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TEI urges FASB to withdraw uncertain tax positions draft.

Tax Executives Institute has strongly urged the Financial Accounting Standards Board to withdraw its July 14, 2005, exposure draft on uncertain tax positions. Calling the proposed interpretation FAS 109 unworkable, TEI recommended that the FASB abandon the exposure draft's asset recognition model in favor of retaining and affirming current accounting principles for contingent tax liabilities under FAS 5.

TEI's views were set forth in a letter dated September 12, 2005, from Michael P. Boyle, TEI's International President. Mr. Boyle explained that while supporting the FASB's goals of improving consistency and comparability of financial reporting, TEI does not believe the exposure draft should be adopted. Indeed, because the asset recognition model underlying the FASB's proposed interpretation is fundamentally flawed, the exposure draft would neither represent an improvement over current accounting principles nor produce greater consistency and comparability of financial statements. Under the exposure draft, tax benefits would not be recognized unless they are "probable" of being realized.

TEI's comments explained that, since income taxes are generally self assessed, the primary uncertainty about a tax benefit is whether the taxing authority will assert a sustainable, post-filing claim that an enterprise owes an additional liability. "Unpaid taxes," Mr. Boyle said, "are a liability and challenges by a tax authority to an enterprise's uncertain tax positions are fundamentally about whether an asset (i.e., the amount of cash not paid to the taxing authority) is impaired or an additional liability will be incurred." Application of the exposure draft's asset recognition model, TEI concluded, will be confusing and complex and will not supply meaningful information to readers.

In addition, the threshold determination undergirding the proposed interpretation--that tax positions should not be recognized unless they are probable of being sustained on audit based solely on the technical merits of the position--"is at odds with pragmatic, prudent tax judgments that financial statements should reflect," TEI said. "The requirement that tax benefits must satisfy, in effect, a 'should-prevail' level of confidence for initial recognition ... will systematically overstate tax expense and tax liabilities (or understate tax as sets) in certain periods and create gains in subsequent periods when the statute of limitations expires (or an examination is concluded and the matter resolved)." As a result, the exposure draft will not faithfully present a financial statement issuer's cash flows.

TEI also observed that the dual standard for recognition and derecognition of tax benefits--and the corresponding resources required to document whether an enterprise satisfies the dual recognition standards--will impose substantial implementation and ongoing costs on financial statement issuers without enhancing the reliability of the financial statements.

The letter acknowledged that an implicit concern of the exposure draft is that enterprises might overstate tax benefits by making unreasonable assumptions about audit detection risks or taking speculative positions. "If guidance is needed in these areas," Mr. Boyle said, "TEI supports a presumption that, when applying FAS 5 paragraph 38 to loss contingencies related to tax positions, the enterprise must assume that (1) it is probable that a position will be examined by the relevant taxing authority and (2) the position will be challenged if there is a reasonable basis for a challenge. If the criteria are satisfied, a loss based on a reasonable estimate of the tax liability to be incurred should be accrued." TEI's proposed presumption would be consistent with current accounting practice for large companies and likely most SEC registrants, Mr. Boyle noted. The real challenge to the consistent determination and reporting of tax liabilities in financial statements, he concluded, lies in the application of complex and nebulous tax rules to myriad facts and circumstances.

TEI also urged a substantial delay in the proposed interpretation's effective date. "Analyzing and computing the cumulative effect of the accounting change to implement the far-reaching effects of a fundamental change in the recognition of all tax positions as well as making the necessary process control changes to comply with the documentation and testing requirements of section 404 of the Sarbanes-Oxley Act will require substantial time and resources for all companies, especially those operating on a global basis." Since companies "would require more time to understand [the FASB's proposed interpretation], reevaluate all tax positions for all open tax years, review the effect of the adoption of the Interpretation with their audit firms," the interpretation should not be effective until the later of December 15, 2006, or six months following its adoption.

In other comments, TEI recommended that, if an asset recognition model is ultimately adopted, the benefits of tax positions satisfying the legal threshold necessary to avoid statutory penalties should be permitted to be recognized in financial statements. For example, if the standard for properly reporting an item on a tax return is "substantial authority" or "reasonable basis," the amount of tax benefit represented by the position should be recognized as long as the taxpayer can demonstrate that the minimum legal level of confidence in its position. Under TEI's proposed approach, the letter explains, "the standard for recognition of tax benefits for financial reporting would reflect and align with the tax reporting standards of the various jurisdictions where the company files tax returns."

Alternatively, TEI said, the standard for recognition of a benefit from a tax position under an asset recognition model should be no higher than a "more likely than not" level of confidence. Such a level of confidence "should be sufficient for recognition of the benefit in the financial statements because that amount would represent the enterprise's best estimate of what it believes the tax outcome will ultimately be."

TEI's letter also responded to questions posed by the FASB in the exposure draft. TEI's comments on the exposure draft are reprinted in this issue, beginning on page 425.
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Title Annotation:Recent Activities
Publication:Tax Executive
Date:Sep 1, 2005
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