ASC 740 CURRENT ISSUES Practical Issues Impacting Income Tax - - PowerPoint PPT Presentation
ASC 740 CURRENT ISSUES Practical Issues Impacting Income Tax Provisions BDO US A, LLP, a Delaware limited liability partnership, is the U.S . member of BDO International Limited, a UK company limited by guarantee, and forms part of the
BDO US A, LLP, a Delaware limited liability partnership, is the U.S . member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.
Practical Issues Impacting Income Tax Provisions
AS C 740 – Practical Issues Impacting Income Tax Provisions 2
DANIEL NEWTON
Tax Partner –AS C 740 Technical Practice Leader National Tax Office 617.239.7026 dnewton@ bdo.com
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AS C 740 – Practical Issues Impacting Income Tax Provisions 4
Tax Expense/Benefit/Deferral Other ASC 740 Issues Disclosure Y ear 2012 2013 2014 2015 2016 2017 2018 Tax/ Expense Restatements 113 103 114 95 104 84 54 Total Restatements 854 876 857 757 686 573 516 %
13.2% 11.8% 13.3% 12.5% 15.2% 14.7% 10.5%
Source: 2018 Financial Restatements; An Eighteen Year Comparison published August 2019 by Audit Analytics.
Tax continues to be one of the top accounting issues resulting in restatements.
“ Consists of errors or irregularities in approach, understanding or calculation associated with various forms of tax obligations or benefits. Many of these restatements relate to foreign tax, specialty taxes or planning issues. S
between tax and book adj ustments.” Financial Restatements:
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AS C 740 – Practical Issues Impacting Income Tax Provisions 6
EC approved a new PCAOB standard intended to enhance the auditor reporting model
matters arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and relates to: accounts or disclosures that are material to the financial statements AND involved especially challenging ,subj ective, or complex auditor j udgement
Identification of the CAM Description of how the CAM was addressed in the audit Description of the principal considerations that lead the auditor to determine the matter was a CAM Reference to the financial statements
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filers
companies who are required to report CAMs
S ecurities and Exchange Act of 1934 Rule 17a-5,employee stock purchase, savings or other similar plans and emerging growth companies.
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element within the income tax provision
Tax & Audit should conduct assessment together
Risk Assessment / Planning S ubstantive Procedures S pecific Element(s) of Income Tax Provision CAM guidance re: taxes
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accelerated filers based on a recent Int elligize CAM S urvey report (9/ 10/ 19)
limitations (IRC §162(m)) – K12 Inc.
tax provision process.
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B decided to add to its agenda a proj ect regarding simplifications to accounting for income taxes
implification Initiative
B had noted that accounting for income taxes has been among the top areas of restatement over the last several years (13-15 %
and practitioners the Board identified certain requirements that had less relevance given tax reform as well as other requirements which were complex and prone to errors
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The Board decided to remove the following exceptions in Topic 740, Income Taxes:
there is a loss from continuing operations and income or a gain from other items (for example, discontinued operations or other comprehensive income)
method investments when a foreign subsidiary becomes an equity method investment
subsidiary when a foreign equity method investment becomes a subsidiary (therefore, an entity would have the ability to assert indefinite reinvestment for the entire basis difference of a subsidiary)
period when a year-to-date loss exceeds the anticipated loss for the year.
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The board also decided the following:
accordance with Topic 740 and account for any incremental amount as a non- income-based tax.
considered part of the initial recognition of book goodwill and when it should be considered a separate transaction.
and deferred tax expense to legal entities that are not subj ect to tax in their separate financial statements.
the annual effective tax rate computation in the interim period that includes the enactment date.
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related to employee stock ownership plans and investments in qualified affordable housing proj ects accounted for using the equity method.
the accounting for nondeductible goodwill by private companies.
