4.4 Interest (Expense and Income) and Penalties
ASC 740-10
30-29
Paragraph 740-10-25-56 establishes the requirements under which
an entity shall accrue interest on an underpayment of income
taxes. The amount of interest expense to be recognized shall be
computed by applying the applicable statutory rate of interest
to the difference between the tax position recognized in
accordance with the requirements of this Subtopic for tax
positions and the amount previously taken or expected to be
taken in a tax return.
30-30
Paragraph 740-10-25-57 establishes both when an entity shall
record an expense for penalties attributable to certain tax
positions as well as the amount.
4.4.1 Interest Expense
ASC 740-10-30-29 requires that an entity recognize and compute
interest expense by applying the applicable statutory rate of interest to the
difference between the tax position recognized in the financial statements, in
accordance with ASC 740, and the as-filed tax position.
Paragraphs B52 and B53 of Interpretation 48, which were not codified, explain that the FASB, during its redeliberations of the provisions of Interpretation 48, considered whether to require accrual of interest on (1) management’s best estimate of the amount that would ultimately be paid to the tax authority upon settlement or (2) the difference between the tax benefit of the as-filed tax position and the amount recognized in the financial statements. The FASB concluded that accruing interest on the basis of management’s best estimate would be inconsistent with the approach required in Interpretation 48 for recognizing tax positions and that the
amount of interest and penalties recognized should be consistent with the amount of
tax benefits reported in the financial statements.
4.4.2 Interest Income
ASC 740 does not discuss the recognition and measurement of interest income on UTBs;
however, an entity should recognize and measure interest income to be received on an
overpayment of income taxes in the first period in which the interest would begin
accruing according to the provisions of the relevant tax law.
4.4.3 Penalties
Penalties should be accrued if the position does not meet the minimum statutory
threshold necessary to avoid payment of penalties unless a widely understood
administrative practices and precedents exception (discussed below) is
applicable.
In many jurisdictions, penalties may be imposed when a specified
threshold of support for a tax position taken is not met. In the United States, some
penalties are transaction-specific (i.e., not based on taxable income) and others,
such as penalties for substantial underpayment of taxes, are based on the amount of
additional taxes due upon settlement with the tax authority. Taxing authorities may
also assess penalties that are unrelated to income taxes. For example, a taxing
authority may impose penalties associated with taxes that are outside the scope of
ASC 740 or that are related to informational filings. Penalties that are not related
to an income tax are not generally within the scope of ASC 740. Such penalties are
also not within the scope of the entity’s policy for presenting interest and
penalties in the income statement and balance sheet (see Section 13.3.1).
ASC 740-10-25-57 indicates that an entity must recognize, on the basis of the
relevant tax law, an expense for the amount of a statutory penalty in the period in
which the tax position that would give rise to a penalty has been taken or is
expected to be taken in the tax return. Penalties required under the relevant tax
law should thus be recorded in the same period in which the liability for UTBs is
recognized. If the penalty was not recorded when the tax position was initially
taken because the position met the minimum statutory threshold, the entity should
recognize the expense in the period in which its judgment about meeting the minimum
statutory threshold changes.
Example 4-2
On December 31, 20X7, a calendar-year-end entity expects to a
take a tax position that will reduce its tax liability in
its 20X7 tax return, which will be filed in 20X8. The entity
concludes that the tax position lacks the specified
confidence level (e.g., substantial authority) required to
avoid the payment of a penalty under the relevant tax law.
In its December 31, 20X7, financial statements, the entity
should record a liability for the penalty amount the tax
authority is expected to assess on the basis of the relevant
tax law.
An entity should consider a tax authority’s widely understood administrative
practices and precedents in determining whether the minimum statutory threshold to
avoid the assessment of penalties has been met. If the tax authority has a widely
understood administrative practice or precedent that modifies the circumstances
under which a penalty is assessed (relative to the statutory criteria), the entity
should consider this administrative practice or precedent in determining whether a
penalty should be assessed. Anecdotal evidence, such as the entity’s historical
experience with the tax authority in achieving penalty abatement, would not be
considered an administrative practice.
To take such a widely understood policy into consideration, the entity must conclude
that the tax authority would not assess penalties provided that the tax authority
has full knowledge of all the relevant facts. The use of such a policy is limited to
whether the tax authority would assess penalties. It does not apply to the
determination of the amount of penalties that the entity will actually pay once they
are assessed. That is, a tax authority’s historical practice of abating penalties
during negotiations with the entity when the threshold to avoid the assessment of
penalties has not been met is not relevant to the accrual and measurement of
penalties. If the entity concludes that penalties are applicable under ASC
740-10-25-56 because there is no widely understood policy, the entity must calculate
the penalties to accrue on the basis of the applicable tax code.
Example 4-3
A U.S. corporate entity applies the
provisions of ASC 740 to its tax positions and recognizes a
liability for its UTBs. The entity accrues interest by
applying the applicable statutory rate of interest to the
difference between the tax position recognized in the
financial statements, in accordance with ASC 740, and the
as-filed tax position. The entity identifies a written
policy in the tax authority’s manual that allows its field
agents to ignore the statute and not assess penalties when
an entity has a reasonable basis for its return position and
the tax authority has routinely applied the exception in
circumstances that are similar to the entity’s specific
situation. The entity should consider that policy when
determining whether it must accrue penalties related to its
UTBs.
Example 4-4
An entity applies the provisions of ASC 740
to its tax positions and recognizes a liability for its
UTBs. The entity accrues interest by applying the applicable
statutory rate of interest to the difference between the tax
position recognized in the financial statements, in
accordance with ASC 740, and in the as-filed tax position.
The entity did not meet the minimum statutory threshold to
avoid assessment of penalties; however, the entity’s past
experience indicates that it is probable that the tax
authority will abate all penalties assessed during the
examination process. The entity may not take its past
experience into consideration because it does not constitute
a widely understood administrative practice or precedent
relative to whether a penalty would be assessed under the
circumstances. Since the entity did not meet the minimum
statutory threshold to avoid the assessment of penalties,
the entity must accrue penalties on the basis of the
applicable statutory rate.
See Section 13.3.1 for a discussion related to presentation of
interest (expense and income) and penalties in the financial statements.