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Global tax accounting services newsletter
Focusing on tax
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April – June 2015
Global tax accounting services newsletter
Introduction In this issue Accounting and reporting updates
Recent and upcoming major tax law changes
Tax accounting refresher Contacts and primary authors
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Introduction
Andrew Wiggins Global and UK Tax Accounting Services Leader +44 (0) 121 232 2065 [email protected]
The Global tax accounting services newsletter is a quarterly publication from PwC’s Global Tax Accounting Services (TAS) Group. In the newsletter we highlight issues that may be of interest to tax executives, finance directors, and financial controllers.
In this issue, we provide an update on the activity of the Financial Accounting Standards Board (FASB), the uncertain tax position project of the International Financial Reporting Standards (IFRS) Interpretation Committee, and the status of the exposure draft on recognition of deferred tax assets for unrealised losses released by the International Accounting Standards Board (IASB) in 2014. We also update you on the status of the new revenue standard and developments with country-by-country reporting.
In addition, we draw your attention to some significant tax law and tax rate changes that occurred around the globe during the quarter ended June 2015.
Finally, in the tax accounting refresher section we highlight certain aspects of accounting for income taxes associated with foreign branch operations—traditionally a complicated area of tax accounting.
This newsletter, tax accounting guides, and other tax accounting publications are also available online and on our new TAS to Go app, which you can download anywhere in the world via App Stores. To register for our quarterly TAS webcasts and access replays, please click here.
If you would like to discuss any of the items in this newsletter, tax accounting issues affecting businesses today, or general tax accounting matters, please contact your local PwC team or the relevant Tax Accounting Services network member listed at the end of this document.
You should not rely on the information contained within this newsletter without seeking professional advice. For a thorough summary of developments, please consult with your local PwC team.
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Global tax accounting services newsletter
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Tax accounting refresher Contacts and primary authors
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In this issue
Accounting and reporting updates
The FASB activity update
The IFRS Interpretations Committee (IFRS IC) activity update
Status of the new revenue standard
Country-by-country (CbC) reporting developments
Recent and upcoming major tax law changes
Notable tax rate changes
Other important tax law changes
Tax accounting refresher
Accounting for income taxes associated with foreign branch operations
Contacts and primary authors
Global and regional tax accounting leaders
Tax accounting leaders in major countries
Primary authors
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Accounting and reporting updates
This section offers insight into the most recent developments in accounting standards, financial reporting, and related matters, along with the tax accounting implications.
The FASB activity update
Overview
On 8 June 2015, the FASB issued an exposure draft on tax accounting for stock compensation (see the Q1 of 2015 newsletter for the background) that includes the following revisions to the current guidance:
Recognition of all excess tax benefits
(‘windfalls’) and deficiencies (‘shortfalls’)
within income tax expense and elimination
of the requirement that cash taxes payable
be reduced in order to record a windfall
tax benefit.
Elimination of the requirement to display the gross amount of windfalls as an operating outflow and financing inflow in the statement of cash flows.
The proposed amendments to the accounting for
excess tax benefits and tax deficiencies would be
applied prospectively, while the proposed
amendments related to the classification on the
statement of cash flows would be applied
retrospectively for all prior periods presented.
The exposure draft did not specify an effective date. The FASB decided to wait until comments
are received on the proposal before determining a timeline.
The comment period for the exposure draft will end on 14 August 2015. Stakeholders are encouraged to provide comments on the above proposals.
Takeaway
The steps recently taken by the FASB and the
ongoing efforts of the FASB staff are intended to
reduce the complexity of accounting for income
taxes. Organisations should be proactively
evaluating the implications of the changes being
proposed in these tax accounting areas.
Consideration should be given to responding to the exposure draft by the end of the comment period.
There are also likely to be further developments as the FASB works through the tax accounting topics on its agenda.
Reshaping the tax function of the future
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Accounting and reporting updates
The IFRS IC update
Exposure draft on recognition of deferred
tax assets (DTAs) for unrealised losses
As we previously reported in the Q3 2014
newsletter, in August 2014, the IASB published
for comment the Exposure Draft on Recognition of
DTAs for Unrealised Losses (Proposed
amendments to International Accounting Standard
12 Income Taxes (IAS 12)). The comment period on
the Exposure Draft ended on 18 December 2014.
At its meeting in March 2015, the IFRS IC was
presented with a summary and an analysis of the
68 comment letters received on the Exposure
Draft, and decided to propose that the IASB should
proceed with the proposed amendments, subject to
some changes to the proposed wording.
The staff will present the IFRS IC’s
recommendations at a future IASB meeting.
Uncertain tax positions
As mentioned in the Q4 of 2014 newsletter, the
IFRS IC decided to proceed with developing
guidance in the form of an interpretation for the
measurement of uncertain tax positions (UTPs).
It was expected that the IFRS IC would issue the
draft interpretation for comment at the time when
this newsletter was going to production.
