Accounting for Income Taxes Quarterly Hot Topics

In this issue: Accounting Developments Federal International Multistate Controversy Did You Know? Additional resources: Financial Accounting & Reporting - Income Taxes Dbriefs Webcasts Heads Up Newsletter Tax Newsletters Accounting for Income Taxes Quarterly Hot Topics December 2010 Accounting Developments AICPA Conference on SEC and PCAOB Developments Income Tax Disclosures The American Institute of Certified Public Accountants (AICPA) hosts an annual conference on Securities and Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB) developments. Current financial reporting, accounting, and regulatory developments are discussed at this conference, including income tax accounting and disclosure topics. This year the SEC staff provided insights into several key income tax disclosure considerations, as follows: 1. Foreign and domestic components of tax provision The SEC observed that they may comment when multinational registrant disclosures do not provide sufficient information to allow an investor to determine separately the effective tax rates applicable to net income from domestic operations, as well as to net income from foreign operations, particularly in circumstances where the registrants had minimal income tax expense because substantial amounts of profit were derived from countries with little or no tax. 2. Rate reconciliation disclosure The SEC staff also reminded registrants that SEC Regulation S-X Rule 4-08(h) requires that any individual item exceeding 5 percent of income tax expense must be disclosed separately when providing the rate reconciliation disclosure requirement in ASC 740-10-50-11 and 50-12, specifically noting that multinational registrants with a significant item for differences in tax rates between U.S. and foreign jurisdictions may have incorrectly included other reconciling items as a component of that item. If registrants have other significant rate reconciliation items in foreign jurisdictions, those items should be disclosed distinctly as required under SEC Regulation S-X Rule 4-08(h). 3. Undistributed earnings of foreign subsidiaries Finally, the SEC staff discussed the ASC 740 exception regarding undistributed earnings of foreign subsidiaries when such earnings are indefinitely reinvested and suggested that registrants consider additional disclosure in the Management Discussion and Analysis (MD&A), to address the impact of such an assertion on the company s liquidity. The SEC staff provided the example of a company with cash and short-term investments held in an offshore subsidiary, where earnings are 1

asserted to be permanently reinvested. If such cash were ever required to meet debt obligations in the United States, companies should consider disclosing the potential significant U.S. tax liability that may result upon repatriation. For additional information on the proposed Accounting Standards Update, please see Deloitte s Heads Up publication issued December 16, 2010 SECeasons Greetings! Highlights of the 2010 AICPA Conference on Current SEC and PCAOB Developments. Pending IASB Guidance on Measurement of Deferred Tax Assets and Liabilities under IAS 12 On December 3, 2010, the IASB considered comments received on its exposure draft released September 10, 2010, Deferred Tax: Recovery of Underlying Assets, in which it outlined a planned amendment to provide an exception to the measurement principle in IAS 12. On December 20, 2010, the IASB issued amendments to IAS 12 Income Taxes. The amendment provides a practical solution to the problem by introducing a presumption that recovery of the carrying amount will, normally be, through sale. Previously, the measurement principle indicated that the measurement of a deferred tax asset or liability should reflect the tax consequences that would follow from the manner in which the entity expects to recover or settle the carrying amount of its assets and liabilities. The exception requires a rebuttable presumption that certain types of assets and liabilities will be recovered via sale, and therefore the related deferred tax asset or liability should be measured based on that premise (e.g. applying capital gains rates if sale would result in a capital gain). As a result of comments received, the IASB determined that the exception applies only to investment assets measured using the fair value method under IAS 40 (the original exposure draft also included property, plant and equipment as well as intangible assets), and that the exception is required to be rebutted if the underlying asset is held by an entity for which the business model objective is to recover the asset s economic benefits throughout its useful life. The amendment is effective beginning in 2012, and must be applied retroactively. For additional information on the amendment, please see the IASB website at http://www.iasplus.com/pressrel/1012ias12amend.pdf and http://media.ifrs.org/iasbupdate3dec10.html. Federal New Section 162(m)(6) Deduction Limits for Compensation Paid by Health Insurance Providers The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively referred to as PPACA ) were both signed into law by the President in March 2010. Among other revenue provisions, the PPACA added Internal Revenue Code (IRC) Section 162(m)(6) to limit the deduction for compensation paid for services provided by individuals to a covered health insurance provider to $500,000 per year. The rules apply not only to health care providers, but also to all members of their parent subsidiary controlled group. These rules are effective for remuneration paid in taxable years beginning after 2012 with respect to services performed after 2009. This new deduction limitation is similar in some respects to existing IRC Section 162(m), but there are several important differences. First, the PPACA deduction limit applies to a broad range of individuals including officers, employees, directors, and other individuals who perform services for the health insurance provider. Second, the limit applies to both current and deferred compensation. Thus, to the extent the 2

