7.2 Items Accounted for Separately From the AETR

ASC 740-270

Exclusion of Items From Estimated Annual Effective Tax Rate

30-10 This guidance identifies items that are always excluded from the determination of the estimated annual effective tax rate. This guidance also specifies the alternatives for including or excluding certain investment tax credits in the estimated annual effective tax rate.

Items Always Excluded From Estimated Annual Effective Tax Rate

30-11 The effects of changes in judgment about beginning-of-year valuation allowances and effects of changes in tax laws or rates on deferred tax assets or liabilities and taxes payable or refundable for prior years (in the case of a retroactive change) shall be excluded from the estimated annual effective tax rate calculation.

30-12 Taxes related to an employee share-based payment award within the scope of Topic 718 when the deduction for the award for tax purposes does not equal the cumulative compensation costs of the award recognized for financial reporting purposes, significant unusual or infrequently occurring items that will be reported separately or items that will be reported net of their related tax effect shall be excluded from the estimated annual effective tax rate calculation.

30-13 As these items are excluded from the estimated annual effective tax rate, Section 740-270-25 requires that the related tax effect be recognized in the interim period in which they occur. See Example 3 (paragraph 740-270-55-24) for illustrations of accounting for these items in the interim period which they occur.

Certain Tax Credits

30-14 Certain investment tax credits may be excluded from the estimated annual effective tax rate. If an entity includes allowable investment tax credits as part of its provision for income taxes over the productive life of acquired property and not entirely in the year the property is placed in service, amortization of deferred investment tax credits need not be taken into account in estimating the annual effective tax rate; however, if the investment tax credits are taken into account in the estimated annual effective tax rate, the amount taken into account shall be the amount of amortization that is anticipated to be included in income in the current year (see paragraphs 740-10-25-46 and 740-10-45-28).

30-15 Further, paragraphs 842-50-30-1 and 842-50-35-3 through 35-4 require that investment tax credits related to leases that are accounted for as leveraged leases shall be deferred and accounted for as return on the net investment in the leveraged leases in the years in which the net investment is positive and explains that the use of the term years is not intended to preclude application of the accounting described to shorter periods. If an entity accounts for investment tax credits related to leveraged leases in accordance with those paragraphs for interim periods, those investment tax credits shall not be taken into account in estimating the annual effective tax rate.

Ability to Make Estimates

30-16 This guidance addresses the consequences of an entity’s inability to reliably estimate some or all of the information which is ordinarily required to determine the annual effective tax rate in interim financial information.

30-17 Paragraph 740-270-25-3 requires that if an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated be reported in the interim period in which the item is reported.

30-18 Estimates of the annual effective tax rate at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision. If a reliable estimate cannot be made, the actual effective tax rate for the year to date may be the best estimate of the annual effective tax rate.

30-19 The effect of translating foreign currency financial statements may make it difficult to estimate an annual effective foreign currency tax rate in dollars. For example, in some cases depreciation is translated at historical exchange rates, whereas many transactions included in income are translated at current period average exchange rates. If depreciation is large in relation to earnings, a change in the estimated ordinary income that does not change the effective foreign currency tax rate can change the effective tax rate in the dollar financial statements. This result can occur with no change in exchange rates during the current year if there have been exchange rate changes in past years. If the entity is unable to estimate its annual effective tax rate in dollars or is otherwise unable to make a reliable estimate of its ordinary income (or loss) or of the related tax (or benefit) for the fiscal year in a jurisdiction, the tax (or benefit) applicable to ordinary income (or loss) in that jurisdiction shall be recognized in the interim period in which the ordinary income (or loss) is reported.

Effect of Operating Losses

30-20 This guidance addresses changes to the general methodology to determine income tax expense (or benefit) in interim financial information as set forth in paragraph 740-270-30-5 when an entity has experienced or expects to experience operating losses.

30-21 An entity may have experienced year-to-date ordinary income (or loss) at the end of any interim period. These year-to-date actual results of either ordinary income (or loss) may differ from the results expected by the entity for either ordinary income (or loss) for the full fiscal year. This guidance identifies the required methodology for recording interim period income taxes for each of the four possible relationships of year-to-date ordinary income (or loss) and expected full fiscal year ordinary income (or loss).See Examples 1 through 2 (paragraphs 740-270-55-2 through 55-23 ) for example computations in these different situations. This guidance also establishes income tax benefit limitations when ordinary losses exist.

