Tax Accounting Services - Accounting for Income Taxes: 2014 Year-end Hot Topics
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Tax Accounting
Services
Accounting for Income
Taxes: 2014 Year-end
Hot Topics
January 2015
Contents A year in review 1 Tax law developments 2 Standard setting update 5 SEC comment letters 7 Uncertain tax positions 8 Valuation allowances 9 Indefinite reinvestment assertions 11 Financial instruments 13 Intercompany transactions 15 Foreign currency 17 Business combinations and disposals 19 Tax accounting method changes 22 Stock-based compensation 23 Taxes not based on income 25 Intraperiod tax allocation 26 Contacts 27
A year in review Calendar year 2014 has seen considerable activity in the legislative and regulatory landscapes both in the United States and abroad. These developments, combined with an environment of political and economic uncertainty, have added to the existing challenges in accounting for income taxes. The global tax environment continues to evolve as companies are faced with a rapidly-changing business landscape, increased stakeholder scrutiny, and a heightened enforcement environment. Trends in responsibility and integrated reporting, as well as the use of non- GAAP measures have also gained momentum. Managing tax risks and addressing a perception that companies may not be paying their “fair share” of tax are in the spotlight as stakeholders have increasingly shown interest in these areas. Tax planning and certain areas of tax accounting have become Boardroom issues. As in prior years, this publication is focused on topics we believe will be widely relevant to the preparation of 2014 year-end financial statements. Some topics have been discussed in our prior annual publications; however, their continuing importance warrants their inclusion in 2014. For information related to presentation and disclosure, please refer to the separate PwC Tax Accounting Services Income Tax Disclosure publication. Unless specifically indicated, the discussion and references throughout the publication pertain to US generally accepted accounting principles (US GAAP) and reporting considerations. 1 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics
Tax law developments
Under US GAAP, Accounting US and state tax law developments Significant changes include: (1)
Standards Codification (ASC) 740, • United States federal – As eliminating the bank franchise tax
Income Taxes, requires companies to mentioned in our 2013 Hot Topics and subjecting all corporations to a
measure current and deferred income publication, a number of US tax law revised corporate franchise tax, (2)
taxes based upon the tax laws that are provisions expired on December 31, reducing the corporate tax rate
enacted as of the balance sheet date of 2013. At the end of 2014 President from 7.1% to 6.5%, (3) increasing
the relevant reporting period. As a Obama signed into law the Tax the MTA surcharge rate from 17%
result, for the measurement of Increase Prevention Act of 2014, to 25.6%, (4) establishing a 0% tax
deferred tax assets and liabilities, the providing for a one-year retroactive rate for “qualified New York
applicable tax rate applied to extension of expired business and manufacturers”, (5) phasing out the
cumulative temporary differences is individual tax provisions. Key capital base tax rate to 0% by 2021,
based upon the enacted law for the business provisions that were (6) implementing a new unitary
period in which the temporary renewed through December 31, 2014 combined reporting system, (7)
differences are expected to be realized include the research credit, 50- revising the net operating loss
or settled. Thus, even legislation percent bonus depreciation, look- provisions, and (8) establishing
having an effective date in the future through treatment for controlled a single receipts factor
will typically cause an immediate foreign corporations (CFCs), and the apportionment formula with
financial reporting consequence subpart F exception for active customer sourcing provisions.
upon enactment. financing income. New York City has yet to conform to
Under International Financial • The Internal Revenue Service (IRS) these changes; taxpayers will be
Reporting Standards (IFRS), issued final regulations on the IRC required to determine their overall
International Accounting Standard Section 174 deduction for research state and city liabilities under two
(IAS) No. 12, Income Taxes, requires and experimentation expenditures different tax regimes.
companies to measure current and (T.D. 9680) that adopt, with • Rhode Island –On June 19, 2014,
deferred income taxes based on the tax certain modifications, the Governor Lincoln Chafee signed
laws that are enacted or substantively proposed regulations issued in into law the following changes to
enacted as of the balance sheet date of September 2013. the business corporation tax: (1) a
the relevant reporting period. This can tax rate reduction from 9% to 7%,
• The IRS issued final
mean that for a particular reporting (2) mandatory unitary combined
regulations under Section 168
period, the effects of a tax law may be reporting, (3) special treatment for
regarding disposals of tangible
reported under IFRS but not under US entities organized in ‘tax haven’
depreciable property (T.D. 9689),
GAAP. For additional information, countries, (4) single sales factor
which modify the proposed
please refer to the PwC Global Tax apportionment, and (5) repeal of
regulations issued in September
Accounting Services publication related party expense add-backs.
2013.
Around the World: When to account The new law also repealed the
for tax law changes. • The IRS issued final Section 861
franchise tax for tax years
regulations (T.D. 9676) regarding
At each reporting date, other tax law beginning on or after January 1,
the allocation and apportionment of
developments, such as federal, state, 2015.
interest expense in calculating the
and international court decisions, • Michigan - On July 14, 2014, the
foreign tax credit. These regulations
should also be timely considered for Michigan Supreme Court held that
finalized temporary and proposed
effects on existing uncertain tax International Business Machines
regulations without substantive
positions, or on positions expected to Corporation (IBM) was entitled to
change.
be taken in the future. The existence of use the Multistate Tax Compact’s
controls to proactively monitor, • The IRS indicated that final
(MTC) elective three-factor
evaluate, and timely consider the regulations applying to foreign
apportionment formula to calculate
accounting implications of such currency translation under Section
its 2008 Michigan business tax. The
matters is critical. 987 could be issued by the end of the
court further held that the modified
calendar year.
