Deloitte's Roadmap: Income Taxes

Preface

We are pleased to present the 2024 edition of Income Taxes, which provides Deloitte’s insights into and interpretations of the income tax accounting guidance in ASC 740.1 The income tax accounting framework has been in place for many years; however, views on the application of that framework to current transactions continue to evolve because structures and tax laws are continually changing. Therefore, while the Roadmap is intended to be a helpful resource, it is not a substitute for consultation with Deloitte professionals on complex income tax accounting questions or transactions.

The body of the Roadmap combines the income tax accounting rules from ASC 740 with Deloitte’s interpretations and examples in a comprehensive, reader-friendly format. The Roadmap reflects Accounting Standards Updates (ASUs) issued by the FASB through August 2024 and includes pending content from recently issued ASUs. Readers should refer to the transition guidance in the FASB Accounting Standards Codification or in the relevant ASU to determine the effective date(s) of the pending guidance.

Each chapter of this publication typically starts with a brief introduction and includes excerpts from ASC 740 or related guidance, Deloitte’s interpretations of those excerpts, and examples to illustrate the relevant guidance. Note that some of the calculations in the examples use rounded numbers for simplicity. The 2024 edition of this Roadmap includes new guidance and editorial enhancements to reflect our latest thinking and input from standard setters and regulators. Appendix I highlights significant changes made to this publication since issuance of last year’s edition.

For certain accounting issues discussed in this publication, multiple views or policies under U.S. GAAP may be acceptable. Unless specifically noted otherwise, an accounting policy elected in these situations should be consistently applied. Entities are encouraged to consult with their accounting advisers for assistance in making such elections.

Be sure to check out On the Radar (also available as a stand-alone publication), which briefly summarizes key issues and trends related to the accounting and financial reporting topics addressed in the Roadmap.

Footnotes

For the full titles of standards, topics, and regulations, see Appendix G. For the full forms of abbreviations, see Appendix H.

On the Radar

The accounting for income taxes under ASC 740 can be extremely complex. The amount of income tax expense an entity must record in each period does not simply equal the amount of income tax payable in each period. Rather, ASC 740 requires an entity to record income tax expense in each period as if there were no differences between (1) the timing of the recognition of events in income before tax for U.S. GAAP purposes and (2) the timing of the recognition of those events in taxable income.

In accordance with ASC 740-10-10-1, an entity’s overall objectives in accounting for income taxes are to (1) “recognize the amount of taxes payable or refundable for the current year” (i.e., current tax expense or benefit) and (2) “recognize deferred tax liabilities [DTLs] and assets [DTAs] for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns” (resulting in deferred tax expense or benefit). An entity’s total tax expense is generally the sum of these two components and can be expressed as the following formula:

To apply the guidance in ASC 740, entities must understand not only the standard’s accounting requirements but also the tax codes under various jurisdictions. Accordingly, coordination between the accounting and tax departments is generally required.

Legislative and Economic Setting

In 2022, two pieces of legislation with significant tax-related provisions were enacted. The CHIPS Act of 2022 (H.R. 4346), signed into law on August 9, 2022, established an advanced manufacturing investment credit under new IRC Section 48D. The Inflation Reduction Act of 2022 (H.R. 5376), signed into law on August 16, 2022, included (1) a 15 percent book minimum tax (corporate alternative minimum tax [AMT]) on the adjusted financial statement income (AFSI) of applicable corporations; (2) a plethora of clean-energy tax incentives in the form of tax credits, some of which have a direct-pay option or transferability provision; and (3) a 1 percent excise tax on certain corporate stock buybacks.

The provisions of the Inflation Reduction Act went into effect for taxable years beginning after December 31, 2022. While the ASC 740 ramifications of the corporate AMT were relatively minor (see Sections 5.7.1 and 3.3.4.10), the direct-pay and transferability provisions of the new tax credits have presented (and continue to present) a host of new challenges (see Section 12.2).

In addition, multinational entities have been navigating the Organisation for Economic Co-operation and Development’s (OECD’s) Pillar Two tax regime, which introduces a global minimum corporate tax rate of 15 percent. To implement the global minimum tax, individual countries are responsible for establishing laws and regulations in line with the framework provided by the OECD. Many countries have enacted legislation that went into effect in 2024. Generally, we expect these new taxes to be accounted for in a manner similar to AMTs for consolidated financial statements, but the accounting impacts of each new law will need to be separately evaluated in each jurisdiction. See Section 3.3.4.10 and Appendix F for further details.

Standard-Setting Activity

In December 2023, the FASB issued ASU 2023-09, which establishes new income tax disclosure requirements within ASC 740 in addition to modifying and eliminating certain existing requirements. The ASU’s amendments are intended to enhance the transparency and decision-usefulness of such disclosures. Under the new guidance, public business entities (PBEs) must consistently categorize and provide greater disaggregation of information in the rate reconciliation. The ASU also includes additional disaggregation requirements related to income taxes paid. The ASU’s disclosure requirements apply to all entities subject to ASC 740. PBEs must apply the amendments to annual periods beginning after December 15, 2024 (2025 for calendar-year-end PBEs). Entities other than PBEs have an additional year to adopt the guidance.

For more information about ASU 2023-09, see Appendix B.

Accounting for Investments in Tax Credit Structures

In March 2023, the FASB issued ASU 2023-02, which expands the use of the proportional amortization method — which previously applied only to low-income housing tax credit investments — to other tax equity investments that meet certain revised criteria in ASC 323-740-25-1. The ASU is intended to improve the accounting and disclosures for investments in tax credit structures.

For additional information about tax credit structures, see Appendixes C and D of Deloitte’s Roadmap Equity Method Investments and Joint Ventures.

Contacts

Chapter 1 — Overview

1.2 Background of ASC 740

A basic principle of the taxation of income in many jurisdictions, including the U.S. federal jurisdiction, is that an entity is taxed only on its net earnings (i.e., it is taxed on total revenue after allowable expenses incurred to generate the revenue have been deducted to arrive at a net amount of taxable income). Generally, an entity applies a rate or series of rates to taxable income to determine a preliminary amount of income tax owed for the period. In many jurisdictions, the entity then reduces that preliminary amount by available income tax credits, if any, to determine the ultimate amount of tax owed in a particular period.

If there were no differences between the way an entity determined its income before tax under U.S. GAAP and its taxable income, and there were no tax credits or tax loss carryforwards available, a profitable entity could simply multiply its U.S. GAAP income before tax by the statutory tax rate(s) applicable to the jurisdiction(s) in which the income was earned and record an income tax payable and corresponding expense each period. While there are many similarities between the treatment of items of income and loss under U.S. GAAP and for income tax reporting purposes, there are still many differences. Accordingly, ASC 740 provides a framework for the accounting for income taxes that takes into account these differences. Under this framework, the amount of income tax expense an entity is required to record in each period does not simply equal the amount of income tax payable in each period. Rather, ASC 740 requires an entity to record income tax expense in each period as if there were no differences between (1) the timing of the recognition of events in income before tax for U.S. GAAP purposes and (2) the timing of the recognition of those events in taxable income. ASC 740 also requires an entity to reduce income tax expense otherwise determined each period (or record an overall income tax benefit) for the expected benefit of net operating losses (NOLs) and tax credits that, in many taxing jurisdictions, may be carried forward or back to reduce taxable income in a future period or get a refund of taxes paid in a prior period.

Chapter 2 — Scope

2.7 Refundable Tax Credits

Certain tax jurisdictions provide refundable credits (e.g., qualifying R&D credits in certain countries and state jurisdictions and alternative fuel tax credits for U.S. federal income tax) that do not depend on the entity’s ongoing tax status or tax position (e.g., an entity may receive a refund despite being in a taxable loss position). Tax credits, such as refundable credits whose realization does not depend on the entity’s generation of taxable income or the entity’s ongoing tax status or tax position, are not considered an element of income tax accounting under ASC 740. Thus, even if the credit claims are filed in connection with a tax return, the refunds are not considered part of income taxes and therefore are not within the scope of ASC 740. In such cases, an entity would not record the credit as a reduction of income tax expense; rather, the entity should determine the credit’s classification on the basis of its nature.

When determining the classification of these credits, an entity may consider them to be a form of government grant or assistance. An entity may look to paragraphs 24 and 29 of IAS 20 for guidance on government grants. Under paragraph 24 of IAS 20, an entity presents government grants related to assets “either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset.” Further, paragraph 29 of IAS 20 states, “Grants related to income are presented as part of profit or loss, either separately or under a general heading such as ‘Other Income’; alternatively, they are deducted in reporting the related expense.”

In rare circumstances, a tax law may change the way a tax credit is realized. For example, a jurisdiction may have historically required that a credit be realized on the tax return as a reduction in taxes payable but subsequently changes the law so that the credit can be realized even though an entity has not first incurred a tax liability (i.e., the credit amount becomes refundable but was not when it arose). In this situation, an entity would generally continue to apply ASC 740 to the credits recognized at the time of the law change. Any new refundable credits earned after the tax law change would be accounted for as refundable credits in accordance with the guidance in this section.

Credits whose realization ultimately depends on taxable income (e.g., investment tax credits [ITCs] and R&D credits) would be within the scope of ASC 740. See Section 12.2 for more information about the accounting for ITCs.

2.7.1 Selling Income Tax Credits to Monetize Them

Some tax jurisdictions might allow an entity that generates certain types of income tax credits to either use the credit to reduce its income tax liability or effectively “sell” all or a portion of it by assigning the right to claim the credit to another qualified entity. If, however, the credit can be used only to reduce an income tax liability either of the entity that generated it or the entity to which it is sold and would never be refundable by the government, we believe that the credit is within the scope of ASC 740.2

In situations in which an entity does not have sufficient taxable income to use all or a portion of the income tax credit or in which using it might take multiple tax years, the entity might achieve a better economic benefit (i.e., present value benefit) by selling the credit. In such situations, the entity that generated the credit should initially recognize and measure it in accordance with the recognition and measurement criteria of ASC 740. To the extent that the income tax credit does not reduce income taxes currently payable, the entity would recognize a DTA for the carryforward and assess it for realizability in a manner consistent with the sources of income cited in ASC 740-10-30-18.3 See Section 5.3 for additional discussion.

If the entity were to subsequently sell the income tax credit, we understand based on a FASB staff technical inquiry that it would be most appropriate to reflect any proceeds and resulting gain/loss on the sale as a component of the tax provision. Alternatively, we believe the sale could be treated no differently than the sale of any other asset, with gain or loss recognized in pretax earnings for any difference between the proceeds received and the recorded carrying value (i.e., the DTA for the income tax credit recognized under the guidance in ASC 740 on recognition and measurement).

Footnotes

While we believe accounting for the credits within the scope of ASC 740 is most appropriate, consistent with feedback received from the FASB staff, we believe it would also be acceptable for a company to account for the transferable credits in a manner similar to refundable credits as the company generating the credit does not need taxable income in order to monetize the credit.

While we believe such assessment would generally be predicated upon the normal course of business (i.e., an entity would not factor in its ability to sell the underlying tax attribute as a basis for realizing the related DTA), we understand based on a technical inquiry with the FASB staff that it would also be acceptable to consider the expected proceeds when assessing realizability.

