same Member State. Although the non-deductibility of financial transfers made to parent companies of other Member States constitutes a restriction on the freedom of establishment, it is justified by the need to safeguard the

balanced allocation of taxing rights between Member States and the prevention of tax avoidance and it is proportionate to those objectives. OY AA applied to make a group contribution to its parent company, however the advance ruling from the Finnish Central Tax Board stated that such a contribution could not be tax deductible for OY AA. The case was referred to the ECJ which decided in favour of the Finish authorities on the grounds that the restriction was proportionate in order to safeguard the balanced allocation of the taxing powers of the Member States and also to prevent tax avoidance.

In all the cases mentioned the Court is recognising that the restriction by Member States on the cross-border deductibility of expenses and charges constitutes in principle a restriction on the freedom of establishment as portrayed in article 43 of the EC Treaty. However, the Court is reserving the right to scrutinise such a restriction in terms of proportionality and the right of a Member State to safeguard the balanced allocation of its taxing powers. Therefore, one might argue that a restriction on the freedom of establishment arises when a Member State cannot prove that the restriction was imposed in order to safeguard the balance allocation of taxing powers and the Court finds such restriction not to be proportionate in order to attain this objective.

CONCLUSION

Member States have retained their sovereignty on the imposition of direct taxes in their respective countries. However, Member States need to exercise such power consistently with Community law. Apart from the requirements of Community Law, Member States are also finding that their power to impose direct taxation is being constrained by ECJ decisions. This article has mainly focused on case law in relation to cross-border group loss relief, surrendering of losses between companies and their permanent establishments and cases dealing with deductibility of expense and charges in cross-border situations.

Marks and Spencer has left a number of unresolved issues. The Court has failed to debate whether the decision in Marks and Spencer refers only to tax regimes similar to the UK-pre Mark and Spencer or whether the same reasoning can be extended to other tax regimes or permanent establishment. Also, in Marks and Spencer the Court only discussed terminal losses thus avoiding all argumentation with regards to losses recapture.

It is immediately noticeable that in defending the freedom of establishment the ECJ was not always consistent with the principals established in Marks and Spencer. A case in point is the OY AA case were the ECJ failed to consider the exhaustion of possibilities test as developed in Marks and Spencer, resulting in a stricter enforcement of Community Law, also taking into account the decision in the Deutsche Shell case were the Court actually decided on the basis that the PE could not utilise the currency losses in its resident Member State.

In the Rewe case the court held that the balanced allocation of taxing power was considered in Marks and Spencer in conjunction with tax avoidance and double deduction and could not be taken on its own merits, while the same Court accepted this argumentation as providing the lack of proportionality in X Holding.

The Court applied the exhaustion of possibilities test as developed in Marks and Spencer in the Krankenhein case in order to allow the reintegration of the permanent establishment losses. The same concept is also applied in the Lidl case. One can argue that principles established in Marks and Spencer with regards to subsidiaries, are also applicable for permanent establishment. Thus, it would be logical to

Winter 2011FEATUREReferences:

1. Marks & Spenser Plc V Halsey (Inspector of Taxes) (C-446/03) 13/12/2005, ECR I-10837.

2. Ibid. para 31Even though, according to their wording, the provisions concerning the freedom of establishment are directed to ensuring that foreign nationals and companies are treated in the host Member State in the same way as nationals of that State, they also prohibit the Member State of origin from hindering the establishment in another Member State of one of its nationals or of a company incorporated under is legislation....

3. Socit Papillion V. Ministre Du Budget, Des Comptes Publics Et De La Function Publique C-418/07.

4. X Holding v Staatssectretaris van Financien (Case C-337/08 ) 25/02/2010

5. Ibid para 29;

6. Stahlwerk Ergste Westig V Finanzamt Dsseldorf Mettman C-415/06 06/11/07. 7. Lidl Belguim Vs Finanzamt Heibrown C414-06 15/05/08.

8. Finanzamtfr Krperschaften III in Berlin V Krankenheim Ruhesitz Case C-157/07 23/10/08.

9. Keller Holding V Finanzamt Offenbach Am Main-Land C-471/04, 2006. 10. Rewe Zentralfinanz eG V Finanzamt Kln-Mitte C-347/04, 2007.

11. Deutsche Shell GmbH V Finanzamt Fr Grossunternehmen in Hamburg C-293/06, 2008, para. 43.

12. Oy AA C-231/05, 2007.

assume that the reverse is also true, that is principles applicable to a permanent establishment situation would also be applicable to a subsidiary situation. However, the court in X Holding held that that non-resident permanent establishments and non-resident subsidiaries were not in an objectively comparable situation.

