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 discussion of 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
would 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.