11th Annual Domestic Tax Conference. 28 April 2016 New York City

Transcription

1 11th Annual Domestic Tax Conference 28 April 2016 New York City

2 Accounting for income tax 2016 insights and challenge areas

3 Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. This presentation is 2016 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Page 2

4 Today s presenters Joan Schumaker Partner, Ernst & Young LLP Charlie Gengler Partner, Ernst & Young LLP John Vitale Partner, Ernst & Young LLP George Wong Partner, Ernst & Young LLP Page 3

5 Agenda Developments Recent legislative and other developments Accounting standard updates FASB project status Internal control over financial reporting PCAOB focus areas SEC focus areas Tax provision challenges and current issues Restatement trends and common causes of tax restatements Other current tax accounting issues Tax provision process best practices Page 4

6 Legislative and other developments Federal Legislation enacted in 2015 with effects in 2016 and later years On 18 December 2015, President Obama signed into law the Consolidated Appropriations Act, 2016 (the Act) reinstating retroactively certain tax benefits and credits (collectively, tax extenders) that had expired. The Act made a number of the provisions permanent and extended the others for two or five years. On 2 November 2015, President Obama signed into law legislation introducing a new audit system and income tax liability rules for certain partnerships. The Bipartisan Budget Act of 2015 repealed the prior audit system and income tax liability rules for certain partnerships. The changes are effective for tax years beginning after 31 December Page 5

7 Legislative and other developments State Significant legislation enacted since 1 January 2016 Delaware On 27 January, enacted legislation phasing in a single sales factor apportionment formula by Asset management companies, telecommunication companies and companies whose principal headquarters are in Delaware may use either a single-sales factor or an equally weighted three-factor apportionment formula. The changes are effective for tax years beginning on or after 1 January Louisiana On 4 March, enacted exemption from tax 100% (rather than 72%) of dividend income received by corporations from certain banks. Change applies to all exclusions from taxable income claimed on any return filed or any tax year beginning on or after 1 January 2015, regardless of the tax year to which the return relates. On 9 March, enacted permanent (rather than temporary) limit on net operating loss (NOL) usage to 72% of taxable income. Effective 1 January Other changes include: Require use of NOLs in order of newest to oldest (effective 1 January 2017) Require adjustment to state taxable income to add back certain related party interest expenses, intangible expenses and management fees deducted for federal income tax purposes (applies tax years beginning on or after 1 January 2016) On 10 March, enacted legislation changing the order in which companies may claim tax credits. Change effective upon enactment. Page 6

8 Legislative and other developments International Significant legislation enacted since 1 January 2016 Chile On 27 January, enacted legislation simplifying the new income tax system enacted under the Tax Reform Law. The enacted legislation includes the following changes: Election of new regimes, Attribution Regime vs. Semi-integrated Regime Modification of imputation orders to determine tax treatment on distributions from 1 January 2017 Modification of thin capitalization rules Modification of foreign tax credits Substitution tax in lieu of Global Aggregate Tax or Withholding tax Limitation of the general anti-avoidance rules to transactions executed after 30 September 2015 Clarification of CFC (Controlled Foreign Corporation) rules Other reporting obligations Page 7

9 Legislative and other developments International Significant legislation enacted since 1 January 2016 Israel On 5 January 2016, Israel enacted legislation reducing the corporate income tax rate to 25% from 26.5%. In addition, the withholding tax rates on interest, royalties, and capital gains related to corporate investors are reduced to 25%. Changes are retroactively effective to 1 January Japan On 29 March 2016, Japan enacted legislation reducing its 23.9% corporate income tax rate to 23.4% for tax years beginning on or after 1 April 2016, and to 23.2% for tax years beginning on or after 1 April Other changes include: Reducing the limit on NOL usage to 60% (from 65%) of taxable income for tax years beginning on or after 1 April 2016, 55% of taxable income for tax years beginning on or after 1 April 2017, and 50% of taxable income for tax years beginning on or after 1 April 2018 Reducing the local enterprise tax rate applicable to base income to 3.6% from 6% for tax years beginning on or after 1 April 2016 Page 8

