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Moderator:
David Gaul, Vice President Tax – Cypress Semiconductor
Recent SEC Comment Letters:
Rusty Thomas, Partner – KPMG
Jeff Sokol , Partner – Deloitte
Complex Tax Accounting Issues:
Chad Bowar, Partner - Ernst & Young
Ty Kanaaneh, Partner - PwC
Intraperiod Allocation and Tax Holidays:
Jim Songey, Partner – Grant Thornton
Scott Jaconetty – BDO Seidman
Accounting for Income Taxes
2011 High Tech Tax Institute Nov 8, 2011
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Rusty Thomas
Tax Partner, KPMG
[email protected]
Jeff Sokol
Tax Partner, Deloitte
[email protected]
408-704-4121
Foreign Income & Foreign Tax Rates
SEC Comment
“Please consider providing disclosures to explain in greater detail the impact on your effective income tax rates and obligations of having proportionally higher earnings in countries where you have lower statutory tax rates. You should consider explaining the relationship between the foreign and domestic effective tax rates in greater detail… We refer you to Item 303(a)(3)(i) of Regulation S-K and Section III.B of SEC Release 33-8350. ”
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Foreign Income & Foreign Tax Rates
Item 303(a)(3)(i) of Regulation S-K :
“A company should describe any unusual or infrequent events or transactions or any significant economic changes that materially affected the amount of reported income from continuing operations and, in each case, the extent to which income was so affected. In addition, describe any other significant components of revenues or expenses that, in the registrant’s judgment, should be described in order to understand the registrant’s results of operations.”
Section. III. B of Sec Release No. 33-8350
“Disclosure should emphasize material information that is required or promotes understanding…and provide investors and other users with material information that is necessary to an understanding of the company’s financial condition and operation performance.”
Foreign Income & Foreign Tax Rates
Response Letter
“We advise the Staff that we disclosed the impact of earnings in foreign jurisdictions, along with how those earnings impact our effective tax rate comparatively to the higher tax rate in the U.S., in the following sections of our Filings: (a) … “MD&A” of 200910-K, and (b) on income tax footnote of the Q3 201010-Q.”
“…We respectively submit that our earnings from our recurring foreign operations were not materially affected by any unusual or infrequent events or transactions, which would necessitate additional disclosures as stated in Item 303(a)(3)(i) of Reg. S-K.”
“…We believe that we have met the preceding criteria (i.e. material information) because our disclosures indicate the risk that our tax rate could fluctuate depending on the geographic distribution of our world-wide earnings…”
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Foreign Income & Foreign Tax Rates
Response Letter, cont.
“…In future filings, we will expand our MD&A discussion of our effective tax rate by providing more detail on our mix of U.S. and international income before income taxes, as well as changes in the effective tax rate due to changes in unrecognized tax benefits.”
“…We will ensure that future MD&A disclosures address the impact on our effective tax rate of emphasizing production and distribution through our regional operational centers, particularly those in Ireland, Singapore and Puerto Rico, and any anticipated impact of economic uncertainty…”
Foreign Rate Differential
SEC Comment
“Please clarify what the foreign rate differential represents in each of the three years presented. As part of your response, explain how the foreign rate differential is determined in each fiscal year and identify the
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Foreign Rate Differential
Response Letter
“The significant component of foreign rate differentials in each of the three years relates to the undistributed earnings of certain foreign subsidiaries that we intend to reinvest indefinitely in those foreign subsidiaries.”
“We determine the impact to the tax rate as a result of earning income in foreign jurisdictions with lower effective tax rates than the statutory federal income tax rate in the following manner:
We determine the U.S. liability related to the foreign earnings by taking the total amount of foreign earnings and multiplying it by the federal statutory tax rate of 35%.
We then compare the amount above to the actual amount of foreign taxes that have been expensed in the current year, which in certain locations includes local income taxes, potential withholding taxes, and other franchise taxes based on income. The difference between the two amounts represents the amount
of the benefit that we recognize.”
Foreign Rate Differential
Response Letter
“We note the Staff’s comment, and in response thereto, respectfully advise the Staff as follows:
(i) For each of the last three years, the “differences between U.S. and foreign tax rates on foreign income, including withholding taxes” represents the difference between the actual foreign taxes expensed and the foreign taxes that would have been expensed assuming a hypothetical application of a notional 35% tax rate to our foreign income. This number has increased as our foreign income taxed at rates below the notional 35% tax rate has increased.
