Tax Executives Institute
May 7, 2012

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG
TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY
FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY
ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons, associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
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THE MATERIAL CONTAINED IN THESE COURSE MATERIALS IS CURRENT AS OF THE
DATE PRODUCED. THE MATERIALS HAVE NOT BEEN AND WILL NOT BE UPDATED TO
INCORPORATE ANY TECHNICAL CHANGES TO THE CONTENT OR TO REFLECT ANY
RESPONSIBLE FOR VERIFYING WHETHER OR NOT THERE HAVE BEEN ANY TECHNICAL
CHANGES SINCE THE PRODUCTION DATE AND WHETHER OR NOT THE FIRM STILL
APPROVES ANY TAX SERVICES OFFERED FOR PRESENTATION TO CLIENTS. YOU
AS PART OF YOUR DUE DILIGENCE.
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 FASB ASC 740-10-30(e) (SFAS 109.17(e)): “Reduce deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not
(a likelihood of more than 50 percent) that some portion or all of the deferred tax assets
 Recognition or non-recognition of a valuation allowance is not optional
 A valuation allowance must be adjusted as circumstances change
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 All available evidence, positive and negative, must be considered when assessing the need for a valuation allowance.
 existence of sufficient taxable income of the appropriate character within the carryback period and carryforward period available under the law.
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 Need for valuation allowance is generally determined separately for each jurisdiction
 Even within a single jurisdiction, need for valuation allowance with respect to different types of and differing limitations on utilization
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 Future Business Combinations
 Anticipated Changes in Tax Laws and Rates
 Anticipated Changes in Tax Status
 Sale of “Held-to-Maturity” Securities

 Net Losses in Future Years
 Expected Forgiveness of Debt
 Changes in Fair Value of Assets and Liabilities
 Events Dependent upon Future Market Conditions
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 Company must consider:
– All available negative evidence
– All available positive evidence
 Evidence will include objective and subjective information
 the extent that it can be objectively verified
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 Examples of negative evidence
– Cumulative losses in recent years
– Past/expected future losses
– Brief carryback and carryforward periods
– realize tax benefits
– History of carryforwards expiring unused
–
– Unfavorable trends, developments, or contingencies
– Going-concern issues
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 Significant piece of negative evidence that is difficult to overcome
 Presumption:
– Valuation allowance is needed if cumulative losses in recent years
 However, not determinative by itself

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 No methodology prescribed in ASC 740
 In practice, generally:
– “Losses” = pre-tax book income losses
– including, discontinued operations
– y
– excluding, cumulative effect of changes in accounting principles
– “Recent years” = current year and prior two years
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One of the examples of negative evidence is cumulative losses in recent years.
True or False : When evaluating historical cumulative losses, the Company should consider
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 Examples of positive evidence
– Strong earnings history
– Appreciated net asset values
– Taxes paid in potential carryback years
–
– Favorable recent developments
– Sales backlog
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 Weigh positive evidence (indicating DTA will be realized) against negative evidence
(indicating DTA will not be realized)

