Tax Accounting Presentation Institute of International Bankers

Transcription

1 Tax Accounting Presentation Institute of International Bankers June 18, 2009 J. Scott Gregory P C

2 Table of contents Section 1 Tax Accounting Considerations and Fair Value Accounting 2 Exposure Draft 3 Tax Accounting Method Considerations Upon Adoption of IFRS 4 Appendix

3 Section 1 Tax Accounting Considerations With Respect to Fair Value Accounting When tax is on cost basis Impact on effective tax rate Valuation allowance Interest-related declines in FV of debt securities When tax is on 475 (mark-to-market) basis Specific international banking-related issues

4 Section 1 Tax Accounting Considerations and Fair Value Accounting When tax is on cost basis. FAS 109 and IAS 12 use a balance sheet approach to recognize and measure deferred taxes. Fair value measurement impacts the carrying value of assets and liabilities and could result in temporary difference if book/tax symmetry is not present. Book carrying values reported on the balance sheet are compared with their relative tax bases. Resulting differences are considered taxable or deductible temporary differences, which will result in deferred taxes. Unrealized Book Gain Unrealized Book Loss DTL DTA Lower Cash Tax Increase Cash Tax Caution: During volatile markets, this could have the effect of significantly increasing deferred tax assets and liabilities which could impact capital ratios. PricewaterhouseCoopers 3

5 Section 1 Tax Accounting Considerations and Fair Value Accounting Impact on Effective Tax Rate Given the current volatility in the marketplace, FV accounting could have a significant impact on an organization s effective tax rate. - Values have been marked down over the past year or two - Values have rebounded with improving market conditions - Values may be marked up in future quarters because of accounting rule changes Recent FASB Statement of Position ( FSP ) on FAS 157 Pressure on IASB to change FV measures Example 1: Valuation allowance on DTA If an entity has suffered an other-than-temporary impairment (OTTI) on investment positions that it does not mark-to-market (MTM) for tax purposes, then it will be required to book a deferred tax asset. Deferred tax asset must be assessed for realizability To the extent the asset requires a valuation allowance, it will have an impact on the effective tax rate. PricewaterhouseCoopers 4

6 Section 1 Tax Accounting Considerations and Fair Value Accounting Impact on Effective Tax Rate Example 2 Reversal of deferred tax liability If an entity had an investment that had previously appreciated in value, the unrealized gain would have been a taxable temporary difference for which a DTL was recorded. If the value of that security flips to below its tax basis, the DTL will flip to a DTA, which would need to be assessed for realizability. If the previously recorded DTL was a source of future taxable income to support existing DTAs, the result could be a need for a valuation allowance (VA) on the existing DTAs plus the new DTA created. PricewaterhouseCoopers 5

7 Section 1 Tax Accounting Considerations and Fair Value Accounting Valuation Allowance Interest-related declines in FV of debt securities Interest-related decline in fair value of an AFS security is not considered OTTI if management has the intent and ability to hold until expected recovery in fair value How is expected recovery in value considered when assessing the need for a valuation allowance against the DTAs? View 1 While the recovery of book basis provides a future source of taxable income, it is not viewed in isolation - If this income in conjunction with other sources of income contributes to overall positive future income then evidence may be used to support realization of DTAs - However, if this income only serves to reduce future losses of the company, the amount recovered does not provide support for the realization of DTAs - VA cannot be avoided unless evidence that benefit of DTA will be realized as a result of future taxable income. View 2 - AFS-related DTAs would be evaluated separately from the company s other DTAs - Future taxable income implicit in recovery if the book basis of AFS security would offset the deductions underlying the same DTAs - No VA would be necessary, even if VA would be necessary for all other DTAs PricewaterhouseCoopers 6

8 Section 1 Tax Accounting Considerations and Fair Value Accounting Valuation Allowance Interest-related declines in FV of debt securities - Example (DTA)/DTL AFS - Pool 1 (10) AFS - Pool 2 6 Net (4) Equity Securities (10) Total (14) Question: How much valuation allowance should be recorded? A) 14 B) 10 C) 4 * Assume character is the same. PricewaterhouseCoopers 7