(ii) There are no other significant components within this item other than the computation noted above.
(iii) The Company performed a comprehensive review in 2010 of its expenses and income related to transfer pricing as part of its on-going tax strategy. This review resulted in changes to our mix of income across tax jurisdictions and an increase in the difference between the notional 35% U.S. tax rate and foreign tax rates on foreign income, including withholding taxes.
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Undistributed Earnings
SEC Comment
“In future filings please clarify why you believe it is not practicable to determine the amount of unrecognized deferred tax liability related to undistributed earnings of foreign subsidiaries.”
Undistributed Earnings
ASC 740-30-50-2:
“All of the following information shall be disclosed whenever a deferred tax liability is not recognized because of the exceptions to
comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures:
a. a description of the types of temporary differences for which a deferred tax liability has not been recognized and the types of events that would cause these temporary differences to become taxable;
b. the cumulative amount of each type of temporary difference;
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Undistributed Earnings
Response Letter
“…we asserted, pursuant to ASC 740-30-25-3, that the undistributed earnings of foreign subsidiaries are indefinitely invested in foreign operations. It is not practicable to calculate the potential liability as there is a significant amount of uncertainty due to the fact that dividends received from our foreign subsidiaries could bring additional foreign tax credits, which could ultimately reduce the U.S. tax cost of the dividend. In addition, significant judgment is required to analyze any additional local withholding tax and other indirect tax consequence that may arise due to the distribution of these earnings. These reasons make it impracticable to accurately calculate the amount of deferred tax liabilities related to the undistributed earnings, particularly in light of the fact that we have no current intention of distributing these unremitted earnings. As a result, we respectfully submit that we should not be required to add anything additional to our current disclosure…”
Undistributed Earnings
A Second Response Letter
“The Company believes that it is not practicable to determine the amount of the unrecognized deferred tax liability on undistributed earnings as of January 1, 2011, principally due to the difficulty in determining the amount and use of foreign tax credits. There are many factors and assumptions that are required to estimate the use of these credits…”
“Accordingly, in future annual filings, [] plans to include a disclosure similar to the following: Except as noted below and where required by U.S. tax laws and generally accepted accounting principles, no provision was made for U.S. income taxes on the undistributed earnings of the Company’s foreign affiliates, as the Company intends to use those earnings in its foreign operations for an indefinite period of time. As of the fiscal year end 20xx, the undistributed earnings of the Company’s foreign affiliates was approximately $xx million. If the Company had not intended to utilize the undistributed earnings in its foreign operations for an indefinite period of time, the deferred tax liability as of fiscal year end 20xx would have been in the range of $xx million to $xx million.”
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Liquidity Related Disclosure
SEC Comments
“Tell us your consideration of providing liquidity disclosures to discuss the potential tax impact associated with the repatriation of undistributed earnings of foreign subsidiaries. In this regard, consider disclosing the amount of investments that are currently held by your foreign
subsidiaries and disclose the impact of repatriating the undistributed earnings of foreign subsidiaries. We refer you to Item 303(a)(1) of Regulation S-K and Section IV of SEC Release 33-8350.”
Liquidity Related Disclosure
SEC Comments
“We note your response to prior comment 2 and your liquidity discussion where you indicate that the company intends for certain cash balances to remain outside of the U.S. and that you believe you have sufficient sources of liquidity to meet your U.S. liquidity needs through ongoing cash flows, external borrowings or both. While we note your intent is to permanently reinvest such funds outside of the U.S., we continue to believe you should consider providing enhanced liquidity to disclose the amount of cash and investments held by foreign subsidiaries that would be subject to the potential tax impact associated with the repatriation of undistributed earnings on foreign subsidiaries. In this respect, this disclosure would illustrate that some investments are not presently available to fund domestic operations such as the payment of dividends, corporate expenditures or acquisitions without paying a significant amount of taxes upon their repatriation.”
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Liquidity Related Disclosure
Item 303(a)(1) of Regulation S-K
“Company should “Identify any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant's liquidity increasing or decreasing in any material way.”
