scaling complex rules.

Transcription

1 scaling complex rules. Accounting for Income Taxes: Recent Trends & Developments DALLAS CPA Society Katherine Morris, CPA May 8, 2014

2 a tangled web of complex matters Accounting for Income Taxes Course Learning Objectives: This presentation will provide participants with one hour of A&A credit and the knowledge of recent trends & developments impacting the reporting of income taxes in the financial statements under ASC 740. April 21, 2014

3 Agenda of Tax Provision Recent Trends Recent Trends Focus on Issues 1. Valuation allowance (VA) considerations 2. Effective tax rate (ETR) reconciliation / Interim Reporting 3. Indefinite reinvestment of foreign earnings 4. Uncertain tax positions (UTP) Best Practices will be shared during each topic discussion. 3 April 21, 2014

4 Recent Trends Accounting for Income Taxes is most relevant to C-Corporations and has been one of the key areas of restatements, material weaknesses and significant deficiencies for public filers over the past 12 years. (Audit Analytics - Analysis of past 12 years, report released April 2013) Observation: Similar to the impact of Sarbanes-Oxley on auditing, the SEC s focus on income taxes has trickled down from the audit of public companies and are now addressed by both those performing audits and those conducting peer reviews of auditors of private companies. 4 April 21, 2014

5 Recent Trends - FASB s Agenda FASB removes IFRS / FASB convergence project on income taxes of IAS 12 & ASC 740 from agenda (January 29, 2014, FASB vote) FASB income tax Agenda: Cash flows from income taxes Intraperiod tax allocation Earnings indefinitely reinvested in foreign subsidiaries Intercompany transfers of assets 5 April 21, 2014

6 Recent Trends SEC & PCAOB SEC and Investor Focus: DISCLOSURES & TRANSPARENCY Recent SEC inspections have found that the income tax disclosures provided in corporate financial filings often focus on immaterial matters that don't adequately support accounting conclusions related to valuation allowances and unrepatriated foreign earnings (December 2013) PCAOB Reviews: DOCUMENTATION Documentation is lacking with respect to the judgments, estimates and assertions 6 April 21, 2014

7 Recent Trends SEC Technical Focus SEC Comments current technical focus: Valuation allowances Rate reconciliation Repatriation of foreign earnings and liquidity ramifications Unrecognized tax benefits Transparency: SEC continues to ask registrants to provide early-warning disclosures about changes in the business, issues, and how they may potentially affect the financial statements. 7 April 21, 2014

8 value of DTAs are still an issue 1. Valuation Allowances - Considerations

9 1. Valuation Allowances (VA) Considerations Overview General Rule: Reduce a Deferred Tax Asset (DTA) by a Valuation Allowance (VA) if, based on the weight of all available evidence, it is more likely than not (i.e., >50%) that some portion or all of the DTA will not be realized (ASC ) Reduce the DTA to the amount that is more likely than not to be realized 9 April 21, 2014

10 Valuation Allowances Documentation Issues Lack of documentation and disclosure of positive and negative evidence No contemporaneous support for need for / release of VA Take Aways Contemporaneously Analyze & Document: Management s responsibility to contemporaneously examine, support and document rationale for the need for and for changes in valuation allowances Disclose (i.e., be transparent in footnotes): Public filers - discuss in a transparent manner in the MD&A and the footnote disclosure(s) the underlying business reasons why a valuation allowance is needed or not required Auditors are required to retain and assess management s support and documentation 10 April 21, 2014

11 Valuation Allowances Analyze & Document the Evidence Best Practice Qualitative & Quantitative analysis Document the need for and amount of the VA: Negative Evidence Positive Evidence Conclusions Reached Negative Evidence A history of operating losses or tax credit carryforwards expiring unused (Some say a 2-year history of losses) Losses expected in early / start-up years Known circumstances that if unfavorably resolved would adversely effect future operations and profit level 11 April 21, 2014

12 Valuation Allowances Analyze & Document the Evidence Positive Evidence: Sources of Income Future reversals of certain DTLs Caution: consider the reversal criterion Future taxable income exclusive of reversal of DTAs Taxable income or credit carryback opportunities Tax planning strategies creating income Must be considered Must be prudent and feasible! 12 April 21, 2014

13 Valuation Allowances Analyze & Document the Evidence Other Examples of Positive Evidence Contracts or committed sales backlog that would produce more than enough taxable income to realize all or part of the DTAs An excess of appreciated asset value over the tax basis of the entity s net assets in an amount sufficient to realize the deferred tax assets if it would be feasible and prudent to sell Strong earnings history with evidence indicating the loss is an aberration rather than a continuing condition Observation: Some say at least 3 years of earnings REMINDERS: Schedule out and quantify the impact. Remember a valuation allowance is not an all or none amount. 13 April 21, 2014

