ASC 740 Recent Developments 2013 & Q1 2014

Accounting for Income Taxes:

Recent Trends & Developments

DALLAS CPA Society

Katherine Morris, CPA

May 8, 2014

scaling complex

rules….

a tangled web of

complex

matters…

Accounting for

Income Taxes Course Learning Objectives: This presentation will provide participants with one

hour of A&A credit and the knowledge of recent trends & developments impacting the

reporting of income taxes in the financial statements under ASC 740.

January 19, 2015

Agenda of Tax Provision Recent Trends

• Recent Trends

• Focus on Issues

1. Valuation allowance (VA)

considerations

2. Effective tax rate (ETR) reconciliation

/ Interim Reporting

3. Indefinite reinvestment of foreign

earnings

4. Uncertain tax positions (UTP)

Best Practices will be shared during each topic discussion.

3 January 19, 2015

Recent Trends

January 19, 2015 4

Accounting for Income Taxes is most relevant to

C-Corporations and has been one of the key areas

of restatements, material weaknesses and

significant deficiencies for public filers over the

past 12 years. (Audit Analytics - Analysis of past

12 years, report released April 2013)

Observation: Similar to the impact of Sarbanes-Oxley on auditing, the SEC’s

focus on income taxes has trickled down from the audit of public companies

and are now addressed by both those performing audits and those conducting peer reviews of auditors of private companies.

Recent Trends - FASB’s Agenda

FASB removes IFRS / FASB convergence project on

income taxes of IAS 12 & ASC 740 from agenda

(January 29, 2014, FASB vote)

FASB income tax Agenda:

Cash flows from income taxes

Intraperiod tax allocation

Earnings indefinitely reinvested in foreign subsidiaries

Intercompany transfers of assets

5 January 19, 2015

Recent Trends – SEC & PCAOB

January 19, 2015 6

SEC and Investor Focus: DISCLOSURES &

TRANSPARENCY

Recent SEC inspections have found that the income tax

disclosures provided in corporate financial filings often

focus on immaterial matters that don't adequately support

accounting conclusions related to valuation allowances

and unrepatriated foreign earnings (December 2013)

PCAOB Reviews: DOCUMENTATION

Documentation is lacking with respect to the judgments,

estimates and assertions

Recent Trends – SEC Technical Focus

SEC Comments – current technical focus:

Valuation allowances

Rate reconciliation

Repatriation of foreign earnings and liquidity ramifications

Unrecognized tax benefits

Transparency:

SEC continues to ask registrants to provide early-warning

disclosures about changes in the business, issues, and

how they may potentially affect the financial statements.

7 January 19, 2015

value of DTAs are

still an issue…

1. Valuation

Allowances -

Considerations

1. Valuation Allowances (VA) Considerations

Overview

General Rule:

Reduce a Deferred Tax Asset (DTA) by a Valuation Allowance (VA)

if, based on the weight of all available evidence, it is more likely

than not (i.e., >50%) that some portion or all of the DTA will not be

realized (ASC 740-10-30-17)

Reduce the DTA to the amount that is more likely than not to be

realized

9 January 19, 2015

Valuation Allowances – Documentation

Issues Lack of documentation and disclosure of positive and negative

evidence

No contemporaneous support for need for / release of VA

Take Aways Contemporaneously Analyze & Document:

Management’s responsibility to contemporaneously examine, support and document rationale for the need for and for changes in valuation allowances

Disclose (i.e., be transparent in footnotes): Public filers - discuss in a transparent manner in the MD&A and the

footnote disclosure(s) the underlying business reasons why a valuation allowance is needed or not required

Auditors are required to retain and assess management’s support and documentation

10 January 19, 2015

Valuation Allowances –

Analyze & Document the Evidence

Best Practice

Qualitative & Quantitative analysis

Document the need for and amount of the VA:

Negative Evidence

Positive Evidence

Conclusions Reached

Negative Evidence

A history of operating losses or tax credit carryforwards expiring unused (Some say a 2-year history of losses)

Losses expected in early / start-up years

Known circumstances that if unfavorably resolved would adversely effect future operations and profit level

11 January 19, 2015



Positive Evidence: Sources of Income

Future reversals of certain DTLs

Caution: consider the reversal criterion

Future taxable income exclusive of reversal of DTAs

Taxable income or credit carryback opportunities

Tax planning strategies creating income

Must be considered

Must be prudent and feasible!