2.9 Income Taxes Paid by the Entity on Behalf of Its Owners

A pass-through entity, which would not normally be subject to tax, may elect to pay income taxes under a pass-through entity tax regime. In these situations, ASC 740 provides guidance on whether the income taxes are attributed to the pass-through entity or its owners. The determination is based on the laws and regulations of each specific jurisdiction. If an income tax is attributable to the entity, the entity should account for the tax in accordance with ASC 740, including the recognition of deferred taxes if applicable. Conversely, if an income tax is attributable to the owners, the pass-through entity would account for the income taxes paid by applying other guidance. The examples in ASC 740-10-55-226 through 55-228 provide a high-level framework for making this assessment:

ASC 740-10

Example 35: Attribution of Income Taxes to the Entity or Its Owners

55-226 Entity A, a partnership with two partners — Partner 1 and Partner 2 — has nexus in Jurisdiction J. Jurisdiction J assesses an income tax on Entity A and allows Partners 1 and 2 to file a tax return and use their pro rata share of Entity A’s income tax payment as a credit (that is, payment against the tax liability of the owners). Because the owners may file a tax return and utilize Entity A’s payment as a payment against their personal income tax, the income tax would be attributed to the owners by Jurisdiction J’s laws whether or not the owners file an income tax return. Because the income tax has been attributed to the owners, payments to Jurisdiction J for income taxes should be treated as a transaction with the owners. The result would not change even if there were an agreement between Entity A and its two partners requiring Entity A to reimburse Partners 1 and 2 for any taxes the partners may owe to Jurisdiction J. This is because attribution is based on the laws and regulations of the taxing authority rather than on obligations imposed by agreements between an entity and its owners.

Example 36: Attribution of Income Taxes to the Entity or Its Owners

55-227 If the fact pattern in paragraph 740-10-55-226 changed such that Jurisdiction J has no provision for the owners to file tax returns and the laws and regulations of Jurisdiction J do not indicate that the payments are made on behalf of Partners 1 and 2, income taxes are attributed to Entity A on the basis of Jurisdiction J’s laws and are accounted for based on the guidance in this Subtopic.

Example 37: Attribution of Income Taxes to the Entity or Its Owners

55-228 Entity S, an S Corporation, files a tax return in Jurisdiction J. An analysis of the laws and regulations of Jurisdiction J indicates that Jurisdiction J can hold Entity S and its owners jointly and severally liable for payment of income taxes. The laws and regulations also indicate that if payment is made by Entity S, the payments are made on behalf of the owners. Because the laws and regulations attribute the income tax to the owners regardless of who pays the tax, any payments to Jurisdiction J for income taxes should be treated as a transaction with its owners.

The examples in the guidance above highlight certain characteristics that an entity should consider, including:

Whether the jurisdiction also allows the owners to file tax returns and use their pro rata share of tax paid by the entity as a credit against their tax liability.
Whether the entity and the owners are joint and severally liable for payment of income taxes in the jurisdiction.

In many cases, however, the tax law may not specifically state whether the entity and the owners are jointly and severally liable. In these instances, an entity should consider the following:

Whether the owners are ultimately liable if the entity is required (or makes an election) but ultimately fails to pay the tax.
Whether the entity, owners, or both are responsible for paying taxes associated with uncertain tax positions.

No single characteristic is individually determinative with respect to an evaluation of the scope of the taxes paid. Rather, a preponderance of the evidence would be needed to support the conclusion reached. Accordingly, determining whether a tax is attributable to the entity or the owner may be challenging and will, by definition, depend on the specific laws and regulations of the respective jurisdictions.

Chapter 3 — Book-Versus-Tax Differences and Tax Attributes

3.2 Permanent Differences

ASC 740-10

Basis Differences That Are Not Temporary Differences

25-30 Certain basis differences may not result in taxable or deductible amounts in future years when the related asset or liability for financial reporting is recovered or settled and, therefore, may not be temporary differences for which a deferred tax liability or asset is recognized. One example, depending on the provisions of the tax law, could be the excess of cash surrender value of life insurance over premiums paid. That excess is a temporary difference if the cash surrender value is expected to be recovered by surrendering the policy, but is not a temporary difference if the asset is expected to be recovered without tax consequence upon the death of the insured (if under provisions of the tax law there will be no taxable amount if the insurance policy is held until the death of the insured).

25-31 Tax-to-tax differences are not temporary differences. Recognition of a deferred tax asset for tax-to-tax differences is prohibited as tax-to-tax differences are not one of the exceptions identified in paragraph 740-10-25-3. An example of a tax-to-tax difference is an excess of the parent entity’s tax basis of the stock of an acquired entity over the tax basis of the net assets of the acquired entity.

FASB Statement 109, which was codified in ASC 740, effectively described permanent differences as differences that arise from statutory provisions under which (1) specified revenues are exempt from taxation and (2) specified expenses are not allowable as deductions in the determination of taxable income.

In addition, ASC 740-10-25-31 provides guidance on tax-to-tax differences. For example, as a result of a nontaxable business combination, the acquiror’s tax basis in the acquired stock (i.e., outside basis) may exceed the tax basis in the acquired entity’s assets and liabilities (i.e., inside basis). Since such differences are not temporary differences, the recognition of a DTA is prohibited under ASC 740.

The table below illustrates many of the more common permanent differences that result from the application of U.S. federal tax law to items recognized for financial reporting purposes.

Accounting Description	Accounting Treatment	Tax Treatment
Tax-exempt securities:
1. Interest income	Income	Tax exempt (IRC Section 103).
2. Interest paid on debt incurred to buy or carry tax-exempt securities	Expense	Not deductible (IRC Section 265).
3. Amortization of bond premium	Expensed by using interest method (ASC 835-30-35-2)	Not deductible (IRC Section 171(a)); however, basis of bond must be reduced by amount of amortization (IRC Section 1016(a)(5)).
4. Gains or losses upon disposition	Income (loss)	No gain or loss if held to maturity (HTM) by original buyer. If sold or redeemed before maturity, capital gain (loss).
Illegal bribes and kickbacks	Expense	Not deductible.
Treble damages; payments involving criminal proceedings	Expense	Not deductible (IRC Section 162(g)).
Expenses paid or incurred to influence the general public with respect to legislative matters, elections, or referendums	Expense	Not deductible (IRC Section 162(e)(1)(c)).
Expenses paid or incurred with respect to legislative matters that are not in direct interest to the taxpayer’s trade of business	Expense	Not deductible (IRC Treas. Reg. 1.162-20(c)).
Fines and penalties paid to the government of the United States, a territory or possession of the United States, the District of Columbia, a foreign country, or a political subdivision of any of the above for the violation of any law	Expense	Not deductible (IRC Section 162(f)).
Worthless debts from political parties	Expense	Generally, not deductible. May be deducted by banks and other taxpayers if more than 30 percent of all receivables accrued during normal course of business are due from political parties (IRC Section 271).
Income and expenses from sources within possessions of the United States	Income and expense	Income may be exempt and deductions not allowed if certain conditions are met (IRC Section 931).
Certain expenses that a taxpayer chooses to claim a credit in lieu of (i.e., foreign tax credit [FTC], jobs credit)	Expense	Not deductible.
Entertainment expense	Expense	Not deductible (IRC Section 274(a)).
Meals expense	Expense	50 percent is not deductible for tax purposes (IRC Section 274(n)).
Political contributions	Expense	Not deductible (IRC Treas. Reg. 1.162-20(c)(1)).
Certain losses on the disposition of consolidated-group subsidiary stock	Expense	Not deductible (IRC Treas. Reg. 1.1502-36).

3.2.1 Special Deductions

ASC 740-10

Anticipated Future Special Deductions

25-37 The tax benefit of statutory depletion and other types of special deductions such as those that may be available for certain health benefit entities and small life insurance entities in future years shall not be anticipated for purposes of offsetting a deferred tax liability for taxable temporary differences at the end of the current year. The tax benefit of special deductions ordinarily is recognized no earlier than the year in which those special deductions are deductible on the tax return. However, some portion of the future tax effects of special deductions are implicitly recognized in determining the average graduated tax rate to be used for measuring deferred taxes when graduated tax rates are a significant factor and the need for a valuation allowance for deferred tax assets. In those circumstances, implicit recognition is unavoidable because those special deductions are one of the determinants of future taxable income and future taxable income determines the average graduated tax rate and sometimes determines the need for a valuation allowance. See Section 740-10-30 for measurement requirements related to determining tax rates and a valuation allowance for deferred tax assets.

Other common permanent differences that result from the application of U.S. federal tax law include special deductions. The tax law permits certain entities to recognize certain tax benefits for special deductions. Such deductions are reflected in pretax income for tax reporting purposes but not for financial reporting purposes and therefore give rise to permanent differences. While the term “special deduction” is not defined, ASC 740-10-25-37 and ASC 740-10-55-27 through 55-30 offer four examples: (1) tax benefits for statutory depletion, (2) deductions for certain health benefit entities (e.g., Blue Cross/Blue Shield providers), (3) deductions for small life insurance companies, and (4) a deduction for domestic production activities. In addition, the deduction for foreign-derived intangible income (FDII) qualifies as a special deduction.

The next sections summarize the special deductions discussed above.

3.2.1.1 Statutory Depletion

IRC Sections 611–613 allow entities in certain extractive industries, such as oil and gas and mining, to take a deduction for “depletion” when determining taxable income for U.S. federal tax purposes. The depletion deduction for a particular taxable year is calculated as the greater of cost depletion or percentage depletion. Cost depletion is based on the cost of the reserves, and percentage depletion is based on multiplying gross income from the property by a specified statutory percentage, subject to certain limitations. As with other special deductions, entities cannot anticipate the tax benefit from statutory depletion when measuring the DTL related to a taxable temporary difference at year-end. The statutory depletion tax benefit would be recognized no earlier than the year in which the depletion is deductible on the entity’s income tax return.

3.2.1.2 Blue Cross/Blue Shield Organizations

IRC Section 833 entitles Blue Cross and Blue Shield plans to special tax deductions that are not available to other insurers. The deduction allowed for any taxable year is the excess (if any) of (1) 25 percent of the sum of (a) claims incurred during the taxable year and (b) expenses incurred in connection with the administration, adjustment, or settlement of claims over (2) the “adjusted surplus” as of the beginning of the taxable year.

3.2.1.3 Domestic Production Activities Deduction

The domestic production activities deduction was enacted into law in the United States on October 22, 2004, as part of the American Jobs Creation Act of 2004 (the “Jobs Creation Act”). The Jobs Creation Act allowed for a tax deduction of up to 9 percent of the lesser of (1) qualified production activities income or (2) taxable income (after the deduction for the use of any NOL carryforwards). This tax deduction was limited to 50 percent of W-2 wages paid by the taxpayer. ASC 740-10-55-27 through 55-30 provide implementation guidance clarifying that the production activities deduction should be accounted for as a special deduction in accordance with ASC 740-10-25-37. The domestic production activities deduction was repealed upon enactment of the Tax Cuts and Jobs Act of 2017 (the “2017 Act”).

3.2.1.4 Foreign-Derived Intangible Income

IRC Section 250 allows a domestic corporation an immediate deduction against U.S. taxable income for a portion of its FDII. The amount of the deduction depends, in part, on the corporation’s U.S. taxable income. The percentage of income that can be deducted is reduced in taxable years beginning after December 31, 2025.

3.4 Outside Basis Differences

ASC 740-10

25-1 This Section establishes the recognition requirements necessary to implement the objectives of accounting for income taxes identified in Section 740-10-10. The following paragraph sets forth the basic recognition requirements while paragraph 740-10-25-3 identifies specific, limited exceptions to the basic requirements.

25-2 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.

