Frequently asked questions: Accounting considerations of US tax reform (updated as of February 1, 2018)

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1 Frequently asked questions: Accounting considerations of US tax reform (updated as of February 1, 2018) No. US January 24, 2018 (updated as of February 1, 2018) What s inside: Alternative minimum tax..1 Fiscal year ends....2 Remeasurement at the date of enactment Valuation allowance...6 Indefinite reinvestment SAB Presentation and disclosure Business combinations Goodwill impairment Net investment hedges.13 Note: This In depth has been updated as of February 1, 2018 to reflect recent developments and to add additional questions. Questions that were revised or added are marked. Alternative minimum tax Question 1.1: How should AMT credit carryforwards be presented on the balance sheet? Answer 1.1: We believe AMT credit carryforwards may be presented as a receivable (properly classified as current/noncurrent for companies that present a classified balance sheet) or a deferred tax asset. We also believe it is reasonable for a company to bifurcate the balance, presenting the portion of the AMT credit carryforward that is expected to offset the regular tax liability as a deferred tax asset, and presenting the portion that will be recovered via refund as a receivable. National Professional Services Group In depth 1

2 Question 1.2 ( revised February 1, 2018) Should an entity release its valuation allowance on AMT credit carryforwards in light of the ability to obtain a refund under the new law? Answer 1.2: Typically yes. The ability to obtain a refund of any remaining AMT credit carryforward would presumably result in the release of a valuation allowance. However, companies will need to be mindful of their approach to assessing realization of AMT credit carryforwards when the company expects to be subject to the base erosion anti-avoidance tax (BEAT) (see Question 4.2), as well as any limitations on obtaining the refund. For example, refundable AMT credit carryforwards may be subject to sequestration under the requirements of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended. If so, refund payments will be reduced by the applicable sequestration rate for federal government s fiscal year (currently 6.6% for the fiscal year ending September 30, 2018). To the extent that an AMT credit carryforward will be subject to sequestration, a company may need a valuation allowance on the AMT credit carryforward deferred tax asset (or a reserve if the AMT credit carryforward is presented as a receivable) to reflect the anticipated impact of sequestration. Adjustments to any related valuation allowance or reserve may be required when the federal government sets the applicable sequestration rate for a given year. Fiscal year ends Question 2.1: For a company whose financial reporting year end is not a calendar year end, what aspects of the tax law change are recognized through the estimated annual effective tax rate (AETR) and what should be recorded discretely in the period of the tax law change? Answer 2.1: The response is best demonstrated through an example. Assume a company with a June 30 year end expects to generate $250 of book income each quarter, for a total of $1,000 for the year. The company has no permanent differences. The company expects net movement in its temporary differences during the year to reduce taxable income by $300. The composition of the movement in temporary differences is as follows: Temporary difference 7/1/17 (beginning of year) Activity 6/30/18 (end of year) Temp Diff A $500 ($500) $ - Temp Diff B (200) - (200) Temp Diff C Total $300 ($300) $ - Temporary difference A is expected to reverse after the date of enactment, but before the end of the fiscal year. Temporary difference B is expected to reverse after the end of the fiscal year. Temporary difference C originates during the current year and will reverse after the end of the fiscal year. National Professional Services Group In depth 2

3 The temporary differences in this example do not relate to movements in other comprehensive income. See Questions 3.1 and 3.2 for additional considerations on deferred balances that relate to items recorded through other comprehensive income. Determine the tax provision for the year Current provision Deferred provision Book income $1,000 7/1/17 deferreds $300 Perms 105 Temps (300) Taxable income $ 700 6/30/18 deferreds $ - Blended rate - Current expense $ 196 Deferred expense $105 Total tax expense is $301 ($196 + $105). Determine discrete impact of remeasuring deferreds at beginning of year Temporary difference Measured at rate before enactment (A) Measured at rate at which it will reverse (B) Discrete amount recorded (B) - (A) Temp diff A $500@35% = $175 $500@28% = $140 $35 expense Temp diff B ($200)@35% = ($70) $200@21% = ($42) $28 benefit Total $105 $98 $ 7 expense Note that Temporary difference C is not included in the above calculation because it originates in the current year and is therefore captured in the next calculation. National Professional Services Group In depth 3

