24 th Annual Health Sciences Tax Conference

Transcription

1 24 th Annual Health Sciences Tax Conference Accounting for income taxes: hot topics and developments December 8, 2014

2 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 U.S. This presentation is 2014 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 U.S. 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

3 Presenters Bernadette Abdow Senior Director, Tax Reporting AbbVie Corporation Brian Foley Ernst & Young LLP Chicago, IL Tricia Brosnan Vice President, Global Tax Operations Pfizer, Inc. Joan Schumaker Ernst & Young LLP New York, NY Page 3

4 Agenda Developments Legislative and other developments Accounting standards updates FASB project status Internal controls SEC areas of focus Tax provision challenges and practice issues Tax restatements Return-to-provision adjustments Best-practice responses Reduce risk in tax accounting calculations Page 4

5 Legislative and other developments Page 5

6 Legislative and other developments Changes in tax laws and rates Legislative developments continue to occur in 2014 and include: Albania May 20 enacted transfer pricing rules that define controlled transactions, related parties and comparability. The rules also describe accepted transfer pricing methods which align with the Organization for Economic Co-operation and Development (OECD), allow advance pricing agreements and implement mutual agreement procedures for tax treaties (effective June 4, 2014). Austria February 28 legislation disallowing deductions for interest and royalty payments made to affiliated companies subject to an income tax rate below 10% in the affiliated company s jurisdictions; abolishing tax goodwill amortization for acquisitions after February 28, 2014; excluding foreign group members that are resident in countries outside the EU from Austrian tax groups; limiting domestic group s ability to offset its income with losses of foreign group members to 75% of the domestic group income, starting in Bolivia July 21 enacted new transfer pricing laws with varying effective dates. Page 6

7 Legislative and other developments Changes in tax laws and rates Legislative developments continue to occur in 2014 and include: Chile September 29 enacted legislation that gradually increases the corporate tax rate to as high as 27% from 20%, in certain cases, by Other changes include taxing shareholders on annual corporate profits when earned, rather than distributed; limiting the deductibility of related-party interest; eliminating goodwill amortization; and subjecting passive income from a Chilean company s controlled foreign corporations (CFCs) to current taxation (effective dates vary). In addition, on January 31, Chile increased the current foreign tax credit (FTC) limits to be used in Chile (both in the presence and absence of a tax treaty), expanded the foreign taxes that can be credited (beyond a foreign two-tier structure) and expanded the possible carryover of FTC (effective January 1, 2014). El Salvador August 9 imposed alternative minimum tax on the value of net assets with any incremental tax based on income. Other changes include adopting the OECD transfer pricing guidelines, which would allow taxpayers and tax authorities to use those guidelines when determining transfer prices (effective August 9, 2014). Page 7

8 Legislative and other developments Changes in tax laws and rates Legislative developments continue to occur in 2014 and include: France 9 August extended the expiration date of the 10.7% temporary surtax for large companies by one year, to fiscal years ending on or before December 30, Hong Kong March 27 reduced the applicable profits tax rate imposed on captive insurers to 8.25% from 16.5% (effective April 1, 2013). Iceland January 1 enacted new transfer pricing rules (effective January 1, 2014). Italy August 21 allowed certain companies to convert their notional interest deductions into tax credits and a new tax credit for investments in certain plant and equipment (effective June 25, 2014). Japan 31 March repealed the special reconstruction surtax and will allow for deductibility of 50% of meals and entertainment expenses (effective for taxable years beginning on or after April 1, 2014). Page 8

9 Legislative and other developments Changes in tax laws and rates Legislative developments continue to occur in 2014 and include: Korea January 1 eliminated deductibility of reserves used as future R&D and decreased the R&D investment tax credit for medium and large companies (effective January 1, 2014). Macedonia July 23 enacted legislation to tax profits when they are earned, rather than distributed (effective 2014 tax year). Mexico August 11 passed energy reform legislation with income tax changes affecting the oil and gas industry, including allowing companies to: Use different depreciation percentages than those in the income tax law Carry losses from certain deep-water contracts forward 15 years instead of the standard 10 years Expand the definition of a permanent establishment (PE) so that nonresidents performing activities under Mexico s Hydrocarbons Law for more than 30 days in a year will create a PE in Mexico The changes are effective prospectively for new contracts entered into on or after August 11, Page 9

