www.pwc.com
Accounting for Income
Taxes: TEI Update
May 2015
Raleigh, NC
Tamara Williams
Kristen Wallace
Agenda
• Introduction
• Business Combinations
• Outside Basis Differences and Indefinite Reinvestment
• Valuation Allowance
• Interim Reporting
• Accounting Methods and Cash Tax Planning
PwC
2
Business combinations
PwC
PwC
3
Applying ASC 805 (FAS 141R) – Acquisition method
• The form of the transaction and the consideration do not affect the
financial accounting treatment of the acquisition – ASC 805
(FAS 141R)
• ASC 805 typically (FAS 141(R), paragraph 7) states that applying the
acquisition method requires:
- Identifying the acquirer
- Determining the acquisition date
- Recognizing and measuring the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree
- Recognizing and measuring goodwill (as a residual) or a gain from
a bargain purchase
PwC
4
Applying ASC 805 (FAS 141R) – Measurement
period
• During the measurement period the acquirer:
- Adjusts amounts recognized at the acquisition date to reflect new
information obtained about facts that existed at the acquisition
date
- The measurement period cannot exceed 1 year from the acquisition
date
• Measurement period adjustments generally impact goodwill
• Changes outside the measurement period are generally recognized in
income
PwC
5
Acquisition models under US tax law
Taxable versus non-taxable acquisitions
Taxable transactions
Nontaxable transactions
Taxable Asset Acquisition
Taxable Stock Acquisition
Stock Acquisition - IRC Sec 338(h)(10)
Nontaxable Asset Acquisition
(Type A and C reorganization)
Stock Acquisition - IRC Sec 338(g)
Nontaxable Stock Acquisition
(Type B and D reorganization)
The form of the transaction and the consideration used determine the
tax treatment of the acquisition – form matters!
PwC
6
Deferred tax assets and liabilities
Steps
The following steps are generally performed in arriving at the deferred
income tax effects of a business combination:
• Determine the tax structure of the transaction and tax status of the
entities involved in the business combination
• Determine financial statement and tax bases of the net assets
acquired
• Identify and measure temporary differences
• Identify acquired tax benefits
• Consider the treatment of tax uncertainties
• Consider deferred taxes related to goodwill
PwC
7
Deferred tax assets & liabilities
Tax structure considerations
• A nontaxable business combination often results in book and tax
basis differences with respect to the assets acquired
- Book basis reflects fair value
- Tax basis reflects historic cost (likely different from book value)
• A taxable business combination may result in book and tax basis
differences with respect to the acquired assets due to differences in
determining the amount of consideration transferred, valuation and
the allocation of purchase price for book and for tax purposes
• The potential tax consequences of the book and tax basis differences
must be taken into account on the financial statements of the
acquiring entity
PwC
8
Deferred tax assets & liabilities
Identifying and measuring temporary differences
• Goodwill and other intangibles recognized for book purposes may or
may not be recognized for tax purposes.
- To be amortizable for tax purposes, the intangible assets and
goodwill must be defined under §197 and have a tax basis
- Intangibles and goodwill must be acquired in a transaction that
allows the buyer to record the asset’s tax basis at fair value.
◦ Taxable asset purchase, or
◦ Taxable stock purchase for which a §338(g)/§338(h)(10)
election is made.
