4.6 Other Topics

4.6.1 Accounting for the Tax Effects of Tax Positions Expected to Be Taken in an Amended Tax Return or Refund Claim or to Be Self-Reported Upon Examination

In certain jurisdictions, an entity may elect to take a certain tax position on its original tax return but subsequently decide to take an alternative tax position (which is also acceptable) in an amended return. For example, an entity may amend a previously filed income tax return to retroactively elect a deduction for foreign taxes paid rather than to claim a credit or vice versa, or to file a refund claim to carry back a tax operating loss or tax credit to a prior year. Alternatively, an entity under examination may present to the examiner self-identified adjustments (i.e., affirmative adjustments) to change the amount of income, deductions, or credits reflected in the previously filed tax return that is under examination.2

The decision to file an amended tax return or refund claim or to self-report a tax position upon examination may be made before the end of the reporting period even though the process of actually preparing the amended tax return/refund claim, or self-reporting the tax position, might not occur until after the reporting period ends.

An entity should account for the tax effects of its intent to file amended tax returns or refund claims or to report self-identified audit adjustments (i.e., affirmative adjustments) in its financial statements by using the guidance in ASC 740-10. ASC 740-10-05-6 states, in part:

This Subtopic provides guidance for recognizing and measuring tax positions taken or expected to be taken in a tax return that directly or indirectly affect amounts reported in financial statements. [Emphasis added]

In addition, ASC 740-10-25-2 states:

Other than the exceptions identified in the following paragraph, the following basic requirements are applied in accounting for income taxes at the date of the financial statements:

A tax liability or asset shall be recognized based on the provisions of this Subtopic applicable to tax positions, in paragraphs 740-10-25-5 through 25-17, for the estimated taxes payable or refundable on tax returns for the current and prior years.
A deferred tax liability or asset shall be recognized for the estimated future tax effects attributable to temporary differences and carryforwards.

While an amended return or refund claim may be filed after the reporting period has ended, an entity should account for the tax effects in the period in which it concludes that it expects to amend the return or file the refund claim. Such accounting should be consistent with the general recognition and measurement principles of ASC 740-10. An entity should determine its intent with respect to the filing of an amended return or refund claim as of each reporting date. Changes in intent with respect to the filing of an amended return or refund claim should be supported by a change in facts or circumstances.

In a manner consistent with the above discussion, refund claims that an entity intends to file in connection with the carryback of tax attributes (e.g., an NOL or a tax credit) should generally be reflected as an income tax receivable (after the entity considers the recognition and measurement principles of ASC 740-10) in the reporting period in which the entity concludes that it will file the refund claim.

Affirmative adjustments should be accounted for similarly to tax positions that will be taken on a tax return (i.e., similarly to an amended return or refund claim). That is, the entity should account for the tax positions associated with affirmative adjustments in the period in which the entity concludes that it intends to present the positions to an examiner in a future tax examination. Generally, we would expect this to be the period in which the position was originally taken. Such accounting should be consistent with the general recognition and measurement principles of ASC 740-10.

Note that this section does not address the additional considerations that can arise when the filing of the amended tax return or refund claim, or the decision to self-report a tax position, represents the correction of an error. See Section 12.6.1 for guidance on those considerations.

4.6.2 State Tax Positions

Certain operational activities may be taxable in multiple jurisdictions (e.g., federal and state) or may need to be allocated between these jurisdictions on the basis of the application of tax rules (e.g., domestic versus international authorities, state versus state authorities). It is not always certain how these rules should be applied and therefore, management routinely makes judgments about the application of various technical rules (e.g., regarding the jurisdictions in which to report tax positions and how to allocate revenue and expenses among these jurisdictions). In addition to being subject to federal income taxes, an entity could also be subject to income tax imposed by a state or states. While there are similarities between the federal and state income tax rules, there are also differences that give rise to unique state tax positions.