Sec. V. of SEC Release 33-8350
“A company is required to include in MD&A the following information: historical information regarding sources of cash and capital
expenditures;
evaluation of the amounts and certainty of cash flows;
the existence and timing of commitments for capital expenditures and other known and reasonably likely cash requirements; discussion and analysis of known trends and uncertainties; A description of expected changes in the mix and relative cost of
capital resources…”
Liquidity Related Disclosure
Response Letter
“We added the following MD&A disclosure in our 10-Q ‘…While we currently do not foresee a need to repatriate funds, should we require more capital in the U.S. than is generated by our operations locally, we could elect to repatriate funds held in foreign jurisdictions or raise capital in the U.S. through debt or equity issuances. These
alternatives could result in higher effective tax rates or increased interest expense.’…”
“In future filings we will provide a cross reference in MD&A to our disclosure in the notes to the annual financial statements of the amount of temporary differences resulting from earnings for certain non-U.S. subsidiaries which are permanently reinvested outside the U.S. and the unrecognized deferred tax liability associated with these temporary differences…”
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Liquidity Related Disclosure
Sample Disclosure
“Our existing cash, cash equivalents and investment balances may fluctuate during the remainder of fiscal 2011 due to changes in our planned cash outlay, including changes in incremental costs such as direct and integration costs related to our acquisitions. A majority of our cash and investments are held by our foreign subsidiaries. Our intent is to permanently reinvest a significant portion of our earnings from foreign operations, and current plans do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. In the event funds from foreign operations are needed to fund operations in the United States and if U.S. tax has not already been previously provided, we would be required to accrue and pay additional U.S. taxes in order to repatriate these funds.”
Permanent Reinvestment
SEC Comment
“You indicate that a provision has not been made for U.S. taxes on $[ ] million of undistributed earnings of international subsidiaries that could be subject to taxation if remitted to the U.S. You indicate that your intention is to reinvest these earnings permanently or only repatriate them when it is tax efficient to do so. Please tell us how you believe your policy complies with ASC 740-30-25-17. In particular, please describe the specific plans you had as of [ ] 2010 for reinvestment of the undistributed earnings of international subsidiaries which demonstrated that the remittance of these earnings would be postponed indefinitely. We note that in the Liquidity and Capital Resources section you indicated that you repatriated foreign cash in 2008. ”
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Permanent Reinvestment
ASC 740-30-25-17
“The presumption in paragraph 740-30-25-3 that all undistributed earnings will be transferred to the parent entity may be overcome, and no income taxes shall be accrued by the parent entity, for entities and periods identified in the following paragraph if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely or that the earnings will be remitted in a tax-free liquidation. A parent entity shall have evidence of specific plans for reinvestment of undistributed earnings of a subsidiary which demonstrate that remittance of the earnings will be postponed indefinitely. These criteria required to overcome the presumption are sometimes referred to as the indefinite reversal criteria. Experience of the entities and definite future programs of operations and remittances are examples of the types of evidence required to substantiate the parent entity's representation of indefinite postponement of
remittances from a subsidiary. The indefinite reversal criteria shall not be applied to the inside basis differences of foreign subsidiaries. ”
MD&A Disclosure – Changes to ETR
SEC Comment
“Please revise your MD&A to quantify and provide a more robust explanation of the specific tax items that affected changes in your effective tax rate. For example, you indicate that the increase in your effective tax rate in 2009 was the result of a discrete tax item and a change in the mix of U.S. and foreign income as well as a change in the mix of U.S. earnings in states with lower income tax rates. Please revise to quantify and explain the discrete tax item you refer to in your disclosures and please also quantify changes in the sources of income that affected your effective rate.”
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MD&A Disclosure – Changes to ETR
Response Letter
Proposed revision:
“Income taxes – The effective tax rate increased in 2009 to 45% from the 25% rate in 2008. The 2009 effective tax rate was higher primarily as a result of a 10% impact on the rate as a result of the repatriation of foreign earnings of $2 million with no corresponding foreign tax credit to offset the U.S. tax impact. The lesser 2008 effective tax rate was primarily a result of the following: 1.4% benefit on the rate related to the repatriation of $500,000 of earnings, which created beneficial foreign tax credits of $388,000; a 6.3% benefit from foreign earnings in low tax jurisdictions as compared to the U.S. tax rate; and a reduction in state taxes as a result of a reduction in the state blended tax rate against an opening deferred tax liability.”
