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TEI comments on PIR of ASC 740.

On June 10, 2013, TEI submitted the following comments to the Financial Accounting Foundation (FAF) in connection with the FAF's post-implementation review of Financial Accounting Standards Board Statement No. 109, Accounting for Income Taxes (codified as ASC 740). In addition, hundreds of individual TEI members submitted anonymous comments to the FAF using a web-based, electronic survey. In general, TEI's comments concluded that ASC 740 provides useful information to readers of financial statements, but there are a number of problematic rules within the standard that should be refined or eliminated if ASC 740 is to remain an understandable standard that can be applied as intended and result in the reporting of reliable income tax information. The comments, which took the form of a letter from TEI President Carita R. Twinem to FAF President Theresa S. Polley, were prepared under the aegis of TEI's Financial Reporting Committee. Patrick Evans, TEI Chief Tax Counsel, serves as legal staff liaison to the Committee and coordinated the preparation of TEI's comments.

TEI Background

Tax Executives Institute is the preeminent global association of in-house corporate tax executives. Our nearly 7,000 members are accountants, attorneys, and other business professionals employed by approximately 3,000 of the leading companies in the United States, Canada, Europe, and Asia. TEI represents a cross-section of the business community and is dedicated to the development and implementation of sound tax policy and to promoting the uniform and equitable enforcement of the tax laws. The Institute is proud of its record of working with congressional committees, government agencies, and other policy-making bodies, including the Public Company Accounting Oversight Board and the Securities and Exchange Commission, to minimize the cost and burden of tax administration and compliance to the mutual benefit of the government, business, and ultimately the public. We also support efforts to ensure that companies fairly present their financial position in financial statements prepared for investors and in documents filed with the SEC.

TEI members are responsible for conducting the tax affairs of their companies, ensuring their compliance with the tax laws, and preparing financial disclosures of tax related matters. Most of the companies represented by our members issue financial statements that are governed by the FASB's pronouncements, and, of those, most are SEC registrants. For companies governed by other accounting standards, such as International Fiscal Reporting Standards, the FASB's work is also critical since FASB pronouncements are often referenced by other accounting standards boards. In addition, they are subject to scrutiny by the IRS and various other agencies in the United States and foreign jurisdictions on a continual basis.

As a professional association of in-house tax executives, TEI offers a unique perspective. Its members work for companies involved in a wide variety of industries, and thus, their collective perspectives are broad-based and not tied to any particular special interest group. Further, TEI members are responsible for both the tax affairs of their employers and the reporting of tax information in their employers' financial statements. Thus, they are well-versed in the complexities of the tax laws, as well as the financial accounting rules. We believe the diversity, background, and professional training of TEI's members place us in a uniquely qualified position from which to comment on ASC 740. Along with the government and the investing public, our members have the most at stake in trying to craft a financial reporting system that fairly presents the results of company operations and is as administrable and efficient as possible.

Tax Executives Institute commends the FAF for instituting a post-implementation review of ASC 740. Much has changed since the income tax accounting standard was issued in February 1992. Companies have shifted significant aspects of their operations abroad. The complexity of tax laws has increased at an alarming rate. Numerous accounting standards, including business combinations and others, have been revised. And, finally, Sarbanes-Oxley has instituted additional requirements on companies for enhanced corporate governance, internal controls, and financial disclosure. We believe ASC 740 must also evolve if it is to remain an understandable accounting standard that can be applied as intended and result in the reporting of reliable income tax information.

Many TEI members have already participated in the FAF's electronic FAS 109 PIR survey. We are pleased to submit the following additional comments in response to certain questions posed in the survey.

General Opinions on ASC 740

The objective of ASC 740 is to recognize the amount of a) income taxes payable or refundable for the current year, and b) deferred income tax liabilities and assets for the future tax consequences of events that have been recognized in an organization's financial statements or tax returns. In general, we believe the overall approach of ASC 740 is sound. Disclosures such as the composition of income tax expense, the amount of pre-tax income or loss by U.S. source and foreign source, and the statutory; rate reconciliation provide information that is useful to readers in determining the significant factors that influence the issuer's effective tax rate. There are, however, a number of rules within ASC 740 that are problematic and should be refined or eliminated from the accounting standard because they are exceptionally complex, yet pertain to areas that could be eliminated without diminishing the value of financial statements; they do not accurately measure the economic effects of a reporting entity's tax costs or benefits; or consistency and reliability could be improved by a less complex standard.

Effectiveness of Discrete Aspects of ASC 740

The PIR questionnaire elicits feedback on the effectiveness of several discrete aspects of ASC 740. Our comments on these questions are provided below.

Deferred lax Assets and Deferred Tax Liabilities

Question 7 of the PIR questionnaire concerns guidance for computing deferred tax assets (DTAs) and deferred tax liabilities (DTLs). In many cases, the application of this guidance is straightforward. Companies usually maintain records of the book and tax bases of assets and liabilities for income tax return preparation purposes that allow them to reliably compute the amount of the difference and apply the appropriate tax rate. Many book/tax differences reverse within a short period of time, and the resulting DTA or DTL can be a reliable measure of the tax benefit or cost that will be realized in a near-term future period.