We will update you on the developments in relation
to this project in our next newsletter.
Takeaway
The ongoing efforts of the IFRS IC and its staff may
lead to significant near-term improvements.
Organisations should continue to monitor further
developments as the IFRS IC works through
these projects.
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Accounting and reporting updates
Status of the new revenue standard
Overview
In April 2015, the FASB and IASB decided to
propose a one-year delay in the effective date of the
new revenue accounting standard to 1
January 2018.
Early application of the standard continues to be
permitted under IFRS. Companies reporting under
US Generally Accepted Accounting Principles (US
GAAP) would also be allowed to early adopt the
guidance as of the original effective date, i.e., 1
January 2017, if the deferral proposal is approved.
What’s next?
The FASB and IASB discussed several
implementation issues related to the new revenue
standard at joint board meetings in February and
March 2015. The boards were aligned on the need
to address stakeholder feedback on licenses,
performance obligations, and certain practical
expedients upon transition, but did not agree on
the approach.
The IASB is expected to recommend more limited
clarifications while the FASB changes will be more
extensive. The FASB has also decided to propose
changes in other areas, for example, guidance on
collectability and non-cash consideration, and new,
optional ‘practical expedients,’ such as allowing
companies to account for shipping as a cost, rather
than a revenue earning deliverable, and to exclude
all sales taxes from revenue, rather than evaluating
each tax on a jurisdiction-by-jurisdiction basis.
The joint discussions are expected to continue in
the coming months.
The IASB plans to put forth a single package of
proposed amendments later this year, which
should be open for comment for a period of at least
30 days. In contrast, the clarifications proposed by
the FASB will be released for public comment as
multiple exposure drafts.
Takeaway
Although companies will likely have an extra year
to prepare, the implementation effort should not be
underestimated. The earlier implementation issues
are identified, the more likely companies can
identify potential ways to address them. In our
experience, many issues don’t become evident until
companies begin applying the new guidance to
their specific transactions. The implementation
challenges also extend well beyond accounting and
income taxes, as the new guidance will impact
processes, systems, and internal controls.
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Accounting and reporting updates
CbC reporting developments
Overview
On 8 June 2015, the Organisation for Economic
Cooperation and Development (OECD) released a
package of measures for the
implementation of a new CbC reporting
plan developed under the OECD/G20 Base
Erosion and Profit Shifting (BEPS) project.
The new implementation package consists of model
legislation requiring the ultimate parent entity of a
multinational group to file the CbC report in its
jurisdiction of residence, including backup filing
requirements when that jurisdiction does not
require filing.
The package also contains three Model Competent
Authority Agreements to facilitate the
administrative exchange of CbC reports among tax
authorities from different jurisdictions. The model
agreements are based on the Multilateral
Convention on Administrative Assistance in Tax
Matters, bilateral tax conventions and Tax
Information Exchange Agreements (TIEAs).
In detail
Composition of the MNE group
The model legislation in the new implementation package provides that the multinational (MNE) group from which the CbC report would be required is “a collection of enterprises related through ownership or control such that it is either required to prepare consolidated financial statements for financial reporting purposes under applicable accounting principles or would be so required if equity interests in any of the enterprises were traded on a public securities exchange.” Thus, the model legislation makes it clear that purely private MNEs would be required to file a CbC report.
Exclusion of small MNE groups
The model legislation also confirms that small
MNE groups should be exempt from CbC reporting
requirements if the group has less than 750 million
Euro (or the equivalent of 750 million Euro in
another currency as of January 2015) in
consolidated revenue during the fiscal year
immediately preceding the fiscal year for which
reporting would be required.
Which entity would have to file?
Under the model legislation each jurisdiction
would require a CbC report from the ‘Ultimate
Parent’ of an MNE group if that ultimate parent is
tax resident in that jurisdiction. In addition, each
jurisdiction would require a CbC report from any
‘Constituent Entity’ of an MNE group that is tax
resident in that jurisdiction if (1) the ultimate
parent of the group is not obligated to file a CbC
report in its jurisdiction of tax residence; (2) the
ultimate parent’s jurisdiction of tax residence has
an exchange of information relationship (through
treaty, tax information exchange agreement, or the
Multilateral Convention on Administrative
Assistance in Tax Matters) with the constituent
entity’s jurisdiction of tax residence but does not
have a competent authority agreement in place to
effect CbC information exchange with that
jurisdiction; or (3) there has been a ‘systemic
failure’ by the ultimate parent’s jurisdiction to carry
out CbC information exchange. In these
circumstances, the model legislation also provides
that if there is more than one constituent entity
that is tax resident in a particular jurisdiction, the
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MNE group can designate one of those entities to
file the CbC report with that jurisdiction.