The following highlights several 2014 gross receipts component of the tax
tax law changes and developments • New York - On March 31, 2014, fit within the broad definition of an
around the world. Governor Andrew Cuomo signed the income tax under the MTC, thereby
state’s fiscal year 2014-2015 allowing IBM to use the Compact’s
executive budget legislation. The elective formula for this portion of
legislation overhauled the corporate the tax base.
tax regime and made other changes
to various
tax provisions.
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 2
On September 11, 2014, Governor Rick (b) gradual corporate income tax administration from Luxembourg
Snyder signed legislation (S.B. 156) rate increase from 20% to 25% (for to another European Economic
retroactively repealing the Multistate Tax shareholders on the attribution Area (EEA) member state (i.e., to
Compact from the state statutes, effective method)/27% (for shareholders on an EU member, Iceland,
January 1, 2008. The legislation is the cash basis method) in 2018; Liechtenstein or Norway) now have
intended to supersede the Michigan (c)the thin capitalization debt/equity an option to defer the exit tax
Supreme Court’s decision and potentially rules will now be applied to total arising on the migration without
relieve the state from paying refund (foreign and local) indebtedness; (d) incurring interest on the
claims to other taxpayers who elected the a 35% tax on capital gains of foreign outstanding tax liability. In
three-factor apportionment formula. shareholders recognized in addition, a ‘roll over’ is now
connection with the sale or other available for capital gains realized
International tax law developments transfer of Chilean shares; (e) on the disposal of certain qualifying
limitation on amortization of assets (e.g., immovable property) if
• Austria – In 2014 Austria enacted a
goodwill; (f) introduction of CFC and the sale proceeds are reinvested in
number of significant tax measures,
general anti-tax-avoidance rules. an asset allocated to a permanent
including: (a) limitation on
utilization of foreign tax losses to • Hungary – In 2014 changes to tax establishment of the company in
75% of Austrian taxable income; (b) loss carry-forward rules were any other EEA member state and
elimination of goodwill enacted in Hungary. Broadly, tax certain other conditions are
losses incurred after 2015 will be satisfied.
amortization; (c) disallowance of
deductions for ‘golden handshakes’ available for utilization within five • Poland – Stricter thin capitalization
(generally, special severance years, and losses incurred before rules were introduced in Poland. In
payments). 2015 will be available for utilization particular, the debt/equity ratio is
up to 31 December 2025. now 1:1. In addition, there are now
• Australia – The Australian
• Japan – In 2014 tax reform was new CFC provisions which apply to
government repealed the carbon tax
and minerals resources tax. It also enacted in Japan. Key measures of passive income taxed at a rate lower
repealed the following measures the reform include: (a) the than 14.25%. Subsidiaries in ‘tax
termination of the Restoration havens’ also will be treated as CFCs.
retroactively: (a) deduction for
geothermal energy exploration Corporation surtax effective from • Russia – In 2014, Russia eliminated
expenditures (effective from July 1, April 1, 2014, (b) extension of the a 30% tax rate on dividends payable
2014); (b) immediate deduction for temporary suspension of the tax loss on the shares of Russian issuers
certain depreciable assets held by a carry-back for another two years recorded through depositary
small business (effective from (small and medium enterprises programs and other accounts of
January 1, 2014); and (c) loss carry- excluded); (c) temporary suspension foreign intermediaries. This rate
back rules (effective from July 1, of the taxation of retirement pension previously applied when
2013). In addition, amendments funds was extended for another information about the beneficial
were made to thin capitalization three years. owners of dividends was not
rules to reduce the safe harbor debt • India – The Indian Budget 2014 disclosed in due course to a Russian
amount from 75% to 60% of included the following corporate tax tax agent. With the change,
adjusted Australian assets (an changes: (a) general anti-avoidance effective on January 1, 2015, the
effective debt/equity ratio of 1.5:1, rules which become effective April 1, maximum Russian withholding
replacing the existing 3:1 ratio) and 2015; (b) capital gain treatment for income tax rate on dividends will be
increase the de minimis threshold income arising from transactions in 15%.
for allowable debt deductions to securities (including derivatives) of • Spain – The corporate income tax
$2m. Lastly, the participation foreign institutional/portfolio rate in Spain was reduced from
exemption for dividends received investors; (c) an extension of the 30% to 28% for 2015 and to 25% for
from foreign companies on shares concessional 5% withholding tax rate 2016 year (30% rate would
that qualify as debt interests under for foreign loan agreements entered continue to apply to financial
the Australian debt/equity rules was into before June 30, 2017; (d) institutions). In addition, the offset
removed and an integrity measure exemption of Indian capital gains tax of tax losses is now limited to 70%
with respect to the non-resident for the transfer of certain of taxable income, and impairment
capital gains tax provisions government securities between two losses in relation to tangible assets
was introduced. non-Indian residents outside India. and investment property are no
• Chile – Significant tax reform • Luxembourg – The Luxembourg longer tax deductible.
measures were enacted in Chile that Parliament approved law 6556, • Thailand – Thailand reduced its
included: (a) creation of two intending to align certain tax corporate income tax rate for the
alternative methods of income provisions with the European Union 2015 year from 30% to 20%.
taxation at the shareholder level (EU) law. Taxpayers migrating their Without further action the rate will
(attribution basis and cash basis); statutory seat and place of central revert to 30% in 2016.