deduction limitation equals or exceeds the $500,000, the deferred compensation attributable to services performed in that year will not be deductible when paid. Additionally, the PPACA deduction limitation applies to both public and private covered insurance providers, and thus, is not limited to publicly held corporations. Finally, the exceptions for certain performance-based compensation and commission compensation are not available. Therefore, the PPACA deduction limitation applies to all otherwise deductible compensation. It should be noted that the amount of book compensation expense (including equitybased compensation) that will not be deductible under new IRC Section 162(m)(6) is precisely determinable each year, which is unlike the existing IRC Section 162(m) limitation. This is because (a) the existing IRC Section 162(m) limitation is only applicable to certain individuals each year and the composition of that group in future years cannot be determined until that future year, while new IRC Section 162(m)(6) applies to all employees and (b) the limitation under existing IRC Section 162(m) is applied based on the total compensation taxable to the individual in a given year and the total amount that will be taxable to that person in that year cannot be determined until that future year, while new IRC Section 162(m)(6) applies to the amount earned by the individuals in years beginning after 2009 and paid after 2012 (and that compensation is being measured for financial reporting purposes and as such is known). As noted above, new IRC Section 162(m)(6) applies to a covered health insurance provider. Prior to 2012, a covered health insurance provider is any employer qualifying as a health insurance provider that receives premiums for providing health insurance coverage. After 2012, this definition changes to provide that an employer is a covered health insurance provider for a year, if at least 25 percent of the provider s gross premium income is derived from health insurance plans that meet the minimum creditable coverage requirements in the legislation. The deductible compensation limitation applies to the controlled group of the covered health insurance provider. Employers with self-insured plans are not considered covered health insurance providers. ASC 740 Implications: The PPACA may have consequences on how covered health insurance providers record temporary differences related to current, deferred, and equity compensation. Companies should consider the PPACA when measuring DTAs and liabilities related to remuneration earned after 2009 that will be paid after 2012 (e.g., deferred compensation and certain equity-based compensation). When measuring the DTA recognized related to compensation related deductible temporary differences earned after 2009 that will be paid after 2012, companies should consider the limitation (i.e., the deductible temporary difference for which a DTA is recognized should be limited to the amount deductible considering the limitation). Companies should monitor their compensation limitations on a quarterly basis as they will need to consider the potential impact of the PPACA when determining their annual estimated effective tax rate (AETR) for interim reporting purposes as required by ASC 740-270. For more information, read Prescription for change filled Tax provisions in the Patient Protection and Affordable Care Act. International Transition Guidance Issued for Foreign Tax Credit Splitter Legislation On December 6, 2010, the U.S. Treasury Department and the Internal Revenue Service (IRS) issued Notice 2010-92, which provides initial guidance under new IRC Section 909. As reported in our Q3 Newsletter, IRC Section 909, added to the Code on August 10, 2010 by P.L. 111-226, suspends foreign taxes ( split taxes ) that 3

accrue as a result of a foreign tax credit splitting event. Notice 2010-92 addresses the application of IRC Section 909, in post-2010 taxable years (taxable years beginning after December 31, 2010), to pre-2011 taxes : that is, taxes paid or accrued by certain foreign corporations ( IRC Section 902 corporations ) in pre-2011 taxable years (taxable years beginning on or before December 31, 2010). Guidance regarding foreign taxes incurred by IRC Section 902 corporations in post- 2010 taxable years generally will have to await further notices or other administrative pronouncements. Among other important items, the notice permits taxpayers to apply the foreign tax credit (FTC) rules in effect before the enactment of IRC Section 909 (the preeffective date rules ) to any repatriation of foreign taxes from an IRC Section 902 corporation made at any time during the IRC Section 902 corporation s last taxable year that began before 2011. It also provides that only pre-2011 taxes that were incurred in connection with an exclusive list of pre-2011 splitter arrangements enumerated in the notice will be subject to IRC Section 909. When IRC Section 909 was promulgated, there was uncertainty as to how the preeffective date repatriation of foreign taxes from an IRC Section 902 corporation would be treated. In a significant clarification of the statute s effective date, the notice provides that IRC Section 909 does not apply in computing foreign taxes deemed paid under IRC Section 902 or IRC Section 960 before the first day of the IRC Section 902 corporation s first post-2010 taxable year (equivalently, per the notice, on or before the last day of the [IRC Section] 902 corporation s last pre-2011 taxable year ). Thus, taxpayers are permitted to apply the pre-effective date rules to any repatriation of foreign taxes from an IRC Section 902 corporation that occurs at any time during the IRC Section 902 corporation s taxable year that began before 2011. The notice provides that any pre-2011 taxes paid or accrued with respect to an exclusive list of pre-2011 splitter arrangements enumerated in the notice will be subject to IRC Section 909. There are four such pre-2011 splitter arrangements on the list; reverse hybrid structures, certain foreign consolidated groups, group relief and other loss-sharing regimes, and hybrid instruments. It is important to note that the rules relating to group relief and other loss-sharing regimes only apply if certain conditions are satisfied. ASC 740 Implications: Pursuant to ASC 740, the effects of a change in tax law on DTA and liabilities must be included in income from continuing operations in the interim and annual period that includes the enactment date. Accordingly, companies were required to account for the impact of the new legislation on deferred taxes in the period, including August 10, 2010. Companies should account for the additional guidance provided in Notice 2010-92 in the period including December 6, 2010. For instance, companies with IRC Section 902 corporations with a taxable year end other than the calendar year end may determine that certain FTCs that were thought to be subject to the new IRC Section 909 rules are now considered pre-2011 taxes and a favorable discrete adjustment should be made to the deferred tax account in the period, including December 6, 2010. Further, it is possible that fiscal year companies may have adjusted their current year AETR for the change in the tax law. If it is determined that the guidance in Notice 2010-92 would change the estimated FTC for the year on current year earnings, the adjustment to the AETR should be made effective for the interim 4

