asc 740 recent developments 2013 & q1 2014
TRANSCRIPT
Accounting for Income Taxes:
Recent Trends & Developments
DALLAS CPA Society
Katherine Morris, CPA
May 8, 2014
scaling complex
rules….
a tangled web of
complex
matters…
Accounting for
Income Taxes Course Learning Objectives: This presentation will provide participants with one
hour of A&A credit and the knowledge of recent trends & developments impacting the
reporting of income taxes in the financial statements under ASC 740.
January 19, 2015
Agenda of Tax Provision Recent Trends
• Recent Trends
• Focus on Issues
1. Valuation allowance (VA)
considerations
2. Effective tax rate (ETR) reconciliation
/ Interim Reporting
3. Indefinite reinvestment of foreign
earnings
4. Uncertain tax positions (UTP)
Best Practices will be shared during each topic discussion.
3 January 19, 2015
Recent Trends
January 19, 2015 4
Accounting for Income Taxes is most relevant to
C-Corporations and has been one of the key areas
of restatements, material weaknesses and
significant deficiencies for public filers over the
past 12 years. (Audit Analytics - Analysis of past
12 years, report released April 2013)
Observation: Similar to the impact of Sarbanes-Oxley on auditing, the SEC’s
focus on income taxes has trickled down from the audit of public companies
and are now addressed by both those performing audits and those conducting peer reviews of auditors of private companies.
Recent Trends - FASB’s Agenda
FASB removes IFRS / FASB convergence project on
income taxes of IAS 12 & ASC 740 from agenda
(January 29, 2014, FASB vote)
FASB income tax Agenda:
Cash flows from income taxes
Intraperiod tax allocation
Earnings indefinitely reinvested in foreign subsidiaries
Intercompany transfers of assets
5 January 19, 2015
Recent Trends – SEC & PCAOB
January 19, 2015 6
SEC and Investor Focus: DISCLOSURES &
TRANSPARENCY
Recent SEC inspections have found that the income tax
disclosures provided in corporate financial filings often
focus on immaterial matters that don't adequately support
accounting conclusions related to valuation allowances
and unrepatriated foreign earnings (December 2013)
PCAOB Reviews: DOCUMENTATION
Documentation is lacking with respect to the judgments,
estimates and assertions
Recent Trends – SEC Technical Focus
SEC Comments – current technical focus:
Valuation allowances
Rate reconciliation
Repatriation of foreign earnings and liquidity ramifications
Unrecognized tax benefits
Transparency:
SEC continues to ask registrants to provide early-warning
disclosures about changes in the business, issues, and
how they may potentially affect the financial statements.
7 January 19, 2015
1. Valuation Allowances (VA) Considerations
Overview
General Rule:
Reduce a Deferred Tax Asset (DTA) by a Valuation Allowance (VA)
if, based on the weight of all available evidence, it is more likely
than not (i.e., >50%) that some portion or all of the DTA will not be
realized (ASC 740-10-30-17)
Reduce the DTA to the amount that is more likely than not to be
realized
9 January 19, 2015
Valuation Allowances – Documentation
Issues Lack of documentation and disclosure of positive and negative
evidence
No contemporaneous support for need for / release of VA
Take Aways Contemporaneously Analyze & Document:
Management’s responsibility to contemporaneously examine, support and document rationale for the need for and for changes in valuation allowances
Disclose (i.e., be transparent in footnotes): Public filers - discuss in a transparent manner in the MD&A and the
footnote disclosure(s) the underlying business reasons why a valuation allowance is needed or not required
Auditors are required to retain and assess management’s support and documentation
10 January 19, 2015
Valuation Allowances –
Analyze & Document the Evidence
Best Practice
Qualitative & Quantitative analysis
Document the need for and amount of the VA:
Negative Evidence
Positive Evidence
Conclusions Reached
Negative Evidence
A history of operating losses or tax credit carryforwards expiring unused (Some say a 2-year history of losses)
Losses expected in early / start-up years
Known circumstances that if unfavorably resolved would adversely effect future operations and profit level
11 January 19, 2015
Valuation Allowances –
Analyze & Document the Evidence
Positive Evidence: Sources of Income
Future reversals of certain DTLs
Caution: consider the reversal criterion
Future taxable income exclusive of reversal of DTAs
Taxable income or credit carryback opportunities
Tax planning strategies creating income
Must be considered
Must be prudent and feasible!