14 Valuation Allowances Analyze & Document the Evidence Possible Sources of Income Outside Basis Differences in Foreign Sub When expected to reverse in the foreseeable future When the foreign earnings have not been asserted as indefinitely reinvested under APB Opinion 23 Caution: consider impact of cumulative translation adjustment (CTA) Equity Method Investments When there is an a expectation of reversal in the foreseeable future 14 April 21, 2014

15 Valuation Allowances Tax Planning Action or Strategy? Tax Planning Actions Completed in the ordinary course of business For VA assessments, impact is reflected in current year and estimates of future taxable income if implementation has occurred Costs - recognize when incurred Tax Planning Strategies Prudent & feasible strategy an entity would take to prevent a tax attribute from expiring unused For VA assessments, strategies can be anticipated and incorporated into future taxable income projections when quantifying the VA Costs - net against VA amount 15 April 21, 2014

16 Valuation Allowances Issues DTL on Goodwill Naked Credit Guidance on sources of taxable income: Consider DTLs resulting from temporary differences that will reverse in future periods Do not use DTLs created by the book/tax basis difference on nonamortizable book goodwill Common Error Issue Companies often reduce the DTAs by all DTLs, including the naked credit, to compute the amount of the VA By the very nature of goodwill, the DTL is not expected to reverse DTLs on indefinite lived intangibles, such as goodwill, create a Naked (DTL) Credit that cannot be used as a source of income to reduce the DTA when computing the need for a VA 16 April 21, 2014

17 Valuation Allowances Issues DTL on Goodwill Naked Credit Example: Current tax loss, full valuation allowance against the DTA for NOLs $1,000 of tax amortization on goodwill; no other book/tax differences Tax rate = 40% Provision = $400 Current provision = $0 Deferred provision = $400 To establish the DTL for the basis difference in goodwill The indefinite-lived asset temporary difference cannot be considered a source of income to reduce the VA Total tax expense = $400 Observation: even though the Company has a current loss, it has tax expense in the current year because of the $400 increase in the DTL. 17 April 21, 2014

18 Valuation Allowances Recent Development on Goodwill New Guidance (ASU ) Accounting Standard provides a simplified, elective approach to accounting for book goodwill for PRIVATE companies Amortize goodwill over 10 years or less if identifiable shorter life Test for impairment when a triggering event occurs, not annually Effective: years beginning after 12/15/2014; early adoption permitted Implication to VA In Review: Tax Amortization of book goodwill generally creates a ( naked credit ) DTL on an indefinite lived asset that will not reverse in the future An election under ASC effectively re-characterizes goodwill as a finite lived asset i.e., amortizable for book The resulting reversal of the DTL could potentially support recoverability of a DTA when looking at the need for a valuation allowance 18 April 21, 2014

19 Valuation Allowances Issues: Analyze DTAs and DTLs for each Jurisdiction Issue DTLs from different jurisdictions cannot be considered as a source of income to reduce the amount of VA on DTA Example UK DTA = $100; related to UK NOLs with full VA US Parent DTL = $(100), relating to depreciation on US assets UK DTA $100 UK - Valuation Allowance (100) US DTL (100) Consolidated DTL $(100) The US taxable temporary difference cannot be netted against UK DTA to reduce the UK valuation allowance 19 April 21, 2014

20 Valuation Allowances Issue When Can VA Be Released? Guidance: Report changes to the VA in the reporting period they occur Consider what triggering event(s) have occurred since the prior assessment and whether a change in conclusion is warranted Issue: Considerations of when the VA can be released: When did income begin? Is it sustainable? When was a 3-year history of earnings established? Is there a carryback opportunity? Other Has a non profitable business been disposed? Take Aways: Document the analysis of evidence Support the triggering event(s) Judgment i.e., quantify when and how much? Management should apply a consistent policy on what criteria should be used on which to base VA reductions 20 April 21, 2014

21 Valuation Allowances Issue When Can VA Be Released? Public Filers The SEC staff has indicated registrants consider: (1) the magnitude and duration of past losses, (2) the magnitude and duration of current profitability, and (3) changes in factors (1) and (2) that drove losses in the past and those currently driving profitability. Disclosure: Include a discussion of the assessment of positive and negative factors or reasons that led to a reversal of a valuation allowance, and effectively answer the question Why now? 21 April 21, 2014

