Current issues in income tax accounting (US GAAP & IFRS)

Current issues in income tax accounting

(US GAAP & IFRS)

www.pwc.com

May 16, 2012

May 16, 2012

Agenda

Introductions

Basic overview of the model Uncertain tax positions

Unremitted foreign earnings

Special topics (Intraperiod Allocations, Non- controlling interest, Passthrough Accounting) Interim accounting

Q&A

Basic model

Basic principles of ASC 740

• ASC 740 rests on four basic principles (balance sheet focused):

• A current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year (ASC 740-10) (Including Liabilities Pursuant to ASC 740-10)

• A deferred tax liability or asset is recognized for the estimated

• A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and

carryforwards (including ASC 740-10 liabilities) (ASC 740-10).

• The measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated (ASC 740-10).

• The measurement of deferred tax assets is reduced, if necessary, by

the amount of any tax benefits that, based on available evidence, are

not expected to be realized (ASC 740-10).

Income tax components

• Current tax provision is an estimate of taxes payable or refundable on tax returns for the current year (ASC 740-10).

(Includes liabilities for unrecognized tax benefits)

• Deferred tax provision is the change in the estimated future tax effects attributable to temporary differences and carryforwards (ASC 740-10).

740-10).

• Total income tax provision is the combination of the both the

current and deferred components of the provision.

Tax provision process

1. Adjust pretax income for permanent differences.

2. Identify all temporary differences and carryforwards.

3. Calculate the current income tax expense or benefit.

4. Recognize deferred tax assets and liabilities.

5. Evaluate the need for a valuation allowance for gross deferred tax assets.

6. Calculate the deferred income tax expense or benefit.

Permanent differences

(Step 1) – Adjust Pre-tax income for permanent differences

• Permanent Differences…

- These are book versus tax items or book/tax differences that will not reverse in future periods.

• Permanent Differences Do…

- Impact the total tax provision. That is, an increase in current tax - Impact the total tax provision. That is, an increase in current tax expense (I/S debit) is not offset by any deferred tax benefit (I/S credit) of equal amount or vice versa.

• Impact the overall effective rate on the total tax provision.

• Common Permanent Differences

- Percentage Depletion in excess of Tax Basis

Temporary differences

(Step 2) – Identify all temporary differences & carryforwards

• The objective of deferred tax accounting is to:

- Recognize a liability or asset related to temporary differences

• The objective is accomplished by:

- Comparing the aggregate GAAP amount of any one item to that item’s aggregate tax basis (book basis balance sheet versus tax item’s aggregate tax basis (book basis balance sheet versus tax basis balance sheet)

- Recognizing deferred taxes for those items that will produce

taxable or deductable differences when the GAAP balance amount is recovered or settled

And

- Recording deferred taxes for items without related balance sheet

captions (i.e. tax credits and carryforwards)

Deferred tax terminology

(Step 2) – Identify all temporary differences & carryforwards

Current Provision

• Focuses on the change in gross temporary differences Deferred Tax Assets / Liabilities

• Is the tax effect of the cumulative temporary differences plus carryforward attributes

carryforward attributes Valuation Allowance

• Reduces the Deferred Tax Asset to a Realizable Amount

Examples of deferred tax assets

(Step 2) – Identify all temporary differences & carryforwards

• Temporary Depletion (Cost or Percentage)

• Depreciation

• Development Costs

• Deferred Stripping

• Reclamation

• Reclamation

• Compensation accruals (vacation, bonus, commission)

• Contingency accruals (legal, environmental)

• Tax carryforward items, for example:

• Foreign tax credits in worldwide taxation regimes that allow credits for foreign taxes paid

• Net operating losses

• AMT Credits

Deferred tax summary

(Step 2) – Identify all temporary differences & carryforwards

Asset Liabilities Tax Carry-forwards

Deferred Tax Benefit / (DTA)

Tax Basis>Book Basis Tax Basis<Book Basis Only

Deferred Tax Expense / Tax Basis<Book Basis Tax Basis>Book Basis Deferred Tax Expense /

(DTL)

Tax Basis<Book Basis Tax Basis>Book Basis

Current income tax expense/Benefit

(Step 3) – Calculate the current income tax expense or benefit

• Pre-tax book income

• +/- Permanent & temporary items

• Taxable income before NOLS

• - NOL carryforwards

• Taxable income

• X applicable tax rate

• Current tax provision before tax credits

• Tax credits

• = Expected current tax liability (expense)

• +/- Changes within uncertain tax positions

• = Total current tax provision

Deferred tax terminology

(Step 3) – Calculate the current income tax expense or benefit

• Measurement of current and deferred tax liabilities and assets is based on provisions of enacted tax law; effects of future changes in tax laws or rates are not anticipated.