Valuation Allowance – Advance Disclosure
SEC Comment
“We note that you reversed substantially all of your tax valuation allowance in the fourth quarter of fiscal year 2009. Please tell us how you considered providing MD&A disclosure in prior periodic filings alerting readers to the reasonable likelihood that a change in your assessment could have a significant impact on future results. In this regard, it appears that cumulative earnings for the twelve quarters ended September 27, 2009 may have represented a known trend indicative of a potential change in your income tax provision. Please refer to Section III.B.3 of SEC Release 33-8350. ”
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Valuation Allowance – Advance Disclosure
Response Letter
“We considered Section III.B.3 of SEC Release 33-8350 when addressing the potential for reversing the valuation allowance that had been established against our deferred tax assets in the Management’s Discussion and Analysis in our filings. The Company was in a cumulative loss position in the first quarter of 2009. We believe that disclosure of the potential to reverse the valuation allowance at that time would have been premature as the Company had no positive income quarters in 2007 and only two quarters of positive pretax income in 2008.”
UTB 12-Month Look-Forward
SEC Comment
“Regarding the $XX.X million benefit recognized as a result of the lapse in the statute of limitations for certain unrecognized tax benefits, you are required to provide transparent disclosure concerning unrecognized tax benefits when it is reasonably possible that they will significantly increase or decrease within 12 months of the reporting date. We believe such disclosure should have been provided in your 2008 financial statements regarding the lapse of the statute of limitations in 2009, please advise. If applicable, you should revise your financial statement footnote to fully comply with FASB ASC 740-10-50-15d with respect to any significant changes that may take place during 2010. Also disclose the tax years that remain subject to examination by major tax jurisdictions pursuant to ASC 740-10-50-15e. Provide a comprehensive, forward looking discussion in MD&A of the potential impact of any significant changes in unrecognized tax benefits on your future results of operations or explain to us why such disclosure is not necessary. ”
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UTB 12-Month Look-Forward
ASC 740-10-50-15
“An entity within the scope of this Topic (see paragraph 740-10-15-2A) shall disclose all of the following at the end of each annual reporting period presented:
…d. For positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date:
1. The nature of the uncertainty;
2. The nature of the event that could occur in the next 12 months that would cause the change;
3. An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made.”
UTB 12-Month Look-Forward
Response Letter
“In the third quarter of 2008, the Company was aware that the U.S. Federal statute of limitations for the year 2005 would potentially expire on September 15, 2009. However, the Company had been under a tax examination by the IRS for the years 2003-2005. While the IRS field examiners had substantially completed their field work and provided their proposed adjustments, one of the issues the IRS reviewed was the effect of stock option backdating by former management. Stock option
backdating was an IRS “Tier 1” issue, meaning that all backdating cases in the U.S. were uniformly managed by a national “issue owner.” During 2007 and 2008, the resolution of backdating cases was a slow and evolving process. Thus, by the third quarter of 2008, it was not certain if the IRS would request an extension of the statute of limitations for 2005 to allow more time for the backdating issues to be reviewed further. We
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UTB 12-Month Look-Forward
Response Letter, cont.
“In future filings, to the extent that such disclosures in our financial statement footnotes indicate significant future changes, the Company will also provide discussions in MD&A of potential future changes to
unrecognized tax positions. Such discussion will include the timing and effect of potential expiration of statutes of limitations in major tax
jurisdictions, potential effects of tax examinations in progress in major tax jurisdictions and potential changes due to pending changes in tax law and interpretations of regulations, if any.”
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Ty Kanaaneh
Tax Partner, PWC
[email protected]
Chad Bowar
Tax Partner, Ernst & Young
[email protected]
Complex Tax Accounting Issues
1) Tax law changes
2) Intercompany transactions 3) Non-controlling interests
4) Changes in accounting estimates
5) Branch operations – deferred tax accounting
Acquisition accounting:
6) Subsequent intellectual property transfers 7) Contingent consideration
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Tax Law Changes
ASC 740-10-45
Deferred tax liabilities and assets shall be adjusted for the effect of
a change in tax laws or rates. The effect shall be included in
income from continuing operations for the period that includes the
enactment date.