4.6.2.1 Economic Nexus

“Economic nexus” refers to a view, held by some states, that a company deriving income from the residents of a state should be taxable even when the connection with the state is not physical (i.e., its only contact with the state is economic). Many states have enacted tax laws that could subject an out-of-state entity to income taxes in that state in accordance with the economic nexus theory even when the entity has no physical presence in that state.

An entity should consult all relevant law and authorities to determine whether, for a state in which it does not file income tax returns, it is more likely than not that it does not have a filing obligation in that state. While the concept of economic nexus may sometimes be ambiguous and difficult to apply, the entity must, to comply with the requirements of ASC 740, assess the technical merits of its conclusion that it does not have economic nexus in a state. An entity should consider engaging specialists for assistance in performing this assessment.

An entity that concludes that it is more likely than not that it does not have economic nexus in a particular state has met the recognition threshold for this tax position. Conversely, an entity that has a reasonable basis for not filing a state income tax return in a particular state but has concluded that it is more likely than not that it has economic nexus in that state has not met the recognition threshold.

Under ASC 740, if a tax position does not meet the recognition threshold, a liability is recognized for the total amount of the tax benefit of that tax position (see Section 4.2). That liability should not be subsequently derecognized unless there is a change in technical merits, the position is effectively settled, or the statute of limitations expires. In many jurisdictions, it is common for the statute of limitations to begin to run only when a tax return is filed. Therefore, when an entity does not file a state income tax return in such a jurisdiction, the entity cannot consider the statute of limitations in determining whether it has a filing obligation and UTB liability in that state.

Some state tax authorities may have a widely understood administrative practice or precedent under which the authority would, in the event of an examination and in the absence of a voluntary disclosure agreement, look back no more than a certain number of years to determine the amount of income tax deficiency due (i.e., a “lookback period”). If a state tax authority has such a practice, the entity should consider it when calculating the liability for UTBs that meet certain conditions.

In the absence of a widely understood administrative practice or precedent, however, ASC 740 requires accrual of the state income tax liability for every year in which it is more likely than not that the entity had economic nexus with that state, and the state tax liability is determined as if state income tax returns were prepared in accordance with ASC 740’s recognition and measurement guidance. Interest and penalties would be accrued under ASC 740 and on the basis of the relevant tax law. Such liabilities for UTBs would be derecognized only when (1) a change in available information indicates that the technical merits of the position subsequently meet the more-likely-than-not recognition threshold or (2) the position is effectively settled.

For example, assume that an entity has not filed state income tax returns in a particular state and is aware of a widely understood administrative practice under which only entities that have not historically filed tax returns with that state must file six years of tax returns. Accordingly, at the end of each year, the entity is permitted to record a liability for UTBs for the amount of tax due to the state for the most recent six years as if tax returns, prepared in accordance with ASC 740’s recognition and measurement, were filed for the most recent six years. Interest and penalties would be accrued on such deficiencies as required by ASC 740 and on the basis of the relevant tax law.

An entity should be able to demonstrate that it has considered all relevant facts and circumstances in reaching its conclusion about the maximum number of previous years that the state tax authority will require the entity to file under its widely understood administrative practices or precedents. The number of such previous years should not change unless new information becomes available. This guidance applies only to economic nexus when a statute of limitations does not expire because an income tax return has not been filed; it should not necessarily be applied to other situations.

An entity may also consider entering into a state’s voluntary disclosure program, which may limit the number of prior years for which tax returns will be required. The terms and conditions of such programs vary among states; generally, however, voluntary disclosure programs limit lookback periods to three or four years. In addition, when assessing its UTB liabilities, an entity should generally not consider the potential to limit the lookback period until the reporting period in which it enters the particular state’s voluntary disclosure program.3 Therefore, when the entity has entered into such a program, its liability for UTBs for that state’s income taxes would be limited by the number of prior years for which tax returns will be required under the terms and conditions of the program, plus accrued interest and penalties, if applicable. Entities should consult their tax advisers regarding the effect of entering into a state’s voluntary disclosure program.