The model legislation makes it clear that the OECD
members believe that the CbC report can be
collected ‘locally’ if the jurisdiction in which the
ultimate parent is headquartered is not engaged in
collecting and exchanging the reports. The
introduction to the implementation package states
that the model legislation “takes into account
neither the constitutional law and legal system, nor
the structure and wording of the tax legislation of
any particular jurisdiction.” Furthermore,
“[j]urisdictions will be able to adapt this model
legislation to their own legal systems, where
changes to current legislation are required.” It will
be interesting to see if jurisdictions in which
constituent entities are tax resident will find the
collection of global information of the entire
MNE to be within their constitutional and
legal framework.
The model legislation also contains a provision that
would allow MNEs to avoid the filing of CbC
reports locally in situations in which reporting and
exchange is not carried out in the ultimate parent’s
jurisdiction. In these cases MNEs could instead
designate another group entity as a ‘surrogate
parent’ to file CbC reports.
The model legislation provides for an apparently
administratively burdensome system of
‘notifications.’ Under this system, each constituent
entity of the MNE will notify its jurisdiction of tax
residence whether it will act as the ultimate parent
entity or surrogate parent entity. If not, it will need
to notify the jurisdiction which entity in the group
will act as the ultimate parent or surrogate parent
or, where the CbC report will be filed locally. If
there is more than one constituent entity in the
local jurisdiction, it will need to be determined and
reported which entity will be designated as the
filing entity. These notices are to be delivered to the
tax administrations in each jurisdiction in which
the MNE has constituent entities by the end of each
fiscal year for which the CbC report would be made.
Receiving and processing these notices will also
place a further administrative burden on tax
administrations, but presumably they are
considered necessary for the tax administrations to
know where the CbC report for each MNE group
will be filed each year and from which country they
will be exchanged.
Intended use and confidentiality
The implementation package makes it clear that
the OECD members have reached at least initial
consensus on the use and confidentiality of the CbC
reports.
The model legislation provides that the tax
administration collecting the CbC report “shall use
the CbC report for purposes of assessing high-level
transfer pricing risks and other base erosion and
profit shifting related risks in [Country], including
assessing risk of non-compliance by members of
the MNE group with applicable transfer pricing
rules, and where appropriate for economic and
statistical analysis.” The legislation further
provides that “[t]ransfer pricing adjustments by the
[Country Tax Administration] will not be based on
the CbC report.”
The model legislation also provides that “[t]he
[Country Tax Administration] shall preserve the
confidentiality of the information contained in the
CbC report at least to the same extent that would
apply if such information were provided to it under
the provisions of the Multilateral Convention on
Mutual Administrative Assistance in Tax Matters.”
Whether and how countries can actually implement
and police these use and confidentiality restrictions
remains to be seen.
Importantly, the model competent authority
agreements reflect these same restrictions on use
and confidentiality, as the special risk assessment-
only use restriction in the model legislation would
not otherwise apply to a jurisdiction receiving a
CbC report through a treaty-based exchange. The
competent authority agreements, however, further
provide that “Jurisdictions are not prevented from
using the CbC report data as a basis for making
further enquiries into the MNE group’s transfer
pricing arrangements or into other tax matters in
the course of a tax audit and, as a result, may make
appropriate adjustments to the taxable income of a
Constituent Entity.” Presumably, this caveat was
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not considered necessary in the model legislation
because it can be assumed that a jurisdiction
actually collecting the CbC reports directly will
consider itself free to use the information in this
way. Of course, this caveat reflecting the intended
use of the CbC reports to make “further enquiries
into the MNE group’s transfer pricing
arrangements or into other tax matters in the
course of a tax audit” presents one of the main
concerns that MNE groups will have once the CbC
reports are filed and exchanged.
Annexed to the model competent authority
agreements is a Confidentiality and Data
Safeguards Questionnaire which presents a series
of questions to be answered by tax administrations
in working out competent authority agreements to
automatically exchange information electronically.
This type of questionnaire was initially developed
in connection with efforts to implement US Foreign
Account Tax Compliance Act (FATCA)
requirements and the so-called Common Reporting
Standard. Presumably, the questionnaire was
included in the CbC reporting implementation
package to convey to both governments and private
sector stakeholders that governments seeking to
participate in CbC report exchange intend to
take seriously their obligations to keep the
reports confidential.
Penalties
The model legislation contains a note that the
legislation “does not include provisions regarding
penalties to be imposed in the event a Reporting
Entity fails to comply with the reporting
requirements for the CbC report.” The note further
states that “[i]t is assumed that jurisdictions would
wish to extend their existing transfer pricing
documentation penalty regime to the requirements
to file the CbC report.” Thus, the application of
penalties for failure to file CbC reports will be
determined by each jurisdiction, and consequently,
the penalties for failure to report could vary widely.
