E.5 Uncertain Tax Positions
Under U.S. GAAP, an entity cannot recognize a tax benefit for a tax position in its
financial statements unless it is more likely than not that the position will be
sustained upon examination solely on the basis of technical merits. In making this
determination, an entity must assume that (1) the position will be examined by a
taxing authority that has full knowledge of all relevant information and (2) any
dispute will be taken to the court of last resort. If the recognition threshold is
not met, no benefit can be recognized in the financial statements.
If the recognition threshold is met, the tax benefit recognized is measured at the
largest amount of such benefit that is more than 50 percent likely to be realized
upon settlement with the taxing authority that has full knowledge of all relevant
information. The analysis should be based on the amount the taxpayer would
ultimately accept in a negotiated settlement with the taxing authority. Because of
the level of uncertainty associated with a tax position, an entity that applies the
measurement criteria may need to perform a cumulative-probability assessment of the
possible estimated outcomes. The assignment of probabilities associated with the
measurement of a recognized tax position requires a high degree of judgment and
should be based on all relevant facts, circumstances, and information.
See Section 4.2 for additional guidance.
Paragraphs 9 and 10 of IFRIC Interpretation 23 state:
An entity shall consider whether it is probable that a
taxation authority will accept an uncertain tax treatment.
If an entity concludes it is probable that the taxation
authority will accept an uncertain tax treatment, the entity shall determine
the taxable profit (tax loss), tax bases, unused tax losses, unused tax
credits or tax rates consistently with the tax treatment used or planned to
be used in its income tax filings.
The entity assesses whether it is probable that a taxing authority
will accept an uncertain tax treatment. The assessment is based on the tax position
as filed on the tax return and therefore must include consideration of both the
technical merits of the position and the amount included on the return. While IFRIC Interpretation 23 is silent on the definition of “probable,” the word is defined in
IAS 37 as “more likely than not.”
Paragraph 11 of IFRIC Interpretation 23 states:
If an entity concludes it is not probable that the taxation authority will
accept an uncertain tax treatment, the entity shall reflect the effect of
uncertainty in determining the related taxable profit (tax loss), tax bases,
unused tax losses, unused tax credits or tax rates. An entity shall reflect the
effect of uncertainty for each uncertain tax treatment by using either of the
following methods, depending on which method the entity expects to better
predict the resolution of the uncertainty:
(a) the most likely amount — the single most likely amount in a range
of possible outcomes. The most likely amount may better predict the
resolution of the uncertainty if the possible outcomes are binary or are
concentrated on one value.
(b) the expected value — the sum of the probability-weighted amounts in
a range of possible outcomes. The expected value may better predict the
resolution of the uncertainty if there is a range of possible outcomes
that are neither binary nor concentrated on one value.
The determination of whether to use the most likely amount method or
the expected value method is not an accounting policy decision but is based on facts
and circumstances.
In general, although the principles of IFRIC Interpretation 23 are
similar to those in ASC 740 and IAS 37, the methods introduced by IFRIC Interpretation 23 to reflect uncertainty may create measurement differences in
comparison with the cumulative probability assessment requirement under U.S. GAAP. Other differences between IFRIC Interpretation 23 and ASC 740 may include
recognition of interest and penalties, classification, presentation, and disclosure
related to uncertainty in income taxes.
Example E-1
Assume that an entity takes a deduction of
$1,000 that is not a timing item (resulting in a $250
reduction in the income tax payable on the basis of a tax
rate of 25 percent) on its tax return.
Under ASC 740, the entity concludes solely
on the basis of the technical merits of the tax position
that it is more likely than not that the position will be
sustained if the taxpayer takes the dispute to the court of last resort. Under IFRIC Interpretation 23, the entity
concludes that it is not probable that the taxing authority
will accept the tax treatment used in the tax return. This
conclusion includes consideration of how the taxing
authority will evaluate both the technical merits of the
position and the amount shown on the return.
The entity estimates the probabilities of
the possible tax benefit amounts that may be sustained upon
examination by the taxing authority as indicated in the
table below.