4.6.2.2 Due Process

In addition to considering the application of relevant tax rules in accounting for state tax positions, an entity should also consider the “due process clause” and the “commerce clause” of the U.S. Constitution, which limit the states’ rights to tax.

The due process clause of the Fourteenth Amendment requires a definite link between a state and the person, property, or transaction it seeks to tax; the connection need not include physical presence in the state. This clause also requires that the income attributed to the state for tax purposes be rationally related to values connected with the taxing state. The commerce clause of the Constitution gives Congress the authority to regulate commerce among the states.

No state or federal law is allowed to violate the Constitution. In evaluating all tax positions for recognition under ASC 740, as well as for technical merits under the tax law as written and enacted, an entity may need to assess whether the U.S. Supreme Court would overturn that tax law. This analysis is required for recognition even though the court issues certiorari for tax matters involving the constitutionality of state income taxes only in rare circumstances. Generally, an entity will conclude that the court would uphold the tax law. However, in certain situations, an entity may conclude that the applicable tax law violates the Constitution.

For example, with respect to economic nexus, an entity may determine that, under the tax law, it is more likely than not that it has incurred a tax obligation to the tax authority. However, the entity may also conclude that the same tax law more likely than not violates the Constitution. In other words, if the entity were to litigate this position to the U.S. Supreme Court, it is more likely than not that the court, after evaluating such a law, would deem that law unconstitutional; in such a situation, the entity would therefore not have a tax obligation to the tax authority.

An entity must have sufficient evidence to support its conclusion about the constitutionality of the current tax law. This evidence will often be in the form of a legal opinion from competent outside counsel. The legal opinion would state whether the tax law violates the Constitution and whether it is more likely than not that the U.S. Supreme Court would overturn the enacted tax law.

4.6.3 Uncertain Tax Positions in Transfer Pricing Arrangements

Transfer pricing relates to the pricing of intra-entity and related-party transactions involving transfers of tangible property, intangible property, services, or financing between affiliated entities. These transactions include transfers between domestic or international entities, such as (1) U.S. to foreign, (2) foreign to foreign, (3) U.S. to U.S., and (4) U.S. state to state.

The general transfer pricing principle is that the pricing of a related-party transaction should be consistent with the pricing of similar transactions between independent entities under similar circumstances (i.e., an arm’s-length transaction). Transfer pricing tax regulations are intended to prevent entities from using intra-entity charges to evade taxes by inflating or deflating the profits of a particular jurisdiction the larger consolidated group does business in. Even if a parent corporation or its subsidiaries are in tax jurisdictions with similar tax rates, an entity may have tax positions that are subject to the recognition and measurement principles in ASC 740-10-25-6 and ASC 740-10-30-7.

An entity’s exposure to transfer pricing primarily occurs when the entity includes in its tax return the benefit received from a related-party transaction that was not conducted as though it was at arm’s length. A UTB results when one of the related parties reports either lower revenue or higher costs than it can sustain (depending on the type of transaction). While a benefit is generally more likely than not to result from such a transaction (e.g., some amount will be allowed as an interest deduction, royalty expense, or cost of goods sold), the amount of benefit is often uncertain because of the subjectivity of valuing the related-party transaction.

An entity must apply the two-step process (i.e., recognition and measurement) under ASC 740-10 to all uncertain tax positions within its scope. The requirements of ASC 740 in the context of transfer pricing arrangements, including related considerations and examples, are outlined below.

4.6.3.1 Determination of the Unit of Account

Before applying the recognition and measurement criteria, an entity must identify all material uncertain tax positions and determine the appropriate unit of account for assessment. Intra-entity and related-party transactions under transfer pricing arrangements are within the scope of ASC 740 since they encompass “[a]n allocation or a shift of income between jurisdictions.”