period that includes December 6, 2010 (the latter observation would only be applicable to an entity that has an annual accounting period other than the calendar year). For more information on Foreign Tax Credit Splitter Legislation, see Deloitte s December 7, 2010 Tax Alert. Puerto Rico Excise Tax Not an Income Tax On October 25, 2010, the governor of Puerto Rico enacted a law (Act No. 154) that amends several provisions of the Puerto Rico IRC. In particular, Act No. 154 modifies the effectively connected income source rules and introduces a new excise tax on the acquisition of personal property and services. The amended effectively connected income source rules provide that the office or fixed place of business of a person in Puerto Rico will be considered the office or fixed place of business of a foreign entity when the person in Puerto Rico either (a) has authority to negotiate and conclude contracts on behalf of the foreign entity or (b) is a member of the same controlled group as the foreign entity, and for the taxable year or any of the three preceding taxable years it satisfies one of four thresholds (i.e., total gross receipts, total cost, total commissions and fees, and facilitation analysis). If the thresholds are met, the foreign entity will be deemed to be engaged in a trade or business in Puerto Rico and, consequently, a portion of its income, gains, and profits will be treated as Puerto Rico-source effectively connected income. The portion of Puerto Rico-source effectively connected income will be determined based on a formula that considers four factors: payroll, property, sales, and purchases. Additionally, a new temporary excise tax applies, in lieu of the income tax that would otherwise result from the application of the amended effectively connected income source rules, when gross receipts from the sale of personal property manufactured in Puerto Rico or services performed by the person in Puerto Rico exceed USD 75 million for any of the three preceding taxable years. The excise tax will be imposed on the value of the personal property and services acquired in Puerto Rico by the foreign entity after December 31, 2010. The value will be determined according to the invoice rendered for such items, and in the absence of an invoice, the tax will be based on the fair market value of the items. The excise tax will apply as follows: Excise tax rate for sales in 2011-2016 Sales in Rate 2011 4 2012 3.75 2013 2.75 2014 2.5 2015 2.25 2016 1 It is important to note that the Act No. 154 may provide for a tax credit mechanism. Further, subsequent to 2016, the excise tax would no longer be applied in lieu of the income tax. ASC 740 Implications: For ASC 740 purposes, although this tax is (a) levied in lieu of the income tax that would otherwise result from the application of the amended 5

