Current Topics in ASC 740 –
Accounting for Income Tax
TEI Upstate NY Tax Conference
May 6, 2014
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
0
Notice
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 TAXPAYER OR (ii)
PROMOTING MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED
PROMOTING,
HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons, without
limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials
we provide to you
you, including
including, but not limited to
to, any tax opinions
opinions, memoranda
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.
adviser
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
1
Agenda

SEC comments on income taxes

A few
f
reminders off legislative and regulatory developments

Evolution, challenges and next steps from an auditor’s perspective
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
2
SEC comments on
income taxes
SEC – Current US Public Company Regulatory Environment
SEC comments on Income Taxes

Detail of effective tax rate reconciliation disclosures

Detail of valuation allowance disclosures

Timeliness of valuation allowance disclosures

Consistency of assumptions for valuation allowances with other public disclosures

Detail associated with indefinitely reinvested foreign earnings for liquidity disclosures

Foreign jurisdiction considerations in determining deferred tax assets

Tax planning strategy in impacting realization of deferred tax assets and release of valuation allowances

Transfer pricing strategies/exposures related to unrecognized tax benefits
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
4
Undistributed earnings of foreign subsidiaries
SEC comments on income taxes

Because ASC Subtopic 740-30, Income Taxes – Other Considerations or Special Areas, establishes a
presumption that all undistributed earnings of a subsidiary will be transferred to the parent company, an
entity must have specific plans for reinvestment of undistributed earnings that demonstrate the reversal of
th outside
the
t id b
basis
i diff
difference will
ill b
be postponed
t
d indefinitely
i d fi it l

When this assertion appears to be substantive to the registrant's liquidity position, the SEC staff has been
requesting registrants to make disclosures. An example comment includes:
We note your disclosure that you did not record taxes on undistributed earnings of $XXX million at
December 31, 2011 since these earnings are considered to be permanently reinvested. We also note
from your balance sheet that as of December 31, 2011 there is a significant amount of cash recorded on
the balance sheet. If a significant amount of this cash on the balance sheet relates to cash held by
f i subsidiaries,
foreign
b idi i
please
l
revise
i th
the liliquidity
idit section
ti off MD&A tto di
disclose
l
th
the amountt off cash
h and
d
short term investments held by foreign subsidiaries; a statement that the company would need to
accrue and pay taxes if repatriated; and a statement that the company does not intend to repatriate the
funds.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
5
Undistributed earnings of foreign subsidiaries (continued)
SEC comments on income taxes

There are also examples of the staff asking more detailed questions. An example comment:
Describe to us your specific plans for the reinvestment of undistributed earnings of foreign subsidiaries
(ASC 740-30-25-17), and tell us the factors that management considered in determining that there is
sufficient evidence that the undistributed earnings of your foreign subsidiaries will continue to be
indefinitely reinvested (ASC 740-30-25-19). Include your consideration of the amount and percentage of
cash and investments held in foreign jurisdictions in your response.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
6
Supporting indefinite reinvestment:
ASC 740-30-25-17 considerations

In order to support an indefinite reinvestment of earnings example documentation may include:
–
Significant inter-company
inter company or third party debt which would require cash
–
Details of plant expansion to be undertaken
–
Acquisitions planned
–
Documentation of advertising or promotion campaign planned
–
Providing funding for other group members
–
Debt covenants restricting dividend payments
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
7
Supporting indefinite reinvestment:
ASC 740-30-25-17 considerations (continued)


In order to support an indefinite reinvestment of earnings example documentation may include:
–
Additional borrowing plans
–
Past activities of the entity
The company’s documentation supporting plans for reinvestment should not be inconsistent with other
assertions made within the financial statements and/or MD&A (for example: assertions related to going
concern satisfaction of debt covenants
concern,
covenants, etc
etc.))
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
8
Implications of foreign earnings on effective tax rates
SEC comments on income taxes

The SEC staff also identified situations in which companies derive a significant portion of their earnings in
countries with low income tax rates that may not be sustainable because of fiscal imbalances in the
country. In these situations, disaggregated disclosure related to operations in that country may be
appropriate,
i t iincluding
l di di
disclosure
l
off th
the portion
ti off earnings
i
attributable
tt ib t bl tto th
thatt fforeign
i operation.
ti
Th
The St
Staff
ff
did not provide specific guidance for determining whether a country was considered to have a low income
tax rate