Further, tax positions related to transfer pricing generally should be evaluated individually, since two entities and two tax jurisdictions are involved in each transaction. Such an evaluation should be performed even when the transaction is supported by a transfer pricing study prepared by one of the entities. Typically, there would be at least two units of account. For example, the price at which one entity will sell goods to another entity will ultimately be the basis the second entity will use to determine its cost of goods sold. In addition, some transfer pricing arrangements could be made up of multiple components that could be challenged individually or in aggregate by a taxing authority. Therefore, there could be multiple of units of account associated with a particular transfer pricing arrangement. See Section 4.1.2.2 for more information about determining the unit of account.

4.6.3.2 Recognition

ASC 740-10-25-6 indicates that the threshold for recognition has been met “when it is more likely than not, based on the technical merits, that the position will be sustained upon examination.” An entity should apply the recognition threshold and guidance in ASC 740 to each unit of account in a transfer pricing arrangement. In some cases, a tax position will be determined to have met the recognition threshold if a transaction has taken place to generate the tax positions and some level of benefit will therefore be sustained. For example, assume that a U.S. parent entity receives a royalty for the use of intangibles by a foreign subsidiary that results in taxable income for the parent and a tax deduction for the foreign subsidiary. The initial tax filing (income in the receiving jurisdiction and expense/deduction in the paying jurisdiction) may typically meet the more-likely-than-not recognition threshold on the basis of its technical merits, since a transaction between two parties has occurred. However, because there are two entities and two tax jurisdictions involved, the tax jurisdictions could question whether the income is sufficient, whether the deduction is excessive, or both.

4.6.3.3 Measurement

After an entity has assessed the recognition criteria in ASC 740 and has concluded that it is more likely than not that the tax position taken will be sustained upon examination, the entity should measure the associated tax benefit. This measurement should take into account all relevant information, including tax treaties and arrangements between tax authorities. As discussed above, each tax position should be assessed individually and a minimum of two tax positions should be assessed for recognition and measurement in each transfer pricing transaction.

For measurement purposes, ASC 740-10-30-7 requires that the tax benefit be based on the amount that is more than 50 percent likely to be realized upon settlement with a tax jurisdiction “that has full knowledge of all relevant information.” Intra-entity or transfer pricing assessments present some unique measurement-related challenges that are based on the existence of tax treaties or other arrangements (or the lack of such arrangements) between two tax jurisdictions.

Measurement of uncertain tax positions is typically based on facts and circumstances. The following are some general considerations (not all-inclusive):

Transfer pricing studies — An entity will often conduct a transfer pricing study with the objective of documenting the appropriate arm’s-length pricing for the transactions. The entity should consider the following when using a transfer pricing study to support the tax positions taken:
- The qualifications and independence of third-party specialists involved (if any).
- The type of study performed (e.g., benchmarking analysis, limited or specified-method analysis, U.S. documentation report, Organisation for Economic Co-operation and Development report) and, to avoid incurring penalties, whether it satisfies the particular jurisdiction’s requirements.
- The specific transactions and tax jurisdictions covered in the study.
- The period covered by the study.
- The reasonableness of the model(s) and the underlying assumptions used in the study (i.e., comparability of companies or transactions used, risks borne, any adjustments made to input data).
- Any changes in the current environment, including new tax laws in effect.
Historical experience — An entity should consider previous settlement outcomes of similar tax positions in the same tax jurisdictions. Information about similar tax positions, in the same tax jurisdictions, that the entity has settled in previous years may serve as a good indicator of the expected settlement of current positions.
Applicability of tax treaties or other arrangements — An entity should consider whether a tax treaty applies to a particular tax position and, if so, how the treaty would affect the negotiation and settlement with the tax authorities involved.
Symmetry of positions — Even though each tax position should be evaluated individually for appropriate measurement, if there is a high likelihood of settlement through “competent-authority” procedures under the tax treaty or other agreement, an entity should generally use the same assumptions about such a settlement to measure both positions (i.e., the measurement assumptions are similar, but the positions are not offset). Under the terms of certain tax treaties entered into by the United States and foreign jurisdictions, countries mutually agree to competent-authority procedures to relieve such companies of double taxation created by transfer pricing adjustments to previously filed returns. If competent-authority procedures are available, entities should carefully consider whether to pursue relief through them and whether the particular jurisdictions involved are likely to reach an agreement with respect to the particular disputed transactions.

