When the tax return and the tax provision stop agreeing

A frequent failure is drift between the tax provision in the accounts and the returns actually filed. It starts when each is built from separate data, shows up as unexplained true-ups and deferred balances that will not roll forward, and is fixed by reconciling return adjustments back to the ledger.

How the drift begins

The provision is usually prepared under close pressure by people who sit near the general ledger. The return is prepared later, often by a different team or an outside adviser, working from a trial balance extract and their own workpapers. Both start from the same books. They rarely stay aligned.

Small decisions open the gap. The return preparer reclassifies an expense as non-deductible after reading the contract. A fixed asset gets a different tax life on the return than the one assumed in the provision. A foreign subsidiary files locally with figures that were adjusted after group consolidation, and nobody sends the final version back to head office.

None of this is wrong on its own. The trouble is that the change lives only in the return file. The deferred tax schedule keeps the old assumption. The tax accounts in the ledger keep the old balance. Next period the provision starts from a base that no longer matches what the authorities have been told.

Over time the differences stack up. Some reverse naturally and hide themselves. Others sit in a deferred tax asset or liability that nobody can fully explain.

Where it first becomes visible

The earliest signal is usually the return-to-provision true-up. When the return is filed, someone books the difference between estimated and actual current tax. If that entry is large, or keeps landing in the same direction, the provision method is missing something. If it cannot be broken down by item, the problem is worse than a bad estimate.

A second signal comes from the deferred tax roll-forward. A clean roll-forward moves from opening balance to closing balance through identifiable movements: originating differences, reversals, rate changes, true-ups. When a balancing line appears labelled "other" or "unexplained", drift is almost always the cause.

Auditors notice too. They ask for support for a deferred balance and the team produces a spreadsheet that ties to the ledger but not to any filed return. Tax authorities can surface it from the other side, when an inquiry asks about a figure that the finance team does not recognise because it was changed late in the return process.

The effective tax rate is a weaker clue. A swing in the rate that the reconciliation explains only with vague items deserves a closer look, though rate movements have plenty of innocent causes.

Repairing it

Start by rebuilding the link between filed returns and the books. For each entity, take the most recent return as filed and walk every book-to-tax adjustment back to the provision workpaper for that period. Each item lands in one of a few buckets: matched, a timing difference the provision missed, a permanent difference the provision missed, or a genuine error on one side.

This exercise is slow and unglamorous. It also tends to be where the real fix gets decided, because it shows which handoffs keep failing.

Once the inventory of differences is clear, correct the deferred tax balances. Book the adjustments with a clear explanation, and decide with the auditors whether any correction belongs in prior periods.

The lasting cure is procedural. Agree that the return workpaper and the provision workpaper use one shared list of adjustments, with the same descriptions and the same reference for each item. When a preparer changes a treatment on the return, that change must be logged and sent to whoever owns the deferred tax schedule before the return is signed. For foreign entities, the local filing should come back to the group tax team in final form, not as a draft.

Give one person ownership of the true-up entry and require it to be explained line by line. An unexplained true-up should block the close the way an unreconciled bank account would.

Questions for the people who do the work

Written procedures often say the provision and return are reconciled. Practice can look very different. These questions tend to expose the gap:

• When you change a deduction on the return, who do you tell, and how?
• Which version of the trial balance does the return start from, and does anyone check it against the one used for the provision?
• What is in the "other" line of the deferred tax roll-forward, and when was it last cleared?
• Do the local teams abroad send back the return as filed, or only the numbers they expected to file?
• If an auditor asked you to support a single deferred tax item today, which file would you open?
• Has an inquiry from a tax authority ever asked about something you could not find in the books?
• Who books the true-up entry, and who reviews it?

Pay attention to hesitation and to answers that start with "normally". Those usually point at the handoff that breaks.

Points to hold onto during a redesign

Process changes in tax often move work between teams, bring in new software, or shift preparation to an adviser. Each of those moves can sever the informal links that kept the provision and the return close. Before anything goes live, confirm where the shared adjustment list will sit and who updates it. Check that the deferred tax schedule still receives every late change to the return.

APQC's Process Classification Framework® (PCF) is an open standard developed by APQC, a nonprofit that promotes benchmarking and best practices worldwide. To download the full PCF or to view definitions and measures, please visit www.apqc.org/pcf.