Uncertain Tax Positions Proposed Interpretation of SFAS 109 Rita Benassi Randy Green Kathy McEligot August 1, 2005
Polling Question #1 Have you had discussions with senior management/audit committee about the potential impact of these new rules on your financial statements? Not yet I was waiting for the exposure draft to be issued Not yet because I am still educating them on interim accounting rules and fluctuating tax rates Yes and they know they are in for more education sessions Not applicable
Important Caveats The following discussion and examples do not necessarily represent Deloitte Tax LLP or Deloitte & Touche LLP policy with respect to the issues raised The outcome of any independent situation depends upon the specific facts and circumstances in which the issue arises and on the interpretation of SFAS 109 and other relevant literature The views expressed cannot be relied upon as accounting advice
Agenda Current practice Highlights of exposure draft Illustrative examples Q&A
Current Practice
Current Practice Significant diversity Scope All tax positions v. those with certain characteristics Recognition criteria All v. threshold based (e.g., probable) Measurement Probable v. best estimate Income tax contingencies Detection risk Presentation 1
Highlights of Exposure Draft
Accounting for Uncertain Tax Positions Interpretation of SFAS 109 relating to uncertain income tax positions SFAS 5 remains applicable to non-income tax uncertainties Shift to asset recognition model 2
Accounting for Uncertain Tax Positions (cont d) Proposed Interpretation of SFAS 109 (Exposure Draft) issued July 14, 2005 Proposed Interpretation addresses: Initial recognition of tax positions Subsequent recognition and derecognition of tax positions Measurement Classification and Disclosure Interim reporting Interest and penalties Effective date and transition 3
Initial Recognition A tax position recognized in a tax return must be probable of being sustained prior to recognition in the financial statements Probable is used in the SFAS 5 context meaning that an event is likely to occur Probable is a positive assertion that the tax position is valid under tax law Detection risk by taxing authority can not be considered 4
Subsequent Recognition/Derecognition If not initially recognized, tax benefit is subsequently recognized when probable threshold is met After initial recognition, if it becomes more likely than not that the position will not be sustained, the benefit of the tax position is derecognized Use of a valuation allowance or valuation account for derecognition is not appropriate 5
Measurement Two step model: First, determine if probable threshold is met Second, recognize best estimate of amount that will ultimately be sustained (for positions that meet the probable criterion) 6
Polling Question #2 What do you expect the impact of these new rules to be on your financial statements? My income tax reserves will increase My income tax reserves will decrease My income tax reserves will stay the same I do not yet know what will happen to my income tax reserves Not applicable
Classification and Disclosure Classification Liabilities resulting from differences between the financial reporting basis and tax basis of the position generally should not be reported as a deferred tax liability The liability should be classified based on the expected timing of payment Disclosure Follow the disclosure requirements of SFAS 5 7
Interim Reporting Consistent with paragraph 194 of SFAS 109 Changes in judgment about realizability or amount of tax position taken in prior year is a discrete item Changes in judgment about realizability or amount of tax position taken in current year is adjustment to ETR 8
Interest and Penalties If tax law provides for interest on underpayment, interest should be accrued based on the difference between the financial reporting basis and tax basis of the position If a statutory penalty applies, it should be accrued in the period deemed to have been incurred 9
Effective Date and Transition Effective date Comment period will end September 12, 2005. Effective date: annual periods ending after December 15, 2005 Transition Account for the impact of adopting the new pronouncement as a cumulative effect of a change in accounting principle 10
Polling Question #3 Do you plan to send comments on the exposure draft to the FASB by September 12, 2005? Yes No Have not yet decided Not applicable
Illustrative Examples
Example 1: Unit of Account Enterprise A anticipates claiming a $100 R&E credit on its tax return The credit is comprised of equal spending on four separate projects (i.e., $25 tax credit per project) Management believes it is probable that the enterprise will sustain a benefit of approximately $50 What is the measurement analysis? What is the financial statement impact? 11
Example 2: Valuation Versus Validity Enterprise B contributes an intangible asset with a fair value of $100 to a tax exempt entity The tax law in Enterprise B s federal and local jurisdictions allow a deduction for the fair value of contributions to qualified tax exempt entities Management s best estimate of the amount to be sustained is 60 percent of the total amount of the claimed deduction What is the measurement analysis? What is the financial statement impact? 12
