14.10 Disclosures Outside the Financial Statements — MD&A

The filings of public entities must include MD&A. Discussion and analysis of income taxes is an important part of an entity’s MD&A since income taxes can be a significant factor in the entity’s operating results. Such discussion should address the following (if material):

• Critical accounting estimates — The determination of income tax expense, DTAs and DTLs, and UTBs inherently involves several critical accounting estimates of current and future taxes to be paid. Management should provide information about the nature of these estimates in MD&A.
• Liquidity and capital resources — The SEC staff expects registrants to disclose (1) the amount of cash and short-term investments held by foreign subsidiaries that would not be available to fund domestic operations unless the funds were repatriated and (2) whether additional tax expense would need to be recognized if the funds are repatriated. Although we expect scenarios such as these to be less prevalent than they have been historically, an entity may still be subject to income tax on its foreign investments (e.g., foreign exchange gains or losses on distributions and withholding taxes).
• Contractual obligations — See Section 14.4.5.

In addition to discussing the results of operations, SEC Regulation S-K, Item 303(a), requires entities to provide certain forward-looking information related to “material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.”

Many tax-related events and uncertainties may need to be elaborated on in MD&A. For instance, before the enactment of tax law proposals or changes to existing tax rules, an SEC registrant should consider whether the potential changes represent an uncertainty that management reasonably expects could have a material effect on the registrant’s results of operations, financial position, liquidity, or capital resources. If so, the registrant should consider disclosing information about the scope and nature of any potential material effects of the changes.

After the enactment of a new tax law, registrants should consider disclosing, when material, the anticipated current and future impact of the law on their results of operations, financial position, liquidity, and capital resources. In addition, registrants should consider providing disclosures in the critical accounting estimates section of MD&A to the extent that the changes could materially affect existing assumptions used in estimating tax-related balances.

The SEC staff also expects registrants to provide early-warning disclosures to help users understand various risks and how those risks potentially affect the financial statements. Examples of such risks include situations in which (1) the registrant may have to repatriate foreign earnings to meet current liquidity demands, resulting in a tax payment (e.g., withholding taxes) that may not be accrued for; (2) the historical effective tax rate is not sustainable and may change materially; (3) the valuation allowance on net DTAs may change materially; and (4) tax positions taken during the preparation of returns may ultimately not be sustained. Early-warning disclosures give investors insight into management’s underlying assumptions as well as the conditions and risks an entity faces before a material change or decline in performance is reported.