Chapter 12 — Other Investments and Special Situations
Chapter 12 — Other Investments and Special Situations
12.1 Introduction
This chapter provides income tax accounting and disclosure guidance
related to noncontrolling interests, equity method investments (including specific
exceptions in ASC 740 related to corporate joint ventures and changes in ownership of
investees), qualifying investments accounted for by using the proportional amortization
method, regulated entities, and distinguishing a change in estimate from a correction of
an error. The book-versus-tax-differences chapter of this Roadmap (Chapter 3) provides helpful
guidance on the respective definitions of inside and outside basis differences (see
Section 3.3.1) and the
recognition criteria for deferred taxes.
12.2 Income Tax Credits
12.2.1 Accounting for Temporary Differences Related to Investment Tax Credits
ASC 740-10
25-45 An investment credit
shall be reflected in the financial statements to the
extent it has been used as an offset against income
taxes otherwise currently payable or to the extent its
benefit is recognizable under the provisions of this
Topic.
25-46 While it shall be
considered preferable for the allowable investment
credit to be reflected in net income over the productive
life of acquired property (the deferral method),
treating the credit as a reduction of federal income
taxes of the year in which the credit arises (the
flow-through method) is also acceptable.
Pending Content (Transition
Guidance: ASC 323-740-65-2)
25-46
While it shall be considered preferable for the
allowable investment credit to be reflected in net
income over the productive life of acquired
property (the deferral method), treating the
credit as a reduction of federal income taxes of
the year in which the credit arises (the
flow-through method) is also acceptable. For
investments that meet the conditions in paragraph
323-740-25-1 for which an entity has elected to
apply the proportional amortization method, the
flow-through method shall be used.
The guidance in ASC 740-10-25-46 on investment tax credits (ITCs) specifies that
an entity can use either the deferral method or the flow-through method to
account for the receipt of an ITC (e.g., upon purchase or upon the placement of
a purchased or constructed asset in service) as an item of income in the
financial statements.
Under the deferral method, the ITC would result in a reduction to income taxes
payable (or an increase in a DTA if the credit is carried forward to future
years, subject to assessment for realization) that is recognized either as a
reduction to the carrying value of the related asset or as a deferred credit
(i.e., the credit is treated as deferred income). The benefit of the ITC is
either reflected in net income as a reduction to depreciation expense or
recognized as deferred income over the productive life of the related property
(rather than as a reduction to income tax expense).1 Under this method, temporary differences may be created when either the
financial statement carrying amount of the acquired property is reduced or when
a deferred credit is recorded. In some cases, receipt of the credit results in a
statutory reduction in the tax basis of the related asset, which may affect the
temporary basis difference.
Under the flow-through method, the ITC would result in (1) a reduction to income
taxes payable for the year in which the credit arises (or an increase in a DTA
if the credit is carried forward to future years, subject to assessment for
realization) and (2) an immediate reduction to income tax expense. When this
method is applied, temporary differences are generally created only if a
statutory reduction in tax basis occurs.
The following two approaches are acceptable for recording the tax effect of
temporary differences created by ITCs:
-
Gross-up approach — Under this approach, there is no immediate income statement recognition because the DTA or DTL is recorded as an adjustment to the carrying value of the acquired property (or as a deferred credit). The simultaneous equations method is used to calculate the final book basis of the acquired property and the DTA or DTL. (For the FASB’s guidance on, and an illustration of, the simultaneous equations method, see ASC 740-10-25-51 and ASC 740-10-55-171 through 55-182.)
-
Income statement approach — Under this approach, the DTA or DTL is recorded with an offset to income tax expense.
Both approaches are discussed below in greater detail. Note that the approach an
entity selects is an accounting policy election that should be applied
consistently. In addition, since this guidance applies only to the accounting
for ITCs, an entity should not analogize to other situations. In circumstances
other than those related to ITCs, consultation with accounting advisers is
recommended.
Example 12-1
ITC With No Statutory Reduction to Tax Basis
Assume the following:
-
Entity A invests in a qualifying asset for $1,000 that entitles A to an ITC for 25 percent of the purchase price, and it records the following initial entry:Entry 1ATo record the initial purchase.
-
In accordance with the tax law, there is no associated reduction in the tax basis of the related asset.
-
Entity A’s applicable tax rate is 21 percent.
Deferral Method
Under the deferral method, A recognizes the reduction in
taxes payable and records the offsetting credit as a
reduction in the carrying value of the asset, as shown
in the following journal entry:
Entry 1B
If there is no corresponding adjustment to the tax basis
of the qualifying asset (per the tax law), a deductible
temporary difference of $250 arises. The accounting
treatment for the DTA depends on whether A has elected
the gross-up approach or the income statement
approach.
