Chapter 17 - Acctg For Income Taxes In Interim Periods 2m3m4x
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ing for Income Taxes in Interim Periods
Interim Reporting • Prescribes an estimated annual Effective Tax Rate (ETR) approach for calculating a tax provision for interim periods. Conventional wisdom might lead one to believe that using such an approach to record an interim period income tax provision simplifies the otherwise laborious process of computing a discrete tax provision for each interim period.
Interim Reporting • ing for income taxes in interim periods is far from simple. The ETR approach presents a number of unique complexities and challenges and in certain circumstances, can lead to counterintuitive results.
Interim Reporting • Some of the key considerations and complexities in ing for income taxes during interim periods following this general outline:
Interim Reporting Estimated annual effective tax rate approach should generally be used to determine the tax (or benefit) related to ordinary income. Certain items do not meet the definition of ordinary income, the tax effects of such items should be computed and recognized as discrete items when they occur.
Interim Reporting There are limited exceptions to the use of the estimated annual effective tax rate approach and also limitations on the amount of benefits that can be recognized for losses, credits and rate differentials in loss periods.
Interim Reporting There are a number of additional situations that present unique challenges when ing for income taxes in interim periods.
ASC 740-270-25-1 • This guidance addresses the issue of how and when
income tax expense (or benefit) is recognized in interim periods and distinguishes between elements that are recognized through the use of an estimated annual effective tax rate applied to measures of yearto-date operating results, referred to as ordinary income (or loss) and specific events that are discretely recognized as they occur.
ASC 740-270-25-2 • Tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur.
ASC 740-270-25-3 • If an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated shall be reported in the interim period in which the item is reported.
ASC 740-270-25-4 • Tax benefit of an operating loss carryforward from prior years shall be included in the effective tax rate computation if the tax benefit is expected to be realized as a result of ordinary income in the current year.
ing Standard Codification (ASC) 740-270-25-4 • Tax benefit shall be recognized in the manner described in 470-270-45-4 in each interim period to the extent that income in the period and for the year to date is available to offset the operating loss carryforward or, cont.…
ing Standard Codification (ASC) 740-270-25-4 • Cont.… in the case of a change in judgment about realizability of the related deffered tax asset in future years, the effect shall be recognized in the interim period in which the change occurs.
ing Standard Codification (ASC) 740-270-25-5 • Effect of new tax legislation shall not be recognized prior to enactment. The tax effect of a change in tax laws or rates on taxes currently payable or refundable for the current year shall be recorded after the effective dates prescribed in the statutes and
ing Standard Codification (ASC) 740-270-25-5 • Reflected in the computation of the annual effective tax rate beginning no earlier than the first interim period that includes the enactment date of the new legislation.
ing Standard Codification (ASC) 740-270-25-5 • Effect of a change in tax laws or rates on a deferred tax liability or asset shall not be apportioned among interim periods through an adjustment of the annual effective tax rate
ing Standard Codification (ASC) 740-270-25-6 • Tax effect of a change in tax laws or rates on taxes payable or refundable for a prior year shall be recognized as of the enactment date of the change as tax expenses (benefit) for the current year.
ing Standard Codification (ASC) 740-270-25-7 • Effect of a change in the beginning of the year balance of a valuation allowance as a result of a change in judgment about the realizability of the related deferred tax asset in future years shall not be apportioned among interim periods through an adjustment of the effective tax rate but shall be recognized in the interim period in which the change occurs.
ing Standard Codification (ASC) 740-270-30-12 • Taxes related to significant unusual or extraordinary items that will be separately reported or reported net of their related tax effect also shall be excluded from the estimated annual effective tax rate calculation.
ing Standard Codification (ASC) 740-270-30-12 • This description of significant unusual or extraordinary items includes unusual items, infrequently occurring items, discontinued operations and extraordinary items.
ing Standard Codification (ASC) 740-270-45-3 • Extraordinary items and discontinued operations that will be presented net of related tax effects in interim financial statements. • Unusual or infrequently occurring items that will be separately disclosed as a component of pretax income from continuing operations and the tax (or benefit) related to such items shall be included in the tax (or benefit) related to continuing operations.
Method of Computing an Interim Tax Provision
ing Standard Codification (ASC) 740-270-25-2 • Provides the following guidance for calculating an income tax provision in an interim period: • The tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur.
Method of Computing an Interim Tax Provision • Determining the Elements and Tax Effects of Ordinary Income
Method of Computing an Interim Tax Provision • Definition of Tax (or benefit) Related to Ordinary Income • Since the tax effects of current-year ordinary income receive different interim ing treatment than the tax effects of other types of income during the same period, the definition of a tax (or benefit) related to ordinary income becomes important. ASC 740-27020 defines these as follows:
Method of Computing an Interim Tax Provision • Definition of Tax (or benefit) Related to Ordinary Income a. Ordinary Income (or loss) refers to income (or loss) from continuing operations before income taxes (or benefits) excluding significant unusual or infrequently occurring items. Extraordinary items, discontinued operations and cumulative effects of changes in ing principles are also excluded from this term.
Method of Computing an Interim Tax Provision • Definition of Tax (or benefit) Related to Ordinary Income • The term is not used in the income tax context of ordinary income vs. capital gain. The meaning of “unusual or infrequently occurring items” is consistent with their use in the definition of the term, “extraordinary item”.
Method of Computing an Interim Tax Provision • Definition of Tax (or benefit) Related to Ordinary Income b. Tax (or benefit) is the total income tax expense (or benefit) including the provision (or benefit) for income taxes both currently payable and deferred.
Method of Computing an Interim Tax Provision • Items excluded from the Definition of Ordinary Income
Significant Unusual or Infrequent Items • ASC 270-10-45-11A prescribes that “extraordinary items, gains or losses from disposal of a component of an entity and unusual or infrequently occurring items shall not be prorated over the balance of the fiscal year”. Deciding whether events should be classified as unusual or infrequent can be challenging.
Significant Unusual or Infrequent Items • Ordinary Income (or loss)” in ASC 740-27020 refers to the definition of the term “extraordinary item” in ASC 225-20-20, which provides the following: Unusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into the environment in which the entity operates.
Significant Unusual or Infrequent Items • Ordinary Income (or loss)” in ASC 740-27020 refers to the definition of the term “extraordinary item” in ASC 225-20-20, which provides the following:
Infrequency of occurrence. The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into the environment in which the entity operates.
Significant Unusual or Infrequent Items • While both of these criteria should be met to classify an event or transaction as an extraordinary item, only one of theses factors is required for an item to be excluded from the estimated annual effective tax rate.
Significant Unusual or Infrequent Items • ASC 740-270-30-13 provides that the tax effect of significant unusual or extraordinary items that are reported separately within income from continuing operations should be excluded from the estimated annual effective tax rate calculation and instead be recorded on a discrete basis in the period which the item occurs.
Significant Unusual or Infrequent Items • ASC 740-270-30-12 also prescribes discrete treatment for items that are required to be reported net of their related tax effect such as other comprehensive income, discontinued operations and extraordinary items.
Limited Exceptions for Certain Items • Barring the exceptions presented below in Sections TX 17.1.1.3.1 through TX 17.1.1.4.8, Section TX 17.2.2 and Section TX 17.5.1, ASC 740-270 provides no latitude for treating any other tax effects of ordinary income on a discrete-period basis.
Limited Exceptions for certain items • Accordingly, the tax effects of items such as dividends-received deductions and capital gains rates on significant fixed asset dispositions that are not considered unusual or infrequent should be incorporated into the estimated annual effective tax rate rather that record discretely.
Tax-Exempt Interest • While deliberating the ing issues related to ing for income taxes in interim periods, the FASB discussed the historical practice of excluding tax-exempt interest from ordinary income and effectively treating it as discrete income even though interest on tax-exempt securities often forms a portion of ordinary income of an entity that
Tax-Exempt Interest • Despite this mention of recording the tax impacts of interest from taxexempt securities as they are earned, the FASB decided not to provide specific guidance on this issue.
Tax-Exempt Interest • If not for the reference to the then common practice of excluding taxexempt interest from the estimated annual effective tax rate calculation, tax-exempt interest would be treated like any other rate reconciling item related to current year ordinary income.
Tax-Exempt Interest • FASB did not explicitly object to the exclusion of tax-exempt interest from the ETR calculation, we believe that including or excluding tax-exempt interest from the ETR calculation is acceptable as long as the approach is applied consistently.
Investment Tax Credits • ASC 740-270-30-14 provides guidance for handling the impact of investment tax credits when applying the estimated annual effective tax rate approach. Whether investment tax credits are included or excluded depends on the ing treatment selected. ASC 740-270-3014 states:
Investment Tax Credits • Certain investment tax credits may be excluded from the estimated annual effective tax rate. If an entity includes allowable investment tax credits as part of its provision for income taxes over the productive life of acquired property and not entirely in the year the property is placed in service,
Investment Tax Credits • Amortization of deferred investment tax credits need to be taken into in estimating the annual effective tax rate; however, if the investment tax credits are taken into in the estimated annual effective tax rate, the amount taken into shall be the amount of amortization that is anticipated to be included in income in the current year.
Leveraged Leases • ASC 740-270-30-15 states: Paragraphs 840-30-30-14 and 84030-35-34 through 35-35 require that investment tax credits related to leases that are ed for as leveraged leases shall be deferred and ed for as a return on the net investment in the leveraged leases during the years in which the net investment is positive
Leveraged Leases • Explains that the use of the term years is not intended to preclude application of the ing described to shorter periods. If an entity s for investment tax credits related to leveraged leases in accordance with those paragraphs for interim periods, those investment tax credits shall not be taken into in estimating the annual
After-Tax Equity Pickup for Investees owned 50 percent or less • Typically appropriate to record equity in the net income of a 50-percent-orless-owned investee based on its interim statements on an after-tax basis (i.e., the investee would provide taxes in its financial statements based on its own estimated annual effective tax rate calculation).