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The Board affirmed its initial decisions at a meeting on S eptember 4, 2019. In addition, the Board decided that an entity should apply the amendments as follows:
partially based on income (changed from initial retrospective recommendation)
to legal entities that are not subj ect to tax in their separate financial statements
equity method investment or subsidiary
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AS C 740 – Practical Issues Impacting Income Tax Provisions 18
On, March 25th, the FAS BI issued a proposed Accounting S tandard Update (AS U), Disclosure Framework-Changes to the Disclosure Requirements for Income Taxes:
U is a revision to an exposure draft which was issued on July 26,2016
U will apply to all entities that are subj ect to income taxes
that term is defined in the Master Glossary of the Codification
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As proposed all entities would need to disclose:
benefit) and before intra-entity eliminations disaggregated between domestic and foreign
between federal, state, and foreign
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The following disclosures would be required for PBEs only:
tax benefits are presented and the related amounts of such unrecognized tax benefits
released during the reporting period – requires an explanation of what increases were and what decreases were and not merely a statement regarding that there was a net change-S EC Regulation S
and Qualifying Accounts requires registrants to provide a schedule ( basically a rollforward ) on valuation reserves if that information is not disclosed elsewhere in the financial statements. S ee subsequent slide for sample disclosure and rollforward.
assets for carryforwards ( see subsequent slide for further discussion).
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The proposed AS U would:
with U.S . S ecurities and Exchange Commission (S EC) Regulation S
08(h), Rules of General Application— General Notes to Financial S tatements: Income Tax Expense.
amounts to more than 5 percent of the amount computed by multiplying the income before tax by the applicable statutory federal income tax rate.
amounts.
the change in an amount or a percentage of a reconciling item from year to year (see subsequent slide for an example).
— sensitive to variations in pre tax income
significant reconciling items but may omit a numerical reconciliation.
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The amendments in this proposed Update would reduce diversity in practice by explicitly requiring a PBE to disclose:
any valuation allowance) by time period of expiration for each of the first five years after the reporting date, a total for any remaining years, and a total for carryforwards that do not expire.
federal, state, and foreign carryforwards.
asset attributable to carryforwards in accordance with paragraph 740-10-45- 10A.
total amounts of federal, state, and foreign credit carryforwards and the total amounts of other federal, state, and foreign carryforwards (not tax effected), separately for those carryforwards that do not expire and those that do expire, along with their expiration dates (or a range of expiration dates).
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The proposed amendments in the AS U would:
estimate of the range of the reasonably possible change in the unrecognized tax benefits balance in the next 12 months or (2) make a statement that an estimate of the range cannot be made
temporary difference when a deferred tax liability is not recognized because of the exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate j oint ventures.
230, S tatement of Cash Flows, is required for interim periods.
j urisdiction of domicile shall be included in the amount for that j urisdiction of domicile ( currently there is diversity in practice— relates to withholding taxes).
Topic 740 in accordance with AS U 2013-12, Definition of a Public Business Entity.
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The amendments in this proposed Update would be applied prospectively. The effective date and whether early adoption of the proposed amendments should be permitted will be determined after the Board considers stakeholder feedback on the proposed amendments.
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Tax Law Change ASC 740 Issues
limited to 80%
for losses arising in tax years beginning after December 31, 2017.
be repealed for tax years ending after December 31, 2017.
the only source of income is the reversal
need to assess whether the change in tax law would impact their valuation allowance assessment.
post enactment losses which would include reversing deductible temporary differences to the extent they create a “ loss” when scheduled.
relating to short-lived intangibles (i.e., no tax basis) which might result in a situation where only 80% could be offset.
Net Operating Loss Carryforwards and Certain Built-In Losses Following an Ownership Change, must be considered in the scheduling process.