12 January 19, 2015
Valuation Allowances –
Analyze & Document the Evidence
Other Examples of Positive Evidence
Contracts or committed sales backlog that would produce more
than enough taxable income to realize all or part of the DTAs
An excess of appreciated asset value over the tax basis of the
entity’s net assets in an amount sufficient to realize the deferred
tax assets – if it would be feasible and prudent to sell…
Strong earnings history with evidence indicating the loss is an
aberration rather than a continuing condition
Observation: Some say at least 3 years of earnings
REMINDERS:
• Schedule out and quantify the impact.
• Remember a valuation allowance is not an all or none amount.
13 January 19, 2015
Valuation Allowances –
Analyze & Document the Evidence
Possible Sources of Income
Outside Basis Differences in Foreign Sub
When expected to reverse in the foreseeable future
When the foreign earnings have not been asserted as
indefinitely reinvested under APB Opinion 23
Caution: consider impact of cumulative translation adjustment
(CTA)
Equity Method Investments
When there is an a expectation of reversal in the foreseeable
future
14 January 19, 2015
Valuation Allowances –
Tax Planning Action or Strategy?
Tax Planning Actions
Completed in the ordinary course of business
For VA assessments, impact is reflected in current year and estimates of future taxable income if implementation has occurred
Costs - recognize when incurred
Tax Planning Strategies
Prudent & feasible strategy an entity would take to prevent a tax attribute from expiring unused
For VA assessments, strategies can be anticipated and incorporated into future taxable income projections when quantifying the VA
Costs - net against VA amount
15 January 19, 2015
Valuation Allowances – Issues
DTL on Goodwill – Naked Credit
Guidance on sources of taxable income: Consider DTLs resulting from temporary differences that will
reverse in future periods
Do not use DTLs created by the book/tax basis difference on nonamortizable book goodwill
Common Error Companies often reduce the DTAs by all DTLs, including the
naked credit, to compute the amount of the VA
Issue By the very nature of goodwill, the DTL is not expected to reverse
DTLs on indefinite lived intangibles, such as goodwill, create a “Naked (DTL) Credit” that cannot be used as a source of income to reduce the DTA when computing the need for a VA
16 January 19, 2015
Valuation Allowances – Issues
DTL on Goodwill – Naked Credit
Example:
Current tax loss, full valuation allowance against the DTA for NOLs
$1,000 of tax amortization on goodwill; no other book/tax differences
Tax rate = 40%
Provision = $400
Current provision = $0
Deferred provision = $400
To establish the DTL for the basis difference in goodwill
The indefinite-lived asset temporary difference cannot be considered a
source of income to reduce the VA
Total tax expense = $400
Observation: even though the Company has a current loss, it has tax
expense in the current year because of the $400 increase in the DTL.
