Financial accounting: EITF update.

Income Tax and Foreign Companies

This month's column lists new EITF consensuses adopted March 21, 1996 (see the sidebar on page 101). In addition, three earlier consensuses on deferred tax implications for foreign companies that are assessed taxes on dividends paid and for parent companies of the foreign subsidiaries are summarized in our new format.

ISSUE 95-9

Accounting for Tax Effects of Dividends in France in Accordance with FASB Statement no. 109.

Consensus dated: September 20-21, 1995.

Entities affected: French corporations paying dividends to French shareholders and other corporations that are assessed taxes when dividends are paid.

Background: French corporations pay a tax (called a precompte) when dividends are paid to shareholders. The French shareholder initially is taxed on the dividend received but then gets a tax credit for that same amount. The precompte is equal to the tax credit permitted the shareholders, subject to certain limitations. This mechanism eliminates double taxation of dividends.

Issue: Should the payment of this corporate tax by the French corporation be recorded as (1) an increase in income tax expense and income taxes payable; or (2) an increase in dividends paid (retained earnings) in the equity section and withholding taxes payable relating to the dividend recipient?

Consensus: Record payment as withholding taxes payable and dividends paid if both of the following conditions are met: (1) The tax is payable by the corporation if and only if a dividend is distributed to shareholders. The tax does not reduce future income taxes the corporation would otherwise pay. (2) Shareholders receiving the dividend are entitled to a tax credit at least equal to the tax paid by the corporation and that credit is realizable either as a refund or as a reduction of taxes otherwise due, regardless of the tax status of the shareholders.

ISSUE 95-10 Accounting for Tax Credits Related to Dividend Payments in Accordance with FASB Statement no. 109.

Consensus dated: July 20-21, 1995.

Entities affected: Separate financial statements of foreign corporations that receive tax credits related to dividend payments.

Background: Certain foreign jurisdictions tax corporate income at different rates depending on whether that income is distributed to shareholders. For example, undistributed profits of German corporations are taxed at a 45%, while distributed income is taxed at 30%. Enterprises that pay dividends from previously undistributed income receive a tax credit (or tax refund) equal to the difference between (1) the tax computed at the "undistributed rate" in effect the year the income is earned (for tax purposes) and (2) the tax computed at the "distributed rate" in effect the year the dividend is distributed.

Issue: Should a deferred tax asset be recognized for the tax benefits of future tax credits that will be realized when the previously taxed income is distributed?

Consensus: No. Those tax benefits should be recognized as a reduction of income tax expense in the period that the tax credits are included in the enterprise's tax return. Based on the consensus, the enterprise would measure the tax effects of temporary differences using the undistributed rate. This consensus applies only to the separate financial statements of foreign corporations that receive tax credits related to dividend payments and prepare their financial statements in accordance with generally accepted accounting principles.

ISSUE 95-20

Measurement in the Consolidated Financial Statements of a Parent of the Tax Effects Related to the Operations of a Foreign Subsidiary That Receives Tax Credits Related to Dividend Payments.

Consensus dated: November 15-16, 1995.

Entities affected: Parent companies preparing consolidated financial statements that include a foreign subsidiary that receives tax credits for dividends paid.

Background: See Issue no. 95-10 above.

Issue: Should the consensus in Issue no. 95-10 apply to consolidated financial statements in which a parent company expects to remit the earnings of a foreign subsidiary that receives tax credits for dividends paid?

Consensus: The future tax credit to be received when dividends are paid and the deferred tax effects related to the operations of the foreign subsidiary should be recognized in the consolidated financial statements based on the distributed rate if the parent is not applying the indefinite reversal criteria of Accounting Principles Board Opinion no. 23, Accounting for Income Taxes--Special Areas. However, the undistributed rate should be used in the consolidated financial statements to the extent that the parent has not provided for deferred taxes on the unremitted earnings of the foreign subsidiary as a result of applying the indefinite reversal criteria of Opinion no. 23.

EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: [phone].

Statement on Auditing Standards no. 69, The Meaning of "Present Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor's Report, identifies Financial Accounting Standards Board emerging issues task force (EITF) consensuses as sources of established generally accepted accounting principles.

By LINDA A. VOLKERT, CPA, senior technical manager of the AICPA technical hotline team.