• Measurement of deferred tax assets is reduced by the amount of

any tax benefits that are not expected to be realized.

Recognize deferred tax assets and liabilities (Step 4) – Recognize deferred tax assets and liabilities

• The deferred tax expense or benefit for the current year is

computed as the change during the year in an enterprise’s deferred

tax liabilities and assets.

Annual computation of net deferred tax provision

(Step 5) – Evaluate the need for a valuation allowance for gross deferred tax assets

1. Identify types and amounts of cumulative temporary differences and carryforwards (Step 2)

2. Measure total deferred tax liability for 3. Measure total deferred tax asset for 2. Measure total deferred tax liability for

taxable temporary differences using applicable enacted tax rate (Step 4)

3. Measure total deferred tax asset for deductible temporary differences and carryforwards using applicable

enacted tax rate (Step 4)

Calculate deferred tax expense/Benefit

(Step 6) – Calculate the deferred income tax expense or benefit

Deductible (Taxable) Temporary Differences:

Cumulative Temporary Differences BOY

Adjust Cum.

Temp.

Differences BOY

Current Year Differences

Cumulative Temporary Differences EOY

Total Deferred Taxes @ 35.00%

Current Temporary Differences:

Litigation Accrual 20,000 30,000 50,000 17,500

Inventory Reserve – 10,000 10,000 3,500

Subtotal Current Temporary Differences

20,000 – 40,000 60,000 21,000

Noncurrent Temporary Differences:

Noncurrent Temporary Differences:

Accumulated Depreciation (50,000) (100,000) (150,000) (52,500)

Subtotal Noncurrent Temporary Differences

(50,000) – (100,000) (150,000) (52,500)

Total Temporary Differences (30,000) – (60,000) (90,000) (31,500)

Applicable Tax Rate 35.00% 35.00% 35.00%

Total Deferred Taxes (10,500) – (21,000) (31,500)

EOY Cumulative Temporary Differences

(31,500)

BOY Cumulative Temporary Differences

(10,500)

Deferred Tax Expense / (Benefit)

21,000

Uncertain tax positions

Key definitions and concepts

1. Tax Position – Position in a previously filed tax return or expected to be taken in a future tax return (ASC 740-10-20 Glossary)

2. Unit of Account – That which is being measured by reference to the level at which an asset or liability is aggregated or disaggregated (ASC Master Glossary)

3. Recognition – A tax benefit from a UTP may only be recognized if it is “more-likely-than-not” that the position is sustainable based solely on technical merits and any relevant administrative practices (ASC 740-10-55-3)

4. Measurement – Greatest amount of benefit cumulatively >50% likely

of being realized (ASC 740-10-30)

Key definitions and concepts (cont)

5. Subsequent recognition and measurement – Recognition and

measurement subject to change based on new information (ASC 740- 10-35)

6. Effective settlement – The point at which an Uncertain Tax Position becomes certain. (ASC 740-10-25-10)

7. Interest/Penalties

- Required accrual of interest and penalties (ASC 740-10-25-56) - Classification is an accounting policy election (ASC 740-10-25-57) 8. Balance sheet classification – Non-current treatment for “liability for

unrecognized tax benefit” unless cash payment is expected within 12

Key definitions and concepts (cont)

9. Disclosures (ASC 740-10-50-15)

- Tabular roll-forward of aggregated unrecognized tax benefits (UTBs)

- The total amount of UTBs that, if recognized, would affect the effective tax rate

effective tax rate

- The total amount of interest and penalties recognized in the income statement and accrued on the balance sheet

- Discussion of reasonably possible changes in the UTBs in the next 12 months

- Description of open tax years by major jurisdictions

Recognition

• Two-step model (recognition then measurement) beginning with whether the tax position should be recognized (i.e. whether any benefit should be recorded)

• Recognition is based on the following criteria:

- More-likely-than-not (>50%) that the position will be sustained - More-likely-than-not (>50%) that the position will be sustained

upon examination by taxing authority (including any appeal or litigation process)

- Technical merits of the position - No consideration of detection risk

- Past administrative practices accommodation

Recognition

• Temporary differences are considered to have met the recognition threshold

• Positions do not generally affect the aggregate amount of taxes

payable over time, they can generate an economic benefit by delaying the tax payment

• Historically, may have only accrued for interest

• ASC 740 requires separation into two parts

- Sustainable book/tax difference pursuant to ASC 740's recognition criteria

- A liability for any "unrecognized" benefit.