17 January 19, 2015
Valuation Allowances –
Recent Development on Goodwill
January 19, 2015 18
New Guidance (ASU 2014-02) Accounting Standard provides a simplified, elective approach to
accounting for book goodwill for PRIVATE companies Amortize goodwill over 10 years – or less if identifiable shorter life
Test for impairment when a triggering event occurs, not annually
Effective: years beginning after 12/15/2014; early adoption permitted
Implication to VA In Review: Tax Amortization of book goodwill generally creates a (“naked
credit”) DTL on an indefinite lived asset that will not reverse in the future
An election under ASC 2014-02 effectively re-characterizes goodwill as a finite lived asset – i.e., amortizable for book
The resulting reversal of the DTL could potentially support recoverability of a DTA when looking at the need for a valuation allowance
Valuation Allowances – Issues: Analyze
DTAs and DTLs for each Jurisdiction
Issue
DTLs from different jurisdictions cannot be considered as a
source of income to reduce the amount of VA on DTA
Example
UK DTA = $100; related to UK NOLs with full VA
US Parent DTL = $(100), relating to depreciation on US assets
UK DTA $100
UK - Valuation Allowance (100)
US DTL (100)
Consolidated DTL $(100)
The US taxable temporary difference cannot be netted against UK DTA
to reduce the UK valuation allowance
19 January 19, 2015
Valuation Allowances – Issue
When Can VA Be Released? Guidance:
Report changes to the VA in the reporting period they occur
Consider what triggering event(s) have occurred since the prior assessment and whether a change in conclusion is warranted
Issue: Considerations of when the VA can be released:
When did income begin?
Is it sustainable?
When was a 3-year history of earnings established?
Is there a carryback opportunity?
Other…Has a non profitable business been disposed?
Take Aways: Document the analysis of evidence
Support the triggering event(s)
Judgment – i.e., quantify when and how much?
Management should apply a consistent policy on what criteria should be used on which to base VA reductions
20 January 19, 2015
Valuation Allowances – Issue
When Can VA Be Released?
Public Filers
The SEC staff has indicated registrants consider:
(1) the magnitude and duration of past losses,
(2) the magnitude and duration of current profitability, and
(3) changes in factors (1) and (2) that drove losses in the past and those currently driving profitability.
Disclosure: Include a discussion of the assessment of positive and negative factors or reasons that led to a reversal of a valuation allowance, and effectively answer the question “Why now?”
21 January 19, 2015
Valuation Allowances – Issue
DTAs Not a Substitute for Analyzing UTP
Guidance
DTAs should be established for all deductible temporary differences, NOLs and Credits
Record DTAs gross; then consider need for VA
VA may be required if future realization is in doubt due to insufficient future taxable income
Take Aways
A VA is not an appropriate way to handle liabilities on uncertain tax positions (UTPs) that do not meet the recognition or measurement thresholds
Companies are required to examine UTPs even when there is a “full” VA on DTAs
22 January 19, 2015
Valuation Allowances – Recent Development
on Uncertain Tax Positions New Guidance (ASU 2013-11) - Presentation of an Unrecognized Tax
Benefit: When a NOL Tax Credit Carryforward Exists — reduce the DTA for an NOL
carryforward or a tax credit carryforward by the liability for the tax benefit resulting from an uncertain tax position
Exceptions: 1) When the NOL or tax credit carryforward cannot be used to settle taxes resulting
from the disallowance of the tax position, or
2) When the entity does not intend to use the NOL or tax credit carryforward DTA for settlement
If conditions 1) or 2) exist, present the liability for the uncertain tax position and do not net the amount with a DTA.
Effective Date: Public entities: fiscal years beginning after December 15, 2013
Nonpublic entities may wait until fiscal years, and interim periods beginning after December 15, 2014, to adopt the amendments
Early adoption is permitted
23 January 19, 2015
Valuation Allowances – Issue
Impact of Tax Law Changes
General Rule (ASC 740-10-30-17):
Consider all currently available information about future
events when determining whether a valuation allowance
is needed for a DTA.
Reminder
An entity should not consider changes in tax laws or rates
when assessing the realizability of a DTA before the
period in which the change is enacted.
24 January 19, 2015
Valuation Allowances –
SEC Comments on Disclosures
BOILERPLATE DISCLOSURES: Cicely LaMothe, senior assistant chief accountant in the division's
Office of Real Estate and Commodities, said the SEC continues to find boilerplate disclosures on deferred tax valuation allowances (Dec. 2013)
ISSUE
Some registrants simply state that they considered the four sources of taxable income required when determining the ability to realize their deferred tax assets.
SUGGESTED REMEDIES – to increase transparency Address the limitations on the entity's use of net operating losses and
foreign tax credits.