Year-to-Date Ordinary Income; Anticipated Ordinary Income for the Year

30-22 If an entity has ordinary income for the year to date at the end of an interim period and anticipates ordinary income for the fiscal year, the interim period tax shall be computed in accordance with paragraph 740-270-30-5.

30-23 See Example 1, Cases A and B1 (paragraphs 740-270-55-4 through 55-6) for illustrations of the application of these requirements.

Year-to-Date Ordinary Loss; Anticipated Ordinary Income for the Year

30-24 If an entity has an ordinary loss for the year to date at the end of an interim period and anticipates ordinary income for the fiscal year, the interim period tax benefit shall be computed in accordance with paragraph 740-270-30-5, except that the year-to-date tax benefit recognized shall be limited to the amount determined in accordance with paragraphs 740-270-30-30 through 30-33.

30-25 See Example 1, Cases B2 and B3 (paragraphs 740-270-55-7 through 55-8) for illustrations of the application of these requirements.

Year-to-Date Ordinary Income; Anticipated Ordinary Loss for the Year

30-26 If an entity has ordinary income for the year to date at the end of an interim period and anticipates an ordinary loss for the fiscal year, the interim period tax shall be computed in accordance with paragraph 740-270-30-5. The estimated tax benefit for the fiscal year, used to determine the estimated annual effective tax rate described in paragraphs 740-270-30-6 through 30-8, shall not exceed the tax benefit determined in accordance with paragraphs 740-270-30-30 through 30-33.

30-27 See Example 2, Cases A2 and C2 (paragraphs 740-270-55-16 and 740-270-55-20) for illustrations of the application of these requirements.

Year-to-Date Ordinary Loss; Anticipated Ordinary Loss for the Year

30-28 If an entity has an ordinary loss for the year to date at the end of an interim period and anticipates an ordinary loss for the fiscal year, the interim period tax benefit shall be computed in accordance with paragraph 740-270-30-5. The estimated tax benefit for the fiscal year, used to determine the estimated annual effective tax rate described in paragraphs 740-270-30-6 through 30-8, shall not exceed the tax benefit determined in accordance with paragraphs 740-270-30-30 through 30-33.

30-29 See Example 2, Cases A1, B, and C1 (paragraphs 740-270-55-15, 740-270-55-17, and 740-270-55-19) for illustrations of the application of these requirements.

Determining Income Tax Benefit Limitations

30-30 Paragraph 740-270-25-9 provides that a tax benefit shall be recognized for a loss that arises early in a fiscal year if the tax benefits are expected to be either of the following:

Realized during the year
Recognizable as a deferred tax asset at the end of the year in accordance with the requirements established in Subtopic 740-10. Paragraph 740-10-30-5(e) requires that a valuation allowance be recognized if it is more likely than not that the tax benefit of some portion or all of a deferred tax asset will not be realized.

30-31 The limitations described in the preceding paragraph shall be applied in determining the estimated tax benefit of an ordinary loss for the fiscal year, used to determine the estimated annual effective tax rate and the year-to-date tax benefit of a loss.

30-32 The reversal of existing taxable temporary differences may be a source of evidence in determining whether a tax benefit requires limitation. A deferred tax liability related to existing taxable temporary differences is a source of evidence for recognition of a tax benefit when all of the following conditions exist:

An entity anticipates an ordinary loss for the fiscal year or has a year-to-date ordinary loss in excess of the anticipated ordinary loss for the fiscal year.
The tax benefit of that loss is not expected to be realized during the year.
Recognition of a deferred tax asset for that loss at the end of the fiscal year is expected to depend on taxable income from the reversal of existing taxable temporary differences (that is, a higher deferred tax asset valuation allowance would be necessary absent the existing taxable temporary differences).

The requirement to consider the reversal of existing taxable temporary differences is illustrated in Example 2, Case D (see paragraph 740-270-55-21).

30-33 If the tax benefit relates to an estimated ordinary loss for the fiscal year, it shall be considered in determining the estimated annual effective tax rate described in paragraphs 740-270-30-6 through 30-8. If the tax benefit relates to a year-to-date ordinary loss, it shall be considered in computing the maximum tax benefit that shall be recognized for the year to date.

