4.2 Recognition
ASC 740-10
25-5 This Subtopic requires the
application of a more-likely-than-not recognition criterion
to a tax position before and separate from the measurement
of a tax position. See paragraph 740-10-55-3 for guidance
related to this two-step process.
25-6 An entity shall initially
recognize the financial statement effects of a tax position
when it is more likely than not, based on the technical
merits, that the position will be sustained upon
examination. The term more likely than not means a
likelihood of more than 50 percent; the terms
examined and upon examination also include
resolution of the related appeals or litigation processes,
if any. For example, if an entity determines that it is
certain that the entire cost of an acquired asset is fully
deductible, the more-likely-than-not recognition threshold
has been met. The more-likely-than-not recognition threshold
is a positive assertion that an entity believes it is
entitled to the economic benefits associated with a tax
position. The determination of whether or not a tax position
has met the more-likely-than-not recognition threshold shall
consider the facts, circumstances, and information available
at the reporting date. The level of evidence that is
necessary and appropriate to support an entity’s assessment
of the technical merits of a tax position is a matter of
judgment that depends on all available information.
25-7 In making the required
assessment of the more-likely-than-not criterion:
-
It shall be presumed that the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information.
-
Technical merits of a tax position derive from sources of authorities in the tax law (legislation and statutes, legislative intent, regulations, rulings, and case law) and their applicability to the facts and circumstances of the tax position. When the past administrative practices and precedents of the taxing authority in its dealings with the entity or similar entities are widely understood, for example, by preparers, tax practitioners and auditors, those practices and precedents shall be taken into account.
-
Each tax position shall be evaluated without consideration of the possibility of offset or aggregation with other positions.
25-8
If the more-likely-than-not recognition threshold is not met
in the period for which a tax position is taken or expected
to be taken, an entity shall recognize the benefit of the
tax position in the first interim period that meets any one
of the following conditions:
-
The more-likely-than-not recognition threshold is met by the reporting date.
-
The tax position is effectively settled through examination, negotiation or litigation.
-
The statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired.
Accordingly, a change in facts after the reporting date but
before the financial statements are issued or are available
to be issued (as discussed in Section 855-10-25) shall be
recognized in the period in which the change in facts
occurs.
25-9 A
tax position could be effectively settled upon examination
by a taxing authority. Assessing whether a tax position is
effectively settled is a matter of judgment because
examinations occur in a variety of ways. In determining
whether a tax position is effectively settled, an entity
shall make the assessment on a position-by-position basis,
but an entity could conclude that all positions in a
particular tax year are effectively settled.
25-10
As required by paragraph 740-10-25-8(b) an entity shall
recognize the benefit of a tax position when it is
effectively settled. An entity shall evaluate all of the
following conditions when determining effective
settlement:
-
The taxing authority has completed its examination procedures including all appeals and administrative reviews that the taxing authority is required and expected to perform for the tax position.
-
The entity does not intend to appeal or litigate any aspect of the tax position included in the completed examination.
-
It is remote that the taxing authority would examine or reexamine any aspect of the tax position. In making this assessment management shall consider the taxing authority’s policy on reopening closed examinations and the specific facts and circumstances of the tax position. Management shall presume the relevant taxing authority has full knowledge of all relevant information in making the assessment on whether the taxing authority would reopen a previously closed examination.
25-11
In the tax years under examination, a tax position does not
need to be specifically reviewed or examined by the taxing
authority to be considered effectively settled through
examination. Effective settlement of a position subject to
an examination does not result in effective settlement of
similar or identical tax positions in periods that have not
been examined.
25-12
An entity may obtain information during the examination
process that enables that entity to change its assessment of
the technical merits of a tax position or of similar tax
positions taken in other periods. However, the effectively
settled conditions in paragraph 740-10-25-10 do not provide
any basis for the entity to change its assessment of the
technical merits of any tax position in other periods.
25-13
The appropriate unit of account for determining what
constitutes an individual tax position, and whether the
more-likely-than-not recognition threshold is met for a tax
position, is a matter of judgment based on the individual
facts and circumstances of that position evaluated in light
of all available evidence. The determination of the unit of
account to be used shall consider the manner in which the
entity prepares and supports its income tax return and the
approach the entity anticipates the taxing authority will
take during an examination. Because the individual facts and
circumstances of a tax position and of an entity taking that
position will determine the appropriate unit of account, a
single defined unit of account would not be applicable to
all situations.
25-14
Subsequent recognition shall be based on management’s best
judgment given the facts, circumstances, and information
available at the reporting date. A tax position need not be
legally extinguished and its resolution need not be certain
to subsequently recognize the position. Subsequent changes
in judgment that lead to changes in recognition shall result
from the evaluation of new information and not from a new
evaluation or new interpretation by management of
information that was available in a previous financial
reporting period. See Sections 740-10-35 and 740-10-40 for
guidance on changes in judgment leading to derecognition of
and measurement changes for a tax position.
25-15
A change in judgment that results in subsequent recognition,
derecognition, or change in measurement of a tax position
taken in a prior annual period (including any related
interest and penalties) shall be recognized as a discrete
item in the period in which the change occurs. Paragraph
740-270-35-6 addresses the different accounting required for
such changes in a prior interim period within the same
fiscal year.
25-16
The amount of benefit recognized in the statement of
financial position may differ from the amount taken or
expected to be taken in a tax return for the current year.
These differences represent unrecognized tax benefits. A
liability is created (or the amount of a net operating loss
carryforward or amount refundable is reduced) for an
unrecognized tax benefit because it represents an entity’s
potential future obligation to the taxing authority for a
tax position that was not recognized under the requirements
of this Subtopic.