25-3 The only exceptions in applying those basic requirements are:

Certain exceptions to the requirements for recognition of deferred taxes whereby a deferred tax liability is not recognized for the following types of temporary differences unless it becomes apparent that those temporary differences will reverse in the foreseeable future:
1. An excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture that is essentially permanent in duration. See paragraphs 740-30-25-18 through 25-19 for the specific requirements related to this exception.
2. Undistributed earnings of a domestic subsidiary or a domestic corporate joint venture that is essentially permanent in duration that arose in fiscal years beginning on or before December 15, 1992. A last-in, first-out (LIFO) pattern determines whether reversals pertain to differences that arose in fiscal years beginning on or before December 15, 1992. See paragraphs 740-30-25-18 through 25-19 for the specific requirements related to this exception.
3. Bad debt reserves for tax purposes of U.S. savings and loan associations (and other qualified thrift lenders) that arose in tax years beginning before December 31, 1987. See paragraphs 942-740-25-1 through 25-3 for the specific requirements related to this exception.
4. Policyholders’ surplus of stock life insurance entities that arose in fiscal years beginning on or before December 15, 1992. See paragraph 944-740-25-2 for the specific requirements related to this exception.
Subparagraph superseded by Accounting Standards Update No. 2017-15.
The pattern of recognition of after-tax income for leveraged leases or the allocation of the purchase price in a purchase business combination to acquired leveraged leases as required by Subtopic 842-50.
A prohibition on recognition of a deferred tax liability related to goodwill (or the portion thereof) for which amortization is not deductible for tax purposes (see paragraph 805-740-25-3).
A prohibition on recognition of a deferred tax asset for the difference between the tax basis of inventory in the buyer’s tax jurisdiction and the carrying value as reported in the consolidated financial statements as a result of an intra-entity transfer of inventory from one tax-paying component to another tax-paying component of the same consolidated group. Income taxes paid on intra-entity profits on inventory remaining within the consolidated group are accounted for under the requirements of Subtopic 810-10.
A prohibition on recognition of a deferred tax liability or asset for differences related to assets and liabilities that, under Subtopic 830-10, are remeasured from the local currency into the functional currency using historical exchange rates and that result from changes in exchange rates or indexing for tax purposes. See Subtopic 830-740 for guidance on foreign currency related income taxes matters.

ASC 740-30

25-1 This Section provides guidance on the accounting for specific temporary differences related to investments in subsidiaries and corporate joint ventures, including differences arising from undistributed earnings. In certain situations, these temporary differences may be accounted for differently from the accounting that otherwise requires comprehensive recognition of deferred income taxes for temporary differences.

25-2 Including undistributed earnings of a subsidiary (which would include the undistributed earnings of a domestic international sales corporation eligible for tax deferral) in the pretax accounting income of a parent entity either through consolidation or accounting for the investment by the equity method results in a temporary difference.

25-3 It shall be presumed that all undistributed earnings of a subsidiary will be transferred to the parent entity. Accordingly, the undistributed earnings of a subsidiary included in consolidated income shall be accounted for as a temporary difference unless the tax law provides a means by which the investment in a domestic subsidiary can be recovered tax free.

25-4 The principles applicable to undistributed earnings of subsidiaries in this Section also apply to tax effects of differences between taxable income and pretax accounting income attributable to earnings of corporate joint ventures that are essentially permanent in duration and are accounted for by the equity method. Certain corporate joint ventures have a life limited by the nature of the venture, project, or other business activity. Therefore, a reasonable assumption is that a part or all of the undistributed earnings of the venture will be transferred to the investor in a taxable distribution. Deferred taxes shall be recorded, in accordance with the requirements of Subtopic 740-10 at the time the earnings (or losses) are included in the investor’s income.

25-5 A deferred tax liability shall be recognized for both of the following types of taxable temporary differences:

An excess of the amount for financial reporting over the tax basis of an investment in a domestic subsidiary that arises in fiscal years beginning after December 15, 1992.
An excess of the amount for financial reporting over the tax basis of an investment in a 50-percent-or-less-owned investee except as provided in paragraph 740-30-25-18 for a corporate joint venture that is essentially permanent in duration.

Paragraphs 740-30-25-9 and 740-30-25-18 identify exceptions to the accounting that otherwise requires comprehensive recognition of deferred income taxes for temporary differences arising from investments in subsidiaries and corporate joint ventures.

25-6 Paragraph 740-30-25-18 provides that a deferred tax liability is not recognized for either of the following:

An excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary that meets the criteria in paragraph 740-30-25-17.
Undistributed earnings of a domestic subsidiary that arose in fiscal years beginning on or before December 15, 1992, and that meet the criteria in paragraph 740-30-25-17. The criteria in that paragraph do not apply to undistributed earnings of domestic subsidiaries that arise in fiscal years beginning after December 15, 1992, and as required by the preceding paragraph, a deferred tax liability shall be recognized if the undistributed earnings are a taxable temporary difference.

Determining Whether a Temporary Difference Is a Taxable Temporary Difference

25-7 Whether an excess of the amount for financial reporting over the tax basis of an investment in a more-than-50-percent-owned domestic subsidiary is a taxable temporary difference shall be assessed. It is not a taxable temporary difference if the tax law provides a means by which the reported amount of that investment can be recovered tax-free and the entity expects that it will ultimately use that means. For example, tax law may provide that:

An entity may elect to determine taxable gain or loss on the liquidation of an 80-percent-or-more-owned subsidiary by reference to the tax basis of the subsidiary’s net assets rather than by reference to the parent entity’s tax basis for the stock of that subsidiary.
An entity may execute a statutory merger whereby a subsidiary is merged into the parent entity, the noncontrolling shareholders receive stock of the parent, the subsidiary’s stock is cancelled, and no taxable gain or loss results if the continuity of ownership, continuity of business entity, and certain other requirements of the tax law are met.

25-8 Some elections for tax purposes are available only if the parent owns a specified percentage of the subsidiary’s stock. The parent sometimes may own less than that specified percentage, and the price per share to acquire a noncontrolling interest may significantly exceed the per-share equivalent of the amount reported as noncontrolling interest in the consolidated financial statements. In those circumstances, the excess of the amount for financial reporting over the tax basis of the parent’s investment in the subsidiary is not a taxable temporary difference if settlement of the noncontrolling interest is expected to occur at the point in time when settlement would not result in a significant cost. That could occur, for example, toward the end of the life of the subsidiary, after it has recovered and settled most of its assets and liabilities, respectively. The fair value of the noncontrolling interest ordinarily will approximately equal its percentage of the subsidiary’s net assets if those net assets consist primarily of cash.

Recognition of Deferred Tax Assets

25-9 A deferred tax asset shall be recognized for an excess of the tax basis over the amount for financial reporting of an investment in a subsidiary or corporate joint venture that is essentially permanent in duration only if it is apparent that the temporary difference will reverse in the foreseeable future.

25-10 For example, if an entity decides to sell a subsidiary that meets the requirements of paragraphs 205-20-45-1A through 45-1D for measurement and display as a discontinued operation and the parent entity’s tax basis in the stock of the subsidiary (outside tax basis) exceeds the financial reporting amount of the investment in the subsidiary, the decision to sell the subsidiary makes it apparent that the deductible temporary difference will reverse in the foreseeable future. Assuming in this example that it is more likely than not that the deferred tax asset will be realized, the tax benefit for the excess of outside tax basis over financial reporting basis shall be recognized when it is apparent that the temporary difference will reverse in the foreseeable future. The same criterion shall apply for the recognition of a deferred tax liability related to an excess of financial reporting basis over outside tax basis of an investment in a subsidiary that was previously not recognized under the provisions of paragraph 740-30-25-18.

25-11 The need for a valuation allowance for the deferred tax asset referred to in paragraph 740-30-25-9 and other related deferred tax assets, such as a deferred tax asset for foreign tax credit carryforwards, shall be assessed.

25-12 Paragraph 740-10-30-18 identifies four sources of taxable income to be considered in determining the need for and amount of a valuation allowance for those and other deferred tax assets. One source is future reversals of temporary differences.

25-13 Future distributions of future earnings of a subsidiary or corporate joint venture, however, shall not be considered except to the extent that a deferred tax liability has been recognized for existing undistributed earnings or earnings have been remitted in the past.

25-14 A tax benefit shall not be recognized, however, for tax deductions or favorable tax rates attributable to future dividends of undistributed earnings for which a deferred tax liability has not been recognized under the requirements of paragraph 740-30-25-18.

Ownership Changes in Investments

25-15 An investment in common stock of a subsidiary may change so that it is no longer a subsidiary because the parent entity sells a portion of the investment, the subsidiary sells additional stock, or other transactions affect the investment. If a parent entity did not recognize income taxes on its equity in undistributed earnings of a subsidiary for the reasons cited in paragraph 740-30-25-17 (and the entity in which the investment is held ceases to be a subsidiary), it shall accrue in the current period income taxes on the temporary difference related to its remaining investment in common stock in accordance with the guidance in Subtopic 740-10.

25-16 Paragraph superseded by Accounting Standards Update No. 2019-12.

An outside basis difference is the difference between the carrying amount of an entity’s investment (e.g., an investment in a consolidated subsidiary) for financial reporting purposes and the underlying tax basis in that investment (e.g., the immediate parent’s tax basis in the consolidated subsidiary’s stock). From a consolidated financial reporting perspective, an entity’s financial reporting carrying amount in a consolidated subsidiary is eliminated; however, book-to-tax differences in this amount may still result in the need to record deferred taxes.

How an investor should apply the guidance in ASC 740-30 on temporary differences related to investments depends on the type of investment and whether the financial reporting carrying value exceeds the tax basis or vice versa. The table below summarizes the various investment types and applicable guidance. Additional details are discussed in the sections after the table.

Investment	DTA Considerations	DTL Considerations
Domestic subsidiary Domestic corporate joint venture that is essentially permanent in nature	Under ASC 740-30-25-9, a DTA is recognized for the “excess of the tax basis over the amount for financial reporting . . . only if it is apparent that the temporary difference will reverse in the foreseeable future.”	Under ASC 740-30-25-5, recognition of a DTL depends on when the excess of the financial reporting basis over the tax basis of the investment arose: If the outside basis difference arose in fiscal years beginning on or before December 15, 1992, no DTL should be recorded unless the temporary difference will reverse in the foreseeable future. If the entity is a more-than-50-percent-owned subsidiary and the outside basis difference arose in fiscal years beginning after December 15, 1992, a DTL is recorded under ASC 740-30-25-7 unless the investment can be recovered in a tax-free manner without significant cost and the entity expects to use this means of recovery.
Foreign subsidiary Foreign corporate joint venture that is essentially permanent in nature	Under ASC 740-30-25-9, a DTA is recognized for the “excess of the tax basis over the amount for financial reporting . . . only if it is apparent that the temporary difference will reverse in the foreseeable future.”	Under ASC 740-30-25-18, a DTL should not be recognized on the excess of the financial reporting basis over the tax basis of an investment unless it becomes apparent that the temporary difference will reverse in the foreseeable future (i.e., the indefinite reversal criteria are not met).6
Equity method investee (generally, ownership of less than 50 percent but more than 20 percent) that is not a corporate joint venture	A DTA is recognized for the excess of the tax basis of the investment over the amount for financial reporting and must be assessed for realizability (in most jurisdictions, the loss would be capital in character).	A DTL is recorded on the excess of the financial reporting basis over the tax basis of the investment.
Investments in equity securities accounted for under ASC 321, including those in which the measurement alternative is used	Generally, a DTA is recognized for the excess of the tax basis of the investment over the amount for financial reporting (if applicable) and must be assessed for realizability (in most jurisdictions, the loss would be capital in character).	Generally, a DTL is recorded on the excess of the financial reporting basis over the tax basis of the investment (if applicable).

Deferred taxes are always recorded on taxable and deductible temporary differences unless a specific exception applies.

3.4.1 Definition of Foreign and Domestic Investments

ASC 740-10-25-3(a)(1) contains an exception to the requirement to provide a DTL for the “excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture” (emphasis added), while ASC 740-30-25-7 contains an exception to the requirement to provide a DTL for the “excess of the amount for financial reporting over the tax basis of an investment in a more-than-50-percent-owned domestic subsidiary” (emphasis added). Accordingly, it is important to determine whether an entity is a foreign or domestic entity.