30-34 See Example 2, Cases A1 and A2; B; and C1 and C2 (paragraphs 740-270-55-15 through 55-17 and 740-270-55-19 through 55-20) for illustrations of computations involving operating losses, and Example 1, Cases B2 and B3 (see paragraphs 740-270-55-7 through 55-8) for illustrations of special year-to-date limitation computations.

Multiple Tax Jurisdictions

30-35 This guidance addresses possible changes to the general interim period income tax expense methodology when an entity is subject to tax in multiple jurisdictions.

30-36 If an entity that is subject to tax in multiple jurisdictions pays taxes based on identified income in one or more individual jurisdictions, interim period tax (or benefit) related to consolidated ordinary income (or loss) for the year to date shall be computed in accordance with the requirements of this Subtopic using one overall estimated annual effective tax rate with the following exceptions:

If in a separate jurisdiction an entity anticipates an ordinary loss for the fiscal year or has an ordinary loss for the year to date for which, in accordance with paragraphs 740-270-30-30 through 30-33, no tax benefit can be recognized, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). A separate estimated annual effective tax rate shall be computed for that jurisdiction and applied to ordinary income (or loss) in that jurisdiction in accordance with the methodology otherwise required by this Subtopic.
If an entity is unable to estimate an annual effective tax rate in a foreign jurisdiction in dollars or is otherwise unable to make a reliable estimate of its ordinary income (or loss) or of the related tax (or benefit) for the fiscal year in a jurisdiction, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). The tax (or benefit) related to ordinary income (or loss) in that jurisdiction shall be recognized in the interim period in which the ordinary income (or loss) is reported. The tax (or benefit) related to ordinary income (or loss) in a jurisdiction may not be limited to tax (or benefit) in that jurisdiction. It might also include tax (or benefit) in another jurisdiction that results from providing taxes on unremitted earnings, foreign tax credits, and so forth.

See Example 5, Cases A; B; and C (paragraphs 740-270-55-39 through 55-43) for illustrations of accounting for income taxes applicable to ordinary income if an entity is subject to tax in multiple jurisdictions.

Accounting for Income Taxes Applicable to the Cumulative Effect of a Change in Accounting Principle

30-37 Topic 250 establishes the accounting requirements related to recording the effect of a change in accounting principle. The guidance in this Subtopic addresses issues related to the measurement of the tax effect in interim periods associated with those changes.

30-38 The tax (or benefit) applicable to the cumulative effect of the change on retained earnings at the beginning of the fiscal year shall be computed the same as for the annual financial statements.

30-39 When an entity makes an accounting change in other than the first interim period of the entity’s fiscal year, paragraph 250-10-45-14, requires that financial information for the prechange interim periods of the fiscal year shall be reported by retrospectively applying the newly adopted accounting principle to those prechange interim periods. The tax (or benefit) applicable to those prechange interim periods shall be recomputed. The revised tax (or benefit) shall reflect the year-to-date amounts and annual estimates originally used for the prechange interim periods, modified only for the effect of the change in accounting principle on those year-to-date and estimated annual amounts.

Subsequent Measurement

35-1 This guidance addresses the accounting for interim period income tax expense (or benefit) in periods subsequent to an entity’s first interim period within a fiscal year. See Section 740-270-30 for a description of and requirements related to the determination of the estimated annual effective tax rate.

35-2 The estimated annual effective tax rate is described in paragraphs 740-270-30-6 through 30-8. As indicated in paragraph 740-270-30-18, estimates of the annual effective tax rate at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision. If a reliable estimate cannot be made, the actual effective tax rate for the year to date may be the best estimate of the annual effective tax rate.

35-3 As indicated in paragraph 740-270-30-6, at the end of each successive interim period the entity shall make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. As indicated in paragraph 740-270-30-8, the rate so determined shall be used in providing for income taxes on a current year-to-date basis. The rate shall be revised, if necessary, as of the end of each successive interim period during the fiscal year to the entity’s best current estimate of its annual effective tax rate.

35-4 As indicated in paragraph 740-270-30-5, the estimated annual effective tax rate shall be applied to the year-to-date ordinary income (or loss) at the end of each interim period to compute the year-to-date tax (or benefit) applicable to ordinary income (or loss). The interim period tax (or benefit) related to ordinary income (or loss) shall be the difference between the amount so computed and the amounts reported for previous interim periods of the fiscal year.