effectively connected income sourcing rules, and (b) is required to be collected and remitted by the seller of personal property or services, the tax is levied on the purchaser and is based on a percentage of the foreign market value of acquired property and services, and is therefore not considered an income tax to which ASC 740 would apply. This conclusion is not changed if it is ultimately concluded that the tax would be treated as creditable for U.S. federal tax purposes. For more information on the Puerto Rico tax changes, see Deloitte s October 29, 2010 International Tax Alert. Multistate California Tax Law Changes California's Governor Schwarzenegger signed Senate Bill 858 on October 19, 2010, enacting into law the tax provisions of the 2010-2011 state budget. Key franchise tax law changes included in the enacted bill include: Modification of the sales factor provisions in California's apportionment formula that apply to tax years beginning on or after January 1, 2011, for assigning sales that are not sales of tangible personal property, which include: - Reinstating the costs of performance (rather than market ) sourcing rules for taxpayers that do not elect to use a single sales factor apportionment formula under California Revenue and Taxation Code (CRTC) Section 25128.5(a). - Requiring market sourcing for taxpayers making the single sales factor election. Limitation on the use of net operating losses (NOLs) for corporations by: - Extending the suspension of NOL deductions for an additional two years to include taxable years beginning on or after January 1, 2010 and before January 1, 2012. The existing NOL deduction suspension only applied to taxable years beginning on or after January 1, 2008, and before January 1, 2010. - Deferring the two-year carryback of NOLs that was to take effect for taxable years beginning on or after January 1, 2011, until taxable years beginning on or after January 1, 2013, with the phase-in of NOL carryback utilization beginning the same year. Requirement for taxpayers with sales that are not sales of tangible personal property to use market-based sourcing to determine whether they are doing business in California pursuant to the economic nexus rules that become effective in 2011. Modification, for taxable years beginning on or after January 1, 2010, of the 20 percent strict liability penalty imposed on large corporate understatements. For additional details, please refer to Multistate Tax: External Alert October 22, 2010. ASC 740 Implications: The California tax law changes could result in the following financial reporting impacts: Amendments to the sales factor and nexus provisions could impact a company s apportionment factor. Pursuant to ASC 740-10-45-15, when deferred tax accounts are adjusted for the effect of a change in tax law, the 6

effect shall be included in income from continuing operations in the period that includes the enactment date of the applicable law change, which is October 19, 2010; Companies that previously intended to utilize NOLs to reduce their current year taxable income should adjust their income taxes payable and NOL DTA in the period that includes October 19, 2010, to reflect the suspension of NOL deductions for tax years 2010-2011; Companies should assess whether it is more likely than not that some portion of the available NOLs will not be realized on account of the suspension and record any related change to the valuation allowance in the period of enactment in income from continuing operations pursuant to ASC 740-10-45. For example, a company may have relied on the existence of taxable temporary differences scheduled to reverse in tax years 2010 through 2011 as a source of taxable income to recognize the benefit of the NOLs. However, as a result of the NOL suspension, the reversing taxable temporary differences may no longer be an available source of taxable income; The requirement to use market-based sourcing to determine whether a company is doing business in California could impact the determination of whether DTAs and liabilities should be recorded for temporary differences that will reverse in 2011 or later. Pursuant to ASC 740-10-45-15, any change in deferred taxes on account of the change in tax law should be included in income from continuing operations in the period that includes the enactment date, October 19, 2010; The penalty modifications should be considered when determining the amount of penalties related to unrecognized tax benefits (UTBs) accounted for pursuant to ASC 740-10 for taxable years beginning on or after January 1, 2010. New York Adopts 2010-2011 Budget / Further Developments On August 11, 2010, New York s Governor Paterson signed the enacted version of A. 9710-D, thus enacting into law the tax provisions of the 2010-2011 state budget. Significant income tax law changes included in the enacted bill include the following: Deferral of certain tax credits The new law defers the use of most business tax credits in excess of $2 million for taxable years beginning in 2010 through 2012. A taxpayer may use a pro rata share of each of its applicable credits up to $2 million during the deferral years. Credits in excess of the $2 million annual limitation will be deferred until 2013. Deferred nonrefundable credits are converted into a temporary deferral nonrefundable payout credit. This credit can be used to reduce tax liability starting in 2013, but not to an amount that is less than certain minimum taxes specified in the relevant provisions of the various corporate franchise taxes. Taxpayers are allowed an unlimited carryforward of the unused credits. The deferred refundable credits are converted into a temporary deferral refundable payout credit. The deferred refundable credits may be utilized as follows: 50 percent in 2013, 75 percent of the remainder in 2014, and the balance in 2015. Bad debt reserve deduction for banks The new law provides that, for taxable years beginning on or after January 1, 2010, New York State and City will conform to federal tax law with respect to the treatment of bad debt deductions for banking corporations. Previously, New York State and City permitted banking corporations to use a reserve method for accruing bad 7