Gross-Up Approach
Under the gross-up approach, A’s application of a
simultaneous equation yields a DTA of $66 (rounded) and
a reduction to the recorded amount of the qualifying
asset of $66 (rounded). Thus, the qualifying asset
should be recorded at $684 ($1,000 purchase price less
the $250 ITC less the $66 DTA). Entity A will record all
of the entries above as well as the following entry to
account for the qualifying asset, the ITC, and the
initial basis difference in the qualifying asset:
Entry 1C
Income Statement
Approach
Under the income
statement approach, A records a DTA of $53 as a
component of income tax expense. Entity A will record
Entry 1B above and the following entry to account for
the initial basis difference in the qualifying
asset:
Entry 1D
Flow-Through Method
Under the flow-through method, A recognizes the reduction
in taxes payable and records the offsetting credit as a
current income tax benefit, as shown in the following
journal entry:
Entry 1E
Because there is no adjustment to the book basis of the
qualifying asset and it is assumed that there is no
adjustment to the tax basis of the qualifying asset (per
the tax law), no deductible temporary difference arises.
Therefore, the gross-up and income statement approaches
are not applicable.
Example 12-2
ITC With Statutory Reduction to Tax Basis
Assume the same facts as in the example above, except
that in accordance with the tax law, there is an
associated reduction in the tax basis of the related
property equal to 50 percent of the ITC (i.e., $125).
Entity A records the same initial entry as follows:
Entry 2A
Deferral Method
Under the deferral method, A recognizes the reduction in
taxes payable and records the offsetting credit as a
reduction in the carrying value of the asset, as shown
in the following journal entry:
Entry 2B
Because the corresponding adjustment to the tax basis of
the qualifying asset (per the tax law) differs from that
of the adjustment made to the carrying value of the
qualifying asset, a deductible temporary difference of
$125 arises ($750 book basis vs. $875 tax basis). The
accounting treatment for the related DTA depends on
whether A has elected the gross-up approach or the
income statement approach.
Gross-Up Approach
Under the gross-up approach, A’s application of a
simultaneous equation yields a DTA of $33 (rounded) and
a reduction to the recorded amount of the qualifying
asset of $33 (rounded). Thus, the qualifying asset
should be recorded at $717 ($1,000 purchase price less
the $250 ITC less the $33 DTA determined herein). Entity
A will record the entries above and the following entry
to account for the initial basis difference in the
qualifying asset:
Entry 2C
Income Statement Approach
Under the income statement approach, A
records DTA of $26 as a component of tax expense. Entity
A will record Entry 2B and the following entry to
account for the qualifying asset, the ITC, and the
initial basis difference in the qualifying asset:
Entry 2D
Flow-Through Method
Under the flow-through method, A recognizes the reduction
in taxes payable and records the offsetting credit as a
current income tax benefit, as shown in the following
journal entry:
Entry 2E
Although there is no adjustment to the book basis of the
qualifying asset under this approach, the tax basis of
the qualifying asset (per the tax law) differs from the
book basis of the qualifying asset, and an initial
taxable temporary difference of $125 arises ($1,000 book
basis vs. $875 tax basis). The accounting treatment for
the related DTL depends on whether A has elected the
gross-up approach or the income statement approach.
Gross-Up Approach
Under the gross-up approach, A’s application of a
simultaneous equation yields a DTL of $33 (rounded) and
an increase to the recorded amount of the qualifying
asset of $33 (rounded). Thus, the qualifying asset
should be recorded at $1,033 ($1,000 purchase price plus
the $33 DTL determined herein). Entity A will record
Entry 2E and the following entry to account for the
initial basis difference in the qualifying asset:
Entry 2F
Income Statement Approach
Under the income statement approach, A
would not use the simultaneous equations method. Rather,
A would apply its tax rate of 21 percent to the taxable
temporary difference of $125, resulting in the
recognition of a DTL of $26 with the offset to deferred
tax expense. Entity A will record Entry 2E and the
following entry to account for the qualifying asset, the
ITC, and the initial basis difference in the qualifying
asset:
Entry 2G
12.2.2 Accounting for Transferable Tax Credits
As mentioned in Chapter 2.7, certain credits are sold in an effort to monetize
them. Of these credits, a transferability provision was introduced in 2022 for a
number of “eligible credits” as part of the Inflation Reduction Act. The
transferability provision allows an “eligible taxpayer” to elect to transfer
(i.e., sell) the credit, or some portion thereof, to an unrelated taxpayer. In
situations in which an entity does not have sufficient taxable income to use all
or a portion of the income tax credit or in which using it might take multiple
tax years, the entity might achieve a better economic benefit (i.e., present
value benefit) by selling the credit.
Regardless of intent, we believe that a transferable credit should remain within
the scope of ASC 740 if it (1) can be used only to reduce an income tax
liability either for the entity that generated it or the entity to which it is
transferred and (2) would never be refundable by the government. While we
believe that it is most appropriate to account for the credits under ASC 740, on
the basis of feedback received from the FASB staff, we believe that it would
also be acceptable for an entity to account for the transferable credits in a
manner similar to refundable credits (i.e., which are not within the scope of
ASC 740) since the company generating the credit does not need taxable income to
monetize the credit.
In addition to the accounting policy decision discussed above, there are
considerations related to the realizability assessment of the related DTA and
certain interim reporting considerations. The impact of the accounting policy
elections are summarized in the decision tree below.