Time for filing and effective date
Consistent with the OECD guidance issued on 6
February 2015, the model legislation provides that
the CbC report should be filed “no later than 12
months after the last day of the Reporting Fiscal
Year of the MNE group.” Also, the model legislation
provides that the effective date of legislation would
be for reporting fiscal years of MNE groups
beginning on or after 1 January 2016. The 1
January 2016 effective date, however, is presented
in brackets, presumably to acknowledge that some
countries will deviate from that date.
Takeaway
For many OECD countries there may be a need to
implement CbC reporting through changes to
domestic law before it can fully come into effect.
However, it is clear that there is a strong
commitment from countries to implement CbC
reporting effective 1 January 2016, as
recommended by the OECD.
Given the lead time generally required to prepare
internal systems and processes for CbC reporting
and the level of funding and change that may be
required, it is critical that taxpayers begin to assess
now whether their current information and
accounting systems will allow them to comply with
the above CbC reporting requirements, as well
as any subsequent information requests from
tax authorities.
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Recent and upcoming major tax law changes
This section focuses on major changes in the tax law that may be of interest to multinational companies and can be helpful in their tax accounting considerations. It is intended to increase readers’ awareness of the main global tax law changes during the quarter, but does not offer a comprehensive list of tax law changes that should be considered for financial statements.
Notable enacted tax rate changes
Country Prior rate New rate
India (CIT) 30% 25%1
1 The corporate tax rate in India was reduced from 30% to 25% over four years starting with the 2016–2017 financial year. This change
was enacted on 14 May 2015.
Around the world:
When to account for
tax law changes
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Recent and upcoming major tax law changes Other important tax law changes
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Recent and upcoming major tax law changes
Australia
During the second quarter of 2015, the third and
final element of the Investment Manager
Regime became law. Broadly, the new rules
exempt foreign funds (including eligible US
onshore and offshore funds) from Australian tax on
Australian-source gains. The rules apply to
assessments for the 2015-2016 tax year and
subsequent years. Entities have the option to apply
the amendments to earlier tax years beginning 1
July 2011, through 30 June 2015.
During the second quarter of 2015, the Australian
Treasurer delivered the Federal Budget, that
included the following key proposals:
With effect from 1 January 2016, the general
anti-avoidance rules would be expanded to
capture certain arrangements that have a
primary purpose of avoiding a taxable
presence in Australia. This measure would
apply to both new and existing schemes. The
exposure draft legislation for this measure has
been released.
Increased penalties would be introduced for
income years commencing on or after 1 July
2015, for companies that enter into tax
avoidance or profit shifting schemes.
The OECD’s new transfer pricing
documentation standards, including CbC
reporting, would be implemented from 1
January 2016.
In addition, the Australian government released
the exposure draft legislation detailing
amendments to the consolidation regime
previously announced in the 2013–2014 and 2014–
2015 Federal Budgets. The proposed new rules are
aimed at restoring integrity to the consolidation
regime. Most significantly, the rules would remove
perceived ‘double benefits’ or ‘double detriments’
when an Australian target or subsidiary joins a tax
consolidated group. The exposure draft was open
for comments until 19 May 2015.
Canada
During the second quarter of 2015, the Canadian
Federal Minister of Finance presented the 2015
budget that included the following key proposals:
A 50% declining-balance rate would be
introduced for machinery and equipment
acquired between 2015 and 2026 primarily for
use in Canada for the manufacturing and
processing of goods for sale or lease.
The section 55 anti-avoidance rule (which may
tax certain inter-company dividends as capital
gains) would apply to dividends received after
20 April 2015, in situations where one of the
purposes for the dividend is to effect a
significant reduction in the fair market value of
any share or a significant increase in the total
cost of properties of the dividend recipient.
The dividend rental arrangement rules would
be modified for dividends that are paid or
become payable after October 2015. The
modifications deny the inter-corporate
dividend deduction on dividends received from
a Canadian share where there is a synthetic
equity arrangement. A synthetic equity
arrangement would be considered to exist
when the taxpayer (or a person that does not
deal at arm’s length with the taxpayer) enters
into one or more agreements that have the
effect of providing to a counterparty all or
substantially all of the risk of loss and
opportunity for gain or profit.
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Denmark
During the second quarter of 2015, a general anti-
avoidance rule was enacted in Denmark. The rule
will apply to any foreign transactions with a Danish
entity. In essence, the protection normally available
to transactions under Danish tax treaties and EU
Directives will no longer be available unless
multinational companies meet certain substance
and commercial reasons tests. Notably, certain
EU countries may be viewed as tax havens for
Danish purposes.
European Union (EU)
During the second quarter of 2015, the European
Commission presented Tax Transparency
Package 2.0 to fundamentally reform corporate
taxation in the EU, which sets out a series of
initiatives to tackle tax avoidance, secure
sustainable revenues and strengthen the Single
Market for business. Key aspects of the plan
include a proposal for a Common Consolidated
Corporate Tax Base, a framework to ensure
effective taxation where profits are generated and
increased tax transparency.
