Academy of Accounting and Financial Studies Journal (Print ISSN: 1096-3685; Online ISSN: 1528-2635)

Research Article: 2018 Vol: 22 Issue: 4

The Role of Forensic Accounting and Its Relationship with Taxation System in Iraq

Ahmed Mahdi Hadi, The University of Qadisiyah, Iraq

Ahmed Rahi Abed, The University of Qadisiyah, Iraq

Hayder Oudah Kadim, The University of Qadisiyah, Iraq

Abstract

The objective of this study was to investigate the role of forensic accounting in restraining the tax evasion in Iraq particularly when the country is facing severe political unrest and military operations. The study also examined how forensic accounting could be ideally suitable for the current state of Iraqi economy which is facing a transition from oil economy to a tax-based economy, using the ransom sampling method to identify 60 government and semi government tax officials, the study adopted a survey technique. The study encountered a number of important findings regarding the role of forensic accounting in introducing a robust taxation system in Iraq. The study examined the role played by forensic accounting system in bringing tax reforms in the Iraqi context. This study also analyzed the current tax system in Iraq to shed light on key weaknesses and provide proposals for reform and revenue mobilization. The major findings of the study include a necessity of the application of forensic accounting in introducing tax reforms in Iraq. The study recommended that all legal institutions and government agencies should establish forensic accounting units. Educational institutions and universities should also include modules on forensic accounting in their curriculum. It also recommends simplifying direct taxes, increasing non-oil revenues from indirect taxation, and strengthening tax and customs administrations. The study will prove to be a contribution to the Iraqi public accounting practices.

Keywords

Accounting Standards, Taxation, Oil Revenue, Audits.

Introduction

The origin of Forensic Accounting goes back to 1817 (Crumbley, 2001:200:2006) and the term was first used in 1946 by Peloubet (quoted in Joshi, 2003), the term gained prevalence much recently as a response to combat Economic and Financial Crimes (EFCs) and in response to the increased incidents of frauds (Modudgu & Anyaduba, 2013; Ozkul & Pamukcul, 2012). Several universities and law colleges have introduced Forensic accounting modules in their curriculum to provide training and skills needed to fight EFCs. Forensic accounting, also called investigative accounting or fraud audit (Golden et al., 2007) is a merger of forensic science and accounting. According to Crumbley (2003) forensic science “may be defined as application of the laws of nature to the laws of man”. He refers to forensic scientists as examiners and interpreters of evidence and facts in legal cases that also offers expert opinions regarding their findings in court of law. Forensic accounting requires the accountant to possess investigative skills in order to examine into a company’s financial statement. It has now been accepted as a practice for accountants to develop such business skills so that they are capable of investigating cases of fraud, embezzlement of funds and theft of assets. The forensic accountants should be trained to look into fraud cases for which they need to be trained in accounting, auditing and investigative skills (Zysman, 2001) while Hao (2010) affirms that forensic accounting integrates the legal framework with the accounting framework. Forensic accounting therefore requires investigation, litigation support and dispute resolution (Dada et al., 2013).

Forensic accounting is therefore moat suitable for legal review as it offers the highest level of assurance (Apostolou et al., 2000). The term "forensic" is now invariably used as a legal concept suitable to use in a court of law. Forensic accountants are often seen as ‘forensic auditors’ who “investigate” on behalf of accounting firms and government agencies and participate in court trials (Crumbley et al., 2005; Zysman 2001). It blends both domain areas of accounting and law, to effect stronger and more relevant investigations and resolve legal disputes. The forensic accountants offer their services in numerous litigations such as economic damages through breach of contract or warranties, disputes on taxes and business valuations, matters relating to bankruptcy and insolvency, fraud and money laundering and so on. In the government sector and public management forensic accounting plays a major role in determining taxation and other fiscal regulations to guide and regulate revenues matters of the government and its various departments (Nigrini, 2011; Parr and Smith, 2010; Crumbley et al., 2005; Cicchella, 2005).