debt deductions. There is no New York State or City provision in the budget legislation providing for the recapture of previous additions to bad debt reserves as a result of this legislative change. For additional details, please refer to Multistate Tax: External Alert August 10, 2010 (revised, August 17, 2010). ASC 740 Implications: The New York tax law changes could result in the following financial reporting impacts: Generally, refundable tax credits are not accounted for under ASC 740. Companies that previously intended to utilize nonrefundable business credits to reduce their current year taxable income should adjust their income taxes payable and DTAs in the period that includes the enactment date to reflect the limitation and deferral of the credits. The deferred refundable tax credits should not be accounted for as a DTA, rather the amounts to be refunded in 2013-2015 should generally be accounted for as a noncurrent asset. Companies should assess whether it is more likely than not that some portion of the available business tax credits will not be realized on account of the deferral and record any related change to the valuation allowance in the period of enactment in income from continuing operations pursuant to ASC 740-10-45. For example, a company may have relied on the existence of taxable temporary differences scheduled to reverse in tax years 2010 through 2012 as a source of taxable income to recognize the benefit of the tax credits. However, as a result of the new credit deferral, the reversing taxable temporary differences may no longer be an available source of taxable income post 2012. Bank corporations should consider the amendments to the bad debt deduction when calculating the current income tax provision and measuring DTAs and liabilities in future periods. New Jersey Tax Court Adopts Broad Interpretation of Unreasonableness Exception to Addback Rule New Jersey's Corporation Business Tax requires an add-back of intercompany interest when determining taxable income. One exception to this addback rule is where its application would be unreasonable. Previously, the New Jersey Division of Taxation (the Division ) had issued guidance that limited the unreasonableness exception to situations where the recipient of the intercompany interest was subject to tax in New Jersey or to certain cash sweep arrangements. In Beneficial New Jersey, Inc. v. Director, Division of Taxation, Tax Court of New Jersey (August 31, 2010), the New Jersey Tax Court adopted a much broader interpretation of the unreasonableness exception. The fact pattern considered by the Court was the instance in which the taxpayer borrowed from an affiliate, rather than from third parties, because the affiliate could borrow on more favorable terms from the affiliate that it could from the capital markets. The Tax Court held that applying the addback in this situation would be unreasonable because the taxpayer had successfully shown that its intercompany financing arrangements had economic substance. In addition, the taxpayer demonstrated that its affiliate paid taxes on the corresponding intercompany interest income in numerous states. For additional details, please refer to Multistate Tax: External Alert September 14, 2010. 8

ASC 740 Implications: If a company previously recorded an UTB for this issue, it may need to reassess the UTB considering the new information provided by the Beneficial New Jersey, Inc. case decision. Additionally, if an amended return is expected to be filed related to the court decision above, the company should account for the tax benefit that meets the more-likely-than-not recognition and measurement threshold pursuant to ASC 740-10 in the period the company has the intent to file. State Amnesty Programs Recently, Michigan and Washington implemented amnesty programs applicable to income taxes and non-income taxes. Michigan On October 5th, 2010, Michigan Governor Granholm signed Senate Bill 884, thereby adopting a Michigan tax amnesty program that will commence May 15, 2011, and run through June 30, 2011. The tax amnesty program covers certain income and non-income taxes due on or before December 31, 2009, as a result of: (1) a failure or a refusal to file a return, (2) a failure to pay tax, or (3) an excessive claim for refund. A taxpayer may not receive amnesty with respect to covered tax in certain circumstances, including when the taxpayer is eligible to enter into a voluntary disclosure agreement with the Department pursuant to MCL Section 205.30c. To participate in the amnesty program, a taxpayer must do all of the following during the Amnesty Period: Submit a request to participate in the program on a specified form to be issued by the Department; File all original or amended return(s); and Remit full payment of tax and interest due. An eligible taxpayer who participates in the program and complies with the related requirements will receive a complete waiver of both criminal and civil penalties. The Michigan amnesty program does not include an amnesty penalty on taxpayers who fail to participate in the program. For additional details, please refer to Multistate Tax: External Alert October 5, 2010. Washington Washington State has adopted a tax amnesty program (Senate Bill 6892, approved by the governor on December 11, 2010, and filed with the Secretary of State on December 13, 2010) effective February 1, 2011. For eligible taxpayers that fulfill the applicable requirements, the program waives penalties and interest (with some exceptions) that are: (1) unpaid as of February 1, 2011, and (2) imposed with respect to certain enumerated taxes that are first due to the Washington Department of Revenue before February 1, 2011. The following taxes are covered by the program: State business and occupation tax State public utility tax State and local sales and use tax For additional details, please refer to Multistate Tax: External Alert December 17, 2010. 9