France
During the second quarter of 2015, the French
Ministry of Finance released new measures
aimed at increasing transparency and promoting
trust between the French tax authorities (FTA) and
taxpayers. This action is a part of the French
government’s focus on tax evasion and tax fraud on
a national and international scale. The following
four new measures have been announced:
Improving predictability of reassessments by
publishing a list of aggressive tax structures
considered to be illegal by the FTA.
Adopting ten ‘commitments’ to encourage
transparent and constructive dialogue with
taxpayers during tax audits. For example, the
FTA commits to indicating, whenever possible,
the main objectives of an audit at inception to
help a taxpayer anticipate the documents that
will be requested, meeting deadlines in
providing conclusions of the audit to the
taxpayer with timely responses to their
comments, and maintaining confidentiality and
tax secrecy as required under the law.
Creating a national committee of experts
composed of judges, academics, and business
tax directors to provide expertise to the FTA in
the analysis of complex cases.
Creating a Research & Development (R&D) tax
credit advisory board to provide consultation
services to taxpayers during tax audits where
the FTA challenges qualifying expenses.
India
During the second quarter of 2015, previously
announced 2015 Budget proposals were
enacted in India. These included the following:
For current financial year 2015–2016, the tax
surcharge was increased by 2%.
The implementation of the general anti-
avoidance rules was deferred for two years in
order to implement them as part of a
comprehensive regime that addresses the
OECD’s BEPS project.
Tax residency rules were amended to introduce
the ‘place of effective management’ concept.
This concept is essentially defined as the place
where key management and commercial
decisions that are necessary for the conduct of
the business are, in substance, made.
Italy
During the second quarter of 2015, the Italian
government released draft legislation which
covers a large number of international tax issues
including the following:
Roll-back provisions would be introduced for
all Advance Pricing Agreements (APA) and the
potential APA scope would cover exit and entry
values of assets and liabilities in the event
of outbound and inbound transfers of
tax residence.
Costs incurred in transactions with entities
resident in tax heavens, under the so-called
‘Black List’ rules, which are currently non-
deductible unless certain specific exemption
conditions are met, would be deductible up to
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their ‘arm’s length’ value provided the
underlying transactions have actually
taken place.
The attribution of profits to an Italian
permanent establishment of a foreign entity
would follow the principles set out by the
OECD. An optional regime would also be
introduced allowing Italian companies with
foreign branches to exempt such income from
Italian tax.
The draft decree is currently under review in the
Italian Parliament, and is therefore still potentially
subject to modification.
During the quarter, the Italian tax authorities also
issued guidelines addressing the anti-
avoidance rules that apply to the notional
interest deduction (NID) regime. NID is a
notional deduction with respect to ‘new equity,’
which includes retained earnings and certain cash
capital contributions over a particular equity basis
as of 2010.
Malaysia
During the second quarter of 2015, the Malaysian
Ministry of International Trade and Industry
issued guidelines on incentives for multinational
corporations seeking to establish or expand their
presence in Asian countries through a Malaysian
Principal Hub. The incentives are structured in
three tiers based on various criteria including
minimum annual sales, employment, annual
business spending and other qualifying activities.
Through the Principal Hub incentive, Malaysia
hopes to position itself as playing a key role in the
integrated global supply chain of multinationals.
New Zealand (NZ)
During the second quarter of 2015, the NZ Finance
Minister delivered the 2015 Budget that included
a proposal for a new ‘bright line’ test to ensure that
taxpayers selling NZ residential property (with
some exceptions) within two years of purchase will
pay tax on the profits. Additional administrative
requirements would also be introduced for non-
resident investors buying and selling NZ residential
property, including requirements to have a NZ
bank account and Inland Revenue Department
(IRD) number and disclosure of their tax
identification number from the home country.
In addition, the IRD released an Officials’ Issues
Paper proposing several changes to the non-
resident withholding tax (NRWT) rules in
relation to interest earned by non-residents from
related party debt. The Issues Paper is part of the
IRD’s work on BEPS and is a feature of the
government’s tax policy work program announced
by the Minister of Revenue earlier this year.
Broadly the proposals include the following:
The type of instruments that can give rise
to interest income subject to NRWT would
be broadened.
The rules for determining the amount and
timing of interest income subject to NRWT
would be better aligned with the financial
arrangement rules.
Switzerland
During the second quarter of 2015, the Swiss
Federal Council released the updated draft bill of
the Swiss Corporate Tax Reform III (CTR
III) for further parliamentary discussion. The key
elements of CTR III include the following:
CTR III abolishes cantonal holding, domiciliary
and mixed company status, and principal and
Swiss finance branch rules at the federal level.
The changes respond to the European Union’s
and OECD’s criticism concerning these
regimes.
CTR III introduces a cantonal patent box for
patents and similar rights that takes into
account the nexus approach recently developed
by the OECD. Under this provision, the cantons
may grant a maximum relief on patent box
profit of 90%.