• A deferred tax asset is calculated and recorded for excess taxdeductible goodwill over book goodwill at the acquisition date
• Deferred tax liabilities are not recorded related to excess book
goodwill at the acquisition date
PwC
9
Deferred tax assets & liabilities
Identifying and measuring temporary differences
• Bargain purchase may generate differences due to gain recognition
for book purposes and not for tax purposes
• Provision on unremitted earnings existing at acquisition date may
generate differences
• Intangible assets (other than book greater than tax goodwill)
acquired in a business combination may also have differences in book
basis and tax basis which must be recognized in acquisition
accounting
• In-process Research & Development (IPR&D) is considered an
indefinite-lived intangible asset (at the acquisition date and until
project completion or abandonment) resulting in a temporary
difference (even in a non-taxable acquisition)
• The determination of the applicable tax rate to calculate deferred tax
assets and liabilities should consider the effects of the business
PwC
10
combination
Deferred tax assets & liabilities
Exceptions to deferred taxes
• Exceptions for which deferred tax accounts are not required for basis
differences:
- Temporary differences related to book greater than tax goodwill
- Leveraged leases
- Acquired outside basis differences of foreign subsidiaries for which
the indefinite reversal criteria (permanent reinvestment) has been
asserted (ASC 740-30-25-17; APB 23) (buyer’s assertion not prior
assertion of seller)
PwC
11
Deferred tax assets & liabilities
Acquiree’s ability to recognize DTAs (i.e., valuation allowances)
• Evaluating combined results (ASC 805-740-30-3)
- First, look to the four sources of taxable income of the combined
enterprise
- To assess realization of deferred tax assets of the acquiree, may
need to determine interaction of reversal of temporary differences
of both companies
- Impact of assessing realization of acquiree’s DTA at the acquisition
date is recorded as part of acquisition accounting and generally
impacts goodwill
- Acquirer's deferreds may be used as a source of income to assess
realization of acquiree’s deferreds
PwC
12
Changes in the acquired enterprise’s valuation
allowance
Changes in judgment regarding the acquired enterprise’s valuation
allowance should generally be recognized as follows:
Within the measurement period
Outside the measurement period
Goodwill
Income tax provision
Applicable to ALL acquisitions (even if the transaction was before the effective date of
ASC 805/FAS 141(R)).
PwC
13
Changes in the acquirer’s deferreds/valuation
allowance
• At the date of acquisition, any changes in the acquirer’s valuation
allowance are generally recognized in income tax expense
• Other “synergistic” tax impacts on an acquirer (e.g., changes in state
apportionment rates) are also recognized in income tax expense
PwC
14
Other topics
• Tax uncertainties
• Acquisition costs
• Indemnification
PwC
PwC
15
Acquisition-related tax uncertainties
Changes related to an acquired enterprise’s tax uncertainties should generally be
recognized as follows:
Within the measurement period (if “true-up”)
Outside the measurement period
Goodwill
Income tax provision
Applicable to ALL acquisitions (even if the transaction was before the effective date of
ASC 805/FAS 141(R)).
PwC
16
Acquisition-related tax uncertainties
• Interest on pre-acquisition liabilities that accrue after the acquisition
date should not be included in goodwill adjustment, but rather it
should be included in income from continuing operations
PwC
17
Accounting for income tax indemnifications
• Measured according to contractual terms using the same
assumptions used to measure the indemnified amount (i.e., “mirror
image” receivable)
• For example, an indemnification receivable related to an uncertain
tax position would be measured using ASC 740 (FIN 48) assumptions
(i.e., not at fair value)
• Income tax indemnifications should be recorded “gross” on the
balance sheet and income statement
• Subsequent changes to unrecognized tax benefits would impact the
tax provision; however, corresponding changes in indemnification
receivables would be recorded in pre-tax book income
PwC
18
Applying ASC 805 (FAS 141R) – Acquisition method
Acquisition-related costs
• Under ASC 805 (FAS 141(R)), acquisition-related costs (transaction
costs) are required to be expensed for book purposes
• Depending on the type of transaction and the nature of the costs, for
tax purposes, transaction costs could be expensed as incurred,
capitalized as a separate intangible asset, included in the basis of the
stock acquired, included in the basis of other assets, included in taxdeductible goodwill, etc.
• If the transaction costs are not immediately expensed for tax
purposes, then a temporary difference may result
• Rev. Proc. 2011-29 – Safe harbor for success based fees
PwC
19
Applying ASC 805 (FAS 141R) – Acquisition method
Acquisition related costs
• Deferred tax accounting for potential temporary differences
- Alternative 1: Don’t assume the business combination will be
completed. Record a DTA if the transaction costs would result in a
future tax deduction assuming the business combination is NOT
consummated
- Alternative 2: Account for transaction costs based on the tax
treatment that is ultimately expected. Record a DTA only if the
costs are ultimately expected to be included in a tax-deductible
asset (e.g., tax-deductible goodwill) or are otherwise deductible
PwC
20
Acquisition-related costs – Two acceptable
approaches
No anticipation of transaction
PwC
Consider expectations
Are costs deductible?
Stock deal
Asset deal
If yes, record DTA
Part of o/s basis?