10 Legislative and other developments Changes in tax laws and rates Legislative developments continue to occur in 2014 and include: Panama January 10 repealed on a retroactive basis the worldwide income tax system enacted at the end of 2013 and reinstated its territorial income tax system (effective December 31, 2013). Peru July 12 suspended the application of its general anti-avoidance rules for transactions occurring before July 19, Poland September 16 introduced a CFC regime to tax foreign companies income at the direct and indirect shareholder level. Other changes include limiting the deductibility of interest on loans among related parties and lowering the debt-to-equity ratio under the thin capitalization rules. Changes are generally effective January 1, For calendar-year CFCs, the CFC changes are effective January 1, Page 10

11 Legislative and other developments Changes in tax laws and rates Legislative developments continue to occur in 2014 and include: Spain November 28 enacted legislation with a phased-in reduction to the corporate tax rate from 30% to 25% by Nonresident income tax rates are also gradually reduced. Other changes include broadening the tax base, increasing the limitations on deductibility of certain expenses and widening anti-abuse provisions (effective January 1, 2015). In addition, on March 8 Spain enacted new rules under which certain cancellation of indebtedness income is nontaxable for Spanish corporate income tax purposes (effective January 1, 2014). US reminder extenders such as CFC look-through rule, Subpart F active financing exception and research credit expired December 31, Deferred taxes should also be measured consistent with enacted tax law. Page 11

12 Legislative and other developments Brazil Law 12,973 conversion to IFRS-based tax basis Broadest/deepest reform to Brazil s corporate income tax system since 1977 Revokes Transitory Tax Regime tax neutrality for statutory IFRS to old Brazil GAAP differences effective January 1, 2015 (early adoption as of January 1, 2014) Mandatory conversion to IFRS-based tax basis on January 1, 2015 Conversion gains and losses for tax purposes. Taxation of gains can be deferred only if accounted for/tracked in individual subaccounts. Conversion losses are not deductible until realized and must be tracked. New electronic 2014 tax return (ECF) requires cumulative IFRS-to-old GAAP-based tax basis differences as of January 1, Page 12

13 Legislative and other developments Brazil Law 12,973 conversion to IFRS transition Profits and dividends accrued or paid during can use the Old Brazilian GAAP or Brazilian IFRS. Profits and dividends accrued in 2014 must be paid using the old GAAP early adopters to use Brazilian IFRS. Interest on net equity deductions and equity pick-ups between 2008 and 2014 can use either the old GAAP or Brazilian IFRS. Page 13

14 Legislative and other developments Brazil Law 12,973 CFC Rules Taxation now based on change in annual revaluation of investment in CFC for pretax profits, excluding foreign exchange variations; FTC available Temporary provision for deferral of payment for up to eight years Deferral for affiliates (e.g., minority interests) profits; no FTC Exemption for CFC/affiliate profits related to oil and gas operations in Brazil Double tax treaty s business profits (Article 7) override not addressed in new law Option to consolidate certain foreign subsidiaries and branches through 2022 Excludes tax havens, privileged/low tax regimes and entities that fail 80% active income test Early adoption available as of January 2014 Page 14

15 Legislative and other developments Changes in tax laws and rates Alaska July 7 repealed the film production tax credit and the veterans employment credit as of December 31, Arizona April 23 modified several credit and incentive programs, including credits for new employment, capital investment incentives and the credit for increased research activities. The effective dates for the changes vary. California September 18 enacted legislation allowing corporations to use certain film credits to reduce their corporate tax liability below the tentative minimum tax (TMT). The change is effective for tax years beginning on or after January 1, In addition, on September 19, California enacted legislation allowing corporations to use the California Competes Tax Credit to offset their corporate income taxes and even reduce those taxes below the TMT. The changes are retroactively effective for tax years beginning on or after January 1, Page 15