3 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics
• United Kingdom (UK) – The • State aid – At the beginning of 2014,
following budget proposals were the European Commission (EC)
enacted: (a) changes to the grouping announced a new focus on fiscal
rules for the UK debt capitalization state aid. Specifically, the EC has
rules; (b) restrictions on utilization initiated several investigations
of trading losses due to changes in addressing whether a tax benefit
corporate ownership were relaxed, obtained via member state rulings,
(c) annual investment allowance agreements, settlements or targeted
(100% capital allowanced on plant) incentives constitute unlawful State
was increased to GBP 500,000. aid. If a tax benefit is found to be
• Venezuela - On November 18 2014, a State aid, the EC may require the
reform of the Venezuelan Income relevant state to recover the unlawful
Tax Law was enacted creating a 25% tax benefit from the taxpayer with
cap (of the tax period's taxable compound interest for the ten years
income) for utilisation of prior to the opening of the
carryforward losses. investigation. In 2014 the EC opened
a series of investigations into specific
tax rulings and tax regimes. The EC
Other developments
also ordered Spain to recover aid
• Country-by-country reporting – On granted through amortization of
September 16, 2014, the financial goodwill on indirect
Organization for Economic Co- shareholdings. However this
operation and Development (OECD) decision was overruled by the
issued the final template for country- General Court of the EU in
by-country reporting (CBCR December 2014 on the basis that the
template) as part of its first round of EC failed to establish that the
deliverables in relation to the Base Spanish regime was selective.
Erosion and Profit Shifting (BEPS) • Diverted Profits Tax – In December
Action Plan. Using the CBCR 2014, the UK government announced
template, multinationals would be a proposal to introduce a 25% tax
required to report the following data targeting ‘artificially diverted profits’
for all tax jurisdictions in which they (i.e., tax on profits declared overseas
are subject to tax: (1) revenues (from that are made from revenues earned
both related and unrelated party in the UK). A similar announcement
transactions); (2) profit before was also made in Australia.
income tax; (3) cash income tax
paid; (4) current year income tax
accrual;( 5) stated capital; (6)
accumulated earnings; (7) number of
employees; and (8) tangible assets
(excluding cash and equivalents).
The OECD will continue working on
implementation and filing issues and
report on these matters at the
beginning of 2015.
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 4
Standard setting update
Refer to: Throughout 2014, the Financial For public entities, the new guidance will
Accounting Standards Update No. Accounting Standards Board (FASB) has be effective for fiscal years beginning
2014-01, Investments—Equity Method continued to take steps to clarify or after December 15, 2014. For nonpublic
and Joint Ventures: Accounting for amend existing accounting guidance. In entities, the amendments are effective
Investments in Qualified Affordable addition, the FASB has introduced several for annual periods beginning after
Housing Projects (a consensus of the income tax accounting topics as part of its December 15, 2014. Early adoption is
FASB Emerging Issues Task Force) initiative to reduce complexity in permitted.
accounting standards.
Accounting Standards Update No.
2014-02, Intangibles—Goodwill and The following Accounting Standards ASU No. 2014-02 and 2014-03
Other: Accounting for Goodwill (a Updates (ASUs) should be considered in
In January 2014, the FASB issued new
the preparation of year-end financial
consensus of the Private Company guidance on two accounting alternatives
statements and beyond.
Council) previously approved by the Private
Accounting Standards Update No. Company Council (PCC).
ASU No. 2014-01 The new standards provide private
2014-03, Derivatives and Hedging:
Accounting for Certain Receive- In January 2014, the FASB issued a new companies with: (1) an alternative
Variable, Pay-Fixed Interest Rate standard permitting entities to account accounting model for goodwill that
Swaps—Simplified Hedge Accounting for investments in low income housing permits amortization of goodwill on a
Approach (a consensus of the Private tax credit (LIHTC) projects using the straight-line basis over a maximum of
Company Council) ‘proportional amortization’ method if ten years, and (2) a simplified hedge
certain conditions are met which include accounting approach for qualifying
Accounting Standards Update No. 1) it is probable that the tax credits interest rate swaps.
2014-09, Revenue from Contracts with allocable to the investor will be available, Under the alternative accounting model
Customers 2) the investor does not have the ability to related to goodwill, goodwill existing as
Tax Insights from Tax Accounting exercise significant influence over the of the balance sheet date would be
Services – October 10, 2014 – FASB operating and financial policies of the classified as a finite-lived asset.
adds stock compensation tax entity, 3) substantially all of the projected
For companies assessing the need for a
accounting topics to its agenda benefits are from tax credits and other tax
valuation allowance on deferred tax
Tax Insights from Tax Accounting benefits, 4) the investor’s projected yield
assets, the classification of goodwill as a
Services – October 27, 2014 – FASB based solely on the cash flows from the
finite-lived asset may result in taxable
decides to propose changes to income tax credits and other tax benefits is
temporary differences which support the
tax accounting positive, and 5) the investor is a limited
realization of deferred tax assets. It
liability investor in the limited liability
should be noted that while this
entity for both legal and tax purposes, and
alternative accounting model is a
the investor’s liability is limited to its
departure from the prior guidance, it
capital investment.
does not change the prohibition on
Under the proportional amortization recording deferred tax for book-over-tax
method, an entity amortizes the initial goodwill in a business combination.
cost of the investment in proportion to the
These standards are effective for fiscal
tax credits and other tax benefits received.
years beginning after December 15, 2014,
The net investment performance is
with early adoption permitted.
recognized in the income statement as a
component of income taxes. The use of
the proportional amortization method is
an accounting policy election to be made
once and thereafter applied to all eligible
investments in LIHTC programs.
5 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics
ASU No. 2014-09 focused on the simplification of income Stock Compensation Project
In May 2014, the FASB issued new tax accounting: the income tax project In October of 2014, the FASB decided to
guidance that resulted from a joint project and the stock-based compensation add income tax accounting related to
with the International Accounting project. stock-based compensation to its agenda.