4 Calculate the interim provision Q1 Q2 Q3 Q4 Estimated full year pre-tax income $1,000 $1,000 $1,000 $1,000 Tax rate for current year income 35% 28% 28% 28% Tax on current year income AETR impact - originating differences Estimated full year income tax expense Estimated AETR 35% 29.4% 29.4% 29.4% YTD income ,000 YTD income tax expense Discrete adjustment at enactment Total YTD provision Temporary difference C, which originates in the current calendar year, generates a permanent difference that impacts the rate. This is because the impact on the current provision will be recorded at the blended rate of 28%, but the temporary difference will reverse and impact the deferred provision at a 21% rate. This 7% rate differential, multiplied by the gross originating difference of $200, yields a permanent rate impact of $14. The total year-to-date provision of $301 noted above agrees with the total tax expense calculated in the step Determine the tax provision for the year. The impact of the tax law change on the YTD provision at Q2 is inherently captured via the mechanics of calculating the Q2 interim provision above and should be disclosed, if material. In this example, the impact is $14 [(Q1 PBT of 250)*(Q1 AETR of 35% - Q2 AETR of 29.4%)]. Question 2.2: If a US parent is a calendar year-end taxpayer but its controlled foreign corporation (CFC) has a November 30 year end, should the liability for the toll charge on that CFC s earnings & profits (E&P) be recorded as a payable or a deferred tax liability in the parent s December 31, 2017 financial statements? Answer 2.2: We believe that the toll tax liability is most appropriately presented as a payable in the parent s December 31, 2017 financial statements. Although the CFC s E&P will not appear on the parent s tax return until 2018, the parent is required to determine the amount of E&P subject to the toll tax as of either November 2 or December 31, Question 2.3: For non-calendar year companies, would the tax impact of the toll charge be included in the estimated AETR or should it be recorded as a discrete item in the interim period containing the enactment date? Answer 2.3: We believe the tax effect of the toll charge should be recorded discretely. Adjustments to deferred tax assets and liabilities, as well as taxes payable or receivable, resulting from a change in tax law or rates should be accounted for discretely in continuing operations. While prospective effects of a change in tax law would be reflected in the estimated AETR calculation, the enactment of the toll charge would not have a prospective effect. National Professional Services Group In depth 4

5 Additionally, the estimated AETR applies to the tax effect of ordinary income. As the toll charge is not related to an entity s ordinary income for the year and could not have been estimated at the beginning of fiscal year, this further supports discrete accounting. Remeasurement at the date of enactment Question 3.1: The tax reform legislation signed on December 22, 2017 reduces the corporate tax rate to 21% for tax years beginning after December 31, ASC 740 requires deferred taxes to be remeasured at the date of enactment. Can companies remeasure their deferred taxes using December 31, 2017 balances since they do not typically track deferred taxes at an interim date? Answer 3.1: Deferred taxes should be remeasured as of December 22, However, companies might consider changes in deferred taxes between the two dates to determine whether or not there would be a material impact on the financial statements if they were to use December 31 as a proxy. For example, assume a company had available-for-sale securities that are marked to market. The company would need to: remeasure the fair value of the securities as of the date of enactment, with any changes reported in other comprehensive income, update any other-than-temporary impairment assessments as of the date of enactment, measure deferred tax balances (after reflecting the December 22 fair values) at pre-enactment tax rates, following the normal intraperiod allocation (i.e., presumably other comprehensive income), and remeasure the deferred tax balances on December 22 at the tax rates in effect when the deferred tax balances are expected to reverse (which will be the newly enacted tax rates for any differences that will reverse after December 31, 2017). The impact of this remeasurement would be recorded in continuing operations. Then, at December 31, the company would need to remeasure the securities at fair value and remeasure the deferred tax balances using the post-enactment tax rates, with the movement in deferred taxes between December 22 and December 31 being subject to intraperiod allocation in the 2017 annual period. This process can result in different amounts reported in other comprehensive income and current earnings as compared to reflecting the impact of the changes in tax law on deferred tax balances at year end. The size of this difference will depend on the degree to which the fair value of the instruments changed between December 22 and December 31. Question 3.2: A company has a temporary difference and