ASC 740, however, does not generally provide useful guidance on the more complex areas of computing DTAs and DTLs. There are a number of examples where the calculation is very complex because the underlying information is not maintained for tax return purposes and may involve judgment or assumptions that are difficult or impossible to verify. For example, a DTL related to the difference between the book and tax bases of an investment in a foreign subsidiary often cannot be accurately measured because many companies do not maintain precise records of the book and tax bases of such investments. In addition, the amount of foreign income taxes creditable against U.S. income taxes that are related to basis differences may not be readily available. Finally, the portion of the investment that is considered indefinitely reinvested (and for which a DTL is not recorded) is a forward-looking determination that requires many assumptions for which explicit guidance is not currently provided.

Intraperiod Tax Allocation

Question 9 of the PIR questionnaire elicits feedback on intraperiod tax allocation guidance. There are several unique complexities within these rules that do not add to the usefulness of the financial reporting or the value of the information reported. For example, the exception to ASC 740's "with and without" approach, which is provided in ASC 740-20-45-7, is counter-intuitive, and its overly complex application raises concerns that it may mislead readers of financial statements.

The exception requires a company to include its recognized gains and losses in other comprehensive income (OCI) when determining the amount of tax benefit resulting from a loss in continuing operations if the entity maintains a full valuation allowance. When applying this rule, logic dictates that any net DTA recorded will attract an incremental valuation allowance, and thus, no tax benefit will be allocated to continuing operations. This exception, however, actually results in the recognition of a tax benefit in continuing operations because yearly gains realized in OCI are allowed to offset the losses from continuing operations, while the related tax charges are offset to OCI. The ASC 740-20-45-7 exception can also create significant volatility in the company's effective tax rate throughout the year because the income from OCI is recorded discretely.

Application of ASC 740-20 can cause other anomalies that distort the reporting of OCI on the balance sheet and create residual tax effects or tax rate anomalies in future periods. For example, the rules require a company to calculate the tax expense or benefit from items reported in continuing operations without considering the tax effects of items other than continuing operations. Another example is provided by the accounting for post-retirement benefit-related actuarial gains or losses, which are recorded in accumulated OCI (AOCI) and then allocated over time to continuing operations. Additionally, the tax in AOCI is not always measured using the current statutory rate relative to the pre-tax amount. This issue arises when there are changes in tax rates subsequent to when the pre-tax amount was included in OCI. These residual tax effects or rate anomalies are released through the profit and loss statement and are generally not meaningful to financial statement readers.

Use of Valuation Allowances to Reduce Recognized DTAs

PIR question 10 requests respondents' views concerning the establishment and release of valuation allowances. ASC 740 requires management to consider all evidence, both positive and negative, and to use its judgment when determining whether to record a valuation allowance on a DTA. ASC 740 does not, however, provide guidance on the types of evidence that should be considered, and there is no bright-line test for establishing or releasing a valuation allowance, although, in practice, many public accounting firms use a 3-year cumulative loss standard as a refutable starting point. Additionally, current accounting rules require the recording of a valuation allowance against a DTA if it is not "more likely than not" that the DTA will be realized. The valuation allowance is released in the period in which the "more likely than not" standard is met. The basis for the release of a valuation allowance is often highly subjective and subject to significant scrutiny by external auditors and regulators. Furthermore, the effect of the release is a "one-time event" that users may not consider meaningful in their evaluation of the entity's financial results.

ASC 740-10-45-5, Valuation Allowance Allocation, requires a company to allocate its valuation allowance to deferred taxes on a pro rata basis based on the entity's current or non-current classification of DTAs. This rule not only adds a significantly complex reclassification to the end of an entity's closing process, but also results in a misleading financial statement presentation because valuation allowances are specific to certain DTAs and should be matched to the related asset classification to allow for proper netting of current DTAs with current DTLs and noncurrent tax assets with noncurrent liabilities. As discussed below, this misleading presentation becomes obvious when the paragraph 41 valuation allowance reclassification is performed on a valuation allowance that relates to a specific DTA.

The guidance for determining when a valuation allowance should be provided is highly subjective, difficult to apply, and places greater weight on recent and objectively verifiable current information, as compared to more forward-looking information that is commonly used in valuing other assets on the balance sheet or making going concern determinations. Whether it is more likely than not that an entity will have future taxable income sufficient to realize a DTA is largely dependent on the entity's past profitability and the credibility of its forecast of future income of a source and character needed to use the asset. Furthermore, the amount of future taxable income is influenced by the entity's expectations of future originating temporary differences, which are difficult to predict. As a result, entities with a history of substantial taxable income rarely need a valuation allowance, while entities with no recent taxable income often record full valuation allowances. The release of a valuation allowance is a discrete event which is based on a subjective "moment in time" when the entity determines it has met the "more likely than not" test. Absent actually using the DTA in the year the valuation allowance is reversed, such conclusions can be easily second-guessed by external auditors, regulators and users.

