Accounting for Income Taxes: Recent Developments and Current Issues An update regarding recent, pending and proposed ASC 740 guidance

Transcription

1 Accounting for Income Taxes: Recent Developments and Current Issues An update regarding recent, pending and proposed ASC 740 guidance Vickie Carr, Deloitte Robin Miller, PwC American Gas Association Tax Committee Seattle, WA June 23,

2 Agenda For more information, contact Deloitte Touche Tohmatsu Limited. Regulatory Updates Standard Setting Updates Legislative Updates Revenue Recognition Leases Pensions BEPS Brexit Questions 2

3 Regulatory Update 3

4 Auditing and PCAOB developments Inspection staff update and common findings Inspections staff update and common findings PCAOB staff discussed how inspection process has evolved into risk-based approach to identify emerging audit risks and firm specific risks Has refined its review of firms system of quality controls; remediation efforts; and firms root cause analysis processes that involve identification of both positive and negative quality events Has incorporated randomization into their risk-based selection process, which it believes would enable the staff to conclude on the state of audit quality, where audit quality is trending, and inform standard-setting activities Areas of Improvement Understanding issuer and business processes, transactions, and controls to provide better basis for planning the audit Coaching and support of teams by the engagement team itself as well as by national office Firm monitoring at both engagement level and firm level to proactively identify potential problems before it is too late to take action Areas Where Significant Findings Exist Internal control over financial reporting findings continue, with testing of management review controls at top of the list Assessing and responding to risks of material misstatement remains on list, although there has been improvements in testing system-generated data and reports Accounting estimates including fair value measurements remains challenging area but firms are taking significant remedial actions and building tools to improve results For more information, contact Deloitte Touche Tohmatsu Limited.

5 PCAOB inspections Example questions How did you get comfortable no unrecognized tax benefit liability was required with respect to certain intercompany loans? What procedures were performed to test rate reconciliation items were appropriately listed in accordance with the 5% of expected income tax expense threshold? For the 11 items selected, can you walk us through the legal entity structure, how the cash moved between entities and explain why no tax cost or impact on indefinitely reinvested assertions? How did you test and conclude that the book-toreturn adjustments related to Section 199 was a change in estimate and not an error? Request to provide (in person) specific walk-through of testing for internal controls involving: Company s provision process Foreign tax credit modeling process Company s process for identifying uncertain tax positions Company s financial forecasting process Company s process involving indefinite reinvestment assertions Process for how journal entries are recorded in SAP (automated or manual process?) How did the Company document management review controls and how did you test those controls? For more information, contact Deloitte Touche Tohmatsu Limited.

6 PCAOB releases and standard setting Proposed standards on auditor reporting and other information 8/13/2013 PCAOB proposed changes to auditor s reporting model and auditor s responsibilities for other information (similar efforts undertaken by international standard setters and regulators) 5/11/2016 PCAOB re-proposed several changes to auditor s reporting model included in PCAOB s 2013 original proposal; re-proposal Expands auditor s report and requires communication of critical audit matters (CAMs) CAMs are matters communicated to audit committee involving accounts or disclosures material to financial statements that are challenging, subjective or require complex auditor judgment 6/1/2017 approved by the PCAOB in their Standing Advisor Group meeting; now pending SEC approval For more information, contact Deloitte Touche Tohmatsu Limited.

7 Standard Setting Updates 7

8 Standard setting update Proposed disclosures

9 Proposed income tax disclosures Overview Disclose (all) Domestic and foreign components of pretax income or loss Indefinitely reinvested foreign earnings Disaggregation of income taxes paid by country Other disclosures Disclose (public business entities) Unrecognized tax benefits Reason for changes in realizability estimates of deferred tax assets Government assistance Other disclosures April 4, 2014 Field study results and next steps Jan. 7, June 8, 2016 Board deliberations July 26, 2016 Issued proposed ASU Sept. 30, 2016 Comment period ended Jan. 25, 2017 Discussed comments received March 17, 2017 Roundtable on all disclosure projects??? Final ASU For more information, contact Deloitte Touche Tohmatsu Limited.