ASC 740 and ASC 450 Implications: Companies need to consider amnesty programs when determining the amount UTBs and the penalties and interests related to their UTBs recorded for income taxes accounted for pursuant to ASC 740-10. In the case of amnesty programs for non-income taxes, a taxpayer must consider amnesty programs when determining the amount of loss contingencies, including penalties and interest, accounted for under ASC 450. Generally, adjustments to UTBs, contingencies, interest, and penalties, as a result of participation in amnesty programs, should be recorded in the period that an original or amended tax return is filed and all necessary actions have been taken to obtain amnesty. Controversy IRS Releases Final Schedule UTP and Accompanying Guidance On September 24, 2010, the IRS finalized its proposal to require reporting of uncertain tax positions (UTPs) by releasing the final Schedule UTP and related instructions, which are effective for the 2010 tax year. The IRS also issued Announcement 2010-75, which explains the changes incorporated into the final Schedule UTP and accompanying instructions. Finally, the IRS issued Announcement 2010-76, which expands the IRS s policy of restraint with respect to requesting particular documents relating to UTPs and the workpapers associated with the completion of the Schedule UTP. A corporation must file Schedule UTP if it: Files a form 1120, 1120-F, 1120-L, or 1120-PC; Has assets that equal or exceed $100 million (the total asset threshold will be reduced to $50 million beginning with the 2012 tax year and to $10 million starting with the 2014 tax year); The corporation or related party issued audited financial statements reporting all or a portion of the corporation s operations for all or a portion of the corporation s tax year; and Has one or more tax positions that must be reported on Schedule UTP. A corporation must report a U.S. federal income tax position on Schedule UTP if the tax position has been taken on the U.S. federal income tax return for the current tax year or prior tax year 1 and the corporation or a related party has recorded a reserve in the audited financial statements, or the corporation or related party did not record a reserve for the tax position because the corporation expects to litigate the position. Corporations are not required to report tax positions for which no reserve was required because the amount was immaterial for audited financial statement purposes or the tax position was sufficiently certain. A tax position is based on the unit of account used to prepare the audited financial statements. A corporation that uses its entire tax year as a unit of account under IFRS or another method of accounting may not do so for Schedule UTP reporting, but must identify a unit of account based on principles similar to GAAP or modified GAAP or by using any other level of detail that is consistently applied if that identification is reasonably expected to apprise the Service of the identity and nature of the issue underlying a tax position taken in the tax return. 1 A corporation is not required to report on Schedule UTP a tax position taken in a tax year beginning before January 1, 2010, even if a reserve is recorded with respect to that tax position in audited financial statements issued in 2010 or later. 10

The key elements that must be disclosed for each tax position recorded on Schedule UTP include: Primary IRC sections (up to three) relating to the tax position. Whether the tax position creates a difference that is permanent, temporary, or both. Employer Identification Number (EIN) of a pass-through entity if the tax position taken by the corporation relates to a tax position of a pass-through entity, and indication if the pass-through entity is a foreign entity that does not have an EIN. Identification of major tax positions i.e., tax positions whose relative size is equal to or greater than 10 percent the cumulative size of all tax positions listed on Schedule UTP (disregard expect to litigate positions). Ranking of tax positions based on the size of the position expect to litigate positions may be assigned any number. Identification of tax positions related to transfer pricing. A concise description of the tax position, including a description of the relevant facts affecting tax treatment of the position and information that reasonably can be expect to apprise the IRS of the identity of the tax position and the nature of the issue. According to the expanded policy of restraint, the IRS will not assert waiver of privilege with respect to an otherwise privileged document that was provided to an independent auditor as part of an audit of the taxpayer s financial statements. This policy does not apply if the taxpayer has taken any other action that would waive the privilege or if a request for tax accrual workpapers is made under IRM 4.10.20.3 (regarding the taxpayer s involvement in listed transactions and the unusual circumstances standard). The expanded policy of restraint also allows taxpayers to redact certain items from any tax reconciliation workpapers relating to the preparation of Schedule UTP it is asked to produce during an examination, including (1) working drafts, revisions, or comments concerning the concise description of tax positions reported on Schedule UTP; (2) the amount of any reserve related to a tax position reported on Schedule UTP; and (3) computations determining the ranking of tax positions to be reported on Schedule UTP or the designation of a tax position as a major tax position. For additional details, please read IRS Insights: IRS releases final Schedule UTP and accompanying guidance. ASC 740 Implications: The Schedule UTP reporting requirements do not change a company s obligations around financial reporting. However, the IRS has identified certain areas for which consistency between the Schedule UTP reporting and the audited financial statements is required, including: Analysis of whether a reserve has been recorded for audited financial statement purposes; Identification of tax positions for which a reserve was not recorded because the company expects to litigate the position; Immaterial tax positions; Identification of tax positions for which no reserve was required because the positions was determined to be sufficiently certain; Unit of account; 11