Tax Law Changes
• All adjustments to reflect the rate change are measured as of the
enactment date and reflected in income from continuing operations
Retroactive tax rate changes
The effect of the change would be recognized in income from continuing
operations in the period
of enactment Subsequent changes to a
DTA/VA initially recorded in purchase accounting Revaluation of existing
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Tax Law Changes
Intercompany Transactions
• ASC 740-10-25-3(e) and ASC 810-10-45
[formerly FAS 109 ¶ 9(e)]
• ASC 740-10-25-3(e) provides the following exception to the asset and
liability approach prescribed by ASC 740:
‒“A prohibition on recognition of a deferred tax asset for the intra-entity
difference between the tax basis of the assets in the buyer’s
jurisdiction and their cost as reported in the consolidated financial
statements.”
‒“If income taxes have been paid on intra-entity profits on assets
remaining within the consolidated group, those taxes shall be deferred
or the intra-entity profits to be eliminated in consolidation shall be
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Intercompany Transactions
• Basic premise of ASC 740-10-25-3(e)
• Ordinarily there are tax effects when an asset is sold or
transferred between affiliated companies that file separate
tax returns
• Under par. 3(e)
‒Tax impact is deferred
• Carries forward the “matching” concept by requiring taxes
to be deferred until seller’s pre-tax profit is recognized
‒Typically applies when an entity sells, transfers or
contributes an asset to an affiliate
‒Applies even if company does not record a book gain
Intercompany Transactions
Applicability of ASC 740-10-25-3(e)
• Typically applies to intercompany transfers of assets
involving entities domiciled in two different jurisdictions
• However, it also applies to entities domiciled in the same
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Intercompany Transactions
• Applicability of ASC 740-10-25-3(e)
• Applies to inter-company transfers of assets such as:
‒Inventory
‒Fixed assets
‒Intangible assets such as intellectual property
Does not apply to inter-company transfers of stock of a
subsidiary
Intercompany Transactions
• Deferred charges
Deferred charges recorded represents the tax effect of a past
event
Not the same as deferred tax assets
• Not subject to revaluation for tax rate changes
• Not subject to valuation allowance under ASC 740
• Recognized when related asset is sold outside the group or
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Intercompany Transactions
Deferred charges
• Realization test
‒No stand-alone realization test prescribed in accounting
literature
‒If the related asset (e.g., inventory or PP&E) is impaired, a
proportionate write-down of the deferred charge should
occur
‒Carrying amount of asset (e.g., inventory) and the deferred
charge, in total, should not exceed the anticipated
“after-tax” cash flows
Non-controlling Interests - ASC 810
• A non-controlling interest (NCI) is the portion of equity (net
assets) in a subsidiary not attributable, directly or indirectly,
to the parent.
• NCIs are generally classified as a component of equity.
Parent Sub B 80% Unrelated 3rdparty 20%
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Balance sheet presentation
Assets Liabilities Equity – Parent Company investors and Non-controlling interest
Income statement presentation
Sales
Costs, Expenses, Other
Net Income
+/- Non-controlling Interest
Income Attributable to Parent Company shareholders
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Transactions with Non-controlling Interest
•
Purchases or sales of equity interests that do not result in
a change in control will be accounted for as equity
transactions
•
Net assets will not change for subsequent purchase or
sale transactions with NCI as long as control is
maintained.
•
Upon a loss of control, the interest sold as well as any
interest retained will be measured at fair value with any
gain or loss recognized in earnings
Example 1 – Non-controlling corporate
interest
•
Company A has an 80% ownership interest in
Subsidiary B. The other 20% is owned by an unrelated
party.
•
Company A consolidates the financial statements of
Subsidiary B.
•
Company A had pre-tax income from continuing
operations of $400 for the year ended December 31,
2010. This amount includes $100 of pre-tax income
from continuing operations from Subsidiary B.
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Example 1 – Non-controlling corporate
interest (cont.)