16 Legislative and other developments Changes in tax laws and rates District of Columbia July 14 enacted emergency legislation reducing the incorporated and unincorporated business franchise tax rate to 9.4% from 9.975%, effective January 1, Additional rate reductions may occur in future years. The District of Columbia also enacted legislation adopting a single factor apportionment formula and market-based sourcing for use in determining taxable income, effective January 1, The emergency legislation is only effective for 90 days and expired on October 12, Maine April 3 eliminated the super credit for substantial research and development expansion. The maximum research and development credit usage also decreases to 25% from 50% of the tax due, but taxpayers may carry research and development credits forward for 10 years, up from five years. The changes apply to tax years beginning on or after January 1, Page 16

17 Legislative and other developments Changes in tax laws and rates Massachusetts August 13 delayed the adoption of the Financial Accounting Standards (FAS) 109 deduction until Michigan September 11, 2014 enacted legislation to retroactively repeal the Multistate Tax Compact (MTC), effective January 1, The legislation addresses an earlier decision this quarter by the Michigan Supreme Court permitting taxpayers to use the MTC s equally weighted three-factor apportionment formula to determine tax liability under the since-repealed Michigan Business Tax. In addition, on February 25, Michigan enacted changes to the corporate income tax retroactive to tax years beginning after December 31, 2011, including: Clarifying the sourcing rules for sales of tangible personal property Exempting domestic international sales corporations Revising the calculation for investment tax credit recapture Permitting certain companies to eliminate intercompany transactions when determining exemptions, credits and filing thresholds Most of the changes are retroactive to tax years beginning after December 31, The change for intercompany transactions is effective for tax years beginning after December 31, Page 17

18 Legislative and other developments Changes in tax laws and rates Mississippi April 14 enacted alternative apportionment methods for certain taxpayers and required combined filing in certain circumstances. Effective January 1, New Mexico March 10 increased the period in which corporate net operating losses can be carried forward to 20 years from 5 years, applies retroactively to January 1, North Carolina May 29 replaced its net economic loss deduction with a net loss deduction that more closely resembles the federal net operating loss deduction. Companies may carry losses forward up to 15 years, but may not carry them back. Effective for tax years beginning on or after January 1, Page 18

19 Legislative and other developments Changes in tax laws and rates New York State (NYS) March 31 enacted major changes including: Repeal of existing bank franchise tax Reduction in general franchise tax rate from 7.1% to 6.5% (beginning on or after January 1, 2016); increase in Metropolitan Transportation Business Tax Surcharge rate 0% tax rate on the business income base for qualified NYS manufacturers (beginning on or after January 1, 2014) Adoption of an economic presence nexus standard Change in computation of NYS NOLs from a pre-apportioned NOL to a postapportioned NOL, and provision of an NOL conversion subtraction Adoption of a single receipts factor for all NYS taxpayers Change in sourcing of sales to NYS to provide for customer sourcing Elimination of the current subsidiary capital and related franchise tax provisions, and phase-out of the capital base tax through 2020 Generally effective for tax years beginning on or after January 1, 2015 Page 19

20 Legislative and other developments Changes in tax laws and rates Rhode Island June 19 reduced the general corporate income tax rate from 9% to 7%, implemented mandatory unitary combined reporting, eliminated related-party expense add-back requirements (including captive REIT provisions), adopted single sales factor apportionment, required market-based sourcing for sales of services and required inclusion of tax haven corporations in the combined report. These changes are effective for tax years beginning on or after January 1, Utah April 1 modified its income apportionment rules to limit certain taxpayers ability to qualify as sales-factor-weighted taxpayers. The change is effective January 1, Virginia April 1 enacted changes to corporate tax provisions on certain intangible and interest expenses that are deductible for federal tax purposes, but not for state tax purposes. The changes are retroactively effective for tax years beginning on or after January 1, Page 20

