9.8 Changes in U.S. Deferred Income Taxes Related to a Foreign Branch CTA
As discussed in Section 3.3.6.3, a foreign branch of a U.S. corporation is subject to
taxation in two countries; therefore, it will generally have in-country temporary
differences and U.S. temporary differences. Further, because a foreign branch of a U.S.
parent operates in a foreign country, its functional currency as determined under ASC
830 may be, and often is, different from the U.S. parent’s functional currency. For
example, while the U.S. parent’s functional currency is USD, the branch’s functional
currency may be the local currency. When the U.S. parent applies the final currency
regulations issued in December 2024 under IRC Section 987, the branch’s taxable income
or loss is calculated in the branch’s functional currency and then translated into USD
by using the applicable exchange rate for the taxable year. In many cases, the U.S.
temporary differences and DTAs and DTLs related to such assets and liabilities must be
calculated in the functional currency; then, the appropriate exchange rate must be used
to translate the DTAs and DTLs into USD. Therefore, exchange rate changes will cause
fluctuations in the financial reporting carrying value of the U.S. parent’s USD DTAs or
DTLs related to the U.S. temporary differences.
When the change in the carrying value of USD DTAs or DTLs related to
U.S. temporary differences is attributed solely to the fluctuations in the exchange
rate, each of the following views is acceptable for recording the offsetting entry:
- View A — The offsetting adjustment should be recognized in the CTA account. The exchange rate fluctuation’s effect on the carrying value of the assets, including the change in the DTA or DTL, would be captured in CTA as part of the translation of the investment in the branch. Therefore, the foreign currency exchange rate effect on the DTA or DTL would be part of the tax effect of such translation adjustment, which should be recorded in CTA in accordance with ASC 740-20-45-11(b) and ASC 830-20-45-5.
- View B — The offsetting adjustment should be recognized in the U.S. parent’s income statement. Although the branch is considered a foreign entity under ASC 830, the DTAs or DTLs related to the U.S. temporary differences represent assets and liabilities of the parent entity rather than those of the branch being translated. Accordingly, the DTAs or DTLs represent the U.S. parent’s assets or liabilities that are denominated in a currency other than its functional currency. Exchange rate fluctuations will increase or decrease the amount of the parent’s functional currency cash flows upon recovery or settlement of the DTA or DTL; therefore, in accordance with ASC 830-20-35-1, such fluctuations would be reported as foreign currency transaction gains or losses in the determination of net income. Alternatively, under ASC 830-740-45-1, the U.S. parent may classify the transaction gain or loss in deferred tax benefit or expense rather than in pretax income if that presentation is considered more useful.
An entity’s selected view should be applied consistently to all DTAs and
DTLs related to U.S. temporary differences denominated in a foreign currency. The
fluctuation in the exchange rate affects the carrying amount of those deferred taxes in
USD.
Example 9-10
Assume that a U.S. parent company (Parent Co.) establishes a
branch (Branch Co.) in the United Kingdom. In accordance with
ASC 830, management determines that the functional currency of
Parent Co. is USD, and that of Branch Co. is the British pound.
Parent Co. is subject to tax in the United States at 21 percent,
and Branch Co. is subject to tax in the United Kingdom at 20
percent. In addition, the taxes paid by Branch Co. in the United
Kingdom are fully creditable in the United States without
limitation, and Parent Co. intends to elect to claim FTCs in the
year in which the foreign temporary difference reverses.
Assume the following:
- In 20X6, Branch Co. had pretax book income of £200,000.
- For U.S. and U.K. income tax reporting purposes, Branch Co. has a taxable temporary difference of £100,000 because of accelerated depreciation.
- Branch Co. had no other U.K. or U.S. temporary differences.
- The exchange rates in effect during 20X6 were as follows:
- January 1 £1 = $1.5
- December 31 £1 = $1.2
- Weighted average £1 = $1.3
Parent Co. translates depreciation from British
pounds to USD for U.S. income tax purposes by using the
applicable exchange rate for the tax year in accordance with the
final currency regulations issued in December 2024 under IRC
Section 987.
Parent Co. calculates the currency adjustment for the DTAs and
DTLs associated with the U.S. temporary differences as
follows:
To record the currency adjustment of $100, Parent Co. would make
the following journal entries:
Journal Entry 1: Views A and B
Journal Entry 2: View A
Journal Entry 2: View B