Reference expiration dates.
Provide a disclosure indicating the relative magnitude of each source of taxable income that supports the realization of deferred tax assets.
Disclose whether material positive or negative evidence was considered.
25 January 19, 2015
2. Effective Tax Rate (ETR) Reconciliation
“Effective Tax Rate” =
Income Tax Expense / Pretax Income = ETR%
Purpose of ETR Reconciliation
Quantifies and explains the material differences of the
“expected” US federal statutory income tax rate of 34% or 35%
to the company’s “actual” or “effective” tax rate.
27 January 19, 2015
Effective Tax Rate Reconciliation -
Disclosures Reconciling Items: (shown in footnote disclosure)
Examples of Material Rate Reconciliation Items:
Pretax Income * 34 or 35%
State and foreign taxes (net of federal benefit)
Permanent Differences
Changes in the Valuation Allowance
Income Tax Credits
True Ups and changes in reserves or change in prior year tax
Changes in Tax Rates
Show dollars ($s) or percentages (%s)
Separate-line-item disclosure is required for items when meets materiality threshold of >5%: i.e., Pretax Income on reconciling item * Statutory Tax Rate = > 5% of total Tax
Expense
Extraordinary items and Discontinued Operations are disclosed net of tax
28 January 19, 2015
Effective Tax Rate Reconciliation -
SEC Staff Comments on Rate Recs
Reconciling items:
Not labeled correctly / did not adequately describe the
underlying nature of the amount
Inappropriately aggregated material reconciling items
Inconsistent with related amounts disclosed elsewhere in a
registrant’s filing
Foreign tax info not disclosed in MD&A consistent with
footnote:
Each material foreign jurisdiction; each tax rate
Impact of each jurisdiction on the amount in the rate rec
Corrections of errors inappropriately reflected as changes
in estimates
29 January 19, 2015
Effective Tax Rate Reconciliation –
Blended Rate Versus Actual Rate?
Preferred Practice:
Use actual tax rates currently
in effect by jurisdiction,
weighted appropriately,
versus a blended rate
computation
30 January 19, 2015
Effective Tax Rate Reconciliation:
Changes in Tax Law
Impact of new tax legislation or change in rates are
recognized in the period that includes the enactment date
(ASC 740-10-25-47), regardless of the effective date
Continuing Operations:
Include the impact in income from continuing operations for the
period that includes the enactment date. (ASC 740-10-45-15)
Discrete Items:
Impact on DTL or DTA (ASC 740-10-35-4)
Effects on taxes payable or refundable for a prior year when the
change has retroactive effects
31 January 19, 2015
Effective Tax Rate Reconciliation:
Changes in Tax Law
Example: Major business tax provisions “extenders” expired at the end of
2013: R&D credit
Subpart F exemption for active financing income and look-through treatment for payments between related CFCs
15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements
New markets tax credit
Work opportunity tax credit
Action Item: The tax impact of these items cannot be considered in the 2013
financials but in the period if & when a tax law enactment occurs.
32 January 19, 2015
Effective Tax Rate Reconciliation:
Changes in Tax Law
New Legislation: Fixed Assets: Capitalize vs Expense
Final regulations released September 13, 2013 on applying IRC Section 263(a) of the to amounts paid to acquire, produce, or improve tangible property, as well as rules for materials and supplies (IRC Section 162)
Tangible Property Accounting Method Change
Results: Change tax accounting methods / apply rules retrospectively with
a 481(a) adjustment
Changes deferred taxes / book vs tax basis on Fixed Assets Positive 481(a) adjustment creates DTL
Negative 481(a) adjustment creates DTA
Impact of timing of future reversals considered in VA on DTAs analysis
Reclasses in classified balance sheet: base on the expected reversal date of that temporary difference
33 January 19, 2015
Effective Tax Rate
Interim Reporting
General Rule
Apply estimated annual ETR to the year-to-date ordinary
income (or loss) from continuing operations
Revise estimated annual ETR at the end of each interim
period based upon the best current estimate of the annual
ETR
34 January 19, 2015
Interim Reporting
Discrete Events
Issue
Does the event impact the estimated annual effective tax rate for the quarter/interim period computation?