12 January 19, 2015



Other Examples of Positive Evidence

Contracts or committed sales backlog that would produce more

than enough taxable income to realize all or part of the DTAs

An excess of appreciated asset value over the tax basis of the

entity’s net assets in an amount sufficient to realize the deferred

tax assets – if it would be feasible and prudent to sell…

Strong earnings history with evidence indicating the loss is an

aberration rather than a continuing condition

Observation: Some say at least 3 years of earnings

REMINDERS:

• Schedule out and quantify the impact.

• Remember a valuation allowance is not an all or none amount.

13 January 19, 2015



Possible Sources of Income

Outside Basis Differences in Foreign Sub

When expected to reverse in the foreseeable future

When the foreign earnings have not been asserted as

indefinitely reinvested under APB Opinion 23

Caution: consider impact of cumulative translation adjustment

(CTA)

Equity Method Investments

When there is an a expectation of reversal in the foreseeable

future

14 January 19, 2015


Tax Planning Action or Strategy?

Tax Planning Actions

Completed in the ordinary course of business

For VA assessments, impact is reflected in current year and estimates of future taxable income if implementation has occurred

Costs - recognize when incurred

Tax Planning Strategies

Prudent & feasible strategy an entity would take to prevent a tax attribute from expiring unused

For VA assessments, strategies can be anticipated and incorporated into future taxable income projections when quantifying the VA

Costs - net against VA amount

15 January 19, 2015

Valuation Allowances – Issues

DTL on Goodwill – Naked Credit

Guidance on sources of taxable income: Consider DTLs resulting from temporary differences that will

reverse in future periods

Do not use DTLs created by the book/tax basis difference on nonamortizable book goodwill

Common Error Companies often reduce the DTAs by all DTLs, including the

naked credit, to compute the amount of the VA

Issue By the very nature of goodwill, the DTL is not expected to reverse

DTLs on indefinite lived intangibles, such as goodwill, create a “Naked (DTL) Credit” that cannot be used as a source of income to reduce the DTA when computing the need for a VA

16 January 19, 2015

Valuation Allowances – Issues

DTL on Goodwill – Naked Credit

Example:

Current tax loss, full valuation allowance against the DTA for NOLs

$1,000 of tax amortization on goodwill; no other book/tax differences

Tax rate = 40%

Provision = $400

Current provision = $0

Deferred provision = $400

To establish the DTL for the basis difference in goodwill

The indefinite-lived asset temporary difference cannot be considered a

source of income to reduce the VA

Total tax expense = $400

Observation: even though the Company has a current loss, it has tax

expense in the current year because of the $400 increase in the DTL.

17 January 19, 2015


Recent Development on Goodwill

January 19, 2015 18

New Guidance (ASU 2014-02) Accounting Standard provides a simplified, elective approach to

accounting for book goodwill for PRIVATE companies Amortize goodwill over 10 years – or less if identifiable shorter life

Test for impairment when a triggering event occurs, not annually

Effective: years beginning after 12/15/2014; early adoption permitted

Implication to VA In Review: Tax Amortization of book goodwill generally creates a (“naked

credit”) DTL on an indefinite lived asset that will not reverse in the future

An election under ASC 2014-02 effectively re-characterizes goodwill as a finite lived asset – i.e., amortizable for book

The resulting reversal of the DTL could potentially support recoverability of a DTA when looking at the need for a valuation allowance