21 Treasury Notice on inversions (September 23) Applies to inversion transactions closed after September 22 Highlights future regulations to prevent the following: Hopscotch loans made by the CFC to the new foreign parent, instead of its US parent, to avoid US tax on repatriated earnings Skinny down maneuvers by which a US entity pays out large dividends pre-inversion to reduce size and meet the 80% threshold De-controlling strategies by which the new foreign parent buys enough stock to take control of the CFC away from the former US parent Transactions involving the new foreign parent selling its stock in the former US parent to a CFC with deferred earnings in exchange for cash or property of the CFC Spinversion, whereby a US entity transfers assets to a newly formed foreign corporation it spins off to shareholders Treasury considering other guidance retroactive to September 22 Page 21

22 Accounting standards updates Page 22

23 Revenue recognition final standard Overview Revenue recognition standards issued on May 28, Supersedes virtually all US GAAP and IFRS guidance on revenue recognition Industry and interpretive guidance is superseded Requires more estimates and judgments than current guidance US GAAP effective dates for calendar year-ends Transition method Public Nonpublic Early adoption? Retrospective or modified retrospective Q No* * Nonpublic companies may early adopt as of public company effective date Page 23

24 Revenue recognition final standard The five-step model Core principle: recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Step 1: Step 2: Identify the contract(s) with the customer Identify separate performance obligations Step 3: Step 4: Step 5: Determine the transaction price Allocate transaction price to separate performance obligations Recognize revenue when (or as) each performance obligation is satisfied Page 24

25 Revenue recognition Considerations for public companies Public entities that choose the full retrospective approach may elect not to push the effects back further than 2015 for their selected financial data tables. Staff Accounting Bulletin (SAB) Topic 11.M requires disclosure of the effects of recently issued accounting standards. Disclosures are expected to evolve as more information about the effects are known (including the chosen transition method). SEC five-year table? Prior periods presented SAB Topic 11.M (SAB 74) Effective Final revenue standard Retrospective application date Modified retrospective application date (public entity) Modified retrospective application date (nonpublic entity) Page 25

26 Revenue recognition 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 26

27 Revenue recognition 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 is 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 are reported in the period of adoption. This 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 27

28 Discontinued operations (ASU ) Significant changes in criteria Threshold for item held for sale or disposed of Held for sale on acquisition ASC ASU Component Asset group and certain held for sale criteria met Component and strategic shift having a major effect on operations and financial results Business or nonprofit activity and all held for sale criteria met on acquisition date Significant ongoing involvement Scope exceptions (e.g., equity method investments) Prohibited Yes, various (ASC ) Allowed Oil and gas properties using the full cost method Page 28

29 Discontinued operations (ASU ) Effective date and transition Effective dates of ASU for calendar year-ends Public business entities and conduit bond obligors 2015 interim periods within those years All others 2015 interim periods thereafter Early adoption? Yes Prospective transition for disposals after effective date Does not apply to components classified as held for sale before the effective date. Does not change presentation of components previously classified as discontinued operations. Presentation of discontinued operations will likely not be comparable for all periods presented. Page 29

30 Investments in affordable housing projects (ASU ) ASU , Accounting for Investments in Qualified Affordable Housing Projects, issued January 2014 If conditions met, allows investors to elect the proportional amortization method to account for investments in low income housing tax credits (LIHTC) Replaces effective yield method Investor amortizes to income tax expense the cost of investment in proportion to the tax credits and other tax benefits it receives Not applicable to investment in other tax credits or other tax attributes New disclosures required Effective for interim and annual periods beginning after December 15, 2014, and early adoption permitted Applied retrospectively Option to continue effective yield method for existing investments as of the date of adoption Page 30

31 Presentation of unrecognized tax benefits (ASU ) ASU , Presentation of an Unrecognized Tax Benefit (UTB) When a Net Operating Loss (NOL) Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists Effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, for public entities and fiscal years beginning after December 15, 2014, for nonpublic entities Determine whether a deferred tax asset (DTA) is available for offset based on the DTAs that exist at the reporting date and assume tax position is disallowed at the reporting date Present liability associated with UTBs as a reduction to related DTA for NOL, similar tax loss or tax credit carryforward if such settlement is required or expected Present UTB as a liability; not combined with DTA if net settlement is not required or expected Does not change disclosure of unrecognized tax benefits, which are required to be presented gross Applied prospectively; retrospective application permitted Page 31