After-Tax Equity Pickup for Investees owned 50 percent or less • Any incremental investor’s tax, the incremental tax would not be calculated as part of the investor’s overall Effective Tax Rate (ETR) calculation. Instead, this incremental tax would be calculated based on a separate ETR calculation
Other Items that do not Represent Tax Effects Related to Ordinary Income • ASC 740-270-25-2 makes it clear that the only items that should be spread by means of the estimated annual effective tax rate approach are the tax effects of current-year ordinary income (or loss)
Other Items that do not Represent Tax Effects Related to Ordinary Income • Many items resulting from actions that occurred during the year, but not representing tax effects related to current-year ordinary income, should be recorded discretely in the interim period in which they occurred. Examples of these items include the following:
Other Items that do not Represent Tax Effects Related to Ordinary Income Subsequent recognition, derecognition or change in measurement for an uncertain tax position arising in prior periods due to a change in judgment or interpretation of new information Interest and penalties recognized on uncertain tax positions Change in tax law
Other Items that do not Represent Tax Effects Related to Ordinary Income Change in tax status Certain changes in the realizability of deferred tax assets Change in judgment regarding unremitted foreign earnings and other outside basis differences Change in estimate related to a prioryear tax provision
Interest and Penalties recognized on Uncertain Tax Positions • ASC 740-10-25-56 requires that interest be accrued in the first period in which the interest would begin accruing according to the provisions of the relevant tax law.
Interest and Penalties recognized on Uncertain Tax Positions • Interest expense should be accrued as incurred and should be excluded from the ETR calculation. ASC 74010-25-57 indicates that a penalty should be recorded when a position giving rise to a penalty is taken or anticipated to be taken on the current year’s tax return.
Change in Tax Law • ASC 740-10-25-47 through 25-48, ASC 740-10-45-15 and ASC 740-27025-5 through 25-6, adjustments to deferred tax assets and liabilities as a result of a change in tax law or rates should be ed for discretely in continuing operations at the date of enactment.
Change in Tax Law • Effects of a retroactive change in tax rates should also be ed for discretely in continuing operations in the interim period in which the law is enacted.
Change in Tax Law • Prospective effects of a change in tax law or rates on tax expense in the year of enactment should be reflected in the estimated annual effective tax rate calculation.
Change in Tax Status • ASC 740-10-25-32 through 25-34, the effect of a voluntary change in tax status should be recognized discretely on: (1)The date that approved is granted by the taxing authority (2)The filing date, if approval is unnecessary.
Change in Tax Status • Entire effect of a change in tax status should be recorded in continuing operations in accordance with ASC 740-10-45-19.
Certain Changes in the Assessment of the Realizability of Deferred Tax • ASC 740-270-25-7, the tax effect of a change in the beginning-of-the-year balance of a valuation allowance caused by a change in judgment about the realizability of the related deferred tax asset that results from changes in the projection of income expected to be available in future years should be recognized discretely in the interim period in which the
Certain Changes in the Assessment of the Realizability of Deferred Tax • Change in judgment about the realizability of deferred tax assets resulting from changes in estimates of current-year ordinary income and/or deductible temporary differences and carryforwards that is expected to originate in ordinary income in the current year should be considered in determining the estimated effective tax rate.
Certain Changes in the Assessment of the Realizability of Deferred Tax • Change in judgment should not be recorded discretely in the interim period in which it changes.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • Company will sometimes change its intentions about whether it will indefinitely reinvest undistributed earnings of foreign subsidiaries or corporate t ventures that are essentially permanent in duration and thus whether it will record deferred taxes on outside basis differences.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • Tax effect of the change in judgment for the establishment/reversal of the deferred tax liability related to the outside basis difference that had accumulated as of the beginning of the year should be recorded in continuing operations in the interim period during which the intentions changed.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • A portion of the outside basis difference that accumulated as of the beginning of the year may include the effects of currency movements that: (1) had been previously recorded through a Cumulative Translation Adjustment (CTA) as the company had already established a deferred tax liability;
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • A portion of the outside basis difference that accumulated as of the beginning of the year may include the effects of currency movements that: (2) were not recorded through CTA as the company did not recognize a deferred tax liability on the CTA portion of the outside basis difference.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • In either situation, the effect of that currency movement on the outside basis difference as of the beginning of the year reflected in continuing operations in the period in which the change in judgment occurred.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • This treatment is consistent ASC 74030-25-19, which indicates that the tax effect of a subsidiary’s undistributed earnings: should be charged to expense in the period during which the circumstances change should not be recorded as an extraordinary item
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • Tax effect of the change in intensions on unremitted earnings of the current year should be reflected in the determination of the company’s ETR. Any tax effect related to currency movements associated with current-year unremitted earnings that increases or decreases the deferred tax liability would be attributed to CTA for the period.
Change in Estimate Related to a PriorYear Tax Provision • Estimated annual effective tax rate approach should only be used to record the tax effect of current-year ordinary income. A change in estimate in the current year that is related to a prior-year tax provision does not constitute a tax effect on current-year income.
Change in Estimate Related to a PriorYear Tax Provision • Effects of this change should be recorded discretely in the period during which the change in estimate occurs. The next section presents guidance for determining whether a change in the prior-year tax provision is an error or a change in estimate.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Following guidance is intended to assist professionals with judgments as to when changes in tax positions reflected in prior periods or changes in income tax amounts accrued in prior periods constitutes financial reporting “errors” rather than changes in estimates. The following circumstances are among those intended to be covered by this guidance:
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 The discovery that the tax reported in a prior year’s return was either understated or overstated (regardless of whether an amended return has been filed); The discovery that a tax return or tax payment filing requirement was not met;
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 The discovery of misapplication of ASC 740 or related ing principles; or A change in the amount of tax expense or benefit initially recognized related to a prior reporting period
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors A tax accrual is intentionally misstated (without regard to materiality) A mechanical error is made when calculating the income tax provision (e.g., if meals and entertainment expenditures were deducted twice instead of being added back to taxable income or if the wrong disallowance rate was applied
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors Misapplications of ASC 740 and related ing principles and interpretations are made. For example, the company failed to record a tax benefit or contingent tax liability at the balance sheet date
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors that should have been recognized in accordance with such guidance considering the facts and circumstances that existed at the reporting date and that were reasonably knowable at the date the financial statements were issued.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors The company chose to estimate rather than obtain an amount for tax provision purposes at the balance sheet date that was “readily accessible” in the company’s books and records and the actual amount differs from the estimate.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors In assessing whether information was (or should have been) “readily accessible”, consideration should be given to the nature, complexity, relevance and frequency of occurrence of the item.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors In this regard, it would be expected that companies would develop internal control processes to properly consider relevant information relating to frequently occurring or recurring items that could be significant.
Discerning an Error from a Change in ing Estimate in Income Taxes-Revised June 2015
• Example, a company would be expected to have an adequate internal control system to track meals and entertainment charges, to the extent such amounts create a material permanent difference in the company’s tax return.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • If there is a significant difference between the estimate made when closing the books and the actual amount reported on the tax return, this would seem to constitute an error. • This is not to suggest that the level of precision is expected to be completely accurate or that all differences between estimates and actual amounts constitute errors.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • A relatively insignificant difference between an estimate and the actual amount provides evidence that the company’s control system is adequate and that such an adjustment should be treated as a change in estimate in the period identified.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Conversely, consider a company that had never before repatriated foreign earnings (and had not provided deferred taxes on such amounts in accordance with ASC 740-30-25-17). The company decides late in its fiscal year to repatriate some or all of the foreign earnings.
Computing the Tax Provision Attributable to Ordinary Income
Estimated Annual Affective Tax Rate • Metholology With limited exceptions, ASC 740270 requires companies to calculate the estimated annual effective tax rate for current-year ordinary income, including both the current and deferred provisions determined under ASC 740.
Estimated Annual Affective Tax Rate • Metholology Project taxable income for the year, which is in turn used to estimate the annual provision for taxes currently payable, it is necessary to estimate temporary differences and rate differentials entering into the current provision.
Estimated Annual Affective Tax Rate • Metholology The temporary differences used to estimate the current provision are then included in the projected year-end temporary differences used to estimate the annual provision for deferred taxes, including any change in the valuation allowance. These estimates should be updated on each interim financial reporting date.
Estimated Annual Affective Tax Rate • Metholology As a practical matter, however, there may be circumstances in which the estimated annual effective tax rate can be appropriately estimated by considering only rate differentials. These situations often involve temporary differences that are expected to have offsetting effects in the current and deferred provisions (i.e., the effect on the
Estimated Annual Affective Tax Rate • Metholology current provision would be equal in amount but opposite in direction to the effect on the deferred provision). If additional complexities arise (e.g., the enacted tax rate varies between years or a valuation allowance for beginning or ending deferred provisions must typically be made to develop an appropriate estimated annual effective tax rate.
Best Current Estimate
• General The estimated annual effective tax rate should represent the best estimate of the composite tax provision in relation to the best estimate of worldwide pretax book ordinary income.
Best Current Estimate • General The composite tax provision should include federal, foreign and state income taxes, including the effects of: (1)credits, (2)Special deductions (e.g., Internal Revenue Code Section 199 deduction under the American Jobs Creation Act or percentage depletion)
Best Current Estimate • General The composite tax provision should include federal, foreign and state income taxes, including the effects of: (3) Capital gains taxed at different rates, (4) Valuation allowances for current-year changes in temporary differences and losses or income arising during the year.
Best Current Estimate • General The estimated annual ETR is then applied to year-to-date ordinary income to compute the year-to-date interim tax provision on ordinary income.
Best Current Estimate
• General The difference between the year-todate interim tax provision and the year-to-date interim tax provision as of the preceding interim period constitutes the tax provision for that quarter.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR If a significant pretax nonrecognized subsequent event occurs after the interim balance sheet date before financial statement issuance, an important questions arises.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Should the company’s best current estimate of annual pretax ordinary income be updated for the nonrecognized subsequent event, or should the best current estimate only use information that existed as of the balance sheet date?
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Example, assume that, subsequent to the interim balance sheet date, a significant new customer contract was signed. Alternatively, assume a severe hurricane loss was suffered by an insurance company.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR In both instances, the subsequent event significantly changed the company’s current estimate of its annual pretax ordinary income and thereby its estimated annual effective tax rate.