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certain cases to determine the amount of deferred taxes to be recognized in the financial statements. S cheduling needs to take into account the provisions of the tax law including limitations e.g. Code S
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Assume a 25% tax rate Blunder Inc., a calendar year U.S . domestic C Corporation, had been realizing losses in prior years and is unable to reliably proj ect future income. At 12/ 31/ 2018 Blunder has a pre 2018 net operating loss carryover of $1,000 which is limited pursuant to Code S ec 382 to $100 per year. In addition it has deferred tax assets of $200 which reverse ratably over the next two years and deferred tax liabilities which reverse straight line over the next four years. S ince Blunder is not able to rely upon proj ected future income to support its current position it determined based upon the following that it should record a DTL of $ 200 at 12/ 31/ 18:
Gross Amount Rate DTA/DTL Pre 2017 NOL $1,000 25% 250 DTAs @ 12/ 31/ 18 200 25% 50 DTL - int angibles (2,000) 25% (500) DTL - net $(200)
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In assessing the company’ s accounting it is clear that Blunder blundered since it failed to assess whether its temporary differences reversed within the same time frame, were of the same character of income and were within the same j urisdiction. The below would be more accurate in determining its deferred tax position:
DTA (DTL) tax effected 12/31/18 2019 2020 2021 2022 Net Pre 2017 NOL $250 $(25) $(25) $(25) $(25) DTAs 50 (25) (25)
(500) 125 125 125 125 DTL - net $(200) $75 $75 $100 $100 $(350) Proof: Pre 2017 NOL $250 V.A. (150) Recognized pre 2017 NOL 100 DTAs 50 DTLs (500) Net DTL $(350)
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“ Naked Credits” – S
1 2 / 3 1 / 2 0 1 9 1 2 / 3 1 / 2 0 1 9 1 2 / 3 1 / 2 0 2 0 1 2 / 3 1 / 2 0 2 1 1 2 / 3 1 / 2 0 3 4 1 2 / 3 1 / 2 0 3 5 1 2 / 3 1 / 2 0 3 6 Total Average Consolidated Pre- tax book income ( los Ded/ ( Tax) Temp Reversing Deferreds Accrued Vacation 40,000 (40,000)
Bad Debt Reserve 5,000,000 (5,000,000)
Deferred Compensation 300,000 (15,789) (15,789) (15,789) (15,789) (15,789) (15,789) (15,789) (300,000) Deferred Gain 8,000,000 (800,000) (800,000) (800,000) (800,000)
Deferred Rent 5,000,000 (1,000,000) (1,000,000) (1,000,000) (1,000,000)
IRC Sec. 481 Adjustment (1,500,000) 750,000 750,000
Intangible Assets 90,000,000 (6,000,000) (10,000,000) (9,000,000) (8,500,000)
Other Accrued Liabilities 2,500,000 (2,500,000)
Prepaid Insurance (500,000) 500,000
Qualified Film Expense (9,000,000) 7,000,000 2,000,000
Restricted Stock Expense 800,000 (600,000) (200,000)
Fixed Assets 4,000,000 (2,000,000) (1,000,000) (500,000) (500,000)
Installment sale (50,000,000) 50,000,000 I ndefinite Deferreds
(700,000,000)
(9,705,789) (10,265,789) 38,684,211 (10,815,789) (15,789) (15,789) (15,789) (54,640,000)
(9,705,789) (10,265,789) 38,684,211 (10,815,789) (15,789) (15,789) (15,789) Projected 2 0 1 8 loss (7,000,000) NOL CF (600,000,000) (616,705,789) (626,971,579) (588,287,368) (599,103,158) (661,608,421) (661,624,211) (661,640,000) Valuation Allow ance/ Net DTL: Pre 2 0 1 8 NOLs (600,000,000) 2 0 2 0 Usage Per Scheduling Exercise 38,684,211 DTAs w /out NOLs 54,640,000 Pre 2018 NOLs 600,000,000 Pre 2 0 1 8 NOLs - offsets by VA (561,315,789) 2018 projected NOL 7,000,000 Indefinite lived intangibles (700,000,000) "New NOLs" 61,640,000 Valuation allow ance ( 5 6 1 ,3 1 5 ,7 8 9 ) Indefinite Lived DTL (700,000,000) Indefinite Lived DTL @ 80% (assumes Fed only) (560,000,000) Net DTL ( 5 9 9 ,6 7 5 ,7 8 9 ) Based on Scheduling Exercise, "New NOLs" can be supported by the I ndefinite Lived DTL Gross DTA ( DTL) DTA ( DTL) before Attribute 1 2 / 3 1 / 2 0 1 8 - Projected
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Tax Law Change ASC 740 Issues
expensing for qualified assets placed in service after S eptember 27, 2017 and before January 1, 2023.
between 2023 through 2026.
property to include used property provided the taxpayer had not used the property and it is not acquired from a related party.
difference related to depreciation.
differences could give rise to a future source of income which may impact the ability to realize deferred tax assets in the future.
decouple, will need a separate deferred for state depreciation.