35-5 One result of the year-to-date computation is that, if the tax benefit of an ordinary loss that occurs in the early portions of the fiscal year is not recognized because it is more likely than not that the tax benefit will not be realized, tax is not provided for subsequent ordinary income until the unrecognized tax benefit of the earlier ordinary loss is offset (see paragraphs 740-270-25-9 through 25-11). As indicated in paragraph 740-270-30-31, the limitations described in paragraph 740-270-25-9 shall be applied in determining the estimated tax benefit of an ordinary loss for the fiscal year, used to determine the estimated annual effective tax rate, and the year-to-date tax benefit of a loss. As indicated in paragraph 740-270-30-33, if the tax benefit relates to an estimated ordinary loss for the fiscal year, it shall be considered in determining the estimated annual effective tax rate described in paragraphs 740-270-30-6 through 30-8. If the tax benefit relates to a year-to-date ordinary loss, it shall be considered in computing the maximum tax benefit that shall be recognized for the year to date.

35-6 A change in judgment that results in subsequent recognition, derecognition, or change in measurement of a tax position taken in a prior interim period within the same fiscal year is an integral part of an annual period and, consequently, shall be reflected as such under the requirements of this Subtopic. This requirement differs from the requirement in paragraph 740-10-25-15 applicable to a change in judgment that results in subsequent recognition, derecognition, or a change in measurement of a tax position taken in a prior annual period, which requires that the change (including any related interest and penalties) be recognized as a discrete item in the period in which the change occurs.

35-7 See Example 1, Case C (paragraph 740-270-55-9) for an illustration of how changes in estimates impact quarterly income tax computations.

Related Implementation Guidance and Illustrations

Example 1: Accounting for Income Taxes Applicable to Ordinary Income (or Loss) at an Interim Date if Ordinary Income Is Anticipated for the Fiscal Year [ASC 740-270-55-2].
Example 2: Accounting for Income Taxes Applicable to Ordinary Income (or Loss) at an Interim Date if an Ordinary Loss Is Anticipated for the Fiscal Year [ASC 740-270-55-11].
Example 5: Accounting for Income Taxes Applicable to Ordinary Income if an Entity Is Subject to Tax in Multiple Jurisdictions [ASC 740-270-55-37].
Example 6: Effect of New Tax Legislation [ASC 740-270-55-44].

ASC 740-270-25-2 states:

The tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur. [Emphasis added]

The ASC master glossary defines ordinary income (or loss) as follows:

Ordinary income (or loss) refers to income (or loss) from continuing operations before income taxes (or benefits) excluding significant unusual or infrequently occurring items. Discontinued operations and cumulative effects of changes in accounting principles are also excluded from this term. The term is not used in the income tax context of ordinary income versus capital gain. The meaning of unusual or infrequently occurring items is consistent with their use in the definitions of the terms unusual nature and infrequency of occurrence.[1]

Ordinary income does not include items of comprehensive income outside of continuing operations (discontinued operations and OCI). Therefore, the tax effects of such items are excluded from the AETR. Other tax effects of items reported in equity are also excluded from the AETR.

Certain items or events related to continuing operations are specifically excluded from the estimated AETR, and their related tax effects are recognized discretely (i.e., numerator excludes tax effect and denominator excludes any pretax book income or loss), including:

Significant unusual or infrequent items (ASC 740-270-30-8).
Components of pretax income that are not estimable (ASC 740-270-30-17).
Exclusion of a jurisdiction from the AETR (ASC 740-270-30-36(a) and (b)).
Excess tax benefits and tax deficiencies from share-based payment awards (ASC 740-270-30-4).
Tax-exempt interest.
Interest expense when interest is classified as income tax expense.

7.2.1 Significant Unusual or Infrequent Items

In accordance with ASC 740-270-30-8, significant unusual or infrequently occurring items that are separately reported are specifically excluded from the definition of ordinary income and are therefore excluded from the AETR. To qualify for exclusion from the AETR, the item must be:

Significant.
Unusual or infrequently occurring:
- Unusual nature — “The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates” (ASC master glossary).
- Infrequency of occurrence — “The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates” (ASC master glossary).
Separately reported.