10 Proposed income tax disclosures Indefinitely reinvested foreign earnings Disclose (all entities) Amount of undistributed foreign earnings for which there is a change in assertion during period regarding indefinite reinvestment of such earnings and explain circumstances that caused such assertion change* Aggregate of cash, cash equivalents, and marketable securities held by foreign subsidiaries* US Parent Foreign Sub Outside basis difference subject to assertion Example disclosure (change in assertion) Prior to fiscal year 20XX, we asserted that undistributed earnings of our foreign subsidiaries were [indefinitely] reinvested. Primarily due to the increase in our U.S. debt service obligations resulting from issuance of additional unsecured senior notes in aggregate principal amount of $XXX during the current fiscal year and issuance of additional unsecured senior notes in aggregate principal amount of $XXX in current year, management concluded that the ability to access certain amounts of foreign earnings would provide greater flexibility to meet domestic cash flow needs without constraining foreign objectives. Accordingly, in fourth quarter of fiscal year 20XX, we withdrew the [indefinite] reinvestment assertion on $XXX of earnings generated by certain of our foreign subsidiaries through fiscal year 20XX. We provided for U.S. income taxes on $XXX of undistributed foreign earnings, resulting in recognition of a deferred tax liability of approximately $XXX. We recognized additional deferred income tax expense of $XXX related to the impact of fluctuations in foreign currency exchange rates during fiscal year 20XX on the portion of the $XXX of unremitted earnings generated prior to fiscal year 20XX For more information, contact Deloitte Touche Tohmatsu Limited. Note: * Commonly requested in SEC comments 10

11 Proposed income tax disclosures Unrecognized tax benefits Disclose (public business entities) In tabular reconciliation, disaggregate settlements between those using attributes versus those using cash Map unrecognized tax benefit total in tabular reconciliation to balance sheet lines where recorded Eliminates requirement to provide details of positions for which it is reasonably possible that total UTBs will significantly increase/decrease in next 12 months Example disclosure (immediately below tabular reconciliation table) At December 31, ending balance of unrecognized tax benefits presented by statement of financial position line item is as follows: 20X7 20X6 Taxes payable $ 30,000 $ 40,000 Deferred tax liability 120, ,000 Unrecognized tax benefits presented on statement of financial position 150, ,000 Unrecognized tax benefits not presented on statement of financial position 160, ,000 Total unrecognized tax benefits $ 310,000 $ 370, For more information, contact Deloitte Touche Tohmatsu Limited. 11

12 Proposed income tax disclosures Realizability estimates of deferred tax assets for carryforwards Disclose (public business entities) Total federal/state/foreign operating loss and tax credit CFs disclosed by expiration period (first five years after reporting date and total for all remaining years) Total federal/state/foreign DTAs for operating loss and tax credit CFs before valuation allowances; amounts further disaggregated by expiration period (first five years after reporting date and total for all remaining years) Total UTBs that offset DTAs related to operating loss and tax credit CFs Example Disclosure Expires during FY Loss carryforwards (not tax effected) Deferred Tax asset for loss carryforwards before valuation allowance (tax effected) Federal State Foreign Federal State Foreign Total 20X2 $ 1,800 $ 1,550 $ 1,900 $ 720 $ 155 $ 570 $ 1,445 20X3 1,200 1,050 1, X X X Thereafter 1,450 1, Total 4,800 Unrecognized tax benefits at December 31, 20X1 (2,000) Total tax effect of carryforwards after unrecognized tax benefits $ 2, For more information, contact Deloitte Touche Tohmatsu Limited.

13 Proposed income tax disclosures Domestic and foreign components of pre-tax income or loss (All entities) disclose pretax earnings from continuing operations disaggregated by domestic and foreign* PBT before cost sharing = $400 USP $100 cost sharing payment Income or loss generated from registrant s operations located inside registrant s home country Rule 4-08(h) defines foreign income or loss as income or loss generated from registrant s foreign operations, i.e. operations located outside registrant s home country PBT = ($100) DRE FS Example Disclosure Earnings before income taxes 20XX Domestic $ 500 Foreign 100 Total income before income taxes $ 600 Note: *Existing requirement in SEC regulations PBT before cost sharing = $300 Generally more meaningful if domestic and foreign components are grossed up as they correspond more closely to actual amounts of domestic and foreign tax expense and benefit. However, because Rule 4-08(h) is not explicit, we believe that net presentation, with appropriate disclosure, would also be acceptable For more information, contact Deloitte Touche Tohmatsu Limited.