An entity that purchases a transferable credit should generally record a DTA for
the amount of tax credits purchased and a deferred credit for the difference
between the amount paid and the DTA recognized in accordance with ASC 740 (such
deferred credit does not represent a DTL). The deferred credit will be reversed
and recognized as an income tax benefit in proportion to the deferred tax
expense recognized on realization of the associated DTA (i.e., as the credits
are used on the tax return).
12.2.2.1 Accounting Considerations for Valuation Allowances Related to Transferable Credits
If an entity elects to account for a transferable tax credit in accordance
with ASC 740, the entity would recognize a DTA for the carryforward and
assess it for realizability. On the basis of a technical inquiry with the
FASB staff, we understand that it would be most appropriate to reflect any
proceeds and resulting gain or loss on the sale as a component of the tax
provision. Under this approach, and on the basis of the same FASB staff
inquiry, we understand that the valuation allowance could be determined by
either (1) factoring the expected sales proceeds into the assessment of the
realizability of the related DTA or (2) not factoring in the expected sales
when assessing the realizability of the related DTA. We believe that if the
expected sales proceeds are factored into the assessment of the
realizability of the DTA, the DTA (net of valuation allowance) would be
recognized in an amount equal to the amount expected to be realized (i.e.,
the expected sales proceeds). Any difference between the expected sales
proceeds and the actual sales proceeds would be recognized as a component of
income tax expense.
If the expected sales proceeds are not factored into the assessment, an
entity would exclude the expected proceeds, including any discount on the
sale of the credits, when assessing the realizability of the DTA, with the
gain or loss on sale recognized at the time of sale as a component of income
tax expense.
Alternatively, we believe that the sale could be treated no
differently than the sale of any other asset, with gain or loss recognized
in pretax earnings for any difference between the proceeds received and the
recorded carrying value of the DTA for the income tax credit that was
recognized in accordance with the guidance in ASC 740 on recognition and
measurement.2
See Section 12.2.2.2 for considerations related to the interim
reporting of this gain or loss.
12.2.2.2 Impact of Credits on Interim Reporting
In accordance with ASC 740-270-30-8, an entity’s AETR should
“reflect anticipated investment tax credits, foreign tax rates, percentage
depletion, capital gains rates, and other available tax planning
alternatives.” Therefore, regardless of the policy elections described in
Section 12.2.2, an entity would
generally include the effects of the credits in its annual AETR, including
gains and losses projected to occur during the year, if reasonably estimable
(i.e., the denominator would include the reasonably estimable gains or
losses that will affect pretax earnings for the year, and the numerator
would include the reasonably estimable net realizable amount of the tax
credits, along with gains or losses associated with the sale of the credit
that will affect the income tax provision).
Footnotes
1
We are also aware of an alternative view under which the deferred credit
would be reversed through the income tax provision.
2
If an entity’s policy is to reflect gain or loss in
pretax earnings, it would not be appropriate to consider the
expected sales proceeds when assessing realizability of the related
DTA.
12.3 Equity Method Investee Considerations
When an investor owns less than 50 percent of the voting capital, but is
able to exercise significant influence, it generally applies the equity method of
accounting unless an exception applies (i.e., the investor elects the fair value option
under ASC 825-10, or specialized industry accounting requires carrying the investment at
fair value).
In general, under the equity method of accounting, an investor initially
recognizes its investment in an investee (including a joint venture) at cost in
accordance with ASC 805-50-30. In addition, an investor that applies the equity method
of accounting should comply with the requirements of ASC 323-10-35-4, which states, in
part:
Under the equity method, an investor shall recognize its
share of the earnings or losses of an investee in the periods for which they are
reported by the investee in its financial statements rather than in the period in
which an investee declares a dividend. An investor shall adjust the carrying amount
of an investment for its share of the earnings or losses of the investee after the
date of investment and shall report the recognized earnings or losses in income. An
investor’s share of the earnings or losses of an investee shall be based on the
shares of common stock and in-substance common stock held by that investor.
12.3.1 Deferred Tax Consequences of an Investment in an Equity Method Investment
When accounting for income taxes, investors in an equity method
investment should generally recognize the deferred tax consequences for an outside
basis difference unless an exception applies. An entity may need to use judgment,
however, if it applies the equity method to a more-than-50-percent-owned investment
(e.g., because the entity is a VIE and the investor is not the primary beneficiary
or because of other participating rights held by other shareholders) given that the
guidance in ASC 740-30-25-5(b) specifically refers to an investment in a
50-percent-or-less owned investee. In such a case, other guidance might also be
relevant if, for example, the equity method investor could unilaterally determine
whether dividends are granted by the equity method investee or could unilaterally
execute steps that would allow the investment to be recovered in a tax-free
manner.
See Section 3.4 for guidance on the definition
of an outside basis difference. See Section
3.4.1 for guidance on the definition of foreign and domestic
investments. Also see Section 3.4.17.1 for
considerations related to VIEs.