Measurement

• Assuming the recognition threshold has been met, the company then needs to measure the benefit to be sustained:

• Tax positions should be measured at the largest amount that has a cumulative probability >50% of being the ultimate outcome

• Consider the amounts and probabilities of various outcomes

• Consider the amounts and probabilities of various outcomes

Measurement

• Example

Enterprise takes a deduction in a tax return that results in a tax benefit of $100. This position meets the recognition threshold (i.e., MLTN).

Distribution of potential outcomes:

Potential benefit Individual probability Cumulative probability Potential benefit Individual probability Cumulative probability

$100 15% 15%

$80 20% 35%

$60 20% 55%

$40 30% 85%

$20 15% 100%

Recognition of the largest amount that has a cumulative probability of

>50% of being ultimately realized is $60

Subsequent recognition and measurement

• Key areas of judgement and challenges

- Evaluating “new information” that leads to changes in recognition and measurement

- Tracking reversals of temporary differences

Subsequent recognition and measurement

• Recognition and measurement should be reassessed (using ASC 740- 10 model) at each reporting date.

- ASC 740-10 assessment (recognition and measurement) subject to change based on new information

◦ Changes to prior year tax positions would be treated as discrete

◦ Changes to prior year tax positions would be treated as discrete items in the period the change occurs

◦ Changes to current year tax positions would be accounted for under ASC 270-10-45-12

- May occur prior to final to resolution of matter

- “Subsequent event” disclosure considerations

Subsequent recognition and measurement

• Developments in the audit

• Audit plans

• Oral statements by tax authority

• Pre-filing agreements

• Developments in the law

• Public statements by tax authority

• Audit guidelines

• Potential Sources of “New Information”

• Pre-filing agreements

• “LIFE” audits

• Experience in prior audits

• Taxing authority program changes

• APA, competent authority

• Notice of Proposed

• Designation for litigation

• Listing of transactions

Settlement

• In order to apply ASC 740 model for tax uncertainties, Companies must

- Maintain an inventory of Unsettled UTPs - Monitor and track settlement of UTPs

Key Question – When is an Uncertain Tax Position settled ?

Key Question – When is an Uncertain Tax Position settled ?

Effective settlement

• What does Effective Settlement mean?

• Three considerations on “Effective Settlement”

- Whether a tax position has been specifically examined - Whether the examination has been completed.

- Whether there is only a remote likelihood of re-examination

Effective settlement

• Taxing authority has completed examination procedures including appeals and administrative reviews required

• Taxpayer does not intend to appeal or litigate any aspect of tax position included in completed examination

• It is remote that the taxing authority would examine or reexamine

• It is remote that the taxing authority would examine or reexamine

any aspect of the tax position

Unremitted foreign earnings

Unremitted foreign earnings

• Calculation of US DTL on Unremitted Foreign Earnings

• Effective Tax Rate implications

• Unborn Foreign Tax Credits

• Withholding Taxes

• Classification of US DTL

Unremitted foreign earnings

• Permanent Reinvestment Assertion

• Support Required to Substantiate the Assertion

• Effect of assertion on current year earnings and EAETR

• Distributions

• Frequency of updating the assertion

• Partial reinvestment assertion

• Effect of a change in assertion

Special topics

Intraperiod allocation, non-controlling

interest, & Passthrough

Intraperiod tax allocation

What does “Intraperiod Tax Allocation” mean

• Income tax expense (benefit) can be reflected in:

- Continuing operations - Discontinued operations - Extraordinary Items

- Cumulative effect of accounting change - Other comprehensive income (OCI) - APIC

- Goodwill (or other intangible assets)

Intraperiod tax allocation

• ASC 740-20-45-2 states that income tax expense or benefit for the year shall be allocated among continuing operations, discontinued operations, extraordinary items, other comprehensive income, and items charged or credited directly to shareholders’ equity.