Categorization of the tax position i.e., permanent versus temporary; Size of the tax position for purposes of ranking the tax positions; and Related party includes, but not limited to, any entity that is included in consolidated audited financial statements in which the corporation is also included. Did You Know? How to Account for Retroactive Changes in Tax Laws or Rates When retroactive tax legislation is enacted, the effects on deferred taxes are recognized as a component of income tax expense or benefit from continuing operations in the financial statements for the interim or annual period that includes the enactment date (which, for U.S. federal tax law changes, is the date that the President signs a tax bill into law). Further, entities should not anticipate the reenactment of a tax law or rate that is set to expire or has expired. Rather, under ASC 740-10-30-2, an entity should consider the currently enacted tax law as of the reporting date when calculating current and DTAs and liabilities (if an annual reporting date) or when calculating the AETR (if an interim reporting date). If a provision of tax law that previously existed but has expired is retroactively reenacted subsequent to the reporting date, the entity should follow ASC 740-10-25-47 and include the effect of the change as of the date of reenactment. These concepts apply to the recently enacted legislation that is discussed below. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (H.R. 4853) Certain favorable personal tax rates enacted during the George W. Bush administration were scheduled to expire on January 1, 2011. Further, certain favorable business tax provisions, some also enacted during the Bush administration, and others provisions that existed prior to the Bush administration (e.g., the Research & Development (R&D) credit) had already expired as of 2010. The President signed into law on December 17, 2010 the The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 Act (or the Act ) that extends these favorable personal tax rates an additional two years (through 2012) and reenacts many of the already expired business tax provisions, also for two additional years, generally through 2011. Some of the significant tax provisions included in the Act are as follows: Extension of bonus depreciation Under current law, businesses are allowed to recover the cost of capital expenditures over time according to a depreciation schedule. Previous tax laws allowed businesses, beginning January 1, 2008 through December 31, 2009, to take an additional depreciation deduction allowance equal to 50 percent of the cost of the depreciable property placed in service in those years. Under the Small Business Jobs Act of 2010, this temporary increase in the depreciation deduction allowance was extended through December 31, 2010. The Act extends and temporarily increases this bonus depreciation provision for investments in new business equipment. For investments placed in service after September 8, 2010 and through December 31, 2011, the Act provides for 100 percent bonus depreciation. For investments placed in service after December 31, 2011 and through December 31, 2012, the Act provides for 50 percent bonus depreciation. The provision also allows taxpayers to elect to convert existing alternative minimum tax (AMT) credits into refundable credits by foregoing bonus depreciation for taxable years 2011 and 2012. 12

Temporarily extends the increase in the maximum amount and phaseout threshold under IRC Section 179 Under current law, a taxpayer with a sufficiently small amount of annual investment may elect to deduct the cost of certain property placed in service for the year rather than depreciate those costs over time. The tax legislation enacted in 2003 temporarily increased the maximum dollar amount that may be deducted from $25,000 to $100,000. That legislation also increased the phase-out. amount from $200,000 to $400,000 (i.e., the amount of Section 179 property placed in service in excess of these phase-out amounts reduced the maximum dollar amount that could be deducted). A tax law change in 2007, temporarily increased the maximum dollar amounts to $125,000 and $500,000 respectively, and indexed those amounts for inflation. These amounts have been further increased and extended several times on a temporary basis, including most recently as part of the Small Business Jobs Act which increased the thresholds to $500,000 and $2,000,000 for the taxable years beginning in 2010 and 2011. The Act is effective for taxable years beginning after December 31, 2011 and extends the 2007 maximum amount and phase-out thresholds at $125,000 and $500,000 respectively, indexed for inflation. These amounts are scheduled to return to $25,000 and $200,000, respectively, after 2012. R&D credit The Act reinstates for two years (through 2011) the research credit. Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico The Act extends for two years (through 2011) the provision extending the IRC Section 199 domestic production activities deduction to activities in Puerto Rico. Look-through treatment of payments between related controlled foreign corporations and the active financing exception The Act extends for two years (through 2011) the current law look-through treatment of payments between related controlled foreign corporations (CFC) and the active financing exception. IRC Section 954(c)(6), Look-Thru Rule for Related Controlled Foreign Corporations (the look-thru rule ), enacted by the Tax Increase Prevention and Reconciliation Act of 2005 and amended by the Tax Relief and Health Care Act of 2006, the Tax Technical Corrections Act of 2007, and the Tax Extenders and AMT Relief Act of 2008, is effective for taxable years of a foreign corporation beginning after December 31, 2005, and before January 1, 2010, and to taxable years of U.S. shareholders with or within which such taxable years of the foreign corporations end. For periods in which it is effective, the look-thru rule generally excludes from U.S. federal income tax certain dividends, interest, rents, and royalties received or accrued by one CFC of a U.S. multinational enterprise from a related CFC that would otherwise be taxable pursuant to the subpart F regime. IRC Section 954(h), Special Rule for Income Derived in the Active Conduct of Banking, Financing, or Similar Businesses (the active financing exception ), enacted by the Tax and Trade Relief Extension Act of 1998, is effective for taxable years of a foreign corporations beginning after December 31, 1997, and before January 1, 2010 and to taxable years of U.S. shareholders with or within which such taxable years of the foreign corporations end. For periods in which it is effective, the active financing exception generally excludes from U.S. federal income tax qualified banking or financing income of an eligible controlled foreign corporation that would otherwise be taxable income pursuant to the subpart F regime. 13