Valuation Allowances – Issues: Analyze

DTAs and DTLs for each Jurisdiction

Issue

DTLs from different jurisdictions cannot be considered as a

source of income to reduce the amount of VA on DTA

Example

UK DTA = $100; related to UK NOLs with full VA

US Parent DTL = $(100), relating to depreciation on US assets

UK DTA $100

UK - Valuation Allowance (100)

US DTL (100)

Consolidated DTL $(100)

The US taxable temporary difference cannot be netted against UK DTA

to reduce the UK valuation allowance

19 January 19, 2015

Valuation Allowances – Issue

When Can VA Be Released? Guidance:

Report changes to the VA in the reporting period they occur

Consider what triggering event(s) have occurred since the prior assessment and whether a change in conclusion is warranted

Issue: Considerations of when the VA can be released:

When did income begin?

Is it sustainable?

When was a 3-year history of earnings established?

Is there a carryback opportunity?

Other…Has a non profitable business been disposed?

Take Aways: Document the analysis of evidence

Support the triggering event(s)

Judgment – i.e., quantify when and how much?

Management should apply a consistent policy on what criteria should be used on which to base VA reductions

20 January 19, 2015


When Can VA Be Released?

Public Filers

The SEC staff has indicated registrants consider:

(1) the magnitude and duration of past losses,

(2) the magnitude and duration of current profitability, and

(3) changes in factors (1) and (2) that drove losses in the past and those currently driving profitability.

Disclosure: Include a discussion of the assessment of positive and negative factors or reasons that led to a reversal of a valuation allowance, and effectively answer the question “Why now?”

21 January 19, 2015


DTAs Not a Substitute for Analyzing UTP

Guidance

DTAs should be established for all deductible temporary differences, NOLs and Credits

Record DTAs gross; then consider need for VA

VA may be required if future realization is in doubt due to insufficient future taxable income

Take Aways

A VA is not an appropriate way to handle liabilities on uncertain tax positions (UTPs) that do not meet the recognition or measurement thresholds

Companies are required to examine UTPs even when there is a “full” VA on DTAs

22 January 19, 2015

Valuation Allowances – Recent Development

on Uncertain Tax Positions New Guidance (ASU 2013-11) - Presentation of an Unrecognized Tax

Benefit: When a NOL Tax Credit Carryforward Exists — reduce the DTA for an NOL

carryforward or a tax credit carryforward by the liability for the tax benefit resulting from an uncertain tax position

Exceptions: 1) When the NOL or tax credit carryforward cannot be used to settle taxes resulting

from the disallowance of the tax position, or

2) When the entity does not intend to use the NOL or tax credit carryforward DTA for settlement

If conditions 1) or 2) exist, present the liability for the uncertain tax position and do not net the amount with a DTA.

Effective Date: Public entities: fiscal years beginning after December 15, 2013

Nonpublic entities may wait until fiscal years, and interim periods beginning after December 15, 2014, to adopt the amendments

Early adoption is permitted

23 January 19, 2015


Impact of Tax Law Changes

General Rule (ASC 740-10-30-17):

Consider all currently available information about future

events when determining whether a valuation allowance

is needed for a DTA.

Reminder

An entity should not consider changes in tax laws or rates

when assessing the realizability of a DTA before the

period in which the change is enacted.

24 January 19, 2015


SEC Comments on Disclosures

BOILERPLATE DISCLOSURES: Cicely LaMothe, senior assistant chief accountant in the division's

Office of Real Estate and Commodities, said the SEC continues to find boilerplate disclosures on deferred tax valuation allowances (Dec. 2013)

ISSUE

Some registrants simply state that they considered the four sources of taxable income required when determining the ability to realize their deferred tax assets.

SUGGESTED REMEDIES – to increase transparency Address the limitations on the entity's use of net operating losses and

foreign tax credits.

Reference expiration dates.

Provide a disclosure indicating the relative magnitude of each source of taxable income that supports the realization of deferred tax assets.

Disclose whether material positive or negative evidence was considered.