An entity should determine whether an investment is foreign or domestic on the basis of the relationship of the investee to the tax jurisdiction of its immediate parent rather than the relationship of the investee to the ultimate parent of the consolidated group. This determination should be made from the “bottom up” through successive tiers of consolidation. At each level, it is necessary to determine whether the subsidiaries being consolidated are foreign or domestic with respect to the consolidating entity. A subsidiary that is treated as a domestic subsidiary under the applicable tax law of its immediate parent would be considered a domestic subsidiary under ASC 740. The examples below illustrate this concept.

Example 3-17

A U.S. parent entity, P, has a majority-owned domestic subsidiary, S1, which has two investments chartered in a foreign country: (1) a majority ownership interest in another entity, S2, and (2) an ownership interest in a corporate joint venture, CJV1. In preparing its consolidated financial statements, S1 consolidates S2 and applies the equity method of accounting to its investment in CJV1. Under ASC 740, S1 would consider its investments in S2 and CJV1 to be in a foreign subsidiary and foreign corporate joint venture, respectively. Parent P would treat S1 as a domestic subsidiary when consolidating S1.

Example 3-18

A U.S. parent entity, P, has a majority ownership interest in a subsidiary (chartered in a foreign country), FS, which has two investments: (1) a majority ownership interest in another entity, S1, and (2) an ownership interest in a corporate joint venture entity, S2. Both S1 and S2 are located in the same foreign country in which FS is chartered. When preparing the consolidated financial statements, FS would consider S1 and S2 a domestic subsidiary and domestic corporate joint venture, respectively, in determining whether to recognize deferred taxes in the foreign country on the outside basis difference of FS’s investments in S1 and S2. Parent P would consider FS a foreign subsidiary.

Example 3-19

A foreign parent entity, FP, prepares U.S. GAAP financial statements and has two investments: (1) a majority-owned investment in a U.S. entity, US1, and (2) an investment in a corporate joint venture located in the United States, JVUS1. In preparing its consolidated financial statements, FP would consider US1 and JVUS1 a foreign subsidiary and a foreign corporate joint venture, respectively.

Example 3-20

A foreign entity, FP2, prepares U.S. GAAP financial statements and has two investments: (1) a majority-owned investment in another entity, S1, and (2) an investment in a corporate joint venture, JV1. Both S1 and JV1 are located in the same foreign country in which FP2 is chartered. In preparing its consolidated financial statements, FP2 would consider S1 and JV1 a domestic subsidiary and a domestic corporate joint venture, respectively.

Example 3-21

A U.S. parent entity, P, has a majority ownership interest in a subsidiary (chartered in a foreign country), FS, that has two investments: (1) a majority ownership interest in another entity, S1, located in the same foreign country in which FS is chartered, and (2) an investment in a corporate joint venture located in the United States, JVUS1. Before being consolidated by P, FS would treat S1 as a domestic subsidiary and would apply the equity method of accounting to JVUS1, as a foreign corporate joint venture to determine whether to recognize deferred taxes on the outside basis difference of its investments in S1 and JVUS1.

3.4.1.1 Definition of Subsidiary and Corporate Joint Venture

An entity should use the following guidance to determine whether an investment is in either a subsidiary or a corporate joint venture:

ASC 810-10-20 defines a subsidiary as follows:

An entity, including an unincorporated entity such as a partnership or trust, in which another entity, known as its parent, holds a controlling financial interest. (Also, a variable interest entity that is consolidated by a primary beneficiary.)

However, ASC 740-10-20 does not specifically define the term “subsidiary” and does not refer to the definition in ASC 810-10. Rather, in practice, the definition of subsidiary in APB Opinion 18 (codified in ASC 323) has been applied. APB Opinion 18 states that subsidiary refers to “a corporation which is controlled, directly or indirectly, by another corporation. The usual condition for control is ownership of a majority (over 50%) of the outstanding voting stock.” Accordingly, while the definition in ASC 810 includes partnerships and trusts, those entities are not considered subsidiaries under ASC 740 because the earnings of such entities generally pass directly through to their owners. See Section 3.4.15 for further discussion of pass-through entities.

The term corporate joint venture is defined in ASC 740-10-20 as follows:

A corporation owned and operated by a small group of entities (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group. A government may also be a member of the group. The purpose of a corporate joint venture frequently is to share risks and rewards in developing a new market, product or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities. A corporate joint venture also usually provides an arrangement under which each joint venturer may participate, directly or indirectly, in the overall management of the joint venture. Joint venturers thus have an interest or relationship other than as passive investors. An entity that is a subsidiary of one of the joint venturers is not a corporate joint venture. The ownership of a corporate joint venture seldom changes, and its stock is usually not traded publicly. A noncontrolling interest held by public ownership, however, does not preclude a corporation from being a corporate joint venture.

3.4.1.2 Potential DTA: Foreign and Domestic Subsidiaries and Corporate Joint Ventures

The ability to record a DTA related to subsidiaries and corporate joint ventures is governed by ASC 740-30-25-9, which states:

A deferred tax asset shall be recognized for an excess of the tax basis over the amount for financial reporting of an investment in a subsidiary or corporate joint venture that is essentially permanent in duration only if it is apparent that the temporary difference will reverse in the foreseeable future.

As used in ASC 740-30-25-9, the term “foreseeable future” refers to an entity’s ability to reasonably anticipate the reversal of the outside basis difference. Further, we believe that in this context, “reverse” is intended to mean “be realized” (i.e., be taken as a deduction on the parent’s income tax return). Since a deductible outside basis difference in a subsidiary or corporate joint venture generally results in a deduction on the parent’s income tax return only upon sale or taxable liquidation of the subsidiary or corporate joint venture, under ASC 740-30-25-9, a DTA would rarely be recognized before the criteria in ASC 360-10-45-9 through 45-11 are met for classification of assets as held for sale. While future earnings of the subsidiary may reduce the deductible outside basis temporary difference, those future earnings do not result in a reversal of the temporary difference, as the term “reverse” is used in ASC 740-30-25-9. In other words, future earnings of the subsidiary do not result in a deduction on the parent’s income tax return. Therefore, anticipated future earnings of the subsidiary should not be relied upon to support a conclusion that “the temporary difference will reverse in the foreseeable future” and that a DTA can be recorded under ASC 740-30-25-9.

At the point at which the subsidiary or corporate joint venture is classified as held for sale in accordance with the criteria in ASC 360-10-45-9 through 45-11, the deferred tax consequences of the deductible outside basis difference should be recognized as a DTA. In accordance with ASC 740-10-30-18, realization of the related DTA “depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback, carryforward period available under the tax law.” If it is not more likely than not that all or a portion of the DTA will be realized, a valuation allowance is necessary.

ASC 740-30-25-9 through 25-13 apply to more-than-50-percent-owned subsidiaries (foreign or domestic) and corporate joint ventures but do not apply to 50-percent-or-less-owned foreign or domestic investees. However, an entity will need to use judgment to determine whether a recognition exception applies to a subsidiary that is consolidated by applying the variable interest entity (VIE) guidance when less than 50 percent of the voting interest is owned by the investor. See Section 3.4.17.1 for consideration of the VIE model in ASC 810-10 in the evaluation of whether to recognize a DTL.

3.4.1.3 Potential DTL: Domestic Subsidiary

ASC 740-30-25-7 applies to investments in a more-than-50-percent-owned domestic subsidiary and assumes that the subsidiary would be consolidated under ASC 810 (see Section 3.4.1.1). ASC 740-30-25-7 does not allow for the application of the indefinite reversal exception to the recognition of DTLs for undistributed earnings of a domestic subsidiary or corporate joint venture generated in fiscal years beginning on or after December 15, 1992. Therefore, under ASC 740-30-25-3, DTLs must be recognized “unless the tax law provides a means by which the investment in a domestic subsidiary can be recovered tax free” and the entity expects that it will ultimately use that means. The holder of the investment must meet both criteria to avoid recording the DTL (see Section 3.4.3 for more information).

While ASC 740-30-25-7 states that it applies only to more-than-50-percent-owned domestic subsidiaries, an entity will need to use judgment to determine whether a recognition exception applies to a subsidiary that is consolidated under the VIE guidance when less than 50 percent of the voting interest is owned by the investor. See Section 3.4.17.1 for considerations related to the VIE model in ASC 810-10 in the evaluation of whether to recognize a DTL.

3.4.2 Tax Consequences of a Change in Intent Regarding Remittance of Pre-1993 Undistributed Earnings

It is possible for an entity to change its intent regarding remittance of the portion of unremitted earnings that was generated for fiscal years beginning on or before December 15, 1992, for domestic subsidiaries and domestic corporate joint ventures that were previously deemed indefinitely invested.

An entity should apply the guidance in ASC 740-30-25-17 and ASC 740-30-25-19 to tax consequences of a change in intent regarding unremitted earnings that arose in fiscal years beginning on or before December 15, 1992. This guidance states, in part:

25-17 The presumption in paragraph 740-30-25-3 that all undistributed earnings will be transferred to the parent entity may be overcome, and no income taxes shall be accrued by the parent entity . . . if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely or that the earnings will be remitted in a tax-free liquidation. . . .

25-19 If circumstances change and it becomes apparent that some or all of the undistributed earnings of a subsidiary will be remitted in the foreseeable future but income taxes have not been recognized by the parent entity, it shall accrue as an expense of the current period income taxes attributable to that remittance. If it becomes apparent that some or all of the undistributed earnings of a subsidiary on which income taxes have been accrued will not be remitted in the foreseeable future, the parent entity shall adjust income tax expense of the current period.

Example 3-22

Assume that Entity X had $2,000 of unremitted earnings from its investment in a domestic corporate joint venture that arose in fiscal years beginning on or before December 15, 1992, and that management has determined that all of the pre-1993 corporate joint venture earnings were indefinitely reinvested. Therefore, no DTL has been recorded. In addition, assume that during 20X1, unremitted earnings from the joint venture were $1,000 and that X accrued the related deferred income taxes on these earnings. During 20X2, management of the joint venture changed its intent regarding remitting the joint venture’s earnings, concluding that $1,000 of retained earnings would be distributed (via a dividend) to X on December 31, 20X2, and $1,000 on December 31, 20X3, respectively.

ASC 740-10-25-3(a) states that whether reversals pertain to differences that arose in fiscal years beginning on or before December 15, 1992, is determined on the basis of a LIFO pattern. Therefore, X would accrue, as of the date the change in intent occurred in 20X2, a DTL for an additional $1,000 of taxable income representing the tax consequence of only $1,000 of pre-1993 unremitted earnings; the deferred tax consequences of the other $1,000 are related to income generated in post-1993 years, which was previously accrued in 20X1.

3.4.3 Tax-Free Liquidation or Merger of a Domestic Subsidiary

There may be instances in which it is acceptable to treat an outside basis difference in a domestic subsidiary as a nontaxable temporary difference. This can arise when the tax law provides a means to recover the investment tax-free and the entity expects that it will ultimately use that means. There are quantitative and qualitative thresholds associated with the analysis to achieve this treatment.

While U.S. tax law provides a means by which an investment of 80 percent or more in a domestic subsidiary can be liquidated or merged into the parent in a tax-free manner, an 80 percent investment in the subsidiary by itself is not sufficient for an entity to conclude that the outside basis difference is not a taxable temporary difference. Rather, the entity must also intend to ultimately use that means. Satisfying the tax law requirements alone is not sufficient; the entity should also consider:

Any regulatory approvals that may be required (e.g., in a rate-regulated entity in which a merger would be subject to regulatory approval and that approval is more than perfunctory).
Whether the liquidation or merger is subject to approval by the noncontrolling interest holders.
Whether it would be desirable for the entity to recover its investment in a tax-free manner. For example, if the entity’s outside basis in the subsidiary is significantly higher than the subsidiary’s inside basis, tax-free liquidation may be undesirable.