Best Current Estimate • Treatment of Nonrecognized Subsequent Events on the ETR ASC 740-270-35-3 indicates that, at the end of each interim period during the fiscal year, the estimated annual effective tax rate should be revised, if necessary, to reflect the entity’s best current estimate.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR One could reasonably conclude that the company’s best current estimated annual effective tax rate should be based on information available prior to the date of issuance, even though some of that information might be about influential factors that did not exist or were not relevant until after the interim balance sheet date.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Conversely, AU Section 560.05 indicates that nonrecognized subsequent events should not result in the adjustment of the financial statements. If any entity were to incorporate a significant nonrecognized subsequent event into the development of an updated ETR,
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Some of the subsequent events indirect effects would be recorded in the results up until the balance sheet date that preceded the nonrecognized event.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Since the effect of nonrecognized subsequent events should not be reflected in the financial statements, one could reasonably conclude that the effects of a nonrecognized subsequent event should be excluded from the interim calculation of the ETR.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Companies that choose to consider all available information up until issuance date should be careful to exclude items whose tax effects are required to be recognized discretely in the period that they occur, such as:
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR (1)Changes in tax laws or rates; (2)New information received after the reporting date related to the assessment of uncertain tax positions; (3)Discontinued operations, extraordinary items and other significant unusual or infrequent items
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR When there is a significant time lag from the interim date to the date of the issuance of the financial statements (as may be the case with a company reporting on a prior interim period for the first time in connection with a registration statement), it may become
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Increasingly difficult to assert that an event in the extended period should affect the estimated annual effective tax rate applied to the interim period.
Best Current Estimate • Treatment of Nonrecognized Subsequent Events on the ETR We generally believe that the delayed issuance of the financial statements should not result in a different assessment of the estimated annual effective tax rate than would have been the case had the financial statements been issued on a timely basis.
Limitation on Benefits of Losses, Credits and Rate Differential in Loss Periods
• ETR approach is modified by ASC 740-270-30-30 through 30-34, which limit the tax benefit recognized for a loss in interim periods to the amount that is expected to be: (a)Realized during the year; or (b) (b) recognizable as a deferred tax asset at the end of the year.
Limitation on Benefits of Losses, Credits and Rate Differential in Loss Periods
• Those limitations should be applied in determining both separate jurisdiction and worldwide estimated annual effective tax rates and the year-to-date benefit for a loss. Those limitations also apply to rate differentials that would increase the effective benefit rate during loss periods.
Limitation on Benefits of Losses, Credits and Rate Differential in Loss Periods • In applying the guidance in ASC 740-27030-30 through 30-34 related to the realizability of deferred tax assets and the need for a valuation allowance, the central issue that a company needs to consider is the valuation allowance that it expects to recognize at year-end, including any expected change in the valuation allowance during the year. The company cannot simply focus on the benefit of losses in the current year.
Exceptions to the Use of the ETR Approach • ASC 740-270 requires the use of an estimated annual effective tax rate to compute the tax provision for ordinary income in all jurisdictions during an interim period. • In determining that rate, there are two exceptions to the general rule that requires all jurisdictions (and all the tax effects on current-year ordinary income) to be included in the computation of the consolidated worldwide ETR.
Exceptions to the Use of the ETR Approach • If one of these exceptions applies and one or more foreign jurisdictions are excluded from the computation of the worldwide ETR, the U.S. tax effects (e.g., remitted or unremitted dividend income and related foreign tax credits) of the operations in those foreign jurisdictions are also excluded.
Exceptions to the Use of the ETR Approach • State and municipal income tax jurisdictions are subject to the same limitations as foreign jurisdictions with respect to what can be included in the consolidated worldwide ETR.
Exceptions to the Use of the ETR Approach • Jurisdiction with Pretax Losses for which No Tax Benefit can be recognized When a company operates in a jurisdiction that has generated ordinary losses on a year-to-date basis or on the basis of the results anticipated for the full fiscal year and no benefit can be recognized on those losses.
Exceptions to the Use of the ETR Approach • Jurisdiction with Pretax Losses for which No Tax Benefit can be recognized ASC 740-270-30-36 (a) requires the company to exclude that jurisdiction’s income (or loss) from the overall ETR calculation. A separate ETR should be computed and applied to ordinary income (or loss) in that jurisdiction.
Exceptions to the Use of the ETR Approach • Jurisdiction with Pretax Losses for which No Tax Benefit can be recognized In effect, any jurisdiction with losses for which no benefit can be recognized are removed from the base calculation of the ETR. Assuming the reason for no benefit is a full valuation allowance, the separate ETR for that jurisdiction would be zero.
Jurisdiction with Pretax Losses for which No Tax Benefit can be Recognized
• Zero-rate Jurisdiction ASC 740-270 does not specifically address whether a zero-rate jurisdiction should or should not be included in the ETR computation. As there is conceptual for either inclusion or exclusion of a zerorate jurisdiction, we believe this is an aspect of ing for income taxes for which diversity in practice can be expected. The following are four acceptable approaches:
Zero-rate Jurisdictions
• Approach A: Always exclude pre-tag ordinary income or loss from a zerorate jurisdiction from the ETR computation. This view is premised on the theory that the income in a zero-rate jurisdiction is effectively tax-exempt. The exclusion of pre-tax income from a zero-rate jurisdiction is analogous to the optional treatment of tax-exempt income
Zero-rate Jurisdictions • Approach B: Exclude pre-tax ordinary income or loss from a zero-rate jurisdiction from the ETR computation if there is a yearto-date loss in that jurisdiction. The rationale for this view is based on the notion that a loss ultimately will not provide a tax benefit. for this view can be found in ASC 740-270-30-36(a) which requires the exclusion of jurisdictions with year-to-date losses if no tax benefit can be recognized for the year-to-date loss or for an anticipated full-year loss.
Zero-rate Jurisdictions • Approach C: Exclude pre-tax ordinary income or loss from a zerorate jurisdiction from the ETR computation only if a loss is anticipated for the full fiscal year. This view concludes that ASC 740270-30-36(a) is not directly applicable because it addresses positive tax rate jurisdictions in circumstances where a loss would be
Zero-rate Jurisdictions • This view would not exclude income or loss when year-to-date loss is anticipated to reverse in subsequent periods. This view in effect represents a modified analogy to the principle in ASC 740-270-30-36(a).
Zero-rate Jurisdictions • Approach D: Always include pre-tax ordinary income or loss from a zerorate jurisdiction the ETR computation because the underlying principle in ASC 740-270 is that, absent a specific requirement or exception, all current-year ordinary income or loss should be included in the ETR computation.
Zero-rate Jurisdictions • This view differentiates the exception in ASC 740-270-30-36(a) as only applying to taxable jurisdictions for which a valuation allowance may be necessary. This view is premised on the notion that the ETR approach is known to yield, at times, seemingly illogical results in particular periods, yet there are only two narrowly drawn exceptions to full-inclusion, both of which are described with reference to an entity that “is subject to tax”.
Zero-rate Jurisdictions • Approach used should be considered an ing policy election to be applied consistently to all zero-rate jurisdictions of the reporting entity. If it is clearly evident that the approach applied to zero-rate jurisdictions has reporting consequences that would be significantly different than had one or more of the other acceptable approaches outlined above been applied, appropriate disclosure should be considered.
Jurisdictions for which a Reliable Estimate cannot be made • General Overview ASC 740-270-30-36(b) provides the following two situations in which a company should exclude a jurisdiction from the overall computations of the estimated annual effective tax rate: 1. If a company operates in a foreign jurisdiction for which a “reliable estimate” of the annual effective tax rate in of the parent entity’s functional currency cannot be made.
Jurisdictions for which a Reliable Estimate cannot be made • General Overview ASC 740-270-30-36(b) provides the following two situations in which a company should exclude a jurisdiction from the overall computations of the estimated annual effective tax rate: 2. If a reliable estimate of ordinary income for a particular jurisdiction cannot be made.
Jurisdictions for which a Reliable Estimate cannot be made • General Overview Presumably the first situation would arise when the exchange rate between the parent company’s functional currency and the foreign currency is highly volatile (this does not commonly occur in practice).
Jurisdictions for which a Reliable Estimate cannot be made • General Overview With respect to the second situation, the FASB acknowledged that determining whether an estimate is reliable requires the use of professional judgment and may involve the assessment of probability.
Jurisdictions for which a Reliable Estimate cannot be made • General Overview Example, in some cases, a small change in an entity’s estimate ordinary income could produce a significant change in the ETR, an estimate of the ETR would not be reliable if a small change in ordinary income were likely to occur.
Computing a Tax Provision when a Reliable Estimate cannot be made • ASC 740-270-30-17 through 30-18 reads as follows: Paragraph 740-270-25-3 requires that if an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated be reported in the interim period in which the item is reported.
Computing a Tax Provision when a Reliable Estimate cannot be made • Estimates of the annual effective tax rate at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision. If a reliable estimate cannot be made, the actual effective tax rate for the year to date may be the best estimate of the ETR.
Computing a Tax Provision when a Reliable Estimate cannot be made • This excerpt clarifies that the estimated annual effective tax rate is an estimate that is inherently subject to changes. • This fact alone does not justify a departure from the ETR approach.
Computing a Tax Provision when a Reliable Estimate cannot be made • Whether a reliable estimate of ordinary income or loss or the related tax can be made is a matter of judgment. If management is unable to estimate only a portion of its ordinary income, but is otherwise able to reliably estimate the remainder, the tax applicable to that item should be reported in the interim period in which the item
Computing a Tax Provision when a Reliable Estimate cannot be made • An estimated annual effective tax rate must be applied to the remainder of ordinary income and the related tax that can be reliably estimated.
Effects of “Naked Credits” on the Estimated Annual Effective Tax Rate • When a company is incurring losses and has a full valuation allowance, the increase of a deferred tax liability that does not serve as a source of income for the recognition of a deferred tax asset will trigger an estimated tax for the current year.