Final regulations issued in S eptember 2019. Need to assure that properly elect out
Can create issues with various limitations e.g. Code S ec 250 deductions for GILTI & FDII (see example that follows) S tate issues and separate state deferreds for depreciation
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With Bonus Without Bonus PBT (Includes $1,000 book depreciat ion) $2,000 $2,000 Bonus/ regular depreciat ion ($5,000) ($200) GILTI Income $8,000 $8,000 GILTI (S
($4,000) ($4,000) FDII($10,666x 37.5% ) (Loss)-Income ($4,000) ($3,000) ($4,000) $1,800 Add back income (post Code S ec 250 limit ) Net Income $5,857 2,857 3,800 5,600 Tax rat e X 21% X 21% Current expense 600 $1,176 Deferred expense $1,050 $42 Tot al expense $1,650 $1,218 *Example does not take into account foreign tax credits.
1) FDII addback ($13,666= excess 250 deduction (FDII ($10,666)+GILTI($8,000)-($5,000))x$10,666/ 18,666)X37.5% =$2,928 2) GILTI addback ($13,666x($8,000/ $18,666)x50% =$2,929 3) FDII addback ($8,866x($10,666/ $18,666))x 37.5% =$1,899 4) GILTI addback ($8,866x($8,000/ $18,666))x50% =$1,900
(1+2) (3+4)
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Tax Law Change ASC 740 Issues
for commissions and performance based compensation thus classifying all compensation greater than $1M as subj ect to limitation.
“ covered employee” to include the CFO.
CEO, CFO, plus the three highest compensated officers for the year.
is a “ covered employee,” will always be a “ covered employee” .
years beginning after December 31, 2017.
written binding contract as of November 2, 2017 are grandfathered.
compensation due to IRC S
provisions not be recognized for financial statement purposes.
require that all compensation in excess
method they are using for disallowed compensation for reporting purposes:
binding agreements as of November 2, 2017 which could make the award no longer exempt from disallowance.
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Issues encountered include:
cheduling the reversal of year end deferred tax asset to determine if when it vests or is exercised that it will not be limited( issue always existed but more focus with tax reform( AS C 740 concern whether you elect cash first method, stock compensation first
pro rata method in assessing the realizability of the DTA))
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Tax Law Change ASC 740 Issues
deduction for net business interest expense
30%
income plus floor plan financing interest.
without regard to deductions for any items not properly allocable to the trade or business, business interest expense or business interest income, net operating losses, 20% deduction for certain pass throughs and, in the case of tax years beginning before January 1, 2022, depreciation, amortization, and depletion.
interests included.
has annual gross receipts less than $25M for the three taxable years prior to the reporting year.
indefinitely.
December 31, 2017.
would need to be assessed for valuation allowance considerations.
applicable).
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AS C 740 and tax return perspective
enj oyment), rules are complicated
limit that a valuation allowance could be released with respect to NOLs based
additional 163(j ) limitation which will need to be reserved for
set up a VA on the 163(j ) limited interest since unable to proj ect utilization (requires extensive analysis and modeling)
limitation needs to be considered in AS C 740 analysis including relying solely on reversing taxable temporary differences (unlimited carryover period allows for offset versus a naked credit subj ect to the 30% limitation)
ee examples that follow
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Interest Limitation Projected Income With IRC 163(j) Limitation Assumptions: 1) Full valuation allowance on $5,000 of gross NOL carryover as of 12/31/2017 2) Projected loss of $1,000 per year 3) Projected 163(j) disallowance per "Tax Cuts and Jobs Act" of $3,000 per year. 4) Unable to project ever being able to use the 163(j) amount. 5) Assume 21% tax rate 2018 2019 2020 2021 Projected Loss (1,000) (1,000) (1,000) (1,000) 163(j) - originating 3,000 3,000 3,000 3,000 Allowable Interest Deduction (600) (600) (600) (600) Pre-NOL Taxable Income 1,400 1,400 1,400 1,400 NOL C/F Utilization (1,400) (1,400) (1,400) (800) Taxable Income
Rate 21% 21% 21% 21% Tax
126 $ In the above example, the originating 163(j) deduction does generate taxable income which will absorb the NOL carryovers. However, even though the NOL carryovers have been realized, there is no incremental benefit in the instant situation since there is no ability to project the utilization of the
AS C 740 – Practical Issues Impacting Income Tax Provisions 39
Example 2 2018 2019 2020 2021 Projected Loss (1,000) (1,000) (1,000) (1,000) 163(j) - originating 3,000 3,000 3,000 3,000 Allowable Interest Deduction (600) (600) (600) (600) Pre-NOL Taxable Income 1,400 1,400 1,400 1,400 NOL C/F Utilization (1,400) (1,400) (1,400) (800) Taxable Income
Rate 21% 21% 21% 21% Tax
126 $ In this example, which is identical to the one above, certain firms would ignore the fact that there is no incremental benefit and would release the valuation allowance as of 12/31/2017 since the NOLs are able to be utilized. * For simplicity, It has been assumed that depreciation/amortization has been deducted/ added back to the loss and no interest income exists.