An example comment includes:
We note that "foreign earnings taxed at less than the federal rate" had a significant impact on your
effective tax rate. We further note that substantially all of the foreign earnings were generated by
subsidiaries in Ireland and Singapore. Tell us your consideration to include a discussion regarding how
potential
t ti l changes
h
iin such
h countries'
t i ' operations
ti
may iimpactt your results
lt off operations.
ti
Al
Also, ttellll us your
consideration to provide disclosures that explain in greater detail the impact on your effective income
tax rates and obligations of having proportionally higher earnings in countries where the statutory tax
rates differ from that of the U.S. In this regard, you should consider explaining the relationship between
the foreign
g and domestic effective tax rates in g
greater detail as it appears
pp
as though
g separately
p
y
discussing the foreign effective income tax rates may be important information necessary to
understanding your results of operations. We refer you to Item 303(a)(3)(i) of Regulation S-K and
Section III.B of SEC Release 34-48960.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
9
Uncertain tax positions, including the effects of transfer pricing
SEC comments on income taxes

The SEC staff has also recently addressed disclosures related to uncertain tax positions. Related to this
area, recent articles in the press and reviews of SEC comment letters also indicate that the SEC staff are
interested in learning about registrant's dealings with taxing authorities outside of the United States,
i l di related
including
l t d ttransfer
f pricing
i i strategies
t t i or exposures

An example comment received from the SEC Staff includes:
Reference is made to the disclosures regarding Notices of Proposed Adjustment from the IRS for the
20X5 and 20X6 calendar years relating to transfer pricing with your foreign subsidiaries. Please explain
to us how you consider and historically considered transfer pricing when evaluating tax contingencies
and the required tax contingency disclosures. In doing so, please tell us when you received the Notices
of Proposed Adjustment, the approximate time you learned of the IRS position on your transfer pricing,
why
h your ttax contingencies
ti
i att D
December
b 31
31, 20X9
20X9, D
December
b 31
31, 20X0
20X0, and
d March
M h 31,
31 20Y1 are
significantly less than the approximate $X.X billion potential federal income tax expense impact
disclosed and how you have satisfied the disclosure requirements of ASC 740-10-50-15d.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
10
Uncertain Tax Positions

Benefits associated with tax positions must be more-likely-than-not (MLTN) of being sustained based
solely on the technical merits of the tax position to be recognized
–
Detection risk cannot be considered
–
Must assume taxing authority will have full knowledge of relevant information and will examine the
position

Tax planning strategies must meet the MLTN threshold to be considered in supporting the realizability of
deferred tax assets

Administrative practices and precedents of the taxing authority should be considered

Recognized tax positions are measured as the largest benefit more than 50% likely to be realized
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
11
Valuation allowances
SEC comments on income taxes

The SEC staff has addressed changes in valuation allowances and the need for consistency between the
assumptions registrants describe related to an evaluation of the need for a valuation allowance on
deferred tax assets and assumptions used in other accounting areas (e.g., impairments) disclosed in
MD&A or discussed
di
d during
d i conference
f
calls
ll ffor iinvestors
t
and
d analysts.
l t