In Iraqi context, forensic accounting involves investigation of its various revenue sources which, other than oil, are taxes and revenue from state-owned enterprises (Hassan et al., 2014). In the current scenario in Iraq, oil revenue, which constituted more than 90%of total fiscal revenue, has suddenly fallen down, causing a sharp increase of the budget deficit from 6%of GDP in 2013 to 14% in 2017; increase of public debt from 31%of GDP in 2013 to 67%in 2017; and a fall in foreign exchange reserves from $78 billion in 2013 to $45 billion in 2017 (Deloitte, 2017). The exposure of the economy to the fall in oil prices has highlighted the very low level of non-oil tax revenue, and hence Iraq feels the need to increase it through other sources such as taxation. The total tax-to-GDP ratios in Iraq has historically not exceeded 1 percent, a very low share of the economy compared to the average ratio in the MENA region where it is more than 10 times (International Monetary Fund, 2017; The Board of Supreme Audit, 2016). In Iraq, there had been no state level or municipal taxes until 2005. The Iraqi employees also did not pay income tax; however, people paid agriculture income and estate taxes as direct taxes; while commodity taxes, customs and other duties as indirect tax. Taxes therefore provided a very meager percentage of the Iraqi government’s income (Metz, 1988).

While the major source of revenue was oil in Iraq, other sources of revenue in Iraq were very much less diversified as compared to other developing economies. In 2005, when the Iraqi government introduced a few direct and indirect taxes, including the income tax on both Iraqi and non-Iraqi tax residents, as well as corporate income tax rate increased to a flat rate of 15%, there was no robust monitoring system to ensure a proper compliance of the taxation system. So far the taxation system in Iraq was governed under the Federal Income Tax law, Law no. 113 of November 22, 1982, as amended in 2003 (the Federal Income Tax Law). The tax authority is the General Commission for Taxes (GCT) in the Federal Iraq and the Income Tax Directorate (ITD) in the Kurdistan Region. All enterprises registered in Iraq are required to prepare and submit audited financial statements in accordance with Iraqi Uniform Accounting Standards (UAS) which are audited by an Iraqi statutory auditor (Ministry of Finance, 2011). The audited UAS financial statements are later submitted to the GCT along with tax returns (Iraqi Board of Accounting and Auditing Standards, 1997).

Hence in Iraq there has been a lack of appropriate forensic accountancy experts that might ensure implementation of robust financial auditing with the prerequisite objectives and procedures (Al-Jalili, 2012). Iraq requires proper scrutinizing of paperwork under forensic accounting techniques and resolve all types of economic and financial crime cases. It was therefore imperative to carry out a study to explore how forensic accounting techniques can be strengthened in Iraq in order to combat EFCs or any other fraudulent activities in Iraq. This research seeks to determine how the forensic accounting system in Iraq can be developed and overhauled enough to monitor the taxation in accordance with the provision stated in Article 2 and Article 5 of the Federal Income Tax Law (Al-Jalili, 2012; Hassan et al., 2014).

Similarly, not much has been written about tax reforms or revenue generations in developing economies in general and the Iraqi economy in particular. In the context of Iraq, previous accounting studies have considered it more as a “function” of its environment (Gendron et al., 2010; Elsayed & Hoque, 2010). These studies have understood forensic accounting and accountability as those parts of the formalized information used by the state organizations to influence the behavior of their managers only to achieve organizational objectives (Barton, 2001; The Board of Supreme Audit, 2016; Mansour, 2015). For this reason, no study has been able to draw attention to the corrupt practices and illegal activities that had been affecting the public sector management. For the first time this study has endeavored to review the nature of forensic accounting in Iraq, its current activities and to determine what reforms are needed in the existing accounting framework. Another objective of this study was to analyze the applicability of various accounting laws and regulations in Iraq and to see whether there is any inconsistent application of accounting procedures and principles, which is yet another pioneering attempt in this domain of research.

Literature Review

Relevance of Forensic Accounting

Forensic accounting is a science that studies financial statements and reports of forensic experts having a knowledge of accounting, auditing, and relevant aspects of judicial laws (Okoye & Gbegi, 2013). Zysman (2004) too has stated that Forensic Accounting amalgamates accounting, auditing and investigative skills together in any kind of accounting activity in a courtroom setting. Bhasin (2007) reiterates the need and importance of forensic accountants in the fields of criminal investigation, breach and dissolution of partnership deeds; settlement of insurance claims, detection of employee fraud and cases relating to professional negligence. Crumbley (2003) hold the opinion that a forensic accountant is like a financial detective who uses his ever suspicious mind, works like a “financial bloodhound”, who can reconstruct past accounting transactions and can look beyond numbers. Bhasin (2013) laments how legal practitioners unfortunately lack the relevant training and expertise in combating white collar or the economic crimes. Truly speaking, fraud investigators need to look beyond just auditing or accounting skills, they should be trained in resolving Economic and Financial Crimes (EFCs) in order to complement their knowledge of accounting information systems (Ramaswamy, 2005).