Some non-U.S. jurisdictions may stipulate similar rules for liquidation or merger of a subsidiary into a parent in a tax-free manner. A similar analysis should be performed on all subsidiaries for which the tax law provides a means by which a reported investment can be recovered in a tax-free manner and the parent intends to use that means.

In some circumstances, the parent may own less than the required percentage under the applicable tax law (i.e., more than 50 percent but less than 80 percent). In such cases, the parent may still be able to assert that it can recover its investment in a tax-free manner (and thus not treat the outside basis difference in the subsidiary as a taxable temporary difference) if it can do so without incurring significant cost. ASC 740-30-25-8 states:

Some elections for tax purposes are available only if the parent owns a specified percentage of the subsidiary's stock. The parent sometimes may own less than that specified percentage, and the price per share to acquire a noncontrolling interest may significantly exceed the per-share equivalent of the amount reported as noncontrolling interest in the consolidated financial statements. In those circumstances, the excess of the amount for financial reporting over the tax basis of the parent’s investment in the subsidiary is not a taxable temporary difference if settlement of the noncontrolling interest is expected to occur at the point in time when settlement would not result in a significant cost. That could occur, for example, toward the end of the life of the subsidiary, after it has recovered and settled most of its assets and liabilities, respectively. The fair value of the noncontrolling interest ordinarily will approximately equal its percentage of the subsidiary’s net assets if those net assets consist primarily of cash. [Emphasis added]

In this context, one interpretation of significant cost could be that the costs (based on fair value) of acquiring the necessary interest in that subsidiary to recover it tax free are significant. In performing this assessment, the parent can consider the cost that would be incurred at the end of the life of the subsidiary (i.e., once the subsidiary’s assets have been converted to cash and all outstanding liabilities have been settled). Under the “end-of-life” scenario, the carrying value of the noncontrolling interest may be equivalent to fair value. If the cost of assuming the noncontrolling interest at the “end of the subsidiary’s life” is practicable, a tax-free liquidation or merger can be assumed and the outside basis difference would not be treated as a taxable temporary difference (as long as the tax law provides a means for a tax-free liquidation or merger and the entity intends to use this means).

3.4.4 Potential DTL: Foreign Subsidiary and Foreign Corporate Joint Venture

ASC 740-30

Exceptions to Comprehensive Recognition of Deferred Income Taxes

25-17 The presumption in paragraph 740-30-25-3 that all undistributed earnings will be transferred to the parent entity may be overcome, and no income taxes shall be accrued by the parent entity, for entities and periods identified in the following paragraph if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely or that the earnings will be remitted in a tax-free liquidation. A parent entity shall have evidence of specific plans for reinvestment of undistributed earnings of a subsidiary which demonstrate that remittance of the earnings will be postponed indefinitely. These criteria required to overcome the presumption are sometimes referred to as the indefinite reversal criteria. Experience of the entities and definite future programs of operations and remittances are examples of the types of evidence required to substantiate the parent entity’s representation of indefinite postponement of remittances from a subsidiary. The indefinite reversal criteria shall not be applied to the inside basis differences of foreign subsidiaries.

25-18 As indicated in paragraph 740-10-25-3, a deferred tax liability shall not be recognized for either of the following types of temporary differences unless it becomes apparent that those temporary differences will reverse in the foreseeable future:

An excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture that is essentially permanent in duration.
Undistributed earnings of a domestic subsidiary or a domestic corporate joint venture that is essentially permanent in duration that arose in fiscal years beginning on or before December 15, 1992. A last-in, first-out (LIFO) pattern determines whether reversals pertain to differences that arose in fiscal years beginning on or before December 15, 1992.

Outside basis differences in foreign entities (i.e., the holder of the investment is taxable in a jurisdiction different from the investee’s) are taxable temporary differences. DTLs should be recorded for these taxable temporary differences unless the exception in ASC 740-30-25-18(a) applies.

ASC 740-30-25-18(a) states that a DTL is not recognized for an “excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary” unless it becomes apparent that the temporary difference will reverse in the foreseeable future. See Section 3.3.1 for a discussion of inside and outside basis differences.

3.4.5 DTL for a Portion of an Outside Basis Difference

As noted above, ASC 740-30-25-18(a) states that a DTL is not required for an “excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture that is essentially permanent in duration” unless “it becomes apparent that those temporary differences will reverse in the foreseeable future.” In certain circumstances, an entity may require its foreign subsidiary or foreign corporate joint venture to remit only a portion of undistributed earnings, in which case the DTL might be limited only to the portion expected to be remitted.

An entity is permitted to recognize a DTL only for the portion of the undistributed earnings to be remitted in the future (remittances are not limited to dividends or distributions). ASC 740-30-25-18 is not an all-or-nothing requirement.

Example 3-23

Entity A has one subsidiary, B, a wholly owned subsidiary in foreign jurisdiction X. Subsidiary B has $500,000 in undistributed earnings, which represents the entire outside basis difference in B (there has been no fluctuation in the exchange rates). On the basis of available evidence, A has historically concluded that no part of this basis difference was expected to reverse in the foreseeable future and that, therefore, the indefinite reversal criteria in ASC 740-30-25-17 and 25-18 were met in accordance with management’s intent and the associated facts and circumstances. Consequently, A has not historically recorded a DTL on its book-over-tax basis difference in its investment in B.

In the current year, B has net income of $300,000 and declares a one-time dividend for the full $300,000. Subsidiary B has no plans to declare or pay future dividends, and there are no other changes in facts or circumstances to suggest that the indefinite reversal assertion on the existing $500,000 outside basis difference would be inappropriate. Further, the one-time circumstances that led to the distribution of the $300,000 are not expected to reoccur. In this example, A could continue to assert the indefinite reinvestment of B’s earnings in the future. Entity A should document its intent and ability to indefinitely reinvest the undistributed earnings; see the next section for further discussion.

Example 3-24

Assume the same facts as in the example above, except that the dividend was declared as a result of projected shortfalls in Entity A’s working capital requirements during the coming year. The ongoing short-term capital needs of A may suggest that A can no longer indefinitely reinvest the earnings of Entity B. In this example, the indefinite reinvestment assertion may no longer be appropriate and, if not, A should record a DTL on its entire $500,000 outside basis difference.

3.4.5.1 Evidence Needed to Support the Indefinite Reinvestment Assertion

ASC 740-30-25-3 states, in part, that it “shall be presumed that all undistributed earnings of a subsidiary will be transferred to the parent entity.” ASC 740-30-25-17 states that this presumption “may be overcome, and no income taxes shall be accrued by the parent entity . . . if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely.”

An entity’s documented plan for reinvestment of foreign earnings would enable it to overcome the presumption that all undistributed earnings of a foreign subsidiary will be transferred to the parent entity. To support its assertion that the undistributed earnings of a subsidiary will be indefinitely reinvested, an entity should demonstrate that the foreign subsidiary has both the intent and ability to indefinitely reinvest undistributed earnings. Past experience with the entity, in and of itself, would not be sufficient for an entity to overcome the presumption in ASC 740-30-25-3. In documenting its written plan for reinvestment of foreign earnings, an entity should consider such factors as:

Operating plans (for both the parent company and the subsidiary).
Budgets and forecasts.
Long-term and short-term financial requirements of the parent company and the subsidiary (i.e., working capital requirements and capital expenditures).
Restrictions on distributing earnings (i.e., requirements of foreign governments, debt agreements, or operating agreements).
History of dividends.
Tax-planning strategies an entity intends to rely on to demonstrate the recoverability of DTAs that might be inconsistent with its ability to remain reinvested.

This analysis is performed for each foreign subsidiary as of each balance sheet date (see above for guidance on determining whether a specific investment of a consolidated parent company is a foreign or domestic subsidiary). This analysis should be performed on a subsidiary-by-subsidiary basis and determined by using a bottom-up approach. An entity could reach different conclusions for two subsidiaries within the same jurisdiction.

Further, in a business combination, this analysis should be performed by the acquirer as of the acquisition date, regardless of any previous position taken by the acquiree or historical practice by the subsidiary. As a result of the analysis, market participants could reach different conclusions regarding the same acquiree.

3.4.5.2 Ability to Overcome the Presumption in ASC 740-30-25-3 After a Change in Management’s Plans for Reinvestment or Repatriation of Foreign Earnings

An entity may have asserted previously that it had a plan to indefinitely reinvest foreign earnings overseas to overcome the presumption described in ASC 740-30-25-3 that undistributed foreign earnings will be transferred to the parent entity. As a result of various factors, the same entity may later decide to repatriate some or all of its undistributed foreign earnings because of different factors, such as changes in the entity’s liquidity requirements.

A change in management’s intent regarding repatriation of earnings may taint management’s future ability to assert that earnings are indefinitely reinvested. However, it depends on the reason(s) for the change. The following are a few questions an entity could consider in determining whether management’s ability is tainted in this situation:

Did management have sufficient evidence of a specific plan for reinvestment or repatriation of foreign earnings in the past?
Is it clear that this change is a result of a temporary and identifiable event (e.g., a change in tax law available for a specified period)?
Can management provide evidence that supports what has changed from its previous plans?
Does management have a plan for reinvestment of future earnings?

Generally, if the conditions were met, management would be able to assert indefinite reinvestment of foreign earnings in the future.

However, if management’s current actions indicate that its previous plan was not supported by actual business needs (e.g., stated foreign capital requirements were over what proved to be necessary), the change in intent may call into question management’s ability to assert that future foreign earnings are indefinitely reinvested.

3.4.5.3 Change in Indefinite Reinvestment Assertion — Recognized or Nonrecognized Subsequent Event

ASC 740-30-25-19 indicates that the impact of the change in plans would be accounted for in the period in which management’s plans change (e.g., when management no longer can assert that all, or a portion, of its foreign earnings are indefinitely reinvested). However, an entity may need to use judgment to identify the period in which management’s decision to change its plans occurred, especially if this decision occurs soon after the balance sheet date.

An entity should consider the nature and timing of the factors that influenced management’s decision to change its plans when evaluating whether a change in management’s plans for reinvestment or repatriation is a recognized or nonrecognized subsequent event under ASC 855. Specifically, if identifiable events occurred after the balance sheet date that caused the facts or conditions that existed as of the balance sheet date to change significantly, and management changed its intent regarding indefinite reinvestment because of the new facts, the change in intent may be a nonrecognized subsequent event.

In contrast, if the change in intent after the balance sheet date is due to factors other than responding to the occurrence of an identifiable event, the facts or conditions that existed at the end of the period are unlikely to have changed significantly. Therefore, if prior-period financial statements have not been issued or are not yet available to be issued (as these terms are defined in the subsequent-event guidance in ASC 855-10-20), the entity would generally be required to record the effect of the change in management’s plan in these financial statements (i.e., a recognized subsequent event).

Example 3-25

Assume that an identifiable event (e.g., a change in tax rates associated with repatriation of foreign earnings) occurs in period 2 and that this event causes management to reconsider and change its plans in that period. The change in tax rates is an identifiable event that caused the facts or conditions that existed at the end of period 1 to change significantly. In this case, the effect of the change in plans, which is attributable specifically to the change in tax rate, should be recorded in period 2 (i.e., a nonrecognized subsequent event).

In contrast, an entity may change its repatriation plans because of operating factors or liquidity needs and, shortly after a reporting period, may not be able to assert that its foreign earnings are indefinitely reinvested. In this case, an entity must perform a careful analysis to determine whether the conditions causing the changes in management’s plans existed at the end of the reporting period. The results of this analysis will affect whether the accounting effect of the change in plans should be recorded as a recognized or nonrecognized subsequent event under ASC 855.