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 Realization of tax benefits of deductible temporary differences and carryovers is dependent upon enterprise having:
–
 Of an appropriate character
 Within the statutory carryback/carryforward period
 Sources of income
– Taxable income in carryback years
–
– Forecasted future taxable income exclusive of reversing temporary differences and carryforwards
–
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 If evidence of one or more sources of taxable income is sufficient to support conclusion that no valuation allowance is needed, it is generally not necessary to consider other potential income sources
 Taxable income in prior years eligible for carryback and future reversals of taxable temporary differences generally more objective than projections of future taxable income
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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 Definition—“an exercise or analysis performed to determine the pattern and timing of reversal of temporary differences”
 via utilization to offset future taxes that would otherwise be payable when DTLs reverse
 Methods employed should be systematic, logical, and applied consistently from year to year
 Degree of detail is a matter of professional judgment
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 In estimating reversal patterns, consider the following:
– Pattern and time period
– Remaining carryforward and carryback periods
– Character of the taxable and deductible amounts
– Indefinite reversals
– Tax planning strategies
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Example
 Assumptions
– The company’s tax rate is 30%
– Loss carryforward period is three years
– The company has never made any money, and carryback period is not applicable
 Question
– Does the company need to record a valuation allowance for all or a portion of the deferred tax assets?
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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Example (continued)
How much taxable income is available?
Fair value adj. on acquisitions
Depreciation differences
Allowance for doubtful loans
D f d b
Capitalized software
Total net temporary differences
Accumulated taxable income (loss)
2008 Gross future (taxable)
/deductible amounts
(50,000)
(20,000)
40,000
(24,000)
(34,000)
2009
5,000
1,000
(20,000)
8,000
(26,000)
(26,000)
2010
5,000
1,000
(20,000)
8,000
(6,000)
(32,000)
2011
5,000
1,000
2012
5,000
1,000
8,000
14,000
(18,000)
6,000
(12,000)
2013
5,000
1,000
6,000
(6,000)
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Example (continued)
 The Company does not need to record a valuation allowance on all deferred tax assets because of the reversal of temporary differences in future years…
– and $6,000, respectively
– Company can carryforward losses for three years, so these losses can be carried forward to 2012 and 2013, respectively
– The reversal of the taxable temporary differences results in taxable income of $14,000 in
2009, 2010, and 2011 and $6,000 in 2012 and 2013 (and into the future)
– expected in 2010, the reversal of these differences will create $54,000 in future taxable income ($14,000 + $14,000 + $14,000 + $6,000 + $6,000)
– t
Therefore, the Company can definitely prove that $16,200 ($54,000 x 30%) of the deferred t lik l th t ill b li d
 However, as the future taxable income picture is bleak, the remaining deferred tax asset of
$1,800 ($18,000 – $16,200) might need a valuation allowance unless the Company has a
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 Leary, Inc. is a start-up pharmaceutical company backed by wealthy investors. Through its first two years of operations, Leary, Inc has a cumulative net loss of a total of $10 million. The primary asset on Leary’s balance sheet is a trademark that it acquired in its acquisition of classification, is reported on the balance sheet at $10 million, its fair value at the time of the acquisition.
 deferred tax liability (both Huxley Corp. and Leary, Inc applicable tax rate is 30%). Leary, Inc. has recorded a deferred tax asset of $3 million related to the net operating loss carryforward.
Leary, Inc has the ability to carryforward losses for 5 years, but cannot carryback losses to
Inc.’s management.
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 Answer: YES, Leary, Inc. needs a valuation allowance
 Future reversals of existing taxable temporary differences
– Deferred tax liabilities related to intangibles with indefinite lives and goodwill cannot be used as a source of future taxable income because the timing of the reversal of these temporary differences is undeterminable and will not coincide with the reversal related to the NOL (in this case, only five years)
 Taxable income in prior carryback year(s), if carryback is permitted
– The tax law in this case does not allow NOLs to be carried back to prior years
 F t t bl i l i f t diff d f d
– A cumulative loss in recent years (three years) is a significant piece of negative evidence that is difficult to overcome
 Tax planning strategies
– Selling the trademark is a possibility, but this is not prudent and feasible as it represents
Leary, Inc.’s only major asset on its balance sheet. Also, selling the asset is inconsistent
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 Exclusive of reversing temporary differences and carryforwards
 Ability to estimate future income
– Subjectivity generally increases as the number of years increase
 One year of profit does not necessarily equate to a 20 year trend
–
 Corporate budget cycle, industry business cycle, and impairment analysis may indicate appropriate # of years
– fixed # of years)
 Evaluation of significant assumptions financial reporting
 Partial valuation allowances are among the most judgmental areas in income tax accounting
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 Definition—“prudent and feasible actions (including elections for tax purposes) that an enterprise ordinarily might not take but would take, if necessary, to realize a tax benefit for an operating loss or tax credit carryforward before it expires”
 Goal is to alter timing or character of future taxable income or deductible expenses
 Reasonable effort must be made to identify tax planning strategies prior to booking valuation allowance
 Ability to implement the strategy must be primarily under the control of management
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 Search not optional
 Management must make reasonable effort
 Strategy must be prudent and feasible
 Management must have ability and intent

 Implementation expenses or losses must be included in the valuation allowance
 Recognition and measurement of uncertain tax position guidance applies
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 Tax benefit must be reduced by net-of-tax amount of costs or losses that would be recognized if strategy were implemented

– Sale and leaseback of plant and equipment (if overall appreciation in company net assets)
– Switch from tax-exempt to taxable investments
– Disposition of obsolete or excess inventory
– Extinguishing liabilities that give rise to tax deductions upon payment
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Example
How much taxable income is available NOW?
Fair value adj. on acquisitions
Depreciation differences
Allowance for doubtful loans
D f d b
Capitalized software
Total net temporary differences
Accumulated taxable income (loss)
2008 Gross future (taxable)
/deductible amounts
(50,000)
(20,000)
40,000
(24,000)
(34,000)
2009
5,000
1,000
2010
5,000
1,000
(20,000) (20,000)
8,000 8,000
2011
5,000
1,000
8,000
2012
5,000
1,000
(6,000) (6,000) (6,000) 6,000
(6,000) (12,000) (18,000) (12,000)
2013
5,000
1,000
6,000
(6,000)
2014
5,000
1,000
6,000
0
Note: Ignore book income for purposes of this illustration (assume it is zero).
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Example (continued)
 If the Company can delay the payment of the bonus until 2010 (a tax-planning strategy), then full realization of the deferred tax assets, without recording a valuation allowance, would appear proper
– Deferred tax liabilities related to the fair value adjustments and depreciation
(gross $6,000 per year) reverse over 10 and 20 years, respectively
– Losses can be carried forward for 3 years
– Therefore, delaying the bonus payment until 2011 would give the company until 2014 to prove realization of the deferred tax assets
 However…
– To be considered prudent and feasible, the delaying of the bonus payment would have to be legally possible in accordance with the contract
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 Changes in circumstances can cause a change in judgment about the future realizability of a deferred tax asset and result in a revision to the valuation allowance
 allowance will depend upon when realization is expected (i.e., in the current year or in future years)
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 Recognize as part of the annual effective tax rate in the period the event occurs when:
– A benefit is expected to be realized because of current year “ordinary income,” or
– A valuation allowance is expected to be necessary at the end of the year for deductible temporary differences originating during the current year.
Source: Paragraph 20 of APB Opinion 28 (as amended by Statement 109), paragraph 20 of FIN 18.
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 Recognize entire amount of change as a discrete item in the interim period the event occurs when:
– judgment about the realizability of deferred tax assets in future years.
Source: Paragraph 20 of APB Opinion 28 (as amended by Statement 109), paragraph 37 of Statement 109 and paragraph 20 of FIN 18.
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Rachel McClain
Senior Manager rmcclain@kpmg.com
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© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with ti l C ti (“KPMG
International”), a Swiss entity. All rights reserved.
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The KPMG name, logo and “cutting through of KPMG International.