corresponding deferred tax asset/liability for a pension plan. The pension plan is remeasured annually on December 31, 2017, in accordance with ASC 715, with remeasurement gains/losses reflected in other comprehensive income. Should the deferred tax effects of the pension remeasurement be measured at 35% or 21%? Answer 3.2: Changes in deferred taxes related to a pension remeasurement at December 31 would be recorded at 21% and reflected in other comprehensive income along with the pre-tax remeasurement gain or loss. Changes in deferred taxes related to tax reform would have been recorded as of the enactment date of December 22 based on the net pension asset or liability reflected at that date (i.e., prior year balance rolled forward for interest, expected return on assets, benefit payments and contributions, if any.) Changes in deferred tax balances as a result of changes in tax law are reported in National Professional Services Group In depth 5

6 income from continuing operations (i.e., earnings). Since the effect of the tax law change would already be recorded, any deferred tax effects of the remeasurement adjustment after December 22 would use the tax rate at which those deferreds would be expected to reverse (which at December 31 would be 21% for a calendar year-end company). Question 3.3 (added February 1, 2018) What are the more significant potential state tax effects that should be considered as a result of US tax reform? Answer 3.3: US tax reform may have significant state and local tax effects. A deferred state income tax liability or asset gives rise to a US federal income tax asset or liability, which would need to be remeasured based upon the newly enacted 21% tax rate. In practice, many entities employ a blended rate to simplify their income tax calculations (i.e., they use a state tax rate, net of the federal impact). These companies will need to assess whether continued use of the blended rate is appropriate in light of tax reform as states determine whether or not they will decouple from the Internal Revenue Code (IRC) (see PwC s Income taxes guide, Section ). Additionally, entities will need to evaluate how tax reform impacts their previous valuation allowance assessments on state deferred tax assets. Areas of particular significance for states may include the provisions related to: the deemed repatriation toll-charge, introduction of a 100% dividend received deduction on certain qualified dividends from foreign subsidiaries, changes in the interest expense limitations, and full-expensing of capital expenditures. The threshold state income tax question is whether and how a state adopts the IRC. Some states simply begin the determination of state taxable income with federal taxable income (i.e., they do not specifically adopt or reject the IRC). Other states begin with federal taxable income, but generally adopt the IRC in one of three ways: Fixed date conformity: Conformity with the IRC remains fixed as of a specific date until the state legislature adopts a new date Rolling date conformity: State adoption of the IRC conforms to federal amendments automatically Adoption of select sections of the IRC Based on these provisions, each each state will need to assess the impact of the change in tax law as of December 22, Companies will need to evaluate how each state adopts the IRC and record their state tax provisions based on the enacted state law. Valuation allowance Question 4.1 (revised February 1) In general, the tax law causes net operating losses (NOLs) generated in taxable years ending after December 31, 2017 to have an indefinite carryforward period and also places a limitation for taxable years beginning after December 31, 2017 that only 80% of taxable income in any given year can be reduced by NOLs. What impact might these changes have on companies' valuation allowance assessments? Answer 4.1: The indefinite carryforward period of NOLs generated in taxable years ending after December 31, 2017 means that a deferred tax liability that has an indefinite reversal pattern (e.g., taxable temporary differences related to indefinite-lived intangibles or goodwill) may serve as a source of taxable income for those NOLs. Importantly, this might mean that a company with a full valuation allowance that is currently reporting so called naked credits may be able to reverse some or all of that valuation allowance in National Professional Services Group In depth 6