• Analysis Assuming Sub B is a C-corporation
Income from continuing operations, before tax
$400
Income tax expense
160(a)
Net Income
240
Less: Net income attributable to non-controlling
interest
12(b)
Net Income attributable to Company A
$228
(a) = $400*40%
(b) =$60*20% [calculated as ($100-(100*40%))*20%]
Example 2 – Non-controlling partnership
interest
• Analysis Assuming Subsidiary B is a Partnership
Income from continuing operations, before tax
$400
Income tax expense
$152(c)
Net income
$248
Less: Net income attributable to non-controlling
interest
$ 20(d)
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Changes in Accounting Estimates in
Income Taxes
• ASC Master Glossary definition: The term change in accounting
estimate indicates that a change in accounting estimate results
from “new information”
• Change in accounting estimate:
‒ Prior–period accrual that results from new information
‒ Later identification of information that was not reasonably
“knowable” at the original balance sheet date that results in
improved judgment
‒ In assessing whether information is “knowable”:
Is information “readily accessible”?
Nature, complexity, and frequency of occurrence
If frequently occurring or recurring, appropriate internal
controls needed
Changes in Accounting Estimates in
Income Taxes
• Valuation allowances:
‒ Cumulative losses: “Cumulative losses in recent years” is not
defined in ASC 740. Generally, look to 3 years cumulative loss
as guideline vs. bright line.
‒ Timing of release.
• Uncertain tax positions:
‒ Subsequent recognition and measurement.
‒ Effective settlement.
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Branch operations
• The operations of an enterprise conducted in a different country than which it is incorporated
‒ Different than a controlled foreign corporation (“CFC) – which is a controlled company that is incorporated in a different country
• Often subject to tax in two jurisdictions (i.e., the foreign country where it operates and the home country)
‒ Two sets of temporary differences arise
‒ Similar to being taxed by federal and state jurisdictions in the U.S. • Deferred taxes are also provided in the home country for the tax
effects of foreign DTAs and DTLs
‒ Consider the interaction of foreign taxes with home country return (e.g., foreign tax credit or deduction)
• No concept of outside basis exists for a branch because the branch is not a separate taxable entity – therefore indefinite reversal exception does not apply
Foreign branches – ASC 740 implications
• The ASC 740 rules apply to branch operations and single member disregarded entities
• Accounting for branch operations requires the U.S. enterprise to take into account deferred taxes related to local country temporary differences and U.S. foreign temporary differences related to “inside basis” differences
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Foreign branches – deferred taxes
• Computing deferred taxes related to branch operations
‒ First, determine temporary differences in the local country and record any related deferred income tax using the local country applicable tax rate
‒ Second, determine any U.S. temporary differences and record the related deferred income tax using the residual U.S. tax rate ‒ Foreign deferred taxes recorded by the branch are a temporary
difference for U.S. income tax provision purposes because it has a basis in U.S. GAAP statements and no U.S. income tax basis
Foreign branches – deferred taxes
• Reversal of foreign deferred taxes impacts foreign taxes paid and U.S. foreign tax credits/deductions
• The U.S. enterprise must decide in the year of reversal whether to treat foreign taxes paid as a foreign tax credit or as a deduction
• The enterprise also must determine whether a valuation allowance is required
• A foreign DTA creates a U.S. DTL because it represents a reduction in future years’ foreign tax credits or deductions
• A foreign DTL creates a U.S. DTA because it represents an additional future period foreign tax credit or deduction
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Foreign branches – Example
Facts
• Company P has a branch in Country X where the statutory tax rate is 25 percent
• In the current year, the branch has pretax income of $10,000. For Country X and U.S. tax purposes, the branch has excess tax-over-book depreciation of $5,000 and nondeductible inventory reserves of $3,000
• For U.S. purposes, the branch is taxed at 40 percent
• Taxes paid to Country X will be claimed as a foreign tax credit
Question
• How and in which jurisdictions should deferred taxes be recorded on the same depreciation and nondeductible reserves temporary differences?
Foreign branches – Example (cont.)
• Country
X
• $750
• (1,250)
• (500)
• U.S.