• Rule of Thumb - the tax follows the items of income, gain, expense or loss

loss

Authoritative guidance

ASC 740-20-45-7 states that

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 (an “incremental approach”)

PwC Guidance in Guide to Accounting for Income Taxes

Chapter 12.

Intraperiod allocation issues

Intraperiod allocation is a mechanical process:

Calculate the total tax expense from all sources

Calculate the tax expense from continuing operations without regard to other categories

If there is only one category other than continuing operations, allocate If there is only one category other than continuing operations, allocate the entire difference between (1) and (2) to that category

If there is more than one category other than continuing operations,

allocate the difference among the other items in proportion to their

individual effects on total tax expense (ASC 740-20-45-14)

Tax effects specifically allocated to continuing operations

• Changes in tax laws or rates (ASC 740-20-45-8(b); see also ASC 740- 10-25-47 & 48)

• Change in tax status (ASC 740-20-45-8(c); see also ASC 740-10-25-32)

• Changes in the assessment about the realizability of deferred tax

• Changes in the assessment about the realizability of deferred tax

assets that existed at the beginning of the year because of a change in

the expectation of taxable income available in future years that are

not related to “source-of-loss” items (ASC 740-20-45-8(a); see also

ASC 740-10-45-20)

Tax effects specifically allocated to continuing operations

• Tax deductible dividends paid to shareholders (ASC 740-20-45-8(d))

• Tax effect of changes in assertion on plans for repatriation of prior years’ unremitted earnings of foreign subsidiaries

(ASC 740-30-25-19)

Tax effects allocated to specific components other than continuing operations (ASC 740-20-45-11)

• Other comprehensive income

- Cumulative translation adjustments (ASC 830)

- Gains and losses on cash flow hedges - hedging derivatives (ASC 815)

- Unrealized gains and losses of “available-for-sale” debt and equity - Unrealized gains and losses of “available-for-sale” debt and equity

securities (ASC 320)

- Net unrecognized gains and losses and unrecognized prior service

cost related to pension and other OPEB (ASC 715)

Tax effects allocated to specific components other than continuing operations (ASC 740-20-45-11)

• Adjustments of the opening balance of retained earnings for certain changes in accounting principles or a correction of an error

• Gains and losses included in comprehensive income but excluded from net income (i.e., translation, changes in carrying value of net marketable securities)

• An increase or decrease in contributed capital (for example

deductible expenditures recorded as a reduction in the proceeds from issuing capital stock)

• An increase in the tax basis of assets acquired in a taxable business

combination accounted for as a pooling of interests and for which a

tax benefit is recognized at the date of the business combination

Tax effects allocated to specific components other than continuing operations (ASC 740-20-45-11)

• Expenses for employee stock options recognized differently for financial reporting and tax purposes (see ASC 718-740)

• Dividends that are paid on unallocated shares held by an ESOP and that are charged to retained earnings

• Deductible temporary differences and carryforwards that existed at

• Deductible temporary differences and carryforwards that existed at

the date of a quasi-reorganization (except as set forth in (ASC 852-

740-55)

Intraperiod allocations issues-valuation allowances

• In the case of a change in the valuation allowance applicable to

beginning-of-year deferred tax assets that results from changes in circumstances that cause the assessment of the likelihood of

realization of these assets by income in future years to change, the effect is reflected in continuing operations. (ASC 740-10-45-20)

• When income in the current year allows for the release of a

• When income in the current year allows for the release of a

valuation allowance, the benefit from the release of the valuation

allowance is allocated to the current year component of income that

allows for its recognition.

Intraperiod allocations issues-valuation allowances

• However, there is an exception to the extent that the valuation allowance relates to source-of-loss items.

• For the initial recognition of “source-of-loss” items the benefits are allocated back to the prior-year source that generated the loss.

• Source-of-loss items

• Source-of-loss items

- Tax benefits relating to certain equity items.

Non-controlling interest

• The financial statement amounts reported for income tax expense and net income attributable to non-controlling interest differ based on whether the subsidiary is a C-corporation or a partnership. The tax status of each type of entity causes differences in the amounts a parent company would report in its consolidated income tax

provision and net income attributable to non-controlling interest.

provision and net income attributable to non-controlling interest.