Forensic Accounting and Economic and Financial Crimes

Economic and Financial Crimes (EFCs) have increased manifold in this technological era (Adams et al., 2006; Hochberg, 2006; Peterson & Zikmund, 2004; Wells, 2007) despite efforts made by government and other regulatory authorities to combat the evil of economic and financial crimes. A need is therefore felt to introduce forensic accounting to resolve such crimes.

Particularly, there are studies related to forensic accounting essential to curb corruption (Alabdullah et al., 2014) and to stop cybercrimes (Boateng et al., 2010). These studies have however unanimously agreed that accountants and auditors lack the required technical skills and training required to combat such EFCs. In some countries like Ghana and Nigeria, however, Information and Communications Technology (ICT) and rapid growth of the financial sector and financial institutions have led to the emergence of a sophisticated forensic accounting system (Ofori-Dwumfuo and Gyimah, 2013) and stop corruption and other financial and economic crimes (Adegbie and Fakile,2012).

Ahmad (2013) highlighted the role of a forensic accountant in limiting financial corruption practices. According to the author, there is a need to have a law that specifies the duties of a forensic accountant in courts as well as in tax departments. There must be specific forensic accounting requirements, to raise their competency of monitoring the legal disputes and reducing the conflicts between the financier and the tax authority (Diqabriel & Ojb, 2013).

The meaning of Tax Evasion

Alkhatib and Abdul-Jabbar (2017) define tax evasion as an “attempt of a taxpayer not to pay the due taxes totally or partly by following ways and methods that contradict the taxing system provisions, i.e by cheating and fraud.” Mclaren (2008) defines it as “an act of violating law when the taxpayer refrains from paying taxes or reducing the tax to a less value than that they have to abide to.” There are various factors that lead to tax evasion including the instability of political and legal system of a nation for instance, the complicated tax and bureaucratic procedures of taxation department; the lack of control and incompetency of the investigation authorities; and last but not the least, the taxpayers' frustration of not receiving benefits against the taxes paid (Mclaren, 2008 ). The methods of tax evasion include not presenting tax statements or increasing the expenses in order to get exemptions; non registration at the income tax authority even after having high income; non-disclosure of taxable income and other activities; non deliverance of tax deductions from workers' incomes and nonpayment of social security contributions. (Hassan et al., 2014; Al- Kassar, 2014) There are a few studies (Hassan et al., 2014; Al-Kassar, 2014; Al-Jalili, 2012; Alabdullah et al., 2014) that have found in Iraq a complex legislative and forensic accounting framework to address to the issues of tax evasion.

Forensic Accounting Framework in Iraq

Iraq, in general, has two accounting systems: one for government directorates (non-profit organizations), namely a governmental accounting system for which the Ministry of Finance is responsible, and the second is Unified Accounting System (UAS) for profit organizations, for which the Board of Supreme Audit (BSA) is responsible (Al-Jalili, 2012). However, the control of all expenditures is managed by the Ministry of Finance and Board of Supreme Audit which follows a comprehensive auditing system. They also present the government’s annual financial reports to parliament. Such an auditing can be truly termed as forensic accounting of government revenues. It is primarily aimed at reviewing and evaluating the results of the implementation of revenue policies and plans. This type of forensic accounting is done in accordance with internationally-recognized accounting standards and principles. Iraq thus demonstrates a kind of public accountability that uses an accounting framework that reports all the relevant financial information to those stakeholders who should know how the public money is being spent (Hassan et al., 2014).

At the grass root level, Iraq also practices a legislative as well as forensic accounting framework. Both frameworks are exemplified in many incidents for instance while withholding taxes in contracts with foreign parties under instructions no. 2 of 2008, or in matters of upstream oil and gas contracts under Instructions no. 5 of 2011. However, there has been no specific legislation under the current forensic accounting system that would order a withholding on dividends, rents and royalties (Kaddouri, 2011; Looney, 2004). There are however certain accounting procedures laid down for retentions of tax payments and for certain contracts fixed at various rates up to a maximum of 10% of the gross payments (The Board of Supreme Audit, 2016).

Under the Iraqi tax law, Instructions no. 2 of 2008 also laid down that tax clearance can strictly only be awarded once the supplier has completed their tax filing obligations and settled any due taxes in Iraq. If no tax clearance is obtained within 90 or 180 days from the end of the contract (depending on the type of contract), then the amounts retained should strictly be transferred to the tax authority, in accordance with the Instructions. Likewise, Instructions no. 5 of 2011 provide that “subcontractors to whom the Oil and Gas Tax Law applies should be subject to retentions of tax on their contract payments at a rate of 7% of the gross amounts for petroleum contracts and at a rate of 3.3% for non-petroleum contracts”. Both the Instructions provide that the entity making the payment should remit the retained amounts to the tax authority within 30 days of making the payment, with the amounts to be held by the tax authority to be reconciled with the contractor’s final tax calculation. In addition, the whole of the final installment payment should be withheld from the contractor until the contractor has completed the corporate tax filing and has obtained a tax clearance.