An entity should carefully consider whether the tax jurisdictions involved strictly apply the arm’s-length principle. Some jurisdictions may have a mandated statutory margin that may or may not equate to what is considered arm’s length by another reciprocal taxing jurisdiction. In these situations, when an entity measures positions, it may be inappropriate for the entity to assume that they are symmetrical.

The example below illustrates the above considerations. See Section 13.2.4 for a discussion of balance sheet presentation in transfer pricing arrangements under ASC 740.

Example 4-7

Assume that a U.S. entity licenses its name to its foreign subsidiary in exchange for a 2 percent royalty on sales. This example focuses on the two separate tax positions that the entity has identified in connection with the royalty transaction. For tax purposes, the U.S. entity recognizes royalty income in its U.S. tax return and the foreign subsidiary takes a tax deduction for the royalty expense in its local-country tax return. Both positions are deemed uncertain, since the respective tax authorities may either disallow a portion of the deduction (deeming it to be excessive) or challenge the royalty rate used in this intra-entity transaction (deeming it to be insufficient). The entity should evaluate both tax positions under the recognition and measurement criteria of ASC 740. In this example, the “more-likely-than-not” recognition threshold is considered met since a transaction has occurred between the two parties and it is therefore more likely than not that the U.S. entity has income and the foreign subsidiary has a deduction.

The U.S. entity believes that if the IRS examines the tax position, it will more likely than not conclude that the royalty rate should have been higher to be in line with an arm’s-length transaction. In the absence of any consideration of relief through an international tax treaty, the lowest royalty rate that the entity believes is more than 50 percent likely to be accepted by the IRS is 5 percent, on the basis of historical experience and recent transfer pricing studies. A higher royalty rate would not only trigger an increase in taxable income for the U.S. entity but would also result in double taxation of the additional royalty for the amount that is in excess of the deduction claimed by the foreign subsidiary (i.e., 3 percent in this instance — calculated as the 5 percent estimated arm’s-length amount less the original 2 percent recorded in the transaction). If there is a tax treaty between the United States and the relevant foreign tax jurisdiction, that treaty will typically include procedures that provide for competent-authority relief from double taxation. Under such an agreement, the two tax authorities may agree at their discretion on an acceptable royalty rate in each jurisdiction. One tax authority would make an adjustment (i.e., increasing revenue and taxable income) that would require a consistent transfer pricing adjustment (i.e., increasing deduction and reducing taxable income) in the related party’s tax jurisdiction.

In this example, management determines that it would pursue the competent-authority relief. Accordingly, it concludes that it is appropriate to recognize relief from double taxation because of the expected outcome of competent-authority procedures. Also, management has represented that the entity will incur the cost of pursuing a competent-authority process. Therefore, the U.S. entity records a liability that would result from resolution of the double taxation of this non-arm’s-length transaction if the original 2 percent royalty rate is increased through application of the competent-authority process. Management of the U.S. entity believes that a royalty rate of 3.5 percent is the lowest percentage (i.e., greatest benefit) that is more than 50 percent likely to be accepted by the two tax jurisdictions under such a treaty on the basis of its historical experience. Because there is a high likelihood of settlement through the competent-authority process, the foreign subsidiary should also use this assumption when measuring the tax position to ensure symmetry of the two tax positions under ASC 740. Note that this example focuses on one tax position in each jurisdiction; there may be other tax positions related to this transfer pricing arrangement that would have to be similarly analyzed.

4.6.4 Uncertainty in Deduction Timing

A deduction taken on an entity’s tax return may be certain except for the appropriate timing of the deduction under the tax law in the applicable jurisdiction. In such cases, the recognition threshold is satisfied and the entity should consider the uncertainty in the appropriate timing of the deduction in measuring the associated tax benefit in each period.