An entity records the tax effects of significant unusual or infrequently occurring items in the period in which the items occur and excludes those tax effects from the calculation of the estimated AETR. The example below illustrates an interim tax provision that includes a significant unusual or infrequently occurring item.

Example 7-2

Assume the following:

The entity computes its AETR for each quarter of 20X1 on the basis of estimated results expected for the full fiscal year ending December 31, 20X1.
The statutory tax rate and AETR in 20X1 is 25 percent.
In the third quarter, a significant unusual or infrequent loss was realized in the amount of $15,000, and only $10,000 of the loss is deductible for tax purposes.

The AETR estimate of 25 percent applied to ordinary income is not affected by the significant unusual or infrequent item. See ASC 740-270-55-24 through 55-36 for other examples.

7.2.2 Components of Pretax Income That Are Not Estimable

Generally, an entity can reliably estimate ordinary income (or loss); however, there may be instances in which the entity is unable to estimate part of its ordinary income (or loss). In situations in which an entity is unable to estimate a portion of its ordinary income (or loss), the guidance in ASC 740-270-25-3 applies:

If an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated shall be reported in the interim period in which the item is reported.

Accordingly, the pretax amount of ordinary income (or loss) that cannot be reliably estimated and the related tax effects should be excluded from the entity’s estimate of its AETR in all periods, and the tax effects of the item that cannot be estimated should be recorded discretely in the interim period in which that item is reported.

Examples of such items may include (but are not limited to) impairment losses and foreign exchange gains or losses that would not already be excluded from the entity’s estimate of its AETR (e.g., because they are significant unusual or infrequently occurring items).

7.2.3 Exclusion of a Jurisdiction From the AETR

ASC 740-270-30-36 states that for entities subject to tax in multiple jurisdictions, the “interim period tax (or benefit) related to consolidated ordinary income (or loss) for the year to date shall be computed . . . using one overall estimated annual effective tax rate.” However, ASC 740-270-30-36 contains exceptions to this general guidance, which can lead to the exclusion of a jurisdiction from the AETR.

7.2.3.1 Loss Jurisdiction for Which No Tax Benefit Can Be Recognized

ASC 740-270-30-36(a) states:

If in a separate jurisdiction an entity anticipates an ordinary loss for the fiscal year or has an ordinary loss for the year to date for which, in accordance with paragraphs 740-270-30-30 through 30-33, no tax benefit can be recognized, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). A separate estimated annual effective tax rate shall be computed for that jurisdiction and applied to ordinary income (or loss) in that jurisdiction in accordance with the methodology otherwise required by this Subtopic.

An entity must use judgment in determining whether a tax benefit can be recognized. ASC 740-270-30-30 states that “a tax benefit shall be recognized for a loss that arises early in a fiscal year if the tax benefits are expected to be either” (1) “[r]ealized during the year” or (2) “[r]ecognizable as a deferred tax asset at the end of the year in accordance with the requirements established in Subtopic 740-10.” See ASC 740-270-30-32 and Example 2, Case D, in ASC 740-270-55-21 for guidance on situations in which, as ASC 740-270-30-32 states, the “reversal of existing taxable temporary differences may be a source of evidence in determining whether a tax benefit requires limitation.”

The examples below illustrate the guidance in ASC 740-270-30-36(a) with respect to an entity subject to tax in multiple jurisdictions, one of which anticipates an ordinary loss for the year. In the example below, no amount of tax benefit can be recognized for the forecasted loss; in Example 7-4, however, a tax benefit can be recognized for a portion of the forecasted loss.

Example 7-3

Assume the following:

An entity operates through separate corporate entities in three countries: A, B, and C.
The entity has no unusual or infrequently occurring items during the fiscal year and anticipates no tax credits or events that do not have tax consequences.
The full year’s forecasted pretax income (loss) and anticipated tax expense (benefit) for the three countries are shown below.
The entity can reliably estimate its ordinary income (loss) and tax (in dollars) in the three countries for the fiscal year.
An ordinary loss is anticipated for the current year in Country C. Under ASC 740-270-30-30 through 30-33, no tax benefit can be recognized for this loss. Accordingly, in accordance with ASC 740-270-30-36(a), the corporate entity in Country C is excluded from the computation of the overall AETR.

Computation of the overall estimated AETR is as follows:

Quarterly tax computations are as follows:

This example is consistent with Example 5, Case B, in ASC 740-270-55-41.