3.4.6 Measuring Deferred Taxes on Outside Basis Differences in Foreign Investments

As discussed above, analysis of deferred taxes on outside basis differences requires a bottom-up approach whereby an entity must consider its outside basis difference at each level in the organization chart. The entity should start with the lowest entity in the organization structure and determine whether such entity’s direct parent’s financial reporting carrying amount is greater or less than its tax basis. When performing this analysis, the entity should consider the expected manner of recovery (e.g., sale, liquidation, dividend). ASC 740-10-55-24 states, in part, that the “[c]omputation of a deferred tax liability for undistributed earnings based on dividends should also reflect any related dividends received deductions or foreign tax credits, and taxes that would be withheld from the dividend.” Thus, the parent entity should consider withholding taxes, FTCs, and participation exemptions (i.e., a dividends received deduction) when determining the amount of DTL to be recognized.

Many jurisdictions tax earnings of foreign subsidiaries and foreign corporate joint ventures that are essentially permanent in duration (collectively, “foreign investments”) upon distribution of such earnings. Where the immediate parent entity’s outside basis taxable temporary difference in a foreign investment would close upon remittance of foreign earnings and is not indefinitely reinvested, the parent entity would need to recognize a DTL for the additional tax to be imposed in its jurisdiction upon receipt of the earnings. The parent entity may be able to avail itself of a participation exemption and, as stated above, should factor such an exemption into the amount of DTL to be recognized.

For example, in the United States, companies may be entitled to a 100 percent dividends received deduction on the repatriation of earnings that have not previously been taxed. Further, any foreign taxes properly attributable to the earnings that are subject to the 100-percent-dividends-received deduction are not available as an FTC since those earnings are not subject to U.S. federal income tax. The repatriation of earnings to which the 100-percent-dividends-received deduction applies generally should reduce the outside basis difference because the distribution reduces the financial reporting carrying value of the investment but does not reduce the U.S. tax basis in the investment. While there may be no U.S. federal income tax implications of the distribution, there can nonetheless be additional foreign withholding tax and state taxes.

In other instances, however, an outside basis difference may be expected to reverse in a taxable manner, irrespective of whether there is a distribution (e.g., through future Subpart F or GILTI inclusions). To the extent that earnings have been previously taxed (situations involving Subpart F, GILTI, or IRC Section 965 are discussed further below), for example, a U.S. company would receive a basis increase for U.S. income tax purposes. Upon distribution, such earnings are not taxed again; rather, the U.S. tax basis in the investment is reduced by the amount of the previously taxed earnings distributed. In a manner similar to earnings subject to the 100-percent-dividends-received deduction, there can still be additional withholding taxes and state taxes incurred on a repatriation of earnings to the U.S. company; see Section 3.4.13 for a discussion of withholding taxes. In addition, there may be foreign exchange gains or losses that are taxable/deductible upon repatriation, capital gains upon sale of an investment, or foreign income taxes. If a U.S. company is not indefinitely reinvested in the outside basis difference in its investment in a foreign subsidiary or foreign corporate joint venture that is essentially permanent in duration, it may need to recognize a DTL with respect to its investment.

3.4.7 [Reserved]

3.4.8 Outside Basis Difference in a Foreign Subsidiary — Subpart F Income

Under ASC 740-30-25-18, unless it becomes clear that this type of temporary difference will reverse in the foreseeable future, a DTL should not be recognized for an “excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture that is essentially permanent in duration.” Further, there is a rebuttable presumption under ASC 740-30-25-3 that all undistributed earnings will be transferred by a subsidiary to its parent. This rebuttable presumption may be overcome if the criteria of ASC 740-30-25-17 are met (i.e., sufficient evidence shows the subsidiary has invested or will invest the undistributed earnings indefinitely).

Under Subpart F of the Internal Revenue Code, a U.S. parent may be taxed on specified income of a foreign subsidiary (commonly referred to as Subpart F income) when earned by the foreign subsidiary (e.g., certain types of passive income are treated as Subpart F income). When recognized for tax-reporting purposes by the U.S. parent, Subpart F income increases the outside tax basis in a foreign subsidiary. Likewise, when recognized for financial reporting purposes by the foreign subsidiary (and thus in the U.S. parent’s consolidated financial statements), such income increases the U.S. parent’s book basis in the foreign subsidiary.

Subpart F income may result in taxable income for the U.S. parent in the same amount and same period as that in which the income is recognized by the foreign subsidiary for financial reporting purposes. In such cases, current taxable income would be recognized in the period in which the income is recognized for financial reporting purposes, and there would generally be no change in the U.S. parent’s outside basis difference in the foreign subsidiary (i.e., because the book basis and tax basis both generally increase by an equal amount). However, Subpart F income may be taxed in a later period than the period in which the income is recognized for financial reporting purposes. In these cases, there will be an increase in the parent’s book basis in the subsidiary attributable to Subpart F income recognized for financial reporting purposes with no change in the corresponding tax basis. This section does not apply to situations involving Subpart F income that will not be immediately taxable as a result of other circumstances (e.g., a situation in which the Subpart F income is deferred when there is a deficit in E&P but will become includable when the foreign subsidiary in question has positive earnings).

A U.S. parent should generally recognize a DTL for the portion of the outside basis difference that corresponds to amounts that (1) are already recognized for financial reporting purposes by the foreign subsidiary and (2) will be treated as Subpart F income when they are considered to be earned for tax reporting purposes (i.e., amounts within the foreign subsidiary that would give rise to taxable temporary differences under U.S. tax law) because the U.S. parent would be unable to assert that such amounts are indefinitely reinvested in accordance with ASC 740-30-25-17.

The portion of the outside basis taxable temporary difference that corresponds to an inside Subpart F temporary difference should be treated as though it is apparent that it will reverse “in the foreseeable future” and will thus require the recognition of a DTL. Since Subpart F income is often related to passive types of income, in most cases neither the U.S. parent nor the foreign subsidiary can control when it will become taxable to the U.S. parent. Therefore, a deferred tax expense and outside basis DTL should be recognized in the period in which the income is recognized for financial reporting purposes. This is true even if the U.S. parent does not intend to distribute the associated earnings of the foreign subsidiary and irrespective of whether the U.S. parent has elected to treat GILTI as a period cost. See Section 3.4.10 for a discussion of GILTI deferred taxes.

Example 3-26

Entity P, a U.S. parent, owns Entity F, a foreign subsidiary that, in turn, owns an equity method investment that does not meet the ASC master glossary’s definition of a corporate joint venture. Entity P’s tax basis was not affected by undistributed earnings of the equity investee. In addition, its investment (book basis) in F increases by the amount of equity method income recognized by the subsidiary, which increases the outside basis difference in the investment in F (since P’s tax basis was not affected by the undistributed earnings of the equity investee). When F sells or receives a distribution from the equity method investee, the gain or distribution will be treated as Subpart F income that P must recognize immediately. Further, as an equity investor, F has no control over when it might receive a dividend from the equity investee, nor can it assert indefinite reinvestment in the equity method investee because it is not a subsidiary or corporate joint venture that is essentially permanent in duration; therefore, P should not consider the outside basis difference in F that is attributable to the unremitted earnings of the equity method investee to be eligible for treatment as indefinitely reinvested. Accordingly, P should recognize a DTL for that portion of the outside basis difference that will reverse when the investment in the equity investee is recovered, which would trigger recognition of Subpart F income and increase P’s tax basis in F (which has the effect of reversing the corresponding outside basis difference).

3.4.9 Outside Basis Difference in a Foreign Subsidiary — Deferred Subpart F Income

The previous section discusses Subpart F income that will be immediately taxable when considered earned for tax reporting purposes. However, sometimes Subpart F income will actually be deferred, even after it has been earned for tax reporting purposes (“deferred Subpart F income”) because of certain U.S. tax limitations. For example, the amount of currently taxable Subpart F income of any CFC for any taxable year may not exceed such CFC’s E&P for the year. Accordingly, while such amounts may be deferred and recaptured in a future year, current-year Subpart F income is limited to actual E&P earnings.

Assume, for example, that Company Y, a CFC, earns $100 of Subpart F income and generates a non-Subpart F loss of $40 in year 1. Company Y earns $200 of Subpart F income in each of years 2 and 3, $10 of non-Subpart F income in year 2, and $100 of non-Subpart F income in year 3. Because Y’s E&P is $60 in year 1, the amount of Subpart F income attributable to Y in year 1 that Y’s U.S. shareholder must include in its year 1 taxable income is limited to $60. However, in year 2, Y’s U.S. shareholder must include $10 of Y’s deferred Subpart F income from year 1. Likewise, in year 3, the U.S. shareholder must include the remaining $30 of Company Y’s deferred Subpart F income from year 1 that was not taxed in years 1 and 2. Thus, all the deferred Subpart F income from year 1 is recaptured.

If the existence of deferred Subpart F income suggests that some part of the outside basis difference will reverse in the foreseeable future, a DTL should be recorded. However, the mere existence of deferred Subpart F earnings does not automatically suggest that a part of the outside basis difference will reverse in the foreseeable future. Rather, all the facts and circumstances must be assessed. For example, if a recovery and settlement of the subsidiary’s assets and liabilities were to give rise to the taxation of the deferred Subpart F income, a DTL would generally be recognized provided that the amount of the deferred Subpart F income does not exceed the outside basis difference in the foreign subsidiary. (See Section 3.4.12A for additional considerations related to disaggregated outside basis differences.)

When an entity uses the financial reporting carrying amounts of the assets and liabilities to determine whether some part of the outside basis difference would be expected to reverse in the foreseeable future, the DTL recognized would take into account only the tax consequences associated with events that already have occurred and been reported in the financial statements. Further, when additional events, such as future earnings, must occur (e.g., when the recovery of assets and settlement of liabilities alone does not result in the E&P needed to make all the deferred Subpart F income taxable to the U.S. parent), no DTL would be recognized until the financial statements include such future earnings. To assess the effect of recovering assets and settling liabilities, the entity might need to schedule the recovery or settlement. For example, the recovery of certain assets would result in E&P and the settlement of certain liabilities would result in reductions in E&P; however, it could become apparent that the outside basis difference will reverse in the foreseeable future when the entity expects assets to be recovered before the liabilities are settled.

3.4.10 GILTI

The 2017 Act created a new requirement that certain income (i.e., GILTI) earned by a CFC must be included currently in the gross income of the CFC’s U.S. shareholder. GILTI is the excess of the shareholder’s “net CFC tested income” over the net deemed tangible income return (the “routine return”), which is defined as the excess of (1) 10 percent of the aggregate of the U.S. shareholder’s pro rata share of the qualified business asset investment (QBAI) of each CFC with respect to which it is a U.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income.

A domestic corporation is permitted a deduction of up to 50 percent of the sum of the GILTI inclusion and the amount treated as a dividend in accordance with IRC Section 78 (“IRC Section 78 gross-up”). If the sum of the GILTI inclusion (and related IRC Section 78 gross-up) and the corporation’s FDII (see Section 3.2.1.4) exceeds the corporation’s taxable income, the deductions for GILTI and for FDII are reduced by the excess. As a result, the GILTI deduction can be no more than 50 percent of the corporation’s taxable income (and will be less if the corporation is also entitled to an FDII deduction). The maximum GILTI deduction is reduced to 37.5 percent for taxable years beginning after December 31, 2025.

3.4.10.1 GILTI Accounting Policy Election

There may be situations in which a U.S. investor in a CFC has a financial reporting carrying value (i.e., book basis) that does not equal its outside tax basis for U.S. tax purposes in its foreign investment, resulting in an outside basis difference in the foreign investment. In addition, the U.S. investor would have a U.S. tax basis in the CFC’s underlying assets and liabilities held that will be used for calculating GILTI inclusions. Accordingly, a U.S. investor may have book/U.S. tax inside basis differences that, upon reversal, will increase or decrease the GILTI inclusion and, because GILTI inclusions increase the U.S. tax basis in the foreign investment, will also affect the outside basis difference in the foreign investment.