Standards Board (IASB) which clarified Income Tax Project The Board agreed to address the possible
the principles for recognizing revenue and In October of 2014, the FASB agreed to recognition of all windfalls and shortfalls
developed a common revenue standard issue an exposure draft related to two within income tax expense. That
for US GAAP and IFRS. income tax accounting topics. The draft is proposed treatment would replace the
The core principle of the standard is that expected to be issued in January 2015 current guidance which allocates tax
an entity should recognize revenue which with a 120-day comment period. effects between equity and income tax
depicts the transfer of promised goods or The first proposed change would require expense based upon several factors
services to customers in an amount that recognition of the current and deferred requiring complex tracking and
reflects the consideration that the entity income tax consequences of an intra- computations. Furthermore, the Board
expects to be entitled to in exchange for entity asset transfer when the transfer agreed to include the possible
those goods or services. occurs. This would eliminate the current elimination of the current requirement
While there is no financial reporting exception which requires both the buyer to display the gross amount of windfall
impact for this year-end, there is nothing and seller in a consolidated reporting as an operating outflow and financing
precluding proactive tax planning or the group to defer the income tax inflow in the cash flow statement.
assessment of any potential impacts the consequences of an intra-entity asset
new revenue standard may have on (1) transfer. The second proposed change IFRS Interpretations Committee
existing tax return accounting methods or would require the classification of all During 2014, the IFRS Interpretations
(2) processes, controls, or data needs that deferred tax assets and liabilities as non- Committee (IFRIC) considered changes
may result to properly compute taxable current on the balance sheet. This would to International Accounting Standard 12
income and apply the principles of replace the current guidance which related to the recognition of deferred tax
ASC 740. requires deferred taxes for each tax- assets for unrealized losses on available-
For public entities that apply US GAAP, paying component of an entity to be for-sale (AFS) debt securities and the
the amendments in this ASU are effective presented as a net current asset or liability recognition of current income tax on
for fiscal years beginning after December and a net non-current asset or liability. uncertain tax positions. These changes
15, 2016. For nonpublic entities that apply If adopted, these changes would be would be another step towards US GAAP
US GAAP, the amendments are effective effective for financial reporting years and IFRS income tax accounting
for annual reporting periods beginning beginning after December 15, 2016 for convergence.
after December 15, 2017, and interim public entities. For nonpublic entities, In May, the IFRIC recommended to the
periods within annual periods beginning changes would be effective for the year- International Accounting Standards
after December 15, 2018. Early adoption end financial statements for financial Board that the assessment of recognizing
to the public entities’ effective date would reporting years beginning after December a deferred tax asset related to an AFS
be permitted for nonpublic entities. 15, 2017 and interim periods in the debt security would be made in
For IFRS filers, the equivalent standard following year. Early adoption to the combination with the entity’s other
(IFRS 15) should be applied for annual public entities’ effective date would be deferred tax assets. In addition, the
periods beginning on or after January 1, permitted for nonpublic entities. ability and intention to hold the
2017. Early adoption is permitted. In addition to these two proposed investment until the recovery of its
For more information on the new changes, the FASB instructed its staff to amortized cost basis would not in itself
standard, please refer to the “Tax research the possibility of entirely provide a basis for recognizing the
accounting method changes” section of eliminating the intraperiod tax allocation deferred tax asset. This recommendation
this publication. rules and to reassess the disclosure is similar to the guidance expected to be
requirements relating to unremitted issued by the FASB related to the
earnings and other outside basis valuation allowance assessment on the
Income tax accounting
differences in foreign subsidiaries as part deferred tax asset as part of the Board’s
simplification proposals
of its broader Disclosure Framework project on financial instruments.
In 2014, the FASB gave consideration to Project
several topics related to income taxes
which could reduce complexity under
their broader simplification initiative. The
initiative evolved as a result of feedback
from the Financial Accounting
Foundation’s (FAF) Post-Implementation
Reviews of FAS 109 and FAS 123 (R)
which were completed in November of
2o13 and August of 2014, respectively. At
present, there are two projects that are
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 6SEC comment letters
Calendar year 2014 has continued to see the line item was computed by
a significant number of tax-related identifying its significant components
comment letters issued by the staff of the and (2) a reconciliation detailed by
Securities and Exchange Commission country.
(SEC). Of the comment letters released to The SEC staff has continued to emphasize
the public between January 1, 2014 and that a registrant’s indefinite reinvestment
September 30, 2014, almost 500 of the assertion(s) related to foreign earnings
comments related to tax matters. Of should be consistent with its disclosures
those tax- related comments, within: (1) Management’s Discussion and
approximately 80% related to the Analysis of Financial Condition and
Results of Operations (MD&A), (2)
following areas: indefinite reinvestment
financial statement footnotes, and (3)
of foreign earnings, presentation of the other publicly available information. The
effective tax rate, valuation allowance staff has frequently required additional
assessments, and uncertain tax positions. disclosure in the liquidity section of the
As presented in the table below, matters MD&A of potential tax effects from
of management judgment continue to be repatriating offshore cash and cash
an area of focus for the SEC. Emphasis equivalents.
on providing accurate, transparent, and
plain language disclosures for significant
assertions and estimates should be SEC comment letters have also
considered by preparers when assessing reminded preparers of the requirement
their existing and future disclosures. to disclose an estimate of the unrecorded
With respect to deferred tax asset tax liability relating to unremitted
valuation allowance assessments, the earnings, if practicable to calculate. In
SEC seeks to more deeply understand some of those cases, the SEC has
the facts, circumstances, judgments, and challenged management’s assertion of
decisions made by companies. They are impracticability. Preparers asserting
interested in a company’s assessment impracticability should be prepared to
and weighting of the positive and articulate the basis for their view.
negative evidence, including in Disclosure should include the events
situations where there has been a recent which could cause a liability to be
return to profitability. recorded in the future.