Deductible/
deductible asset?
Revisit DTA at close of transaction
No DTA
DTA
21
Outside basis/Indefinite reinvestment
PwC
PwC
22
Outside basis differences
Governing paragraphs
• Outside basis differences are addressed in ASC 740-10. Rules
prescribe different considerations for DTAs and DTLs:
- DTAs: ASC 740-30-25-9 through 13
- DTLs: ASC 740-10-25-3, ASC 740-30-25-5 through 7
Starting premise:
• Record DTAs only if it is apparent that the temporary difference will
reverse in the foreseeable future
• Record all DTLs unless an exception applies
PwC
23
Outside basis differences
Key questions in determining outside basis
• What type of entity is the investee?
- Subsidiary
- Corporate JV
- Equity method investee
- Partnership
• If subsidiary or corporate JV, is it domestic or foreign?
• Type of entity affects the rules that apply and the way that the outside
basis difference is impacted by earnings, dividends, etc.
PwC
24
Outside basis differences
Subsidiaries and Corporate JVs
What is a subsidiary?
• Includes all entities that are consolidated under the traditional
consolidation rules (>50% voting) under ASC-810-15-10 (ARB 51,
par. 2)
What is a corporate JV?
• As defined by ASC 323 (APB 18)
- Narrower than the common usage of the term
• Key is joint control – Does the shareholder have the ability to prevent
distributions from the entity?
- Example: An entity may qualify as a JV even if owners have
different equity interests due to certain corporate governance
rights
PwC
25
Outside basis differences
Definition of “foreign”
Example
U.S.
Parent
1
1
Foreign
2
Domestic
Swiss
HoldCo
Swiss
OpCo
German
OpCo
Dutch
FinCo
2
1
1
Subsidiary is foreign if based in a different jurisdiction than its Parent
PwC
26
Deferred taxes for outside basis differences
Book > Tax basis
Tax > Book basis
Domestic Subsidiary
Record DTL, unless
Record DTA only if it is
apparent that the temporary
• Investment can be recovered tax-free without significant
difference will reverse in the
cost, and
foreseeable future (reversal
• Enterprise expects to ultimately use that means of recovery must be definitely planned –
such as by a sale of the
* For pre 12/15/92 amount, only record DTL if it is apparent it
subsidiary)
will reverse in foreseeable future
Foreign Subsidiary
Record DTL, unless
•
Parent asserts indefinite reversal (earnings will be
indefinitely reinvested or will be remitted without tax
consequences)
Domestic Corporate JV Record DTL (only for pre12/15/92 amount if apparent it will
reverse in the foreseeable future)
Foreign Corporate JV
Record DTL, unless
•
Foreign corporate JV is permanent in duration, and
•
Parent asserts indefinite reversal
Equity Method
Investments
Record DTA or DTL (certain exceptions exist for equity method investees that had once been
subsidiaries or that have no E&P)
Partnerships
Generally, record DTAs and DTLs on outside basis differences rather than inside basis
PwC
27
Outside basis differences
Exception applicable to domestic subsidiary – Book > Tax basis
• Possible means of tax-free recovery include:
- Tax-free liquidation (e.g., §332)
- Tax-free merger
PwC
28
Outside basis differences
Measurement of deferred taxes
Foreign Subsidiaries and Foreign Corporate JVs
• If not indefinitely reinvested, provision for taxes based on estimate of
taxes to be incurred upon distribution
• Consider the following:
- Withholding taxes
- Foreign taxes, if applicable
- U.S. tax, after FTCs
• Re-evaluate position quarterly
• Has there been a change in the indefinite reinvestment assertion?
• Have other factors changed that will affect the measurement?
PwC
29
Outside basis differences
Measurement of deferred taxes
• Factors to consider in computing incremental tax upon repatriation:
- Years in which repatriations are expected to occur
- Blending of tax pools on various dividends
- Form of repatriations (dividend, §956 loan, sale proceeds,
liquidation, check-the-box election)
- FTCs or deductions for foreign taxes paid
- Withholding taxes
- Domestic source loss in year of repatriation
- Impact of §861 expense allocations
- Overall foreign loss carryover
- Anticipated Subpart F implications if owned by CFC
PwC
30
Outside basis differences
Measurement of deferred taxes
What is the significance of E&P in measuring deferred taxes?