22 Valuation Allowances Issue DTAs Not a Substitute for Analyzing UTP Guidance DTAs should be established for all deductible temporary differences, NOLs and Credits Record DTAs gross; then consider need for VA VA may be required if future realization is in doubt due to insufficient future taxable income Take Aways A VA is not an appropriate way to handle liabilities on uncertain tax positions (UTPs) that do not meet the recognition or measurement thresholds Companies are required to examine UTPs even when there is a full VA on DTAs 22 April 21, 2014

23 Valuation Allowances Recent Development on Uncertain Tax Positions New Guidance (ASU ) - Presentation of an Unrecognized Tax Benefit: When a NOL Tax Credit Carryforward Exists reduce the DTA for an NOL carryforward or a tax credit carryforward by the liability for the tax benefit resulting from an uncertain tax position Exceptions: 1) When the NOL or tax credit carryforward cannot be used to settle taxes resulting from the disallowance of the tax position, or 2) When the entity does not intend to use the NOL or tax credit carryforward DTA for settlement If conditions 1) or 2) exist, present the liability for the uncertain tax position and do not net the amount with a DTA. Effective Date: Public entities: fiscal years beginning after December 15, 2013 Nonpublic entities may wait until fiscal years, and interim periods beginning after December 15, 2014, to adopt the amendments Early adoption is permitted 23 April 21, 2014

24 Valuation Allowances Issue Impact of Tax Law Changes General Rule (ASC ): Consider all currently available information about future events when determining whether a valuation allowance is needed for a DTA. Reminder An entity should not consider changes in tax laws or rates when assessing the realizability of a DTA before the period in which the change is enacted. 24 April 21, 2014

25 Valuation Allowances SEC Comments on Disclosures BOILERPLATE DISCLOSURES: Cicely LaMothe, senior assistant chief accountant in the division's Office of Real Estate and Commodities, said the SEC continues to find boilerplate disclosures on deferred tax valuation allowances (Dec. 2013) ISSUE Some registrants simply state that they considered the four sources of taxable income required when determining the ability to realize their deferred tax assets. SUGGESTED REMEDIES to increase transparency Address the limitations on the entity's use of net operating losses and foreign tax credits. Reference expiration dates. Provide a disclosure indicating the relative magnitude of each source of taxable income that supports the realization of deferred tax assets. Disclose whether material positive or negative evidence was considered. 25 April 21, 2014

26 timing is everything 2. Effective Tax Rate / Interim Reporting

27 2. Effective Tax Rate (ETR) Reconciliation Effective Tax Rate = Income Tax Expense / Pretax Income = ETR% Purpose of ETR Reconciliation Quantifies and explains the material differences of the expected US federal statutory income tax rate of 34% or 35% to the company s actual or effective tax rate. 27 April 21, 2014

28 Effective Tax Rate Reconciliation - Disclosures Reconciling Items: (shown in footnote disclosure) Examples of Material Rate Reconciliation Items: Pretax Income * 34 or 35% State and foreign taxes (net of federal benefit) Permanent Differences Changes in the Valuation Allowance Income Tax Credits True Ups and changes in reserves or change in prior year tax Changes in Tax Rates Show dollars ($s) or percentages (%s) Separate-line-item disclosure is required for items when meets materiality threshold of >5%: i.e., Pretax Income on reconciling item * Statutory Tax Rate = > 5% of total Tax Expense Extraordinary items and Discontinued Operations are disclosed net of tax 28 April 21, 2014

29 Effective Tax Rate Reconciliation - SEC Staff Comments on Rate Recs Reconciling items: Not labeled correctly / did not adequately describe the underlying nature of the amount Inappropriately aggregated material reconciling items Inconsistent with related amounts disclosed elsewhere in a registrant s filing Foreign tax info not disclosed in MD&A consistent with footnote: Each material foreign jurisdiction; each tax rate Impact of each jurisdiction on the amount in the rate rec Corrections of errors inappropriately reflected as changes in estimates 29 April 21, 2014

30 Effective Tax Rate Reconciliation Blended Rate Versus Actual Rate? Preferred Practice: Use actual tax rates currently in effect by jurisdiction, weighted appropriately, versus a blended rate computation 30 April 21, 2014

31 Effective Tax Rate Reconciliation: Changes in Tax Law Impact of new tax legislation or change in rates are recognized in the period that includes the enactment date (ASC ), regardless of the effective date Continuing Operations: Include the impact in income from continuing operations for the period that includes the enactment date. (ASC ) Discrete Items: Impact on DTL or DTA (ASC ) Effects on taxes payable or refundable for a prior year when the change has retroactive effects 31 April 21, 2014