A notable amount of attention is given to We expect areas of management
accumulated foreign earnings and the judgment – particularly in the areas of
presentation of the effective tax rate, valuation allowance, foreign tax rates
including foreign rate reconciling items. and unremitted earnings – to be a
The SEC often requests quantitative and continued area of focus by regulators,
qualitative details to support the investors, and commentators in 2015.
amounts included in the ‘foreign rate
reconciling items’ line item. Common
requests include: (1) a discussion of how
7 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot TopicsUncertain tax positions
Refer to: The accounting for an uncertain tax If the requirements of effective
Chapter 16 of the PwC Guide to position does not end with the initial settlement are met, the resulting tax
Accounting for Income Taxes (the PwC determination of a position’s benefit is required to be reported.
Guide) sustainability. As of each balance sheet
date, uncertain positions must be Jurisdictional netting – On a
reassessed with the existence of new jurisdictional basis, ASU No. 2013-11
information. generally requires an unrecognized tax
benefit (UTB) to be presented in the
New information – New information financial statements as a reduction to a
can relate to developments in case law, deferred tax asset for an NOL
changes in tax law, new regulations issued carryforward, similar tax loss, or tax
by taxing authorities, interactions with the credit carryforward. This would be the
taxing authorities, or other developments. case except when an NOL carryforward,
Such developments could potentially similar tax loss, or tax credit
change the estimate of the amount that is carryforward is not available under the
expected to eventually be sustained or tax laws of the applicable jurisdiction to
cause a position to meet or fail to meet the settle any additional income taxes
recognition threshold. While the resulting from the disallowance of a tax
definition of what can constitute new position. In such instances, the UTB
information is expansive, new or fresh re- should be recorded as a liability and
assessment of the same information does cannot be offset against the deferred tax
not constitute new information. asset. The assessment as to whether a
deferred tax asset is available is based on
Effective settlement – For a tax the UTB and deferred tax asset that exist
position to be considered effectively at the reporting date and should be made
settled, all three of the following assuming disallowance of the tax
conditions must be met: position at the reporting date.
• The taxing authority has completed
its expected examination procedures, Disclosures – Required disclosures
including appeals and any related to income tax uncertainties are
administrative reviews required. often extensive and can be highly
sensitive. For more information, please
• The taxpayer does not intend to
refer to the PwC Tax Accounting Services
appeal or litigate any aspect of the
publication – Income tax disclosure.
tax position included in the
completed examination.
• It is remote that the taxing authority
would examine/re- examine any
aspect of the tax position
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 8Valuation allowances
Refer to: The evaluation of the need for, and Triggering events or changes in
Chapters 5 and 6 of the PwC Guide amount of, a valuation allowance for circumstances – There should be
deferred tax assets is an area that often clear, explainable reasons for changes in
presents challenges for financial a valuation allowance. In assessing
statement preparers. The assessment possible changes, it is important to
requires significant judgment and a consider again the basis for amounts
thorough analysis of the totality of both previously provided and how new
positive and negative evidence available information modifies previous
to determine whether all or a portion of judgments. For example, consideration
the deferred tax asset is more likely than should be given to whether the results for
not to be realized. In this analysis, the the current year provide additional
accounting standard proscribes that the insights as to the recoverability of
weight given to each piece of positive or deferred tax assets or as to
negative evidence be directly related to management’s ability to forecast future
the extent to which that evidence can be results. The mere existence of cumulative
objectively verified. Accordingly, recent losses in recent years or for that matter,
financial results are given more weight cumulative income in recent years, is not
than future projections. conclusive in and of itself of whether a
As preparers perform their assessments, valuation allowance is or is
the following reminders may be helpful: not required.
Level at which assessment is Deferred tax asset utilization vs.
performed – Where local law within a realization – The realization of
jurisdiction allows for consolidation, a deferred tax assets is dependent upon the
valuation allowance assessment generally existence of sufficient taxable income of
should be performed at the consolidated an appropriate character that would
jurisdictional level. allow for incremental cash tax savings.
However, where the local tax law does not For example, if tax losses are carried
allow for consolidation, the valuation back to prior years, freeing up tax credits
allowance assessment would typically (which were originally used to reduce the
need to be performed at the separate tax payable) rather than resulting in a
legal-entity level. refund, a valuation allowance would still
be necessary if there are no additional
sources of income to support the
All available evidence – The realization of the freed-up tax credits.
accounting standard requires that all
Certain tax-planning strategies may
available evidence be considered in
provide a source of income for the
determining whether a valuation
apparent recognition of deferred tax
allowance is needed, including events
assets in one jurisdiction, but not provide
occurring subsequent to the balance sheet
incremental tax savings to the
date but before the financial statements
consolidated entity. In order to avoid a
are released. However, a valuation
valuation allowance in reliance on a tax-
allowance assessment should generally
planning strategy, we believe that the
not anticipate certain fundamental
tax-planning strategy should provide
transactions such as initial public
cash savings to the consolidated entity.
offerings, business combinations, and
In a situation where there is an unlimited
financing transactions until those
carryforward period, we do not believe a
transactions are completed.
tax planning strategy can be utilized for
the realization of deferred tax assets. The
reason for this is because a tax-planning
strategy is intended to be a backup plan
for realizing attributes that would
otherwise expire.
9 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot TopicsOutside basis differences – The
reversal of an outside basis difference in
a foreign subsidiary cannot be viewed as
a source of taxable income when the
foreign earnings are asserted to be
indefinitely reinvested.
Taxable temporary differences on equity
method investments can be considered
as a source of taxable income provided
there is an appropriate expectation as to
the timing and character of reversal in
relation to the deferred tax assets.
Indefinite-lived assets – Taxable
temporary differences associated with
indefinite-lived assets (e.g., land,
goodwill, indefinite-lived intangibles)
generally cannot be used as a source of
taxable income. Thus, a valuation
allowance on deferred tax assets may be
necessary even when an enterprise is in
an overall net deferred tax liability
position.