14 Proposed income tax disclosures Disaggregation of income taxes paid between countries Disclose (all entities) Disclose foreign income taxes paid further disaggregated for any country significant to total Example disclosure The domestic and foreign income taxes paid were as follows 20X5 20X4 20X3 United States $650 $ 565 $775 United Kingdom Ireland Other countries Total income taxes paid $ 1,037 $ 872 $ 1,228 14

15 Proposed income tax disclosures Other disclosures and government assistance Other disclosures (public business entities) Disaggregation of income tax expense (benefit) between foreign and domestic jurisdictions* Separately present reconciling items > 5% of the tax at statutory rate in effective tax rate reconciliation* Enacted tax law change, if probable that change will affect entity in future period Explanation of nature and amounts of valuation allowance recognized or released Explanation of year-over-year change in separately presented reconciling items (i.e., > 5% above) Disclose (all entities) (Proposed ASC ) Description of legally enforceable agreement with a government**, including Duration of agreement Commitments made with government under that agreement Amount of benefit that reduces, or may reduce, its income tax burden Note: * Existing requirement in SEC regulations 15

16 Standard setting update Comment letters on proposed disclosures

17 Disclosure Framework Income taxes Summary of comment letters received Topic Indefinitely reinvested foreign earnings Disaggregation of domestic and foreign Disaggregation of income taxes paid Change in tax law Government assistance Comments received Users may inappropriately assume that assets being disclosed are available for repatriation Users may make incorrect assumptions as to amount and timing of repatriation based on proposed disclosure Requested clarification as to whether pretax income (loss) and income tax expense (benefit) would be on pre- or postconsolidation/elimina tions basis Requested term significant be defined either qualitatively, quantitatively, or both or be replaced with term material Proposed disclosure would not be useful as tax payments for individual jurisdictions are impacted by items unrelated to current year profit or loss, and timing of payments can vary by jurisdiction Proposed disclosure would be costly and complex to prepare, requiring significant judgment by preparers Many government agreements contain confidentiality restrictions and as a result, proposed disclosure should be limited to information that does not violate confidentiality agreements Current rate reconciliation requirement of Topic 740 already provides disclosure of significant government assistance received For more information, contact Deloitte Touche Tohmatsu Limited.

18 Disclosure Framework Income taxes Summary of comment letters received (cont.) Topic Valuation allowance Carryforwards Unrecognized tax benefit Transition, implementation, and adoption Comments received Redundant with existing disclosures in ASC and Would be too complex and voluminous for users to understand Proposed disclosure in ASC A(b) should be presented net of valuation allowances Gross carryforwards could be misleading to users without the appropriate knowledge to compute tax effect (non-public Business Entities) Expiration dates of carryforwards are not decision useful as they are not representative of timing in which they may be used, as valuation allowances are not contemplated in proposed disclosure Disaggregation of settlements between deferred tax assets and cash may be challenging due to lack of available information Line items in which unrecognized tax benefits (UTBs) are presented does not provided decisionuseful information. Current requirements of ASC A are sufficient Supported prospective adoption with one-year implementation period and early adoption being permitted For more information, contact Deloitte Touche Tohmatsu Limited.

19 Other standard setting reminders Stock compensation (ASU ) Effective for public entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2016; one year later nonpublic entities Intra-entity asset transfers (ASU ) Effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017 (for nonpublic entities: one year later for annual periods, 2 years later for interim periods i.e., FYs beginning after 12/15/19) Revenue recognition (ASU ) Effective for public entities for annual reporting periods beginning after December 15, 2017; one year later for nonpublic entities Leasing (ASU ) Effective for calendar periods beginning on 1/1/2019 and interim periods therein (public companies); one year later for all other entities For more information, contact Deloitte Touche Tohmatsu Limited.