If an entity is able to recognize any benefit (even a relatively small one) attributable to the anticipated ordinary loss in a separate jurisdiction, the entity cannot exclude ordinary income (or loss) in that jurisdiction and the related tax expense from the overall computation of the estimated AETR. When recognizing a tax benefit for any of the anticipated ordinary loss for the fiscal year or the ordinary loss for the YTD, an entity must include the ordinary loss in the separate jurisdiction and the related tax in the computations of the estimated AETR and interim-period tax (or benefit). When determining whether any tax benefit can be recognized for an ordinary loss in a separate jurisdiction, an entity must consider local tax laws and whether a tax benefit can be recognized for the ordinary loss (e.g., whether the entity can use the losses in a consolidated tax return, can employ income/loss sharing or group relief with other entities in the same jurisdiction, can carry back current-year losses to offset prior-year income, or can recognize a benefit in a different jurisdiction attributable to the loss jurisdiction).

Example 7-4

Assume the same facts as in Example 7-3 except that the entity will be able to recognize a small tax benefit of $1,000 related to the ordinary loss in Country C as a result of a carryback claim. Because the entity can recognize some benefit related to the current-year loss, the income (loss) in Country C should not be removed from the computation of the overall AETR.

Computation of the overall estimated AETR is as follows:

Quarterly tax computations are as follows:

7.2.3.1.1 Foreign Losses Providing a Tax Benefit by Reducing a GILTI Inclusion

Questions arise about whether an entity should exclude ordinary losses in foreign subsidiaries from the estimation of its AETR under ASC 740-270-30-36(a) if the entity concludes that it is not more likely than not that the entity will realize the tax benefits of losses in those foreign jurisdictions, but those losses will provide tax benefits for U.S. tax purposes by reducing the entity’s GILTI inclusion.

We believe that there are two acceptable views.

Under one view, both the loss from the foreign subsidiary and the corresponding U.S. tax benefit related to the reduction in the GILTI inclusion would be contemplated in the estimation of the AETR. ASC 740-270-30-36(b) states, in part:

The tax (or benefit) related to ordinary income (or loss) in a jurisdiction may not be limited to tax (or benefit) in that jurisdiction. It might also include tax (or benefit) in another jurisdiction that results from providing taxes on unremitted earnings, foreign tax credits, and so forth.

Accordingly, because there is a benefit in the U.S. jurisdiction, ordinary losses and the related U.S. benefit derived by reduced GILTI inclusion would be included in the overall AETR.

Under the alternative view, however, the U.S. tax benefit related to the reduction in GILTI inclusion would be included in the estimation of the AETR, but the ordinary loss from the foreign subsidiary would not. ASC 740-270-30-36(a) states:

Under this second view, because the guidance in ASC 740-270-30-36 appears to suggest application on a jurisdiction-by-jurisdiction basis, the ordinary loss from the loss jurisdiction and the related tax (or benefit) in that separate jurisdiction would be excluded. However, the U.S. tax benefit related to the reduction in GILTI inclusion would be included in the estimation of the AETR unless the U.S. jurisdiction is also a loss jurisdiction.

7.2.3.1.2 Zero-Tax-Rate Jurisdictions and Nontaxable Entities

ASC 740 does not provide explicit guidance on how to adjust a parent entity’s consolidated estimated AETR (if at all) when a portion of its business is conducted by entities that either are operating in a zero-tax-rate jurisdiction or are nontaxable.

The exception in ASC 740-270-30-36(a) should not be extended to exclude nontaxable entities or entities that are operating in a zero-tax-rate jurisdiction from the overall computation of the AETR. We do not believe that the exception in ASC 740-270-30-36(a) (discussed in Section 7.2.3.1) is applicable in such circumstances because this paragraph contains a cross-reference to the discussion on realizability of a benefit for current-year losses in ASC 740-270-30-30 through 30-33 and does not focus on nontaxable entities or entities operating in a zero-tax-rate jurisdiction for which no benefit would inherently be recorded. Accordingly, such entities should generally be reflected in the computation of an entity’s AETR regardless of whether they have a profit or loss for the year.

