Accountng for Income Tax

A Roadmap to Accounting for Income Taxes

March 2011

Topic 740, Income Taxes, from the FASB Accounting Standards Codification, copyright by the Financial Accounting Foundation, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116, is reproduced with permission.

International Accounting Standards Board material:

Extracts from International Financial Reporting Standards, International Accounting Standards, and exposure drafts are reproduced with the permission of the International Accounting Standards Committee Foundation.

iGAAP material in Appendix F copyright 2010 Delotte Touche Tohmatsu Limited.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

As used in this document, Deloitte means Deloitte & Touche LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.

March 2011

Copyright 2011 Deloitte Development LLC. All rights reserved.

iContentsPreface 1

Executive Summary 2

Acknowledgments 4

Section 1 Overview and Objectives of the Accounting for Income Taxes 5

Overview of ASC 740 5

Overview of Uncertain Tax Positions 6

Consideration of Tax Positions Under ASC 740 6

Temporary Differences 7

Objectives of ASC 740 7

Section 2 Scope 9

Taxes Within the Scope of ASC 740 10

Provincial Taxes 10

Not-for-Profit Foundation Excise Taxes 11

Texas Margin Tax 11

Michigan Business Tax 11

Section 936 Election by Puerto Rican Subsidiaries 12

Italian Regional Tax on Professional and Business Activities (IRAP) 13

Measuring DTAs and DTLs Under the Mexico Income Tax and Flat Tax (IETU) Regimes 13

Scope Considerations Related to Taxes on Dividends 13

Withholding Taxes for Dividends Paid to Shareholders 14

Tax Effects of Dividends in France 14

Taxes That Are Not Considered Income Taxes 15

Consideration of Other Taxes 15

Puerto Rican Excise Tax 15

Refundable Tax Credits 16

Income Tax Indemnifications Upon Sale of a Subsidiary 16

Penalties Associated With the Untimely Filing of Form 5471 16

Section 3 Recognition and Derecognition 18

Exceptions to the Recognition Criteria 18

Exceptions to Recognition of Deferred Taxes 19

Definition of Subsidiary and Corporate Joint Venture 19

Definition of Foreign and Domestic Investments 19

Definition of Inside and Outside Basis Differences 20

ii

Contents A Roadmap to Accounting for Income Taxes

Recognition Exception for DTLs Related to the Outside Basis Differences of Foreign Subsidiary or Corporate Joint Venture 21

Recognition of Deferred Taxes for Inside Basis Differences 21

Recognition of Deferred Taxes for Temporary Differences Related to Cumulative Foreign Currency Translation Adjustments 22

Hedge of a Net Investment in a Foreign Subsidiary 23

Deferred Taxes Recorded Through the Currency Translation Adjustment 23

Whether a Change in Managements Plans for Reinvestment or Repatriation of Foreign Earnings Is a Recognized or Nonrecognized Subsequent Event 23

Recognition Exception for Certain Pre-12/15/1992 Transactions 24

Tax Consequences of a Change in Intent Regarding Remittance of Pre-1993 Undistributed Earnings 24

Section 936 Election by Puerto Rican Subsidiaries 25

Recognition Exception for Pre-1987 Bad-Debt Reserves for Certain Entities 25

Tax Consequences of Bad-Debt Reserves of Thrift Institutions 25

Tax Consequences of a Reduction of the Tax Base-Year Bad-Debt Reserve for an Annual Period 27

Tax Consequences of a Reduction of the Tax Base-Year Bad-Debt Reserve in an Interim Period 27

Realization of a DTA of a Savings and Loan Association: Reversal of a Thrifts Base-Year Tax Bad-Debt Reserve 28

Recognition Exception for U.S. Steamship Entities 28

Deferred Tax Consequences of Statutory Reserve Funds of U.S. Steamship Entities 28

Recognition Exception for DTLs Related to Acquired Goodwill 29

Deferred Taxes Associated With Goodwill in PreStatement 141(R) Acquisitions 29

Recognition Exception for Transactions Within a Consolidated Group 31

Intercompany Transactions Between Different Tax-Paying Components 31

Subsequent Changes in Tax Rates Involving Intercompany Transactions 32

Recognition Exception for Certain Deferred Taxes Related to Foreign Subsidiaries 32

Indexing of the Tax Basis of Assets and Liabilities 32

Price-Level-Adjusted Financial Statements 33

Highly Inflationary Economies Reporting Currency Is the Functional Currency 33

Change in the Functional Currency When an Economy Ceases to Be Considered Highly Inflationary 34

Recognition Threshold for Tax Positions 34

Consideration of Tax Positions Under ASC 740 36

Considerations of Tax Positions by Tax-Exempt or Pass-Through Entities 37

Recognition and Measurement Assumptions to Be Used 37

Decision Tree for Recognizing Benefits of a Tax Position 38

Legal Tax Opinions Not Required to Support a Tax Position 39

Meaning of the Court of Last Resort and Its Impact on Recognition 39

Impact of the Likelihood of the U.S. Supreme Courts Hearing the Case 39

Consideration of Administrative Practices 40

Consideration of Widely Understood Administrative Practices and Precedents 40

Applying ASC 740 to Questions About Economic Nexus 41

Lookback Period for Accruing a State Income Tax Liability for UTBs 41

Determining the Unit of Account for a Tax Position 42

Determining the Unit of Account 43

Whether Determination of the Unit of Account Is an Accounting Policy Choice 43

Applying the Unit of Account 44

Subsequent Recognition and Derecognition of a Tax Position 44

Decision Tree for the Subsequent Recognition, Derecognition, and Measurement of Benefits of a Tax Position 45

Evaluating the Recognition Threshold After Examination of a Tax Year 46

Effectively Settled Tax Positions 46

Effectively Settled Tax Positions 46

iii


Information Considered for Subsequent Recognition or Derecognition 47

Finality or Certainty of Outcome in Subsequent Recognition, Derecognition, or Measurement of a Tax Position 47

New Information Obtained After the Balance Sheet Date 48

Interim Accounting for a Change in Judgment 48

Changes in Judgment Regarding a Tax Position Taken in the Current Year 49

Changes in Judgment Regarding a Tax Position Taken in the Prior Year 50

Distinguishing a Change in Estimate From a Correction of an Error 50

Recording UTBs 52

Deferred Tax Consequences of UTBs 52


Tax Bases Used in the Computation of Temporary Differences 54


Examples of Temporary Differences 55

Income Tax Consequences of Issuing Debt With a Conversion Feature Accounted for Separately as a Derivative 56

LIFO Inventory of a Subsidiary An Example of a Temporary Difference That May Not Settle Before Disposal of the Subsidiary 58

Accrued Postretirement Benefit Cost and the Effect of the Nontaxable Subsidy Arising From the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 58

Income Tax Effects on Medicare Part D Subsidy Receipts 59

Recognizing Deferred Taxes for Indefinite-Lived Assets 59

Deferred Tax Consequences of Synthetic Leases 60

Basis Differences That Are Not Temporary Differences 60

Permanent Differences 60

Basis Differences That Are Not Temporary Differences 61

Change in Tax Status 62

Change in Tax Status of an Entity 63

Financial Reporting Effect of LIFO Reserve Recapture for Tax Purposes 64

Recognition Date for Conversion to a REIT 64

Loss of Nontaxable Status as a Result of Acquisition 65

Voluntary Change in Tax Status of an Acquired Entity 65

Change in Tax Status as a Result of a Common-Control Merger 65

Change in Tax Status to Taxable: Accounting for an Increase in Tax Basis 66

Built-in Gains of Nontaxable S Corporations 66

Built-in Gain: Recognition and Measurement 67

Tax Holidays 68

Tax Consequences of Tax Holidays 68

Effect of Tax Holidays on the Applicable Tax Rate 69

Special Deductions 69

Special Deductions Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 69

Consideration of Special Deductions That Are Permitted Under the Tax Law 71

Anticipation of Future Losses Not Permitted 72

Considerations When Future Tax Losses Are Expected 73

Anticipated Future Tax Credits 73

Consideration of AMT 74

Example Illustrating the Application of ASC 740 to the AMT System in the U.S. Federal Jurisdiction 74

AMT Rate Not Applicable for Measuring DTLs 75

Consideration of AMT Credit Carryforwards 75

Investment Tax Credits 76

iv


Changes in Laws or Rates 76

Retroactive Changes in Tax Laws or Rates and Expiring Provisions That May Be Reenacted 76

Recognition of Enacted Changes in Tax Laws or Rates Related to Items Recognized in OCI 76

Reporting Tax Effects of a Change in Tax Law in Discontinued Operations 77

Acquired Temporary Differences in Certain Purchase Transactions That Are Not Accounted for as Business Combinations 78

Recognition of Interest and Penalties 82

Recognition and Measurement of Interest and Penalties 82

Interest Income on UTBs 83

Recognizing Interest Expense for Interim-Period Reporting When Interest Is Classified as Income Tax Expense 83

Capitalization of Interest Expense 84

Recognition of the Accrual for Penalties 84

Treatment of Certain Payments to Tax Authorities 85

Direct Transaction With Tax Authority 85

Obtaining Tax Basis Step-Up of Acquired Net Assets Through Payment to a Tax Authority 85