10 Legislative and other developments OECD October 2015, Organisation for Economic Co-operation and Development (OECD) issued final reports on all 15 focus areas in Base Erosion and Profit Sharing (BEPS) project. OECD divided recommendations into 4 categories Minimum standards agreed by the participating countries: Harmful tax practices Action 5, Addressing treaty abuse Action 6, country-by-country (CbC) reporting Action 13, More effective dispute resolution Action 14 Reinforced international standards: Transfer Pricing Guidelines, Actions 8-10 on transfer pricing, Action 13 on transfer pricing documentation OECD Model Tax Convention, including Action 2 on hybrids, Action 7 on permanent establishment status Common standards and best practices: Hybrids Action 2, Controlled foreign company (CFC) rules Actions 3, Interest limitations Action 4, Disclosure of aggressive tax planning Action 12 Analytical reports Digital economy Action 1 Economic analysis of BEPS Action 11 Multilateral instrument Action 15 Page 9

11 Legislative and other developments OECD OECD indicated additional technical work will be done in 2016 and beyond on several of focus areas, including digital economy, harmful tax practices, treaty abuse, permanent establishment and transfer pricing. BEPS Actions 8-10 entitled Aligning Transfer Pricing Outcomes with Value Creation contains revisions to existing OECD Transfer Pricing guidelines; become part of guidelines once formally adopted by OECD council. As a non-government organization, OECD actions are not legislative, however, some laws refer directly to OECD guidelines. Countries that explicitly incorporate the OECD transfer pricing guidelines (e.g., Hungary, Mexico, Norway) Countries that need to act to incorporate the OECD transfer pricing guidelines (e.g., UK, Ireland, Australia) Page 10

12 Legislative and other developments OECD Ongoing activity In addition to the follow-up technical work, the OECD continues to work on the following: Development of multilateral instrument Mechanism to amend bilateral tax treaties to incorporate the treaty-based BEPS recommendations Will include mandatory binding arbitration as an optional provision Negotiations are underway and are to be completed by the end of 2016 so that the instrument is ready for signature in 2017 Peer review processes Work to establish a peer review process to monitor countries' performance in resolving disputes under treaty mutual agreement procedures (MAP) are reportedly "well advanced" Work will continue on identifying and addressing harmful tax practices in OECD and G20 countries and beyond Page 11

13 Legislative and other developments European Commission European Union On 28 January 2016, the European Commission released an anti-tax avoidance package designed to provide uniform implementation of BEPS measures and minimum standards across Member States. The package includes: A proposed European Union (EU) anti-tax avoidance directive that addresses interest deductibility, a general anti-abuse rule, controlled foreign company rules, and a framework to take hybrid mismatches A proposed directive that requires Member States to implement the exchange of Country-by- Country (CbC) reporting in relation to multinational enterprises for fiscal years beginning on or after 1 January 2016 A communication proposing a framework for a new EU external strategy for effective taxation A recommendation on the implementation of measures against tax treaty abuse Page 12

14 Legislative and other developments European Commission On 12 April 2016, the European Commission (EC) published a draft directive on CbC reporting. If adopted, this would: amend existing EU law on disclosure of income tax information. require certain large multinational companies to disclose publicly on the company s website, and on an official register in the EU, specific information including a breakdown of profits, revenues, taxes and employees. This initiative is separate from the OECD BEPS action on CbC reporting, and is also different from the CbC reporting that was proposed as part of the anti-tax avoidance package. This latest EC proposal may be adopted with the support of only a qualified majority rather than unanimous consent. After adoption, all EU member states would have to enact conforming legislation in order to implement into local law. Page 13

15 Legislative and other developments Altera US Federal share-based compensation case On 27 July 2015, US Tax Court ruled in favor of the taxpayer in Altera v. Comm r, 145 T.C. No. 3 (2015). Court held the 2003 revision of cost-sharing regulations (T.D. 9088), to include Stock-Based Compensation (SBC) in shared costs was a legislative regulation subject to the Administrative Procedures Act s (APA) requirement for a Notice and Comment Period. Decision has potentially broad implications for IRS regulatory procedures. Court specifically ruled the IRS failed to address the extensive evidence received that unrelated parties in joint ventures do not share SBC costs. Consequently, rule epitomizes arbitrary and capricious decision making. Treas. Reg. section (d)(2) rule that SBCs be included in the pool of intangible development costs (IDCs) for qualified cost sharing arrangements (QCSAs) was held to be invalid. In February 2016, IRS filed notice of appeal in Ninth Circuit Court of Appeals. The Tax Court s holding does not eliminate the regulation. Page 14