Indirect harmonisation resulting from ECJ decision is only targeting those Member States whose tax regime or provisions are brought under the scrutiny of ECJ, either by the national courts referring the case to the ECJ or by the Commission launching infringement proceeding. Thus, one Member State might be subject to amend its tax legislation to conform with EC law while other Member States would still hold back until their particular legislation is challenged. A case in point are Malta and Cyprus whose legislation on group loss relief still reflects the UK provision pre Marks and Spencer. Another important point is that the ECJ leaves it in the hands of the national courts to interpret its decision, which may result in different interpretations of similar if not the same issues.

As discussed above, leaving harmonisation for cross-border group loss relief in the hands of the ECJ might result in stricter application of EC law for some Member States, which can be considered as discriminatory. It is the authors opinion that a more direct and structured approach needs to be adopted at EU level in order to harmonise cross-border direct tax issues.

About the authorJeanette Calleja Borg holds the position of Assistant Manager in the Business Tax Compliance and Reporting Services Department of one of the largest professional services firms in Malta. Ms. Calleja Borg obtained a Bachelor of Commerce, a Bachelor of Accountancy (Hons.) and subsequently a Masters in Financial Services from the University of Malta. Currently reading for a PhD in International Taxation at the School of Law, within the Centre for Commercial Law Studies at Queen Mary, University of London under the supervision of Prof. David Southern and Dr. Christiana Panaji, she is also carrying out a research scholarship at the Institute for Austrian and International Tax Law under the supervision of Prof. Michael Lang. Ms. Calleja Borg is a certified public accountant and a member of the Malta Institute of Accountants, the Malta Institute of Management and the UK Society of Legal Scholars.

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Winter 2011www.miamalta.org

Winter 2011www.miamalta.org

Keeping UpTimes WITH THE

Interview with IAASB Chairman Prof. Arnold Schilder

Beyond Marks & Spencer

Integrity and Expertise

ECJ case law dealing with the freedom of establishment

Accounts Receivable Management

C O N T E N T S

Cover:

Keeping Up with the Times

Interview with IAASB Chairman Prof. Arnold

Schilder

Photo: D. Aquilina

50FEATURES

8NEWS

ADDRESS

4 Evolving World Evolving Role Ben Scicluna

25

FEAT

URE

S

NEWS

8 Local Update & MIA News 32 IFAC, IASB and FEE News

INTERVIEWS AND LIFESTYLE

12 Keeping Up with the TimesInterview with IAASB Chairman Prof. Arnold

Schilder

30 Bitter Sweet!36 A Walk Down Memory

Lane ( 4 ) Interview with MIA Past President Joseph N. Tabone

44 The SMP Point of ViewInterview with William Spiteri Bailey

54 Spotlight on... Pierre Cordina

FEATURES

18 Transforming Manage-ment Systems & Accounting Functions...By: Anita Aloisio

25 Beyond Marks & Spencer - ECJ Case Law Dealing with the Freedom of EstablishmentBy: Jeanette Calleja Borg

39 Investment Appraisal: A Refresher (Part 2)By: Ray Sladden & Stephen Muscat

50 Accounts Receivable ManagementBy: Josef Busuttil

TECHNICAL

58 Accounting solutions60 IFRS, IAS, ISA Update

STUDENTS

62 ACCA Students notice board

54

12INTERVIEW AND LIFESTYLE

Winter 2011 LIFESTYLE

30

DM, for the uninitiated, is a condition whereby the blood sugar is higher than it should be. There are different forms of DM which are broadly categorised into Types 1 and 2.

In Type 1, the insulin-producing cells suffer damage by a self-destructive mechanism by the body called an auto-immune process. This condition, affects a minority of diabetic patients, is generally sporadic in whom it afflicts, tends to affect the younger patient and generally has a rapid onset and progress, always requiring the patient to go onto therapy with insulin. Insulin is essential for the survival of such patients. As it is not the purpose of this article to discuss the management of this condition, and there being little that one can do to forecast or to prevent it happening, I will not dwell further on this subject.

In Type 2, the insulin-producing cells in the pancreas fail to keep up with the increased demands placed upon them. The condition tends to become more common in the older patient, is often related to overweight issues, often has a family history of the condition and, whilst it may require insulin for better control, insulin is rarely essential for the survival of the patient. The progress of this condition is a fairly indolent one, starting several years previously in a way that allows the patient to have a substantial say into the direction of his future health.