Section 4 Measurement 87

Tax Rate Used for Measurement 89

Tax Rate Used in Measuring Operating Losses and Tax Credits 89

Determining the Applicable Tax Rate on a Loss Carryback 89

Measuring Deferred Taxes for Indefinite-Lived Assets When Different Tax Rates May Apply 90

Use of a Blended Rate to Measure Deferred Taxes 90

Effect of Tax Holidays on the Applicable Tax Rate 90

Consideration of Certain State Matters, Including Optional Future Tax Elections, in the Measurement of DTAs and DTLs 91

Situations in Which Determining the Applicable Tax Rate May Be Complex 92

Subsequent Measurement Changes in Tax Laws or Rates 94

Change in Tax Law That Allows an Entity to Monetize an Existing DTA or Tax Credit in Lieu of Claiming the Benefit in the Future 94

Graduated Tax Rates 95

Graduated Tax Rates 95

Measurement When Graduated Tax Rates Are a Significant Factor 95

Measurement When Future Tax Losses Are Expected in a Graduated Tax Rate Structure 97

Phased-In Change in Tax Rates 97

Measurement When Phased-In Changes in Tax Rates Are Enacted 98

Measurement When Contingent Phased-In Changes in Tax Rates Are Enacted 98

Changes in United Kingdom Tax Law Related to Industrial Building Allowances 99

Alternative Minimum Tax 102

Consideration of AMT Credit Carryforwards 103

AMT Rate Not Applicable for Measuring DTLs 103

Example Illustrating the Application of ASC 740 to the AMT System in the U.S. Federal Jurisdiction 103

Special Deductions and Tax Credits on Deferred Tax Rates 105

Measurement When Special Deductions Are Permitted Under the Tax Law 106

Special Situations Measurement 108

Measurement of Basis Differences in Adjusted Gross Receipts Tax Regimes 108

Tax Benefits Resulting From Investments in Affordable Housing Projects 110

Tax Benefits Resulting From Investments in Nonconventional Fuel Producers 111

Applicability of Push-Down Accounting to Income Taxes and Foreign Currency Translation Adjustments 111

Tax Accounting Implications of the 2008 German Business Tax Reform 112

Applicable Rate in the Measurement of DTAs and DTLs Under the Mexico Income Tax and Flat Tax Regimes 113

vContents A Roadmap to Accounting for Income Taxes

Valuation Allowances 114

Consideration of Future Events 119

Sources of Taxable Income 120

Examples Illustrating Sources of Taxable Income 120

Evaluating a DTA (for Realization) of a Debt Security Attributed to an Unrealized Loss Recognized in OCI 121

Determining the Pattern of Reversals of Temporary Differences 123

Examples Illustrating the Determination of the Pattern of Reversals of Temporary Differences 125

Using the Reversal of DTLs for Indefinite-Lived Assets as a Source of Taxable Income 132

AMT Valuation Allowances 133

Valuation Allowance: Classification in a Classified Balance Sheet 134

Valuation Allowances Tax-Planning Strategies 135

Definition of a Tax-Planning Strategy 138

Examples of Qualifying Tax-Planning Strategies 139

Examples of Nonqualifying Tax-Planning Strategies 140

Recognition and Measurement of a Tax-Planning Strategy 141

The More-Likely-Than-Not Standard 141

Examples Illustrating the Measurement of Valuation Allowances When Tax-Planning Strategies Are Involved 142

Determination of the Need for a Valuation Allowance Related to Foreign Tax Credits 144

Valuation Allowances Considering Positive and Negative Evidence 146

Definition of Cumulative Losses in Recent Years 146

Consideration of Negative Evidence in the Determination of Whether a Valuation Allowance Is Required 147

Cumulative Losses: An Objectively Verifiable Form of Negative Evidence 148

Going-Concern Opinion as Negative Evidence 148

Estimates of Future Income 149

Effect of Nonrecurring Items on Estimates of Future Income 149

Example Illustrating Computation of the Amount of a Valuation Allowance When Negative Evidence Exists 149

Positive Evidence Considered in the Determination of Whether a Valuation Allowance Is Required 151

Additional Examples of Objectively Verifiable Positive Evidence 151

Example Illustrating the Determination of a Valuation Allowance When It Is More Likely Than Not That a Portion of Existing Tax Benefits Will Not Be Realized 152

Reduction of a Valuation Allowance When Negative Evidence Is No Longer Present 153

Measurement of Tax Positions 155

New Information Affecting Measurement of Tax Positions 158

Use of Aggregation and Offsetting in Measuring a Tax Position 158

Measurement: Weighing of Information 158

Measuring a Tax Position Assigning Probabilities in a Cumulative-Probability Assessment 158

Cumulative-Probability Table 159

Cumulative-Probability Approach Versus Best Estimate 159

Example Illustrating Measurement of the Benefit of an Uncertain Tax Position 160

Uncertainty in Deduction Timing 160

Measurement of Uncertain Tax Positions in Transfer Pricing Arrangements 162

Separate Financial Statements of a Subsidiary 164

Subsidiary Financial Statements 165

Acceptable Methods of Tax Allocation 165

Preferable Allocation Method for Public Entities 166

Change in Application of Tax Allocation Methods 166

Valuation Allowance in the Stand-Alone Financial Statements of a Consolidated Group Member 166

Tax Consequences of Tax-Sharing Agreements That Are Not Acceptable for Financial Reporting Purposes 167

Reporting Acquisition Debt in Stand-Alone Financial Statements 168

vi


Tax Benefit of the Deductible Interest in the Stand-Alone Financial Statements 168

Allocating Income Taxes to Unincorporated Divisions in Carve-Out Financial Statements 168

Disclosure Requirements When an Unincorporated Divisions Statement of Revenues and Expenses Is Presented in a Public Filing 169

Single Member LLC Tax Allocation 169

Single Member LLC Joint and Severally Liable 169

Change From Single Member LLC to Multiple Member LLC (or Vice Versa) 169

Publicly Held Single Member LLC 170

Required Disclosures in Stand-Alone Financial Statements for a Member of a Consolidated Group 170

Deferred Credit Arising From Asset Acquisitions That Are Not Business Combinations 170

Section 5 Presentation 171

Current/Noncurrent Classification of DTLs and DTAs 171

Recognition of Changes in Indemnification Assets Under a Tax-Sharing Arrangement 172

Presentation of Valuation Allowances 172

Valuation Allowance: Classification in a Classified Balance Sheet 173

Balance Sheet Classification of Deferred Income Taxes Related to a Change in Tax Accounting Method 175

Balance Sheet Classification of the Liability for UTBs 175

Financial Statement Display of Future Obligations to Tax Authorities Under Regulation S-X, Rule 5.02 176

Interaction of UTBs and Tax Attributes 176

Balance Sheet Presentation in Transfer Pricing Arrangements 178

Presentation of Professional Fees 179

Changes in Tax Laws or Rates 179

Retroactive Changes in Tax Laws or Rates and Expiring Provisions That May Be Reenacted 180

Enacted Changes in Tax Laws or Rates That Affect Items Recognized in OCI 180

Changes in Tax Status of an Entity 181

Change in Tax Status as a Result of a Common-Control Merger 181

Recognition of an Acquiring Entitys Tax Benefits as of the Acquisition Date 182

Classification of Interest and Penalties in the Financial Statements 183

Classification of Interest and Penalties Upon Adoption of the Guidance on Accounting for Income Tax Uncertainties 183

Retrospective Application of a Change in Classification of Interest and Penalties 183

Classification of Unremitted Earnings of a Foreign Subsidiary 184

Presentation of DTAs Related to Losses on AFS Securities 185

Section 6 Disclosure 186

Disclosures Related to Statement of Financial Position 186

Required Level of Detail 186

Disclosure of Change in Tax Status 186

Change in Tax Status to Taxable: Financial Reporting Considerations 187

Disclosure of Temporary Difference and Carryforward Information 187

Definition of Significant With Respect to Disclosing the Tax Effect of Each Type of Temporary Difference and Carryforward That Gives Rise to DTAs and DTLs 187

Disclosure of Worthless Tax Benefits 187

Income-Statement-Related Disclosures 188

Disclosing the Components of Deferred Tax Expense 190

Disclosure of the Tax Effect of a Change in Tax Law, Rate, or Tax Status 190

Disclosure of Intraperiod Allocation 191

Reconciliation of Income Tax Expense to Statutory Expectations 191

Disclosure of the Significant Components of Income Tax Expense (Benefit) 191

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UTB-Related Disclosures 192

Periodic Disclosures of UTBs 192

Separate Disclosure of Interest Income, Interest Expense, and Penalties 192

Disclosing the Effects of Income Tax Uncertainties in a Leveraged Lease 192

Disclosure of Expiration of Statute of Limitations 193

Disclosure Requirements for Effectively Settled Tax Positions 193

Disclosure of UTBs That Could Significantly Change Within 12 Months of the Reporting Date 193

Interim Disclosure Considerations Related to UTBs That Will Significantly Change Within 12 Months 194

Public-Entity Disclosures of UTBs 194

Amounts Included in the Tabular Reconciliation of UTBs 195

Disclosure of Interest and Penalties Recorded in the Tabular Reconciliation of UTBs 195

Presentation of Changes Related to Exchange Rate Fluctuations in the Tabular Reconciliation 195