16 Legislative and other developments State aid: European Commission actions and developments June 2013: European Commission requested Information on IP-regimes from ten Member States (Belgium, Cyprus, France, Hungary, Luxembourg, Malta, the Netherlands, Portugal, Spain, and United Kingdom) June 2013: Information on the tax ruling practices in seven countries requested (i.e., Cyprus, Gibraltar, Malta, the United Kingdom, The Netherlands, Ireland and Luxembourg) October 2013: European Commission opens investigation into Gibraltar s corporate tax system 11 June 2014: The European Commission opened three in-depth investigations to examine decisions of the tax authorities in Ireland, the Netherlands and Luxembourg with regard to tax paid by two US and one Italian multinational corporations (MNC) 1 October 2014: The European Commission extended the scope of its investigation in the Gibraltar corporate tax system to include the Gibraltar tax ruling practice 7 October 2014: The European Commission opened another in-depth investigation to examine a decision of the Luxembourg tax authority with regard to tax paid by a US MNC 15 October 2014: The European Commission ordered Spain to recover aid granted through amended application of tax scheme for acquisition of indirect shareholdings in foreign companies 17 December 2014: The European Commission extended the information enquiry on tax ruling practice to all Member States 3 February 2015: The European Commission opened an in-depth investigation into the Belgian excess profit ruling system 21 October 2015: The European Commission issued a press release announcing that it has decided that the selective tax advantages granted to an MNC in Luxembourg and an MNC in the Netherlands are illegal under EU state aid rules November/December 2015: Netherlands and Luxembourg appealed the Commission s decision 3 December 2015: The European Commission opened an in-depth investigation to examine a decision of Luxembourg's tax authority with regard to tax treatment of a US MNC 11 January 2016 The European Commission concluded that the Belgian excess profit scheme is illegal Page 15

17 Legislative and other developments State aid State aid is defined as: The selective granting of an advantage/award to a specific undertaking or specific undertakings which is capable to distort trade between EU Member States. Considered incompatible with EU s common market because it distorts competition On 21 October 2015, EC releases that selective tax advantages for Fiat in Luxembourg and Starbucks in Netherlands are illegal state aid. On 11 January 2016, EC announces its decision that Belgium s excess profit tax regime is illegal under EU state aid rules. EC held that Belgium s tax rulings granted a selective advantage to multinationals by allowing their corporate tax base to be reduced by the excess profits that allegedly resulted from being part of a multinational group. EC decision is against the Belgian state, however enforcement is against the taxpayer. EC ordered Belgian government to recover approximately 700m Euros of corporate taxes from approximately 35 multinational companies. Page 16

18 Accounting standard updates Page 17

19 Revenue recognition ASU Revenue recognition accounting standard issued on 28 May 2014 Supersedes virtually all industry and interpretive guidance Requires more estimates and judgments than current guidance The FASB has issued a one-year deferral of the original effective date of ASU Standard will be effective for public entities for annual periods beginning after 15 December 2017 (2018 for calendar-year companies) Nonpublic entities will still have the option of an additional year (effective for annual periods beginning after 15 December 2018) Early adoption will be allowed for both public and nonpublic entities using original effective dates (2017 for calendar-year companies) The deferral was issued in ASU on 13 August 2015 The IASB voted for a one-year deferral as well Page 18

20 Revenue recognition standard Effective date Dates shown are for calendar year-end entities Mandatory adoption Effective date First presentation Public 1 January March Q Nonpublic 1 January December 2019 annual F/S Early adoption Public 1 January March Q 1 January March 2017 interim F/S 31 December 2017 annual F/S Nonpublic 31 March 2018 interim F/S 1 January December 2018 annual F/S 1 January March 2019 interim F/S Page 19

21 Revenue recognition standard Transition methods (1) Full retrospective Cumulative catch-up adjustment at 1/1/2016 Financial statements New GAAP New GAAP New GAAP Footnotes ASC 250 disclosures Modified retrospective Cumulative catch-up adjustment at 1/1/2018 Financial statements Legacy GAAP Legacy GAAP New GAAP Footnotes Legacy GAAP (1) This slide does not reflect early adoption Page 20