Effects of “Naked Credits” on the Estimated Annual Effective Tax Rate • The impact of this “naked credit” should be included in a company’s ETR calculation. This inclusion would be required whether the jurisdiction with the “naked credit” is included in an entity’s worldwide ETR calculation or excluded from the worldwide ETR calculation and treated as a separate jurisdiction with a stand-alone estimated annual ETR under ASC
Effects of “Naked Credits” on the Estimated Annual Effective Tax Rate • Discrete treatment is appropriate when the annual estimate of the tax rate is not considered a reliable estimate. • This may happen when a company determines a wide range of potential estimated annual effective tax rates because pretax income is at or near breakeven and it has significant permanent items such as the deferred tax effect from a “naked credit”.
Effects of “Naked Credits” on the Estimated Annual Effective Tax Rate • Consideration should be given to whether the company has the ability to estimate its ETR, given the range of possible outcomes. • The inability to estimate the ETR in a jurisdiction would cause the tax provision for that jurisdiction to be calculated on a discrete basis under ASC 740-270-30-36(b).
Tax Effects Other Than the Tax on Current-Year Ordinary Income • ASC 740-270-25-2 requires that the entire tax (or benefit) related to all items other than the tax effect on ordinary income should “be individually computed and recognized when the items occur”.
Tax Effects Other Than the Tax on Current-Year Ordinary Income • Example of these items include the tax effects related to discontinued operations, other comprehensive income, additional paid-in capital and items in continuing operations that represent tax effects not attributable to current-year ordinary income. • The tax effects represented by these items should be computed and reflected in accordance with the intraperiod allocation rules
Intraperiod Allocation in Interim Periods • General Overview ASC 740-270-45 indicates that the intraperiod allocation rules (ASC 74020-45) should be used to allocate the interim provision throughout the interim financial statements. Although the “with-and-without” model is basically the same for interim and annual periods
Intraperiod Allocation in Interim Periods • General Overview The allocation of tax expense or benefit for interim periods should be performed using the estimated fiscal year income and tax for “ordinary income (or loss)” and the year-to-date income and tax for: (1)an infrequent, unusual, or extraordinary item, (2) the gain or loss on disposal of a discontinued operation, or
Intraperiod Allocation in Interim Periods • General Overview The allocation of tax expense or benefit for interim periods should be performed using the estimated fiscal year income and tax for “ordinary income (or loss)” and the year-to-date income and tax for: (3) another component of the financial statements (e.g., other comprehensive income).
Intraperiod Allocation in Interim Periods • If more than one of the above items is present, the computation should reflect the order of precedence that will be assumed in annual financial statements. Unusual or infrequent items that are included in continuing operations will ordinarily be considered before any items that are excluded from continuing operations.
Intraperiod Allocation in Interim Periods • If more than one item is excluded from continuing operations, the process outlined in ASC 740-20-45-14 should be used to apportion the remaining provision after the tax expense or benefit allocated to continuing operations is considered. This allocation process should be consistent with the process used in the annual calculation.
Subsequent Revisions • Tax attributed to financial statement components that are reported in an early quarter can be subsequently revised to reflect a change in the estimate of tax related to annual ordinary income or changes in yearto-date income or loss in other components.
Subsequent Revisions • ASC 740-270 requires the computation of the interim provision to be performed on a year-to-date basis. As a result, the tax provision for a given quarter equals the difference between the provision recorded cumulatively for the year (via the estimated annual effective tax rate approach) less the amount recorded cumulatively as of the end
Subsequent Revisions • Changes in circumstances from quarter to quarter might make it necessary to record the tax effects in a financial statement category that differs from the one in which the company recorded the tax effects during a previous quarter.
Subsequent Revisions • Goal of the ASC 740-270 model is to treat the interim periods as components of the current annual period. • Intraperiod allocation, like the estimated annual effective tax rate, must be updated and recomputed each quarter.
Intraperiod Allocations that Reflects Discontinued Operations Prior to the Date on which they are Classified as Held for Sale or Disposed Of
• Once operations are classified as discontinued, prior periods are restated to reflect the now discontinued operations prior to the date on which those operations are first reported as discontinued operations,
Intraperiod Allocations that Reflects Discontinued Operations Prior to the Date on which they are Classified as Held for Sale or Disposed Of • ASC 740-270-45-6 through 45-8 provides detailed rules for taking the tax previously assigned to ordinary income and the discontinued operations. • ASC 740-270-55-29 provides an illustration of ing for income taxes applicable to income or (loss) from discontinued operations at an interim date.
Changes in Valuation Allowance • Need for a valuation allowance must be reassessed at each interim reporting date. Pursuant to ASC 740270-25-4 and depending on the circumstances that lead to a change in valuation allowance, the change may be reflected in the estimated annual effective tax rate or recognized discretely in the interim period during which the change in
Changes in Valuation Allowance • Any change in valuation allowance that results from a change in judgment about the realizability of the related deferred tax assets resulting from changes in the projection of income expected to be available in future years is reported in the period during which the change in judgment occurs.
Changes in Valuation Allowance • No portion of the effect should be allocated to subsequent interim periods through an adjustment to the estimated annual effective tax rate for the remainder of the year.
Changes in Valuation Allowance • The following changes in valuation allowance should be considered in determining the ETR for the year: A change in the valuation allowance related to deductible temporary differences and carryforwards that are expected to originate in ordinary income in the current year.
Changes in Valuation Allowance • The following changes in valuation allowance should be considered in determining the ETR for the year: A change in the valuation allowance for beginning-of-year deferred tax assets that results from a difference between the estimate of annual ordinary income (which includes the year-to-date amount) for the current year and the estimate that was inherent in the beginning-of-year valuation allowance.
Changes in Valuation Allowance • If there is a reduction in the valuation allowance for beginning-of-year deferred tax assets that results from income other than ordinary income (e.g., discontinued operations), the benefit should be reflected discretely in year-to-date results (presuming of course, that current-year continuing operations and projections of future income could not have ed the
Initial Recognition of Source-of-Loss Items • Initial recognition of source-of-loss items are generally excluded from recognition in income but rather recorded back to the source of the prior year loss/benefit.
Initial Recognition of Source-of-Loss Items • Example, the initial recognition of a tax benefit of a windfall tax deduction related to stock-based compensation would be recognized in additional paid-in capital. Tax benefits related to source-of-loss items would not enter into the ETR calculation.
Exception to the Basic Intraperiod Allocation Model • ASC 740-20-45-7 which describes the exception to the basic “with-and-without” approach to intraperiod allocation, must also be considered in interim periods. If a company has a valuation allowance and expects: (1) pretax losses from continuing operations; and (2) income in other components of the financial statements
Exception to the Basic Intraperiod Allocation Model • ASC 740-20-45-7 may have an effect on the presentation of the interim period financial statements and may possibly result in the reporting of a tax benefit (which would be incorporated in the estimated annual effective tax rate) in continuing operations, even though no such benefit would be computed using the basic “with-and –without” approach.
Tax ing Considerations of StockBased Compensation During Interim Periods • When an entity calculates its estimated annual effective tax rate, it should not anticipate or estimate the incremental effects of windfalls or shortfalls that may occur over the balance of the year.
Tax ing Considerations of StockBased Compensation During Interim Periods • Example, if an option is due to expire in the current year, the entity should not anticipate that it will be exercised and that a windfall will be recognized, even though the fair value of the underlying stock exceeds the exercise price of the option.
Tax ing Considerations of StockBased Compensation During Interim Periods • If an entity had disqualifying dispositions for incentive stock options (ISOs) or employee stock purchase plans (ESPPs) in the past, it should not anticipate future disqualifying dispositions. The entity should recognize windfalls and shortfalls discretely in the period in which they occur.
Tax ing Considerations of StockBased Compensation During Interim Periods • Example, If an entity does not have a sufficient pool of windfall tax benefits at the beginning of the year, any shortfall should be recorded in the income statement in the period in which the shortfall occurred.
Tax ing Considerations of StockBased Compensation During Interim Periods • If a windfall is recognized later in the year, the shortfall that was recognized earlier in the year should be reversed in the subsequent quarter to the extent that it can be offset against the windfall (because the pool of windfall tax benefits is determined on an annual basis).
Other Complexities
Business Combinations • Acquisition of a business can significantly impact the acquiring company’s estimated annual effective tax rate. • Business combination is a transaction that is not typically ed for in periods prior to the acquisition date, no effect should be given to a business combination in the estimated annual effective tax rate before the interim period in which the business combination is consummated
Business Combinations • Beginning with the interim period in which the purchase is consummated, the estimated annual effective tax rate for the year would be calculated to reflect the expected results, including the results of the acquired company. • That rate would be applied to the consolidated year-to-date ordinary income/loss to compute the year-to-date tax provision/benefit on ordinary income/loss.
Business Combinations • Second acceptable approach would be to divide the annual period into pre-acquisition and post-acquisition periods and determine an estimated annual effective tax rate for each of the two periods.
Business Combinations • After the acquisition is consummated, the tax provision would be the sum of the tax provision for the pre-acquisition period plus the tax computed by applying the ETR for the post-acquisition period to the yearto-date, post-acquisition ordinary income. • This method may not be appropriate if rate differentials that do not relate to the acquired operations occur disproportionately in the post-acquisition period.
Different Financial Reporting and Tax Year-End • If a corporation’s tax year-end date differs from its financial reporting year-end date, the basis for its tax computation and the application of the estimated annual effective tax rate approach in interim statements are impacted.
When Disclosure of Components of Interim Tax Expense is Required • If interim statements are used in lieu of annual statements (i.e., in a registration statement), companies need to disclose the components of interim income tax expense in the same way that companies present the disclosures required in annual statements by SEC FRP 204, Disclosures Regarding Income Taxes. Companies must perform the following tasks:
When Disclosure of Components of Interim Tax Expense is Required Divide the aggregate interim income tax expense calculated using the estimated annual effective tax rate approach between jurisdictions Determine the current and deferred portions of the interim income tax provisions
Disclosures – Revised June 2015 • Guidance on required interim financial statement disclosures can now be found in FSB sections 29.2, 29.4.7.6 and 30.4.3.3. • SEC Regulations S-K, Item 303, requires that a company include in MD&A detailed disclosure of material changes in financial condition and the results of operations.