32 Presentation of unrecognized tax benefits (ASU ) example In Country Z, disallowed tax positions must be settled with available NOL carryforwards Assume Company A has, tax effected, a $75 NOL and $50 in unrecognized tax benefits for which a liability is recorded Footnote disclosure Deferred tax assets Prior to adoption of ASU Following adoption of ASU Accrued environmental costs $100 $100 Net operating loss carryforwards Less: valuation allowance Total deferred tax assets (matches balance sheet) $145 $95 Does not change disclosure of unrecognized tax benefits, which are required to be presented gross Page 32

33 FASB project status Page 33

34 Selected FASB projects Current status Consolidation Financial instruments Project Classification and measurement Impairment Hedging Leases Goodwill for public business entities and not-for-profits Statement of cash flows Definition of a business Status Drafting final standard Re-deliberations FASB staff research Re-deliberations Initial deliberations Page 34

35 FASB simplification initiatives Current status Simplification project Eliminating extraordinary items Subsequent measurement of inventory Status Drafting final standard Re-deliberations Presentation of debt issuance costs Customer s accounting for fees in a cloud computing arrangement Comment period Measurement date: defined benefit plan assets Income taxes: intra-entity asset transfers and balance sheet classification of deferred taxes Balance sheet classification of debt Employee share-based payment accounting improvements Drafting exposure draft Initial deliberations Page 35

36 FASB income tax project Exposure draft proposing amendments to ASC 740 are expected to have a 120-day comment period. Eliminate the exception for income taxes on intercompany transactions Modified retrospective transition with a cumulative catch-up adjustment Require the classification of all deferred tax assets and liabilities as noncurrent Prospective transition Proposed effective date of annual periods, including interim periods within those annual periods, beginning after December 15, 2016, for public companies and December 15, 2017, for private companies Page 36

37 FASB income tax project Separately, FASB voted to propose that all excess tax benefits and tax deficiencies be recognized in the income statement. Transition has not yet been addressed. Page 37

38 FASB income tax project Items considered, but not added to the Board s agenda, included: Income tax accounting for indefinite reinvestment of foreign earnings Valuation allowances Changes to the requirements for offsetting deferred tax assets and liabilities by tax-paying component Page 38

39 FASB project Accounting for goodwill for public business entities and not-for-profit entities The Board met recently to discuss the outreach and research performed on the subsequent measurement of goodwill that the Board requested at the last Board meeting in March. The four potential views analyzed by the staff for the subsequent measurement of goodwill continue to include the following: View A: PCC model View B: Amortize goodwill over its expected useful life, not to exceed a specified number of years, with impairment tests upon the occurrence of a triggering event View C: Direct write-off View D: Simplified impairment test without amortization A decision was not reached at the meeting. Page 39

40 Internal control over financial reporting (ICFR) Page 40

41 Updated COSO internal control framework In May 2013, Committee of Sponsoring Organizations (COSO) released the Internal Control Integrated Framework: 2013 (2013 framework) to provide an updated framework for designing and evaluating internal controls Original 1992 framework is valid through December 15, 2014, after which it is superseded by the 2013 framework SEC staff have not mandated a specific transition date The longer companies use the 1992 framework, the more likely they may be questioned by the SEC staff Disclose framework used Implementing the 2013 framework is opportunity for tax departments to re-challenge internal controls and documentation while company-wide changes may be occurring. Page 41

42 COSO framework Principles of effective internal control Control environment Risk assessment Control activities Information and communication Monitoring activities 1. Demonstrates commitment to integrity and ethical values 2. Exercises oversight responsibility 3. Establishes structure, authority and responsibility 4. Demonstrates commitment to competence 5. Enforces accountability 6. Specifies suitable objectives 7. Identifies and analyzes risk 8. Assesses fraud risk 9. Identifies and analyzes significant change 10. Selects and develops control activities 11. Selects and develops general controls over technology 12. Deploys through policies and procedures 13. Uses relevant information 14. Communicates internally 15. Communicates externally 16. Conducts ongoing and/or separate evaluations 17. Evaluates and communicates deficiencies Page 42