• $1,200
• (2,000)
• 500
• ($300)
(a)
• ($3,000 x 25%)
• (($5,000) x 25%)
• ($3,000 x 40%)
• (($5,000) x 40%)
• ($500 x 100%)
• Nondeductible reserves
• Depreciation
• Branch DTL, Net
• Nondeductible reserves
• Depreciation
• DTA on Branch DTL, Net
• U.S. DTL, Net
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• Non-Taxable stock acquisition of U.S. parent with foreign sales subs • Acquired Dev Tech – Book Fair Value $100, Zero Tax basis
• 6 year book IP life
• IP Sold post acquisition to foreign affiliate • Tax rate 35%
Subsequent IP Transfer Example
Purchase Accounting:
Book
Basis Tax Basis DTL
$100M 0 $35M*
*Offset or debit recorded in goodwill Post Acquisition
IP Sale $120M Proceeds <0> Tax Basis (FMV of Dev Tech $120 Gain
now 120M) X 35% $42M Tax
To Record Sales Entries: Debits Credits
DR. Current Expense $42M CR. ITP $42M DR. Prepaid Tax $42M CR. Current Expense $42M DR. Current Expense $7M CR. Prepaid Tax $7M DR. DTL $5.833M CR. Deferred Exp $5.833M
Subsequent IP Transfer Example
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Contingent Consideration
• Contingent payment arrangements that are an element of
consideration transferred (not employee compensation)
are recognized as of acquisition date as part of fair value
transferred
Subsequent changes in fair value do not affect acquisition date
fair value, and will be recorded in P&L
• For tax purposes, purchaser generally does not recognize
contingent payments until fixed and determinable
To determine if DTA/DTL should be recorded at acquisition date,
acquirer should evaluate ultimate tax consequences that will result if contingency is settled at its carrying amount (fair value)
Contingent Consideration
• Contingent consideration is now recognized as a liability as
of the acquisition date.
At the acquisition date, the accrued liability for the contingent
consideration is recorded at fair value.
• Subsequent changes to the accrued liability for contingent
consideration (based on new information) are now reported in
the results of operations
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Contingent Consideration
Taxable Business Combination (Asset Acquisition) At Acquisition
• Assume contingent consideration settled at carrying amount (tax basis will increase in goodwill and/or intangibles upon payment of consideration). Record deferred taxes as necessary.
• FAS109.30 still prohibits recording a DTL for book > tax basis in goodwill • FAS141R now allows for recording a DTA for tax > book basis in goodwill
Subsequent Changes to Accrual
• Adjust deferred taxes for subsequent changes to fair value of consideration • Deferred tax expense or benefit is recorded through tax provision
• Do not revisit component 1 vs. component 2 goodwill from purchase
• If contingent liability increases, record DTA for goodwill even if book basis in goodwill exceeds tax basis in goodwill
Note: consider imputed interest deductions on earn-out payments
Contingent Consideration
Non-Taxable Business Combination (Share Purchase or Merger) At Acquisition
• Assume contingent consideration settled at carrying amount (tax basis in shares will increase upon payment of consideration). Calculate book vs. tax outside basis in shares and determine need for DTA or DTL.
• FAS 109.34 prohibits recognition of DTA for tax > book outside basis unless difference reverses in foreseeable future.
Subsequent Changes to Accrual
• Measure outside basis difference at time of change. Determine whether DTA or DTL should be adjusted for the change in the outside basis.
• May result in permanent difference for book expense (loss) if no DTA or DTL recorded (for increases/decreases in contingent payment obligation).
Contingent Consideration – Example
• Non-Taxable transaction
• Contingent consideration of up to $600M
• Fair value of contingent consideration on acquisition date of $200M • Fair value of contingent consideration at year end of $300M
• Outside basis difference is not expected to reverse in the foreseeable future
No DTA on outside basis difference established on date of acquisition
Increase to contingent consideration liability at year end of $100M results in permanent difference in the tax provision
Acquisition-Related Costs
• Acquisition-related costs generally are expensed in the period that the related services are received
• Includes direct costs of the transaction, e.g., costs for services of lawyers, investment bankers, accountants, valuation experts and other third parties.
• Includes indirect costs of the transaction, e.g., recurring internal costs (e.g., the cost of maintaining an acquisition department).
• Requirement that acquisition-related costs be expensed does not extend to financing costs
• Debt issuance costs generally deferred and amortized over debt term
Acquisition-Related Costs
• Tax treatment of acquisition-related costs
• Depending upon applicable tax law, costs may be deductible, included in tax-deductible goodwill, capitalized as separate intangible asset, or added to tax basis of stock acquired • Revenue Procedure 2011-29 – 70% deductible safe harbor for
success based fees
• Tax accounting considerations
• Accounting policy election as to whether or not the business combination will actually close
• Tax accounting treatment is dictated by the policy election and applicable tax law.