9 Section 1 Tax Accounting Considerations and Fair Value Accounting When tax is on Sec. 475 (a mark-to-market basis) When a taxpayer is MTM for tax purposes and is using FV for accounting purposes, generally no book tax difference exists. However, this assumes IRS will accept FV accounting method as a true measure of market value. PricewaterhouseCoopers 8

10 Section 1 Tax Accounting Considerations and Fair Value Accounting When tax is on Sec. 475 (a mark-to-market basis) (cont d) Things to consider: - If the methodology to measure FV changes for book purposes, the taxpayer will need to review the methodology used for tax. Is there a change in accounting method requiring a Form 3115? - Will 475 safe harbor apply? Note: no safe harbor for IFRS fair values - Has the company considered uncertain tax positions and recorded appropriate liabilities for interest and penalties? E.g., Level III modeling, adjustments to the model, potential IRS challenges PricewaterhouseCoopers 9

11 Section 1 Tax Accounting Considerations and Fair Value Accounting Specific international banking-related issues Large swings in value can cause financial statement and cash tax charges due to - Limitations on utilization of post-ownership change losses due to Sec Unavailability of NYC NOL carryovers - Branch profits tax - tax on dividend equivalent amount - US branch interest expense deductions as a result of increase or decrease in the tax basis of US Assets (Treas. Reg ) ETR permanent difference PricewaterhouseCoopers 10

12 Section 2 Exposure Draft Background Uncertain Tax Positions Intraperiod Allocation Model Other Changes to Consider

13 Section 2 Exposure Draft Background - Status of the income tax convergence project 2004 FASB/IASB set scope and initial project plan Tentative decisions regarding amendments to FAS 109 and IAS 12 reached by FASB and by IASB, respectively Fall 2008 FASB suspended deliberations to amend FAS 109 March 2009 IASB released an Exposure Draft of a revised income tax accounting standard. Comments are due July 31, 2009 Future? IASB will adopt a new tax accounting standard FASB is expected to issue an Invitation to comment to solicit input as it considers its convergence strategy. The FASB will then decide whether to eliminate differences in the accounting for income taxes FASB s options: 1. Amend FAS 109, 2. Replace FAS 109 with IFRS standard, or 3. Leave FAS 109 as is. PricewaterhouseCoopers 12

14 Section 2 Exposure Draft Background Overview of the IASB s Proposal Proposal retains the IAS 12 approach Stock-based compensation Intercompany transactions Foreign exchange differences on nonmonetary assets Proposal uses a new approach Uncertain tax positions Initial recognition Tax rate (distributed vs. undistributed) Proposal uses a US GAAP based approach Outside basis differences Valuation allowance Intraperiod allocation also seeking comments on the IAS 12 model Tax basis PricewaterhouseCoopers 13

15 Section 2 Exposure Draft Uncertain Tax Positions Proposes New Model Requires tax positions to be measured at probability-weighted-average amount of all possible outcomes No separate recognition threshold Assumes tax authorities will review Changes in measurement should be based on new information Proposal does not include explicit guidance on unit of account No guidance on accounting for interest and penalties, but disclosure of classification is required PricewaterhouseCoopers 14

16 Section 2 Exposure Draft Uncertain Tax Positions Example Comparing US GAAP to the proposal Entity A takes a tax deduction of $1,000. Entity A estimates the position has an 80% probability of being sustained. Potential benefit Individual probability Probability weighted calculation Cumulative probability $1,000 80% $800 80% 0 20% 0 100% Recognition of the benefit compares as follows: US GAAP Single best estimate (allowed under current IAS 12) Proposed accounting (weighted average probability) $1,000 $1,000 $800 PricewaterhouseCoopers 15

17 Section 2 Exposure Draft Uncertain Tax Position Disclosures - Proposes new model Tabular rollforward disclosure is not required, but other disclosures are required. Adjustments are recognized for current tax of prior periods, including changes in uncertain tax positions. Major sources to enable users to assess possible financial effects of the estimation uncertainty and its timing include: - Description of uncertainty; and - Indication of its possible financial effects on amounts recognized, and timing of those effects. PricewaterhouseCoopers 16