However, in jurisdictions with
unlimited carryforward periods for tax
attributes (e.g., NOLs, AMT credit
carryforwards, and other non-expiring
loss or credit carryforwards), deferred
tax assets may be supported by the
indefinite-lived deferred tax liabilities.
To the extent a jurisdiction has annual
limitations on carryforward usage, a
valuation allowance may need to be
considered, despite an unlimited
carryforward period.
Disclosures – Due to the significant
judgments involved in determining
whether a deferred tax asset is
realizable, clear and transparent
disclosures are crucial. For more
information, please refer to the PwC Tax
Accounting Services publication –
Income tax disclosure.
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 10Indefinite reinvestment assertions
Refer to: The assertion of indefinite reinvestment of • Management should consider
Chapter 11 of the PwC Guide foreign subsidiary earnings continues to be whether any intercompany
one of the more complex and judgmental transactions, such as a loan or a
Tax Accounting Services Thought
Leadership, Deferred Taxes on Foreign areas of accounting for income taxes. The credit support agreement
Earnings – A Road Map growth in unremitted foreign earnings provided by the foreign
together with differences in global tax laws operations to the US parent, may
has made the application of the indefinite be relevant in assessing the
reinvestment assertion a matter of indefinite reinvestment
heightened concern for many stakeholders. assertion. Such events should be
Companies should consider the following reviewed to consider whether
when evaluating their indefinite they result in the need to record
reinvestment assertion: a current tax liability or whether
there is income tax uncertainty
• There should be coordination and related to the matter.
alignment among multiple business Transactions that present risk of
functions within a company’s global US taxation may suggest that
organization, such as treasury, legal, foreign funds or liquidity are
operations, and business development. needed in the US, potentially
Processes or controls must be in place to contravening an assertion of
ensure that the indefinite reinvestment indefinite reinvestment.
assertion is consistent with the best
• In many instances, such as in the
information available to the
case of an equity method
organization and represents the
investment or the impact of a
organization’s cohesive view, plans, and
consolidated variable interest
expectations.
entity, it is imperative to
• A specific documented plan should understand the parent
address the parent’s and subsidiary’s company’s ability to control
long and short- term projected working distributions or other
capital and other financial needs. transactions that would
Evidence maintained by management otherwise cause a taxable event
should include discussion as to why any to occur. For example, if
excess earnings are not needed by the activities are occurring at the
parent or another operation within the CFC level or below that will cause
group. In cases where management is the recognition of subpart F
considering the expected rate of return income by the CFC’s US parent,
on reinvesting foreign earnings as the underlying facts and
compared with the after-tax return on circumstances must be examined
repatriated funds, that assessment to determine whether recording
should be included in the company’s deferred taxes can be avoided for
documentation. the item that may become
• Management should consider the subject to US tax.
consistency of its assertion with the • Management must have the
parent and subsidiary’s long and short- ability and intent to indefinitely
term budgets and forecasts, any past postpone taxation. The assertion
dividends, and the tax consequences of a should be supported by all levels
decision to remit or reinvest. of management who would be
expected to have significant
decision-making input relative to
plans or transactions that could
affect the assertion. Where
controlling or shared ownership
is present, the assertions must be
aligned with the expectations of
owners who may have
governance or decision-making
influence.
11 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics• The liquidity and overall financial • In limited circumstances, foreign taxes
health of the company must be that are expected to become foreign tax
factored into the assessment of the credits in the foreseeable future may be
assertion. If the unremitted earnings appropriate to recognize as a deferred
could be needed at the parent level to tax asset prior to the actual repatriation
meet existing or anticipated event. Among factors to consider, the
obligations (e.g., to fund a pension company must be committed to making
obligation), it may be difficult to the repatriation that triggers the foreign
support an assertion of indefinite tax credit benefit in the near term. There
reinvestment. The tax profile of the may also be limited circumstances in
company also should be considered. which a tax liability for an anticipated
For example, if unremitted earnings repatriation would be recorded even
were needed to avoid the expiration though there is an overall tax-over-book
of foreign tax credit carryforwards, outside basis difference.
and the repatriation of earnings
would represent a better rate of Disclosures - Due to the significant
return on capital than other judgments involved in assessing
alternatives, it might be difficult to indefinite reinvestment as well as the
support an indefinite reinvestment potential magnitude of the unrecorded
assertion. deferred tax liability, disclosure must be
• When the outside tax basis exceeds carefully considered. For more
the book basis in a foreign information, please refer to the PwC Tax
subsidiary, a deferred tax asset with Accounting Services publication –
respect to that temporary difference Income tax disclosure.
is recognized only when it is apparent
that the difference will reverse in the
foreseeable future. Recognition of a
benefit may, for example, occur when
there is a planned disposal of the
subsidiary. The expectation of the
generation of near-term future
subsidiary profits (which would
cause the outside basis to shrink),
however, would not be a basis for
recognizing a deferred tax asset on
the outside basis difference.