An example comment received from the SEC staff includes:
We note the significant reduction in your valuation allowance recorded during fiscal 2011. Please
describe, supplementally and in detail, the events and circumstances that resulted in this reduction and
explain how your accounting complies with GAAP. As a related matter, please identify the location of
your related disclosures in MD&A and/or elsewhere throughout the filing.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
12
Valuation allowances (continued)
SEC comments on income taxes
 The SEC staff may comment if a Tax planning strategy is used to support a release:
We note your disclose that you developed a tax planning strategy during fiscal year 2011 that resulted in
the reduction of the valuation allowance
allowance. In future filings
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.
 The SEC staff may also comment if a Company has not released its valuation allowance:
We note on p
page
g F-33 that yyou state that you
y intend “to maintain the valuation allowance until sufficient
positive evidence exists to support the reversal of some or all of the allowance”. Please tell us the various
factors you consider in evaluating whether your valuation allowance is necessary in light of the historical
periods in 2011 and interim 2012 in which you recorded net income. If you are changing the valuation
allowance only for the amount of NOL used during the period, please tell us the basis for determining that
this change in valuation allowance is appropriate and how you determined that it was more likely than not
that your tax benefits will not be realized. See ASC 740-10-30-17 for guidance.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
13
Valuation allowances (continued)
SEC comments on income taxes
 Lastly, the SEC staff has commented on assumptions around evaluating the need for a valuation allowance
on deferred tax assets:
We note the significant deferred tax assets recorded at each balance sheet date. Please revise future
filings to provide a more detailed explanation of how you determined it is more likely than not that you will
realize deferred tax assets. Please ensure your disclosures address each of the following, as appropriate:
•
To the extent that you are relying on future pre-tax income, please disclose the amount of pre-tax income
you need to generate to realize your deferred tax assets
assets. Please also include an explanation of the
anticipated future trends included in your projections of future taxable income.
•
If you are relying on reversal of existing deductible temporary differences to support the realizability of
your deferred tax assets, p
y
please disclose that the deferred tax liabilities yyou are relying
y g on are of the
same character and will reverse in both the same period and jurisdiction as the temporary differences
giving rise to the deferred tax assets assets.
•
If you are also relying on tax-planning strategies, please disclose the nature of your tax planning
strategies how each strategy supports the realization of deferred tax assets
strategies,
assets, the amount of the shortfall
that each strategy covers, and any uncertainties, risks, or assumptions related to the tax-planning
strategies.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
14
Valuation allowance
General concept

FASB ASC 740-10-30-5(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 will not be realized. The valuation allowance shall be sufficient to reduce the
d f
deferred
d ttax assett to
t the
th amountt that
th t is
i more likely
lik l th
than nott tto be
b realized.”
li d ”

Recognition or nonrecognition of a valuation allowance is not optional

A valuation allowance must be adjusted as circumstances change

Need for valuation allowance is generally determined separately for each tax-paying
tax paying component
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
15
Valuation allowance
Sources of income

Realization of tax benefits of deductible temporary differences and carryforwards is dependent upon
enterprise having:
–

Sufficient taxable income:

Of an appropriate character

Within the statutory carryback/carryforward period
Sources of income:
–
Taxable income in carryback years
–
Future reversals of existing temporary differences
–
Forecasted future taxable income exclusive of reversing temporary differences and carryforwards
–
Tax planning strategies
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
16
Valuation allowance
Scheduling of temporary differences

Definition—“an exercise or analysis performed to determine the pattern and timing of reversal of
temporary differences”

Not mandatory
y under FASB ASC 740,, but useful in determining
g whether DTAs will be realized 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

Objective is to minimize complexity in selecting method

Degree of detail is a matter of professional judgment
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
17
Valuation allowance
Scheduling of temporary differences (continued)