Disclosure of Fully Reserved DTAs in the Reconciliation of UTBs 195

Items Included in the Tabular Disclosure of UTBs From Uncertain Tax Positions May Also Be Included in Other Disclosures 196

Disclosing the Settlement of a Tax Position When Cash Paid in Settlement Differs From the UTB 196

Consideration of Tabular Disclosure of UTBs in an Interim Period 196

Presentation in the Tabular Reconciliation of a Federal Benefit Associated With Unrecognized State and Local Income Tax Positions 197

Disclosure of UTBs That, If Recognized, Would Affect the ETR 197

Example of UTBs That, If Recognized, Would Not Affect the ETR 197

Disclosure of Liabilities for UTBs in the Contractual Obligations Table 197

Public Entities Not Subject to Income Taxes 198

Tax Bases in Assets 198

Entities With Separately Issued Financial Statements That Are Members of a Consolidated Tax Return 198

Required Disclosures in Stand-Alone Financial Statements for a Member of a Consolidated Group 198

Policy-Related Disclosures 199

Other Disclosures 199

SEC Staff Disclosure Guidance 200

Section 7 Intraperiod Tax Allocation 203

Allocation of Income Tax Expense or Benefit for the Year 203

Intraperiod Tax Allocation: General Rule 203

Intraperiod Tax Allocation: Application Level 204

Allocation to Continuing Operations 204

Intraperiod Tax Allocation: Application of the With and Without Rules 206

Intraperiod Tax Allocation of Changes in Valuation Allowances 207

Changes in Valuation Allowances Resulting From Items Other Than Continuing Operations 207

Intraperiod Tax Allocation: Exception to the General Rule 208

Intraperiod Allocation: Treatment of Certain Out-of-Period Adjustments 211

Tax Benefits for Dividends Paid to Shareholders: Recognition 212

Intraperiod Tax Allocation: Tax Benefit From a Worthless Stock Deduction 212

Income Tax Accounting Considerations Related to When a Subsidiary Is Deconsolidated 213

Fresh-Start Accounting: Subsequent Increase or Decrease in a Valuation Allowance 215

Subsequent Changes in Valuation Allowances for Pre-Quasi-Reorganization Tax Benefits 215

Subsequent Recognition of Tax Benefits From a Quasi-Reorganization 215

Allocations to Items Other Than Continuing Operations 215

Tax Consequences of Securities Classified as Held to Maturity, Trading, and AFS 218

AFS Securities: Methods of Accounting for Deferred Taxes 219

AFS Securities: Valuation Allowance for Unrealized Losses 220

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AFS Securities: Valuation Allowance Changes Not Recorded Directly in Stockholders Equity 220

Assessing Realization of Tax Benefits From Unrealized Losses on AFS Securities 221

Holding Gains and Losses Recognized for Both Financial Reporting and Tax Purposes 222

Treatment of Tax Benefit for Dividends Paid on Shares Held by an ESOP 223

Tax Consequences of Transactions Among (and With) Shareholders 223

Section 8 Other Considerations or Special Areas 226

Basis Differences From Investments in Subsidiaries and Corporate Joint Ventures 226

Definition of Foreign and Domestic Investments 227

Accounting for Temporary Differences Related to an Investment in a Subsidiary 228

Consideration of the VIE Model in ASC 810-10 in the Evaluation of Whether to Recognize a DTL 229

Equity Method Investee Considerations 230

Tax Effects of Investor Basis Differences Related to Equity Method Investments 230

Deferred Tax Consequences of an Investment in an Equity Method Investment (a 50-Percent-or-Less-Owned Investee) 231

Tax Consequences of Investments in Pass-Through Entities 232

Tax Consequences From Sales of Stock by Equity Method Investees 232

Presentation of Tax Effects of Equity in Earnings of an Equity Method Investee 232

Noncontrolling Interests in Pass-Through Entities: Income Tax Financial Reporting Considerations 233

Accounting for the Tax Effects of Transactions With Noncontrolling Shareholders 233

Other Considerations Related to Foreign and Domestic Subsidiaries 235

Deferred Tax Consequences of an Investment in a More-Than-50-Percent-Owned Subsidiary 235

Tax-Free Liquidation or Merger of a Subsidiary 236

Exception to Deferred Taxes for an Investment in a More-Than-50-Percent-Owned Domestic Subsidiary 236

Tax Consequences of Business Combinations Achieved in Stages: Other Tax Considerations 237

State Tax Considerations in Connection With the Assessment of Outside Basis Differences Under ASC 740-30-25-7 238

Realization of a DTA Related to an Investment in a Subsidiary: Deferred Income Tax Exceptions Not a Source of Income 239

Recognition of a DTA Related to a Subsidiary Classified as a Discontinued Operation 240

Change in Investment From a Subsidiary to an Equity Method Investee 241

Exceptions to Comprehensive Recognition of Deferred Income Taxes for Outside Basis Differences 242

Evidence Needed to Support the Indefinite Reinvestment Assertion 242

DTL for a Portion of an Outside Basis Difference 243

Ability to Overcome the Presumption in ASC 740-30-25-3 in the Future After a Change in Managements Plans for Reinvestment or Repatriation of Foreign Earnings 243

Whether a Change in Managements Plans for Reinvestment or Repatriation of Foreign Earnings Is a Recognized or Nonrecognized Subsequent Event 244

Presentation and Disclosure Considerations 245

Disclosure of Outside Basis Differences 246

Section 9 Interim Reporting 247

Estimated Annual Effective Tax Rate 247

Estimating the AETR for Interim Reporting of Income Taxes 248

Tax-Exempt Interest in the Calculation of the Estimated AETR 250

How Regulated Entities Should Account for Income Taxes in Interim Periods 250

Ability to Make Reliable Estimates 250

Calculating an Interim Tax Provision When Ordinary Income Cannot Be Reliably Estimated 251

Estimates Regarding Stock Compensation 251

Computing the APIC Pool Impact in Interim Financial Statements 251

Interim Financial Statements: Anticipating the Tax Effects of Share-Based Payment Awards 252

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Change in Judgments and Estimates 252

Interim Accounting for a Change in Judgment About Tax Positions 253

Interim-Period Treatment of a Nonrecognized Subsequent Event With Respect to the AETR 253

Impact of Changes in an Indefinite Reinvestment Assertion for Interim-Period Tax Purposes 254

Multiple Tax Jurisdictions 254

Effect of Operating Losses 257

Income Tax Benefit of a Loss in Interim Periods 263

Recognition of the Tax Benefit of a Loss in an Interim Period 263

Operating Loss Carryforward and Changes in a Valuation Allowance 264

Intraperiod Tax Allocation in Interim Periods 264

Adjustments of Intraperiod Tax Allocation From a Prior Interim Period 264

Changes in the Valuation Allowance in an Interim Period 265

Certain Tax Credits 266

Changes in Tax Laws and Rates Occurring in Interim Periods 267

Changes in Tax Laws and Rates Occurring in Interim Periods 268

Discontinued Operations and Unusual, Infrequently Occurring, or Extraordinary Items 271

Interim Income Tax Accounting for Significant Unusual or Infrequently Occurring Items 272

Other Presentation and Discontinued Operations 274

Interim Implications of Intraperiod Tax Allocation for Discontinued Operations When There Is a Loss From Continuing Operations 277

Cumulative Effect of a Change in Accounting Principle 279

Disclosure Variations in Customary Income Tax Expense Relationships 280

Recognizing Interest Expense for Interim-Period Reporting When Interest Is Classified as Income Tax Expense 280

Consideration of Tabular Disclosure of UTBs in an Interim Period 280

Section 10 Stock Compensation 282

Overview of Income Tax Effects of Share-Based Payment Awards 282

Income Tax Considerations for Awards That Ordinarily Result in a Tax Deduction 282

Recognition of Income Tax Effects of Share-Based Payment Awards 283

Tax Effects of Share-Based Compensation 283

Incentive Stock Options 284

Nonqualified Stock Options 284

Change in Tax Status of an Award 285

Recharge Payments Made by Foreign Subsidiaries 285

Impact of Research and Development Cost-Sharing Arrangements 286

Interaction Between ASC 740 and ASC 718-740-25-10 287

Measurement of Income Tax Effects of Share-Based Payment Awards 288

Measuring DTAs in Reference to the Current Stock Price 288

Subsequent Measurement of Income Tax Effects of Share-Based Payment Awards 289

Basic Income Tax Effects of Share-Based Payment Awards 289

Tax Effects of Awards With Graded Vesting 290

Recognizing Income Tax Effects on an Award-by-Award Basis 291

Income Tax Effects of Early Exercise of Awards 292

Measuring the Excess Tax Benefit Associated With Share-Based Compensation: Tax Credits and Other Items That Affect the ETR 292

Amounts Included in the Excess Tax Benefits Available for Offset (APIC Pool) 293

Realization of Excess Tax Benefits 293

Tax Effects of Expiration of an Award 294

Combining Employee and Nonemployee APIC Pools 295

xContents A Roadmap to Accounting for Income Taxes

Impact of Acquisitions, Sales, Spin-Offs, and Investments in Equity Method Investees on the APIC Pool Parent-Company Awards 295

Subsequent Measurement Guidance for Interim Financial Statements 296

Computing the APIC Pool Impact in Interim Financial Statements 296

Interim Financial Statements: Anticipating the Tax Effects of Share-Based Payment Awards 297