Interim Reporting • Prescribes an estimated annual Effective Tax Rate (ETR) approach for calculating a tax provision for interim periods. Conventional wisdom might lead one to believe that using such an approach to record an interim period income tax provision simplifies the otherwise laborious process of computing a discrete tax provision for each interim period.
Interim Reporting • ing for income taxes in interim periods is far from simple. The ETR approach presents a number of unique complexities and challenges and in certain circumstances, can lead to counterintuitive results.
Interim Reporting • Some of the key considerations and complexities in ing for income taxes during interim periods following this general outline:
Interim Reporting Estimated annual effective tax rate approach should generally be used to determine the tax (or benefit) related to ordinary income. Certain items do not meet the definition of ordinary income, the tax effects of such items should be computed and recognized as discrete items when they occur.
Interim Reporting There are limited exceptions to the use of the estimated annual effective tax rate approach and also limitations on the amount of benefits that can be recognized for losses, credits and rate differentials in loss periods.
Interim Reporting There are a number of additional situations that present unique challenges when ing for income taxes in interim periods.
ASC 740-270-25-1 • This guidance addresses the issue of how and when
income tax expense (or benefit) is recognized in interim periods and distinguishes between elements that are recognized through the use of an estimated annual effective tax rate applied to measures of yearto-date operating results, referred to as ordinary income (or loss) and specific events that are discretely recognized as they occur.
ASC 740-270-25-2 • Tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur.
ASC 740-270-25-3 • If an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated shall be reported in the interim period in which the item is reported.
ASC 740-270-25-4 • Tax benefit of an operating loss carryforward from prior years shall be included in the effective tax rate computation if the tax benefit is expected to be realized as a result of ordinary income in the current year.
ing Standard Codification (ASC) 740-270-25-4 • Tax benefit shall be recognized in the manner described in 470-270-45-4 in each interim period to the extent that income in the period and for the year to date is available to offset the operating loss carryforward or, cont.…
ing Standard Codification (ASC) 740-270-25-4 • Cont.… in the case of a change in judgment about realizability of the related deffered tax asset in future years, the effect shall be recognized in the interim period in which the change occurs.
ing Standard Codification (ASC) 740-270-25-5 • Effect of new tax legislation shall not be recognized prior to enactment. The tax effect of a change in tax laws or rates on taxes currently payable or refundable for the current year shall be recorded after the effective dates prescribed in the statutes and
ing Standard Codification (ASC) 740-270-25-5 • Reflected in the computation of the annual effective tax rate beginning no earlier than the first interim period that includes the enactment date of the new legislation.
ing Standard Codification (ASC) 740-270-25-5 • Effect of a change in tax laws or rates on a deferred tax liability or asset shall not be apportioned among interim periods through an adjustment of the annual effective tax rate
ing Standard Codification (ASC) 740-270-25-6 • Tax effect of a change in tax laws or rates on taxes payable or refundable for a prior year shall be recognized as of the enactment date of the change as tax expenses (benefit) for the current year.
ing Standard Codification (ASC) 740-270-25-7 • Effect of a change in the beginning of the year balance of a valuation allowance as a result of a change in judgment about the realizability of the related deferred tax asset in future years shall not be apportioned among interim periods through an adjustment of the effective tax rate but shall be recognized in the interim period in which the change occurs.
ing Standard Codification (ASC) 740-270-30-12 • Taxes related to significant unusual or extraordinary items that will be separately reported or reported net of their related tax effect also shall be excluded from the estimated annual effective tax rate calculation.
ing Standard Codification (ASC) 740-270-30-12 • This description of significant unusual or extraordinary items includes unusual items, infrequently occurring items, discontinued operations and extraordinary items.
ing Standard Codification (ASC) 740-270-45-3 • Extraordinary items and discontinued operations that will be presented net of related tax effects in interim financial statements. • Unusual or infrequently occurring items that will be separately disclosed as a component of pretax income from continuing operations and the tax (or benefit) related to such items shall be included in the tax (or benefit) related to continuing operations.
Method of Computing an Interim Tax Provision
ing Standard Codification (ASC) 740-270-25-2 • Provides the following guidance for calculating an income tax provision in an interim period: • The tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur.
Method of Computing an Interim Tax Provision • Determining the Elements and Tax Effects of Ordinary Income
Method of Computing an Interim Tax Provision • Definition of Tax (or benefit) Related to Ordinary Income • Since the tax effects of current-year ordinary income receive different interim ing treatment than the tax effects of other types of income during the same period, the definition of a tax (or benefit) related to ordinary income becomes important. ASC 740-27020 defines these as follows:
Method of Computing an Interim Tax Provision • Definition of Tax (or benefit) Related to Ordinary Income a. Ordinary Income (or loss) refers to income (or loss) from continuing operations before income taxes (or benefits) excluding significant unusual or infrequently occurring items. Extraordinary items, discontinued operations and cumulative effects of changes in ing principles are also excluded from this term.
Method of Computing an Interim Tax Provision • Definition of Tax (or benefit) Related to Ordinary Income • The term is not used in the income tax context of ordinary income vs. capital gain. The meaning of “unusual or infrequently occurring items” is consistent with their use in the definition of the term, “extraordinary item”.
Method of Computing an Interim Tax Provision • Definition of Tax (or benefit) Related to Ordinary Income b. Tax (or benefit) is the total income tax expense (or benefit) including the provision (or benefit) for income taxes both currently payable and deferred.
Method of Computing an Interim Tax Provision • Items excluded from the Definition of Ordinary Income
Significant Unusual or Infrequent Items • ASC 270-10-45-11A prescribes that “extraordinary items, gains or losses from disposal of a component of an entity and unusual or infrequently occurring items shall not be prorated over the balance of the fiscal year”. Deciding whether events should be classified as unusual or infrequent can be challenging.
Significant Unusual or Infrequent Items • Ordinary Income (or loss)” in ASC 740-27020 refers to the definition of the term “extraordinary item” in ASC 225-20-20, which provides the following: Unusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into the environment in which the entity operates.
Significant Unusual or Infrequent Items • Ordinary Income (or loss)” in ASC 740-27020 refers to the definition of the term “extraordinary item” in ASC 225-20-20, which provides the following:
Infrequency of occurrence. The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into the environment in which the entity operates.
Significant Unusual or Infrequent Items • While both of these criteria should be met to classify an event or transaction as an extraordinary item, only one of theses factors is required for an item to be excluded from the estimated annual effective tax rate.
Significant Unusual or Infrequent Items • ASC 740-270-30-13 provides that the tax effect of significant unusual or extraordinary items that are reported separately within income from continuing operations should be excluded from the estimated annual effective tax rate calculation and instead be recorded on a discrete basis in the period which the item occurs.
Significant Unusual or Infrequent Items • ASC 740-270-30-12 also prescribes discrete treatment for items that are required to be reported net of their related tax effect such as other comprehensive income, discontinued operations and extraordinary items.
Limited Exceptions for Certain Items • Barring the exceptions presented below in Sections TX 17.1.1.3.1 through TX 17.1.1.4.8, Section TX 17.2.2 and Section TX 17.5.1, ASC 740-270 provides no latitude for treating any other tax effects of ordinary income on a discrete-period basis.
Limited Exceptions for certain items • Accordingly, the tax effects of items such as dividends-received deductions and capital gains rates on significant fixed asset dispositions that are not considered unusual or infrequent should be incorporated into the estimated annual effective tax rate rather that record discretely.
Tax-Exempt Interest • While deliberating the ing issues related to ing for income taxes in interim periods, the FASB discussed the historical practice of excluding tax-exempt interest from ordinary income and effectively treating it as discrete income even though interest on tax-exempt securities often forms a portion of ordinary income of an entity that
Tax-Exempt Interest • Despite this mention of recording the tax impacts of interest from taxexempt securities as they are earned, the FASB decided not to provide specific guidance on this issue.
Tax-Exempt Interest • If not for the reference to the then common practice of excluding taxexempt interest from the estimated annual effective tax rate calculation, tax-exempt interest would be treated like any other rate reconciling item related to current year ordinary income.
Tax-Exempt Interest • FASB did not explicitly object to the exclusion of tax-exempt interest from the ETR calculation, we believe that including or excluding tax-exempt interest from the ETR calculation is acceptable as long as the approach is applied consistently.
Investment Tax Credits • ASC 740-270-30-14 provides guidance for handling the impact of investment tax credits when applying the estimated annual effective tax rate approach. Whether investment tax credits are included or excluded depends on the ing treatment selected. ASC 740-270-3014 states:
Investment Tax Credits • Certain investment tax credits may be excluded from the estimated annual effective tax rate. If an entity includes allowable investment tax credits as part of its provision for income taxes over the productive life of acquired property and not entirely in the year the property is placed in service,
Investment Tax Credits • Amortization of deferred investment tax credits need to be taken into in estimating the annual effective tax rate; however, if the investment tax credits are taken into in the estimated annual effective tax rate, the amount taken into shall be the amount of amortization that is anticipated to be included in income in the current year.
Leveraged Leases • ASC 740-270-30-15 states: Paragraphs 840-30-30-14 and 84030-35-34 through 35-35 require that investment tax credits related to leases that are ed for as leveraged leases shall be deferred and ed for as a return on the net investment in the leveraged leases during the years in which the net investment is positive
Leveraged Leases • Explains that the use of the term years is not intended to preclude application of the ing described to shorter periods. If an entity s for investment tax credits related to leveraged leases in accordance with those paragraphs for interim periods, those investment tax credits shall not be taken into in estimating the annual
After-Tax Equity Pickup for Investees owned 50 percent or less • Typically appropriate to record equity in the net income of a 50-percent-orless-owned investee based on its interim statements on an after-tax basis (i.e., the investee would provide taxes in its financial statements based on its own estimated annual effective tax rate calculation).
