Chapter 13 — Presentation of Income Taxes

It is not appropriate to net the federal effect of a state DTL or DTA against the state deferred tax. ASC 740 generally requires separate identification of temporary differences and related deferred taxes for each tax-paying component of an entity in each tax jurisdiction, including U.S. federal, state, local, and foreign tax jurisdictions. ASC 740-10-45-6 states the following regarding the offsetting of DTAs and DTLs:

For example, assume that Company A has a state DTL of $100 related to a fixed asset and that this DTL represents taxes that will need to be paid when the fixed asset is recovered at its financial reporting carrying amount. The future state taxes will result in a $100 deduction on the U.S. federal income tax return, and a DTA of $21 ($100 deduction × 21% tax rate) should be recognized for that future deduction. In this example, A should report a $100 state DTL and separately report a $21 federal DTA. It would not be appropriate to report a “net of federal tax benefit” state DTL of $79.

In addition to improper presentation of DTAs and DTLs in the balance sheet, improperly netting the federal effect of state deferred taxes against the state deferred taxes themselves can result in, among other things, (1) an improper assessment of whether a valuation allowance is necessary in a particular jurisdiction or (2) improper disclosures related to DTAs and DTLs.

On the basis of this guidance, an entity will generally classify a liability associated with a UTB as a noncurrent liability because the period between the filing of the tax return and the final resolution of an uncertain tax position with the tax authority will generally extend over several years. An entity should classify as a current liability only those cash payments that management expects to make within the next 12 months to settle liabilities for UTBs.

In addition, an entity should reclassify a liability from noncurrent to current only when a change in the balance of the liability is expected to result from a payment of cash within one year or the operating cycle, if longer. For example, the portion of the liability for a UTB that is expected to reverse because of the expiration of the statute of limitations within the next 12 months would not be reclassified as a current liability. See Section 14.4.1 for more information on the disclosure requirements related to UTBs.

Assume that an entity takes, or expects to take, a $200 deduction in the U.S. federal tax jurisdiction related to a UTB in its current-year tax return and for which the entity records a UTB of $40 (20 percent tax rate × $200) in its financial statements. This UTB would be settled as of the reporting date without the payment of cash because of the application of available tax NOL carryforwards of $1,000 in the U.S. federal tax jurisdiction for which the entity has recognized a $200 DTA.

As discussed in ASC 740-10-45-10A and 45-10B, the entity’s balance sheet should reflect the UTB as a reduction of the entity’s NOL carryforward DTAs. Under ASC 740-10-45-10A, an entity must present a UTB, or a portion of a UTB, in its balance sheet “as a reduction to a deferred tax asset for [an NOL] carryforward, a similar tax loss, or a tax credit carryforward” except when:

• An NOL or other carryforward is not available under the governing tax law to settle taxes that would result from the disallowance of the tax position.
• The entity does not intend to use the DTA for this purpose (provided that the tax law permits a choice).

If either of these conditions exists, an entity should present a UTB as a liability and not net the UTB with a DTA.

The assessment of whether to net the UTB with a DTA should be performed as of the reporting date (i.e., on a hypothetical-return basis). The entity should not evaluate whether the DTA will expire or be used before the UTB is settled. However, the entity must consider whether there are any limitations on the use of the DTA in the relevant tax jurisdiction.

Therefore, if the uncertain tax position of $200 is not sustained, the entity may use its $1,000 NOL carryforward to offset such a position, thus resulting in a $40 reduction to the existing NOL carryforward DTA of $200. That is, the entity would present a net DTA of $160.

In some cases, if two governments follow the Organisation for Economic Co-operation and Development’s transfer pricing guidelines to resolve substantive issues related to transfer pricing transactions between units of the same entity, an asset could be recognized in one jurisdiction because of the application of competent-authority procedures and a liability could be recognized for UTBs from another tax jurisdiction that arose because of transactions between the entity’s affiliates that were not being considered at arm’s length.

In this case, an entity should present the liability for UTBs and the tax benefit on a gross basis in its balance sheet. In addition, a public entity would include only the gross liability for UTBs in the tabular reconciliation disclosure. However, in the disclosure required by ASC 740-10-50-15A(b), the public entity would include the liability for UTBs and the tax benefit on a net basis in the amount of UTBs that, if recognized, would affect the ETR.

For more information on UTBs related to transfer pricing arrangements, see Section 4.6.3.

The liability for UTBs recognized under ASC 740 is not a result of the investment alternatives above; rather, it is a result of a difference in the amount of benefit recognized in the financial statements compared with the amount taken, or expected to be taken, in a tax return. The liability for UTBs is not a borrowing, as contemplated in ASC 835-20, and should not be considered a financing activity. Therefore, the related interest expense should not be capitalized but should be expensed as incurred.

It is preferable for a public entity to present interest income attributable to an overpayment of income taxes as an element of nonoperating income, separately stated in the income statement or in a note to the financial statements as interest on refund claims due from tax authorities.

On the basis of informal discussions with the SEC staff, we understand that the staff currently does not have a view on this matter and may not object to an entity’s including interest income attributable to overpayment of income taxes as an element of its provision for income taxes. Accordingly, the SEC staff has advised us that if an entity’s accounting policy is to include interest income attributable to overpayment of income taxes within the provision for income taxes, this policy must be prominently disclosed and transparent to financial statement users. The SEC staff has also indicated that it believes that a public entity that has an accounting policy to include interest income or expense on overpayments and underpayments of income taxes should consistently display such amounts as income tax in the balance sheets, statements of operations, statements of cash flows, and other supplemental disclosures. Further, we believe that companies should present interest income in a manner consistent with the policy election related to interest expense on UTBs. See Section 14.4.4.1 for more information regarding disclosures related to interest income.

It is not appropriate for an entity to include such costs as income tax expense or benefit in the financial statements. ASC 740 defines income tax expense (or benefit) as the sum of current tax expense (benefit) and deferred tax expense (benefit), neither of which would include fees paid to professionals in connection with tax matters.

Further, SEC Regulation S-X, Rule 5-03(b)(11),3 specifies that an entity should include only taxes based on income within the income tax expense caption in the income statement. Therefore, it is inappropriate to include professional fees within the income tax caption.