In January 2018, the FASB staff issued a Q&A document in which it stated that a company may elect, as an accounting policy, to either (1) treat taxes due on future U.S. inclusions in taxable income under the GILTI provision as a current-period expense when incurred or (2) factor such amounts into the company’s measurement of its deferred taxes (the “GILTI deferred method”).

The decision tree below illustrates the approach for determining the deferred tax accounting for outside basis differences in foreign investments that are expected to reverse as a result of the GILTI provision.

3.4.10.2 GILTI Deferred Method — Overview

We believe that in a manner consistent with the mechanics of the GILTI computation, GILTI DTAs and DTLs should generally be computed on a U.S.-shareholder-by-U.S.-shareholder basis if the GILTI deferred method is elected. Further, when multiple U.S. shareholders are includable in a U.S. consolidated income tax return, the aggregation rules applicable to such consolidated tax filings should be considered. Multiple CFCs within the same U.S. consolidated tax return group would be analyzed in the aggregate. If a U.S. shareholder has a mixture of profitable and unprofitable CFCs that, in the aggregate, are not profitable to the extent that future GILTI inclusions are not expected at the U.S. shareholder level, no GILTI DTAs and DTLs would be recorded. Conversely, if a U.S. shareholder has a mixture of profitable and unprofitable CFCs that, in the aggregate, are profitable to the extent that future GILTI inclusions are expected, that U.S. shareholder should measure GILTI DTAs and DTLs as discussed below.

3.4.10.3 GILTI Deferred Method — Measurement of Deferred Taxes

In determining the amount of U.S.-investor-level deferred taxes necessary for foreign investments under this model, companies should “look through” the outside basis of the CFC to determine how the book/U.S. tax inside basis differences will reverse and how such reversals will affect future GILTI inclusions and the outside basis difference.

Unlike other situations involving outside basis differences in foreign subsidiaries, this “look through” approach (see Section 3.4.15) would be employed even if no overall outside basis difference in the CFC exists, or if only an overall deductible outside basis difference in the CFC exists.

In addition, in assessing the GILTI impact of the CFC’s underlying assets and liabilities, a company would, in a fashion similar to branch accounting, recognize U.S. DTAs or DTLs to account for the U.S. income tax effects of the future reversal of any in-country DTAs and DTLs (also referred to as “anticipatory foreign tax credit/deduction” or “anticipatory” DTAs and DTLs). When determining the amount of a U.S. anticipatory DTA or DTL, an entity must carefully consider all applicable provisions in the tax law, since the amount of the incremental foreign taxes that will be creditable and realizable, or forgone, because of the future reversal of the local in-country DTAs and DTLs may be difficult to assess and subject to limitations (e.g., an 80 percent limitation, limitations as a result of expense allocations, and a limitation on utilization as a result of the absence of a carryforward or carryback period, as well as tax rate differences). For example, a local-country DTL that will reverse in the same year(s) in which a GILTI inclusion is expected may be creditable against the U.S. tax in that year, subject to the 80 percent limitation. In addition, U.S. DTAs that reverse in the same year as the local in-country deferred might further limit the FTC. Future FTCs directly related to future book income and future expense allocation limitations directly related to future book expense generally should not be included in the measurement of the anticipatory DTA or DTL until such income or expense, or both, are recognized (i.e., such FTCs and expense allocation limitations should be limited to those directly tied to existing temporary differences). See also Section 3.3.6.3.1, which discusses the measurement of anticipatory DTAs and DTLs.

While many “branch-like” principles are employed in the look-through model described above, unlike a branch, a CFC that will have substantially all of its income taxable in the United States as a result of a GILTI inclusion may still have a residual outside basis difference that is not related to the CFC’s underlying assets or liabilities (i.e., inside/outside tax basis disparities). An entity should then analyze that residual outside basis difference to determine whether it would result in a taxable or deductible amount when the investment is recovered and whether an ASC 740 outside basis exception (i.e., ASC 740-30-25-18(a) or ASC 740-30-25-9) applies. For more information about accounting for foreign branch operations, see Section 3.3.6.3.

In summary, recorded GILTI DTAs and DTLs under the look-through model will consist of the following three items:

DTAs and DTLs related to inside book/U.S. tax basis differences that will affect future GILTI inclusions, identified by “looking through” the CFC’s outside basis to the CFC’s underlying assets and liabilities.
DTAs and DTLs related to the U.S. tax consequences of settling the CFC’s in-country DTAs or DTLs (i.e., anticipatory DTAs and DTLs).
Any DTA or DTL related to a residual outside basis temporary difference for which an exception has not been applied.

There have been a number of discussions with the FASB and SEC staffs about the more significant aspects of the guidance on measuring GILTI-related deferred taxes. Accordingly, while other acceptable accounting approaches may exist, entities that plan to apply methods that are inconsistent with those discussed herein are strongly encouraged to consult with their income tax accounting advisers.

3.4.10.4 GILTI Deferred Method — Other Considerations

3.4.10.4.1 Net Deemed Tangible Income Return

Given that the CFC’s routine return is excluded from the GILTI inclusion, we believe that there is more than one acceptable approach to accounting for the routine return in the measurement of GILTI DTAs and DTLs, including the following:

Special deduction — The routine return could be treated akin to a special deduction, with the benefit recognized when the GILTI inclusion is reduced by the routine return. Under this approach, the routine return is viewed as dependent on future events, including future investments in QBAI and interest expense deductions, and it therefore would not be factored into the tax rate expected to apply to the temporary differences.
Graduated tax rate — Under this approach, the amount of taxable income equal to the routine return would be considered income taxed at a zero rate. Accordingly, if the routine return represents a significant factor, companies would measure GILTI DTAs and DTLs by using the average graduated tax rate applicable to the amount of estimated annual taxable income in the periods in which the aforementioned deferred taxes are estimated to be settled or realized. Companies will need to use judgment in determining the periods in which GILTI DTAs and DTLs will reverse and the estimated annual taxable income in each of those periods. See Section 3.3.4.1.

Other models may also be acceptable in certain situations (e.g., a portion of the book/U.S. tax basis difference that will reverse and represent a routine return might not be considered a taxable temporary difference for which a deferred tax would be recorded in accordance with ASC 740-10-25-30).

The approach an entity selects would be an accounting policy election that must be applied consistently.

3.4.10.4.2 IRC Section 250 Deduction (the “GILTI Deduction”)

The GILTI deduction is intended to lower the GILTI income inclusion (with the intent of lowering the ETR on the included income) and, in many cases, will immediately apply when a company has a GILTI inclusion. Accordingly, we believe that if a company generally expects to be able to apply the full GILTI deduction in the period in which the GILTI DTAs and DTLs reverse, it should consider the deduction in the measurement of the GILTI DTAs and DTLs in accordance with ASC 740-10-55-24 (see guidance in Appendix A). As noted above, however, the GILTI deduction is “up to,” rather than “guaranteed” to be, 50 percent7 and could be reduced by the taxable income limitation, which is applied in combination with the FDII deduction. An entity should carefully consider this limitation when factoring the GILTI deduction into the measurement of U.S. GILTI DTAs and DTLs. For example, when the taxable income limitation and expense allocation limitations are expected to apply and be significant (e.g., in situations in which the U.S. operations generate significant losses or an entity expects to forgo the GILTI deduction because it expects to use existing NOL carryforwards), entities may conclude that factoring the GILTI deduction into the rate is not appropriate. See additional discussion in Section 5.7.2.

3.4.11 Deemed Repatriation Transition Tax (IRC Section 965)

Under the 2017 Act, a U.S. shareholder of a specified foreign corporation (SFC)8 was required to include in gross income, at the end of the SFC’s last tax year beginning before January 1, 2018, the U.S. shareholder’s pro rata share of certain of the SFC’s undistributed and previously untaxed post-1986 foreign E&P. The inclusion generally was reduced by foreign E&P deficits that were properly allocable to the U.S. shareholder. In addition, the mandatory inclusion was reduced by the pro rata share of deficits of another U.S. shareholder that is a member of the same affiliated group. A foreign corporation’s E&P were taken into account only to the extent that they were accumulated during periods in which the corporation was an SFC (referred to below as a “foreign subsidiary”). The amount of E&P taken into account was the greater of the amount determined as of November 2, 2017, or December 31, 2017, unreduced by dividends (other than dividends to other SFCs) during the SFC’s last taxable year beginning before January 1, 2018.

The U.S. shareholder’s income inclusion was offset by a deduction designed to generally result in an effective U.S. federal income tax rate of either 15.5 percent or 8 percent. The 15.5 percent rate applied to the extent that the SFCs held cash and certain other assets (the U.S. shareholder’s “aggregate foreign cash position”), and the 8 percent rate applied to the extent that the income inclusion exceeded the aggregate foreign cash position.

The 2017 Act permits a U.S. shareholder to elect to pay the net tax liability9 interest free over a period of up to eight years.

3.4.11.1 Classification of the Transition Tax Liability

The transition liability should be recorded as a current/noncurrent income tax payable. ASC 210 provides general guidance on the classification of accounts in statements of financial position. An entity should classify as a current liability only those cash transition tax payments that management expects to make within the next 12 months. The installments that the entity expects to settle beyond the next 12 months should be classified as a noncurrent income tax payable.

3.4.11.2 Measurement of the Transition Tax Obligation — Discounting

Although ASC 740-10-30-8 clearly prohibits discounting of DTAs and DTLs, it does not address income tax liabilities payable over an extended period. In January 2018, the FASB staff issued a Q&A document in which it stated that the deemed repatriation transition tax liability should not be discounted. The staff indicated that “paragraph 740-10-30-8 prohibits the discounting of deferred tax amounts. Due to the unique nature of the tax on the deemed repatriation of foreign earnings, the staff believes that the guidance in paragraph 740-10-30-8 should be applied by analogy to the payable recognized for this tax.” The staff also noted that:

ASC 835-30 applies to the accounting for business transactions conducted at arm’s length and the interest rate “should represent fair and adequate compensation to the supplier.”
“[T]he transition tax liability is not the result of a bargained” arm’s length transaction.
The scope exception in ASC 835-30-15-3(e) that indicates that ASC 835-30 does not apply to “transactions where interest rates are affected by tax attributes or legal restrictions prescribed by a governmental agency (such as, income tax settlements)” would apply to the transition tax obligation.
Because the amount of the deemed repatriation transition tax is inherently subject to uncertain tax positions, measurement of the ultimate amount to be paid is potentially subject to future adjustment. Since uncertain tax positions are not discounted, it would not be appropriate to discount the transition tax liability “when the uncertain tax position is undiscounted.”

3.4.12 “Unborn” FTCs — Before the 2017 Act

When a U.S. company has concluded that the earnings of one or more of its foreign subsidiaries will not be indefinitely reinvested, the U.S. parent must recognize a DTL related to the portion of the outside basis difference for which reversal is foreseeable. Under U.S. federal tax law, when the U.S. parent receives a dividend from a foreign subsidiary, the parent is permitted to treat itself as having paid the foreign taxes that were paid by the foreign subsidiary. The parent does this by grossing up the taxable amount of the dividend by an amount equal to the related taxes. An FTC is allowed in an amount equal to this gross-up; such a credit is commonly referred to as a “deemed paid” credit. In certain circumstances, a deemed-paid FTC may exceed the U.S. taxes on the grossed-up dividend and, when the dividend is actually paid, such an excess FTC (commonly referred to as a “hyped credit”) will be available to offset U.S. taxes otherwise payable on unrelated foreign source income in the year of the dividend (or to offset U.S. taxes on foreign source income in prior or subsequent tax years by carryback or carryforward of the excess FTCs). Alternatively, instead of claiming an FTC, the U.S. parent can choose to deduct the foreign taxes by not grossing up the taxable amount of the dividend on its U.S. federal tax return.