32 Effective Tax Rate Reconciliation: Changes in Tax Law Example: Major business tax provisions extenders expired at the end of 2013: R&D credit Subpart F exemption for active financing income and look-through treatment for payments between related CFCs 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements New markets tax credit Work opportunity tax credit Action Item: The tax impact of these items cannot be considered in the 2013 financials but in the period if & when a tax law enactment occurs. 32 April 21, 2014

33 Effective Tax Rate Reconciliation: Changes in Tax Law New Legislation: Fixed Assets: Capitalize vs Expense Final regulations released September 13, 2013 on applying IRC Section 263(a) of the to amounts paid to acquire, produce, or improve tangible property, as well as rules for materials and supplies (IRC Section 162) Tangible Property Accounting Method Change Results: Change tax accounting methods / apply rules retrospectively with a 481(a) adjustment Changes deferred taxes / book vs tax basis on Fixed Assets Positive 481(a) adjustment creates DTL Negative 481(a) adjustment creates DTA Impact of timing of future reversals considered in VA on DTAs analysis Reclasses in classified balance sheet: base on the expected reversal date of that temporary difference 33 April 21, 2014

34 Effective Tax Rate Interim Reporting General Rule Apply estimated annual ETR to the year-to-date ordinary income (or loss) from continuing operations Revise estimated annual ETR at the end of each interim period based upon the best current estimate of the annual ETR 34 April 21, 2014

35 Interim Reporting Discrete Events Issue Does the event impact the estimated annual effective tax rate for the quarter/interim period computation? Discrete Events Exclude events during the quarter that do not relate to continuing operations or are unusual or infrequent Recognize in the period in which they occur Examples: Settlement of a tax audit related to prior years Change in tax law which requires retroactive adjustments that fall out of the current year (i.e., Re-enactment of R&D credit). 35 April 21, 2014

36 Interim Reporting Income from Continuing Operations NOT discrete events: Company hires additional employees in Q3 and grants ISO s forcing an expense for the year Company releases all of its valuation allowance in the current quarter based on current years earnings 36 April 21, 2014

37 Interim Reporting Loss YTD / Forecasts Income Issue: The Company has a loss year-to-date but forecasts income; no valuation allowance Results: Show tax benefit YTD; will offset future income Show tax expense in future periods that reflect income 37 April 21, 2014

38 global operations 3. Indefinite Reinvestment of Foreign Earnings

39 3. Indefinite Reinvestment of Foreign Earnings General Rule Compute deferred taxes for all differences in book versus tax basis Exception to the General Rule for CFCs: A DTL is not recognized for differences in the amount of the investment in the shares of the CFC subsidiary owned by the parent unless it becomes apparent that temporary differences will reverse in the foreseeable future (e.g., when foreign earnings are repatriated to the U.S.) 39 April 21, 2014

40 Indefinite Reinvestment of Foreign Earnings Exception NOT an election Exception applies if the specific facts and circumstances warrant Based on a company s ability and intent to control the reversal of a taxable temporary differences (i.e., the outside basis difference in the stock of CFC due to unrepatriated earnings) Management s Position Does Management intend to permanently reinvest the foreign earnings overseas? Caution: review the underlying facts do they support Management s Representation? Document the facts supporting management s positions 40 April 21, 2014

41 Foreign Reinvestment of Earnings SEC Comments EVIDENCE REQUIRED Craig Olinger, deputy chief accountant in the SEC's Division of Corporation Finance, said: In its inspection of public company filings, an SEC registrant would not be required to recognize a deferred tax liability for those overseas earnings if it provides sufficient evidence that its foreign subsidiary has indefinitely reinvested -- or will indefinitely reinvest -- the undistributed earnings. (December 10, 2013, Tax Analysts) 41 April 21, 2014

42 Indefinite Reinvestment of Foreign Earnings Best Practices Supporting Assertion Issues Factor in the liquidity and overall financial health of the U.S. operations If unremitted earnings could be needed at the parent level to meet existing and anticipated obligations, it may be difficult to support an assertion of indefinite reinvestment Support: A specific documented plan should lay out items such as the parent and CFC s long-term and short-term Projected working capital and other financial needs in all locations Budgets and forecasts, past dividends, previously taxed income, and tax consequences of a decision to remit or reinvest Impact of support provided by CFC to US for transactions, such as mergers, acquisitions, servicing loans or meeting covenants or credit obligations Alignment among management of multiple business functions within a company s global organization 42 April 21, 2014