Subsequent Measurement Guidance on Awards Granted Before the Adoption of Statement 123(R) 297

Recording Tax Benefits of Awards Granted Before the Adoption of Statement 123(R) 297

Effect on the APIC Pool When the Full Corresponding DTA Does Not Exist Upon Exercise 298

Valuation Allowances on Excess Tax Benefits Established Before the Adoption of Statement 123(R) 300

Subsequent Measurement Guidance for Nonpublic Entities 301

Application of the Prospective Application Method to Nonpublic Entities APIC Pool 301

Calculating the APIC Pool When a Company Becomes Public After Adopting Statement 123 301

Presentation of Income Tax Effects of Share-Based Payment Awards 302

Balance Sheet Classification of DTAs Related to Nonqualified Stock Options 303

ESOP: Income Tax Accounting Example 303

Tax Benefit of ESOP Dividends 304

EPS Considerations 305

Inclusion of Out-of-the-Money Share-Based Payment Awards With a Dilutive Effect Under the Treasury Stock Method Because of Tax Benefit Deficiencies 305

Estimating Expected Disqualifying Dispositions in the Calculation of the Tax Benefit Component of Assumed Proceeds 306

Realization of Excess Tax Benefits in the Calculation of the Tax Benefit Component of Assumed Proceeds 307

Tax Benefit Component of Assumed Proceeds 307

Statement of Cash Flows 308

Presentation in the Statement of Cash Flows of the Income Tax Effects of Share-Based Payment Awards 308

Presentation in the Statement of Cash Flows of Tax Benefit Deficiencies of Share-Based Payment Awards 309

Earnings-per-Share Treatment of the Tax Benefits of Dividends on Unallocated Stock 309

Section 11 Business Combinations 311

General Recognition of Deferred Taxes in a Business Combination 311

Tax Consequences of Business Combinations 314

Recognition of an Acquiring Entitys Tax Benefits Not Considered in Acquisition Accounting 314

Accounting for Uncertainty in Income Taxes in Business Combinations 315

Deferred Taxes Associated With Acquired Intangible Assets 315

Recording Deferred Taxes in a Business Combination on Inside and Outside Basis Differences 315

Accounting for the Settlement of a Preexisting Relationship 317

Reacquired Rights 319

Income Tax Accounting for Transaction Costs in a Business Combination 321

Income Tax Accounting for Acquisition-Related Costs Incurred in a Period Before Consummation of a Business Combination 321

Income Tax Accounting for Acquisition-Related Costs Incurred in a Business Combination 322

Initial Measurement of the Income Tax Consequences of Contingent Consideration in a Business Combination 323

Tax Consequences of Business Combinations Achieved in Stages: Remeasurement of the Original Investment 324

Tax Consequences of Business Combinations Achieved in Stages: Other Tax Considerations 326

Accounting for Income Taxes in a Business Combination That Resulted in a Bargain Purchase 327

Applicable Tax Rates: Business Combination Accounting 329

Initial Measurement of the Tax Effects of Contingencies Assumed in a Business Combination 330

Accounting for the Tax Effects of Contingent Environmental Liabilities Assumed in a Business Combination 331

Research and Development Assets Acquired in a Business Combination 332

Obtaining Tax Basis Step-Up of Acquired Net Assets Through Payment to a Tax Authority 333

Income Tax Accounting for Assets Acquired in a Business Combination That Were Subject to an Intercompany Sale 333

Tax Considerations Related to Leveraged Leases Acquired in a Business Combination 333

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Goodwill 334

Deferred Taxes Associated With Goodwill 334

Allocation of Tax Amortization of Goodwill 337

Deferred Taxes Associated With Goodwill in PreStatement 141(R) Acquisitions 338

Subsequent Accounting for Goodwill 340

Impact of ASC 350 on Accounting for Income Taxes 340

Goodwill Impairment Test Tax Considerations 341

Determining the Deferred Tax Effects of a Goodwill Impairment 342

Tax Effects of Goodwill Remaining in a Reporting Unit Upon Disposal of a Subsidiary 344

Replacement Awards Classified as Equity 345

Tax Benefits of Tax-Deductible Share-Based Payment Awards Exchanged in a Business Combination 346

Tax Benefits Received From the Disqualifying Disposition of Incentive Stock Options Exchanged in a Business Combination 349

Accounting for Changes in Forfeiture Estimates Affecting Share-Based Payment Awards Exchanged in a Business Combination 351

Allocation of Consolidated Tax Expense to the Acquired Entity After an Acquisition 354

Subsequent Measurement for Assets Acquired and Liabilities Assumed 355

Revisions to Accounting for a Business Combination After the Measurement Period 355

Recognition of an Acquiring Entitys Tax Benefits After the Acquisition Date 356

Subsequent Measurement of the Income Tax Consequences of Contingent Consideration in a Business Combination 356

Subsequent Measurement of the Tax Effects of Contingencies Assumed in a Business Combination 359

Changes in Valuation Allowances 362

Accounting for Changes in Acquirers and Acquirees Valuation Allowances as of and After the Consummation or Acquisition Date 363

Changes in Tax Positions 363

Changes in Uncertain Income Tax Positions Acquired in a Business Combination 363

Uncertainty in Income Taxes in a Business Combination Measurement Period 364

Disclosure 365

Section 12 Foreign Currency Matters 366

Price-Level-Adjusted Financial Statements 368

Highly Inflationary Economies Reporting Currency Is the Functional Currency 369

Change in the Functional Currency When an Economy Ceases to Be Considered Highly Inflationary 369

Section 13 Qualified Affordable Housing Project Investments (Guidance in the Equity Method and Joint Ventures Section of ASC 323-740) 371

Appendix A Glossary of Topics, Standards, and Regulations 379

Appendix B Abbreviations 385

Appendix C Glossary of Terms in ASC 740-10 388

Appendix D Sample Disclosures of Income Taxes 395

Appendix E Sample SEC Comments: Income Taxes 406

Appendix F Accounting for Income Taxes Under IFRSs 421

1PrefaceTo our friends and clients:

Were pleased to present the first edition of A Roadmap to Accounting for Income Taxes. This Roadmap provides Deloittes insights into and interpretations of the income tax accounting guidance in ASC 7401 and IFRSs (in Appendix F). The income tax accounting framework has been in place for many years; however, views on the application of that framework to current transactions continue to evolve because structures and tax laws are continually changing. Therefore, use of this Roadmap, though it is intended as a helpful resource, is not a substitute for consultation with Deloitte professionals on complex income tax accounting questions or transactions.

The body of this Roadmap combines the income tax accounting rules and implementation guidance from ASC 740 with Deloittes interpretations and examples in a comprehensive, reader-friendly format. The Roadmaps organization mirrors the order of ASC 740. Each section of this publication typically starts with a brief introduction and includes excerpts from ASC 740 (followed by pre-Codification references in brackets), Deloittes interpretations of those excerpts, and examples to illustrate the relevant guidance. Where applicable, we also include cross-references linking to other Roadmap paragraphs (links are in blue; as a reminder, use [alt] and [left arrow] to return to the paragraph you were originally reading).

This Roadmap also includes six appendixes.

We hope that you find this Roadmap a useful tool when considering the income tax accounting guidance.

Sincerely,

Deloitte & Touche LLP

1 For the full titles of standards, topics, and regulations, see Appendix A.

2The following is a brief summary of the Roadmaps 13 sections and 6 appendixes:

Section 1, Overview and Objectives of the Accounting for Income Taxes Includes excerpts from the overview and objectives subsection of ASC 740 as well as a brief summary of the evolution of the income tax accounting guidance and its application to tax positions.

Section 2, Scope Discusses the differences between taxes that are within the scope of ASC 740 (i.e., income taxes) and taxes that are not considered income taxes and therefore are accounted for under other U.S. GAAP.1

Section 3, Recognition and Derecognition Contains comprehensive recognition guidance on all transactions that are within the scope of ASC 740 as well as on the exceptions to the recognition criteria. Specific topics covered include when a tax position taken or expected to be taken on a tax return meets the ASC 740 recognition criteria; determining the unit of account to use in applying those criteria; when recognition or derecognition is warranted after the original assessment of the criteria; examples of temporary differences; and other special circumstances in which recognition consideration is warranted, such as changes in tax laws, rates, or tax status.

Section 4, Measurement Expands on many of the topics that are introduced in the Recognition section. This section provides guidance on the amount at which an entity should measure a tax asset or liability in its financial statements when the recognition criteria for that asset or liability have been met (as discussed in Section 3). Specifically, this section focuses on (1) the appropriate tax rate to be used, (2) how uncertainty should be considered, and (3) how to evaluate DTAs for realizability and when a valuation allowance would be appropriate.

Section 5, Presentation, and Section 6, Disclosure Provide general guidance on presentation and disclosure matters related to the statement of financial position, income statement, and footnotes for income taxes. See also Appendix D, which contains a comprehensive disclosure example (discussed below).

Section 7, Intraperiod Tax Allocation ASC 740 prescribes an accounting model, known as intraperiod tax allocation, for allocating an entitys total annual income tax provision among continuing operations and the other components of an entitys financial statements (i.e., discontinued operations, extraordinary items, OCI, and shareholders equity). Although it may appear simple, this model is one of the more challenging aspects of income tax accounting. This section provides insights (including illustrations) into some of the complexities associated with intraperiod tax allocation.