Under ASC 740, the entity would measure the
associated tax benefit at the largest amount of benefit that
is more than 50 percent likely to be realized upon
settlement. Therefore, the entity should recognize a tax
benefit of $200 because this represents the largest benefit
with a cumulative probability of more than 50 percent.
Accordingly, the entity should record a $50 income tax
liability.
Under IFRIC Interpretation 23, the entity
must recognize the effect of uncertainty because it is not
probable that the full deduction taken on its tax return
will be accepted by the taxing authority. To measure the
required liability, the entity should select the measurement
method that best predicts the resolution of uncertainty. By
applying the most likely amount method, the entity would
initially calculate a $50 income tax liability on the basis
of a $200 benefit with a 30 percent likelihood. However, the
entity would observe that there was a range of possible
outcomes that were neither binary nor concentrated on one
value. Consequently, the entity would conclude that the
expected value method, which results in recognition of an
$85 income tax liability on the basis of a $165 sustained
benefit, would best predict the resolution of uncertainty in
view of the facts and circumstances surrounding this tax
position.
E.5.1 Presentation
Under U.S. GAAP, ASC 740-10-45-11 states that an entity should “classify an
unrecognized tax benefit that is presented as a liability in accordance with
paragraphs 740-10-45-10A through 45-10B as a current liability to the extent the
entity anticipates payment (or receipt) of cash within one year or the operating
cycle, if longer.” ASC 740-10-45-12 states that an “unrecognized tax benefit
presented as a liability shall not be classified as a deferred tax liability
unless it arises from a taxable temporary difference.” See Section 13.2.2 for additional guidance.
Under IFRS Accounting Standards, IAS 12 generally requires an
entity to present all current tax for current and prior periods, to the extent
unpaid, as a current tax liability. Similarly, IAS 1 generally requires an
entity to classify a liability as current when the entity does not have the
unconditional right to defer settlement of the liability for at least 12 months
after the reporting period (which is similar to the treatment for a demand
payable).
E.5.2 Classification of Interest Expense and Penalties
Under U.S. GAAP, ASC 740-10-45-25 permits an entity, on the basis of its
accounting policy election, to classify (1) interest in the financial statements
as either income taxes or interest expense and (2) penalties in the financial
statements as either income taxes or another expense classification. The
election must be consistently applied. An entity’s accounting policy for
classification of interest may be different from its policy for classification
of penalties. For example, interest expense may be recorded above the line as
part of interest expense, and penalties may be recorded below the line as part
of income tax expense. See Section 13.3.1
for additional guidance.
Classification of interest and penalties was discussed by the IFRS
Interpretations Committee, which, as reported in the September 2017 IFRIC
Update, concluded that entities do not have an accounting policy choice between
applying IAS 12 and applying IAS 37 to such amounts. Instead, they must use
judgment to determine whether a particular amount payable or receivable for
interest and penalties is an income tax.
When there is no significant uncertainty with respect to the overall amount of
income tax payable, but an entity deliberately delays payment of the amount, the
resulting interest and penalties can be clearly distinguished from the assessed
income tax. Accordingly, in such circumstances, instead of presenting the
interest and penalties as income tax in the financial statements, the entity
should present them separately on the basis of their nature (i.e., either as a
finance cost [interest] or operating expense [penalties]).
However, an entity risks incurring interest and penalties if there is significant
uncertainty regarding the amount of income tax to be paid and the entity has, on
the basis of discussions with the tax authorities, withheld payment for the full
amount of tax possibly payable (to avoid, for example, prejudicing a future
appeal against the amount claimed as due by the tax authorities). In such
circumstances, since possible interest and penalties can be seen as being part
of the overall uncertain tax position, it is appropriate to consider them as
part of tax expense (income).
E.5.3 Subsequent Events
Under U.S. GAAP, changes in recognition and measurement of an uncertain tax
position should be based on changes in facts and circumstances (i.e., new
information) and accounted for in the period in which the new information
arises. Therefore, all new information would be considered nonrecognized
subsequent events under ASC 855. See Section
4.5.2 for additional guidance.
Under IFRS Accounting Standards, changes should also be based on
changes in facts and circumstances (i.e., new information). However, an entity
applies IAS 10 to determine whether a change that occurs after the reporting
period is an adjusting or nonadjusting event.