18 Section 2 Exposure Draft Intraperiod Allocation - Proposes FAS 109 Approach Generally prohibits backwards tracing but includes exceptions (e.g., certain equity accounts) IASB also included the IAS 12 model as an alternative for comment - Generally requires backwards tracing can be difficult to determine Invitation to comment asks questions on both approaches Both approaches can be difficult to apply Both can be arbitrary at some level PricewaterhouseCoopers 17

19 Section 2 Exposure Draft Intraperiod Allocation - Example Year 1 The company records an other-than-temporary impairment (OTTI) on AFS securities. The company currently has no valuation allowance. Year 2 The company records a valuation allowance - Under US GAAP The VA is recorded in continuing operations, which increase tax expense and affects the ETR. - Under current IFRS The VA is recorded in equity, where the DTA originated. Consequently, income tax expense and the ETR is not affected. PricewaterhouseCoopers 18

20 Section 2 Exposure Draft Other Changes to Consider Stock-based compensation Intercompany transactions Foreign exchange differences on non-monetary assets Initial recognition Tax Rate (distributed vs. undistributed) Outside basis difference Valuation allowance Tax basis PricewaterhouseCoopers 19

21 Section 3 Tax Accounting Considerations Upon Adoption of IFRS SEC Roadmap Practical Application Impacted Areas Relevant Questions Issues to Consider

22 Section 3 Tax Accounting Method Considerations Upon Adoption of IFRS Current Roadmap PricewaterhouseCoopers 21

23 Section 3 Tax Accounting Method Considerations Upon Adoption of IFRS Practical Application Impacted Areas Assessing the tax implications can be a labor intensive effort - Will it necessitate changes in tax accounting methods? - Will it create an opportunity for a tax accounting method change that is strategic in light of the organization s overall tax planning objective? Tax accounting methods affect computation of: - Taxable income for domestic companies (Schedule M adjustments) - E&P for foreign companies - Book-tax basis differences, which affect DTAs/DTLs PricewaterhouseCoopers 22

24 Section 3 Tax Accounting Method Considerations Upon Adoption of IFRS Relevant Questions Issues to Consider Can any newly adopted method of accounting continue to be followed under relevant tax law? If the newly adopted book method is permissible, is it the most strategic and preferable method for tax purposes? What if the book method of accounting is not permissible under tax law? - Will the company be able to compute the temporary differences and Schedule M items? - Will systems need to be updated or procedures revised to capture the necessary deferred taxes and Schedule M items? Will the changes in the tax accounting method have a significant impact on taxable income, E&P, or deferred taxes? (e.g., thin-cap rules, transfer pricing) PricewaterhouseCoopers 23

25 Section 3 Tax Accounting Method Considerations Upon Adoption of IFRS Impact of Book Accounting Method Change on Tax Accounting Methods Countries fall into 3 general categories: - Dependent - taxable profit is based on the legal entity statutory accounts with only limited adjustments (e.g., China, Luxembourg, Turkey) - Quasi-dependent taxable profit is principally based on the legal entity statutory accounts with a number of adjustments provided for under the tax law (Brazil, Sweden, U.K.) - Independent taxable profit is determined in accordance with a specific set of tax rules with little or no direct reliance on the legal entity statutory accounts (e.g., U.S., Canada, Denmark) PwC analysis of 108 countries - Dependent 5 - Quasi-dependent 94 - Independent - 9 PricewaterhouseCoopers 24

26 Section 3 Tax Accounting Method Considerations Upon Adoption of IFRS Take Aways Impact upon adoption of IFRS depends on the country in question. - Independent countries Will primarily change the computation of many book-tax basis differences and in some cases eliminate them. But may require accounting method changes with regard to: - Any methods where book-tax conformity is required for tax but the method is not permitted for books (e.g., LIFO in the U.S.) - Costs that are re-characterized as inventoriable for books (resulting in recharacterizations between Sections 471 and 263A) - Circumstances where erroneous accounting methods are uncovered - Circumstances where more favorable accounting methods are discovered - Quasi-dependent and Dependent countries may have more direct impacts on taxable income. Decisions may significantly impact - Cash taxes - Compliance procedures Tax department needs to be involved in accounting policy decisions to ensure that: - Tax considerations are addressed, and - Compliance issues are appropriately managed within the organization and with the taxing authorities. PricewaterhouseCoopers 25