Section 8, Other Considerations or Special Areas Provides accounting and disclosure guidance on specific items related to investments in subsidiaries and corporate joint ventures, including guidance on applying ASC 740 to the (1) tax consequences of undistributed earnings of subsidiaries, (2) change in ownership basis of subsidiaries, and (3) recognition of certain DTAs and DTLs. This section also covers presentation and disclosure issues not discussed in other sections of this Roadmap.

Section 9, Interim Reporting The core principle of ASC 740-270 is that the interim period is integral to the entire financial reporting year. Thus, this section describes the general process for allocating an entitys annual tax provision to its interim financial statements. This section also discusses estimating an entitys annual effective tax rate, which is determined and updated in each interim reporting period.

Executive Summary

1 For the full forms of acronyms, see Appendix B.

3Executive Summary A Roadmap to Accounting for Income Taxes

Section 10, Stock Compensation This section provides recognition, measurement, and presentation guidance on the tax effects of share-based payment awards. It also includes guidance on interim reporting of tax effects of share-based payment awards and other related topics.

Section 11, Business Combinations Addresses the income tax considerations related to business combinations. In particular, the section focuses on some of the more challenging aspects of the business combination accounting guidance, such as contingent consideration, bargain purchases, acquisition costs, reacquired rights, preacquisition contingencies, and goodwill.

Section 12, Foreign Currency Matters, and Section 13, Qualified Affordable Housing Project Investments (Guidance in the Equity Method and Joint Ventures) These sections consist mostly of the relevant Codification sections and are included in this Roadmap for completeness.

Appendix A Glossary containing the full titles of topics, standards, and regulations used in the Roadmap.

Appendix B Glossary containing the full forms of acronyms used throughout the Roadmap.

Appendix C Contains excerpts from the ASC 740 glossary of terms that are important to the accounting for income taxes.

Appendix D Includes a comprehensive disclosure example.

Appendix E Comprises a sample of recent SEC comments on income tax matters, which should be particularly useful for SEC registrants.

Appendix F A comprehensive discussion of the income tax accounting guidance under IFRSs.

4This publication is the culmination of years of consultations on the income tax accounting implications of complex transactions.

Richard Paul supervised the overall preparation of this Roadmap and extends his deepest appreciation to all professionals that helped in its development. Bernie De Jager from the Accounting Consultation group of Deloitte & Touche LLPs National Office and Mark Fisher from the Washington National Tax group of Deloitte Tax LLP were instrumental in developing the guidance in this Roadmap. Courtney Sachtleben, Scott Cerutti, Sean St. Germain, Ken Pressler, Michael Robison, Joseph Renouf, Yvonne Rudek, and Jeanine Pagliaro were the core team from Deloitte & Touche LLPs Accounting Standards and Communications group that worked tirelessly to make this Roadmap a success. In addition, much of the guidance in this Roadmap was developed by professionals who have moved on to different opportunities but whose efforts were also instrumental. Those individuals include Phil Hueber, Robin Kramer, Tim McKay, Randall Sogoloff, Stefanie Tamulis, Stephanie Wolfe, and many others.

We would also like to thank Doug Barton, Rita Benassi, and Bob Uhl for their leadership and guidance in helping develop this Roadmap.

Acknowledgments

5Section 1 Overview and Objectives of the Accounting for Income Taxes

1.01 The accounting for income taxes under ASC 740 is sometimes very specific and can be complex. An entitys primary objective in accounting for income taxes under ASC 740 is to reflect its after-tax financial position in its balance sheet. To accomplish this objective, an entity employs the balance sheet model for recording current and deferred taxes. This section summarizes the core concepts under ASC 740 and gives an overview of the objectives of accounting for income taxes.

Overview of ASC 740 740-10-05 (Q&A 01)

1.02 As noted in ASC 740-10-10-1, an entitys overall objectives in accounting for income taxes under ASC 740 are to (1) recognize the amount of taxes payable or refundable for the current year and (2) recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. However, an entity achieves these objectives in a significantly different manner than it did under previous superseded guidance.

1.03 Under the prior superseded guidance, the principal objective was matching. Tax expense was determined without regard to timing differences. The difference between that amount and the actual tax was recorded as a deferred tax. The deferred tax accounts were residuals, reported as either deferred liabilities or assets. These amounts did not, except by coincidence, represent the amount of taxes that would be paid or refunded in a future reporting period.

1.04 Other previously superseded guidance was based on a balance sheet approach. This approach focused on the amount of taxes payable or receivable for the future tax return consequences of reporting-date temporary differences. In addition, under this other previously superseded guidance, recognition and measurement of DTAs and DTLs did not anticipate the tax consequences of earning income in future years. Two events were necessary to recognize a DTA: (1) the existence of a deductible temporary difference or tax credit or loss carryforward and (2) income (from taxable temporary differences or prior tax returns) that permitted the realization of the potential benefit. Because the tax consequences of earning income in future years could not be anticipated, this other previously superseded guidance effectively limited the recognition of DTAs to the amount of the deductible temporary difference or loss that could be carried back to recover previously paid or accrued income taxes.

1.05 Under ASC 740, the balance sheet approach was modified to incorporate a one event approach to DTA recognition. In accordance with ASC 740, the critical event for recognition of an asset is the event that gives rise to the deductible temporary difference or tax credit or NOL carryforward. Once that event occurs, those tax benefits should be recognized subject to a realizability assessment. In effect, earning taxable income in future years is treated as a confirmation of realizability and not as a prerequisite to asset recognition. At the same time, management should consider future events to record those tax assets at amounts that are more likely than not to be realized in future tax returns. In the case of DTLs, ASC 740 requires an entity to include in its balance sheet an obligation for the tax consequences of taxable temporary differences even when losses are expected in future years.

6Section 1 Overview and Objectives of the Accounting for Income Taxes A Roadmap to Accounting for Income Taxes

1.06 The following is a brief summary of deferred tax accounting under ASC 740:

DTLsarerecognizedforfuturetaxableamounts.

Ingeneral,DTAsarerecognizedforfuturedeductionsandoperatinglossandtaxcreditcarryforwards.

ThemarginaltaxrateisusedtomeasureDTAsandDTLs.

AvaluationallowanceisrecognizedtoreduceDTAstotheamountsthataremorelikelythannottoberealized.

Theamountofthevaluationallowanceisbasedonallavailablepositiveandnegativeevidenceaboutthefuture.

Deferredtaxexpenseorbenefitiscomputedasthedifferencebetweenthebeginningandendingbalanceof the net DTA or DTL for the period.

Ingeneral,DTAsandDTLsareclassifiedascurrentornoncurrentinaccordancewiththeclassificationofthe related asset or liability for financial reporting purposes.

Theeffectsofchangesinratesorlawsarerecognizedonthedateofenactment.

1.07 ASC 7401 states the following regarding its objectives:

ASC 740-10

05-1 The Income Taxes Topic addresses financial accounting and reporting for the effects of income taxes that result from an entitys activities during the current and preceding years. [FAS 109, paragraph 1] Specifically, this Topic establishes standards of financial accounting and reporting for income taxes that are currently payable and for the tax consequences of all of the following:

a. Revenues, expenses, gains, or losses that are included in taxable income of an earlier or later year than the year in which they are recognized in financial income

b. Other events that create differences between the tax bases of assets and liabilities and their amounts for financial reporting

c. Operating loss or tax credit carrybacks for refunds of taxes paid in prior years and carryforwards to reduce taxes payable in future years. [FAS 109, paragraph 3]

05-5 There are two basic principles related to accounting for income taxes, each of which considers uncertainty through the application of recognition and measurement criteria:

a. To recognize the estimated taxes payable or refundable on tax returns for the current year as a tax liability or asset

b. To recognize a deferred tax liability or asset for the estimated future tax effects attributable to temporary differences and carryforwards. [EITF 91-8, paragraph Status]

05-6 This Subtopic provides guidance for recognizing and measuring tax positions taken or expected to be taken in a tax return that directly or indirectly affect amounts reported in financial statements. This Subtopic also provides accounting guidance for the related income tax effects of individual tax positions that do not meet the recognition thresholds required in order for any part of the benefit of that tax position to be recognized in an entitys financial statements. Under this Subtopic, a tax position is first evaluated for recognition based on its technical merits. Tax positions that meet a recognition criterion are then measured to determine an amount to recognize in the financial statements. That measurement incorporates information about potential settlements with taxing authorities. [FIN 48, paragraphs 2 and B27]

Overview of Uncertain Tax Positions

Consideration of Tax Positions Under ASC 740740-10-05 (Q&A 02)

1.08 ASC 740 applies to all tax positions in a previously filed tax return or tax positions expected to be taken in a future tax return. A tax position can result in a permanent reduction of income taxes payable, a deferral of income taxes otherwise currently payable to future years, or a change in the expected realizability of DTAs.

1.09 The definition of tax position in ASC 740-10-20 lists the following examples of tax positions that are within the scope of ASC 740:

1. A decision not to file a tax return (e.g., a decision not to file a specific state tax return because nexus was not established).

1 Note that ASC 740 incorporates guidance from Statement 109 as well as from all the interpretive guidance that was issued from the time that standard was issued to the time this Roadmap was published. For convenience, the FASB Accounting Standards Codification (ASC or the Codification) sections reprinted in blue boxes from ASC 740 throughout this Roadmap include references to the corresponding pre-Codification guidance.