12.3.1.1 Potential DTL: Domestic Investee
Equity investors that hold less than a majority of the voting
capital of an investee do not possess majority voting power and, therefore,
generally cannot control the timing and amounts of dividends, in-kind
distributions, taxable liquidations, or other transactions and events that may
result in tax consequences for investors. Therefore, for a 50
percent-or-less-owned investee, whenever the carrying amount of the equity
investment for financial reporting purposes exceeds the tax basis in the stock
or equity units of a domestic investee, a DTL is generally recognized in the
balance sheet of the investor (in the absence of the exception in ASC
740-30-25-18(b)). An entity should consider the guidance in ASC 740-10-55-24
when measuring the DTL. The DTL is measured by reference to the expected means
of recovery. For example, if recovery is expected through a sale or other
disposition, the capital gain rate may be appropriate. Conversely, if recovery
is expected through dividend distributions, the ordinary tax rate may be
appropriate.
12.3.1.2 Potential DTL: Foreign Investee
ASC 740-30-25-5(b) requires equity investors that hold less than a majority of
the voting capital of a foreign investee to recognize a DTL for the excess
amount for financial reporting purposes over the tax basis of a foreign equity
method investee that is not a corporate joint venture that is essentially
permanent in duration. The indefinite reversal criterion in ASC 740-30-25-17
applies only to a consolidated foreign subsidiary or a foreign corporate joint
venture that is essentially permanent in duration. A related topic is discussed
in Section 3.4.4.
12.3.1.3 Potential DTA: Foreign and Domestic Investee
ASC 740-30-25-9 does not apply to 50-percent-or-less-owned
foreign or domestic investees that are not corporate joint ventures that are
permanent in duration. Therefore, equity investors that hold a noncontrolling
interest in an investment that is not a corporate joint venture that is
essentially permanent in duration should generally record a DTA for the excess
tax basis of an equity investee over the amount for financial reporting
purposes. As with all DTAs, in accordance with ASC 740-10-30-18, realization of
the related DTA “depends on the existence of sufficient taxable income of the
appropriate character (for example, ordinary income or capital gain) within the
carryback, carryforward period available under the tax law.” If realization of
all or a portion of the DTA is not more likely than not, a valuation allowance
is necessary.
12.3.2 Tax Effects of Investor Basis Differences Related to Equity Method Investments
In certain situations, there may be a difference between the cost of an equity method
investment and the investor’s share of the investee’s individual assets and
liabilities. ASC 323-10-35-13 requires entities to account for the “difference
between the cost of an [equity method] investment and the amount of underlying
equity in net assets of an investee . . . as if the investee were a consolidated
subsidiary.” Entities therefore determine any difference between the cost of an
equity method investment and the investor’s share of the fair values of the
investee’s individual assets and liabilities by using the acquisition method of
accounting in accordance with ASC 805. Differences of this nature are known as
“investor basis differences” and result from the requirement that investors allocate
the cost of the equity method investment to the individual assets and liabilities of
the investee. Like business combinations, investor basis differences may give rise
to deferred tax effects. To accurately account for its equity method investment, an
investor would consider these inside basis differences in addition to any outside
basis difference in its investment.
In accordance with ASC 323-10-45-1, equity method investments are
presented as a single consolidated amount. Accordingly, tax effects attributable to
the investor basis differences become a component of this single consolidated amount
and are not presented separately in the investor’s financial
statements as individual current assets and liabilities or DTAs and DTLs. The
example below illustrates this concept.
Further, the investor’s share of investee income or loss needs to be adjusted for
investor basis differences, including those associated with income taxes.
Example 12-3
Investor Y purchases a 40 percent interest
in Investee Z for $2 million cash and applies the equity
method of accounting. The book value of Z’s net assets is
$3.5 million. The table below shows the book values and fair
values of Z’s net assets (along with Y’s proportionate
share) as of the investment acquisition date. Investee Z did
not record any DTAs or DTLs in its own financial
statements.
The statutory tax rate of Y and Z is 25
percent.
Since equity method goodwill is treated as
if it were goodwill acquired in a business combination,
there is no DTL associated with this basis difference.
Because the total amount of the basis difference between the
cost of Y’s investment ($2 million) and its proportionate
share of the book value of Z’s net assets ($1.4 million) has
not changed, the DTL recognized in the memo accounts
increases the basis difference attributable to equity method
goodwill in an amount equal to the DTL.
See Example
4-10 in Section
4.5 of Deloitte’s Roadmap Equity Method Investments and Joint
Ventures for the above example’s predecessor, which illustrates
the initial recognition of basis differences. See Example 5-13 in Section 5.1.5.2 of Deloitte’s Roadmap
Equity Method Investments
and Joint Ventures for an expanded version of the above
example that illustrates the subsequent measurement of basis differences.
12.3.3 Change in Investment From a Subsidiary to an Equity Method Investee
ASC 740-30-25-15 provides guidance on situations in which an investment in common
stock of a subsidiary changes in such a manner that it is no longer considered a
subsidiary (e.g., the extent of ownership in the investment changes so that it
becomes an equity method investment). In these cases, an entity must recognize a
deferred tax expense in the current period to recognize a DTL related to the equity
method investment when the subsidiary becomes an equity method investment. The
example below illustrates this concept.