Discrete Events
Exclude events during the quarter that do not relate to continuing operations or are unusual or infrequent
Recognize in the period in which they occur
Examples:
Settlement of a tax audit related to prior years
Change in tax law which requires retroactive adjustments that fall out of the current year (i.e., Re-enactment of R&D credit).
35 January 19, 2015
Interim Reporting
Income from Continuing Operations
NOT discrete events: Company hires additional employees in Q3 and grants ISO’s
forcing an expense for the year
Company releases all of its valuation allowance in the current quarter based on current years’ earnings
36 January 19, 2015
Interim Reporting
Loss YTD / Forecasts Income
Issue:
The Company has a loss year-to-date but forecasts
income; no valuation allowance
Results:
Show tax benefit YTD; will offset future income
Show tax expense in future periods that reflect
income
37 January 19, 2015
3. Indefinite Reinvestment of Foreign
Earnings
General Rule
Compute deferred taxes for all differences in book versus
tax basis
Exception to the General Rule for CFCs:
A DTL is not recognized for differences in the amount of
the investment in the shares of the CFC subsidiary owned
by the parent unless it becomes apparent that temporary
differences will reverse in the foreseeable future (e.g.,
when foreign earnings are repatriated to the U.S.)
39 January 19, 2015
Indefinite Reinvestment of Foreign Earnings
Exception – NOT an election
Exception applies if the specific facts and circumstances
warrant
Based on a company’s ability and intent to control the reversal
of a taxable temporary differences (i.e., the outside basis
difference in the stock of CFC due to unrepatriated earnings)
Management’s Position
Does Management intend to permanently reinvest the foreign
earnings overseas?
Caution: review the underlying facts – do they support
Management’s Representation?
Document the facts supporting management’s positions
40 January 19, 2015
Foreign Reinvestment of Earnings SEC
Comments
EVIDENCE REQUIRED
Craig Olinger, deputy chief accountant in the SEC's Division of
Corporation Finance, said:
In its inspection of public company filings, an SEC registrant would not
be required to recognize a deferred tax liability for those overseas
earnings if it provides sufficient evidence that its foreign subsidiary has
indefinitely reinvested -- or will indefinitely reinvest -- the undistributed
earnings. (December 10, 2013, Tax Analysts)
41 January 19, 2015
Indefinite Reinvestment of Foreign Earnings
– Best Practices Supporting Assertion
Issues Factor in the liquidity and overall financial health of the U.S.
operations
If unremitted earnings could be needed at the parent level to meet existing and anticipated obligations, it may be difficult to support an assertion of indefinite reinvestment
Support: A specific documented plan should lay out items such as the
parent and CFC’s long-term and short-term Projected working capital and other financial needs in all locations
Budgets and forecasts, past dividends, previously taxed income, and tax consequences of a decision to remit or reinvest
Impact of support provided by CFC to US for transactions, such as mergers, acquisitions, servicing loans or meeting covenants or credit obligations
Alignment among management of multiple business functions within a company’s global organization
42 January 19, 2015
4. Uncertain Tax Positions
General Rule:
ASC 740-10, fka FIN 48, requires
all material income tax positions
for all open tax years to be
reviewed.
If the position is more likely than
not to be sustained upon audit, an
amount must be accrued.
44 January 19, 2015
Uncertain Tax Positions – Issue
Position Taken
When is a tax position considered “taken”?
1. A position taken in a previously filed return or expected to
be taken in a future tax return (original or amended)
2. When the taxpayer fails to file a required return
45 January 19, 2015
Uncertain Tax Positions – Issue
Effectively Settled
A tax position is considered to be “effectively settled”
when:
1. Exam is complete (ASC 740-10-25-10a)
2. The taxpayer does not intend to appeal or litigate any
aspect of the exam’s conclusions (ASC 740-10-25-10b)
3. When it is remote that the taxing authority would
examine/reexamine any aspect of a tax position (ASC 740-
10-25-10c)
46 January 19, 2015
Uncertain Tax Positions – Issue
Changes in Judgment
Issue: Company changes the liability for uncertain tax positions.