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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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
18
Valuation allowances (continued)
SEC comments on income taxes
• Registrants must continually evaluate both the positive and negative evidence in determining whether to
record, maintain, or reverse a valuation allowance
• When a registrant has either initially recognized or reversed an existing valuation allowance, the Staff is
likely to question why that occurred in the current period rather than in an earlier or later period
• The Staff emphasized the degree to which positive evidence is objectively verifiable is critical in
concluding that it is more likely than not that a registrant will realize its DTAs
• The Staff noted that it is difficult to demonstrate that factors contributing to cumulative losses will not
recur
• They noted losses due to the economic downturn are generally not considered an aberration
• The Staff focuses on the consistency of assumptions made by a registrant throughout its filing
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
19
Accounting for Income taxes
A Few Reminders of Legislative
and Regulatory Developments
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
20
FASB ASU No. 2014-02 Accounting for Goodwill for Private Companies
The ASU provides private companies with an accounting alternative to amortize goodwill on a straight-line
basis over 10 years, or less if the company demonstrates that another useful life is more appropriate. The
ASU also provides private companies the alternative to use a simplified goodwill impairment model.
ASU 2014-02, if elected, should be applied prospectively to goodwill existing as of the beginning of the
period of adoption and new goodwill recognized in annual periods beginning after December 15
15, 2014
2014, and
interim periods within annual periods beginning after December 15, 2015. Early application is permitted,
including application to any period for which the private company’s annual or interim financial statements
have not yet been made available for issuance.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
21
FASB ASU No. 2014-02 Accounting for Goodwill for Private Companies
(Continued)
ASC 740 implications would depend on whether the goodwill is non-tax deductible or tax deductible:
Non-tax deductible goodwill: the ASU does not change the prohibition on the recognition of a deferred tax
liability on goodwill that is not deductible for tax purposes. Book amortization of goodwill will result in an
unfavorable permanent difference.
Tax deductible goodwill: book amortization will be a timing difference that would either (a) increase a
deferred tax asset or (b) decrease a deferred tax liability previously recognized for historical tax
amortization.
Goodwill amortization that includes both tax deductible and non-tax deductible components: allocation to
each component based on policy choice. Common approaches include pro rata allocation to tax-deductible
and nondeductible goodwill.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
22
FASB ASU No. 2014-02 Accounting for Goodwill for Private Companies
(Continued)
Impact on electing the accounting alternative to amortize goodwill on valuation allowance consideration:
Prior to ASU 2014-02, tax amortization of goodwill may have created deferred tax liability (DTL) that was
associated with an indefinite lived asset and, generally, such DTL would not be considered as a source of
income to support the realization of deferred tax assets.
The election to amortize goodwill over a finite period may change such a determination and the reversal of
the DTL could potentially support the realizability of deferred tax assets.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
23
FASB ASU 2013-11 – Presentation of UTP
ASU 2013-11 (EITF Issue 13C) –
y for an Unrecognized
g
Tax Benefit When a Net Operating
p
g Loss or Tax Credit
Presentation of a Liability
Carryforward Exists
Background

Wh an entity
When
tit h
has a liliability
bilit ffor an unrecognized
i d ttax b
benefit
fit and
d a nett operating
ti lloss carryforward
f
d (NOL)
or tax credit carryforward exists, the loss of the tax position may reduce the NOL or tax credit
carryforward rather than result in cash payment

This issue is related solely to presentation. There is no impact on recognition or measurement of
uncertain tax positions

Due to a lack of authoritative guidance, some diversity exists in gross versus net presentation
Final Consensus was reached by the Task Force