The reform proposes a cantonal super-
deduction for research and development costs.
The reform proposes to adapt the current
cantonal capital tax. The cantons may relieve
the capital tax on equity to the extent it
relates to patents and similar rights as well
as participations.
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The extent of cantonal rate reductions will be at
the cantons’ discretion.
USA
During the second quarter of 2015, the IRS and US
Treasury issued final regulations under
Section 7874 (TD 9720) for determining when
an expanded affiliated group will be considered to
have substantial business activities in a foreign
country. Broadly, the final regulations retain the
25% bright-line rule provided in the 2012
temporary regulations. They apply to acquisitions
completed on or after 3 June 2015, and are
effective as of 4 June 2015.
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In this section we highlight certain aspects of accounting for income taxes associated with foreign branch operations—traditionally a complicated area of tax accounting.
Accounting for income taxes associated with foreign branch operations
Foreign branch operations generally represent
operations of an entity conducted in a country that
is different from the country in which the entity is
incorporated. For US entities, a branch can also
take the form of a wholly owned foreign
corporation that has elected for tax purposes to be
treated as a disregarded entity of its immediate
parent corporation.
Taxation of foreign branches may vary between
various jurisdictions, which in turn may impact
accounting for income taxes associated with such
operations. While specifics of tax accounting for
branches may need to be worked out for each
jurisdiction, in our discussion below we will focus
on the key aspects of the income tax standards IAS
12 (IFRS) and ASC 740 (US GAAP) relating to
branch operations.
Inside basis differences
Branch operations are often subject to tax in two
jurisdictions: the foreign country in which the
branch operates and the entity’s home country.
Accordingly, the entity should typically have two
sets of temporary differences relating to the
branch’s underlying assets and liabilities (generally
referred to as ‘inside basis’ differences) that give
rise to deferred tax assets and liabilities. Such
differences arise in (1) the foreign jurisdiction in
which the branch operates and (2) the entity’s
home jurisdiction.
Under both IFRS and US GAAP, the temporary
differences in the foreign jurisdiction will be based
on the differences between the book basis and the
related foreign country tax basis of each asset and
liability. The temporary differences in the home
country jurisdiction will be based on differences
between the book basis and the home country tax
basis in each asset and liability.
Some countries, like the UK, provide a tax
exemption in the entity’s home country for certain
branch profits. Consequently, no credit is available
in the home country for foreign taxes paid by the
branch. To the extent that the branch tax
exemption applies, only temporary differences
arising in the foreign jurisdiction would need to
be considered.
IFRS and US GAAP: similarities and
differences
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Outside basis differences
Under IFRS, a temporary difference might also
arise between the total carrying amount of the
reporting entity’s net assets in the branch and the
tax base of the reporting entity’s investment in the
branch. This temporary difference is sometimes
referred to as ‘outside basis’ difference.
Situations where outside basis differences in
relation to branches could arise are quite rare.
Nevertheless, the IAS 12 specifically addresses
them as it was written broadly and with flexibility
in mind. Outside basis differences may arise, for
example, due to undistributed profits (e.g., if
branch profits are taxed on distribution) or changes
in foreign exchange rates.
Where the book value of the entity’s net assets in
the branch is greater than their tax base (e.g., due
to retained profits) an entity needs to recognise a
deferred tax liability (DTL), except to the extent
that both of the following conditions are satisfied:
1) the entity is able to control the timing of the
reversal of the temporary difference; and
2) it is probable that the temporary difference will
not reverse in the foreseeable future.
As an entity controls the ultimate distribution of
the profits of a branch, it is able to control the
timing of the reversal of temporary differences
associated with that investment. Therefore, if the
entity has determined that those profits will not be
distributed in the foreseeable future it does not
recognise a DTL.
Where the tax base of the entity’s net assets in the
branch is greater than the book value (e.g., due to
accumulated losses or write-downs), the entity
shall recognise a DTA, but only to the extent that it
is probable that:
1) the temporary difference will reverse in the
foreseeable future; and
2) taxable profit will be available against which
the temporary difference can be utilised.
Under US tax rules, income in the branch is
directly taxable to the owner. As a result, there
generally should be no timing differences
associated with the investment in the branch itself
under US GAAP. However, timing differences may
arise in relation to foreign currency movements.
These are discussed later in this section.
Foreign taxes
The entity should record deferred taxes in its home
country for the tax effects of foreign DTA and DTL
because each would be expected to constitute a
temporary difference in the home country deferred
tax computation. More specifically, when a
deferred foreign tax liability is settled, it increases
foreign taxes paid, which in turn decreases the
home country taxes paid as a result of additional
foreign tax credits or deductions for the additional
foreign taxes paid. Equally, when a deferred foreign
tax asset in the foreign jurisdiction is recovered, it
reduces foreign taxes paid, which increases the
home country taxes as a result of lower foreign tax
credits or deductions for foreign taxes paid.