• The basic model requires an evaluation of the outside basis difference
in the investment (i.e., “earnings” is only one component, albeit the
most significant, of outside basis difference)
Questions to consider:
What is the outside basis difference in the
investment?
• How will the difference reverse?
• What are the expected tax
consequences of the reversal?
• Why is retained earnings different than
E&P?
PwC
Reversal due to repatriation of
earnings:
• Distributions will result in a current
income tax provision to the extent it is
repatriation of E&P
• Excess distributions over the amount of
existing E&P will be treated as a return
of capital and then capital gain
31
Outside basis differences
Asserting indefinite reinvestment under ASC 740-30-25 (APB 23)
• Presumption that unremitted earnings will be repatriated
• Repatriation of earnings – account for a temporary difference unless
the investment can be recovered on a tax-free basis
• May overcome presumption if satisfy “indefinite reinvestment
criteria”
PwC
32
Outside basis differences
Asserting indefinite reinvestment under ASC 740-30-25 (APB 23)
Significant focus on companies’ ability to assert as well as changes
in their assertions
• “When Taxes and Profits Are Oceans Apart” (NYT 7-05-14)
• "Bring Back Our Dollars: Lululemon’s Overseas Cash is Coming Home " (WSJ
6-13-14)
• "EBay to Take $3 Billion Tax Charge" (WSJ 4-29-14)
• "Overseas Earnings Continue to Grow" (WSJ 3-31-14)
Current economic environment – impact on ability to assert
• Are significant payments due near-term, such as debt or pension funding?
• Have there been any recent remittances?
• Will a U.S. investment or acquisition necessitate financing by redeployment of
foreign subsidiary funds?
• Have there been any defaults or debt covenant violations?
• Is there substantial doubt about the ability to continue as a going concern?
PwC
33
Outside basis differences
Asserting indefinite reinvestment under ASC 740-30-25 (APB 23)
• Sufficient evidence must show that the subsidiary has invested or will
invest the undistributed earnings indefinitely or that the earnings
will be remitted in a tax-free manner
• Consider:
- Forecasts of parent and subsidiary
- Financial requirements of parent (e.g., liquidity needs)
- Financial requirements of subsidiary (e.g., working capital and capital
expenditure needs)
- Past history of dividends
- Planned acquisitions
- Tax consequences of decision to remit or reinvest
- Restrictions in loan agreements
- Restrictions by foreign governments on repatriations
- Any program designed to influence remittances
• Assertion must be applied on an entity-by-entity basis
PwC
34
Outside basis differences
Asserting indefinite reinvestment under ASC 740-30-25 (APB 23)
• Specific plans that support the assertion must be documented and
maintained
• Absence of cash in subsidiary is not determinative
• Not sole responsibility of tax department – requires involvement of
treasury, controller, and senior financial management
• Also, if the assertion is being made by a subsidiary with respect to its
foreign subsidiary, the Parent corporation’s plan must also be
considered
PwC
35
Outside basis differences
Asserting indefinite reinvestment under ASC 740-30-25 (APB 23)
• Ability to assert indefinite reinvestment is driven by a company’s
overall business strategy, financial plans and structure of investments
- Cross-functional collaboration is imperative
• Disclosure of the unrecorded tax liability is required, unless determined
“impracticable”
- Financial statement assertion that an estimate is impracticable requires
appropriate company-specific support
- Recent trending towards either recording or disclosing the estimated
liability
• Calculation of the liability can be highly judgmental and subject to
continual re-measurement
PwC
36
Outside basis differences
Change in assertion
• Reflect change
- In continuing operations
- In the period that change in assertion occurs as a discrete period
item
• Rule applies to all assertion changes
- Foreign – ASC 740-30-25 (APB 23)
- Domestic – ASC 740-30-25-9 through 13 (FAS 109 par. 33 and 34)
(to be discussed below)
PwC
37
Outside basis differences
Asserting indefinite reinvestment under ASC 740-30-25 (APB 23)
SEC comment letter
ABC: "You repatriated $7.5 million in 2010 and $17.5 million in 2011 of
foreign earnings to the U.S. In your Form 10-Q for the period ended
March 31, 2012, you also disclose your intention to repatriate current
year foreign earnings in 2012. As of December 31, 2011, you have not
recognized deferred income taxes on $591.6 million of undistributed
earnings of your international subsidiaries since such earnings are
considered to be reinvested indefinitely.