Guidance: Measurement of a tax position should "be based on management's best
judgment given the facts, circumstances, and information available at the reporting date"
Subsequent changes in judgment must be based on the evaluation of new information
Additional analysis of existing information would not typically constitute new information for purposes of adjusting prior estimates
Presentation: A change in judgment that results in subsequent recognition,
derecognition or a change in measurement of a position taken in a prior annual period must be recognized as a discrete item in the period in which the new information becomes available. (ASC 740-10-25-15)
Disclose change
47 January 19, 2015
Uncertain Tax Positions –
SEC Comments/Expectations
Observations Failure to provide required disclosures about
unrecognized tax benefits, which include a tabular reconciliation of such benefits (under ASC 740-10-50-15 and 50-15A).
Where no liability or benefit for unrecognized tax benefits exists (or for which such benefits are immaterial), consider disclosing those facts.
Lack of transparent disclosures about possible future changes in unrecognized tax benefits about
(1) The tax rate reconciliation impact,
(2) The impact on valuation allowances, and
(3) Registrants’ assertions that foreign earnings are indefinitely reinvested.
48 January 19, 2015
Uncertain Tax Positions – Documentation Procedures
Technical merit of tax positions
Measurement
By jurisdiction Federal
State International
Interest & penalties
Material items
Current period activity
Changes in judgment
Assumptions
January 19, 2015
Documentation Supporting a Tax Position Tax Year:
Tax Jurisdiction: Insert tax jurisdiction.
Tax Position: Describe the tax position.
Unit of Account: Describe the selected unit of account.
Does the tax position meet the “more likely than not”
recognition threshold: Meets / Does Not Meet Recognition Criteria.
Why does the tax position meet or fail to meet the “more
likely than not” recognition threshold:
Qualitative Law Analysis: Include the technical merits of the
tax position applied to the facts and circumstances of the tax
position.
Amount recorded in the tax return: $
Income tax expense for the current fiscal period: $
Income tax expense for the prior fiscal period(s): $
Current tax liability recorded: $
Noncurrent tax liability recorded: $
Deferred taxes on item: $
Liability for unrecognized tax benefit at the balance-sheet
date:
$
Support amounts recorded for the unrecognized tax
benefit:
Measurement: Calculate the largest amount of benefit that is
greater than 50 percent likely of being realized/i.e., probability
tables.
Measurement – Assess the Probability of
Outcomes
Possible
Estimated
Outcome
Individual Probability of
Occurring
Cumulative
Probability
of Occurring
$ 100 10% 10%
$ 80 20% 30%
$ 60 25% 55%
$ 50 20% 75%
$ 40 10% 85%
$ 20 10% 95%
$ 0 5% 100%
•NOTES:
•$60 is the largest amount of benefit > than 50% likely of being realized upon settlement
•$40 would be recorded on the balance sheet as an “unrecognized tax benefit” ($100 - $60)
Process: Document measurement process using a probability table or
some other source of measurement.
January 19, 2015
Recognition & Measurement
JURISDICTION: Federal
Description of Identified Uncertain Tax
Positions in Current Period
Tax (Benefit) or
Accrual –
Recognition
Criteria Met?
Amount to be
Reported
“Measurement”
1
2
Total
Process: Document decision process on recognition criteria – MLTN or not? –
and document results from the measurement step – i.e., the amount to be
reported.
January 19, 2015
Thank you
Material discussed in this presentation is meant to provide general information and should not be acted on without professional advice tailored to your firm’s or company’s individual needs.
To ensure compliance with Treasury Department regulations, any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Service Code or applicable state or local tax law provisions or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.
January 19, 2015