27 QUESTIONS? PricewaterhouseCoopers 26

28 Contact Information J. Scott Gregory (646) PricewaterhouseCoopers 27

29 Section 4 Appendix Additional Changes in IAS 12 Exposure Draft

30 Section 4 IAS 12 Exposure Draft Stock-based compensation - IAS 12 Approach Tax benefit is measured based on intrinsic value at each reporting date Increases volatility in effective tax rate compared to US GAAP model - Tax benefit recorded in the P&L is limited to the tax effect of the compensation charge for each individual award (i.e., shortfalls are recorded in the P&L) - Additional tax benefits are recorded directly in equity - IFRS does not apply US GAAP concept of additional paid-in-capital (APIC) pool - Movements in share price will result in volatility in tax provision PricewaterhouseCoopers 29

31 Section 4 IAS 12 Exposure Draft Intercompany transactions - IAS 12 Approach IASB proposal - recognizes the income tax consequences when the transaction occurs same as the current IASB model. FAS 109 defers tax impact of intercompany transactions until third party sale. IASB proposal Additional disclosures include any DTAs and DTLs resulting from transaction and net tax expense for all such transfers or for those transfers that are not considered customary for the group. PricewaterhouseCoopers 30

32 Section 4 IAS 12 Exposure Draft Foreign exchange on nonmonetary assets IAS 12 Approach IASB proposal - If functional currency does not equal local currency, nonmonetary assets/liabilities translated at historical rates create temporary differences from exchange rate movements. - Record deferred taxes on the basis difference. Differs from the current US GAAP model - FAS 109 does not recognize deferred taxes for such temporary differences. PricewaterhouseCoopers 31

33 Section 4 IAS 12 Exposure Draft Initial recognition of DTA or DTL - Proposes new model Initial recognition - Acquire an asset Tax basis differs from book basis Asset acquisitions that are not business combinations and do not impact accounting or tax profit - Asset is adjusted to remove entity-specific tax impact on the price paid - Deferred taxes are recognized - Difference between consideration paid and recognized asset/liability (and deferreds) is the discount or premium to deferred taxes - Under current IFRS, deferred taxes are not recorded - Under current US GAAP, asset/liability is grossed up per EITF PricewaterhouseCoopers 32

34 Section 4 IAS 12 Exposure Draft Tax rate - Proposes new model Use substantively enacted rate - Substantively enacted = Enacted in the US jurisdiction Consider expectations when distributed and undistributed rates differ - Current IFRS Use undistributed rate, do not consider expectations - Current US GAAP Generally use higher rate, do not consider expectations - Application unclear if expect to distribute some but not all earnings PricewaterhouseCoopers 33

35 Section 4 IAS 12 Exposure Draft Outside basis differences Proposes FAS 109 Approach DTA or DTL is not recognized for foreign subsidiary or joint venture if - Investment is permanent in duration; and - Temporary difference is not expected to reverse in foreseeable future. Permanent in duration Need evidence of specific plans to reinvest earnings. Current IAS 12 exception applies to foreign and domestic subsidiaries, joint ventures, and associates. Domestic subsidiaries - Exception not explicit - If can reverse tax-free, then no deferred tax accounting PricewaterhouseCoopers 34

36 Section 4 IAS 12 Exposure Draft Valuation Allowance Proposes FAS 109 Approach US GAAP Deferred taxes are recognized in full, but are then reduced by a valuation allowance if it is considered more-likely-than-not that some portion of the deferred taxes will not be realized. IFRS Deferred taxes are recognized when considered probable (defined as morelikely-than-not) that sufficient taxable profits will be available to utilize the temporary difference. Valuation allowances are not allowed to be recorded. PricewaterhouseCoopers 35

37 Section 4 IFRS convergence Tax basis - Proposes FAS 109 Approach Defined as the measurement under enacted tax law of asset or liability Asset Liability Expected tax consequence of selling for book value Expected tax consequence of settling at book value IASB noted that definition is meant to be consistent with US GAAP. - However, definition is more specific than US GAAP (i.e., links tax basis to asset sale). Under current IFRS, tax basis is determined based on management s expected method of recovery or settlement. - Under proposal, expected method of recovery or settlement impacts measurement of deferred taxes, but not tax basis. PricewaterhouseCoopers 36

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