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 12Financial instruments
Refer to: Various forms of capital financing result Permanent Items – Permanent items
Chapter 3 of the PwC Guide in differences between an issuer’s related to financial instruments may
financial reporting basis and the tax arise due to specific provisions within
basis of financial instruments. These the tax law. For instance, the applicable
basis differences must be assessed to high yield debt obligation (AHYDO)
determine whether a temporary rules pursuant to Section 163(e)(5) may
difference exists for which a deferred tax result in the permanent disallowance of
asset or liability should be provided. interest deductions on certain debt
Often, this will depend on the manner in instruments.
which the financing is expected to be Companies should assess the potential
settled and whether the settlement impact of permanent items at the time
method is within the company’s control. of the issuance of the financial
The following are some tax accounting instrument and consider the impact on
aspects of this complex area to keep the entity’s effective tax rate.
in mind:
Embedded Derivatives – A
Classification of debt versus convertible debt instrument (i.e., hybrid
equity– In evaluating whether certain financial instrument) may require
basis differences in financial instruments bifurcation of the embedded derivative
are considered temporary differences for from the host contract for financial
which deferred taxes should be reporting purposes, but remain viewed
recognized, it is necessary to have an as one instrument for tax purposes. In
understanding of the appropriate situations where the instrument is
classification for both financial reporting treated differently for book and tax
and tax purposes. Certain financial purposes, a book-tax basis difference
instruments may be structured in a way may result for which deferred taxes
that requires debt or liability treatment would need to be recognized. Deferred
for financial reporting purposes but taxes would be considered for both the
equity treatment under the applicable tax host contract and the bifurcated
law, or vice versa. A basis difference that embedded derivative. While those
is created from a financial instrument deferred tax balances will typically
that, upon reversal, has no offset at issuance, the temporary
corresponding tax impact (e.g., a hybrid differences will not remain equal over
financial instrument treated as equity for time as the bifurcated embedded
tax purposes and liability for US GAAP derivative will be marked to fair value
purposes) would not be considered a on an ongoing basis while the premium
temporary difference for which deferred or discount on the host contract will be
taxes would be recognized. accounted for under other applicable US
Characterization of an instrument as GAAP. However, in certain situations
debt or equity for US federal income tax (e.g., instrument treated as equity for
purposes depends on the terms of the tax purposes) where there is no future
instrument and all surrounding facts and tax effect anticipated with the
circumstances. settlement of the hybrid financial
The proper identification of the financial instrument, we would not expect
instrument’s classification for both US deferred taxes to be recognized.
GAAP and tax purposes is the starting
point in evaluating whether any Debt Extinguishment – A debt
applicable book-tax basis difference will extinguishment can occur when the
result in the recognition of deferred taxes issuer reacquires its debt for cash, other
at issuance and/or throughout the term assets, or equity. For accounting
of the instrument. purposes, an extinguishment gain or
loss will be recognized in earnings based
on the difference between the
reacquisition price and the net carrying
amount of the original debt.
13 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot TopicsThe reacquisition price is the amount
paid to settle the debt, including any call
premium, miscellaneous costs of
reacquisition, and the fair value of any
assets transferred or equity issued. The
net carrying amount includes any
unamortized debt issuance costs and any
unamortized debt discount or premium
related to the extinguished debt.
The related tax effects of a debt
extinguishment need to be considered
within the context of the applicable tax
law. The acquisition or extinguishment
of debt at a premium (i.e., paying more
than the tax basis) may, in certain cases,
result in a current tax benefit for the
payment in excess of the tax basis. For
instance, the applicable tax law may
indicate that if a corporation pays a
premium over the adjusted issue price
(i.e., tax basis) to repurchase debt, the
premium paid, in whole or in part, may
be deductible as interest. However, there
may be situations in which the premium
paid to reacquire debt in excess of its tax
basis may be disallowed (e.g., in the case
of a convertible debt instrument where
the premium paid relates to the
conversion feature). The extinguishment
of debt for an amount less than the
adjusted issue price (i.e., tax basis)
typically gives rise to cancellation of debt
taxable income.
Debt extinguishment gains or losses are
recognized in earnings, and therefore,
any related current tax effects from the
extinguishment or deferred taxes that are
eliminated, or reversed, upon the
extinguishment will also be recognized in
the income statement through the
income tax provision. However, there are
certain exceptions under ASC 740 which
would provide for the current and
deferred tax implications to be
recognized in stockholders’ equity.
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 14Intercompany transactions
Refer to: In many instances, there are tax effects The general rule is that a deferred tax
Chapter 2 of the PwC Guide when an asset is sold or transferred asset cannot be recognized for an excess
between affiliated companies that are tax-over-book outside basis difference
consolidated for financial statement unless it is apparent that reversal will
purposes, but file separate tax returns. The occur in the foreseeable future (e.g., the
seller’s separate financial statements will entity is planning to sell the subsidiary in
generally reflect the profit on the sale and the near future).
a tax expense on that profit. The buyer’s
separate financial statements will reflect Special considerations
the asset at the intra-entity price, which
will also be the buyer’s tax basis. However, In certain cases, determining whether an
in consolidation, the seller’s pretax profit arrangement is considered an intra-entity
will be eliminated, and the asset will be transfer of an asset is judgmental and
carried at its cost to the seller until sold to depends on the facts and circumstances.
an unrelated third party or otherwise This might be the case, for example, with
recovered (e.g., through amortization or regard to an intra-entity transfer of
impairment). intellectual property (IP) related to in-
process research & development.
In the case of an IP transaction,
In general
determining whether the arrangement
Deferral provisions under ASC 810, constitutes a transfer as opposed to a
Consolidation and ASC 740 apply to these license to use the asset is often
intercompany transfers of assets, whereby judgmental and depends on the
no immediate tax impact is recognized in individual facts and circumstances. In
the consolidated financial statements. The some cases, the arrangement constitutes
tax effects to the seller are deferred in an outright sale or an exclusive license
consolidation and the buyer is prohibited for the entire economic life of the IP, and
from recognizing a deferred tax asset for there may be little doubt that an asset
the excess of the buyer’s tax basis over the has been transferred. In other situations
consolidated carrying amount of the asset. where the IP is being licensed, it may be
Instead, the tax benefit resulting from any difficult to determine whether the
step-up in tax basis is recognized as it is arrangement constitutes an in-substance
realized each period, via deduction on the sale or merely a temporary license of the
tax return. IP. Intra-entity arrangements should be
reviewed to determine whether they
Exceptions confer ownership rights and burdens and
whether the benefits and risks associated
When the intra-entity transaction is the
with the IP have been transferred. One
sale of stock of a subsidiary, it involves the
way to make this determination is to
“outside” tax basis. Because the guidance
consider whether the new holder of the
refers to the intra-entity transfer of assets,
IP would recognize an asset on its
we do not believe that the exception
separate balance sheet, if it were to
should be extended to the transfer of stock
prepare separate company financial
of a subsidiary (i.e., an outside basis
statements.
difference). Rather, the guidance related
to outside basis differences would be
applied.