Example 7-5

Entity P is a nontaxable flow-through entity that has a wholly owned subsidiary, S, a taxable C corporation that operates in a jurisdiction in which the tax rate is 25 percent. Estimated annual pretax income for P and S is $900 and $100, respectively. Estimated annual consolidated pretax income and tax expense are $1,000 and $25, respectively, resulting in an estimated AETR of 2.5 percent. The YTD pretax income of P and S is $370 and $30, respectively. The YTD interim tax expense is $10 ($400 YTD consolidated pretax income multiplied by 2.5 percent).

Example 7-6

Entity P operates in a jurisdiction in which the tax rate is 25 percent and has a wholly owned subsidiary, S, that operates in a jurisdiction in which the tax rate is 0 percent. Estimated annual pretax income (loss) for P and S is $1,100 and ($100), respectively. Estimated annual consolidated pretax income and tax expense are $1,000 and $275, respectively, resulting in an annual estimated AETR of 27.5 percent. The YTD pretax income (loss) for P and S is $430 and ($30), respectively. The YTD interim tax expense is $110 ($400 YTD consolidated pretax income multiplied by 27.5 percent).

7.2.3.2 Inability to Estimate AETR in Dollars or Unreliable Estimate of Ordinary Income (or Loss) or Related Tax Expense (or Benefit)

ASC 740-270-30-36(b) states:

If an entity is unable to estimate an annual effective tax rate in a foreign jurisdiction in dollars or is otherwise unable to make a reliable estimate of its ordinary income (or loss) or of the related tax (or benefit) for the fiscal year in a jurisdiction, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). The tax (or benefit) related to ordinary income (or loss) in that jurisdiction shall be recognized in the interim period in which the ordinary income (or loss) is reported. The tax (or benefit) related to ordinary income (or loss) in a jurisdiction may not be limited to tax (or benefit) in that jurisdiction. It might also include tax (or benefit) in another jurisdiction that results from providing taxes on unremitted earnings, foreign tax credits, and so forth.

ASC 740-270-30-36(b) provides additional exceptions to the general rule that the interim period tax (or benefit) related to consolidated ordinary income (or loss) for the YTD should be computed by using one overall estimated AETR. It indicates that if an entity is (1) unable to estimate an AETR in a foreign jurisdiction in dollars or (2) unable to make a reliable estimate of (a) its ordinary income (or loss) or (b) the related tax (or benefit) for the fiscal year, the entity should exclude that jurisdiction from the overall AETR.

An entity may not be able to reliably estimate an AETR in a foreign jurisdiction in dollars2 if the relevant foreign exchange rate is highly volatile. The determination of what constitutes a “reliable estimate” is a matter of judgment.

7.2.4 Excess Tax Benefits and Deficiencies Related to Share-Based Payment Awards

When a share-based payment award is granted to an employee, the fair value of the award is generally recognized over the vesting period, and a corresponding DTA is recognized to the extent that the award is tax deductible. The tax deduction is generally based on the intrinsic value at the time of exercise (for an option) or on the fair value upon vesting of the award (for restricted stock), and it can be either greater (excess tax benefit) or less (tax deficiency) than the compensation cost recognized in the financial statements.

ASC 740-270-30-4, ASC 740-270-30-8, and ASC 740-270-30-12 require entities to account for excess tax benefits and tax deficiencies as discrete items in the period in which they occur (i.e., entities should exclude them from the AETR). Therefore, the effects of expected future excesses and deficiencies should not be anticipated. The tax effects of the expected compensation expense should be included in the AETR.

Example 7-7

If, in the first quarter, an exercise of stock options results in a tax deficiency, but it is anticipated that in the second quarter a large excess tax benefit will result, an entity should still record an income tax expense related to the tax deficiency in the first quarter. In the second quarter, if an excess tax benefit does result, the income tax expense recorded in the first quarter resulting from the deficiency can be reversed as income tax benefit.

7.2.4.1 Interim Tax Effects of Awards Expected to Expire Unexercised During the Year

When estimating the AETR for the current interim period, an entity should not include the estimated effects of the expiration of awards expected to occur in a future interim period. For example, if share-based payment awards are expected to expire unexercised in the second quarter because they are “deep out of the money,” the entity should not consider the anticipated income tax expense as a result of the write-off of the related DTAs when estimating the AETR to compute the tax provision for the first quarter. Instead, the entity should record the income tax expense related to the write-off of the DTA upon expiration of an award in the period in which the awards expire unexercised. See Chapter 10 for general guidance on the accounting for income taxes associated with share-based payments and Section 10.2.4.2 for guidance related to the accounting for awards that expire unexercised.