Example 4-8

Assume the following:

An entity purchases equipment for $1,000 in 20X7.
The entity’s earnings before interest, depreciation, and taxes are $1,200 each year in years 20X7–20Y1.
For book purposes, the equipment is depreciated ratably over five years
For tax purposes, the entity deducts the entire $1,000 in its 20X7 tax return.
The entity has a 25 percent tax rate and is taxable in only one jurisdiction.
There is no half-year depreciation rule for accounting or tax purposes.
For simplicity, interest and penalties on tax deficiencies are ignored.

In applying the recognition provisions of ASC 740-10-25-5, the entity has concluded that it is certain that the $1,000 equipment acquisition cost is ultimately deductible under the tax law. Thus, the tax deduction of the tax basis of the acquired asset would satisfy the recognition threshold in ASC 740-10-25-6. In measuring the benefit associated with the deduction, the entity concludes that the largest amount that is more than 50 percent likely to be realized in a negotiated settlement with the tax authority is $200 per year for five years (the tax life is the same as the book life).

Exclusive of interest and penalties, the entity’s current-year tax benefit is unaffected because the difference between the benefit taken in the tax return and the benefit recognized in the financial statements is a temporary difference.

However, although interest and penalties are ignored in this example for simplicity, ASC 740-10-25-56 requires an entity to recognize interest and penalties on the basis of the provisions of the relevant tax law. In this case, the entity would begin accruing interest in 20X8. Therefore, even though this is a timing difference, the accrual of interest (and penalties, if applicable) will have an impact on profit and loss (P&L).

The 20X7 tax return reflects a $250 reduction in the current tax liability for the $1,000 deduction claimed. For book purposes, the entity will recognize a balance sheet credit of $200, or ($1,000 – $200) × 25%, for UTBs associated with the deduction claimed in year 1. The liability for UTBs will be extinguished over the succeeding four years at $50 ($200 × 25 percent) per year. The entity would record the following journal entries, excluding interest and penalties, for the tax effects of the purchased equipment:

See Section 3.3.5 for a discussion related to the accounting for tax method changes.

4.6.5 Deferred Tax Consequences of UTBs

Recording a liability for a UTB may result in a corresponding temporary difference and DTA. The examples below illustrate how a DTA can arise from the accounting for a UTB.

Example 4-9

Company A has taken an uncertain tax position in State B that reduces its taxes payable by $10,000 in that state. In assessing the uncertain tax position under ASC 740, A determines that it is not more likely than not that the position, on the basis of its technical merits, will be sustained upon examination. Therefore, A records a $10,000 liability for the UTB.

Company A will receive an additional federal tax deduction if it is ultimately required to make an additional tax payment to the state. Therefore, A should record a DTA for the indirect benefit from the potential disallowance of the uncertain tax position taken on its tax return in State B.

If the federal tax rate is 25 percent, A would record the following journal entries to account for the uncertain tax position and the indirect tax benefit:

Like other DTAs, the DTA created as a result of recording the liability for the UTB should be evaluated for realizability.

Example 4-10

Company A begins operations in State B but does not file a tax return in that state. ASC 740-10-20 indicates that the “decision not to file a tax return” is a tax position. In assessing the tax position under ASC 740, A determines that it may have nexus in B and that it is not more likely than not that the position, on the basis of its technical merits, will be sustained upon examination. Therefore, A records a $10,000 liability for the taxes payable to B for the current year.

However, if A were to file a return in B, it would also have a large deductible temporary difference that would result in an $8,000 DTA in that state. Therefore, A should record a DTA as a result of potential nexus in B and evaluate it for realizability.

If the federal tax rate is 21 percent, A would record the following journal entries to account for the uncertain tax position and the related temporary difference:

See Section 14.4.1.7 for further discussion of the presentation of deferred taxes resulting from UTBs.

