14.3 Income Statement

ASC 740-10

50-9 The significant components of income tax expense attributable to continuing operations for each year presented shall be disclosed in the financial statements or notes thereto. Those components would include, for example:

Current tax expense (or benefit)
Deferred tax expense (or benefit) (exclusive of the effects of other components listed below)
Investment tax credits
Government grants (to the extent recognized as a reduction of income tax expense)
The benefits of operating loss carryforwards
Tax expense that results from allocating certain tax benefits directly to contributed capital
Adjustments of a deferred tax liability or asset for enacted changes in tax laws or rates or a change in the tax status of the entity
Adjustments of the beginning-of-the-year balance of a valuation allowance because of a change in circumstances that causes a change in judgment about the realizability of the related deferred tax asset in future years. For example, any acquisition-date income tax benefits or expenses recognized from changes in the acquirer’s valuation allowance for its previously existing deferred tax assets as a result of a business combination (see paragraph 805-740-30-3).

50-10 The amount of income tax expense (or benefit) allocated to continuing operations and the amounts separately allocated to other items (in accordance with the intraperiod tax allocation provisions of paragraphs 740-20-45-2 through 45-14 and 852-740-45-3) shall be disclosed for each year for which those items are presented.

50-11 The reported amount of income tax expense may differ from an expected amount based on statutory rates. The following guidance establishes the disclosure requirements for such situations and differs for public and nonpublic entities.

Public Entities

50-12 A public entity shall disclose a reconciliation using percentages or dollar amounts of the reported amount of income tax expense attributable to continuing operations for the year to the amount of income tax expense that would result from applying domestic federal statutory tax rates to pretax income from continuing operations. The statutory tax rates shall be the regular tax rates if there are alternative tax systems. The estimated amount and the nature of each significant reconciling item shall be disclosed.

Nonpublic Entities

50-13 A nonpublic entity shall disclose the nature of significant reconciling items but may omit a numerical reconciliation.

All Entities

50-14 If not otherwise evident from the disclosures required by this Section, all entities shall disclose the nature and effect of any other significant matters affecting comparability of information for all periods presented.

Related Implementation Guidance and Illustrations

Income-Tax-Related Disclosures [ASC 740-10-55-79].
Example 29: Disclosure Related to Components of Income Taxes Attributable to Continuing Operations [ASC 740-10-55-212].

14.3.1 Rate Reconciliation

Reporting entities often pay income taxes in multiple jurisdictions other than the domestic federal jurisdiction (e.g., domestic state and local jurisdictions, foreign federal and foreign local or provincial jurisdictions), and the applicable income tax rates vary in each jurisdiction. Further, tax laws often differ from financial accounting standards; therefore, permanent differences can arise between pretax income for financial reporting purposes and taxable income.

Thus, a reporting entity’s income tax expense cannot generally be determined for a period by simply applying the domestic federal statutory tax rate to the reporting entity’s pretax income from continuing operations for financial reporting purposes. See ASC 740-10-50-12 and 50-13 above.

The disclosure requirement addressed by ASC 740-10-50-12 and 50-13 is often referred to as the “rate reconciliation” disclosure requirement. ASC 740 does not require a reporting entity to include a specific number or type of reconciling items in the rate reconciliation. Reconciling items will vary depending on the reporting entity’s facts and circumstances. However, the SEC staff frequently comments on rate reconciliation disclosures that are not clear and transparent. A reporting entity should evaluate its reconciling items to ensure that they clearly communicate to financial statement users the events and circumstances affecting the reporting entity’s ETR.

14.3.1.1 Evaluating Significance of Reconciling Items in the Rate Reconciliation

ASC 740-10-50 does not define the term “significant.” However, SEC Regulation S-X, Rule 4-08(h)(2), states that as part of the reconciliation, public entities should disclose all reconciling items that individually make up 5 percent or more of the computed amount (i.e., income before tax multiplied by the applicable domestic federal statutory tax rate).

Reconciling items may be aggregated in the disclosure if they are individually less than 5 percent of the computed amount. Reconciling items that are individually equal to or greater than 5 percent of the computed amount should not be netted against other offsetting reconciling items into a single line item that is itself less than 5 percent.

SEC Regulation S-X, Rule 4-08(h)(2), states, in part, that public entities can omit this reconciliation in the following circumstances:

[When] no individual reconciling item amounts to more than five percent of the amount computed by multiplying the income before tax by the applicable statutory Federal income tax rate, and the total difference to be reconciled is less than five percent of such computed amount, no reconciliation need be provided unless it would be significant in appraising the trend of earnings.

Because SEC Regulation S-X, Rule 4-08(h), does not apply to non-PBEs, such entities must often use judgment in determining whether they need to disclose the nature of a particular reconciling item or items.

14.3.1.2 Appropriate Federal Statutory Rate for Use in the Rate Reconciliation of a Foreign Reporting Entity

ASC 740-10-50-12 indicates that the federal statutory income tax rate a foreign reporting entity (i.e., the parent of the consolidated group that is not domiciled in the United States) should use when preparing the rate reconciliation disclosure should be based on application of “domestic federal statutory tax rates to pretax income from continuing operations.” SEC Regulation S-X, Rule 4-08(h)(2), states, in part:

Where the reporting person is a foreign entity, the income tax rate in that person’s country of domicile should normally be used in making the above computation, but different rates should not be used for subsidiaries or other segments of a reporting entity.