43 Tax ICFR Precision and evidence of review controls When thinking about precision (the nature or level at which the review control operates), consider the following: Is the control capable of identifying errors? Would the control identify errors or fraud that could be material to the financial statements? Does the control address the relevant risks? Does the control identify errors? Nature of the errors? Examples? If not, why? Nature of the questions identified: follow-up; outcome? Is there contradictory evidence indicating the control is not suitably designed? What evidence of the control exists? Is evidence sufficient to support the assessment? A signature is not sufficient. Page 43

44 Attributes of a review control Who Who performs the control? Do they possess competence and authority? When When or how often is the control performed (timeliness)? What What procedures are performed? What info or data is used? What does the reviewer evaluate? What precision is encompassed? What types of errors are identified? What actions are taken or result? Page 44

45 Tax ICFR Design example Poor example Appropriate personnel review the return to provision true-up calculation. Better example On an annual basis, in the period in which the federal income tax return is filed (when), the Chief Accounting Officer (who) reviews the return to provision calculation, ensuring all positions taken on the income tax return were appropriately considered in the prior year income tax provision (what, why). All return to provision items $250k or greater (net of tax) are evaluated for the effect on the current year or prior year income tax provision (what). Considerations are documented within the return to provision workpaper file and supported with supplemental evidence, if necessary (how). Page 45

46 SEC areas of focus Page 46

47 Regulatory focus income taxes Foreign earnings Realizability of deferred tax assets Effective tax rate reconciliation Page 47

48 Foreign earnings Indefinite reinvestment Not an all or nothing assertion Positive assertion requires specific documentation and evidence of plans each reporting period Consider financial reporting implications of tax planning SEC comments: Please explain to us how you evaluated the criteria for the exception to recognition of a deferred tax liability in accordance with ASC and 18 for undistributed earnings that are intended to be indefinitely reinvested. Describe the type of evidence and your specific plans for reinvestment for these undistributed earnings that sufficiently demonstrates that remittance of earnings will be postponed indefinitely. Page 48

49 Foreign earnings Disclosure Certain disclosures are required when the deferred tax liability is not recognized: The cumulative amount of the temporary difference (i.e., outside basis difference where the book basis of the investment exceeds its tax basis before application of a tax rate) The amount of the unrecognized deferred tax liability related to the difference or statement that it is not practicable to determine Notably, there is no practicability exception for disclosing the temporary difference required by ASC (b). Page 49

50 Realizability of deferred tax assets How evidence was weighted Cumulative losses Consideration of the four sources of taxable income, including the prominence of each source and the material uncertainties, assumptions or limitations associated with each source Timing and reason for changes in valuation allowance Consistency of assumptions Consistency of accounting with Management s Discussion & Analysis disclosures SEC comments: Please substantially revise your disclosure in future filings to provide investors with quantitative and qualitative information of the material positive and negative factors that you considered when arriving at your conclusion that it is more likely than not that the deferred tax assets will be realized. Page 50

51 Realizability of deferred tax assets SEC comments (cont.) Please discuss the significant estimates and assumptions used in your analysis, including the specific factors that changed during fiscal 2012 and led you to determine the reversal was appropriate at this time. Please discuss how you determined the amount of valuation allowance to reverse. Please disclose the amount of pre-tax income you need to generate to realize these deferred tax assets. Include an explanation of the anticipated future trends included in your projections of future taxable income. Confirm to us that the anticipated future trends included in your assessment of the realizability of your deferred tax assets are the same anticipated future trends used in estimating the fair value of your reporting units for purposes of testing goodwill for impairment and any other assessment of your tangible and intangible assets for impairment. If you are also relying on tax-planning strategies, please disclose the nature of your tax-planning strategies, how each strategy supports the realization of deferred tax assets, the amount of the shortfall that each strategy covers, and any uncertainties, risks or assumptions related to these tax-planning strategies. Please show us in your supplemental response what your revisions to future filings will look like. Page 51