25 January 19, 2015

timing is

everything…

2. Effective Tax

Rate / Interim

Reporting

2. Effective Tax Rate (ETR) Reconciliation

“Effective Tax Rate” =

Income Tax Expense / Pretax Income = ETR%

Purpose of ETR Reconciliation

Quantifies and explains the material differences of the

“expected” US federal statutory income tax rate of 34% or 35%

to the company’s “actual” or “effective” tax rate.

27 January 19, 2015

Effective Tax Rate Reconciliation -

Disclosures Reconciling Items: (shown in footnote disclosure)

Examples of Material Rate Reconciliation Items:

Pretax Income * 34 or 35%

State and foreign taxes (net of federal benefit)

Permanent Differences

Changes in the Valuation Allowance

Income Tax Credits

True Ups and changes in reserves or change in prior year tax

Changes in Tax Rates

Show dollars ($s) or percentages (%s)

Separate-line-item disclosure is required for items when meets materiality threshold of >5%: i.e., Pretax Income on reconciling item * Statutory Tax Rate = > 5% of total Tax

Expense

Extraordinary items and Discontinued Operations are disclosed net of tax

28 January 19, 2015

Effective Tax Rate Reconciliation -

SEC Staff Comments on Rate Recs

Reconciling items:

Not labeled correctly / did not adequately describe the

underlying nature of the amount

Inappropriately aggregated material reconciling items

Inconsistent with related amounts disclosed elsewhere in a

registrant’s filing

Foreign tax info not disclosed in MD&A consistent with

footnote:

Each material foreign jurisdiction; each tax rate

Impact of each jurisdiction on the amount in the rate rec

Corrections of errors inappropriately reflected as changes

in estimates

29 January 19, 2015

Effective Tax Rate Reconciliation –

Blended Rate Versus Actual Rate?

Preferred Practice:

Use actual tax rates currently

in effect by jurisdiction,

weighted appropriately,

versus a blended rate

computation

30 January 19, 2015

Effective Tax Rate Reconciliation:

Changes in Tax Law

Impact of new tax legislation or change in rates are

recognized in the period that includes the enactment date

(ASC 740-10-25-47), regardless of the effective date

Continuing Operations:

Include the impact in income from continuing operations for the

period that includes the enactment date. (ASC 740-10-45-15)

Discrete Items:

Impact on DTL or DTA (ASC 740-10-35-4)

Effects on taxes payable or refundable for a prior year when the

change has retroactive effects

31 January 19, 2015


Changes in Tax Law

Example: Major business tax provisions “extenders” expired at the end of

2013: R&D credit

Subpart F exemption for active financing income and look-through treatment for payments between related CFCs

15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements

New markets tax credit

Work opportunity tax credit

Action Item: The tax impact of these items cannot be considered in the 2013

financials but in the period if & when a tax law enactment occurs.

32 January 19, 2015


Changes in Tax Law

New Legislation: Fixed Assets: Capitalize vs Expense

Final regulations released September 13, 2013 on applying IRC Section 263(a) of the to amounts paid to acquire, produce, or improve tangible property, as well as rules for materials and supplies (IRC Section 162)

Tangible Property Accounting Method Change

Results: Change tax accounting methods / apply rules retrospectively with

a 481(a) adjustment

Changes deferred taxes / book vs tax basis on Fixed Assets Positive 481(a) adjustment creates DTL

Negative 481(a) adjustment creates DTA

Impact of timing of future reversals considered in VA on DTAs analysis

Reclasses in classified balance sheet: base on the expected reversal date of that temporary difference

33 January 19, 2015

Effective Tax Rate

Interim Reporting

General Rule

Apply estimated annual ETR to the year-to-date ordinary

income (or loss) from continuing operations

Revise estimated annual ETR at the end of each interim

period based upon the best current estimate of the annual

ETR

34 January 19, 2015

Interim Reporting

Discrete Events

Issue

Does the event impact the estimated annual effective tax rate for the quarter/interim period computation?