7 connection with the tax law change to the extent that deductible temporary differences are expected to reverse and generate an indefinite-lived NOL. The limit on the use of future NOLs to 80% of taxable income for taxable years beginning after December 31, 2017 must be considered when determining how much of the NOL will be realized. For example, each dollar of deferred tax liability (both indefinite and finite-lived) that serves as a source of taxable income would only provide realization for 80 cents of the NOL. So a company would need, for example, $125 of taxable income to realize $100 of NOLs. Question 4.2: In certain instances, deferred tax assets, such as AMT credit carryforwards and NOLs, may not be fully realized if a company is subject to BEAT in future years. Should companies consider this potential outcome when performing their valuation allowance assessments? Answer 4.2: Possibly. The FASB staff issued a Q&A (FASB staff Q&A #4) on the accounting for BEAT, in which it concluded that BEAT should be considered a period cost that is, an entity should not consider BEAT in the measurement of deferred taxes. The Q&A also notes that [t]he staff also believes that an entity would not need to evaluate the effect of potentially paying the BEAT in future years on the realization of deferred tax assets recognized under the regular tax system because the realization of the deferred tax asset (for example, a tax credit) would reduce its regular tax liability, even when an incremental BEAT liability would be owed in that period. Although FASB staff Q&A #4 indicates that companies would not need to evaluate the effect of the interaction of BEAT with its deferred tax assets, we believe that companies may elect to do so. A company may choose to take this route in order to avoid an abnormally high effective tax rate in a future year when a deferred tax asset is consumed in the regular tax calculation but a BEAT liability exists such that no or a reduced benefit is realized from the deferred tax asset. To illustrate, consider a company with $1,000 in AMT credit carryforwards as of December 22, Ignoring BEAT, it assumes full recovery of that $1,000 deferred tax asset. In 2018, it has pre-tax income of $1,200 and it computes $300 of expected regular tax and $330 of expected BEAT. In that scenario, $300 of AMT credits will offset the regular tax, but the company would still pay $330 of BEAT. At the end of 2018, the company will only have $700 of AMT credit carryforwards left with $350 refunded and $350 carrying over to the next year to repeat the process. However, it will not have realized any economic benefit for the $300 of AMT credits that offset regular tax in Thus, its effective tax rate would be 52.5% ($330 of BEAT plus write-off of AMT credit of $300 = $630 / $1,200). Question 4.3 (added February 1, 2018) How should a company measure the valuation allowance on NOL carryforwards if the company elects to consider the impact of BEAT? Answer 4.3: Valuation allowances are assessed based on "all available evidence." We believe one reasonable approach would be to consider the expected benefit of an NOL on a with-and-without basis. This approach would compare estimates of the total tax due (regular tax plus BEAT) considering utilization of NOLs (the with calculation) to an estimate in which the NOL does not exist (the without calculation). A valuation allowance would be recorded for the difference between these two amounts. By necessity, this approach will require scheduling both future taxable income and future estimated BEAT payments over the estimated utilization period of the NOLs. These projections would then need to be updated each period to reflect current projections. National Professional Services Group In depth 7

8 Indefinite reinvestment Question 5.1: Do the measurement period provisions of SEC Staff Accounting Bulletin No. 118 (SAB 118) apply when a company is still re-evaluating its indefinite reinvestment assertion in light of tax reform? Answer 5.1: Based on Example 1 of SAB 118, we believe that a company that is still evaluating whether to change its indefinite reinvestment assertion in light of tax reform can identify that conclusion as incomplete under SAB 118. If the company ultimately changes its assertion during the SAB 118 measurement period, the company would account for the change in assertion as part of the change in tax law. Question 5.2: Now that historical E&P has been subject to taxation through the toll charge, what should a company disclose if it is still asserting indefinite reinvestment? Answer 5.2: Disclosures under ASC 740 continue to apply. Although earnings and profits will already have been taxed in the US federal jurisdiction through the toll charge, other taxes (e.g., withholding taxes, state taxes) may still apply to unremitted foreign earnings. If the company is asserting indefinite reinvestment related to investments in foreign subsidiaries, it will need to disclose the amount of outside basis difference and the amount of any unrecognized deferred tax liability for temporary differences, if determination of that liability is practicable, or a statement that determination is not practicable. We believe it may be difficult in many cases to assert that it is not practicable to measure the unrecorded deferred tax liability. Question 5.3: Many companies may decide to no longer assert indefinite reinvestment in light of tax reform. If a company is no longer asserting indefinite reinvestment, how should the deferred tax liability be measured? Answer 5.3: Companies that do not assert indefinite reinvestment must record a deferred tax liability for any taxable temporary differences that would be incurred when the outside basis difference reverses. This will depend on how management anticipates the outside basis