Under the entity perspective (also known as the entity theory) the reporting entity is deemed to have substance of its own, separate from that of its owners. Economic resources provided by capital providers become resources of the entity and cease to be resources of the capital providers. In exchange for the resources provided, capital providers are granted claims on the economic resources of the reporting entity. Claims of different capital providers have different priorities and different rights with respect to the reporting entity, but they all represent claims on the economic resources of the reporting entity. Therefore, financial reporting from the perspective of the entity involves reporting on the economic resources of that entity and the claims on those resources held by its capital providers.
This is the approach that now underpins the IASB’s work. Note that in the process of adopting this ‘entity perspective’ they have explicitly rejected the ‘proprietary perspective’, which they define as follows:
In contrast, under the proprietary perspective (also known as the proprietary theory), the reporting entity does not have substance of its own separately from that of its proprietors or owners. The resources of equity capital providers remain their resources and do not become resources of an entity because the entity does not exist separately from its owners. Lenders and other creditors provide economic resources to the owners of an entity in exchange for a claim against the resources that would otherwise accrue to the benefit of the owners. In other words, the claims of lenders and other creditors reduce the owners’ equity in the resources associated with the reporting entity. Therefore, financial reporting from the perspective of the proprietor involves reporting on the assets of the owners, the liabilities of the owners to their lenders and other creditors, and the net residual owners’ equity in the reporting entity.
In other words they, quite correctly in my opinion (a rare occurrence of my saying that) think that the shareholders of a company are a remote from owning it, or having claim upon it as any other provider of capital, a class that they think includes all lenders and creditors.
However you look at it the IASB and FASB do know something about business (this I concede). And what they are saying is that shareholders are nothing special. In fact they say that companies stand entirely independent of those who own them. I’m not sure that’s true of SMEs, but let’s leave that aside for now.
That somewhat blows the incidence argument apart. I agree with the IASB: in the case of large quoted companies these organisations are entities in their own right, not now answerable in any real way to their notional owners (look at the treatment of Fannie Mae and Freddie Mac this weekend and you’ll see exactly what I mean), not even acting in the sole interest of those supposed owners (another clear implication of this decision) and not to be considered an extension of their identity.
But let’s be abundantly clear: if that is true then they are very definitely taxable in their own right and the withdrawal of funds from them should be subject to taxation consequence because that is normally true when title to legal property is transferred.
This decision is important: it means the case for corporation tax has been settled in very large degree by the accounting profession, who, it has to be said know more about the reality of this issue than economists ever will.