Discrete Events

Exclude events during the quarter that do not relate to continuing operations or are unusual or infrequent

Recognize in the period in which they occur

Examples:

Settlement of a tax audit related to prior years

Change in tax law which requires retroactive adjustments that fall out of the current year (i.e., Re-enactment of R&D credit).

35 January 19, 2015

Interim Reporting

Income from Continuing Operations

NOT discrete events: Company hires additional employees in Q3 and grants ISO’s

forcing an expense for the year

Company releases all of its valuation allowance in the current quarter based on current years’ earnings

36 January 19, 2015

Interim Reporting

Loss YTD / Forecasts Income

Issue:

The Company has a loss year-to-date but forecasts

income; no valuation allowance

Results:

Show tax benefit YTD; will offset future income

Show tax expense in future periods that reflect

income

37 January 19, 2015

global

operations…

3. Indefinite

Reinvestment of

Foreign Earnings

3. Indefinite Reinvestment of Foreign

Earnings

General Rule

Compute deferred taxes for all differences in book versus

tax basis

Exception to the General Rule for CFCs:

A DTL is not recognized for differences in the amount of

the investment in the shares of the CFC subsidiary owned

by the parent unless it becomes apparent that temporary

differences will reverse in the foreseeable future (e.g.,

when foreign earnings are repatriated to the U.S.)

39 January 19, 2015

Indefinite Reinvestment of Foreign Earnings

Exception – NOT an election

Exception applies if the specific facts and circumstances

warrant

Based on a company’s ability and intent to control the reversal

of a taxable temporary differences (i.e., the outside basis

difference in the stock of CFC due to unrepatriated earnings)

Management’s Position

Does Management intend to permanently reinvest the foreign

earnings overseas?

Caution: review the underlying facts – do they support

Management’s Representation?

Document the facts supporting management’s positions

40 January 19, 2015

Foreign Reinvestment of Earnings SEC

Comments

EVIDENCE REQUIRED

Craig Olinger, deputy chief accountant in the SEC's Division of

Corporation Finance, said:

In its inspection of public company filings, an SEC registrant would not

be required to recognize a deferred tax liability for those overseas

earnings if it provides sufficient evidence that its foreign subsidiary has

indefinitely reinvested -- or will indefinitely reinvest -- the undistributed

earnings. (December 10, 2013, Tax Analysts)

41 January 19, 2015

Indefinite Reinvestment of Foreign Earnings

– Best Practices Supporting Assertion

Issues Factor in the liquidity and overall financial health of the U.S.

operations

If unremitted earnings could be needed at the parent level to meet existing and anticipated obligations, it may be difficult to support an assertion of indefinite reinvestment

Support: A specific documented plan should lay out items such as the

parent and CFC’s long-term and short-term Projected working capital and other financial needs in all locations

Budgets and forecasts, past dividends, previously taxed income, and tax consequences of a decision to remit or reinvest

Impact of support provided by CFC to US for transactions, such as mergers, acquisitions, servicing loans or meeting covenants or credit obligations

Alignment among management of multiple business functions within a company’s global organization

42 January 19, 2015

solitary facts…

4. Uncertain Tax

Positions

4. Uncertain Tax Positions

General Rule:

ASC 740-10, fka FIN 48, requires

all material income tax positions

for all open tax years to be

reviewed.

If the position is more likely than

not to be sustained upon audit, an

amount must be accrued.

44 January 19, 2015

Uncertain Tax Positions – Issue

Position Taken

When is a tax position considered “taken”?

1. A position taken in a previously filed return or expected to

be taken in a future tax return (original or amended)

2. When the taxpayer fails to file a required return

45 January 19, 2015


Effectively Settled

A tax position is considered to be “effectively settled”

when:

1. Exam is complete (ASC 740-10-25-10a)

2. The taxpayer does not intend to appeal or litigate any

aspect of the exam’s conclusions (ASC 740-10-25-10b)

3. When it is remote that the taxing authority would

examine/reexamine any aspect of a tax position (ASC 740-

10-25-10c)

46 January 19, 2015


Changes in Judgment

Issue: Company changes the liability for uncertain tax positions.