difference will reverse. For example, to the extent the outside basis difference is expected to reverse through distributions, the distributions may be subject to withholding taxes by foreign tax authorities. The deferred tax liability may also need to capture other potential taxes, including state income taxes, and the impact of foreign currency movements related to unremitted earnings. Intraperiod allocation should also be considered when recording deferred tax liabilities. Unrealized foreign currency gains and losses associated with the subsidiary s net assets, including unremitted earnings, represent translation gains and losses that are reported as part of other comprehensive income (OCI). Therefore, the deferred tax effect of the translation gains and losses would also be recorded through OCI. If withholding taxes are accrued as part of the deferred tax liability, the treatment of foreign currency movements will likely differ. The withholding tax is an obligation of the parent. Assuming a US parent with a withholding tax payable in a foreign currency, any change in the amount of the withholding tax liability caused by foreign currency exchange rate changes is a transaction gain or loss, which is recorded through the income statement (either within tax expense or in pre-tax earnings, depending on the company s policy). National Professional Services Group In depth 8

9 Question 5.4: What should a company consider if it plans to assert indefinite reinvestment for prospective earnings (2018 and forward)? Answer 5.4: A company that asserts indefinite reinvestment will need to continue to have evidence of specific plans for reinvestment of undistributed earnings of a subsidiary that demonstrate that remittance of the earnings will be postponed indefinitely. While investment needs in the subsidiary are key to this analysis, liquidity needs at the parent company should also be considered. In light of the tax law change, additional considerations might include, for example, whether there is sufficient cash available at the parent level to pay the toll tax or to pay down debt in order to minimize the impact of the interest expense limitation going forward. To the extent that a company is no longer asserting indefinite reinvestment on historical earnings (2017 and prior), it may be difficult to justify a different assertion for prospective earnings when the incremental tax cost of repatriating future earnings would likely not be significantly different than the incremental tax cost of repatriating historical earnings. SAB 118 Question 6.1: Should a company apply the guidance in SAB 118 to individual aspects of the income tax provision or comprehensively to all aspects of the provision? Answer 6.1: SAB 118 provides guidance on the accounting for various effects of US tax reform that may be at different stages of completion. We believe it is reasonable that companies may be able to complete their analysis and accounting conclusions for some effects (and therefore record them) while recording provisional amounts for other effects. At the same time, they may be unable to develop provisional estimates in other areas, and therefore may follow old tax law for those until a reasonable estimate can be made. Question 6.2: Does the guidance in SAB 118 apply to valuation allowance assessments when certain aspects of the assessment are incomplete? Answer 6.2: We believe SAB 118 may apply to a company s valuation allowance assessment when it is not complete as a result of evaluating the impact of tax reform. Many of the effects of the tax law change could impact a valuation allowance assessment. Therefore, to the extent that income tax effects are recorded as provisional or not recorded because information is not available, prepared, and/or analyzed (including computations), the company s ability to conclude on its valuation allowance assessment may be impacted. In this situation, companies should indicate the status of the valuation allowance assessment in their SAB 118 disclosures. Example 2 in SAB 118 addresses a valuation allowance assessment. Question 6.3: If Treasury issues guidance that clarifies provisions or application of the new tax law subsequent to a company s period-end but prior to the issuance of its financial statements, should the company account for any impact resulting from the new guidance in its not-yet-issued financial statements? Answer 6.3: If the guidance is interpretive in nature, we believe that a company can identify the item to which the guidance relates as being accounted for on a provisional basis under SAB 118, and account for the effects of the new guidance in the subsequent period. Alternatively, we believe it would also be acceptable for a company to record the effects of the guidance in its financial statements for the prior period that have yet to be issued. It should be clear from the company s disclosures which approach they have followed. National Professional Services Group In depth 9