15 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot TopicsIn making this determination, the legal
and contractual rights conveyed in the
arrangement are the primary
considerations, however, the relevant
income tax laws should also be
considered. While not necessarily a
bright-line indication of the accounting
treatment, the characterization of the
arrangement and subsequent tax
treatment under the relevant income tax
laws, as either a license or a sale may
provide additional context to assist with
the determination.
Other special areas should be given
consideration, including, but not limited
to accounting for the release of a
valuation allowance concurrent with an
intra-entity asset transfer, intra-entity
transfers as potential tax- planning
strategies to support realization of
deferred tax assets, the effects of changes
in respective uncertain tax positions, and
the effects of subsequent law changes or
transactions such as a disposal via spinoff
or sale of the seller and/or buyer entity.
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 16Foreign currency
Refer to: Few areas in accounting for income taxes • Income that has been (or is expected
Chapter 11 of the PwC Guide are more difficult to apply than the tax to be) taxed under the US Subpart F
accounting for the effects of fluctuations provisions but not repatriated is
Tax Accounting Services Thought
in foreign currency values. commonly referred to as previously
Leadership, Foreign Currency Tax
The following are some aspects to keep in taxed income (PTI). PTI can
Accounting
mind: generally be repatriated without
• Translation adjustments on foreign further taxation other than potential
subsidiary stock typically create a withholding taxes and any tax
portion of the outside basis consequences resulting from
temporary difference related to the changes in foreign currency rates.
parent’s investment in the subsidiary. Whether taxes should be provided
Generally, the cumulative translation on the unrealized foreign currency
adjustment (CTA) reflects the gains gains or losses associated with PTI
and losses associated with the depends upon whether the company
translation of a foreign subsidiary’s has the ability and intent to
books from its functional currency indefinitely reinvest the amounts
into the reporting currency and is that correspond to PTI.
reflected in other comprehensive • Similarly, if the owner of a foreign
income (OCI). If the outside basis branch has the ability and intention
difference is not indefinitely to postpone remittance indefinitely,
reinvested, deferred taxes are and the respective branch-related
recorded for the tax estimated to be CTA will only become taxed upon
incurred upon repatriation of the remittance, an accounting policy
outside basis difference, including may be applied to allow an
the portion attributable to the CTA indefinite reinvestment assertion to
account. be considered for the CTA of a
• When the indefinite reinvestment foreign branch.
assertion has been made on • If a company changes its indefinite
unremitted earnings, deferred taxes reinvestment assertion, the tax
are not typically provided on impact of current-year movement in
translation adjustments. In some the CTA account should generally be
cases, financial statement preparers recorded in other comprehensive
have not provided tax on unremitted income (OCI). However, because the
earnings because it is expected that beginning-of-year CTA account
their repatriation will result in no balance arose in prior years, the tax
additional US tax because of the effects associated with the
availability of foreign tax credits. beginning-of-year balance should be
Consideration must still be given to recorded to continuing operations
whether a tax provision is required and not “backwards traced” to OCI.
with respect to CTA (or other • When subsequent adjustments to
amounts that comprise the outside deferred taxes are not recorded in
basis difference). CTA, tax effects lodged therein will
not necessarily equal the respective
deferred taxes reflected in the
balance sheet for the temporary
differences related to the gains or
losses in CTA. Recognition of those
lodged tax effects in net income
would generally occur only upon the
sale of a foreign operation or actions
that result in a complete liquidation.
17 Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics• A parent company may enter into a
transaction that qualifies as a hedge
of its net investment in a foreign
subsidiary. Any gains or losses
associated with such a hedge are
recognized in the CTA account.
Because the tax consequences will be
triggered upon settlement of the
hedge with no possibility for deferral
even if the indefinite reversal
exception applies, deferred taxes
should be recorded (in CTA) for
temporary differences resulting from
the hedging transaction.
• When the functional currency of a
foreign business is the same as the
reporting currency, deferred taxes on
non-monetary assets and liabilities
should be computed in the local
foreign currency by comparing the
historical book and historical tax
bases in the local foreign currency.
The local foreign currency deferred
tax is then remeasured into the
reporting currency using the current
exchange rate consistent with the
requirement that all deferred taxes
are translated at the current rate.
Any additional tax depreciation in
the foreign tax returns is treated as a
permanent difference as there is no
corresponding amount in pre-tax
income.
• When the functional currency of a
foreign operation differs from the
reporting currency, the reserve for
foreign uncertain tax positions, like
other balances, are subject to
translation adjustments each
reporting period. Translation must
be applied even if the uncertain tax
position reserves (or other accounts
attributable to the foreign business)
are maintained by the parent
company.
• Intercompany loans between parent
companies and foreign subsidiaries
should be reviewed carefully to
determine the accounting impact of
foreign currency movements.
Differences in the functional
currencies, the denomination of the
loan, local country taxation of foreign
exchange and whether the loan is
considered a long-term advance
(permanent capital) can affect the
accounting for foreign currency
translation adjustments.
Tax Accounting Services – Accounting for Income Taxes: 2014 Year-end Hot Topics 18You can also read