Guidance: Measurement of a tax position should "be based on management's best

judgment given the facts, circumstances, and information available at the reporting date"

Subsequent changes in judgment must be based on the evaluation of new information

Additional analysis of existing information would not typically constitute new information for purposes of adjusting prior estimates

Presentation: A change in judgment that results in subsequent recognition,

derecognition or a change in measurement of a position taken in a prior annual period must be recognized as a discrete item in the period in which the new information becomes available. (ASC 740-10-25-15)

Disclose change

47 January 19, 2015

Uncertain Tax Positions –

SEC Comments/Expectations

Observations Failure to provide required disclosures about

unrecognized tax benefits, which include a tabular reconciliation of such benefits (under ASC 740-10-50-15 and 50-15A).

Where no liability or benefit for unrecognized tax benefits exists (or for which such benefits are immaterial), consider disclosing those facts.

Lack of transparent disclosures about possible future changes in unrecognized tax benefits about

(1) The tax rate reconciliation impact,

(2) The impact on valuation allowances, and

(3) Registrants’ assertions that foreign earnings are indefinitely reinvested.

48 January 19, 2015

Appendix…

Documentation

of UTPs – Best

Practices

Uncertain Tax Positions – Documentation Procedures

Technical merit of tax positions

Measurement

By jurisdiction Federal

State International

Interest & penalties

Material items

Current period activity

Changes in judgment

Assumptions

January 19, 2015

Documentation Supporting a Tax Position Tax Year:

Tax Jurisdiction: Insert tax jurisdiction.

Tax Position: Describe the tax position.

Unit of Account: Describe the selected unit of account.

Does the tax position meet the “more likely than not”

recognition threshold: Meets / Does Not Meet Recognition Criteria.

Why does the tax position meet or fail to meet the “more

likely than not” recognition threshold:

Qualitative Law Analysis: Include the technical merits of the

tax position applied to the facts and circumstances of the tax

position.

Amount recorded in the tax return: $

Income tax expense for the current fiscal period: $

Income tax expense for the prior fiscal period(s): $

Current tax liability recorded: $

Noncurrent tax liability recorded: $

Deferred taxes on item: $

Liability for unrecognized tax benefit at the balance-sheet

date:

$

Support amounts recorded for the unrecognized tax

benefit:

Measurement: Calculate the largest amount of benefit that is

greater than 50 percent likely of being realized/i.e., probability

tables.

Measurement – Assess the Probability of

Outcomes

Possible

Estimated

Outcome

Individual Probability of

Occurring

Cumulative

Probability

of Occurring

$ 100 10% 10%

$ 80 20% 30%

$ 60 25% 55%

$ 50 20% 75%

$ 40 10% 85%

$ 20 10% 95%

$ 0 5% 100%

•NOTES:

•$60 is the largest amount of benefit > than 50% likely of being realized upon settlement

•$40 would be recorded on the balance sheet as an “unrecognized tax benefit” ($100 - $60)

Process: Document measurement process using a probability table or

some other source of measurement.

January 19, 2015

Recognition & Measurement

JURISDICTION: Federal

Description of Identified Uncertain Tax

Positions in Current Period

Tax (Benefit) or

Accrual –

Recognition

Criteria Met?

Amount to be

Reported

“Measurement”

1

2

Total

Process: Document decision process on recognition criteria – MLTN or not? –

and document results from the measurement step – i.e., the amount to be

reported.

January 19, 2015

Thank you

Material discussed in this presentation is meant to provide general information and should not be acted on without professional advice tailored to your firm’s or company’s individual needs.

To ensure compliance with Treasury Department regulations, any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Service Code or applicable state or local tax law provisions or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.

January 19, 2015

questions…

Katherine D. Morris, CPA

(404) 317-1883

[email protected]

January 19, 2015

ASC 740 Recent Developments 2013 & Q1 2014

Documents

Transcript of ASC 740 Recent Developments 2013 & Q1 2014