10 However, if the guidance is legislative in nature - such as new regulations - we would expect the effects to be accounted for in the period of enactment consistent with any change in tax law. See Section 7.3 of PwC s Income taxes guide for discussion of the difference between legislative and interpretive guidance. Question 6.4: Should an entity estimate or record provisional amounts under SAB 118 for expected state tax law changes in response to federal reform? Answer 6.4: No. Consideration of future changes in tax law is prohibited. ASC 740 requires that the tax effects of changes in tax laws or rates be recognized in the period in which the law is enacted. If those laws change, the tax effect of the change in law would be recognized in the period of enactment. SAB 118 would not apply to state law changes. However, application of SAB 118 may impact certain aspects of the state tax provision. Provisional amounts may be recorded under SAB 118 when the accounting is incomplete but a reasonable estimate can be determined. This amount could include related state tax effects. For example, the provisional amount of the toll charge may include a reasonable estimate of the associated state tax expense from the toll charge for those states that conform to the IRC (see Question 3.3). Question 6.5 (added February 1, 2018) The FASB staff has indicated that a company should make and disclose a policy election as to whether it will (1) recognize deferred taxes for basis differences expected to reverse as GILTI or (2) account for GILTI as period costs if and when incurred. How should a company proceed if it has not determined its GILTI accounting policy election for the period ending December 31, 2017? Answer 6.5: A company can apply the SAB 118 guidance to the selection of a GILTI accounting policy election provided it continues to act in good faith toward determining such policy. A company will not be deemed to have made a GILTI accounting policy election until it discloses that its GILTI accounting policy election is final (i.e., the GILTI accounting policy election is no longer disclosed as incomplete under SAB 118), or at the point in time at which it records a material deferred tax amount related to GILTI whether provisional or final during the SAB 118 measurement period. If a company records deferred taxes related to GILTI in the period of enactment or in a subsequent period within the SAB 118 measurement period, and that amount is material, the company will have made its GILTI accounting policy election. Any changes to that accounting policy would be subject to the requirements of ASC 250, Accounting Changes and Error Corrections, including justification of the change as preferable and retrospective application. On the other hand, if a company chooses an accounting policy to record deferred taxes for GILTI but is still refining its measurement methodology, the company may disclose that its measurement methodology is provisional under SAB 118. Subsequent changes to the measurement methodology during the SAB 118 measurement period would be subject to the SAB 118 guidance, rather than ASC 250. However, if a company elects an accounting policy to record deferred taxes for GILTI but does not disclose the measurement methodology as provisional under SAB 118, any subsequent changes to the measurement methodology would be subject to ASC 250. A calendar year-end company that still has not determined its GILTI accounting policy as of its 2018 first quarter should treat any anticipated GILTI tax as a component of current tax expense in its 2018 AETR calculation until such time that it finalizes its accounting policy election during the SAB 118 measurement period. Including GILTI as a period cost National Professional Services Group In depth 10

11 in the AETR calculation does not mean that the company has made an accounting policy election to treat GILTI as a period cost as long as the company continues to disclose that the accounting policy election is incomplete under SAB 118. It is our understanding that the SEC staff would not object to these views. Presentation and disclosure Question 7.1: If a company is a non-calendar year filer using a blended rate for fiscal 2018, what rate should the rate reconciliation in the fiscal year-end financial statements start with? Answer 7.1: Reporting entities are required to reconcile income tax expense attributable to continuing operations to the applicable statutory Federal income tax rate applied to pre-tax income from continuing operations. We believe that either the statutory rate for an individual company (i.e., the blended rate) or the end of period rate (i.e., 21%) is appropriate to use as the starting point for the rate reconciliation. One factor to consider is that the following year s rate reconciliation will start with 21%; therefore, choosing 21% for the current year would ensure consistency between the two years. Starting with 21% would likely require including a line item in the reconciliation to get to the blended rate for the current year. Alternatively, a company might choose to start with the blended rate applicable to the current year earnings or loss. Starting with a blended rate would warrant disclosure of the rate and the basis for using it. Question 7.2 (added February 1, 2018) As the toll tax liability is paid, how should the payments be presented in the statement of cash flows? Answer 7.2: Toll tax payments should be reflected as operating cash flows in accordance with ASC 230, Statement of Cash Flows, because they are payments to a government for taxes. Although due to the long-term nature of the liability (i.e., payable in installments over eight years), some may think it should be reflected as financing cash flows, this would not be appropriate. In addition, when the indirect method is used in the statement of cash flows, annual toll tax installments should be included in the "income taxes paid" disclosure. Question 7.3 (added February 1, 2018) ASC A requires public companies to disclose a reconciliation (i.e., tabular rollforward) of the beginning and ending balances of unrecognized tax benefits (UTBs) from uncertain positions. These amounts should include UTBs that are reported in the financial statements as a direct reduction to the deferred tax asset for the NOL carryforward, a similar tax loss, or the tax credit carryforward to which it relates. In instances when a UTB reduces an NOL, should the UTB (as disclosed in the tabular rollforward) be adjusted to reflect the reduced corporate tax rate from 35% to 21%? Answer 7.3: Yes. The tabular rollforward reflects tax benefits that have not yet been recognized in the financial statements. In this scenario, the tax benefit that would be recognized upon a favorable resolution of the tax position would result in an NOL carryforward that would provide a 21% tax benefit. As a result, the tabular rollforward should reflect the UTB at the reduced rate. This conclusion applies both when the UTB is directly associated with a tax position taken in a tax year that resulted in the recognition of the NOL, and when the UTB itself did not generate the NOL, but rather the NOL is available to offset any additional income if the tax position is disallowed. National Professional Services Group In depth 11

12 Business combinations Question 8.1: In a business combination that was completed before the enactment of the tax reform, how does the new tax law affect the assumptions and inputs used for determining fair values when allocating purchase consideration to assets acquired and liabilities assumed? Answer 8.1: A company should determine the fair value of assets acquired and liabilities assumed using market-participant assumptions as of the acquisition date. As described in Question 9.3, the closer the transaction closing date is to the December 22, 2017 enactment date, the higher the likelihood the marketplace participant assumptions used in a fair value estimate would have incorporated expectations of the tax law change. Question 8.2: If a business combination was completed before December 22, 2017, but an ASC 805 measurement period adjustment is identified after that date, how should changes to deferred taxes resulting from the measurement period adjustment be recorded? Answer 8.2: New information obtained during the ASC 805 measurement period that results in adjustments to the provisional amounts of assets or liabilities and associated deferred taxes would first be measured using the provisions of the tax laws that were in effect on the acquisition date, and recorded as an adjustment to goodwill. Then, as a second step, the deferred taxes would be further adjusted to reflect the enactment of the new tax law in accordance with ASC 740, with the second adjustment being recorded to continuing operations. For example, assume a company records an indefinite-lived intangible asset acquired in a business combination at a provisional amount of $100 as of September 30, The intangible asset has no tax basis and the company records a deferred tax liability of $35 using its statutory rate of 35%. Goodwill of $200 was recorded in the acquisition. In the quarter ended December 31, 2017, the company receives information it was seeking and adjusts the intangible asset s provisional amount to $160. The company would record a $60 ($160 less $100) increase in the intangible asset carrying amount, a $21 ($60*35%) increase in the deferred tax liability, and a decrease to goodwill of $39. The company would then account for the tax law change. This would consist of two pieces: (1) remeasuring the original deferred tax liability of $35 at the new statutory rate of 21% (original temporary difference of 100 * 21% = $21, yielding a $14 reduction to the deferred tax liability), and (2) adjusting the $21 increase in the deferred tax liability to $12.60 ($60*21%) for a further $8.40 income tax benefit. Goodwill impairment Question 9.1: Does the tax law change represent an event that would trigger an interim goodwill impairment assessment? Answer 9.1: It depends. Goodwill should be tested for impairment if an event occurs or circumstances change (i.e., triggering events) between annual impairment tests that could more likely than not reduce the fair value of a reporting unit below its carrying amount. Examples of events and circumstances that may represent triggering events for an interim impairment test are outlined in ASC C. Such factors include negative macroeconomic conditions, cost increases, and a sustained decrease in share price, among others. While for many companies the tax law change will positively impact goodwill impairment assessments, that may not always be the case. A company s analysis should be based on the specific facts and circumstances of the reporting unit being considered for impairment. National Professional Services Group In depth 12