Non-controlling interest

• A C-Corporation is generally a taxable entity and is responsible for the tax consequences of transactions by the corporation. Therefore, a parent that consolidates a C-corporation would include the income taxes of the C-corporation, including the income taxes attributable to the non-controlling interest, in the consolidated income tax

provision. Net income attributable to the non-controlling interest provision. Net income attributable to the non-controlling interest would be calculated as the non-controlling interest’s share of the C- corporation’s net income, which would include a provision for

income taxes.

Non-controlling interest

• The legal liability for income taxes of a partnership generally dones not accrue to the partnership itself. Instead, the investors are

responsible for income taxes on their share of the partnership’s

income. Therefore, a parent that consolidates a partnership would

only reort income taxes on its share of the partner’s income in the

consolidated income tax provision. This would result in a reconciling

consolidated income tax provision. This would result in a reconciling

item in the parent’s effective tax rate reconciliation that should be

disclosed, if material.

Partnerships and other flow-through entities

• Generally, deferred taxes related to investment in a foreign or

domestic partnership (and other flow-through entities that are taxes

as partnerships, such as multi-member LLCs) should be measured

based on the differences between the financial statement investment

and its tax basis (i.e. outside basis differences).

Partnerships and other flow-through entities

• Exceptions to the general guidance have been made in practice.

Specifically, different views exist regarding if and when deferred

taxes should be provided on the portion of an outside basis difference

attributable to nondeductible goodwill.

Partnerships and other flow-through entities

• We believe that an entity must adopt a consistent policy to

(1) look through the outside basis of the partnership and exclude it from the computation of deferred taxes on all underlying items for which ASC 740 provides an exception to its comprehensive model of recognition

-or-

(2) not look through the outside basis of the partnership and record

deferred taxes based on the entire difference between the book and

tax bases of its investment.

Interim period reporting

Interim reporting

• ASC 70-270-30-6 (Interim Reporting) states that

At the end of each interim period the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. In some cases, the estimated annual effective tax rate will be the statutory rate modified as may be appropriate in

particular circumstances. In other cases, the rate will be the entity's

particular circumstances. In other cases, the rate will be the entity's

estimate of the tax (or benefit) that will be provided for the fiscal

year, stated as a percentage of its estimated ordinary income (or

loss) for the fiscal year (see paragraphs 740-270-30-30 through 30-

34 if an ordinary loss is anticipated for the fiscal year).

Interim reporting

• ASC 70-270-30-8 (Interim Reporting) further states that

The estimated effective tax rate shall also reflect anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains rates, and other available tax planning alternatives.

However, in arriving at this estimated effective tax rate, no effect shall be included for the tax related to significant unusual or

shall be included for the tax related to significant unusual or

extraordinary items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year. The rate so determined shall be used in

providing for income taxes on a current year-to-date

basis.

Interim reporting

PwC Guidance at Guide to Accounting for Income Taxes

Chapter 17.

Basic rules

• Calculate the tax effects of current-year ordinary income or loss using an estimated full year effective tax rate.

• All other items are recorded discretely, which includes:

- Significant, unusual or infrequent items - Extraordinary items

- Extraordinary items

- Discontinued operations

- Cumulative effects of changes in accounting principles

• Concept is that each interim period is primarily an integral part of

the annual period.

Interim reporting

• ASC 740-270-25-9 states that

The tax effects of losses that arise in the early portion of a fiscal year shall be recognized only when the tax benefits are expected to be

either:

a. Realized during the year a. Realized during the year

b. Recognizable as a deferred tax asset at the end of the year in

accordance with the provisions of Subtopic 740-10.

Interim reporting

• ASC 740-270-25-5 states that

The effects of new tax legislation shall not be recognized prior to enactment. The tax effect of a change in tax laws or rates on taxes currently payable or refundable for the current year shall be

recorded after the effective dates prescribed in the statutes and reflected in the computation of the annual effective tax rate

reflected in the computation of the annual effective tax rate

beginning no earlier than the first interim period that includes the enactment date of the new legislation. The effect of a change in tax laws or rates on a deferred tax liability or asset shall not be

apportioned among interim periods through an adjustment of the

annual effective tax rate.