Example 3: Differences Related to Timing Enterprise F acquired an intangible asset for $15 that has an indefinite life for financial statement purposes Based on uncertainty in the tax code, Enterprise F plans to deduct the entire balance for tax purposes in year 1 The tax position to be claimed on the return is not probable of being sustained; the probable position is that the intangible is subject to straight-line amortization over 15 years for tax purposes What is the measurement analysis? What is the financial statement impact? 13
Example 4: Net Operating Loss Carryforwards Prior to adoption of this Interpretation, Enterprise I recognized deferred tax assets for NOL carryforwards that were created by tax positions that do not meet the probable criterion Management has concluded that it is more likely than not that sufficient taxable income will be available to realize the NOL deferred tax assets Should Enterprise I derecognize the DTAs upon adoption of this interpretation? 14
Example 5: More Likely Than Not on Adoption Enterprise J has evaluated uncertain tax positions in all open tax years Management concludes that some positions do not meet the probable criterion, but it is more likely than not that the positions will be sustained Should Enterprise J derecognize the tax benefits for positions that are more likely than not upon adoption of this Interpretation? 15
Polling Question #4 Do you feel you have enough resources in house today to do all the necessary calculations? I have enough of the right resources and can get all the other tax work done too I do not have enough of the right resources to do this analysis and get all the other tax work done I do not have enough of the right resources to do this type of analysis no matter what else needs to get done Not applicable
What Should You Be Doing Right Now? Review all uncertain tax positions in all open years for all jurisdictions Recalculate reserve amounts based on rules in exposure draft Recalculate deferred tax balances based on rules in exposure draft 16
Polling Question #5 Where are you in the process of determining the impact of these new rules? I have started the process, but was waiting for the exposure draft to be issued to go further I have spent a significant amount of time already, but will now refine calculations based on the exposure draft Logging on to this webcast is my first step in the process Not applicable
What Should You Be Doing Right Now? (cont d) Calculate cumulative effect of accounting change Anticipate disclosure timing for cumulative effect Send comments in before September 12, 2005 17
Polling Question #6 How long do you think it will take to calculate the amount of your cumulative effect? More than two months One to two months One week I really have no idea at this point Not applicable
Questions & Answers 29
Thank you for joining today s webcast. To request CPE credit, click the link below. 30
The information contained in this publication is for general purposes only and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by Deloitte & Touche to the reader. This material may not be applicable or suitable for, the reader s specific circumstances of needs. Therefore, the information should not be used as a substitute for consultation with professional accounting, tax, or other competent advisors. Please contact a local Deloitte & Touche professional before taking any action based upon this information. 31
About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms and their respective subsidiaries and affiliates. Deloitte Touche Tohmatsu is an organization of member firms around the world devoted to excellence in providing professional services and advice, focused on client service through a global strategy executed locally in nearly 150 countries. With access to the deep intellectual capital of 120,000 people worldwide, Deloitte delivers services in four professional areas, audit, tax, consulting and financial advisory services, and serves more than one-half of the world s largest companies, as well as large national enterprises, public institutions, locally important clients, and successful, fast-growing global growth companies. Services are not provided by the Deloitte Touche Tohmatsu Verein and, for regulatory and other reasons, certain member firms do not provide services in all four professional areas. As a Swiss Verein (association), neither Deloitte Touche Tohmatsu nor any of its member firms has any liability for each other s acts or omissions. Each of the member firms is a separate and independent legal entity operating under the names Deloitte, Deloitte & Touche, Deloitte Touche Tohmatsu or other related names. In the US, Deloitte & Touche USA LLP is the US member firm of Deloitte Touche Tohmatsu and services are provided by the subsidiaries of Deloitte & Touche USA LLP (Deloitte & Touche LLP, Deloitte Consulting LLP, Deloitte Financial Advisory Services LLP, Deloitte Tax LLP and their subsidiaries), and not by Deloitte & Touche USA LLP. The subsidiaries of the US member firm are among the nation's leading professional services firms, providing audit, tax, consulting and financial advisory services through nearly 30,000 people in more than 80 cities. Known as employers of choice for innovative human resources programs, they are dedicated to helping their clients and their people excel. For more information, please visit the US member firm s web site at www.deloitte.com/us. 32