13 Question 9.2: A company performs its annual goodwill impairment assessment as of October 1, 2017 and determines that the carrying amount of a reporting unit is greater than its fair value, indicating that the reporting unit s goodwill may be impaired (or is impaired if the entity has adopted ASU , Simplifying the Test for Goodwill Impairment ). Prior to recording a goodwill impairment charge, the company determines that the fair value of the reporting unit will exceed its carrying amount at December 31, 2017 due to the impact of the change in tax law. Can the company forgo recording the October 1st goodwill impairment? Answer 9.2: No. The carrying amount of a reporting unit should be based on the carrying amounts of the assets and liabilities comprising the reporting unit as reflected in the company s balance sheet on the impairment testing date. A reporting unit s fair value is also determined on the impairment testing date. Even if an interim goodwill impairment test determines that no impairment exists at December 31, or that the calculated October 1 impairment charge would be less using the December 31 assessment, the company should record the impairment resulting from its October 1 assessment. Question 9.3: What assumptions and inputs should be used for determining the fair value of a company s reporting units in a goodwill impairment assessment that is performed as of a date before the enactment of tax reform? Answer 9.3: A company should determine the fair value of its reporting units using market participant assumptions that existed as of the impairment assessment date. The closer the impairment assessment date is to the December 22, 2017 enactment date, the higher the likelihood that market participant assumptions would incorporate expectations of tax reform (ASC 360 includes examples of how to measure cash flows when multiple scenarios are possible). An impairment assessment performed on or after enactment should include the impact of the tax law change when determining fair value. Net investment hedges Question 10.1 (added February 1, 2018) ASC 815 permits companies to hedge on an after-tax basis, so that the hedging instrument generates a total after-tax gain or loss in the cumulative translation adjustment (CTA). This offsets the total loss or gain in CTA on the designated portion of the hedged item which, assuming an indefinite reinvestment assertion has been made, is not tax-effected. Assume a calendar year-end company has a hedge of a net investment on an after-tax basis. The company assessed effectiveness at the beginning of the quarter and concluded that the hedging relationship was highly effective. How should the company account for the impact of the change in the corporate income tax rate under the new tax law on their after-tax net investment hedges in 2017? Answer 10.1: Because of the change in the corporate income tax rate, the gains and losses on a hedging instrument will be taxed at a different rate than before. As a result, the hedging instrument will no longer generate an after-tax gain or loss that offsets the loss or gain on the designated portion of the hedged item unless the hedge is dedesignated and redesignated considering the new tax rate. As a result of the reduced tax rates, the company would be over-hedged. Absent a dedesignation and redesignation as of December 22, 2017 that considers the new tax rate, the change in tax law will result in ineffectiveness. Companies are required to measure and recognize ineffectiveness in net investment hedging relationships in current earnings, unless the company has early adopted ASU , Targeted Improvements to Accounting for Hedging Activities. National Professional Services Group In depth 13

14 We do not believe that a company would be required to perform a reassessment of effectiveness of the hedging relationship on the date of enactment of the new law (December 22, 2017) in order to continue to apply hedge accounting through December 31, However, we believe that a company is required to measure and record ineffectiveness resulting from the tax rate change from December 22, 2017 until December 31, 2017 (in addition to any other ineffectiveness). In addition, we do not believe that a company would need to record ineffectiveness on a cumulative basis for gains and losses recorded in CTA prior to December 22, To have a deeper discussion, contact: Jennifer Spang Partner jennifer.a.spang@pwc.com Brett Cohen Partner brett.cohen@pwc.com Eric Suplee Director eric.m.suplee@pwc.com Kassie Bauman Director kathleen.bauman@pwc.com Subscribe to our weekly newsletter at PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.