20 Legislative Updates ASC 740 and Tax Reform Proposals 20

21 ASC 740 effect of tax law changes Timing The effect of a change in tax laws or rates shall be recognized at the date of enactment Intraperiod allocations Income tax effects of changes in tax law or rates are allocated to continuing operations Items/events partially excluded from the AETR may include changes in tax laws/rates Interim Rate: Impact of tax law/rate changes on current taxes of the CY Discrete: Impact of tax law changes on beginning of the year DTAs/DTLs recognized in period of tax law/rate change (reflected in the period the changes are enacted) Rate: Impact of tax law changes on DTAs/DTLs arising in the CY subsequent to the enactment date For more information, contact Deloitte Touche Tohmatsu Limited.

22 Federal tax reform overview Evaluation of proposed tax rates and ongoing proposals Corporate Tax Rate Reform Proposed Rate Considerations 35% Current Tax Rate 25% Camp II Proposal 20% House GOP Proposal 15% Trump Administration Proposal Considerations that may lower tax base Repeal Corporate AMT Full Expensing of Capital Investments Retain R&D Credit Retain LIFO Considerations that may increase tax base Interest Expense Limitation Repeal Most Business Expenses (Trump Administration) Repeal IRC For more information, contact Deloitte Touche Tohmatsu Limited.

23 Other recent tax law changes UK anti-hybrid rules Published 12/9/2015 IRC 385 regulations (Treatment of Certain Interests in Corporations as Stock or Indebtedness) Issued 10/13/2016 IRC 987 regulations (Income and Currency Gain or Loss With Respect to a Section 987 QBU) Issued 12/7/ For more information, contact Deloitte Touche Tohmatsu Limited.

24 Tax Reform proposals domestic overview Evaluation of proposed tax rates and ongoing proposals Headline rate Corporate Tax Rate Reform 35% Current Tax rate 25% Camp II proposal Base Repeal Corporate AMT Full expensing of capital investments Retain R&D credit Retain LIFO 20% House GOP proposal 15% President Trump proposal Impact on taxes and/or tax rate Interest expense limitation Repeal IRC Section 199 Repeal most business expenses (President Trump) For more information, contact Deloitte Touche Tohmatsu Limited.

25 Tax Reform Proposals ASC 740 considerations Evaluate the impact on : Deferred taxes reduction in tax rate could have unfavorable impact for net DTA position, favorable impact for net DTL position Inventory of temporary differences e.g., DTA for interest could be eliminated DTAs for specific tax attributes foreign tax credits (i.e., future availability), AMT credits Potential effective tax rate (ETR) impact Unfavorable impact for Section 199, COGS related to imports, interest or other business expenses Favorable impact for exempt foreign sales, dividends received and non-passive Subpart F income Valuation allowance implications Change in net deferred tax position Future projections of income Re-evaluate outside basis exceptions: Repatriate prior to enactment to utilize FTC (no longer permanently reinvested) Deemed repatriation enactment may cause forced change in assertion Other considerations : State tax conformity Disclosures For more information, contact Deloitte Touche Tohmatsu Limited.

26 Revenue Recognition Standard 26

27 Introduction Key points Adoption of ASC 606 / IFRS 15 Effective Date Annual reporting periods beginning after December 15, 2017 and December 15, 2018 for public entities and nonpublic entities, respectively GAAP Analysis Will require companies to perform an in depth analysis of each type of revenue stream for financial statement purposes. Tax departments should be involved throughout this analysis to assess the areas of tax compliance and planning, as well as the associated magnitudes. System Impacts May impact the way data is captured, as well as additional information that may be required Overall Tax Impacts Will result in numerous tax impacts from both a technical and systems standpoint IRS Expectations The Internal Revenue Service understands that the adoption of the new revenue recognition standards will have federal income tax implications and expects companies to perform the requisite procedures in order to address these implications* Cash Tax Impact The new revenue recognition standards may result in accelerated revenue recognition for tax purposes and associated cash outlays to taxing authorities Note: * On March 28, 2017, the IRS issued Notice , proposing automatic consent procedures for companies to change their tax revenue recognition methods related to the adoption of the new revenue standards. The IRS is soliciting comments on the proposed procedural guidance For more information, contact Deloitte Touche Tohmatsu Limited. 27