Example 12-4
Assume that Entity X had $1,000 of
unremitted earnings from its investment in a foreign
subsidiary, FI, and that management has determined that all
earnings were indefinitely reinvested and that the related
temporary difference would not reverse in the foreseeable
future. Therefore, no DTL has been recorded. Further assume
that at the beginning of 20X1, FI sold previously owned
capital stock to an unrelated third-party investor such that
X no longer has a controlling financial interest in Fl.
However, because of its equity share of FI, X was required
to use the equity method of accounting in accordance with
ASC 323. During 20X1, X’s equity in earnings of FI was
$2,000 and no dividends were paid or payable. In addition, X
can no longer control the dividend policy of FI because it
no longer controls a majority of the seats on the board of
directors, and FI has announced a change in dividend policy
beginning with 20X2 in which 20 percent of retained
earnings, as of December 31, 20X2, will be paid to
shareholders of record as of that date.
During 20X1, X would accrue as a current
charge to income tax expense from continuing operations the
tax effect of establishing (1) a DTL for the tax
consequences of $2,000 of taxable income attributable to its
share of equity in earnings of FI during 20X1, and (2) a DTL
for its portion of the 20 percent equity in retained
earnings to be distributed in 20X2 in accordance with FI’s
new policy of remitting earnings in the future (calculated
on the basis of the retained earnings balance at the end of
20X1).
See Section
11.3.6.3 for further discussion of the tax consequences of business
combinations achieved in stages.
12.3.4 Accounting for an ITC Received From an Investment in a Partnership Accounted for Under the Equity Method
The accounting for ITCs was originally addressed in APB Opinion 2
(codified in ASC 740-10-25-46), which discusses direct investments in acquired
depreciable property that generate ITCs. Since that guidance was introduced,
however, the types of vehicles through which entities take advantage of ITCs have
evolved. For example, entities often invest in partnerships whose operations include
investments in assets that qualify for ITCs, which can then be passed through
directly to the investors.
While ASC 740 addresses the accounting by an entity that directly owns an asset that
generates an ITC, it does not explicitly address the accounting by a reporting
entity that is an investor in a flow-through entity that owns the asset that
generates the credit that is then passed through to the investor. In the latter
case, the reporting entity must first consider whether it is required under ASC 810
(including the VIE subsections of ASC 810-10) to consolidate the flow-through entity
in which it has invested. If consolidation of the investee is not required, the
reporting entity would most often account for the investment by using the equity
method.
There are two acceptable approaches (“Approach 1” and “Approach 2”)
on how a reporting entity that accounts for its investment in a flow-through entity
under the equity method should account for the tax benefits received in the form of
ITCs. The approach an entity selects is an accounting policy election that should be
applied consistently. (See Section 12.2 for a
discussion of the accounting for temporary differences related to ITCs.)
12.3.4.1 Approach 1 — Account for ITCs as an Income Tax Benefit
Under Approach 1, the investor would account for the tax benefits received in the form of ITCs as an income tax benefit. This method is consistent with accounting for the tax benefits under the flow-through method. It is also consistent with ASC 323-740-55-8 (formerly Exhibit 94-1A of EITF Issue 94-1), which contains an
example of the application of the equity method to a QAHP investment that does
not qualify for the proportional amortization method. In that example, the tax
credits are recorded in the income tax provision in the year that they are
received.
12.3.4.2 Approach 2 — Apply a Model Similar to the Deferral Method
Approach 2 is premised on the guidance originally contained in paragraph 3 of APB Opinion 4 on an ITC that was passed through to a lessee under
an operating lease for leased property. More specifically, paragraph 3 of APB
Opinion 4 provided an example in which the asset generating the ITC was not
carried on the lessee’s balance sheet; rather, the ITC was passed through to the
lessee in a manner similar to the way it would be passed through to an investor
in a flow-through entity.3 In the example, the Interpretation indicated that the “lessee should
account for the credit by whichever method is used for purchased property” and
then provided clarification on how to apply the deferral method if that
method is selected, suggesting that the lessee could use either the deferral
method or the flow-through method even in a situation in which the underlying
asset that generated the credit was not actually reflected in the reporting
entity’s financial statements.
Under Approach 2, the tax benefits from the ITCs would be
deferred and amortized over the useful life of the related assets, resulting in
a cost reduction that would be reflected as an adjustment in the equity method
earnings (i.e., “above the line”). That is, the deferral method would yield an
increase in the equity method earnings because less depreciation would flow
through to the investor.4
Changing Lanes
ASC 740-10-25-46, as amended by ASU 2023-02, requires an entity to use a
different policy for investments accounted for under the proportional
amortization method even if the deferral method is used for other
investments. That is, if an investor in a flow-through entity generates
ITCs and uses the proportional amortization method to account for that
investment, the investor must use the flow-through method to account for
the ITCs generated by the investee. If the investor has other
investments that are not accounted for under the proportionate
amortization method and previously used the deferral method to account
for ITCs, it should continue to use that method for such investments.
12.3.5 Presentation of Tax Effects of Equity in Earnings of an Equity Method Investee
The investor’s income tax provision equals the sum of current and deferred tax
expense, including any tax consequences of the investor’s equity in earnings and
temporary differences attributable to its investment in an equity method
investee.