After-Tax Equity Pickup for Investees owned 50 percent or less • Any incremental investor’s tax, the incremental tax would not be calculated as part of the investor’s overall Effective Tax Rate (ETR) calculation. Instead, this incremental tax would be calculated based on a separate ETR calculation
Other Items that do not Represent Tax Effects Related to Ordinary Income • ASC 740-270-25-2 makes it clear that the only items that should be spread by means of the estimated annual effective tax rate approach are the tax effects of current-year ordinary income (or loss)
Other Items that do not Represent Tax Effects Related to Ordinary Income • Many items resulting from actions that occurred during the year, but not representing tax effects related to current-year ordinary income, should be recorded discretely in the interim period in which they occurred. Examples of these items include the following:
Other Items that do not Represent Tax Effects Related to Ordinary Income Subsequent recognition, derecognition or change in measurement for an uncertain tax position arising in prior periods due to a change in judgment or interpretation of new information Interest and penalties recognized on uncertain tax positions Change in tax law
Other Items that do not Represent Tax Effects Related to Ordinary Income Change in tax status Certain changes in the realizability of deferred tax assets Change in judgment regarding unremitted foreign earnings and other outside basis differences Change in estimate related to a prioryear tax provision
Interest and Penalties recognized on Uncertain Tax Positions • ASC 740-10-25-56 requires that interest be accrued in the first period in which the interest would begin accruing according to the provisions of the relevant tax law.
Interest and Penalties recognized on Uncertain Tax Positions • Interest expense should be accrued as incurred and should be excluded from the ETR calculation. ASC 74010-25-57 indicates that a penalty should be recorded when a position giving rise to a penalty is taken or anticipated to be taken on the current year’s tax return.
Change in Tax Law • ASC 740-10-25-47 through 25-48, ASC 740-10-45-15 and ASC 740-27025-5 through 25-6, adjustments to deferred tax assets and liabilities as a result of a change in tax law or rates should be ed for discretely in continuing operations at the date of enactment.
Change in Tax Law • Effects of a retroactive change in tax rates should also be ed for discretely in continuing operations in the interim period in which the law is enacted.
Change in Tax Law • Prospective effects of a change in tax law or rates on tax expense in the year of enactment should be reflected in the estimated annual effective tax rate calculation.
Change in Tax Status • ASC 740-10-25-32 through 25-34, the effect of a voluntary change in tax status should be recognized discretely on: (1)The date that approved is granted by the taxing authority (2)The filing date, if approval is unnecessary.
Change in Tax Status • Entire effect of a change in tax status should be recorded in continuing operations in accordance with ASC 740-10-45-19.
Certain Changes in the Assessment of the Realizability of Deferred Tax • ASC 740-270-25-7, the tax effect of a change in the beginning-of-the-year balance of a valuation allowance caused by a change in judgment about the realizability of the related deferred tax asset that results from changes in the projection of income expected to be available in future years should be recognized discretely in the interim period in which the
Certain Changes in the Assessment of the Realizability of Deferred Tax • Change in judgment about the realizability of deferred tax assets resulting from changes in estimates of current-year ordinary income and/or deductible temporary differences and carryforwards that is expected to originate in ordinary income in the current year should be considered in determining the estimated effective tax rate.
Certain Changes in the Assessment of the Realizability of Deferred Tax • Change in judgment should not be recorded discretely in the interim period in which it changes.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • Company will sometimes change its intentions about whether it will indefinitely reinvest undistributed earnings of foreign subsidiaries or corporate t ventures that are essentially permanent in duration and thus whether it will record deferred taxes on outside basis differences.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • Tax effect of the change in judgment for the establishment/reversal of the deferred tax liability related to the outside basis difference that had accumulated as of the beginning of the year should be recorded in continuing operations in the interim period during which the intentions changed.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • A portion of the outside basis difference that accumulated as of the beginning of the year may include the effects of currency movements that: (1) had been previously recorded through a Cumulative Translation Adjustment (CTA) as the company had already established a deferred tax liability;
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • A portion of the outside basis difference that accumulated as of the beginning of the year may include the effects of currency movements that: (2) were not recorded through CTA as the company did not recognize a deferred tax liability on the CTA portion of the outside basis difference.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • In either situation, the effect of that currency movement on the outside basis difference as of the beginning of the year reflected in continuing operations in the period in which the change in judgment occurred.
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • This treatment is consistent ASC 74030-25-19, which indicates that the tax effect of a subsidiary’s undistributed earnings: should be charged to expense in the period during which the circumstances change should not be recorded as an extraordinary item
Change in Judgment Regarding Unremitted Foreign Earnings and Other Outside-Basis Differences • Tax effect of the change in intensions on unremitted earnings of the current year should be reflected in the determination of the company’s ETR. Any tax effect related to currency movements associated with current-year unremitted earnings that increases or decreases the deferred tax liability would be attributed to CTA for the period.
Change in Estimate Related to a PriorYear Tax Provision • Estimated annual effective tax rate approach should only be used to record the tax effect of current-year ordinary income. A change in estimate in the current year that is related to a prior-year tax provision does not constitute a tax effect on current-year income.
Change in Estimate Related to a PriorYear Tax Provision • Effects of this change should be recorded discretely in the period during which the change in estimate occurs. The next section presents guidance for determining whether a change in the prior-year tax provision is an error or a change in estimate.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Following guidance is intended to assist professionals with judgments as to when changes in tax positions reflected in prior periods or changes in income tax amounts accrued in prior periods constitutes financial reporting “errors” rather than changes in estimates. The following circumstances are among those intended to be covered by this guidance:
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 The discovery that the tax reported in a prior year’s return was either understated or overstated (regardless of whether an amended return has been filed); The discovery that a tax return or tax payment filing requirement was not met;
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 The discovery of misapplication of ASC 740 or related ing principles; or A change in the amount of tax expense or benefit initially recognized related to a prior reporting period
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors A tax accrual is intentionally misstated (without regard to materiality) A mechanical error is made when calculating the income tax provision (e.g., if meals and entertainment expenditures were deducted twice instead of being added back to taxable income or if the wrong disallowance rate was applied
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors Misapplications of ASC 740 and related ing principles and interpretations are made. For example, the company failed to record a tax benefit or contingent tax liability at the balance sheet date
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors that should have been recognized in accordance with such guidance considering the facts and circumstances that existed at the reporting date and that were reasonably knowable at the date the financial statements were issued.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors The company chose to estimate rather than obtain an amount for tax provision purposes at the balance sheet date that was “readily accessible” in the company’s books and records and the actual amount differs from the estimate.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors In assessing whether information was (or should have been) “readily accessible”, consideration should be given to the nature, complexity, relevance and frequency of occurrence of the item.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Example of Errors In this regard, it would be expected that companies would develop internal control processes to properly consider relevant information relating to frequently occurring or recurring items that could be significant.
Discerning an Error from a Change in ing Estimate in Income Taxes-Revised June 2015
• Example, a company would be expected to have an adequate internal control system to track meals and entertainment charges, to the extent such amounts create a material permanent difference in the company’s tax return.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • If there is a significant difference between the estimate made when closing the books and the actual amount reported on the tax return, this would seem to constitute an error. • This is not to suggest that the level of precision is expected to be completely accurate or that all differences between estimates and actual amounts constitute errors.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • A relatively insignificant difference between an estimate and the actual amount provides evidence that the company’s control system is adequate and that such an adjustment should be treated as a change in estimate in the period identified.
Discerning an Error from a Change in ing Estimate in Income TaxesRevised June 2015 • Conversely, consider a company that had never before repatriated foreign earnings (and had not provided deferred taxes on such amounts in accordance with ASC 740-30-25-17). The company decides late in its fiscal year to repatriate some or all of the foreign earnings.
Computing the Tax Provision Attributable to Ordinary Income
Estimated Annual Affective Tax Rate • Metholology With limited exceptions, ASC 740270 requires companies to calculate the estimated annual effective tax rate for current-year ordinary income, including both the current and deferred provisions determined under ASC 740.
Estimated Annual Affective Tax Rate • Metholology Project taxable income for the year, which is in turn used to estimate the annual provision for taxes currently payable, it is necessary to estimate temporary differences and rate differentials entering into the current provision.
Estimated Annual Affective Tax Rate • Metholology The temporary differences used to estimate the current provision are then included in the projected year-end temporary differences used to estimate the annual provision for deferred taxes, including any change in the valuation allowance. These estimates should be updated on each interim financial reporting date.
Estimated Annual Affective Tax Rate • Metholology As a practical matter, however, there may be circumstances in which the estimated annual effective tax rate can be appropriately estimated by considering only rate differentials. These situations often involve temporary differences that are expected to have offsetting effects in the current and deferred provisions (i.e., the effect on the
Estimated Annual Affective Tax Rate • Metholology current provision would be equal in amount but opposite in direction to the effect on the deferred provision). If additional complexities arise (e.g., the enacted tax rate varies between years or a valuation allowance for beginning or ending deferred provisions must typically be made to develop an appropriate estimated annual effective tax rate.
Best Current Estimate
• General The estimated annual effective tax rate should represent the best estimate of the composite tax provision in relation to the best estimate of worldwide pretax book ordinary income.
Best Current Estimate • General The composite tax provision should include federal, foreign and state income taxes, including the effects of: (1)credits, (2)Special deductions (e.g., Internal Revenue Code Section 199 deduction under the American Jobs Creation Act or percentage depletion)
Best Current Estimate • General The composite tax provision should include federal, foreign and state income taxes, including the effects of: (3) Capital gains taxed at different rates, (4) Valuation allowances for current-year changes in temporary differences and losses or income arising during the year.
Best Current Estimate • General The estimated annual ETR is then applied to year-to-date ordinary income to compute the year-to-date interim tax provision on ordinary income.
Best Current Estimate
• General The difference between the year-todate interim tax provision and the year-to-date interim tax provision as of the preceding interim period constitutes the tax provision for that quarter.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR If a significant pretax nonrecognized subsequent event occurs after the interim balance sheet date before financial statement issuance, an important questions arises.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Should the company’s best current estimate of annual pretax ordinary income be updated for the nonrecognized subsequent event, or should the best current estimate only use information that existed as of the balance sheet date?
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Example, assume that, subsequent to the interim balance sheet date, a significant new customer contract was signed. Alternatively, assume a severe hurricane loss was suffered by an insurance company.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR In both instances, the subsequent event significantly changed the company’s current estimate of its annual pretax ordinary income and thereby its estimated annual effective tax rate.