….Please tell us whether you had previously considered the foreign
earnings that were repatriated during 2010 and 2011 to be permanently
reinvested. If so, please tell us at what point you determined that they
would not be; Please tell us the country from which these earnings were
or will be repatriated as well as the facts and circumstances that led you
to determine it is necessary to repatriate these earnings; and Please tell us
how you concluded that the remaining $591.6 million should be
considered permanently reinvested in light of your repatriation of
amounts in previous years.”
PwC
38
Case study
Deferred tax on outside basis difference
Company X purchased 100% of Company Y, a foreign entity, on
January 1 for $2,100,000. During the year, Company Y earned
$7,550,000 in pre-tax income and recorded a tax expense of
$2,218,190. The Company Y made no distributions during the year.
Questions
1. What is the difference between the book and tax basis for this entity
at the end of Year 1?
2. What would the tax consequences be if the earnings are permanently
reinvested? Note: Assume E&P equals book income.
PwC
39
Case study continued
Deferred tax on outside basis difference
1. What is the difference between the book and tax basis for this entity
at the end of Year 1?
Book Purchase Price
2,100,000
Book Pre-Tax Income
7,550,000
Book Tax Expense
(2,218,190)
End of Year 1 Book Outside Basis
$ 7,431,810
Tax Purchase Price
Contributions/Distributions
End of Year 1 Tax Outside Basis
2,100,000
$ 2,100,000
Book Outside Basis
7,431,810
Tax Outside Basis
2,100,000
Temporary Difference (TTD)
PwC
$ 5,331,810
40
Case study continued
Deferred tax on outside basis difference
2. What would the tax consequences be if the earnings are permanently
reinvested?
No deferred tax liability is recorded on the taxable temporary difference
of $5.3M for outside basis difference.
If the Company did not make an indefinite reinvestment assertion, the
Company would have to assess the manner in which the temporary
difference would most likely reverse (e.g., dividend distribution or sale
of subsidiary) and the associated tax consequences.
PwC
41
Valuation allowances
PwC
PwC
42
Valuation allowances
• ASC 740-10-30-2 states that with respect to computing the balance in
deferred tax assets and liabilities, the following principles should be
applied:
• The measurement of current and deferred tax liabilities and assets
is based on provisions of the enacted tax law; the effects of future
changes in tax laws or rates are not anticipated.
• The measurement of deferred tax assets is reduced, if necessary, by
the amount of any tax benefits that, based on available evidence, are
not expected to be realized (valuation allowance)
PwC
43
Valuation allowances
• ASC 740-10-30-18 states that:
Future realization of the tax benefit of an existing deductible
temporary difference or carryforward ultimately depends on the
existence of sufficient taxable income of the appropriate
character (i.e. ordinary income or capital gain) within the carryback/
carryforward period available under the tax law.
• Valuation allowance may be necessary in situations even when…
- Carry-forward period of tax attributes is long or unlimited
- Company expects to return to profitability in the foreseeable future
PwC
44
Valuation allowances
• ASC 740-10-30-5(e) requires a Valuation Allowance (VA) for
Deferred Tax Assets (DTAs) if based on the weight of the available
evidence it is more likely than not (more than 50%) that some
portion or all of the DTAs will not be realized
• Evaluating the need for and amount of a VA for DTAs often requires
significant judgment and extensive analysis of the evidence
- Evidence that is “objective and verifiable” is given more weight
than evidence that is subjective
- Both positive and negative evidence should be considered
- There is no “magic formula” to evaluating the evidence
PwC
45
Valuation allowances
ASC 740-10-30-18 identifies four possible sources of taxable income to
consider:
• Objective sources of realization
- Future reversals of existing taxable temporary differences (DTLs)
◦ Detail scheduling not required for the reversal of a DTL, but
must adjust for assets with indefinite useful lives which may
result in “naked credits” (e.g., land, goodwill, indefinite-lived
intangibles)
◦ Consider tax character of the taxable income generated by the
DTL if relevant under local tax law
- Taxable income in prior carryback year(s) if carryback is permitted
under the tax law
PwC
46
Valuation allowances
ASC 740-10-30-18 identifies four possible sources of taxable income to
consider:
• Subjective sources of realization
- Future taxable income exclusive of reversing temporary differences
and carryforwards (i.e., projections)
◦ Estimate as pre-tax book income adjusted for permanent
differences
◦ Relies on management’s ability to produce reliable forecasts
- Tax planning strategies
PwC
47
Valuation allowances
- Consider tax-planning strategies (TPS) to realize a tax benefit for
an operating loss (or credit carryforward) before it expires.