28 Revenue Recognition Standard Tax Considerations: Tax Accounting methods Overview of tax revenue recognition rules: The tax law contains specific revenue recognition rules, under which revenue generally is recognized the earlier of when it is due, paid or earned. Amounts due or paid in advance of being earned (advance payments) may be eligible for tax deferral under specific provisions (Rev. Proc or Section 451 regulations), but tax deferral generally cannot exceed the book deferral. Revenue generally earned for: Goods, when benefits and burdens of ownership of good transfers Services, when services (or divisible services) are complete Licenses, over the period the licensee has the right to use the property Long-term contracts, as costs are incurred 28

29 Revenue Recognition Standard Tax Considerations Potential tax accounting methods impact, in general: Financial accounting changes will impact cash taxes in certain instances: Recognition of advance payments deferred to extent of book deferral Treatment of additional items as deferred revenue as opposed to as accrued liabilities (e.g., customer loyalty programs) Identification of impermissible tax method Changes could impact book-tax differences and deferred taxes, including: Recognition of sale of goods, services, long-term contracts, licensing revenue Contingent consideration Time value of money adjustments Changes also may require tax accounting method changes 29

30 Revenue Recognition Standard Other Potential Tax Impact? Accounting for income taxes adjustments to deferred tax balances, impacts on any valuation allowances, uncertain tax positions International potential impact to E&P, foreign source income allocations, debt netting calculations, allocation of interest expense under fair market value apportionment method, VAT State and local potential impact on apportionment, sales and use taxes. Transfer pricing impact on benchmarking analyses (e.g., timing of impact on comparables), impact on intercompany invoice amounts, need to allow additional lead in case for year-end transfer pricing adjustments Tax deductions impacted by revenue Section 199 deduction computation, Calculation of credits (e.g., R&E) 30

31 Revenue Recognition Standard What are we seeing currently? Financial accounting assessing now, and in many cases identified accounting changes. Tax beginning to assess impact of changes on current tax accounting methods Need to consider impact on all tax areas Finance and Tax should communicate regarding impact of new standard, considering especially: Tax budget needs Systems needs to capture data needed to properly report revenue for tax purposes Document conclusions related to financial accounting and tax implications 31

32 Leases 32

33 ASC 842 leases What you need to know Virtually all leases on balance sheet FASB preserves classification model, mostly consistent with current GAAP Changes to the definition of a lease will likely impact accounting for power purchase and power sales arrangements Transition models proposed Impacts Balance sheet will be grossed up Financial metrics and debt covenants may be impacted Subsequent remeasurement may require additional effort Elements of a contract may be a lease and will now be on balance sheet Looking forward Issued Q Effective date 2019 (Early adoption permitted) Consideration for power & utilities companies Pole attachments Renewable energy contracts Easements and rights of way First mile / last mile 33

34 New leasing standard (Topic 842) Overview of income tax implications Lease characterization for federal income tax purposes has not changed (e.g., true lease vs. sale) as a result of Topic 842. For tax, the focus remains on which party bears the benefits and burdens of ownership. Topic 842 does not contain tax accounting guidance and only includes minor, conforming amendments to ASC Topic 740, Accounting for Income Taxes, that do not change the basic requirements of current accounting. Topic 842 will create book/tax differences consistent with current GAAP. However, since the new standard may result in the recognition of more assets and liabilities, ASC 842 may require entities to record new or adjust existing DTAs and DTLs. Topic 842 may also impact the computation of state and local income-based taxes as a result of changes to the apportionment formula For more information, contact Deloitte Touche Tohmatsu Limited.