22 Transition Full retrospective Apply new revenue recognition standard to all existing contracts as of 1 January 2016 (for calendar year-end entities who do not adopt early) Need to inventory contracts with performance remaining as of 1 January 2016 Will have to keep two sets of books for FY 2016 and FY 2017 if the standard creates differences Cumulative catch-up adjustment as of 1 January 2016 for contracts with performance remaining under current guidance Practical expedients Need not restate contracts completed before adoption that begin and end within the same annual reporting period Need not estimate variable consideration for contracts completed before adoption (i.e., use known consideration as of contract completion) Need not disclose the amount of the transaction price allocated to remaining performance obligations for prior periods presented Disclose which expedients used and a qualitative assessment of their effects Page 21

23 Transition Modified retrospective Apply new revenue recognition standard to all existing contracts as of 1 January 2018 (for entities who do not adopt early) Need to inventory contracts with performance remaining as of 1 January 2018 Cumulative catch-up adjustment as of 1 January 2018 for contracts with performance remaining under current guidance Present comparative periods (2016 and 2017 for calendar year-end entities) under current revenue guidance Required to report in the year of adoption (2018 for calendar year entities) under both the new standard (on the face of the financial statements) and under current guidance (disclosure), requiring two sets of books Disclose the amount by which each financial statement line item is affected compared with current accounting Explain significant changes Page 22

24 Other transition considerations SAB Topic 11.M (SAB 74) disclosures SEC Staff Bulletin Topic 11.M (SAB 74) requires disclosure of potential effects of recently issued accounting standards to the extent those effects are known. Starting with the first financial statements filed after release of the standard, entities should consider the following disclosures: A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier (only for Foreign Private Issuers using IFRS) A discussion of the methods of adoption allowed by the standard and the method the registrant expects to use, if determined A discussion of the effect the standard is expected to have on the financial statements or, if the effect isn t known or reasonably estimable, a statement to that effect Disclosure of other significant matters that the registrant believes might result from adopting the standard (e.g., planned or intended changes in business practices) Page 23

25 Revenue recognition standard Tax technical considerations Taxpayers will need to determine when and how any change in revenue recognition for financial reporting purposes is recognized for tax purposes. For taxpayers applying a deferral method for advance payments, the amounts deferred for tax purposes are determined by reference to the amounts deferred for financial statement purposes. Consider whether a change in revenue recognition for financial statement purposes is also a permissible method for tax purposes. In certain jurisdictions, local tax liability is based upon statutory financial statements. When local statutory financial statements are prepared under IFRS, the statutory financial statements may change with adoption of the standard Evaluate whether a foreign subsidiary s earnings and profits (E&P) or local tax change the amount by which a distribution is taxable as a dividend, the amount of Subpart F inclusion, or deemed paid foreign tax credits. Evaluate intercompany prices and transfer pricing policies where adoption changes revenue, profits or third-party comparables used in determining transfer pricing. Companies may need to review the methodology for compiling sales apportionment data. Page 24

26 Revenue recognition standard Income tax accounting considerations New temporary differences may arise or existing temporary differences may be computed differently Companies may need to revise their processes and data collection tools Valuation allowance considerations may change Change in deferred tax assets, temporary difference reversals or expected future taxable income may affect judgments regarding the realizability of deferred tax assets Multinational companies will need to consider the effects of changes in revenue recognition for financial reporting purposes at foreign subsidiaries Jurisdiction-by-jurisdiction analysis necessary to assess whether the change in revenue recognition for financial reporting results in temporary differences due to differences in timing and amount of revenue recognized for financial reporting and tax purposes Current and deferred tax consequences of the cumulative effect adjustment reported in the period of adoption Requires careful consideration of the income tax accounting effect of individual items included in the cumulative effect adjustment A change in an accounting method for tax purposes requires careful consideration of the period the change in method is considered for financial reporting purposes Page 25

27 Classification of deferred taxes ASU FASB issued ASU , Balance Sheet Classification of Deferred Taxes, that requires the classification of all deferred tax assets and liabilities as noncurrent No longer allocate valuation allowances between current and noncurrent No change to jurisdictional offsetting requirements For public business entities, standard effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, standard effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption permitted for all entities in any interim or annual period Entities may elect either a prospective or retrospective transition approach Page 26