Best Current Estimate • Treatment of Nonrecognized Subsequent Events on the ETR ASC 740-270-35-3 indicates that, at the end of each interim period during the fiscal year, the estimated annual effective tax rate should be revised, if necessary, to reflect the entity’s best current estimate.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR One could reasonably conclude that the company’s best current estimated annual effective tax rate should be based on information available prior to the date of issuance, even though some of that information might be about influential factors that did not exist or were not relevant until after the interim balance sheet date.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Conversely, AU Section 560.05 indicates that nonrecognized subsequent events should not result in the adjustment of the financial statements. If any entity were to incorporate a significant nonrecognized subsequent event into the development of an updated ETR,
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Some of the subsequent events indirect effects would be recorded in the results up until the balance sheet date that preceded the nonrecognized event.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Since the effect of nonrecognized subsequent events should not be reflected in the financial statements, one could reasonably conclude that the effects of a nonrecognized subsequent event should be excluded from the interim calculation of the ETR.
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Companies that choose to consider all available information up until issuance date should be careful to exclude items whose tax effects are required to be recognized discretely in the period that they occur, such as:
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR (1)Changes in tax laws or rates; (2)New information received after the reporting date related to the assessment of uncertain tax positions; (3)Discontinued operations, extraordinary items and other significant unusual or infrequent items
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR When there is a significant time lag from the interim date to the date of the issuance of the financial statements (as may be the case with a company reporting on a prior interim period for the first time in connection with a registration statement), it may become
Best Current Estimate
• Treatment of Nonrecognized Subsequent Events on the ETR Increasingly difficult to assert that an event in the extended period should affect the estimated annual effective tax rate applied to the interim period.
Best Current Estimate • Treatment of Nonrecognized Subsequent Events on the ETR We generally believe that the delayed issuance of the financial statements should not result in a different assessment of the estimated annual effective tax rate than would have been the case had the financial statements been issued on a timely basis.
Limitation on Benefits of Losses, Credits and Rate Differential in Loss Periods
• ETR approach is modified by ASC 740-270-30-30 through 30-34, which limit the tax benefit recognized for a loss in interim periods to the amount that is expected to be: (a)Realized during the year; or (b) (b) recognizable as a deferred tax asset at the end of the year.
Limitation on Benefits of Losses, Credits and Rate Differential in Loss Periods
• Those limitations should be applied in determining both separate jurisdiction and worldwide estimated annual effective tax rates and the year-to-date benefit for a loss. Those limitations also apply to rate differentials that would increase the effective benefit rate during loss periods.
Limitation on Benefits of Losses, Credits and Rate Differential in Loss Periods • In applying the guidance in ASC 740-27030-30 through 30-34 related to the realizability of deferred tax assets and the need for a valuation allowance, the central issue that a company needs to consider is the valuation allowance that it expects to recognize at year-end, including any expected change in the valuation allowance during the year. The company cannot simply focus on the benefit of losses in the current year.
Exceptions to the Use of the ETR Approach • ASC 740-270 requires the use of an estimated annual effective tax rate to compute the tax provision for ordinary income in all jurisdictions during an interim period. • In determining that rate, there are two exceptions to the general rule that requires all jurisdictions (and all the tax effects on current-year ordinary income) to be included in the computation of the consolidated worldwide ETR.
Exceptions to the Use of the ETR Approach • If one of these exceptions applies and one or more foreign jurisdictions are excluded from the computation of the worldwide ETR, the U.S. tax effects (e.g., remitted or unremitted dividend income and related foreign tax credits) of the operations in those foreign jurisdictions are also excluded.
Exceptions to the Use of the ETR Approach • State and municipal income tax jurisdictions are subject to the same limitations as foreign jurisdictions with respect to what can be included in the consolidated worldwide ETR.
Exceptions to the Use of the ETR Approach • Jurisdiction with Pretax Losses for which No Tax Benefit can be recognized When a company operates in a jurisdiction that has generated ordinary losses on a year-to-date basis or on the basis of the results anticipated for the full fiscal year and no benefit can be recognized on those losses.
Exceptions to the Use of the ETR Approach • Jurisdiction with Pretax Losses for which No Tax Benefit can be recognized ASC 740-270-30-36 (a) requires the company to exclude that jurisdiction’s income (or loss) from the overall ETR calculation. A separate ETR should be computed and applied to ordinary income (or loss) in that jurisdiction.
Exceptions to the Use of the ETR Approach • Jurisdiction with Pretax Losses for which No Tax Benefit can be recognized In effect, any jurisdiction with losses for which no benefit can be recognized are removed from the base calculation of the ETR. Assuming the reason for no benefit is a full valuation allowance, the separate ETR for that jurisdiction would be zero.
Jurisdiction with Pretax Losses for which No Tax Benefit can be Recognized
• Zero-rate Jurisdiction ASC 740-270 does not specifically address whether a zero-rate jurisdiction should or should not be included in the ETR computation. As there is conceptual for either inclusion or exclusion of a zerorate jurisdiction, we believe this is an aspect of ing for income taxes for which diversity in practice can be expected. The following are four acceptable approaches:
Zero-rate Jurisdictions
• Approach A: Always exclude pre-tag ordinary income or loss from a zerorate jurisdiction from the ETR computation. This view is premised on the theory that the income in a zero-rate jurisdiction is effectively tax-exempt. The exclusion of pre-tax income from a zero-rate jurisdiction is analogous to the optional treatment of tax-exempt income
Zero-rate Jurisdictions • Approach B: Exclude pre-tax ordinary income or loss from a zero-rate jurisdiction from the ETR computation if there is a yearto-date loss in that jurisdiction. The rationale for this view is based on the notion that a loss ultimately will not provide a tax benefit. for this view can be found in ASC 740-270-30-36(a) which requires the exclusion of jurisdictions with year-to-date losses if no tax benefit can be recognized for the year-to-date loss or for an anticipated full-year loss.
Zero-rate Jurisdictions • Approach C: Exclude pre-tax ordinary income or loss from a zerorate jurisdiction from the ETR computation only if a loss is anticipated for the full fiscal year. This view concludes that ASC 740270-30-36(a) is not directly applicable because it addresses positive tax rate jurisdictions in circumstances where a loss would be
Zero-rate Jurisdictions • This view would not exclude income or loss when year-to-date loss is anticipated to reverse in subsequent periods. This view in effect represents a modified analogy to the principle in ASC 740-270-30-36(a).
Zero-rate Jurisdictions • Approach D: Always include pre-tax ordinary income or loss from a zerorate jurisdiction the ETR computation because the underlying principle in ASC 740-270 is that, absent a specific requirement or exception, all current-year ordinary income or loss should be included in the ETR computation.
Zero-rate Jurisdictions • This view differentiates the exception in ASC 740-270-30-36(a) as only applying to taxable jurisdictions for which a valuation allowance may be necessary. This view is premised on the notion that the ETR approach is known to yield, at times, seemingly illogical results in particular periods, yet there are only two narrowly drawn exceptions to full-inclusion, both of which are described with reference to an entity that “is subject to tax”.
Zero-rate Jurisdictions • Approach used should be considered an ing policy election to be applied consistently to all zero-rate jurisdictions of the reporting entity. If it is clearly evident that the approach applied to zero-rate jurisdictions has reporting consequences that would be significantly different than had one or more of the other acceptable approaches outlined above been applied, appropriate disclosure should be considered.
Jurisdictions for which a Reliable Estimate cannot be made • General Overview ASC 740-270-30-36(b) provides the following two situations in which a company should exclude a jurisdiction from the overall computations of the estimated annual effective tax rate: 1. If a company operates in a foreign jurisdiction for which a “reliable estimate” of the annual effective tax rate in of the parent entity’s functional currency cannot be made.
Jurisdictions for which a Reliable Estimate cannot be made • General Overview ASC 740-270-30-36(b) provides the following two situations in which a company should exclude a jurisdiction from the overall computations of the estimated annual effective tax rate: 2. If a reliable estimate of ordinary income for a particular jurisdiction cannot be made.
Jurisdictions for which a Reliable Estimate cannot be made • General Overview Presumably the first situation would arise when the exchange rate between the parent company’s functional currency and the foreign currency is highly volatile (this does not commonly occur in practice).
Jurisdictions for which a Reliable Estimate cannot be made • General Overview With respect to the second situation, the FASB acknowledged that determining whether an estimate is reliable requires the use of professional judgment and may involve the assessment of probability.
Jurisdictions for which a Reliable Estimate cannot be made • General Overview Example, in some cases, a small change in an entity’s estimate ordinary income could produce a significant change in the ETR, an estimate of the ETR would not be reliable if a small change in ordinary income were likely to occur.
Computing a Tax Provision when a Reliable Estimate cannot be made • ASC 740-270-30-17 through 30-18 reads as follows: Paragraph 740-270-25-3 requires that if an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated be reported in the interim period in which the item is reported.
Computing a Tax Provision when a Reliable Estimate cannot be made • Estimates of the annual effective tax rate at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision. If a reliable estimate cannot be made, the actual effective tax rate for the year to date may be the best estimate of the ETR.
Computing a Tax Provision when a Reliable Estimate cannot be made • This excerpt clarifies that the estimated annual effective tax rate is an estimate that is inherently subject to changes. • This fact alone does not justify a departure from the ETR approach.
Computing a Tax Provision when a Reliable Estimate cannot be made • Whether a reliable estimate of ordinary income or loss or the related tax can be made is a matter of judgment. If management is unable to estimate only a portion of its ordinary income, but is otherwise able to reliably estimate the remainder, the tax applicable to that item should be reported in the interim period in which the item
Computing a Tax Provision when a Reliable Estimate cannot be made • An estimated annual effective tax rate must be applied to the remainder of ordinary income and the related tax that can be reliably estimated.
Effects of “Naked Credits” on the Estimated Annual Effective Tax Rate • When a company is incurring losses and has a full valuation allowance, the increase of a deferred tax liability that does not serve as a source of income for the recognition of a deferred tax asset will trigger an estimated tax for the current year.