◦ ASC 740-10-30-19 states that an enterprise “shall” consider
“actions” (tax planning strategies) in determining the amount of
valuation allowance required
◦ TPS are tax actions that an entity ordinarily might not take, but
would take to prevent an operating loss or tax credit
carryforward from expiring unused
PwC
48
Valuation allowances
More on tax planning strategies
• ASC 740-10-30-19 requires that TPS must be prudent and feasible,
- Prudent/Subjective interpretation
- Feasibility/Sliding scale – Easy to Difficult
• Would result in realization of deferred tax assets,
• Net of transaction costs, and
• Must be “more likely than not” with respect to the technical merits
(uncertain tax position threshold)
PwC
49
Valuation allowances
Potential Tax Planning Strategies might include:
• Sale/leaseback of operating assets
• Accelerating repatriation of foreign earnings, if deferred taxes were
previously provided (no permanent reinvestment assertion)
• Forgo a loss carryback (carryback would free up FTCs)
• Changing from LIFO to FIFO
• Accelerating royalties
• Sale of non-core appreciated assets
• Changing tax depreciation methods (accelerated to straight-line)
• Deferring contributions to pension plans
PwC
50
Negative evidence
• ASC 740-10-30-21 provides that
- Forming a conclusion that a valuation allowance is not needed is
difficult when there is negative evidence such as cumulative losses
in recent years.
• ASC 740-10-30-21 lists the following examples of negative evidence
- A history of operating loss or tax credit carryforwards expiring
unused
- Losses expected in early future years (by a presently profitable
entity)
- Unsettled circumstances that, if unfavorably resolved, would
adversely affect future operations and profit levels on a continuing
basis in future years
- Brief carryback, carryforward period in jurisdictions where results
are traditionally cyclical or where a single year’s reversals of
deductible differences will be larger than the typical level of
PwC
51
taxable income.
Positive evidence
• ASC 740-10-30-22 provides examples (not prerequisites) of positive
evidence that might support a conclusion that a valuation
allowance is not needed when there is negative evidence
- Existing contracts or firm sales backlog that will produce more
than enough taxable income to realize the DTA on existing sales
prices and cost structures
- An excess of appreciated asset value over the tax basis of the
entity’s net assets in an amount sufficient to realize the DTA
- A strong earnings history exclusive of the loss that created the
future deductible amount
PwC
52
Weighing the evidence
• ASC 740-10-30-23 states:
-
•
PwC
An entity shall use judgment in considering the relative impact
of negative and positive evidence. The weight given to the
potential effect of negative and positive evidence shall be
commensurate with the extent to which it can be objectively
verified. The more negative evidence that exists, the
more positive evidence is necessary and the more difficult
it is to support a conclusion that a valuation allowance is not
needed for some portion or all of the deferred tax asset. A
cumulative loss in recent years is a significant piece of
negative evidence that is difficult to overcome
PwC Measurement Guideline (3 YR Cumulative Loss)
-
Current year and 2 prior years (Rolling 12 quarter analysis)
-
Cumulative Pre-Tax Loss adjusted for:
◦
Permanent items and
◦
Cumulative effect of book changes in accounting methods
53
Change in valuation allowance record/release
• When do you record or release the VA?
- Companies should evaluate the need for a VA each reporting
period
- Recording and releasing valuation allowances is a highly
judgmental area with the use of estimates therefore, proper
documentation of facts and circumstances around the decision is
critical
- The SEC scrutinizes changes in valuation allowances and has
become more aggressive in asking for more details in the
corporation’s “Management Discussion and Analysis” section of its
financial statements.