Unrecognized tax benefits should be shown as a reduction of a deferred tax asset for an NOL or tax
credit carryforward (rather than as a liability) when the uncertain tax position would reduce the NOL,
similar tax loss, or tax credit carryforward under the provisions of the tax law
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
24
FASB ASU 2013-11 – Presentation of UTP (Continued)
Unrecognized tax benefits shall be presented as a liability, and not be combined with deferred tax
assets, to the extent:
The net operating
p
g loss carryforward,
y
, a similar tax loss,, or a tax credit carryforward
y
is not available at the
reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would
result from the disallowance of a tax position
The tax law does not require the use, and the entity does not intend to use, the deferred tax asset for such
purpose
Unrecognized
tax benefits may also be presented as an adjustment to deferred taxes or an
amount refundable
The ASU
is applied prospectively
Retrospective
application and early adoption permitted
Effective
for fiscal periods, including interim periods within such fiscal periods, beginning after
December 15, 2013 (all entities other than non-public entities) and after December 15, 2014 (nonpublic entities)
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
25
Repair Regulations – ASC 740 Considerations
The final repair regulations provide guidance on the application of §162(a) and §263(a) to amounts paid to
acquire,
q
,p
produce or improve
p
tangible
g
p
property.
p y The regulations
g
were issued September
p
19,, 2013 and
generally apply to taxable years beginning on or after January 1, 2014. Transition guidance issued in
January and February 2014.
Adoption of the new regulations may result in reclassification of the balance sheet depending on the
significance of the adjustment to deferred taxes.
There may be correlative effects on the annual effective tax rate to the extent a change in method affects
current year taxable income and thus increases or reduces a §199 or percentage depletion deduction
deduction.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
26
Mexican Tax Reform
Mexico’s Congress on 31 October 2013 passed an economic package for the 2014 tax year, including
certain anticipated tax reform provisions. Included in the provisions are (but not limited to) the following
changes:
•Impose a corporate income tax rate of 30%
•Repeal the current phase-down of the corporate income tax rate
•The
The law repeals the IETU (single business tax), certain “emergency
emergency provisions
provisions” in the income tax law, and
the tax on cash deposits.
•A 10% income tax withholding on dividends distributed. Application of the new withholding tax would apply
beginning in 2014, but not to distributions of profits subject to corporate-level tax before 2014.
•Disallow
Disallow deduction for technical assistance
assistance, interest and royalty payments when pay to a foreign related
party
•Repeal of the tax consolidation regime.
•Modified definition of “maquila operation”
The tax reform may have significant deferred tax impact for period covering the enactment date.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
27
UK Research Tax Credit
On July 17, 2013, the U.K. government enacted a new research and development expenditure credit
(RDEC) that will replace the R&D tax credit system for larger companies in the United Kingdom for
qualifying expenditures incurred on or after April 1, 2013. Applying the RDEC is mandatory as of April 1,
2016 until
2016;
til th
thatt d
date,
t a company may choose
h
which
hi h ttax credit
dit system
t
tto apply.
l
One of the government's aims in changing the current system is for the credit to be accounted for within
profit before tax in order to encourage more research and development by large companies by making the
benefits "more visible and certain."
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
28
UK Research Tax Credit (Continued)
The key terms of the RDEC include:
Entities generally will be entitled to a gross credit of 10% of qualifying R&D expenditures (certain entities
will be entitled to a higher
g
rate of 49%);
);
The gross credit is taxable;
The credit will be offset against the corporation tax liability of a tax-paying entity;
If there is no corporation tax liability (or the credit exceeds the corporation tax liability), the company can
receive the credit in cash (subject to conditions; see below);
Any credit in excess of the corporation tax liability for the period will be restricted to the company's PAYE
and NIC liability in relation to company and group employees involved in R&D activities. Any credit in excess
of this amount may be carried forward to be claimed in the following year.
The
Th credit
dit is
i offset
ff t against
i t the
th corporation
ti tax
t liability
li bilit off other
th accounting
ti periods
i d and
d may b
be offset
ff t
against the corporation tax liability of other group companies;
The amount of cash received will be net of tax. The notional tax incurred may be surrendered to other
group companies or carried forward for offset against future tax liabilities.
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
29
UK Research Tax Credit (Continued)
For example, if a company were to generate 100 pounds of RDEC in a year where the company's taxable
income from other operations netted to zero and the tax rate were 20 percent, the company would receive a
cash refund of 80 pounds.
The net 80 payment would consist of 100 of credit, less 20 of withholding. The company would report 100 of
taxable income for the entire credit and compute a 20 corporation tax liability. The 20 corporation tax liability
would be satisfied by the 20 withholding.
ASC Topic 740, Income Taxes , applies to only taxes based on income. As it relates to the RDEC, the U.K.
income tax system serves only as a mechanism for administering the refunds to eligible parties. The tax
credit is not income based and is not within the scope of ASC Topic 740. Therefore, the benefit of the
entire credit, gross of the withholding, should be presented within pretax income either as other income or