Effects of “Naked Credits” on the Estimated Annual Effective Tax Rate • The impact of this “naked credit” should be included in a company’s ETR calculation. This inclusion would be required whether the jurisdiction with the “naked credit” is included in an entity’s worldwide ETR calculation or excluded from the worldwide ETR calculation and treated as a separate jurisdiction with a stand-alone estimated annual ETR under ASC
Effects of “Naked Credits” on the Estimated Annual Effective Tax Rate • Discrete treatment is appropriate when the annual estimate of the tax rate is not considered a reliable estimate. • This may happen when a company determines a wide range of potential estimated annual effective tax rates because pretax income is at or near breakeven and it has significant permanent items such as the deferred tax effect from a “naked credit”.
Effects of “Naked Credits” on the Estimated Annual Effective Tax Rate • Consideration should be given to whether the company has the ability to estimate its ETR, given the range of possible outcomes. • The inability to estimate the ETR in a jurisdiction would cause the tax provision for that jurisdiction to be calculated on a discrete basis under ASC 740-270-30-36(b).
Tax Effects Other Than the Tax on Current-Year Ordinary Income • ASC 740-270-25-2 requires that the entire tax (or benefit) related to all items other than the tax effect on ordinary income should “be individually computed and recognized when the items occur”.
Tax Effects Other Than the Tax on Current-Year Ordinary Income • Example of these items include the tax effects related to discontinued operations, other comprehensive income, additional paid-in capital and items in continuing operations that represent tax effects not attributable to current-year ordinary income. • The tax effects represented by these items should be computed and reflected in accordance with the intraperiod allocation rules
Intraperiod Allocation in Interim Periods • General Overview ASC 740-270-45 indicates that the intraperiod allocation rules (ASC 74020-45) should be used to allocate the interim provision throughout the interim financial statements. Although the “with-and-without” model is basically the same for interim and annual periods
Intraperiod Allocation in Interim Periods • General Overview The allocation of tax expense or benefit for interim periods should be performed using the estimated fiscal year income and tax for “ordinary income (or loss)” and the year-to-date income and tax for: (1)an infrequent, unusual, or extraordinary item, (2) the gain or loss on disposal of a discontinued operation, or
Intraperiod Allocation in Interim Periods • General Overview The allocation of tax expense or benefit for interim periods should be performed using the estimated fiscal year income and tax for “ordinary income (or loss)” and the year-to-date income and tax for: (3) another component of the financial statements (e.g., other comprehensive income).
Intraperiod Allocation in Interim Periods • If more than one of the above items is present, the computation should reflect the order of precedence that will be assumed in annual financial statements. Unusual or infrequent items that are included in continuing operations will ordinarily be considered before any items that are excluded from continuing operations.
Intraperiod Allocation in Interim Periods • If more than one item is excluded from continuing operations, the process outlined in ASC 740-20-45-14 should be used to apportion the remaining provision after the tax expense or benefit allocated to continuing operations is considered. This allocation process should be consistent with the process used in the annual calculation.
Subsequent Revisions • Tax attributed to financial statement components that are reported in an early quarter can be subsequently revised to reflect a change in the estimate of tax related to annual ordinary income or changes in yearto-date income or loss in other components.
Subsequent Revisions • ASC 740-270 requires the computation of the interim provision to be performed on a year-to-date basis. As a result, the tax provision for a given quarter equals the difference between the provision recorded cumulatively for the year (via the estimated annual effective tax rate approach) less the amount recorded cumulatively as of the end
Subsequent Revisions • Changes in circumstances from quarter to quarter might make it necessary to record the tax effects in a financial statement category that differs from the one in which the company recorded the tax effects during a previous quarter.
Subsequent Revisions • Goal of the ASC 740-270 model is to treat the interim periods as components of the current annual period. • Intraperiod allocation, like the estimated annual effective tax rate, must be updated and recomputed each quarter.
Intraperiod Allocations that Reflects Discontinued Operations Prior to the Date on which they are Classified as Held for Sale or Disposed Of
• Once operations are classified as discontinued, prior periods are restated to reflect the now discontinued operations prior to the date on which those operations are first reported as discontinued operations,
Intraperiod Allocations that Reflects Discontinued Operations Prior to the Date on which they are Classified as Held for Sale or Disposed Of • ASC 740-270-45-6 through 45-8 provides detailed rules for taking the tax previously assigned to ordinary income and the discontinued operations. • ASC 740-270-55-29 provides an illustration of ing for income taxes applicable to income or (loss) from discontinued operations at an interim date.
Changes in Valuation Allowance • Need for a valuation allowance must be reassessed at each interim reporting date. Pursuant to ASC 740270-25-4 and depending on the circumstances that lead to a change in valuation allowance, the change may be reflected in the estimated annual effective tax rate or recognized discretely in the interim period during which the change in
Changes in Valuation Allowance • Any change in valuation allowance that results from a change in judgment about the realizability of the related deferred tax assets resulting from changes in the projection of income expected to be available in future years is reported in the period during which the change in judgment occurs.
Changes in Valuation Allowance • No portion of the effect should be allocated to subsequent interim periods through an adjustment to the estimated annual effective tax rate for the remainder of the year.
Changes in Valuation Allowance • The following changes in valuation allowance should be considered in determining the ETR for the year: A change in the valuation allowance related to deductible temporary differences and carryforwards that are expected to originate in ordinary income in the current year.
Changes in Valuation Allowance • The following changes in valuation allowance should be considered in determining the ETR for the year: A change in the valuation allowance for beginning-of-year deferred tax assets that results from a difference between the estimate of annual ordinary income (which includes the year-to-date amount) for the current year and the estimate that was inherent in the beginning-of-year valuation allowance.
Changes in Valuation Allowance • If there is a reduction in the valuation allowance for beginning-of-year deferred tax assets that results from income other than ordinary income (e.g., discontinued operations), the benefit should be reflected discretely in year-to-date results (presuming of course, that current-year continuing operations and projections of future income could not have ed the
Initial Recognition of Source-of-Loss Items • Initial recognition of source-of-loss items are generally excluded from recognition in income but rather recorded back to the source of the prior year loss/benefit.
Initial Recognition of Source-of-Loss Items • Example, the initial recognition of a tax benefit of a windfall tax deduction related to stock-based compensation would be recognized in additional paid-in capital. Tax benefits related to source-of-loss items would not enter into the ETR calculation.
Exception to the Basic Intraperiod Allocation Model • ASC 740-20-45-7 which describes the exception to the basic “with-and-without” approach to intraperiod allocation, must also be considered in interim periods. If a company has a valuation allowance and expects: (1) pretax losses from continuing operations; and (2) income in other components of the financial statements
Exception to the Basic Intraperiod Allocation Model • ASC 740-20-45-7 may have an effect on the presentation of the interim period financial statements and may possibly result in the reporting of a tax benefit (which would be incorporated in the estimated annual effective tax rate) in continuing operations, even though no such benefit would be computed using the basic “with-and –without” approach.
Tax ing Considerations of StockBased Compensation During Interim Periods • When an entity calculates its estimated annual effective tax rate, it should not anticipate or estimate the incremental effects of windfalls or shortfalls that may occur over the balance of the year.
Tax ing Considerations of StockBased Compensation During Interim Periods • Example, if an option is due to expire in the current year, the entity should not anticipate that it will be exercised and that a windfall will be recognized, even though the fair value of the underlying stock exceeds the exercise price of the option.
Tax ing Considerations of StockBased Compensation During Interim Periods • If an entity had disqualifying dispositions for incentive stock options (ISOs) or employee stock purchase plans (ESPPs) in the past, it should not anticipate future disqualifying dispositions. The entity should recognize windfalls and shortfalls discretely in the period in which they occur.
Tax ing Considerations of StockBased Compensation During Interim Periods • Example, If an entity does not have a sufficient pool of windfall tax benefits at the beginning of the year, any shortfall should be recorded in the income statement in the period in which the shortfall occurred.
Tax ing Considerations of StockBased Compensation During Interim Periods • If a windfall is recognized later in the year, the shortfall that was recognized earlier in the year should be reversed in the subsequent quarter to the extent that it can be offset against the windfall (because the pool of windfall tax benefits is determined on an annual basis).
Other Complexities
Business Combinations • Acquisition of a business can significantly impact the acquiring company’s estimated annual effective tax rate. • Business combination is a transaction that is not typically ed for in periods prior to the acquisition date, no effect should be given to a business combination in the estimated annual effective tax rate before the interim period in which the business combination is consummated
Business Combinations • Beginning with the interim period in which the purchase is consummated, the estimated annual effective tax rate for the year would be calculated to reflect the expected results, including the results of the acquired company. • That rate would be applied to the consolidated year-to-date ordinary income/loss to compute the year-to-date tax provision/benefit on ordinary income/loss.
Business Combinations • Second acceptable approach would be to divide the annual period into pre-acquisition and post-acquisition periods and determine an estimated annual effective tax rate for each of the two periods.
Business Combinations • After the acquisition is consummated, the tax provision would be the sum of the tax provision for the pre-acquisition period plus the tax computed by applying the ETR for the post-acquisition period to the yearto-date, post-acquisition ordinary income. • This method may not be appropriate if rate differentials that do not relate to the acquired operations occur disproportionately in the post-acquisition period.
Different Financial Reporting and Tax Year-End • If a corporation’s tax year-end date differs from its financial reporting year-end date, the basis for its tax computation and the application of the estimated annual effective tax rate approach in interim statements are impacted.
When Disclosure of Components of Interim Tax Expense is Required • If interim statements are used in lieu of annual statements (i.e., in a registration statement), companies need to disclose the components of interim income tax expense in the same way that companies present the disclosures required in annual statements by SEC FRP 204, Disclosures Regarding Income Taxes. Companies must perform the following tasks:
When Disclosure of Components of Interim Tax Expense is Required Divide the aggregate interim income tax expense calculated using the estimated annual effective tax rate approach between jurisdictions Determine the current and deferred portions of the interim income tax provisions
Disclosures – Revised June 2015 • Guidance on required interim financial statement disclosures can now be found in FSB sections 29.2, 29.4.7.6 and 30.4.3.3. • SEC Regulations S-K, Item 303, requires that a company include in MD&A detailed disclosure of material changes in financial condition and the results of operations.
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