28 Financial instruments: Classification and measurement ASU FASB issued ASU , Recognition and Measurement of Financial Assets and Financial Liabilities Measure many equity investments at fair value and recognize changes in fair value in net income unless the investments qualify for practicability exception Assess the realizability of a deferred tax asset (DTA) related to an available-for-sale (AFS) debt security in combination with other DTAs Use the same four sources of taxable income that are used for other DTAs Include the expected reversal of unrealized losses on AFS debt securities that an entity has both the intent and ability to hold until recovery as a component of its overall projection of future taxable income May not be able to rely on projections of future taxable income for purposes of evaluating realizability of DTAs if significant negative evidence exists (e.g., cumulative losses in recent years) Page 27

29 Financial instruments: Classification and measurement ASU No longer separately evaluate the DTAs related to AFS debt securities Can not solely rely on intent and ability to hold debt securities with unrealized losses until recovery, which may not be until maturity, akin to a tax planning strategy For public business entities, standard effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2017 For nonpublic business entities, standard effective for annual periods beginning after 15 December 2018 and interim periods in annual periods beginning after 15 December 2019 Can early adopt as of effective date for public business entities Early adoption permitted for certain provisions (does not include income tax provision) Generally apply modified retrospective approach Page 28

30 Leases ASU The IASB issued IFRS 16 Leases in January The FASB issued ASU , Leases, in February Effective date 1 January 2019 for calendar-year public business entities with early adoption permitted Key changes to today s US GAAP guidance include: Lessees would recognize assets and liabilities for most leases. For lessors, the guidance would modify today s classification criteria and accounting for salestype and direct financing leases. Leases would be classified using criteria similar to current US GAAP without the bright lines. Classification would determine how entities recognize lease-related revenue and expense, and would continue to affect what lessors record on the balance sheet. New presentation and disclosure requirements Page 29

31 Leases ASU Application of the new guidance results in changes to pre-tax book accounting: Lessees Likely recognize new lease-related assets and liabilities on the balance sheet and may change measurement of other lease-related assets and liabilities Lessors May see a change in the recognition and measurement of lease-related assets and/or derecognition of underlying assets for certain leases Timing of recognition of lease income may change for some leases Special accounting for leveraged leases is eliminated These changes affect certain aspects of accounting for income taxes such as: Recognition and measurement of DTAs and deferred tax liabilities (DTLs) Assessment of the recoverability of DTAs (i.e., the need for and measurement of a valuation allowance) Page 30

32 Stock compensation ASU ASU , Improvements to Employee Share-Based Payment Accounting, issued in March 2016 Excess tax benefits and tax deficiencies recognized in the income statement (prospective transition) Account for excess tax benefits and tax deficiencies as discrete items in the interim period in which they occur Eliminates the requirement that excess tax benefits not be recognized until they are realized (modified retrospective transition with a cumulative catch-up adjustment to retained earnings) Excess tax benefits presented as an operating activity in the statement of cash flows (prospective or retrospective transition) For public business entities, effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption is permitted for all entities in any interim or annual period for which financial statements have not been issued Page 31

33 IFRS developments IAS 12 amendments recognition of DTAs for unrealized losses IAS 12 amended for years beginning on/after 1 January 2017, early adoption permitted Decreases below cost in the carrying amount of a fixed-rate debt instrument measured at fair value for which the tax base remains at cost give rise to a deductible temporary difference irrespective of whether the debt instrument s holder expects to recover the carrying amount of the debt instrument by sale or by use, e.g., continuing to hold it to maturity Determining temporary differences and estimating probable future taxable profit against which deductible temporary differences are assessed for utilization are two separate steps and the carrying amount of an asset is relevant only to determining temporary differences The carrying amount of an asset does not limit the estimation of probable future taxable profit Future taxable profit includes the probable inflow of taxable economic benefits that results from recovering an asset, and that may exceed the carrying amount of the asset Must consider whether tax law restricts the sources of taxable profits against which it may make deductions on the reversal of that deductible temporary difference, e.g., capital loss limitations Page 32

34 FASB project status Page 33

35 FASB income taxes simplification project Intercompany scope exception Proposal would eliminate exception that requires deferral of the income tax effects of intercompany sales/transfers of assets Would recognize income tax expense in the period of the sale/transfer Would recognize deferred tax effects of the difference between the tax basis of the asset in the buyer s jurisdiction and its book basis after elimination of the intercompany profit For public business entities, FASB expects proposed amendments effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, FASB expects proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption permitted, but not before the effective date for public business entities Modified retrospective transition approach In October 2015, FASB asked its staff to research the costs and benefits of deferring the income tax effects only for intercompany inventory transactions Page 34