Interim reporting

• ASC 740-270-25-6 adds that

The tax effect of a change in tax laws or rates on taxes payable or refundable for a prior year shall be recognized as of the enactment date of the change as tax expense (benefit) for the current year. See Example 6 (paragraph 740-270-55-44) for illustrations of

accounting for changes caused by new tax legislation.

accounting for changes caused by new tax legislation.

Interim reporting

• ASC 740-270-25-2 states the general rules that

• The tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur.

• “Other items” often are referred to as “discrete items.”

Interim reporting

• Key questions:

- What is the definition of “the tax (or benefit)”?

- What is the definition of “ordinary income”?

- What are “other (discrete) items”?

Interim reporting – Definitions

• Tax (or benefit) is the total income tax expense (or benefit),

including the provision (or benefit) for income taxes both currently payable and deferred. (ASC 740-270-20 Glossary)

• Ordinary income (or loss) refers to income (or loss) from

continuing operations before income taxes (or benefits) excluding significant unusual or infrequently occurring items. Extraordinary significant unusual or infrequently occurring items. Extraordinary items, discontinued operations, and cumulative effects of changes in accounting principles are also excluded from this term. The term is not used in the income tax context of ordinary income versus capital gain. The meaning of unusual or infrequently occurring items is

consistent with their use in the definition of the term extraordinary

item. (ASC 740-270-20 Glossary)

Interim reporting – Definitions

Extraordinary items are events and transactions that are

distinguished by their unusual nature and by the infrequency of their occurrence. Thus, both of the following criteria should be met to

classify an event or transaction as an extraordinary item:

a.Unusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and

typical activities of the entity, taking into account the environment in which the entity operates (see paragraph 225-20-60-3).

b.Infrequency of occurrence. The underlying event or transaction

should be of a type that would not reasonably be expected to recur

in the foreseeable future, taking into account the environment in

which the entity operates (see paragraph 225-20-60-3). (ASC 740-

270-20 Glossary)

Interim period tax provisions

• Discrete items are excluded from the annual effective tax rate computation and are separately reported in interim reports or reported net of tax effects in interim reports.

(ASC 740-270-30-11 through 13).

Potential discrete tax items

• Tax true-ups

• Resolution of tax audits

• Statute of limitation expiration

• Changes in prior years’ unrecognized tax benefits

• Certain changes in valuation allowances

• Changes in tax laws or rates

• Changes in judgment about unremitted earnings

ASC 740-270 interim reporting

• The annual ETR also includes the effect of valuation allowances on:

- Temporary differences arising in the current year

- Beginning-of-the-year DTAs if attributable to changes in estimates of the current year’s income (ASC 740-270-30-7)

• The ETR estimate applies to year-to-date ordinary income.

• The ETR estimate applies to year-to-date ordinary income.

• The ETR estimate excludes

- Jurisdictions with losses and no tax benefit

- Jurisdictions with no reliable estimate

ASC 740-270 interim reporting

• The ETR represents the best estimate of the composite tax provision in relation to the best estimate of worldwide pretax book ordinary income.

• The composite tax provision should include federal, foreign and state

income taxes, and should reflect anticipated investment tax credits,

foreign tax rates, percentage depletion, capital gains rates, and other

foreign tax rates, percentage depletion, capital gains rates, and other

available tax planning alternatives. (ASC 740-270-30-8)

Interim reporting – Computation

• Steps to compute the interim tax provision using the annual effective tax rate

- Determine projected annual taxable income using projected pretax income, permanent and temporary differences, credits and

carryforwards for the entire year for each tax component of each jurisdiction

jurisdiction

- Compute the tax for the year for each component

- Aggregate the pretax book income and tax expense for the year - Compute the estimated effective tax rate for the year

- Apply this rate to year-to-date consolidated book ordinary

Interim reporting – Computation (cont)

• Steps to compute the interim tax provision using the annual effective tax rate

- Determine the tax impacts of discrete items occurring during the year-to-date interim period

- Sum the two computed tax amounts to derive income tax for the - Sum the two computed tax amounts to derive income tax for the

year-to-date interim period

- Current quarter’s provision = the difference between the year-to-

date provision for the current quarter and the previous quarter’s

year-to-date provision

Interim reporting

• Exclude from the consolidated annual estimated tax rate

computation loss jurisdictions for which no benefit can be recognized on those losses (ASC 740-270-30-36)

• Compute a separate annual estimated rate for each such loss

jurisdiction

Interim reporting

Exercise 2-1

Changes in valuation allowances

• If realization of deferred tax asset is driven by “future” years’ income projections – the change in valuation allowance is considered a

“discrete event” in the quarter as of the date the change in circumstances occurs.