AS C 740 – Practical Issues Impacting Income Tax Provisions 40
Q1 of 2018 the facts remain the same.
replaced by the originating 163(j ) deduction. Thus the deferred tax asset at the BOY and EOY are $0 due to the full valuation allowance position.
since $1,400 of the NOL carryover would have been absorbed by the taxable income
Analysis of Expense
estimated annual rate pursuant to AS C 740-270-30-36 since no tax benefit can be realized. This entity would prepare its own annual effective tax rate and would apply that rate to its y-t-d Income/ (loss) in accordance with the subtopic.
Replacement Theory Benefit Theory BOY DTA $0 $1,050 Current Year Movement (294) EOY DTA $0 $756
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Beta Company (Company) , a US corporation , has been in a loss position for both financial reporting and tax purposes for the last 3 years. However, in 2018 the Company generates taxable income due the application of Internal Revenue Code Section(IRC) 163(j) ,limitation
Beta's deferred tax asset (DTA) and liability (DTL) position as of December 31,2018 is as follows: DTA (DTL) Net operating loss carryover(NOL)--pre 2018 $5,000 163(j) limitation 4,000 Bad debt reserve 100 Property, plant & equipment (PPE)
Indefinite lived intangible
Net DTL
The pre-2018 NOLs are not subject to limitation pursuant to IRC 382,limitation on net operating loss carryovers and certain built-in losses following an ownership change for the first example and are limited to $150 per year in the second example. The net operating losses expire ratably between 2034-2037.
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The bad debt deduction is expected to reverse the following year while the DTL for the PP&E will reverse ratably over the next 5 years. The following is the analysis the Company would perform to determine its ending deferred tax position for 2018: Deferred tax position REVERSALS 12/31/2018 12/31/2019 12/31/2020 12/31/2021 12/31/2022 12/31/2023 Indefinite Final DTL PPE
1,800 1,800 1,800 1,800 1,800 Bad debt reserve 100
Indefinite lived intangible
7,000 163(j) interest 4,000
Income(loss)
1,190 1,260 1,260 1,260 1,260 5,670 NOL 5,000
Income(loss)/DTA(DTL)
$1,230 5,670 6900 The above example illustrates that Beta is able to support its deferred tax assets solely with the reversal of taxable temporary differences pursuant to ASC 740-10-30-18a and thus will recognize a DTL of $6,900. Since the Company is able to support the realization of its deferred tax assets with the revesal of its taxable temporary difference it is not necessary to consider other evidence as as outlined in ASC 740-10-30-18.
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Deferred tax position REVERSALS 12/31/2018 12/31/2019 12/31/2020 12/31/2021 12/31/2022 12/31/2023 Indefinite Final DTL PPE
1,800 1,800 1,800 1,800 1,800 Bad debt reserve 100
Indefinite lived intangible
7,000 163(j) interest 4,000
Income(loss)
1,190 1,260 1,260 1,260 1,260 5,670 NOL 5,000
Income(loss)/DTA(DTL)
1,040 1,110 1,110 1,110 $1,110 5,670 11,150
The above example illustrates that Beta is able to support its deferred tax assets solely with the reversal of taxable temporary differences pursuant to AS C 740-10-30-18a and thus will recognize a DTL of $11,150. S ince the Company is able to support the realization of its Deferred tax assets with the reversal of its taxable temporary difference it is not necessary to consider other evidence as outlined in AS C 740-10-30-18.
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after tax reform?