4.6.6 UTBs and Spin-Off Transactions

In a spin-off transaction, a reporting entity (the “spinnor”) may distribute one or more of its subsidiaries (“spinnees”) to its shareholders in the form of a dividend. After the spin-off is finalized, complexities can arise in the accounting for uncertain tax positions in the separate financial statements of the spinnor and spinnee when, before a spin-off, they file a consolidated tax return as a “consolidated return group.” Under U.S. federal tax law, members of a consolidated return group are severally liable for all tax positions taken in the consolidated return. The taxing authority typically seeks collection of the payment of the consolidated return group’s tax liabilities from the parent of the consolidated return group; however, if the IRS cannot collect from the parent of the consolidated return group (e.g., the parent is insolvent), the IRS can seek payment from a subsidiary of the consolidated return group. The example below illustrates the accounting for UTBs in a spin-off transaction.

Example 4-11

Company A, in the current reporting period, spins off a portion of its business that was conducted by Company B. Before the spin-off, A and B were in the same federal consolidated return group and (1) A had recognized a liability for uncertain tax positions in its consolidated financial statements associated with B’s operations and (2) B had recognized the liability in its stand-alone financial statements prepared under the separate-return approach (see Section 8.3.1.1). Under the terms of the separation agreement, A will be responsible for settlement of the uncertain tax positions in tax returns for periods before the spin-off. Company A is solvent as of the date of the spin-off and is expected to remain so afterward.

Company A

Upon completion of the spin-off transaction, A should continue to recognize a liability associated with the uncertain tax position. Because the uncertain tax position was taken in a consolidated return group filed by A, the primary obligor under the consolidated return regulations was and will continue to be A. Accordingly, A should continue to recognize the liability for the UTB associated with the uncertain tax position under ASC 740.

Company B

Each of the following views is acceptable:

View A — Because A is the primary obligor, B cannot be the primary obligor and therefore should not continue to recognize the liability for the UTB. In accordance with the consolidated return regulations, the liability is retained by A, and B is typically liable only if A becomes insolvent. Accordingly, B no longer has an uncertain tax position under ASC 740 and would remove the liability with an offsetting credit to capital at the time of the spin-off. Company B would separately assess its contingent liability to the tax authority if A becomes insolvent under ASC 450.
This view is consistent with the guidance in ASC 405-40 on obligations resulting from joint and several liability obligations, which can be applied by analogy even though income taxes are not within its scope. ASC 405-40-30-1 states:
Obligations resulting from joint and several liability arrangements included in the scope of this Subtopic initially shall be measured as the sum of the following:
1. The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors
2. Any additional amount the reporting entity expects to pay on behalf of its co-obligors. If some amount within a range of the additional amount the reporting entity expects to pay is a better estimate than any other amount within the range, that amount shall be the additional amount included in the measurement of the obligation. If no amount within the range is a better estimate than any other amount, then the minimum amount in the range shall be the additional amount included in the measurement of the obligation.
View B — Because B is still an obligor under the consolidated return regulations, it should continue to record a liability for the UTB under ASC 740. The uncertain tax position was generated by B and presented in its separate company financial statements before the spin-off. In addition, although A insulates B from liability to a degree, B could be required to settle the uncertain tax position. Accordingly, B should apply ASC 740 in recording and subsequently measuring an uncertain tax benefit. Company B would also record an indemnification receivable, subject to (1) any contractual limitations on its amount and (2) management’s assessment of the collectibility of the indemnification asset (by analogy to the guidance in ASC 805-20-35-4), reflecting the fact that A has agreed to be responsible for settlement of the uncertain tax positions.

While View A and View B are both acceptable, the selected method would represent an accounting policy that should be consistently applied and appropriately disclosed.

See Section 11.3.6.5 for additional guidance on indemnification agreements.

Footnotes

Presenting affirmative adjustments upon examination, rather than claiming the position on an originally filed income tax return, might be part of the entity’s strategy to avoid penalties on a particular tax position in a particular tax jurisdiction or to limit the jurisdiction’s ability to make other changes to the year (i.e., changes that are unrelated to the adjustment being sought by the entity).

Some states require an entity to be accepted into the voluntary disclosure program before being afforded audit protection for previous years.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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.