The control of blood sugar forms a continuous variable during ones lifetime and anyone destined to develop diabetes shows a steady rise to the sugar level over a given time frame. In other words, one isnt fine one day and poorly the next, although it may seem to be so to the patient who depends on symptoms such as tiredness, weight loss, itching, excessive thirst and urination to guide him towards his doctor. For this latter sort of patient, it is estimated that the state of diabetes would have been around for up to 10 years, before the patient realises that something is very wrong. Most regrettably this means 10 years of lost opportunities and of bad health investments.

Ideally, DM should be a biochemical diagnosis, picked up the condition in its earliest stages by blood testing, at which point no clinical features are apparent. A normal fasting sugar is up to 6mmol/ l but levels greater than 5.5 mmol/ l are considered to fall in the pre-diabetes range. In DM, the fasting blood sugar is greater than 7 mmol/ l. At this latter the seeds for the further complications of diabetes begin to be sown.

Not all patients whose levels are pre-diabetic become diabetic and medicine still isnt that accurate at forecasting an individuals future. Notwithstanding, some people are more prone than others to take this misdirected step. The enabling factors tend to be situations where other family members have diabetes, where the individual concerned demonstrates too much weight around the waist (so, if the measuring tape reads more than 80cms in a female or 94cm in a male, beware!), and especially so, if the

excessive weight is accompanied by a blood pressure greater than 135/ 85, or there is an excessive amount of triglyceride fat in blood (>1.7mmol/l) or a lack of good HDL cholesterol (

32

Winter 2011 NEWS-GLOBAL

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Winter 2011 NEWS-GLOBAL

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New members appointed to the IAASB The Public Interest Oversight Board (PIOB), an independent body that oversees the International Auditing and Assurance Standards Boards (IAASBs) activities, has confirmed a number of new and reappointed members of the IAASB. The appointments were recommended by the IFAC Board and are effective January 1, 2011. The new members of the IAASB are: Jean Blascos (France), a practitioner in a transnational firm; Jianshen Chen (China), a practitioner in a large national firm; and Merran Kelsall (Australia), a non-practitioner and chair of a national auditing standards setter. John Archambault (United States), Jon Grant (UK) and Caithlin McCabe (Australia) were reappointed for an additional term. In addition, Diana Hillier was reappointed as deputy chair of the IAASB.

IAESB proposes clarified standard on Continuing Professional Development The International Accounting Education Standards Board (IAESB) released for public exposure a proposed revision of International Education Standard (IES) 7, Continuing Professional Development: A Program of Lifelong Learning and Continuing Development of Professional Competence. IES 7, drafted in 2004, introduces the concepts of continuing professional development (CPD) learning that develops and maintains competence to enable professional accountants to perform their roles effectively as relevant, verifiable, and measurable learning activities and outcomes. The proposed redrafting aims to assist the ongoing worldwide development of CPD systems and compliance mechanisms. IAESB expects to increase the opportunity for mobility of labour, and in so doing to contribute to the global economy through these revision efforts.

World Congress of Accountants: Accountants in the next decadeWorld CEOs say accountants Must Embrace Change and Seize Opportunities,

Chief executive officers of accounting institutes from around the world shared their visions on the accountants

of the future at the World Congress of Accountants 2010. The World Congress closed with the final plenary session titled Accountants in the Next Decade Embracing Change and Seizing Opportunities,. Chaired by IFAC CEO Ian Ball, the session looked into how the recent global economic crisis changed the environment for the accountancy profession; the impact that increased globalisation will have on the profession; how should the audit evolve to meet new needs; how might the skills and competencies of accountants change in the years ahead and whether accountancy will remain an attractive option for young people in the future.

Other items on the World Congress agenda included integrated reporting and sustainability; the roles and responsibilities of professional accountants; XBRL and the communication of business information; governance and international standards; the role of and challenges for SMPs; IFRS and the convergence of accounting standards; and Islamic finance.

IFAC announces Gran Tidstrm as its new President; Warren Allen elected as Deputy President

IFAC announced that Mr. Gran Tidstrm of Sweden has been appointed president of IFAC for a two-year term ending in November 2012. The IFAC Council also approved the nomination of Mr. Warren Allen of New Zealand for deputy president, a role previously held by Mr. Tidstrm. A European representative to IFAC since 2000, Mr. Tidstrm became a member of the IFAC Board in 2003, served as chair of the Planning and Finance