as a deduction
d d ti ffrom th
the related
l t d expenditures.
dit
The
Th credit
dit would
ld nott be
b presented
t d as a reduction
d ti off income
i
tax expense.
Because the credit is taxable, even if the enterprise is in an overall loss position, the credit has the economic
effect
ff
off providing a benefit
f to the recipient equal to the amount net off the withholding. Accounting policy
election may be made under which an enterprise would present an amount net of the withholding in pretax
income.
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30
Other Recent changes
Changes in tax rates and law (enacted during 2013) include, but are not limited to:
•Finland’s corporate tax rate decreased 4.5 percent to 20 percent beginning January 1, 2014.
•Portugal’s corporate tax rate decreased 2 percent to 23 percent beginning January 1, 2014.
•Norway’s corporate tax rate decreased 1 percent to 27 percent beginning January 1, 2014.
•United
U it d Ki
Kingdom
d
corporate
t ttax rate
t will
ill d
decrease b
by 2 percentt tto 21 percentt on A
Aprilil 1
1, 2014
2014.
•Vietnam’s corporate tax rate will decrease 3 percent to 22 percent from 2014 (Decree
218/2013/ND-CP
218/2013/ND
CP also made other changes to law on corporate income tax).
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31
American Taxpayer Relief Act of 2012
Extenders only through December 31, 2013:
•Look through treatment of payments between related CFCs
•Look-through
•Subpart F exception for active financing income
•Research credits
•50% bonus depreciation
•15-year QLHI
Expirations should be considered for portion of year after December 31, 2013.
Deferred tax calculations should be based on enacted tax law.
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32
AUDITING INCOME TAX PROVISIONS
Evolution, Challenges and Next
Evolution
Steps from an Auditor’s
Perspective
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33
Background - ICOFR Timeline
2004
2005
2006
2007
2008
Transition
from AS2 2004
to AS5 in 2007
SEC
Interpretive
Guidance 2007
2009
2010
2011
2012
2013
Pervasiveness of Inspections
Findings Increase
SEC Speech
Dec 2009
PCAOB 4010
Report
&
Staff Audit
Practice Alert
on
Professional
Skepticism in
Dec 2012
PCAOB
Released Part
II of
Competitors
Inspection
Report
COSO 2013
Framework
SEC: “Congress never intended that the 404 process should become inflexible, burdensome, and wasteful. The objective
of Section 404 is to provide meaningful disclosure to investors about the effectiveness of a company’s
company s internal controls
systems, without creating unnecessary compliance burdens or wasting shareholder resources.”
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34
Background - SEC Speech (December 2009)
“Observations from annual reviews of
registrants’ disclosures of material
weaknesses make me wonder whether
registrants and auditors are identifying and
reporting all material weaknesses”
“the correlation between the reporting of a material
weakness and the existence of a material adjustment
continues to increase over time...”
D
December
b 2009 SEC S
Speech
hb
by SEC St
Staff:
ff R
Remarks
k b
before
f
th
the 2009 AICPA N
National
ti
l
Conference on Current SEC and PCAOB Developments by Doug Besch
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member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
* Through May 2013
35
Current Regulatory Environment
The PCAOB continues to focus on management’s and the auditor’s testing of the design and operating
effectiveness of management review controls
Management review controls are controls where a process owner exercises judgment in the review of key
information
Typically management review controls relate to:
Multiple financial statement accounts
Significant estimates
In particular, they have focused on:
Metrics/criteria used in the operation of the control to identify misstatement (precision)
Evidence of outliers/exceptions that were detected
Controls over the completeness and accuracy of data/information used in the operation of the control
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Impact on Tax Provisions
The preparation of an income tax provision requires significant management judgment and there needs to
be adequate controls in place to ensure the following are appropriately recorded:
Valuation of Deferred Tax Assets
Uncertain tax positions
Undistributed earnings of foreign subsidiaries – indefinite reversal criteria
Transfer pricing
Other areas – purchase price allocations, share-based transactions, tax restructurings, 382 studies, and
repatriations
A significant amount of data is utilized to prepare the tax provision – both for the tax basis and book basis –
to calculate a tax provision
Several constituents within the organization have knowledge
knowledge, information and/or are entering into
transactions that could have a tax implication and impact on the tax provision. This requires effective and
timely communication within the organization.
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Impact on Tax Provisions (continued)
Generally, third-party experts will also be involved to assist management in certain aspects of the provision.
What are the controls and documentation to support the various components of the tax provision and
management’s judgments?
Due to these complexities, the tax provision is generally an area of audit focus by the auditor for testing
controls and substantive procedures because there is significant judgment
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Documentation
The SEC does not provide a lot of guidance about how specific management’s documentation of the design
and operation of a control should be. The SEC staff has stated, on pages 20-22 of its 2007 interpretative
guidance (SEC Release No. 33-8810), that the nature and extent of evidence should increase as the risk
related
l t d tto the
th control
t l iincreases. M
Managementt R
Review
i
C
Controls
t l (MRC
(MRCs)) are, b
by d
definition,
fi iti
hi
higher
h risk
i k and
d
therefore, it is expected that management should have more robust evidence surrounding the design and