2. An allocation or a shift of income between jurisdictions (e.g., transfer pricing).

3. The characterization of income or a decision to exclude reporting taxable income in a tax return (e.g., interest income earned on municipal bonds).

4. A decision to classify a transaction, entity, or other position in a tax return as tax exempt (e.g., a decision not to include a foreign entity in the U.S. federal tax return).

1.10 Uncertainties related to tax positions not within the scope of ASC 740, such as taxes based on gross receipts, revenue, or capital, should be accounted for under other applicable literature (e.g., the contingency guidance in ASC 450).

Temporary Differences

1.11 ASC 740 states the following regarding the temporary difference approach:

ASC 740-10

05-7 A temporary difference refers to a difference between the tax basis of an asset or liability, determined based on recognition and measurement requirements for tax positions, and its reported amount in the financial statements that will result in taxable or deductible amounts in future years when the reported amount of the asset or liability is recovered or settled, respectively. Deferred tax assets and liabilities represent the future effects on income taxes that result from temporary differences and carryforwards that exist at the end of a period. Deferred tax assets and liabilities are measured using enacted tax rates and provisions of the enacted tax law and are not discounted to reflect the time-value of money.

05-8 As indicated in paragraph 740-10-25-23, temporary differences that will result in taxable amounts in future years when the related asset or liability is recovered or settled are often referred to as taxable temporary differences. Likewise, temporary differences that will result in deductible amounts in future years are often referred to as deductible temporary differences. Business combinations may give rise to both taxable and deductible temporary differences. [FAS 109, paragraph 13]

05-9 As indicated in paragraph 740-10-25-30, certain basis differences may not result in taxable or deductible amounts in future years when the related asset or liability for financial reporting is recovered or settled and, therefore, may not be temporary differences for which a deferred tax liability or asset is recognized. [FAS 109, paragraph 14]

05-10 As indicated in paragraph 740-10-25-24, some temporary differences are deferred taxable income or tax deductions and have balances only on the income tax balance sheet and therefore cannot be identified with a particular asset or liability for financial reporting. In such instances, there is no related, identifiable asset or liability for financial reporting, but there is a temporary difference that results from an event that has been recognized in the financial statements and, based on provisions in the tax law, the temporary difference will result in taxable or deductible amounts in future years. [FAS 109, paragraph 15]

Objectives of ASC 740

ASC 740-10

10-1 There are two primary objectives related to accounting for income taxes:

a. To recognize the amount of taxes payable or refundable for the current year

b. To recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns.

As it relates to the second objective, some events do not have tax consequences. Certain revenues are exempt from taxation and certain expenses are not deductible. In some tax jurisdictions, for example, interest earned on certain municipal obligations is not taxable and fines are not deductible. [FAS 109, paragraph 6]

10-2 Ideally, the second objective might be stated more specifically to recognize the expected future tax consequences of events that have been recognized in the financial statements or tax returns. However, that objective is realistically constrained because:

a. The tax payment or refund that results from a particular tax return is a joint result of all the items included in that return.

b. Taxes that will be paid or refunded in future years are the joint result of events of the current or prior years and events of future years.

c. Information available about the future is limited. As a result, attribution of taxes to individual items and events is arbitrary and, except in the simplest situations, requires estimates and approximations. [FAS 109, paragraph 7]


ASC 740-10 (continued)

10-3 Conceptually, a deferred tax liability or asset represents the increase or decrease in taxes payable or refundable in future years as a result of temporary differences and carryforwards at the end of the current year. That concept is an incremental concept. A literal application of that concept would result in measurement of the incremental tax effect as the difference between the following two measurements:

a. The amount of taxes that will be payable or refundable in future years inclusive of reversing temporary differences and carryforwards

b. The amount of taxes that would be payable or refundable in future years exclusive of reversing temporary differences and carryforwards. [FAS 109, paragraph 87]

However, in light of the constraints identified in the preceding paragraph, in computing the amount of deferred tax liabilities and assets, the objective is to measure a deferred tax liability or asset using the enacted tax rate(s) expected to apply to taxable income in the periods in which the deferred tax liability or asset is expected to be settled or realized. [FAS 109, paragraph 18]

1.12 The overall objective of accounting for income taxes is to reflect (1) the amount an entity currently owes to tax authorities and (2) an asset or liability for the tax effects of the transactions or events that have occurred but that have not yet been reflected in a tax return or vice versa. An asset will be recorded for items that will result in future tax deductions (sometimes referred to as a benefit), and liabilities are recorded for items that will result in the inclusion of future taxable income in an entitys tax return. This balance sheet approach is used to calculate temporary differences that, in effect, take into account the total tax that would be payable (or receivable) if all of an entitys assets and liabilities were realized at their carrying value at a specific time (the reporting date).

1.13 In certain situations, an entity may determine that its ability to actually use a deduction for a DTA on a future tax return is uncertain. For example, an entity may have recorded a DTA for accumulated operating losses that it can use to offset future income on future tax returns. However, on the basis of forecasts of future taxable income, the entity determines, using its best estimate, that it most likely will not be able to use all of the accumulated operating losses to offset future taxable income on future tax returns before the attribute expires under tax rules. In this situation, the entity would need to record a valuation allowance to reduce the DTA to the amount it ultimately expects to be able to deduct on its tax return. See Section 4, Measurement, for further discussion of valuation allowances.

1.14 The total tax provision for a period includes the amount of expense (or benefit) related to the total tax that is expected to be paid (or refunded) in connection with income, expenses, and other events captured in that periods financial statements. This provision consists of current tax expense (benefit) (i.e., the amount expected to be reflected on the current-period income tax return(s)) and deferred tax expense (benefit) (i.e., change in DTAs and DTLs for the period). Generally, an increase in a DTA and a decrease in a DTL decrease deferred tax expense. Similarly, a decrease in a DTA and an increase in a DTL increase deferred tax expense.

1.15 Income tax expense (or benefit) is not just one line item in the income statement. A model known as intraperiod tax allocation (see Section 7, Intraperiod Tax Allocation) is used to allocate these amounts among other components of an entitys financial statements through discontinued operations, extraordinary items, OCI, and shareholders equity. This allocation also applies to the reporting of information in the interim financial statements. Section 9, Interim Reporting, discusses the method for allocating income tax expense (or benefit) among the interim periods on the basis of its core principle that the interim period is an integral component of the entire financial reporting year.

9Section 2 Scope 2.01 The scope of ASC 740 can be described as including any tax that is based on income, regardless of how the tax is labeled by a jurisdiction. However, although this principle may appear simple, entities must use significant judgment in determining whether a tax is within the scope of ASC 740 because the accounting model for income taxes is very different from the accounting model for other types of taxes that are not within ASC 740s scope. Those nonincome taxes are often accounted for under the contingencies guidance in ASC 450 or other sections of the FASB Accounting Standards Codification (ASC or the Codification) and therefore no deferred taxes are recognized. When a tax is determined to be an income tax, the income tax accounting guidance is required for each component in each tax jurisdiction.

ASC 740-10

15-2 The principles and requirements of the Income Taxes Topic are applicable to domestic and foreign entities in preparing financial statements in accordance with U.S. generally accepted accounting principles (GAAP), including not-for-profit entities (NFP) with activities that are subject to income taxes. [FAS 109, paragraph 4]

15-2AA The Sections of this Subtopic relating to accounting for uncertain tax positions are applicable to all entities, including tax-exempt not-for-profit entities, pass-through entities, and entities that are taxed in a manner similar to pass-through entities such as real estate investment trusts and registered investment companies. [ASU 200906, paragraph 3]

15-3 The guidance in the Income Taxes Topic applies to:

a. Domestic federal (national) income taxes (U.S. federal income taxes for U.S. entities) and foreign, state, and local (including franchise) taxes based on income

b. An entitys domestic and foreign operations that are consolidated, combined, or accounted for by the equity method. [FAS 109, paragraph 4]

2.02 ASC 740 includes the following implementation guidance on determining whether a tax is considered an income tax. Although this guidance is based on a U.S. state tax that subsequently changed, it may still prove helpful:

ASC 740-10 Implementation Guidance

55-26 Local (including franchise) taxes based on income are within the scope of this Topic. A tax, to the extent it is based on capital, is a franchise tax. As indicated in paragraph 740-10-15-4(a), if there is an additional tax based on income, that excess is considered an income tax. A historical example that illustrates this guidance is presented in Example 17 (see paragraph 740-10-55-139).

Determining Whether a Tax Is an Income Tax

55-139 The guidance in paragraph 740-10-55-26 addressing when a tax is an income tax is illustrated using the following historical example.

55-140 In August 1991, a state amended its franchise tax statute to include a tax on income apportioned to the state based on the federal tax return. The new tax was effective January 1, 1992. The amount of franchise tax on each corporation was set at the greater of 0.25 percent of the corporations net taxable capital and 4.5 percent of the corporations net taxable earned surplus. Net taxable earned surplus was a term defined by the tax statute for federal taxable income.

55-141 In this Example, the total computed tax is an income tax only to the extent that the tax exceeds the capital-based tax in a given year.