For calendar year-end foreign corporations, these provisions lapsed on December 31, 2009. The Act retroactively extends the look-through treatment through 2011. For additional details, please read, Congress Extends the Bush Tax Cuts. ASC 740 Implications: When retroactive legislation is enacted in the fourth quarter of the annual accounting period (which is the case for this legislation as it relates to companies that use the calendar year as their annual accounting period), the effect on the annual accounting period will be captured in the normal tax accounting process of determining the year-end current and deferred tax accounts. There will be no interim period considerations. However, for companies that have an annual accounting period other than the calendar year, the accounting for this legislation will be more complicated. As it relates to those companies that have an annual period other than the calendar year, the Act can have an impact on both the current-year measure of tax expense or benefit (either current or deferred), as well as the tax expense or benefit recognized in prior annual periods that ended subsequent to the effective date of the retroactive legislation. Both the prior annual period effect (if any) and the current annual period effect are recognized in the interim and annual period that includes the date of enactment (December 17, 2010). When retroactive legislation is enacted in an interim period prior to the fourth quarter of the annual accounting period, the current annual accounting period effect is generally recognized by updating the annual effective tax rate (AETR) for the effect of the retroactive legislation. That updated AETR is then applied to the year-to-date ordinary income through the end of the interim period that includes the enactment date. The cumulative amount of tax expense or benefit for the current year is then adjusted to this amount, which effectively catches up the prior interim periods for the change in law. A company that is not using an AETR approach for some reason (which should be the exception) would be required to determine the actual effect of retroactive legislation on its year-to-date activity. When retroactive legislation effects the computation of an interim tax expense or benefit, the impact on the company s balance sheet should follow its normal policy for adjusting the balance sheet accounts (current and deferred) on an interim basis. As noted, some companies (based on their particular fiscal yearend) will also recognize the effect that the retroactive legislation will have on the prior annual accounting period (periods that ended subsequent to the retroactive effective date). These effects might be reflected as changes to current tax accounts, deferred tax accounts, or both. Amounts pertaining to the prior annual accounting period must be recognized entirely in the period that includes the enactment date and should not be reflected in the current period AETR described above. The Act contains a provision (similar to previous legislation) that allows a company to elect to convert certain credits to refundable credits by foregoing additional first year bonus depreciation. Accelerated utilization of these credits as a result of this provision will not have any effect on tax expense or benefit if the credit being monetized was previously recognized as a DTA without any offsetting valuation allowance. However, if this provision results in the utilization of a credit that was previously not expected to be utilized and therefore offset by a valuation allowance, the reversal of the valuation allowance will result in a benefit recognized in the tax provision. Finally, a company that has not yet issued its report for the interim or annual period that ended prior to the enactment (taking into account the effect that any 52/53 week convention has on that date) cannot consider the enactment in preparing those 14

statements; however, the effect that the retroactive legislation will have on the period being reported on should still be disclosed, which generally will require computations similar to those described above in order to determine the amount to disclose.due to the recent enactment of the tax provisions for bonus depreciation and IRC Section 179 discussed above, electing taxpayers will record a decrease in their current income tax provision and an increase in the deferred tax liability related to fixed assets in the current period. To the extent taxpayers can avail bonus depreciation or the IRC Section 179 deduction and also have domestic production activities, taxpayers will likely need to determine whether they will receive a greater benefit by claiming the IRC Section 199 deduction or additional depreciation deduction as the IRC Section 199 deduction can be limited by the amount of taxable income and the IRC Section 199 deduction provides a permanent benefit while IRC Section 179 and bonus depreciation deduction do not. Any reduction anticipated in the IRC Section 199 deduction as a result of a taxpayer availing itself of the elective depreciation provisions, would need to be accounted for as an adjustment to the estimated AETR used for interim reporting purposes as required by ASC 740-270 in the current interim period (for fiscal year-end companies). Credits whose realization ultimately depends on reducing taxes payable (e.g., R&D credits) are generally recognized as a reduction of current income taxes under ASC 740 but can also be recognized as a DTA when the credits generated exceed the taxes payable. When recognized as a DTA, whether there is any benefit to be accounted for will depend on whether that DTA is considered more-likely-than-not to be realized (if not more-likely-than-not, it will be offset by a valuation allowance). Talk to Us If you have any questions or comments about the ASC 740 implications described above or other content of Accounting for Income Taxes Quarterly Hot Topics, contact the Deloitte Washington National Tax Accounting for Income Taxes Group at: USNationalWNTActIncomeTaxesGrp@deloitte.com. 15