As noted, the appropriate rate for public entities is normally the federal rate in the reporting entity’s jurisdiction of domicile. That rate should be applied to pretax income from continuing operations of all subsidiaries or other segments of the reporting entity, even if most of the operations are located outside that jurisdiction.1 SEC Regulation S-X, Rule 4-08(h)(2), also notes that if the rate used differs from the U.S. federal corporate income tax rate (e.g., because the reporting entity is domiciled in a foreign jurisdiction), “the rate used and the basis for using such rate shall be disclosed.”

Question 1 in paragraph 5 of SAB Topic 6.I (codified in ASC 740-10-S99-1(5)) provides an exception to the general rule and states:

Question 1: Occasionally, reporting foreign persons may not operate under a normal income tax base rate such as the current U.S. Federal corporate income tax rate. What form of disclosure is acceptable in these circumstances?

Interpretive Response: In such instances, reconciliations between year-to-year effective rates or between a weighted average effective rate and the current effective rate of total tax expense may be appropriate in meeting the requirements of Rule 4-08(h)(2). A brief description of how such a rate was determined would be required in addition to other required disclosures. Such an approach would not be acceptable for a U.S. registrant with foreign operations. Foreign registrants with unusual tax situations may find that these guidelines are not fully responsive to their needs. In such instances, registrants should discuss the matter with the staff.

The use of a rate other than the federal rate in the reporting entity’s jurisdiction of domicile could be subject to challenge and, accordingly, consultation is encouraged in these situations.

While SEC Regulation S-X, Rule 4-08(h), does not apply to non-PBEs, we believe that it would generally be appropriate for such entities to determine the domestic federal statutory rate in a manner consistent with how public reporting entities determine it.

14.3.1.3 Computing the “Foreign Rate Differential” in the Rate Reconciliation

The unit of account for various reconciling items is not always clear. For example, an entity with foreign operations will commonly include a reconciling item referred to as a “foreign rate differential.” Because it is often unclear what the foreign rate differential reconciling line should include, diversity in practice exists.

We believe that a line in the rate reconciliation described as the foreign rate differential should generally include only the effects on an entity’s ETR of differences between the domestic federal statutory tax rate and the statutory income tax rate in the applicable foreign jurisdiction(s), multiplied by pretax income from continuing operations in each respective foreign jurisdiction.

14.3.2 Other Income Statement Disclosure Considerations

ASC 740-10-50-9 requires an entity to disclose significant components of income tax expense or benefit that are attributable to continuing operations for each year presented in the financial statements.

14.3.2.1 Disclosure of the Components of Deferred Tax Expense

One of the components required to be disclosed in ASC 740-10-50-9 is deferred tax expense (or benefit). In many circumstances, certain changes between the beginning-of-year and end-of-year deferred tax balances do not affect the total deferred tax expense or benefit. Examples of such circumstances include, but are not limited to, the following:

If a business combination has occurred during the year, DTLs and DTAs, net of any related valuation allowance, are recorded as of the acquisition date as part of acquisition accounting. There would be no offsetting effect to the income tax provision.
If a single asset is purchased (other than as part of a business combination) and the amount paid is different from the tax basis attributable to the asset, the tax effect should be recorded as an adjustment to the carrying amount of the related asset in accordance with ASC 740-10-25-51.
For consolidated subsidiaries in foreign jurisdictions for which the functional currency is the same as the parent’s reporting currency but income taxes are assessed in the local currency, deferred tax balances should be remeasured in the functional currency as transaction gains or losses or, if considered more useful, as deferred tax benefit or expense, as described in ASC 830-740-45-1.
For consolidated subsidiaries in foreign jurisdictions for which the local currency is the functional currency and income taxes are assessed in the local currency, deferred tax balances should be translated into the parent’s reporting currency through the CTA account. The revaluations of the deferred tax balances are not identified separately from revaluations of other assets and liabilities.

In addition, other changes in deferred tax balances might result in an increase or a decrease in the total tax provision but are allocated to a component of current-year activity other than continuing operations (e.g., discontinued operations and the items in ASC 740-20-45-11 such as OCI).

14.3.2.2 Disclosure of the Tax Effect of a Change in Tax Law, Rate, or Tax Status

ASC 740-10-50-9(g) requires an entity to disclose the tax consequences of adjustments to a DTL or DTA for enacted changes in tax laws or rates or a change in the entity’s tax status. An entity may provide such disclosures on the face of its income statement as a separate line item component (e.g., a subtotal) that, in the aggregate, equals the total amount of income tax expense (benefit) allocated to income (loss) from continuing operations for each period presented. However, the entity should not present the effects of these changes on the face of the income statement or in the footnotes in terms of per-share earnings (loss) amounts available to common shareholders because such disclosure would imply that the normal earnings per share (EPS) disclosures required by ASC 260 are not informative or are misleading.

Footnotes

This would apply to (or include) a tax inversion.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.