7.2.4.2 Measuring the Excess Tax Benefit or Tax Deficiency Associated With Share-Based Compensation: Tax Credits and Other Items That Affect the ETR

Entities may receive tax credits or deductions for qualifying expenditures, which often include employee share-based compensation costs (e.g., the research and experimentation credit and the FDII deduction) that lower the entity’s ETR and can affect the determination of the excess tax benefit or tax deficiency that must be (1) accounted for under ASC 718-740-35-2 and (2) treated as a discrete item in the period in which the excess tax benefit or tax deficiency occurs. Accordingly, the excess tax benefit or deficiency of a share-based compensation deduction may differ from the amount computed on the basis of the applicable jurisdiction’s statutory tax rate multiplied by the excess or deficiency of the tax compensation deduction over an award’s corresponding compensation costs recognized for financial reporting purposes (e.g., “direct tax effects”).

Under U.S. GAAP, there are several acceptable approaches to determining the excess tax benefits or deficiencies that must be accounted for discretely under ASC 718-740-35-2:

One acceptable approach is to consider only the direct tax effects of the share-based compensation deduction. Under this approach, an entity would multiply its applicable income tax rate, as described in ASC 740-10-30-8, by the amount of cumulative share-based compensation cost and the deduction reported on a tax return to determine the amount of the DTA and the actual tax benefit, respectively. The income tax rate for each award should be computed on the basis of the rates applicable in each tax jurisdiction, as appropriate. Under this approach, the indirect effects of the deduction are not considered. The actual tax benefit is computed by multiplying the tax deduction by the applicable income tax rate in effect in the period in which the award is settled, which, in the absence of a change in enacted tax rate or tax law, would generally equal the rate used when the associated DTA was recognized (e.g., the jurisdiction’s statutory tax rate).
A second acceptable approach would be to perform a full ASC 740 “with-and-without” computation. Under this approach, the entire incremental tax effect of the actual tax deduction would be compared with the entire incremental tax effect of the cumulative amount of compensation cost recognized for book purposes as if it were the actual tax deduction. The difference would be the amount of excess tax benefit or tax deficiency.
A third acceptable alternative would be to compare the entire incremental tax effect of the actual tax deduction with the DTA recognized to determine the excess tax benefit or tax deficiency.

Use of one of the approaches described above to measure the excess tax benefit or tax deficiency constitutes an accounting policy that should be applied consistently to all awards and related tax effects.

7.2.5 Tax-Exempt Interest

It is acceptable for an entity to either include or exclude tax-exempt interest income when computing its estimated AETR. However, if tax-exempt interest income is included in ordinary income, we believe that the resulting tax benefit (permanent difference) should be included in the calculation of the estimated AETR. Whichever method is elected should be consistently applied.

As described in paragraph 80 of Interpretation 18, the FASB did not provide explicit guidance requiring a specific approach and instead stated, “the accounting practice . . . for tax-exempt interest income in interim periods appears to be uniform.” Comments received from respondents suggest that the common practice at the time among financial institutions was to exclude tax-exempt interest income from the estimated tax rate calculation.

7.2.6 Interest Expense When Interest Is Classified as Income Tax Expense

ASC 740-10-45-25 indicates that interest recognized for the underpayment of income taxes can be classified in the statement of operations as either income tax or interest expense, depending on the entity’s accounting policy election.

An entity that has adopted an accounting policy to include interest expense for the underpayment of income taxes as a component of income taxes in accordance with ASC 740-270 should not recognize interest expense through the estimated AETR for interim reporting purposes. This is because the interest expense relates to prior-year UTBs and is not based on taxes for current-year income and expense amounts. This conclusion was confirmed with the SEC staff.

Footnotes

[1]

Although the phrase “unusual or infrequently occurring items” is consistent with the definition in ASC 220 of “infrequency of occurrence” and “unusual nature,” the reference in ASC 220 applies to items that are not classified as a separate component of continuing operations.

Although the standard refers to “dollars,” we believe that this concept would apply to any reporting entity that has difficulty estimating an AETR in a foreign jurisdiction in its reporting currency.

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.