36 FASB income taxes disclosure project Initial deliberations foreign earnings FASB tentatively decided to require additional disclosures as follows: Pre-tax income (loss) disaggregated between domestic and foreign earnings Income tax expense (benefit) disaggregated between domestic and foreign Income taxes paid disaggregated between domestic and foreign Foreign income taxes paid to any country that are significant relative to total income taxes paid The amount of and explanation for a change in assertion about the temporary difference for the cumulative amount of investments associated with undistributed earnings that are (1) asserted to be essentially permanent in duration, or (2) no longer asserted to be essentially permanent in duration Foreign earnings that are indefinitely reinvested for any country that represents at least 10% of the entity s total foreign earnings that are indefinitely reinvested Page 35

37 FASB income taxes disclosure project Initial deliberations uncertain tax positions FASB tentatively decided to add requirements that public entities disclose as part of the tabular rollforward of unrecognized tax benefits the following: Settlements disaggregated between those that are cash and noncash (e.g., an existing net operating loss carryforward used to settle with the taxing authority) A breakdown of the total amount of unrecognized tax benefits by the balance sheet line item in which the amounts are presented FASB also tentatively decided to eliminate for all entities the requirement to disclose certain information when it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date Page 36

38 FASB income taxes disclosure project Initial deliberations other disclosures The FASB also made tentative decisions for other income tax disclosures that would require entities to disclose: Information about an enacted change in tax law if it is probable that the change will affect the entity in a future period Page 37

39 FASB income taxes disclosure project Initial deliberations other disclosures FASB also made tentative decisions for other income tax disclosures that would require public entities to disclose: Income tax rate reconciliations Individual reconciling items of more than 5% of amount of pretax income times applicable federal statutory income tax rate A qualitative description of items that have caused a significant change in the rate An explanation of the nature and amounts of valuation allowances recorded and released during the reporting period The amounts and expiration dates of tax carryforwards recorded on the tax return (not tax effected) and in the financial statements (tax effected) and the total amount of unrecognized tax benefits that offsets carryforwards. Page 38

40 FASB income taxes disclosure project Initial deliberations transition and next steps FASB tentatively decided to require prospective transition for all income tax disclosures FASB asked its staff to perform outreach on the operability of requiring companies to disclose cash and cash equivalents, marketable securities and loans underlying undistributed earnings that are indefinitely reinvested After the outreach is complete, FASB plans to issue an exposure draft on the proposal Page 39

41 FASB government assistance disclosure project proposal FASB proposal would require for-profit entities to make certain disclosures about assistance they receive from legally enforceable agreements with governments: The nature of the assistance, including a general description of the significant categories and the form in which the assistance has been received The accounting policy used to account for the government assistance The line items on the balance sheet and income statement that are affected by government assistance and the amounts The amounts of government assistance received that are not directly recorded in the financial statements (e.g., loan guarantees, loans with below-market rates, tax abatements) unless impracticable to do so Page 40

42 FASB government assistance disclosure project proposal The disclosure requirements would apply to certain arrangements accounted for under the income tax guidance in addition to grants, loan guarantees and other types of government assistance. The guidance would be applied prospectively to all agreements existing at the effective date and those entered into after the effective date. Entities would be permitted to apply the guidance retrospectively. FASB is currently redeliberating the proposal based upon feedback received during the comment period. Page 41

43 Internal control over financial reporting (ICFR) Page 42

44 ICFR focus areas Complete understanding of the process and the related controls Completeness and accuracy of data used in the performance of controls Evidence of control operation, particularly for management review controls Page 43

45 Management review controls The objectives of management review controls typically involve determining whether: Accounting is appropriate. There are potential errors or misstatements. Information is complete and accurate. Other controls were performed timely and effectively. Detect and correct controls may be manual or dependent on IT Performed by an individual(s) with appropriate competence and authority Management review controls are very common in income tax processes. Review of the income tax provision Review of uncertain tax positions Review of realizability of deferred tax assets Page 44

46 Management review controls When designing review controls, management should consider: Risk of material misstatement (i.e., importance of the control) Verification of the completeness, accuracy and integrity of data and reports used Precision of the control Criteria used by the reviewer to identify matters for investigation How items identified for investigation are resolved Review control documentation Evidence of control operation Policies and procedures design of the review control Page 45