Because it is the investor’s tax provision, not the investee’s, the tax consequences
of the investor’s equity in earnings and temporary differences attributable to its
investment in the investee should be recognized in income tax expense and not be
offset against the investor’s equity in earnings.
Footnotes
3
See also paragraph 11 of APB Opinion 2.
4
Alternatively, under the deferral method, instead of
reducing the cost basis of the qualifying asset or assets, an entity
could recognize a deferred credit. In this scenario, the recovery of the
deferred credit would result in a reduction to the income tax provision
over the life of the qualifying asset or assets.
12.4 Noncontrolling Interests
The ASC master glossary defines a noncontrolling interest as the
“portion of equity (net assets) in a subsidiary not attributable, directly or
indirectly, to a parent.” Consequently, noncontrolling interests are presented only
in the consolidated financial statements of a parent whose holdings include a
controlling interest in one or more subsidiaries it partially owns. The objective of
accounting for noncontrolling interests is to present users of the consolidated
financial statements with a clear depiction of the portion of a subsidiary’s net
assets, net income, and net comprehensive income that is attributable to equity
holders other than the parent.
12.4.1 Accounting for the Tax Effects of Transactions With Noncontrolling Shareholders
A parent accounts for changes in its ownership interest in a subsidiary over
which it maintains control (“control-to-control” transactions) as equity
transactions. The parent cannot recognize a gain or loss in consolidated net
income or comprehensive income for such transactions and is not permitted to
step up a portion of the subsidiary’s net assets to fair value to the extent of
any additional interests acquired (i.e., no additional acquisition method
accounting). As part of the equity transaction accounting, the entity must also
reallocate the subsidiary’s AOCI between the parent and the noncontrolling
interest.
The tax accounting consequences related to stock transactions associated with a
subsidiary are addressed under ASC 740-20-45-11. The direct tax effect of a
change in ownership interest in a subsidiary when a parent maintains control is
generally recorded in shareholders’ equity. Some transactions with
noncontrolling shareholders may create both a direct and an indirect tax effect.
It is important to properly distinguish between the direct and indirect tax
effects of a transaction since the accounting for each may be different. For
example, the indirect tax effect of a parent’s change in its assumptions
associated with undistributed earnings of a foreign subsidiary resulting from a
sale of its ownership interest in that subsidiary is recorded as income tax
expense in continuing operations rather than in shareholders’ equity. Similarly,
a parent’s change in ownership in a domestic subsidiary that causes a change in
its ability and intent to recover the investment in a tax-free manner would be
an indirect tax effect and recorded in continuing operations (see ASC
740-30-25-3).
Example 12-5
Parent Entity A owns 80 percent of its foreign
subsidiary, which operates in a zero-rate tax
jurisdiction. The subsidiary has a net book value of
$100 million as of December 31, 20X9. Entity A’s tax
basis of its 80 percent investment is $70 million.
Assume that the carrying amounts of the interest of the
parent (A) and noncontrolling interest holder (Entity B)
in the subsidiary are $80 million and $20 million,
respectively. The $10 million difference between A’s
book basis and tax basis in the subsidiary is
attributable to undistributed earnings of the foreign
subsidiary. In accordance with ASC 740-30-25-17, A has
not historically recorded a DTL for the taxable
temporary difference associated with undistributed
earnings of the foreign subsidiary because A has
specific plans to reinvest such earnings in the
subsidiary indefinitely and the reversal of the
temporary difference is therefore indefinite.
On January 1, 20Y0, A sells 12.5 percent of its 80
percent interest in the foreign subsidiary to a
nonaffiliated entity, Entity C, for total proceeds of
$20 million. As summarized in the table below, this
transaction (1) dilutes A’s interest in the subsidiary
to 70 percent and decreases its carrying amount by $10
million (12.5% × $80 million) to $70 million, and (2)
increases the total carrying amount of the
noncontrolling interest holders (B and C) by $10 million
to $30 million.
Below is A’s journal
entry on January 1, 20Y0, before consideration of income
tax accounting:
Entity A’s current tax payable and tax expense from its
taxable gain on the sale of its investment in the
subsidiary is $2,812,500, which is computed as follows:
[$20 million selling price – ($70 million tax basis ×
12.5% portion sold)] × 25% tax rate. The amount consists
of the following direct and indirect tax effects:
- The direct tax effect of the sale is $2.5 million. This amount is associated with the difference between the selling price and book basis of the interest sold by A (i.e., the gain on the sale) and is computed as follows: [$20 million selling price – ($80 million book basis × 12.5% portion sold)] × 25% tax rate. The gain on the sale of A’s interest is recorded in shareholders’ equity; therefore, the direct tax effect is recognized in shareholders’ equity.
- The indirect tax effect of the sale is $312,500. This amount is associated with the preexisting taxable temporary difference (i.e., the undistributed earnings of the subsidiary) of the interest sold for which a DTL was not recognized because of A’s assertion regarding the undistributed earnings of the subsidiary and is computed as follows: [($80 million book basis – $70 million tax basis) × 12.5% portion sold] × 25% tax rate. The partial sale of the subsidiary results in a change in A’s assertion regarding the indefinite reinvestment of the subsidiary’s earnings associated with the interest sold by A. This is considered an indirect tax effect and recognized as income tax expense in continuing operations.