Problem Statement

In spite of several legal provisions, the forensic accounting system in Iraq has failed to deliver the desired results. Al-Kassar (2014) argues that this would be because taxes do not play a significant role in providing financial resources to the state of Iraq and are mainly used as an effective method to create disparities in income levels of the citizens, which are the objectives of the tax laws in Iraq. According to the author, a forensic system fails to exist in Iraq due to increased dependence on oil revenues and exemptions of income taxes for all Iraqi governmental employees. It is also due to the complex tax laws in Iraq and the lack of appropriate public accountability management system (Alabdullah et al., 2014). Earl (2005) highlighted that accountability and data management are the heart of contemporary reform efforts worldwide. Accountability has become the watchword of education, with data holding a central place in the current wave of large-scale reform. Unfortunately both are missing in the context of Iraqi economy. The authorities and the auditors the Iraqi forensic accounting system has failed to play their statutory role of providing management of financial accounts independently and objectively (Al-Kassar, 2014).

Moreover, due to political unrest in Iraq and other regional political and military operations, the Iraqi economy failed to remain stable (Iraq, 2011; Ministry of Finance, Annual reports, 2011). There is a lack of transparency in the public sector financial management regulatory framework and a poor coordination between the public accountability institutions with no clear allocation of roles and responsibilities. This has not only resulted in misuse of laws but also eruption of practices such as corruption and security issues (Iraq, 2011). The problem was also aggravated due to the lack of any latest written documentation as the existing documented accounting framework of Iraq dates back to 1940’s with only minor amendments (Metz, 1988; Majid, 2001; Iraq, 2011; The Asian Organization of Supreme Audit Institution, 2010). With the fall of the previous government, the Iraqi Coalition Provisional Authority (CPA) introduced a financial management legislative (FML) framework, which attempted to collect and document Iraq’s accounting rules and regulations, but they are also not complete and not yet comprehensively documented (Iraq, 2011).

With the increase in the tax values imposed on companies, this grave phenomenon –tax evasion –appeared threatening to the state's economy and detaining the achievement of its goals and economic and social policies (Abidin & Haseeb, 2018; Hamzah, 2018; Haseeb, 2018; Suryanto, 2016). Moreover, not all the Iraqi officials are familiar with the accounting concepts and standards. The key challenge before the Iraqi government therefore is to design and disseminate to all its officials an effective forensic accounting and audit procedure to ensure that the government is able to know a true account of financial activities across various departments of the government. Not much attention has been paid in the recent times and this study seeks to fill this gap in the literature by exploring the need for accountability of government revenues, and in particular taxes.

Objectives of the Study

The main objectives of this study are:

1. To ascertain whether the forensic accounting concept with all its goals and mission is competent enough to resolve crimes such as tax evasion.

2. To examine the applicability of forensic accounting in limiting tax evasion in Iraq.

3. To identify the most modern methods that can be followed by the Iraqi tax officials to combat tax evasion.

Methodology

This study investigates the existing taxation system in Iraq in order to identify its key weaknesses and explore the possibilities of reform and revenue mobilization within the scope of a forensic consideration and legal procedures. For this purpose, it employed survey research design methods in order to understand the significance of forensic accounting techniques in bringing reforms in the Iraqi taxation system. It collected primary data with the help of a research questionnaire. The purposive sampling method was used to identify respondents. This study was restricted to a random sample of the study population which comprised 60 tax officials from various government and private tax agencies in Iraq located at Hillah and Najaf. For the secondary data, the researchers relied on the descriptive and analytical case studies found in law books, previous research papers published in legal periodicals and journals and articles on forensic accounting and tax evasion.

This research paper covers both theoretical and empirical material aspects of this study. The theoretical side defines the accountability and auditing principles of a forensic accounting system while the empirical side studies the economic situation of Iraqi government in terms of its revenues from taxation and oil resources. The study has also attempted to analyze methods to increase non-oil revenue resources including taxation.