43 solitary facts 4. Uncertain Tax Positions

44 4. Uncertain Tax Positions General Rule: ASC , fka FIN 48, requires all material income tax positions for all open tax years to be reviewed. If the position is more likely than not to be sustained upon audit, an amount must be accrued. 44 April 21, 2014

45 Uncertain Tax Positions Issue Position Taken When is a tax position considered taken? 1. A position taken in a previously filed return or expected to be taken in a future tax return (original or amended) 2. When the taxpayer fails to file a required return 45 April 21, 2014

46 Uncertain Tax Positions Issue Effectively Settled A tax position is considered to be effectively settled when: 1. Exam is complete (ASC a) 2. The taxpayer does not intend to appeal or litigate any aspect of the exam s conclusions (ASC b) 3. When it is remote that the taxing authority would examine/reexamine any aspect of a tax position (ASC c) 46 April 21, 2014

47 Uncertain Tax Positions Issue Changes in Judgment Issue: Company changes the liability for uncertain tax positions. Guidance: Measurement of a tax position should "be based on management's best judgment given the facts, circumstances, and information available at the reporting date" Subsequent changes in judgment must be based on the evaluation of new information Additional analysis of existing information would not typically constitute new information for purposes of adjusting prior estimates Presentation: A change in judgment that results in subsequent recognition, derecognition or a change in measurement of a position taken in a prior annual period must be recognized as a discrete item in the period in which the new information becomes available. (ASC ) Disclose change 47 April 21, 2014

48 Uncertain Tax Positions SEC Comments/Expectations Observations Failure to provide required disclosures about unrecognized tax benefits, which include a tabular reconciliation of such benefits (under ASC and 50-15A). Where no liability or benefit for unrecognized tax benefits exists (or for which such benefits are immaterial), consider disclosing those facts. Lack of transparent disclosures about possible future changes in unrecognized tax benefits about (1) The tax rate reconciliation impact, (2) The impact on valuation allowances, and (3) Registrants assertions that foreign earnings are indefinitely reinvested. 48 April 21, 2014

49 Appendix Documentation of UTPs Best Practices

50 Uncertain Tax Positions Documentation Procedures Technical merit of tax positions Measurement By jurisdiction Federal State International Interest & penalties Material items Current period activity Changes in judgment Assumptions April 21, 2014

51 Documentation Supporting a Tax Position Tax Year: Tax Jurisdiction: Tax Position: Unit of Account: Insert tax jurisdiction. Describe the tax position. Describe the selected unit of account. Does the tax position meet the more likely than not recognition threshold: Why does the tax position meet or fail to meet the more likely than not recognition threshold: Amount recorded in the tax return: Income tax expense for the current fiscal period: Income tax expense for the prior fiscal period(s): Current tax liability recorded: Noncurrent tax liability recorded: Deferred taxes on item: $ Meets / Does Not Meet Recognition Criteria. Qualitative Law Analysis: Include the technical merits of the tax position applied to the facts and circumstances of the tax position. $ $ $ $ $ Liability for unrecognized tax benefit at the balance-sheet date: Support amounts recorded for the unrecognized tax benefit: $ Measurement: Calculate the largest amount of benefit that is greater than 50 percent likely of being realized/i.e., probability tables.

52 Measurement Assess the Probability of Outcomes Possible Estimated Outcome Individual Probability of Occurring Cumulative Probability of Occurring $ % 10% $ 80 20% 30% $ 60 25% 55% $ 50 20% 75% $ 40 10% 85% $ 20 10% 95% $ 0 5% 100% NOTES: $60 is the largest amount of benefit > than 50% likely of being realized upon settlement $40 would be recorded on the balance sheet as an unrecognized tax benefit ($100 - $60) Process: Document measurement process using a probability table or some other source of measurement. April 21, 2014

53 Recognition & Measurement JURISDICTION: Federal Description of Identified Uncertain Tax Positions in Current Period 1 Tax (Benefit) or Accrual Recognition Criteria Met? Amount to be Reported Measurement 2 Total Process: Document decision process on recognition criteria MLTN or not? and document results from the measurement step i.e., the amount to be reported. April 21, 2014

54 Thank you Material discussed in this presentation is meant to provide general information and should not be acted on without professional advice tailored to your firm s or company s individual needs. To ensure compliance with Treasury Department regulations, any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Service Code or applicable state or local tax law provisions or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein. April 21, 2014

55 questions Katherine D. Morris, CPA (404) April 21, 2014