Below is A’s journal
entry on January 1, 20Y0, to account for the income tax
effects of the sale of its interest in the foreign
subsidiary:
In addition, as a result of the sale, A should reassess
its intent and ability to indefinitely reinvest the
earnings of the foreign subsidiary associated with its
remaining 70 percent ownership interest. A DTL should be
recognized if circumstances have changed and A concludes
that the temporary difference is now expected to reverse
in the foreseeable future. This reassessment and the
recording of any DTL may occur in a period preceding the
actual sale of its ownership interest, since a liability
should be recorded when A’s assertion regarding
indefinite reinvestment changes.
12.4.2 Noncontrolling Interests in Pass-Through Entities: Income Tax Financial Reporting Considerations
ASC 810-10-45-18 through 45-21 require consolidating entities to report earnings
attributed to noncontrolling interests as part of consolidated earnings and not
as a separate component of income or expense. Thus, the income tax expense
recognized by the consolidating entity will include the total income tax expense
of the consolidated entity. When there is a noncontrolling interest in a
consolidated entity, the amount of income tax expense that is consolidated will
depend on whether the noncontrolling interest is a pass-through (i.e., a U.S.
partnership) or taxable entity (e.g., a U.S. C corporation).
ASC 810 does not affect how entities determine income tax expense under ASC 740.
Typically, no income tax expense is attributable to a pass-through entity;
rather, such expense is attributable to its owners. Therefore, a consolidating
entity with an interest in a pass-through entity should recognize income taxes
only on its controlling interest in the pass-through entity’s pretax income. The
income taxes on the pass-through entity’s pretax income attributed to the
noncontrolling interest holders should not be included in the consolidated
income tax expense.
Example 12-6
Entity X has a 90 percent controlling interest in
Partnership Y (an LLC). Partnership Y is a pass-through
entity and is not subject to income taxes in any
jurisdiction in which it operates. Entity X’s pretax
income for 20X3 is $100,000. Partnership Y has pretax
income of $50,000 for the same period. Entity X has a
tax rate of 25 percent. For simplicity, this example
assumes that there are no temporary differences.
Given the facts above, X
would report the following in its consolidated income
statement for 20X3:
In this example, ASC 810 does not affect how X determines
income tax expense under ASC 740, since X recognizes
income tax expense only for its controlling interest in
the income of Y. However, ASC 810 does affect the ETR of
X. Given the impact of ASC 810, X’s ETR is 24.2 percent
($36,250/$150,000). Provided that X is a public entity
and that the reconciling item is significant, X should
disclose the tax effect of the amount of income from Y
attributed to the noncontrolling interest in its
numerical reconciliation from expected to actual income
tax expense.
12.5 Regulated Entities
ASC 980-740
Income Taxes Applicable to Regulated Entities
25-1 For regulated
entities that meet the criteria for application of paragraph
980-10-15-2, this Subtopic specifically:
- Prohibits net-of-tax accounting and reporting
- Requires recognition of a deferred tax liability for tax benefits that are flowed through to customers when temporary differences originate and for the equity component of the allowance for funds used during construction
- Requires adjustment of a deferred tax liability or asset for an enacted change in tax laws or rates.
25-2 If, as a
result of an action by a regulator, it is probable that the
future increase or decrease in taxes payable for (b) and (c) in
the preceding paragraph will be recovered from or returned to
customers through future rates, an asset or liability shall be
recognized for that probable future revenue or reduction in
future revenue pursuant to paragraphs 980-340-25-1 and
980-405-25-1. That asset or liability also shall be a temporary
difference for which a deferred tax liability or asset shall be
recognized.
25-3 Example 1 (see
paragraph 980-740-55-8) illustrates recognition of an asset for
the probable revenue to recover future income taxes.
25-4 Example 2 (see
paragraph 980-740-55-13) illustrates adjustment of a deferred
tax liability when the liability represents amounts already
collected from customers.
12.5.1 Regulated Entities Subject to ASC 980
Regulated entities preparing financial statements under U.S. GAAP would apply ASC
740 when determining the tax amounts to record. In addition, ASC 980-740 relies
on the general standards of accounting for the effects of regulation in ASC 980
and, in a manner consistent with those standards, requires recognition of (1) an
asset when a DTL is recognized if it is probable that future revenue will be
provided for the payment of those DTLs and (2) a liability when a DTA is
recognized if it is probable that a future reduction in revenue will result when
that DTA is realized.
ASC 980-740-25-1 prohibits net-of-tax accounting on the basis that commingling
assets and liabilities with their related tax effects confuses the relationship
among the various classifications in financial statements. Therefore, in
accordance with ASC 980-740-25-1, regulated entities should adjust the reported
net-of-tax amount of construction in progress and plant in service to the pretax
amount.
12.6 Special Situations
12.6.1 Distinguishing a Change in Estimate From a Correction of an Error
A change in a prior-year tax provision can arise from either a change in
accounting estimate or the correction of an error.