52 Effective tax rate reconciliation Clearly label items in the income tax rate reconciliation For material rate reconciling items associated with foreign jurisdictions, disclose the specific jurisdictions that materially affect the effective tax rate, their tax rates and information about the effects of such foreign jurisdictions (e.g., magnitude and mix) on the effective tax rate May question whether large provision to return or trueup adjustments reflect prior year errors rather than changes in estimates Registrants should determine that rate reconciliation information is consistent with other disclosures in MD&A or footnotes Page 52

53 Tax provision challenges and practice issues Page 53

54 Tax provision challenges Restatements General causes: Application of tax technical rules Tax basis Intra-period tax allocation Interim periods Accounting for outside basis differences Realizability of deferred tax assets (DTAs) Tax-planning strategies Deferred tax liabilities as source of income Income tax errors are a leading cause of restatements Page 54

55 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 55

56 Intra-period allocation Be mindful of the complexity of the intra-period 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 intra-period allocation rules? Page 56

57 Intra-period 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 the 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 57

58 Accounting for outside-basis differences Outside-basis differences may not be recognized if certain exceptions are applicable Section of Income taxes 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 58

59 Realizability of 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? Page 59

60 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 60

61 Realizability of DTAs What is a tax-planning strategy? A strategy that is prudent and feasible A strategy that a company ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused A strategy that would result in the realization of DTAs Common pitfalls Substituting or refreshing one DTA with another without evaluating the new DTA for realizability Considering a projection of future taxable income a tax-planning strategy Page 61

62 Realizability of DTAs Company A could sell a noncore asset: The book basis of the asset is $100. The tax basis of the asset is $10. The fair value of the asset is $300. The company has a net operating loss of $200 that is expected to expire in two years. The enacted tax rate for the company is 30%. Assume the company was previously break-even and has no taxable temporary differences. Is the sale of a noncore asset a qualified tax planning strategy? Page 62

63 Realizability of DTAs Conclusion: Yes and no A decision to sell an appreciated noncore asset may represent a tax-planning strategy to the extent it results in the reversal of a temporary difference in an earlier period. In the example, the existing $90 taxable temporary difference may reverse in an earlier period. In some cases, what appear to be tax-planning strategies also represent forecasts of future income. Excess of fair value over book basis is a projection of future taxable income. Pretax gain on sale would be subject to the same limitations as any other projections of future income. In the example, the $200 excess is a projection. Projection of future taxable income is not a tax-planning strategy. Page 63

64 Best-practice responses Page 64

65 Best-practice responses Reduce risk in accounting calculations Uncertain tax positions Automate unrecognized tax benefit calculations and roll-forwards, including interaction with other tax attributes, interest and penalty calculations, and cumulative translation adjustments Fixed assets Improve reporting of tax return deductions and deferred taxes Reconcile sub-ledgers and general ledgers to source data and tax systems to uncover areas for improvement Share-based payments Support balances for deferred tax assets, additional paid-in capital (APIC pool), Section 162(m) adjustments, and unrecognized tax benefits by entity; consider deductibility of payments to foreign employees Tax-basis balance sheets Support cumulative temporary differences by entity with book and tax-basis balance sheets that agree to tax returns and general ledgers; automate inputs and calculations Legal entity calculations Improve legal entity data and engage finance for items outside tax department s direct control (e.g., forecasts, legal entity reporting, intercompany profit elimination) Page 65

66 Best-practice responses Reduce risk in accounting calculations Intercompany transactions Review intercompany transactions for compliance with tax accounting rules Improve spreadsheets and tools to minimize risk of errors, reduce hours and manage risk. Consider implementing a standardized process and/or tool for: Tax-basis balance sheets to validate deferred taxes Unrecognized tax benefit computations and tracking NOL tracking Indefinite reinvestment assertion documentation and outside-basis difference calculations Share-based payment tax accounting, APIC pools and deferred tax proofs Section 162(m)(6) deferred tax computations Fixed asset deferred tax reconciliations More than 50% of Fortune 1000 companies use Excel spreadsheets to compute their global income tax provision. Consider a third party to test and improve Excel spreadsheets for enhanced efficiency, accuracy and controls Page 66

67 Questions? Page 67

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