For example, in the recent economic recession, many businesses experienced operating losses and lost visibility over the prospects for recovery. As a result, these entities recorded valuation allowances against their DTAs. When the economy in general and the business sector in particular showed sustained recovery, some of these entities reversed valuation allowances previously recorded. We noted the issuance of comment letters by the SEC questioning the valuation allowance reversals and public comments indicating that economic downturns could not be considered unusual or one-time "aberrations." (For examples, see Deloitte, SEC Comment Letter Examples, September 2012, in particular "Realizability of Deferred Tax Assets in the Current Economic Environment," available at http:// / assets / Dcom-UnitedStates / Local%20Assets / Documents / Tax/us tax SEC_Comment_Examples_Income_Taxes_092112.pdf.)

Disclosure Requirements for Unrecognized DTLs for Temporary Differences Related to Investments in Foreign Subsidiaries/Corporate Joint Ventures that Are Essentially Permanent in Nature

Question 11 of the PIR requests comments on the disclosure requirements for the APB 23 exception (codified as ASC 740-10-25-3) to the general rule that a U.S. multinational must accrue U.S. taxes on foreign earnings of its controlled non-U.S, subsidiaries. Under the exception, a U.S. multinational is not required to record a DTL on undistributed foreign earnings that are indefinitely reinvested abroad. We believe the APB 23 exception is sound, but the disclosure requirements are overly complex, difficult to prepare, and provide little predictive value to readers of financial statements. Computation of a DTL for indefinitely reinvested foreign earnings involves calculating a hypothetical repatriation amount, hypothetical taxable income inclusion, and hypothetical foreign tax credit calculation. Each calculation is complex and involves numerous assumptions. Factors to consider include the manner in which basis differences will reverse (i.e., sale, repatriation, loan, etc.), data collection, currency fluctuations, impact of permanent E&P adjustments, tracking of book and tax stock basis, and forecasting. The disclosure is not comparable across companies because of the subjectivity in applying the factors. Further, an exception is provided to computing the tax amount if the company determines that the computation is not practicable. In practice, most multinational companies avail themselves of this exception and do not provide the tax estimate because of the complexities cited above, which calls into question the usefulness of the disclosure requirement in the first instance. Due to the subjectivity and uncertainty regarding when, if ever, such taxes would be paid, this disclosure requirement is, in our opinion, of limited use to readers.

Disclosure of Significant Portions of Deferred Taxes

Question 13 of the PIR questionnaire elicits feedback on the requirement to disclose the approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of DTLs and DTAs (before allocation of valuation allowances). The usefulness of financial statement disclosures is negatively affected by the mismatch between categorizing deferred taxes into current and non-current assets and liabilities by jurisdiction (which causes significant complexity for large multinational companies), and reporting the significant components of deferred taxes on a consolidated basis. This mismatch makes it difficult, perhaps impossible, for readers to estimate the impact of deferred tax reversals by jurisdiction or business unit. In our view, the jurisdictional approach should be reconsidered, due to its administrative complexity and limited usefulness to readers of financial statements.

Compliance Costs

Question 32 of the PIR requests respondents to identify the aspects of ASC 740 that result in excessive compliance costs. The exceptions and special rules discussed in this paper are examples where the complexity and cost of complying with ASC 740 outweigh the utility that the resulting financial statement disclosures have to readers of financial statements. In addition, many of the principles of ASC 740 must be applied on an entity-by-entity and jurisdiction-by-jurisdiction basis. For this reason, costs of complying with ASC 740 are typically increased significantly by business expansion (including expansion through acquisitions) and entry into foreign markets. Business expansion changes the nature of the company's assets and liabilities and can create new types of temporary differences. Expansion through acquisitions creates DTAs and DTLs as a result of differences between legacy tax bases and allocated purchase price, and the acquiring company is required to document and measure the target entity's tax bases. Expansion into foreign markets requires the entity to determine the differences between tax bases of its assets and liabilities determined under foreign law and the book bases of its assets and liabilities determined under U.S. GAAP, which are usually different from the foreign jurisdiction's accounting principles. Often, the company will need to upgrade its accounting systems to ensure accurate tracking of activities on a legal entity basis and to invest in tools and process improvements which allow the company to perform accurate accounting for income taxes in each jurisdiction in which it operates.


TEI appreciates the opportunity to provide these comments in connection with the FAF's post-implementation review of ASC 740. These comments were prepared under the aegis of TEI's Financial Reporting Committee. Should you have any questions about the comments, please do not hesitate to contact Patrick Evans of the Institute's legal staff at 202.638.5601 or
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Title Annotation:Tax Executives Institute, Financial Accounting Standards Board Statement No. 109 on Accounting for Income Taxes
Publication:Tax Executive
Date:May 1, 2013
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