The primary source of guidance on accounting changes and error corrections is ASC
250. ASC 250-10-20 defines a change in accounting estimate as a “change that has
the effect of adjusting the carrying amount of an existing asset or liability .
. . . Changes in accounting estimates result from new information.” A change in
a prior-year tax provision is a change in accounting estimate if it results from
new information, a change in facts and circumstances, or later identification of
information that was not reasonably knowable or readily accessible as of the
prior reporting period. In addition, ASC 740-10-25-14 and ASC 740-10-35-2 state
that the subsequent recognition and measurement of a tax position should “be
based on management’s best judgment given the facts, circumstances, and
information available at the reporting date” and that subsequent changes in
management’s judgment should “result from the evaluation of new information and
not from a new evaluation or new interpretation by management of information
that was available in a previous financial reporting period.”
In contrast, ASC 250-10-20 defines an error in previously issued
financial statements (an “error”) as an “error in recognition, measurement,
presentation, or disclosure in financial statements resulting from mathematical
mistakes, mistakes in the application of [GAAP], or oversight or misuse of facts
that existed at the time the financial statements were prepared. A change from
an accounting principle that is not generally accepted to one that is generally
accepted is a correction of an error.” In determining whether the change is a
correction of an error, an entity should consider whether the information was or
should have been “reasonably knowable” or “readily accessible” from the entity’s
books and records in a prior reporting period and whether the application of
information at that time would have resulted in different reporting. The
determination of when information was or should have been reasonably knowable or
readily accessible will depend on the entity’s particular facts and
circumstances.
Distinguishing between a change in accounting estimate and a
correction of an error is important because they are accounted for and reported
differently. In accordance with ASC 250-10-45-23, an error correction is
typically accounted for by restating prior-period financial statements.
However, ASC 250-10-45-17 specifies that a change in accounting estimate is
accounted for prospectively “in the period of change if the change affects that
period only or in the period of change and future periods if the change affects
both.” Under ASC 250-10-50-4, if the change in estimate affects several future
periods, an entity must disclose the “effect on income from continuing
operations, net income (or other appropriate captions of changes in the
applicable net assets or performance indicator), and any related per-share
amounts of the current period.”
If the change to the prior-period tax provision is determined to be an error, the
entity should look to ASC 250 for guidance on how to report the correction of
the error. Additional guidance is also provided by SAB Topics 1.M (SAB 99) and 1.N (SAB 108).
An entity must often use judgment in discerning whether a change
in a prior-year tax provision results from a correction of an error or a change
in estimate.
The following are examples of changes that should be accounted for as changes in
accounting estimate:
- A change in judgment (as a result of a change in facts or circumstances or the occurrence of an event) regarding the sustainability of a tax position or the need for a valuation allowance.
- The issuance of a new administrative ruling.
- Obtaining additional information on the basis of the experience of other taxpayers with similar circumstances.
- Adjusting an amount for new information that would not have been readily accessible from the entity’s books and records as of the prior reporting date. For example, to close its books on a timely basis, an entity may estimate certain amounts that are not readily accessible. In this case, as long as the entity had a reasonable basis for its original estimate, the subsequent adjustment is most likely a change in estimate.
- Developing, with the assistance of tax experts, additional technical insight into the application of the tax law with respect to prior tax return positions involving very complex or technical tax issues. Because both tax professionals and the tax authorities are continually changing and improving their understanding of complex tax laws, such circumstances typically constitute a change in estimate rather than an error.
- Making a retroactive tax election that affects positions taken on prior tax returns if the primary factors motivating such a change can be tied to events that occurred after the balance sheet date.
- Deciding to pursue a tax credit or deduction retroactively that was previously considered not to be economical but that becomes prudent because of a change in facts and circumstances. Such a decision is a change in estimate if the entity evaluated the acceptability of the tax position as of the balance sheet date and analyzed whether the tax position was economical but concluded that it was not prudent to pursue this benefit. The decision would not be considered a change in estimate if the entity did not consider or otherwise evaluate the acceptability of the tax position as of the balance sheet date.
The following are examples of changes that should be accounted for as error corrections:
- Intentionally misstating a tax accrual.
- Discovering a mathematical error in a prior-year income tax provision.
- Oversight or misuse of facts or failure to use information that was reasonably knowable and readily accessible as of the balance sheet date.
- Misapplying a rule or requirement or the provisions of U.S. GAAP. One example is a situation in which an entity fails to record a DTA, a DTL, a tax benefit, or a liability for UTBs that should have been recognized in accordance with ASC 740 on the basis of the facts and circumstances that existed as of the reporting date that were reasonably knowable when the financial statements were issued.
- Adjusting an amount for new information that would have been readily accessible from the entity’s books and records as of the prior reporting period. In assessing whether information was or should have been “readily accessible,” an entity should consider the nature, complexity, relevance, and frequency of occurrence of the item.
12.7 Investments Accounted for Under the Proportional Amortization Method
See Appendixes
C and D
of Deloitte’s Roadmap Equity
Method Investments and Joint Ventures for interpretative
guidance on investments accounted for under the proportional amortization method in
accordance with ASC 323-740.