47 Management review controls Control evidence can include: Draft documents or documents with tickmarks, notes, questions s Calculation reiterations Meetings (participation/ observation) PCAOB Std five auditor testing of design and operating effectiveness of a control includes a mix of: Inquiry of appropriate personnel (inquiry alone does not provide sufficient evidence) Observation of the company s operations Inspection of relevant documentation Re-performance of the control Page 46

48 AICPA national conference December 2015 SEC staff remarks on ICFR Commission s management guidance for ICFR is aligned with PCAOB AS No. 5 PCAOB s ICFR findings may reflect not only inadequate audit execution but also deficiencies in management s controls and management s assessments Discussed the level of evidence that management is required to retain to support the effectiveness of controls (including management review controls) Page 47

49 PCAOB focus areas Page 48

50 PCAOB 7 May 2015 audit committee dialogue Identified deficiencies related to: Auditing estimates (including tax-related estimates) auditing the estimate and related internal controls Identified emerging risk area: Auditing of management s indefinite reinvestment assertion and the related internal controls Questions to consider: How is understanding of critical assumptions and methods obtained? How is contrary evidence evaluated? What is the nature of evidence gathered regarding management s assertions? Are indefinite reinvestment assertions consistent with other disclosures (e.g., MD&A)? Page 49

51 AICPA national conference December 2015 PCAOB remarks related to tax PCAOB staff stated that inspections will likely focus on the following areas of emerging risks in 2016 that pertain to tax: Risks associated with mergers and acquisitions Income taxes, specifically matters related to a company s assertions related to undistributed cash held in overseas subsidiaries Cybersecurity risks Page 50

52 SEC focus areas Page 51

53 AICPA national conference December 2015 SEC staff remarks on income tax Focus on quality and clarity of management discussion and analysis (MD&A) disclosures, including those related to income tax rate reconciliations, valuation allowances and earnings that have not been repatriated Enhance disclosures in MD&A when: Income tax expense is material to financial statements both recorded expense and expense based on statutory tax rate There are material fluctuations or lack of fluctuations that were expected in the effective tax rate (ETR) There are risks and uncertainties Provide transparent disclosure in MD&A of significant foreign earnings, including earnings and tax rates within specific jurisdictions and jurisdictions effects on the ETR Page 52

54 AICPA national conference December 2015 SEC staff remarks on reinvestment of foreign earnings SEC staff has asked registrants to explain how they have overcome the presumption and to provide evidence of specific plans for reinvestment of foreign earnings (e.g., past experience, working capital forecasts, long-term liquidity plans, capital improvement programs, merger and acquisition plans, investment plans). SEC staff also requests similar evidence when registrants assert that they intend to indefinitely reinvest only a portion of undistributed foreign earnings or when undistributed foreign earnings are considered to be indefinitely reinvested, but there is a recent history of repatriation. Staff indicated that when there is a change in assertion, registrants should disclose the facts and circumstances that led to it during the reporting period. Page 53

55 AICPA national conference December 2015 SEC staff remarks on liquidity and reinvested foreign earnings Example SEC staff comment If significant to an understanding of your liquidity, in future filings please clarify the amount of cash and investments held outside of the US. Additionally, to the extent material, please describe any significant amounts that may not be available for general corporate use related to cash and investments held by foreign subsidiaries where you consider earnings to be indefinitely invested. Also, address the potential tax implications of repatriation. Page 54

56 SEC comment focus Comment area 2015 Ranking 2014 Ranking 2014 and 2015 % of total registrants that received comment letters Management s discussion and analysis % Fair value measurements % Revenue recognition % Non-GAAP financial measures % Signatures, exhibits and agreements % Income taxes % Segment reporting % Intangible assets and goodwill % Acquisitions and business combinations % Executive compensation disclosures % Page 55

57 Tax provision challenges and current issues Page 56

58 Tax restatements increased past three years Common errors Generally, three most common causes of restatements are: Classification errors 5% Acquisitions/ dispositions 16% Deferred tax accounting 44% Deferred tax accounting Accounting for acquisitions/dispositions (specifically purchase accounting and goodwill impairment calculations) Valuation allowance adjustments During 2015, issues relating to stock-based compensation arose more frequently Stock-based compensation 8% Improper classification of current and non-current deferred tax assets also commonly cited Other errors often cited: Other 16% Valuation allowance 11% Errors relating to intercompany activities Treatment of federal and state carryforwards Foreign taxes (foreign tax credits, currency translation adjustments) Capitalization/depreciation/amortization of tangible and intangible assets purposes Pension plan accounting (foreign and domestic) Page 57

