2.8 Obligations for Indemnification of Uncertain Tax Positions of a Subsidiary Upon Sale — Subsidiary Previously Filed a Separate Tax Return

Assume that Company A enters into an agreement to sell 100 percent of the outstanding stock in its wholly owned subsidiary, Company Z, to Company B. Before the sale, Z files a separate tax return in which a tax position is taken that requires the recognition of a liability for an unrecognized tax benefit (UTB). As part of the purchase agreement, A indemnifies B for any future settlement with the tax authority in connection with the uncertain tax position taken by Z in its prior tax return.

Because Z filed a separate tax return, A is not directly liable for any of Z’s tax obligations after the sale. By indemnifying B for any loss related to Z’s prior tax positions, however, A has entered into a guarantee contract, which would generally be within the scope of ASC 460 (see ASC 460-10-15-4(c) and ASC 460-10-55-13(c)).

Therefore, A would generally recognize a guarantee liability on the sale date and on each reporting date thereafter in accordance with the recognition and measurement provisions of ASC 460.

Assume the following:

• The uncertain tax benefit is $110.
• Settlement of the indemnification liability would result in a deduction for the seller.
• The guarantee is within the scope of ASC 460, and the initial guarantee liability determined under ASC 460 is $100.
• Company A has an ETR of 25 percent.
• For A, the disposition of Z does not qualify for presentation as a discontinued operation in accordance with ASC 205-20.

The following entries illustrate A’s accounting for the UTB upon the sale of Z.

To record the indemnification liability (recognition would adjust the seller’s gain and loss on sale):

To record the deductible temporary difference related to the difference between the reported amount and the tax basis of the indemnification liability (i.e., 25% of $100):

If the UTB liability were ultimately settled with the tax authority for $76, Z would make a cash payment to the tax authority and A would make a cash payment to B in satisfaction of its indemnification liability. The following entries illustrate A’s accounting upon settlement.

To record the settlement of its indemnification liability — by transferring cash to B — for less than the recorded amount of the guarantee liability:

To record the reduction in taxes payable related to the deduction for the payment of the indemnification and reversal of the related DTA, resulting in total net current and deferred tax expense in the period of payment of $6 ($25 deferred tax expense less $19 current tax benefit [i.e., 25% of $76]):