• If realization of deferred tax asset is driven by “current” year’s

income projections – the change in valuation allowance is part of the income projections – the change in valuation allowance is part of the annualized effective tax rate computation.

• To apply these rules the deferred tax assets must be divided between

those expected to be realized in the current year and those expected

to be realized in future years.

Change in valuation allowance during an interim period

(FAS 109, ¶193 and ¶194, uncodified)

• Need to segregate the effect of the change into two portions:

1. The amount of the change that relates to the current year 2. The amount of the change that relates to future years

• The first portion is reflected as an element of the effective annual tax rate

rate

• The second portion is recognized on a discrete basis

Valuation allowances – Release in interim period

Facts: Assume that an enterprise has $3,000,000 of net operating loss carryforwards available at the beginning of year 20X7. At that date, the enacted tax rate was 35%. Because of uncertainty related to

realizability, management established a valuation allowance of

$1,000,000 at the end of 20X6.

Although the company broke even for the first six months of 20X7, due Although the company broke even for the first six months of 20X7, due to a recent increase in sales orders and firm contracts, the company

now estimates it will have income of $200,000 for the current year, and income in future years is expected to be sufficient to allow recognition of the entire deferred tax asset. This will permit a full reversal of the valuation allowance for NOL carryforwards that existed at the

beginning of the year

Changes in tax laws or rates

• Changes impacting deferred taxes - discrete event in the quarter the date of enactment occurs

• Changes impacting current year taxes payable or receivable – annualized effective tax rate item beginning the first interim reporting period as of the date of new legislation

• Changes impacting prior year taxes payable or receivable - discrete

event in the quarter in which the date of enactment occurs

Interim reporting

• Reliability of estimates

- When a company operates in a jurisdiction where a "reliable

estimate" of the translated effective tax rate cannot be made, ASC 740-270-30-36(b) requires the company to exclude the "ordinary"

income (or loss) in that jurisdiction and the related tax (or benefit) attributable to “ordinary” income in that jurisdiction from the

attributable to “ordinary” income in that jurisdiction from the

overall estimate of the ETR and interim period tax (or benefit)

Interim reporting

• ASC 740-270-30-17 states

• Paragraph 740-270-25-3 requires that if an entity is unable to

estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated be reported in the interim period in which the item is reported.

in the interim period in which the item is reported.

• ASC 740-270-30-18 further states that if a "reliable estimate" of

the ETR cannot be made, the actual tax rate for the year-to-date may

represent the most appropriate estimate of the annual effective tax

rate.

Interim reporting

• These paragraphs make it clear that the effective tax rate approach

must be used to the extent that, but only to the extent that, a reliable

estimate can be made.

Interim reporting

• Disclosure considerations:

- The tax effects of significant unusual or infrequent items that are recorded separately or reported net of their related tax effect (ASC 740-270-30-8)

- Significant changes in estimates or provisions for income taxes - Significant changes in estimates or provisions for income taxes

(ASC 270-10-50-1(d)), e.g., changes during the period in the

assessment of the need for a valuation allowance

Interim reporting – Disclosure

• ASC 740-270-50-1 states that

Application of the requirements for accounting for income taxes in interim periods may result in a significant variation in the

customary relationship between income tax expense and pretax

accounting income. The reasons for significant variations in the

customary relationship between income tax expense and pretax

customary relationship between income tax expense and pretax

accounting income shall be disclosed in the interim period financial

statements if they are not otherwise apparent from the financial

statements or from the nature of the entity's business.

Interim reporting

• Disclosure considerations - SAB 74

- Material changes to uncertain tax positions, amounts of uncertain

tax benefits that, finalized would affect the effective tax rate, total

amounts of interest and penalties and positions that are expected

amounts of interest and penalties and positions that are expected

to change within the next 12 months and open tax years.

Questions & Answers

Thank you

Sharon Powers

sharon.powers@us.pwc.com

Carolyn Iacobelli

carolyn.iacobelli@us.pwc.com James Terry

james.terry@us.pwc.com