55-142 A deferred tax liability is required to be recognized under this Subtopic for the amount by which the income-based tax payable on net reversing temporary differences in each future year exceeds the capital-based tax computed for each future year based on the level of capital that exists as of the end of the year for which deferred taxes are being computed.

55-143 The portion of the current tax liability based on income is required to be accrued with a charge to income during the period in which the income is earned. The portion of the deferred tax liability related to temporary differences is required to be recognized as of the date of the statement of financial position for temporary differences that exist as of the date of the statement of financial position.

10

Section 2 Scope A Roadmap to Accounting for Income Taxes

ASC 740-10 Implementation Guidance (continued)

55-144 Because the state tax is an income tax only to the extent that the tax exceeds the capital-based tax in a given year, under the requirements of this Subtopic, deferred taxes are recognized for temporary differences that will reverse in future years for which annual taxable income is expected to exceed 5.5% (.25% of net taxable capital/4.5% of taxable income) of expected net taxable capital. In measuring deferred taxes, see paragraph 740-10-55-138 to determine whether a detailed analysis of the net reversals of temporary differences in each future year is warranted. While the tax statutes of states differ, the accounting described above would be appropriate if the tax structure of another state was essentially the same as in this Example. [EITF 91-8, paragraph Discussion]

Taxes Within the Scope of ASC 740 740-10-15 (Q&A 08)

2.03 The scope of ASC 740 clearly states that it only applies to income taxes. ASC 740-10-20 defines income taxes as [d]omestic and foreign federal (national), state, and local (including franchise) taxes based on income. Taxable income is further defined as [t]he excess of taxable revenues over tax deductible expenses and exemptions for the year as defined by the governmental taxing authority.

2.04 Although ASC 740 provides no further guidance on this matter, the term taxes based on income implies a tax system in which the tax payable is calculated on the basis of the entitys revenue minus the costs allowed by the jurisdiction being considered. For the tax to be an income tax, the tax computation would not need to include all income statement accounts. A tax levied on a subset of the income statement, such as a tax on net investment income (i.e., a tax on investment income less investment-related expenses), would also qualify as a tax based on income since it would be computed on the basis of a portion of net income less expenses incurred to generate the income.

2.05 Determining which taxes qualify as income taxes under ASC 740 may not always be clear, especially when certain taxes appear to have characteristics of both an income tax and a gross-revenue or VAT. As explained above, the scope of ASC 740 is limited to taxes based on income, where income is determined after revenues and gains are reduced by some amount of expenses and losses. Therefore, taxes based solely on revenues (e.g., gross revenues or sales tax) would not be within the scope of ASC 740 because the taxable base amount is not reduced by any expenses. Taxes based on gross receipts, revenue, or capital should be accounted for under other applicable literature (e.g., the contingencies guidance in ASC 450). This section includes examples of specific tax systems in which taxes appear to have characteristics of either an income tax or other tax and the appropriate application of ASC 740 to those systems.

2.06 See 2.412.46 for a discussion of refundable tax credits that are not considered an element of income tax accounting under ASC 740.

Provincial Taxes 740-10-15 (Q&A 12)

2.07 Many mining companies are subject to a provincial mining tax consisting of two parts: a production-based tax and a profit-based tax. The production-based tax is a fixed minimum amount per ton of product sold. However, depending on the profitability of the mine, the total tax may exceed the fixed minimum amount per ton. The profit-based tax is assessed on any profits in excess of this fixed minimum amount.

2.08 By analogy, ASC 740-10-15-4(a) and ASC 740-10-55-139 through 55-144 provide guidance on this type of hybrid tax. The guidance concludes that the total computed state tax is an income tax only to the extent that the tax exceeds the capital-based tax in a given year. Accordingly, the company should consider any amount of the provincial mining tax greater than the fixed minimum amount per ton of product sold as an income tax and include this amount within the income tax expense line item.

2.09 The production component of the provincial mining tax should not be included as part of the income tax expense line item because it is not based on income. Authoritative accounting literature contains limited guidance on income statement presentation of the production tax component as either cost of sales or an operating expense. The presentation must be logical and reflect the substance of the entitys operations. Accordingly, because the production-based tax is directly and incrementally related to tons sold, it would be preferable to classify the production portion of the provincial mining tax as a component of cost of sales. However, given the diverse classification of similar types of taxes within the industry, it would be acceptable to classify the production-based portion of the provincial mining tax as a separate line item within operating expenses.

11


2.10 In a manner consistent with ASC 740-10-15-4(a) and ASC 740-10-55-139 through 55-144, provincial deferred taxes under ASC 740 are recognized only for temporary differences that will reverse in future years for which the total provincial mining tax is expected to exceed the production tax portion on the basis of the fixed minimum amount per ton of product sold. Determining whether a deferred tax should be recorded will require estimates of the effects that future transactions and events will have on both components of the provincial tax. If an entity is unable to determine whether the total provincial mining tax is expected to exceed the production component in future years, the entity should disclose that no deferred taxes have been recorded because it is unable to determine whether temporary differences exist for this tax jurisdiction. This concept is illustrated in 2.132.15.

Not-for-Profit Foundation Excise Taxes 740-10-15 (Q&A 13)

2.11 Not-for-profit foundations that make certain minimum distributions are generally exempt from federal income taxes. However, such foundations are subject to an excise tax on their net investment income.

2.12 This excise tax meets the definition of a tax based on income and therefore is within the scope of ASC 740. Thus, in this case, basis differences related to investment securities should be treated as temporary differences, deferred taxes should be recognized, and the need for a valuation allowance (if any DTAs exist) should be evaluated.

Texas Margin Tax 740-10-15 (Q&A 11)

2.13 On May 18, 2006, the State of Texas enacted House Bill 3 (the Bill), which replaces the states franchise tax with a margin tax. The margin tax is assessed at 1 percent of Texas-sourced taxable margin (excluding entities primarily engaged in retail or wholesale trade, which will be assessed at 0.5 percent). The taxable margin is computed as the lesser of (1) 70 percent of total revenue or (2) total revenue less (a) cost of goods sold or (b) compensation. The Bill defines and provides guidance on the terms revenue, cost of goods sold, and compensation.

2.14 Although the Bill states that the new tax is not an income tax, it is determined by applying a tax rate to a base that takes both revenues and expenses into account; therefore, the new tax is considered an income tax. Further, the expense that is taken into account (either compensation or cost of goods sold) will typically be the single largest expense in the determination of net profit. Therefore, the margin tax has characteristics of an income tax and should be accounted for as such in accordance with ASC 740. Moreover, an entity should apply ASC 740 even when the entity estimates that its tax will be based only on revenue (i.e., when it expects 70 percent of revenue to be less than 100 percent of total revenue less cost of goods sold or compensation).

2.15 The base used to compute the margin tax (i.e., revenue only, revenue less cost of goods sold, or revenue less compensation) affects book-tax differences. ASC 740-10-30-8 indicates that entities should measure a DTA or DTL by using the enacted tax rate(s) expected to apply to taxable income in the periods in which the deferred tax liability or asset is expected to be settled or realized. Therefore, if an entity expects to be subject to more than one measure of taxable margin in the future, it may be required to schedule the reversal of those temporary differences to measure the related DTA or DTL. See 4.904.99 for a discussion of how to measure the Texas margin tax.

Michigan Business Tax 740-10-15 (Q&A 09)

2.16 House Bill No. 5104 (HB 5104) was enacted in 2007 and amends the Michigan Business Tax (MBT) to provide for a deduction from the business income tax (BIT) base beginning in the 2015 tax year. This deduction, which will extend through the 2029 tax year, is intended to offset the financial statement expense associated with establishing DTLs resulting from the ASC 740 income tax treatment of the BIT and Gross Receipts Tax (GRT) elements of the MBT.1 To create this offset, the law uses the book-tax basis differences on which the BIT and GRT DTLs are determined to calculate the amount of additional deductions available in computing the BIT over a 15-year period beginning in 2015.

The Book-Tax Difference Deduction2.17 HB 5104 creates a deduction (the Deduction) from a taxpayers preapportioned BIT base. The Deduction is equal to the total book-tax difference triggered by the enactment of the MBT that results in a net DTL.2 Characteristics of the Deduction include the following:

1 See Senate Fiscal Agency, H.B. 5104: Floor Analysis (September 29, 2007). 2 Section 1201(2)(i) of Mich. Comp. Laws. See also Section 1201(3) of Mich. Comp. Laws.

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TheDeductionisbasedonthebook-taxdifferencesforthefirstfiscalperiodendingafterJuly12,2007(i.e., the date the MBT was enacted).

Ataxpayerstotalbook-taxdifferenceisdeductedfromthepreapportionedBITtaxbasefor15successivetax years, beginning in 2015, in the following percentages:

o Four percent per year for the 20152019 tax years.

o Six percent per year for the 20202024 tax years.

o Ten percent per year for the 20252029 tax years.

Book-taxdifferenceisdefinedasthedifference,ifany,betweenthepersonsqualifyingassetsnetbook value shown on the persons books and records for the first fiscal period ending after July 12, 2007, and the qualifying assets tax basis on that same date.

Qualifyingassetisdefinedasanyassetshownonthepersonsbooksandrecordsforthefirstfiscalperiod ending after July 12, 2007, in accordance with generally accepted accounting principles.