. taxpayer was not subj ect to taxation on the earnings of a foreign subsidiary until the earnings were distributed to the taxpayer with certain exceptions e.g. subpart F income
. Outside basis difference concerns – income recognition
2019.
ubpart F inclusions – virtually the same as under pre-tax reform and takes precedence
2019 but did not address basis rules as had been done in the proposed regulations (reserved for future regulation)
AS C 740 – Practical Issues Impacting Income Tax Provisions 46
income after the previous mandatory inclusions, does not create a basis adj ustment for tax purposes but this portion of the outside basis difference (book vs tax) can be recovered tax free.
ec 956 (Investment in U.S . Property)
the impact of Code S ec 956 – regulations limit the application of 956 to instances where an amount would be taxable after the application Code S
ec 245A
till need controls in place to monitor this if either of above issues are applicable
AS C 740 – Practical Issues Impacting Income Tax Provisions 47
AB 118 measurement period ended December 22, 2018
tax returns (extended due date 10/ 15/ 18). Final regulations allow basis elections to be made or revoked within 90 days of the publication of the regulations in the Federal Register.
C 740 Issues
ec 965 installment payments
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Tax Law Change AS C 740 Issues
taxes GILTI in a manner similar to S ubpart F . Applies whether the income is distributed or not (specifically stated that it is not S ubpart F income).
tangible income return.”
includes gross income of the CFC other than:
ubpart F income;
ubpart F (954(b)(4));
(954(d)(3)); and
(907(c)(1)).
deductions (including taxes) properly allocable to the corporation’s gross income, determined without regard to the tested income exceptions
asset investment (“ QBAI” ) over interest expense.
C 740 consequence, a company must conclude that it will be a GILTI taxpayer.
require systems to be developed to track the necessary data to conclude whether the tax applies or does not apply.
(calendar year) and 2019 (fiscal year) companies in developing effective tax rate.
deferred taxes for any outside basis differences that are expected to reverse as GILTI.
S ubpart F income.
AS B staff concluded that companies could make a policy election to recognize or not recognize deferred taxes on underlying temporary differences that would reverse as GILTI.
AS C 740 – Practical Issues Impacting Income Tax Provisions 49
Tax Law Change AS C 740 Issues
the aggregate of its adj usted bases as of the close of each quarter in specified property. Adj usted basis is determined using the alternative depreciation system under IRC S ec. 168(g).
deduction of 50%
years beginning after December 31, 2017 and before January 1, 2026 reduced to 37.5% for years thereafter.
80%
aggregate tested income multiplied by the aggregate tested foreign income taxes paid or accrued by all CFCs (GILTI is in its own separate tax credit basket and there is no carryover allowed).
after December 31, 2017.
based upon effective rate – e.g., foreign taxes paid/ accrued over E&P earnings and not based upon comparison of US
statutory rates.
AS C 740 – Practical Issues Impacting Income Tax Provisions 50
C 740 consequence, a company must conclude that it will be a GILTI taxpayer.
track the necessary data to conclude whether the tax applies or does not apply.
effective tax rate.
differences that are expected to reverse as GILTI.
matter for a future regulation proj ect.
AS C 740 – Practical Issues Impacting Income Tax Provisions 51
ubpart F income.
B staff concluded that companies could make a policy election to recognize or not recognize US deferred taxes on foreign subsidiary temporary differences that would reverse as GILTI.
deferred taxes for temporary differences impacting GILTI
taxes paid/ accrued over E&P earnings and not based upon comparison of US vs. foreign statutory rates (in June proposed regulations were issued which would allow all high tax earnings and not j ust subpart F income to be excluded).
AS C 740 – Practical Issues Impacting Income Tax Provisions 52
Valuation allowance considerations
DTA’ s which have a valuation allowance
proj ect out NOL utilization and reduce valuation allowance
incremental cash tax benefit due to NOL’ s.
is less tax with the NOL’ s , reduce V/ A by such amount. Need to consider FTC’ s and section 250 deduction in this comparison.
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These materials do not constitute tax or legal advice, and cannot be relied upon for purposes of avoiding penalties under the Internal Revenue Code. These materials may omit discussion of exceptions, qualification, definitions, effective dates, j urisdictional differences, and other relevant authorities and
specific transaction. BDO will not be responsible for any error, omission, or inaccuracy in these materials.