Findings and Results

This results of the preliminary survey focused on Iraqi accounting standards, and the relevant Laws and Acts that dealt with taxation including the current forensic accounting procedures. The feedings reveal that the BSA Law (1990) had promulgated certain accounting regulations in Iraq based on accepted international standards. This Law had also coordinated with the Commission for Public Integrity (CPI) (now renamed the Commission on Integrity) to improve on a continuous basis the rules, practices and standards applicable to forensic accounting for public funds in Iraq. Later, the amended draft BSA Law of 2005, Article 3, mandated the expansion of the accounting systems based on the local and international standards in order to improve rules and standards applicable to the management and accounting (Ministry of Finance, 2016). An interesting revelation of the study was the role that external auditors in Iraq played to deter themselves from application of forensic accounting and to devise methods to stop tax evasion. The findings also indicate that forensic accounting was not the method mandated by the external auditors to detect tax evasion cases. Additionally, the findings also suggested that there were no governmental officials trained in forensic accounting.

The study also observed that in spite of an institutional framework, there existed a lack of capacity in public accountability institutions and a lack of clarity in the financial management regulatory framework. The study also found out through various media reports and unresolved cases that there was a poor coordination between the public accountability institutions owing to their unclear allocation of roles and responsibilities (Deloitte, 2017). The Iraqi government had though recognized the need for greater clarity and consistency in public accounting and had given priority to setting up a public sector accounting framework in Iraq.

The Iraqi government also signed an agreement with the IMF under a Stand-By Arrangement (SBA) in 2006 in order to review the government’s Chart of Accounts (CoA) and the Financial Management Information System (FMIS) project. The IMF’s recommendation also proved that Iraq lacked the documentary evidence of its forensic accounting standards. The IMF also reported that the government’s accounting policies were not consolidated or codified; hence, there was limited confidence in its financial reports. The IMF also reported inconsistency in reporting and accounting among ministries, which was also evidence of the non-reliability of its financial statements. Consequently, IMF emphasizes on a pressing need to document and apply a coherent set of accounting policies through a structured process of consolidation of existing legislation, instructions and standards and review (International Monetary Fund, 2017).

These findings are consistent with that of Zysman (2004), Crumbley et al. (2009) and Crumbley et al. (2007) who also emphasized on the relationship between forensic accounting and quality assurance in financial matters.

Discussion

The status of taxation in Iraq was also studied during the course of this research. Table 1 shows that government revenues are derived from direct taxes, indirect taxes and oil revenues. The table reveals that taxes do not play a significant role in the financial resources of Iraq. The decrease in tax revenue, as a percentage of total revenue, during the past two decades (as shown in Table 1) and subsequent to the economic sanction imposed on Iraq in later years is due to increased dependence on oil revenues and exemptions of income taxes for all Iraqi governmental employees.

Table 1
REVENUE STATUS IN IRAQ
  1997 2008 2012 2017 Percentage of GDP
Direct Taxes 41% 0.66% 2% 2% 5%
Indirect Taxes 9.7% 0.37% 0.5% 0.7% 6%
Oil revenue 49.8% 98.97% 97% 97% 95%

Taxes in Iraq include personal and corporate income taxes, excise taxes, and tariffs. Other tax revenues include social contributions-such as payments for social security and hospital insurance grants, and net revenues from public enterprises. The government can discharge its duties only if sufficient resources are available. Forensic accounting is an important tool to ensure that the state receives the required income. It is accomplished only if the revenue audit is performed by the Board of Supreme Audit and the Iraq Integrity Commission keeping in view the national priorities.

There are other repercussions of the fall in the taxation. First, there was a deficit in the Iraqi budget, both the operating budget and the investment budget. There was also a fall in foreign investment due to security reasons and the economic sanctions on Iraq by the western powers (Majid, 2001). Hence, the situation grew more complex due to the lack of appropriate forensic accounting management systems. There was also inadequate revenue to fund important services provided by the government due to the large deficit in the general budget.

Conclusion, Suggestions and Implications

The study reveals that there is an urgent need to make amendments in the current laws dealing with taxation and revenue management systems. The Iraqi government can also formulate new accountability and enforcement agencies at the regional level in order to meet local as well as international challenges. The creation of new accountability institutions would help in streamlining and forensic monitoring the taxation procedures. A certain amount of fiscal decentralization may also be considered to manage public taxation system. The current forensic system at the national level has failed to support efficient and effective public management, thereby providing ample scope for fraudulent and corrupt activities. Further, the lack of a unified accounting system at the sub-national level and the insufficiency of forensic auditors must also be looked into in order to establish sound corporate taxation governance.

References