59 Material weaknesses Causes Segregation of duties 6% Documentation 6% Improper treatment 40% Primary causes fall in three general areas: People Processes and controls Accounting errors (valuation allowances, NOLs, pensions state taxes, leases, impairment mentioned in 2015) People issues are typically described as: Personnel with insufficient technical knowledge, experience, training in tax accounting People 31% Lack of investment, resources and focus in tax reporting Process and control issues include: Lack of adequate policies and procedures to ensure the completeness, accuracy, preparation and review of the income tax provision Lack of documentation Review procedures 17% Lack of timely reconciliation of tax accounts Inadequate monitoring of significant transactions and new reporting requirements Financial close and work compressions Improper segregation of duties Page 58

60 Appropriate application of tax basis Essential starting point: Maintaining a detailed and accurate record of the tax basis of all assets and liabilities, including those without a book basis A fluctuation analysis of tax basis supporting the deferred tax balances may not provide sufficient audit evidence Common pitfall: Not properly identifying a tax basis or attribute or not appropriately recording and tracking the tax basis or attribute in subsequent periods Requires technical understanding of tax law Often for multiple taxing jurisdictions May be simple or complex How is the tax basis evaluated? Page 59

61 Intraperiod allocation Be mindful of the complexity of the intraperiod allocation rules Common pitfalls: Failure to apply the exception (losses from continuing operations and income from other sources) Failure to consider interaction of exception with the interim reporting rules Inappropriate backwards tracing Failure to follow two-step process when income from discontinued operations is recognized in an interim period and losses from continuing operations are expected for the year Are there losses from continuing operations and income from another source? Does the financial reporting reflect the exception to the intraperiod allocation rules? Page 60

62 Intraperiod allocation Exceptions to the general rule apply in all situations where there is: A loss from continuing operations Cumulative income from all other sources Exception also applies to interim periods when company anticipates an ordinary loss from continuing operations for the year Applicable even to periods of a full valuation allowance Does not change overall annual tax provision (benefit) However, may change tax provision (benefit) between interim periods The result of this computation (as well as the need to do the computation) is often counterintuitive. Page 61

63 Accounting for outside basis differences Outside basis differences may not be recognized if certain exceptions are applicable Section of Income taxes FRD (Financial Reporting Developments), Exceptions to deferred tax accounting for outside basis differences: Summary of application of exceptions and common entity types Common pitfalls: Not providing taxes for outside basis difference related to investments in partnerships or equity method investments No longer qualifying for exception with changes in investment ownership Are the exceptions to outside basis differences appropriately applied? Page 62

64 Realizability of deferred tax assets (DTAs) Same framework Establishing a valuation allowance for the first time Determining whether a valuation allowance continues to be necessary Have all four sources of taxable income been considered? Is there taxable income in carryback periods of the appropriate character? Are tax planning strategies considered appropriately? Page 63

65 Realizability of DTAs Future reversals of existing taxable temporary differences Evaluate DTAs on a gross basis Consider the timing of reversal of existing taxable temporary differences Common pitfall: DTAs evaluated on a net basis Common pitfall: Naked credits are used as a source of taxable income Will the deferred tax liabilities result in taxable income in the appropriate period? Are there deferred tax liabilities associated with book balances that do not have a known period when they may affect the income statement? Page 64

66 Tax provision process best practices Page 65

67 Tax provision process best practices Prepare tax basis balance sheets to prove cumulative deferred taxes by entity Prepare technical tax accounting white papers for issues and transactions Analyze state (including apportionment changes) and foreign tax rates for changes Document outside basis differences, including indefinite reinvestment assertions and prepare outside basis difference calculations (consider previously taxed income and unrecaptured Subpart F income) Document valuation allowance considerations (four sources of taxable income) and prepare position paper Consider tool to improve computations related to uncertain tax positions Page 66

68 Tax provision process best practices Evaluate intercompany transactions and tax provision effects Conduct regular meetings with external auditors for significant transactions, changes in business, etc. Challenge annually prior-year processes to identify areas for improvement Build-in controls to reduce risk of Excel templates Implement standardized global procedures Refresh internal controls for income taxes Page 67

69 11th Annual Domestic Tax Conference 28 April 2016 New York City