• Tax-deductible goodwill attributable to acquisition costs is excluded from analysis of Component 1/Component 2
tax-deductible goodwill vs. book goodwill resulting from purchase price allocation
Valuation allowance: mid-year release
Intraperiod tax allocation: general rule & exception
Tax holidays
Jim Songey, Grant Thornton LLP Scott Jaconetty, BDO
Selected Topics
ASC 740
Valuation Allowance: Mid-Year Release
ASC 740-270-25-7
The effect of a change in the beginning-of-the-year of a valuation allowance as a result of a change in judgment about the realizability of the related deferred tax asset in future years
Shall not be apportioned among interim periods through an adjustment of the effective tax rate Shall be recognized in the interim period in which the change occurs
(See Example A)
The change in the valuation allowance is necessary as a result of a change in judgment about the realizability of the related DTA in the
current year
The effect is spread over remaining interim periods in the year as an adjustment to the estimated AETR
Example
Assume the following:
Entity A has a DTA of $20,000 that relates to $50,000 of NOLs that all expire in 20X9 at the beginning of fiscal year 20X1
A full valuation allowance is recorded against the DTA because A believes, based on the available evidence, that is more likely than not that the DTA will not be realized
Assume that A has no other DTAs or DTLs Entity A's tax rate is 40%
At the beginning of the year, A estimates, based on new evidence, that it will earn $4,000 of income before tax in each of the quarters in 20X1
At the end of the second quarter, A estimates, based on new evidence, that it will earn $100,000 of taxable income in 20X2-20X4. A concludes that it's more like thank not that all of its DTAs will be realized.
Example (Continued)
The following table illustrate A's tax provision in each of the four quarters of 20X1
Intraperiod Tax Allocation
General rule
Exception
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General Rule (740-20-45-7)
The tax effect of pretax income or loss from continuing
operations generally should be determined by a computation that does not consider the tax effects of items that are not included in continuing operations
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Exception Rule/With Rule
The exception to that incremental approach is that all items (for example, extraordinary items, discontinued operations, other comprehensive income, and so forth) be considered in determining the amount of tax benefit that results from a loss from continuing operations and that shall be allocated to continuing operations
Example
Assume the following:
The entity's pretax financial income and taxable income are the same The entity's ordinary loss from continuing operations is $500The entity also has a $500 extraordinary gain The tax rate is 40 percent
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Example (Continued)
Income tax expense is allocated between the pretax loss from operations and the extraordinary gain as follows.Total income tax expense $0
Tax benefit allocated to the
loss from operations 200
Incremental tax expense allocated
to the extraordinary gain $200
Backward-tracing prohibition
Subsequent changes in DTA/DTL are recognized in tax expense even though the original tax benefit/expense was not recognized in tax expense from continuing operations.79
Example:
DTA XXX
Original entry OCI XXX OCI XXX
Valuation Allowance XXX
Changes in judgment resulting in decreased valuation allowance
Valuation allowance XXX Income tax expense XXX
Changes in judgment resulting in increased valuation allowance
Income tax expense XXX Valuation allowance XXX
"Lingering effects" of changes in judgment on
other comprehensive income
Because of the prohibition against backwards tracing, dangling debits or credits will exist in other comprehensive income
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Tax Holidays
ASC 740-10-25-35
•
There are tax jurisdictions that may grant an entity a holiday from income taxes for a specified period. An entity may have an expected future reduction in taxes payable during a tax holidayASC 740-10-25-36
•
Recognition of a deferred tax asset for any tax holiday is prohibited because of the practical problems in distinguishing unique tax holidays for which recognition of a deferred tax asset might be appropriate from generally available tax holidays and measuring the deferred tax asset83
Effect of tax holidays on the applicable tax rate
Using a rate that reflects the tax holiday to record a DTA or DTL fortemporary differences scheduled to reverse during the period of a tax holiday does not violate the "recognition of a deferred tax asset for any tax holiday is prohibited" language of ASC 740-10-25-36
Tax consequences of tax holidays
An entity cannot take benefit of the tax holding until the
agreement is entered into. For example, if a company is 95% sure the holiday will be granted the tax benefit of the of the holiday cannot be recognized until the agreement is in place.