PwC
54
Change in valuation allowance record/release
• Same guidance applies for release as establishment
- “More likely than not” threshold
- Weighing of all available positive and negative evidence
- Emphasis on what is objectively verifiable, etc.
• Cumulative pre-tax book income is not a prerequisite for release
• Consider indefinite carryforward jurisdictions
PwC
55
Change in valuation allowance record/release
•
ASC 740-270-25-7 requires that changes in the beginning-of-the-year valuation
allowance amounts due to a change in judgment should not be included in the
annual effective tax rate to measure tax expense for an interim period
-
•
Record the VA change as a discrete tax adjustment
Changes in the valuation allowance for changes in judgment based on current
year activity should be included in the annual effective tax rate to measure tax
expense for the interim period
-
Change in the VA related to deductible temporary differences and
carryforwards that are expected to originate in ordinary income in the
current year
-
Change in the VA for beginning-of-the-year deferred tax assets that results
from a difference between the estimate of income for the current year
versus the estimate of income inherent in the beginning-of-the-year VA
◦
PwC
Pre-tax book income generated in the current year
56
SEC staff views of disclosures and valuation
allowance assessments
• Establishing a valuation allowance too late
– Staff may inquire whether the previous analysis was appropriate
– With the benefit of hindsight, may challenge prior years’ financial statements
• Period in which valuation allowance is released
• Staff focused on management being overly conservative and when it may
suggest earnings management (i.e., “selecting” the future periods to
release the valuation allowance)
• Estimates used need to be consistent with other estimates involving
assumptions about the future used in the preparation of the financial
statements (e.g., impairments)
• When it is at least reasonably possible that a material adjustment of the
valuation allowance will occur in the near term, the financial statements
must disclose that possibility
PwC
57
SEC Comment Letter on valuation allowance
releases
ABC: “We note that you reversed $227.3 million of the valuation
allowance in 2010. Tell us in detail why you did not reverse some
portion of the valuation allowance in 2009 in which you reflected
earnings. Tell us what your forecasts for future earnings were at the end
of 2009 and why you believe that you can rely upon your
forecast at the end of 2010.
Also tell us in detail about the cumulative earnings for the last 12
quarters prior to the recognition of the deferred tax asset in the quarter
ended June 30, 2010. Show us how you applied your NOL carryforwards
of $1.1 billion, which generally start expiring in 2020 through 2026 to
your forecasted earnings. Tell us why this guidance regarding increase
earnings expectations has not been provided in Risk Factors,
MD&A and other portions of this filing.”
PwC
58
SEC Comment Letter on valuation allowance
releases
XYZ: "We note your disclosure that you developed a tax planning
strategy during fiscal year 2010 that resulted in the reduction of the
valuation allowance. In future filings, please provide investors with
a better understanding as to what the tax planning strategy
is, specifically why you believe the strategy is reasonable,
prudent and feasible, the amount of deferred tax assets that are
impacted by the strategy, and the amount you reduced the valuation
allowance as a result of the strategy. Please provide us with the
disclosures you intend to include in future filings."
PwC
59
Interim Reporting
PwC
PwC
60
Estimated Annual Effective Tax Rate (“ETR”)
• The ETR represents the best estimate of the composite tax provision
in relation to the best estimate of worldwide pretax book ordinary
income.
• The composite tax provision should include federal, foreign and state
income taxes, and should reflect anticipated investment tax credits,
foreign tax rates, percentage depletion, capital gains rates, and other
available tax planning alternatives.