In considering the amount of deferred taxes to be
recorded in the home country as they relate to
foreign DTA and DTL, an entity must consider how
those foreign deferred taxes, when paid, will
interact with the tax computations in the home
country tax return. For example, in the US, a
taxpayer makes an annual election to deduct
foreign taxes paid or to take them as a credit
against its US tax liability. In making this decision
a taxpayer will need to consider a number of
factors, including the interaction of the income and
taxes of the foreign branch with the income and
taxes of the entity’s other branches and
foreign corporations.
If the taxpayer expects to take a credit for the
foreign taxes to be paid, it should record (before
considering any related credit limitations) a home
country DTA (DTL) for each related foreign DTL
(DTA) at a rate of 100% for the amount of the
foreign deferred taxes that are expected to be
creditable (see example below).
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If the foreign taxes that will be paid as the deferred
taxes reverse are not expected to be fully creditable
(e.g., in situations where the foreign tax rate
exceeds the home country tax rate), unique
considerations can arise. As a result, it may be
appropriate to record home country deferred taxes
on foreign country deferred taxes at a rate of less
than 100% of the foreign deferred tax asset or
liability, or under US GAAP it may be appropriate
to record such deferred taxes at a rate of 100% with
a valuation allowance for the portion of any net
foreign deferred taxes that, when paid, result in
credits that are expected to expire unutilised.
If the entity expects to deduct (rather than take a
credit for) foreign taxes paid, it should establish in
the home country jurisdiction deferred taxes on the
foreign DTA and DTL at the home country enacted
rate that is expected to apply in the period during
which the foreign deferred taxes reverse.
If there is no net DTA in the foreign jurisdiction
(e.g., due to a full valuation allowance under US
GAAP), a corresponding DTL in the home country
jurisdiction would generally be inappropriate.
Example
Background/facts
Company P has a branch in Country X where
the statutory tax rate is 25%.
In the current year, the branch is profitable.
For tax purposes in both Country X and
Company P’s home country, the branch has
excess tax over book depreciation of $5,000
and accruals deductible when paid of $3,000.
Both of these items represent
temporary differences.
In Company P’s home country, the branch is
taxed at 40%.
Taxes paid to Country X will be claimed as a foreign
tax credit.
Question
What are the amounts of deferred income taxes to
be recorded in the consolidated financial
statements?
Analysis/conclusion
Because the branch is taxed in both Country X and
Company P’s home country, the taxable and
deductible temporary differences in each
jurisdiction must be computed. A DTA for the
home country’s tax effects of the foreign DTL
associated with the depreciable property, as well as
a DTL for the home country’s tax effects of the
foreign DTA associated with the reserves, would be
included in the deferred tax balance. The effect of
these foreign deferred taxes on the foreign taxes
paid will, in turn, affect the home country tax
liability as a result of the impact on future credits
or deductions for foreign taxes paid.
This concept is illustrated below:
Country X
Accruals
deductible
when paid
$750 $3,000 x 25%
Depreciation $(1,250) ($5,000) x 25%
Branch DTL,
Net
$(500)
Home country
Accruals
deductible
when paid
$1,200 $3,000 x 40%
Depreciation $(2,000) ($5,000) x 40%
DTA on branch
DTL, Net
$500 $500 x 100%;
presumes 100%
foreign tax credit
Home country
DTL, Net
$(300)
Total DTA
/(DTL)
$(800)
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Foreign currency translation
Another area that must be considered is accounting
for foreign currency movements in relation to
foreign branches, including foreign currency
movements on branches’ temporary differences.
Under IFRS, a DTA (subject to the recognition test)
or a DTL should be recognised on foreign currency
movements on temporary differences related to a
foreign branch. The resulting deferred tax is
credited or charged to profit or loss.
Under US GAAP the effects of translating the
financial account balances from the branch’s
functional currency to the parent’s reporting
currency, including foreign currency movements on
temporary differences related to a foreign branch,
should be recorded in the cumulative translation
adjustments (CTA) account. In circumstances when
the temporary differences associated with the
translation adjustments of the foreign branch will
not be taxed in the home country until there is a
remittance of cash, for example, in the United
States, a question arises as to whether or not an
entity can apply an indefinite reversal assertion to
the CTA of the branch.
We believe the answer depends upon which of two
acceptable views the entity applies in its
interpretation of the accounting literature. View 1 is
that an indefinite reversal assertion is not available
for a branch and View 2 allows for the application
of an indefinite reversal assertion (when facts and
circumstances permit). The views are summarised
as follows:
View 1 — An exception to comprehensive
recognition of deferred taxes only applies to outside
basis taxable temporary differences related to
investments in foreign subsidiaries and certain
foreign corporate joint ventures. Because branch
income is directly taxable to the owner or parent,
there is technically no outside basis difference
in the branch and therefore the exception is
not applicable.