25-17
A tax position recognized in the financial statements may
also affect the tax bases of assets or liabilities and
thereby change or create temporary differences. A taxable
and deductible temporary difference is a difference between
the reported amount of an item in the financial statements
and the tax basis of an item as determined by applying this
Subtopic’s recognition threshold and measurement provisions
for tax positions. See paragraph 740-10-30-7 for measurement
requirements.
Related Implementation Guidance and Illustrations
-
Recognition and Measurement of Tax Positions — a Two-Step Process [ASC 740-10-55-3].
-
Example 1: The Unit of Account for a Tax Position [ASC 740-10-55-81].
-
Example 2: Administrative Practices — Asset Capitalization [ASC 740-10-55-90].
-
Example 3: Administrative Practices — Nexus [ASC 740-10-55-93].
-
Example 11: Information Becomes Available Before Issuance of Financial Statements [ASC 740-10-55-117].
-
Example 32: Definition of a Tax Position [ASC 740-10-55-223].
-
Example 33: Definition of a Tax Position [ASC 740-10-55-224].
-
Example 34: Definition of a Tax Position [ASC 740-10-55-225].
-
Example 35: Attribution of Income Taxes to the Entity or Its Owners [ASC 740-10-55-226].
-
Example 36: Attribution of Income Taxes to the Entity or Its Owners [ASC 740-10-55-227].
-
Example 37: Attribution of Income Taxes to the Entity or Its Owners [ASC 740-10-55-228].
-
Example 38: Financial Statements of a Group of Related Entities [ASC 740-10-55-229].
An assessment of whether a tax position meets the more-likely-than-not recognition
threshold is based on the technical merits of the tax position. If that threshold is
not met, no benefit can be recognized in the financial statements for that tax
position.
When recognizing a tax position, an entity must assess the position’s technical
merits under the tax law for the relevant jurisdiction. That assessment often
requires consultation with tax law experts.
4.2.1 Meaning of the Court of Last Resort and Its Impact on Recognition
As part of the technical merit assessment, an entity must assess what the outcome
of a dispute would be if the matter was taken to the court of last resort.
According to ASC 740-10-55-3, the “recognition threshold is met when the
taxpayer (the reporting entity) concludes that . . . it is more likely than not
that the taxpayer will sustain the benefit taken . . . in a dispute with taxing
authorities if the taxpayer takes the dispute to the court of last resort.”
The court of last resort is the highest court that has
discretion to hear a particular case in a particular jurisdiction. In
determining whether a tax position meets the more-likely-than-not recognition
threshold, an entity must consider how the court of last resort would rule. To
form a conclusion, an entity must examine all laws against which the court of
last resort would evaluate the tax position.
In the United States, the U.S. Supreme Court, as the highest judicial body, is
the highest court that has discretion to hear an income-tax-related case. It is
thus the ultimate court for deciding the constitutionality of federal or state
law. Many more cases are filed with the U.S. Supreme Court than are heard; the
justices exercise discretion in deciding which cases to hear.
When evaluating the recognition criteria in ASC 740, an entity should not
consider the likelihood that the U.S. Supreme Court will hear a case regarding
the constitutionality of the applicable tax law. In assessing the tax position
for recognition, the entity should assume that the case will be heard by the
court of last resort.
The highest courts of jurisdictions outside the United States that hear
income-tax-related cases may not be these jurisdictions’ supreme courts. In
addition, in foreign jurisdictions, supreme courts may also not evaluate a case
against laws other than income tax laws. Tax positions should be evaluated
against all laws that apply in each relevant jurisdiction.
4.2.2 Legal Tax Opinions Not Required
An entity is not required to obtain a legal tax opinion to support its conclusion
that a tax position meets the recognition criteria in ASC 740-10-25-6. However,
the entity must have sufficient evidence to support its assertion that a tax
benefit should be recognized on the basis of the technical merits of the
relevant law. In addition, the entity should determine whether it has the
appropriate expertise to evaluate all available evidence and the uncertainties
associated with the relevant statutes or case law. The entity must use judgment
in determining the amount and type of evidence it needs in addition to, or in
lieu of, a tax opinion to demonstrate whether the more-likely-than-not
recognition threshold is met.
4.2.3 Consideration of Widely Understood Administrative Practices and Precedents
When assessing whether a tax position meets the more-likely-than-not recognition
threshold, an entity is allowed under ASC 740 to consider past administrative
practices and precedents only when the tax position taken by the entity could
technically be a violation of tax law but is known to be widely accepted by the
tax authority. An example of this concept is the tax authority’s accepting the
immediate deduction of the cost of acquired fixed assets that are below a
reasonable dollar threshold even though this may be considered a technical
violation of the tax law.
Because ASC 740 does not provide guidance on when an administrative practice and
precedent is considered “widely understood,” this assertion depends on the
specific facts and circumstances of the tax position; therefore, an entity must
use professional judgment to decide what constitutes “widely understood.” An
entity that asserts that an administrative practice and precedent is widely
understood should document the basis of that assertion, including the evidence
to support it. Such evidence may include reliable knowledge of the tax
authority’s past dealings with the entity on the same tax matter when the facts
and circumstances have been similar. The use of administrative practices and
precedents is expected to be infrequent.
With respect to administrative practices and precedents, the SEC
has indicated1 that if a tax authority objects to an entity’s tax position but has
previously granted prospective transition by indicating that no additional taxes
would be due for prior periods, the entity should “consider
the taxing authority’s practice of addressing fund industry issues on a
prospective basis as part of the administrative practices and precedents of
the taxing authority” (emphasis added) when analyzing the technical
merits of the specific tax position.