(ASC 740-270-30-8)
PwC
61
Interim reporting
• Exclude from the consolidated annual ETR computation loss
jurisdictions for which no benefit can be recognized on those losses
• Exclude from consolidated annual ETR entities for which a reliable
estimate of ordinary income cannot be made
PwC
62
Annual ETR – Ordinary income loss
• Only items that should be spread by means of an effective rate
methodology are the tax effects of current-year ordinary income (or
loss)
• Ordinary income (or loss) refers to income (or loss) from continuing
operations before income taxes (or benefits) excluding significant
unusual or infrequently occurring items
• As a result, certain items that result from actions occurring during
the year (but that do not represent a tax effect of current-year
ordinary income) should be recorded discretely in the period in
which they occur
PwC
63
Discrete items
• Examples of discrete items include the following:
- Significant, unusual or infrequent items
- Extraordinary items
- Discontinued operations
- Cumulative effects of changes in accounting principles
PwC
64
Discrete items
• Examples of other potential discrete items
- RTP true-ups
- Resolution of tax audits
- Statute of limitation expiration
- Other changes in prior years’ unrecognized tax benefits
- Valuation allowance adjustments
- Changes in tax laws or rates
- Changes in assertions on unremitted earnings
- Changes in tax status
PwC
65
Interim reporting
• Disclosure considerations:
- The tax effects of significant unusual or infrequent items that are
recorded separately or reported net of their related tax effect (ASC
740-270-30-8)
- Significant changes in estimates or provisions for income taxes
(ASC 270-10-50-1(d)), (e.g., changes during the period in the
assessment of the need for a valuation allowance)
- Significant variations may need to be disclosed if the customary
relationship between income tax expense and pretax accounting
income is not otherwise apparent from the financial statements or
from the nature of the entity's business (ASC 740-270-50-1 )
- Disclosures related to uncertain tax positions
PwC
66
Accounting methods and cash tax
planning
PwC
PwC
67
Accounting Method Change Procedures
U.S. taxpayer generally is considered to have adopted an accounting
method if:
• Proper method used in a single return; or
• Erroneous method consistently used in at least two consecutive
returns (Rev. Rul. 90-38)
NOTE that a correction of an error, change in fact or change in
character is NOT a change in method.
PwC
68
Accounting Method Change Procedures (cont.)
• Once adopted, must obtain IRS Commissioner consent to change an accounting
method for tax purposes (§446(e)).
• Why file a request for change in method?
- For favorable changes, could lose benefit of unauthorized change on exam
- For unfavorable changes, risk of IRS initiated change on exam with less
favorable terms and conditions (Rev. Proc. 2002-18)
◦ Change effected in the earliest open year
◦ No spread of §481(a) adjustment
◦ Exam agent determines new method (likely least favorable method for
taxpayer if there are multiple permissible methods)
◦ Interest and possible penalties assessed
- Cash tax planning
- Audit protection
PwC
69
Tax Accounting – Voluntary Changes from Proper
Accounting Methods
Can be automatic or non-automatic
Automatic
• Reflect in the financial statements when –
- Management concludes that it is qualified and
- Has the intent and ability to file the method change
Non-Automatic
• Require affirmative consent of the IRS
• Reflect in financial statements when approval is granted
PwC
70
Tax Accounting – Voluntary Changes from
Improper Accounting Methods
• Consider whether historical F/S contained an error and effects of
any unrecognized tax benefits
• Taxpayer receives “audit protection” for prior years
• Can be automatic or non-automatic
Automatic
• Reflect in the financial statements when Form 3115 has been filed
with the IRS
Non-Automatic
• Require affirmative consent of the IRS
• Reflect in the financial statements when Form 3115 has been filed
with the IRS
PwC
71
Tax Accounting – Negative v. Positive Adjustments
Negative 481(a) – Reduce taxable income
• Entire 481(a) adjustment made in year of change
• Affects only the current payable
• No future tax consequences
Positive 481(a) – Increase taxable income
• 481(a) adjustment spread evenly over 4 years
• Gives rise to two temporary differences
1.
Temporary differences already in existence
2. Deferral of the catch-up (i.e., the 481(a) adjustment)
represents deferred income for tax purposes with no book
basis, for which DTL is recorded.
PwC
72
Tax Accounting Services (TAS) App
PwC
PwC
73
TAS app update
PwC’s Tax Accounting Services to Go mobile application is live!
Current Availability:
- iPhone/iPad via App Store on iTunes
- Android devices via Google Play
- Windows devices via Windows Phone Store
PwC
74
TAS app update
PwC’s Tax Accounting Services to Go mobile application is live!
Functionality overview:
• Latest tax accounting articles/publications
• Tax accounting specialist directory
- National TAS & NPSG
- Tax market champions
• Resource library
- Accounting for income taxes guide
- SEC comment letters
- TAS webcasts
• Search capabilities
PwC
75
Thank you for joining us.
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should
not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty
(express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted
by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of
care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for
any decision based on it.
PwC
76