operating effectiveness of the control.
The SEC has stated on pages 44-45 of its 2007 interpretative guidance:
“In contrast (to management), the auditor is responsible for conducting an independent audit that
includes appropriate professional skepticism. Moreover, the audit of ICOFR is integrated with the audit
of the entity’s financial statements. While there is a close relationship between the work performed by
managementt and
d its
it auditor,
dit th
the ICOFR audit
dit will
ill nott necessarily
il be
b lilimited
it d tto th
the nature
t
and
d extent
t t off
procedures management has already performed as part of its evaluation of ICOFR. There will be
differences in the approaches used by management and the auditor because the auditor does not have
the same information and understanding as management and because the auditor will need to
integrate
g
its tests of ICOFR with the financial statement audit.
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39
Documentation (continued)
“We agree with those commentators that suggested coordination between management and auditors
on their respective efforts will ensure that both the evaluation by management and the independent
audit are completed in an efficient and effective manner.”
Engagement teams may find it beneficial to work with management early in the audit process to formalize
their policies and enhance and maintain their documentation with respect to the design and operating
effectiveness of MRCs. This up-front effort can prove to be time well spent and improve sufficiency of
evidence for purposes of management’s assessment and the engagement team’s audit of ICOFR.
Often, management documents the design and operating effectiveness of the MRCs, but not in sufficient
detail. Concluding
g on the design
g and operating
g effectiveness of MRCs from an audit perspective becomes
increasingly difficult when management does not maintain sufficiently detailed documentation regardless of
whether such documentation is appropriate for management’s assessment.
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Documentation (continued)
For key MRC’s, the documentation should include, among other things:
The metrics,, thresholds and other criteria that the control is designed
g
to operate;
p
;
Whether the criteria are consistently applied;
What constitutes an outlier or exception;
How external and internal factors influence the design and operating effectiveness of the control and;
How identified outliers or exceptions are resolved.
Establishing criteria for the operation of a control is important regardless of whether or not a control
is an MRC. It is p
particularly
y important
p
that auditors understand and management
g
articulate the
established criteria for MRCs because:
The criteria might not be readily discernible based on the description of the control;
Without established criteria, it is difficult to determine whether the precision of the control is sufficient to
detect or prevent a material misstatement; and
Without established criteria, it is difficult to determine whether the operation of the control is consistently
performed.
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Documentation (continued)
For information utilized in the operation of control, controls are necessary to ensure the data is complete and
accurate.
As auditors move forward with evaluating whether, based on the established criteria, the MRC operates at a
sufficient level of precision, it is important they have a sufficient understanding of what the control operator is
supposed to do, how often he/she is supposed to do it, and what he/she is specifically considering when
executing the control. In essence, auditors should place themselves in the position of the control operator.
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Best Practices
Due to the disparity of complexities that can exist in a particular tax provision, there is not one
recommended approach to ensure you have designed suitable controls and maintain an appropriate level of
documentation.
For example, a tax provision can be non-complex – no global operations and the business operates in a few
states, as compared to multinational corporation entering into many complex transactions with tax
implications.
Some key considerations:
As the
A
th level
l
l off complexity
l it iincreases iin a particular
ti l ttax provision,
i i
ensure you h
have appropriately
i t l considered
id d
the various judgments involved and points in the process where misstatements could arise. Ensure controls
exist and are designed to address the specific risk of a material misstatement – disaggregated
controls/reviews inherently are more precise
Ensure an understanding of precision level for the control evaluation (to prevent or detect a material
misstatement) versus operational
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43
Best Practices (continued)
Document significant judgments (i.e., valuation allowance, APB 23 assertion, uncertain tax positions)
Ensure effective and timely communication within the organization – interaction of the tax personnel with the
controllership group to review and discuss key tax positions and related documentation
To the extent third parties are assisting in certain aspects of the provision, management should ensure the
data being utilized by the third party is complete and accurate and the report/analysis provided to
management is appropriate
Consistency of information utilized is important (i.e., projections for a valuation allowance memorandum
should
h ld b
be consistent
i t t with
ith a goodwill
d ill evaluation)
l ti )
Effective coordination of the audit team and tax specialists
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44
Presenter Contact Information
Pauline W.F. Mak
Partner, Federal Tax Practice
KPMG
G LLP
(617) 988-6767
pmak@kpmg.com
www.us.kpmg.com
k
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45
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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.
57310CHI
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