TheDeductionmustnotexceedtheamountnecessarytooffsetthenetDTLofthetaxpayerascomputedin accordance with generally accepted accounting principles, which would otherwise result from imposition of the BIT and the GRT.

TotheextentthattheDeductionexceedsataxpayersBITbase,anyunusedamountmaybecarriedforward as an adjustment to the taxpayers BIT base in future years.

2.18 By providing for a future deduction from a taxpayers preapportioned BIT tax base, the new law may create an equivalent net DTA that should cancel out the provision impact of the establishment of a net DTL resulting from accounting for the BIT and GRT elements of the MBT as income taxes for financial statement purposes. Although the precise mechanics for arriving at DTAs for the BIT and GRT elements of the MBT continue to be developed, the new law should essentially create a deduction that is equivalent to the book-tax difference for which a deferred BIT or GRT tax liability is required.

2.19 An entity will need to apply the principles of ASC 740 to determine whether a valuation allowance is needed against the newly created DTA. While this new law was intended to eliminate a financial accounting charge for the MBT, entities need to consider that the deductions defined under the statute are likely to be in different periods than the expected income. Because of this, the DTL is not necessarily sufficient to allow recognition of the DTA.

Section 936 Election by Puerto Rican Subsidiaries 740-10-25 (Q&A 13)

2.20 If a Puerto Rican (or Virgin Island) subsidiary of a U.S. parent elects tax treatment under Section 936 of the IRC, income from this subsidiary that is attributable to Puerto Rico (or the Virgin Islands) is exempt from U.S. regular taxes. However, all current-year earnings of a Section 936 subsidiary, regardless of whether such earnings are distributed, are taxed in the Puerto Rican tax jurisdiction at the Puerto Rican statutory rates.

2.21 Puerto Rico also has a tollgate tax on dividends from a Section 936 subsidiary to its U.S. parent. The percentage of the tollgate tax on unremitted earnings ranges from zero to 10 percent, depending on factors such as the ratio of dividends to earnings and the length of time the earnings are kept in Puerto Rico.

2.22 The tollgate tax should be considered an income tax whenever it is necessary to measure DTLs on unremitted earnings of a Section 936 entity. The FASB staff has taken the informal position that a Section 936 entity is not a foreign subsidiary and that, therefore, only unremitted earnings that arose in fiscal years beginning on or before December 15, 1992, are potentially exempt from deferred tax accounting under ASC 740-10-25-3(a)(2). Any DTL would be calculated on the basis of the rate(s) management actually expects it would ultimately pay. Therefore, an entity may have a tax-planning strategy to reduce the tollgate tax to zero by not remitting Section 936 earnings until after the statutory holding period. In accordance with ASC 740-10-05-9, certain basis differences may not result in taxable or deductible amounts in future years when the related asset or liability for financial reporting is recovered or settled and, therefore, may not be temporary differences for which a deferred tax liability or asset is recognized.

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Italian Regional Tax on Professional and Business Activities (IRAP) 740-10-15 (Q&A 10)

2.23 The Italian Government Local Tax (the IRAP) consolidated and replaced the following taxes that existed previously in Italy: the Local Income Tax (ILOR), a net-worth-based tax, a tax on health insurance, the Local Tax on Business and Professional Activities (ICIAP), and an additional VAT. The taxable base to be used for the IRAP simplistically equals revenues less expenses (excluding labor costs and, for some taxpayers, interest expense), making the IRAP appear to have characteristics of an income tax.

2.24 The Italian Association of Accountants has defined the IRAP as an income tax. However, the U.S. IRS (IRS Release 98-5, Mutual Agreement Between the United States and Italy on Partial Creditability of Italian Regional Tax) will only allow a portion of the IRAP (specifically, the portion related to the tax base that existed before exclusion of labor costs and interest expense) to qualify as an income tax for FTC purposes. Accordingly, the appropriate financial statement classification (and whether the IRAP is considered an income tax) is a matter of judgment that depends on an entitys particular facts and circumstances.

2.25 For example, if the ultimate IRAP taxable base for an entity approximates net income (as might be the case for a business with a low labor content), it may be preferable to account for the tax as an income tax. Similarly, if the ultimate IRAP taxable base for another entity approximates that used for gross revenue tax or VAT (as might be the case for an entity with a high labor content), it may be preferable to account for the tax as a period expense. Determining whether the IRAP is considered an income tax under ASC 740 requires judgment. Consultation with income tax accounting experts should be considered.

Measuring DTAs and DTLs Under the Mexico Income Tax and Flat Tax (IETU) Regimes 740-10-15 (Q&A 15)

2.26 The 2008 Mexican Tax Reform Bill, enacted on October 1, 2007, requires an entity to calculate taxes under two parallel tax systems, the Corporate Income Tax (ISR) and the Business Flat Tax (IETU).

2.27 If the IETU tax is greater than the ISR tax in a particular year, the entity must pay the ISR tax plus the incremental IETU tax. That is, if an entity calculates an IETU tax of $100 and an ISR tax of $80 for the year, the entity must pay an ISR tax of $80 and an IETU tax of $20 for that year.

2.28 The ISR is an income tax under ASC 740 because it is calculated by using a comprehensive net income model as a tax base. The IETU tax is calculated on a modified tax base in which income and deductions are calculated on gross receipts less certain current-period deductions that are identified by statute. For example, capital expenditures are fully deductible in the year of purchase under the IETU tax system but are depreciated over the tax life of the assets for ISR tax purposes. Furthermore, certain expenses, such as salaries and wages, most interest, and certain royalties paid to related parties, are nondeductible for IETU purposes. Certain credits are available for IETU purposes, such as a payroll credit calculated by multiplying taxable wages by the IETU tax rate. The ISR statutory tax rate is 28 percent, and the IETU statutory tax rate is 16.5 percent, 17 percent, and 17.5 percent in 2008, 2009, and thereafter, respectively.

2.29 The IETU is determined by applying a tax rate to a base that takes into account both revenues and expenses; it is therefore considered an income tax. Deductible expenses, such as purchases and administrative expenses, will typically be the largest expense items in the determination of net profit. Given the magnitude of the deductions (adjustments) applied in the determination of the tax base, the IETU has characteristics of an income tax and should therefore be considered an income tax under ASC 740. The entity cannot lower ISR taxes due in later years as a result of IETU tax paid in earlier years.

Scope Considerations Related to Taxes on Dividends

2.30 ASC 740 includes the following implementation guidance on determining whether a payment made on dividends distributed is considered an income tax:

ASC 740-10 Implementation Guidance

Payment Made Based on Dividends Distributed

55-72 The following guidance refers to provisions which may be present in the French tax structure; however, it shall not be considered a definitive interpretation of the historical or current French tax structure for any purpose.

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ASC 740-10 Implementation Guidance (continued)

55-73 The French income tax structure is based on the concept of an integrated tax system. The system utilizes a tax credit at the shareholder level to eliminate or mitigate the double taxation that would otherwise apply to a dividend. The tax credit is automatically available to a French shareholder receiving a dividend from a French corporation. The precompte mobilier (or precompte) is a mechanism that provides for the integration of the tax credit to the shareholder with the taxes paid by the corporation. The precompte is a tax paid by the corporation at the time of a dividend distribution that is equal to the difference between a tax based on the regular corporation tax rate applied to the amount of the declared dividend and taxes previously paid by the corporation on the income being distributed. In addition, if a corporation pays a dividend from earnings that have been retained for more than five years, the corporation loses the benefit of any taxes previously paid in the computation of the precompte.

55-74 Paragraph 740-10-15-4(b) sets forth criteria for determining whether a tax that is assessed on an entity based on dividends distributed is, in effect, a withholding tax for the benefit of recipients of the dividend to be recorded in equity as part of the dividend distribution in that entitys separate financial statements. A tax that is assessed on a corporation based on dividends distributed that meets the criteria in that paragraph, such as the French precompte tax, should be considered to be in effect a withholding of tax for the recipient of the dividend and recorded in equity as part of the dividend paid to shareholders. [EITF 95-9, paragraph Issue]

Withholding Taxes for Dividends Paid to Shareholders 740-20-45 (Q&A 06)

2.31 A tax jurisdiction may impose a withholding tax upon an entity, to be paid for the benefit of the recipients when the entity makes a dividend distribution. In certain instances, an entity will receive a future tax benefit for actually withholding the tax from the recipients distributions (e.g., a reduction in future income taxes in an amount equivalent to the withholding tax).

2.32 If an entity receives a future tax benefit related to the withholding tax, the entity should recognize a DTA for the future tax benefit. The income tax benefit should be recognized as income tax expense from continuing operations. Otherwise, if the entity does not receive a tax benefit, there is no current or deferred tax consequence because the recognition of a withholding tax is not an income tax within the scope of ASC 740. Instead, the withholding tax is a payment on the recipients behalf, with no tax benefit to the entity making the distribution, and should be recorded in equity as part of the dividend distribution.

2.33 This conclusion is analogous to the guidance in ASC 740-10-15-4. That guidance indicates that a tax that is assessed on an entity based on dividends distributed is, in effect, a withholding tax for the benefit of recipients of the dividend and should be recorded in equity as part of the dividend distribution in that entitys separate financial statements if the tax meets both of the following conditions:

Thetaxispayablebythe[corporation]ifandonlyifadividend

Accountng for Income Tax

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