35 Tax impacts leasing guidance Tax Impacts of GAAP Accounting Changes On Day 1, equal and offsetting deferred tax liabilities (DTL)s, related to the leased asset, and deferred tax assets (DTA)s, related to the lease liability, will be recorded as a result of the new leasing standard requiring lessee s to record both operating and capital leases on the balance sheet along with corresponding lease liability. Subsequent periods: - Finance Lease: The DTL and DTA created on Day 1 will differ in subsequent periods as the asset amortizes S/L over the shorter of the useful life or lease term while the lease liability rolls off by interest and principal - Operating lease: The DTL and DTA created on Day 1 will differ in subsequent periods (not the same difference under the finance lease) as the asset amortizes as the difference between the S/L lease and the interest expense on the lease liability while the lease liability rolls off by interest and principal Renewable facility lessees may be considered the owner for GAAP under the new guidance, long-term purchase power agreements are re-assessed to meet the definition of lease 35

36 Tax impacts leasing guidance (continued) Other Tax Considerations State Tax Considerations - Net worth taxes: state tax liabilities may increase for the lessee/decrease for the lessor as property is oftentimes a component of the net worth calculation - Apportionment Lessee: There could be a potential that the lessee would inadvertently overstate their property factor (i.e., potentially both the operating lease asset and the operating lease expense * 8 may also be included) leading to higher state tax liability Lessor: May inadvertently overstate their property factor by including assets in its property factor that should not be included (as they are reflected in the lessee s apportionment) While companies are re-assessing their lease inventory for GAAP purposes, it may also be a good time to re-assess the classification for tax purposes as the definitions do not align 36

37 Pensions 37

38 Presentation of pension and postretirement benefit costs ASU Issued March 2017 The net periodic pension and postretirement costs will be disaggregated into its components and presented in separate line items The amounts that are eligible for capitalization would be limited to the service cost component Other components presented outside of operating income Service cost component presented with other compensation costs 38

39 ASU Disclosure requirements including interim disclosures Illustrative examples for disclosures and situations Effective dates - Effective Jan. 1, 2018, for calendar year public companies. A year later for all others - Early adoption permitted at the beginning of an annual period for which financial statements (interim or annual) have not been made available No exception granted to rate-regulated entities 39

40 Presentation of pension and postretirement benefit costs (continue) Key accounting issues: Service cost less than net periodic costs - Record as regulatory asset? (GAAP to FERC difference) Can you accrue equity AFUDC on the asset created above? If net periodic costs is less than service costs, what do you do? 40

41 Base erosion and profits shifting ( BEPS ) and State Aid 41

42 Base erosion and profits shifting (BEPS) Project overview Introduction OECD published its Action Plan on BEPS in June Several items published as discussion drafts for public comment Recently, OECD published final recommendations on each of action items included in initial action plan Countries moving forward on BEPS agenda both independently and multi laterally -Several countries to date with enacted BEPS related legislation Major areas of focus Financing transactions Royalty deductions with little or no corresponding income Intellectual property Permanent establishment Digital economy Hybrid entities Transfer pricing documentation and transparency Note: BEPS may lead to more tax disputes regarding allocation of income between related affiliates For more information, contact Deloitte Touche Tohmatsu Limited.

43 State Aid General overview Background Four Criteria Harmful tax Practice Regimes that apply to mobile activities and unfairly erode tax bases of other countries Code of Conduct Concerns measures which affect, or may affect, in a significant way, the location of business activity in the EU State Aid Advantage in any form conferred on a selective basis to undertakings by national public authorities Intervention by the State or through State resources Competition has been or may be distorted 1 2 State Aid 3 4 Giving rise to an advantage on a selective basis Intervention is likely to affect trade between Member States 43

44 Brexit 44

45 Brexit ASC 740 implications UK gave formal notification under Article 50 of the Lisbon Treaty on March 29, 2017 to withdraw from EU Not considered a change in tax law Appropriate to account for income tax effects of the withdrawal at the earlier of: Date of enacted (substantively enacted for entities issuing under IFRS) changes in the tax laws throughout negotiation period or Date UK actually withdraws from EU Disclose uncertainties and potential income tax accounting effects (if potentially material): Description of the UK withdrawal from the EU Entity s activities that could be affected by withdrawal Potential income tax accounting effects on the entity s financial statements For more information, contact Deloitte Touche Tohmatsu Limited.

46 Questions Disclaimer: This presentation contains general information only and the respective speakers and their firms are not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should 46 consult a qualified professional advisor. The respective speakers and their firms shall not be responsible for any loss sustained by any person who relies on this presentation.