View 2 — In deliberating ASC 740, the FASB
indicated that the underlying rationale for the
exception to recognising deferred taxes related to
investments in foreign subsidiaries is based on the
inherent complexity and hypothetical nature of the
calculation. However, application of the exception
depends on an entity’s ability and intent to control
the timing of the events that cause temporary
differences to reverse and result in taxable amounts
in future years. In particular, the exception focuses
on the expectation of owner or parent taxation in
the home jurisdiction. If taxation of the CTA occurs
only upon a remittance of cash from the branch,
the timing of taxation can be controlled by the
owner or parent. On that basis, an indefinite
reversal assertion could be applied to the CTA of a
foreign branch (even though the assertion could
not apply to the periodic earnings of the branch
since they pass through to the parent). This is not
an ‘analogous’ temporary difference which would
be prohibited; rather, it is in the scope of the
exception. That is because such amount relates to a
foreign operation and carries with it the same
measurement complexities as any other foreign
outside basis difference.
The view taken is an accounting policy that should
be applied consistently. Accordingly, if View 1 is
adopted, it would be applied to all of the company’s
foreign branches. If View 2 is adopted, indefinite
reversal could be asserted for any branch for which
the criteria are supportable by specific plans
relating to the unremitted branch earnings. As a
result, under View 2, an indefinite reversal
assertion could be made and supported for one
branch while not being made for another.
For a company applying View 2, other points to
note are as follows:
The fact that earnings have already been taxed
can make the assertion difficult when there is a
possibility of repatriation from
foreign operations.
When an overall translation loss exists in the
CTA, it is necessary to demonstrate that the
temporary difference will reverse in the
foreseeable future before recognising a DTA.
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In the event that an indefinite reversal
assertion changes, the deferred taxes
attributable to current year CTA movement are
recorded to other comprehensive income.
However, because the beginning-of-year CTA
balance did not arise during the year, but
rather in prior years, the tax effects associated
with those prior-year cumulative balances
should be recorded to continuing operations.
The US Internal Revenue Service (IRS) has
indicated that final regulations applying to foreign
currency translation could be issued by the end of
the calendar year. These regulations may impact
US GAAP accounting for foreign currency
movements in relation to branches as
discussed above.
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Contacts
For more information on the topics discussed in this newsletter or for other tax accounting questions, including how to obtain copies of the PwC publications referenced, contact your local PwC engagement team or your Tax Accounting Services network member listed here.
Global and regional tax accounting leaders
Global and United Kingdom
Andrew Wiggins
Global and UK Tax Accounting
Services Leader
+44 (0) 121 232 2065
EMEA
Kenneth Shives
EMEA Tax Accounting
Services Leader
+32 (2) 710 4812
Asia Pacific
Terry Tam
Asia Pacific Tax Accounting
Services Leader
+86 (21) 2323 1555
Latin America
Marjorie Dhunjishah
Latin America Tax Accounting
Services Leader
+1 (703) 918 3608
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Contacts
Tax accounting leaders in major countries
Country Name Telephone Email
Australia Ronen Vexler +61 (2) 8266 0320 [email protected]
Belgium Koen De Grave +32 (3) 259 3184 [email protected]
Brazil Manuel Marinho +55 (11) 3674 3404 [email protected]
Canada Spence McDonnell
Nicole Inglis
+1 (416) 869 2328
+1 (604) 806 7781
China Terry Tam +86 (21) 2323 1555 [email protected]
Finland Kaj Wasenius +358 (20) 787 7302 [email protected]
France Marine Gril-Gadonneix +33 (1) 56 57 43 16 [email protected]
Germany Heiko Schäfer +49 (69) 9585 6227 [email protected]
Hungary David Williams +36 (1) 461 9354 [email protected]
India Pallavi Singhal +91 (80) 4079 6032 [email protected]
Italy Marco Meulepas +39 (02) 9160 5501 [email protected]
Japan Masanori Kato +81 (3) 5251 2536 [email protected]
Mexico Fausto Cantu +52 (81) 8152 2052 [email protected]
Netherlands Jurriaan Weerman +31 (0) 887 925 086 [email protected]
Poland Jan Waclawek +48 (22) 746 4898 [email protected]
Romania Mariana Barbu +40 (21) 225 3714 [email protected]
Singapore Paul Cornelius +65 6236 3718 [email protected]
South Africa Loren Benjamin +27 (11) 797 5426 [email protected]
Spain Alberto Vila +34 (915) 685 782 [email protected]
United Kingdom Andrew Wiggins +44 (0) 121 232 2065 [email protected]
United States David Wiseman +1 (617) 530 7274 [email protected]
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Primary authors
Andrew Wiggins
Global and UK Tax Accounting
Services Leader
+44 (0) 121 232 2065
Katya Umanskaya
Global and US Tax Accounting
Services Director
+1 (312) 298 3013
Steven Schaefer
National Professional Services
Group Partner
+1 (973) 236 7064
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