A DTA should not be recognized for the anticipated excess FTCs that will arise in a future year when the foreign subsidiary pays the dividend. The anticipated excess FTC that will arise in a future period when the dividend is paid is considered to be “unborn.” The example below illustrates the circumstances that can lead to an unborn FTC.

Example 3-27

Terms Used

FC — Functional currency (in this example, the local currency is the functional currency).
E&P — Earnings and profits (similar to retained earnings but generally measured by using a tax concept of profit).
Tax pool — The cumulative taxes paid in connection with the E&P. The pool is (1) measured in U.S. dollars (USDs) by translating the amount payable each year at the average exchange rate for the year and (2) reduced by the amounts lifted (i.e., considered to be “born”) with prior dividends.

When Sub A distributes 100 FC in a future period, the U.S. parent will receive $110 (based on the reporting-date exchange rate). If the U.S. parent deducted foreign taxes in the year of the distribution, it would simply report the $110 as taxable income and determine the related tax liability — that is, it would not separately claim a deduction for deemed-paid foreign taxes. However, in this example, the U.S. parent has determined that it will claim an FTC for the foreign taxes paid by Sub A. Under U.S. tax law, the dividend received will be grossed up for the taxes paid by Sub A in connection with its earnings. In this example, Sub A has cumulative E&P of 400 LC. Because it is distributing 100 LC, it is distributing 25 percent of its total E&P. Therefore, 25 percent of the cumulative tax pool is treated as associated with the 100 LC being distributed. To be entitled to claim the $250 as an FTC, the U.S. parent must gross up the $110 received for the related taxes (25 percent of the tax pool of $1,000, or $250). As noted in Section 3.4.10, such gross-ups are required by IRC Section 78 and are often referred to as “IRC Section 78 gross-ups” for this reason. Since the U.S. parent is now paying tax on an amount that corresponds to Sub A’s pretax income that is being distributed, the U.S. parent is entitled to claim the IRC Section 78 gross-up amount as an FTC. In this example, the resulting $250 of FTC is greater than the U.S. tax on Sub A’s pretax income of $126. The excess amount is an unborn hyped FTC related to Sub A. The U.S. parent did not actually pay the $250 of foreign taxes but is deemed to have paid those taxes, and the first moment it is deemed to have paid those taxes is when the dividend is received from Sub A.

ASC 740-10-55-24 states, in part, that the “[c]omputation of a deferred tax liability for undistributed earnings based on dividends should also reflect any related dividends received deductions or foreign tax credits, and taxes that would be withheld from the dividend.” Thus, it requires a U.S. parent to consider available FTCs when determining the DTL related to a distribution of unremitted earnings from a foreign subsidiary.

We do not believe that in Example 3-27 a DTA should be established for the $124 of unborn FTC, since the unborn FTC does not meet the definition of a DTA. ASC 740-10-20 defines deferred tax asset as the “deferred tax consequences attributable to deductible temporary differences and carryforwards.”

Further, ASC 740-10-20 defines carryforwards, in part, as follows:

Deductions or credits that cannot be utilized on the tax return during a year that may be carried forward to reduce taxable income or taxes payable in a future year. An operating loss carryforward is an excess of tax deductions over gross income in a year; a tax credit carryforward is the amount by which tax credits available for utilization exceed statutory limitations.

The unborn FTC cannot be recognized as a DTA related to a carryforward since such an amount is not a tax credit “available for utilization” on a tax return that is carried forward for use on subsequent tax returns because it exceeds statutory limitations. In other words, for an FTC to be recognized as a “carryforward” DTA, the tax return must first show FTCs as being carried forward. The $124 in this example has the potential to become a carryforward if it is not fully used in the year in which Sub A pays the dividend. However, as of the current reporting date, there is only a plan to remit from Sub A in the foreseeable future (it is therefore necessary to measure the DTL related to the taxable temporary difference in Sub A). Until the period that includes the remittance causing the excess FTC to be born, no DTA should be recognized, but the DTL related to the investment in Sub A could be reduced to zero after taking the expected FTC into consideration.

Connecting the Dots

Since enactment of the 2017 Act, the relevance of unborn FTCs has greatly diminished because almost all of the foreign earnings are taxed in the United States in the period in which they are earned in the form of Subpart F, GILTI, or branch income. Therefore, FTCs are available to the U.S. parent in the same period in which the income is earned.

3.4.12A Foreign Exchange Gain (or Loss) on Distributions From a Foreign Subsidiary When There Is No Overall Taxable (or Deductible) Outside Basis Difference

Before the issuance of FASB Statement 109, APB Opinion 23 provided guidance on the establishment of a liability for unremitted foreign earnings. That guidance stated that such earnings were presumed to be repatriated, and a liability should be recorded for the tax consequences of the remittance, unless a company could demonstrate specific plans for reinvestment. As a result of the adoption of the balance sheet approach in Statement 109, the concept of a liability for unremitted earnings evolved into the recognition of a DTL for an outside basis difference in a company’s investment in a foreign subsidiary. This is because unremitted earnings typically resulted in an increase in the book basis of the investment and no corresponding increase in its tax basis. Further, it was generally presumed under this approach that no income tax related to earnings of a foreign corporate subsidiary would be incurred in the parent’s tax jurisdiction until a repatriation occurred. The concepts in APB Opinion 23 and Statement 109 were codified in ASC 740-30-25-18(a), which states that an entity should recognize a DTL for an “excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture that is essentially permanent in duration” if the temporary difference will reverse in the foreseeable future. In this context, it is still presumed that the unremitted earnings in a foreign subsidiary or foreign corporate joint venture will be distributed to its parent and that the outside basis temporary difference will reverse unless the indefinite reversal criteria of ASC 740-30-25-17 are met.

However, the 2017 Act greatly increased the likelihood that a foreign subsidiary may have positive cumulative unremitted foreign earnings even though the book basis of the parent’s investment in the foreign subsidiary may not be greater than its tax basis (e.g., the U.S. parent’s tax basis in the foreign subsidiary may have increased as a result of taxable income inclusions related to the transition tax under IRC Section 965 or GILTI). Sometimes, a distribution of the unremitted earnings may even result in a reduction in the book basis of the parent’s investment in the foreign subsidiary that exceeds the reduction in the tax basis (i.e., the distribution could create or increase a deductible temporary difference rather than result in the reversal of a taxable outside basis difference) even though the distribution results in taxable income (i.e., for the currency gain) in the parent’s jurisdiction.

For example, the U.S. taxable income or loss of a U.S. parent as a result of the remittance of earnings by a foreign corporate subsidiary is now typically limited to any foreign currency gain or loss calculated for tax purposes. Such amounts, however, would already have increased or decreased the book basis but generally would not have affected the tax basis before distribution.

In these situations, a questions may arise about whether a U.S. parent should record a DTL when (1) there is no overall outside basis difference on its investment in a foreign subsidiary or the overall outside basis difference is deductible, (2) the U.S parent intends to repatriate the foreign subsidiary’s earnings, and (3) the entity expects that there will be a foreign exchange gain in the parent’s jurisdiction upon distribution.

We believe that there are two acceptable approaches:

View A — A DTL should not be recognized when no overall outside basis taxable temporary difference exists as of the reporting date (i.e., the financial reporting basis does not exceed the tax basis) even if the entity would incur an income tax liability if the unremitted earnings were repatriated. This is because the recovery of the entire financial reporting carrying amount of the investment would result in either (1) no taxable gain (when there is no outside basis difference) or (2) a loss (when the basis difference is deductible) for tax purposes.
View B — If, in a prior period, a company has undistributed earnings that have been recognized in the financial statements that would trigger an investor-level tax upon distribution, and the company is not asserting that such earnings are indefinitely reinvested, the investor would disaggregate the outside basis difference into multiple components, such as (1) a temporary difference related to unremitted earnings, (2) a temporary difference related to financial statement gain or loss reported in OCI related to the unremitted earnings, and (3) other temporary differences that will not reverse as a result of a distribution of unremitted earnings (e.g., cumulative translation adjustment [CTA] reported in OCI related to the foreign subsidiary’s capital accounts or residual outside basis differences).10 The recognition of a DTL in this instance would be acceptable, irrespective of the overall outside basis difference in the investment in the subsidiary (i.e., disaggregation would be acceptable). This approach is consistent with the accounting discussed in Section 3.4.11.2 for the transition tax obligation and the guidance in ASC 740-30-25-19, which states, in part:

If . . . it becomes apparent that some or all of the undistributed earnings of a subsidiary will be remitted in the foreseeable future but income taxes have not been recognized by the parent entity, it shall accrue as an expense of the current period income taxes attributable to that remittance.

Generally, the same two views would also apply to the reverse scenario (i.e., there is no overall outside basis difference in a foreign subsidiary or the overall outside basis difference is taxable, the entity intends to remit the foreign earnings, and the entity expects that there will be a tax benefit associated with a foreign exchange loss in the parent’s jurisdiction upon distribution). However, additional considerations are necessary when a DTA (as opposed to a DTL) is recorded because of the requirements in ASC 740-30-25-9, which only allow for the recording of a deferred tax asset related to a temporary difference in an investment that is expected to reverse in the “foreseeable future.” We believe that a reporting entity that meets this criterion may record a DTA even when no overall deductible outside basis difference exists if it has definitive plans to repatriate earnings in the foreseeable future. For additional details regarding how to interpret the “foreseeable future” criteria related to recording a DTA, see Section 3.4.1.2.

The application of either view described above would be considered an accounting policy that should be consistently applied.

Example 3-28

Entity X, a U.S. entity, has a wholly owned subsidiary, Entity Y, located in foreign jurisdiction Z. As of December 31, 20X9, Y has the following balances and outside basis difference, and it anticipates a distribution of its accumulated unremitted earnings to X in the foreseeable future:

Under View A described above, X would not record a DTL related to its investment in Y, notwithstanding the fact that it will incur a tax liability related to a financial statement gain of 5 USD on the planned 200 FC remittance, since X has an overall deductible outside basis difference in Y. Further, under the exception in ASC 740-30-25-9, X would not recognize a DTA for its overall deductible temporary difference in Y unless it becomes apparent that the deductible temporary difference will reverse in the foreseeable future. Under this approach, a current-year tax expense will result from the distribution in the year it is made (without an offset by any reversal of deferred tax). Such expense can be viewed as attributable to X’s inability to record a DTA on the incremental 5 USD deductible outside basis difference (i.e., that increase in the deductible temporary difference is subject to the exception under ASC 740-30-25-9) rather than to the lack of establishing a DTL in a prior period.

Under View B, X would record a DTL for the future tax effects of the financial statement gain of 5 USD that would be triggered upon the distribution of 200 FC. The remaining deductible temporary difference that is a component of the overall deductible outside basis difference would be recorded when it becomes apparent that the deductible temporary difference will reverse in the foreseeable future, in a manner consistent with ASC 740-30-25-9.

See Section 3.4.11.2 for a discussion of the measurement of the transition tax obligation in periods before its inclusion in the tax return.

3.4.13 Withholding Taxes Imposed on Distributions From Disregarded Entities and Foreign Subsidiaries

Multinational companies generally operate globally through entities organized under the laws of the respective foreign jurisdiction that govern the formation of legally recognized entities. These foreign entities might be considered partnerships or corporations under local law; however, sometimes no legal entity exists, and the assets and liabilities are simply viewed as an extension of the parent entity doing business in the jurisdiction (i.e., a “true branch” or “division”).

In the case of a legal entity, under U.S. Treasury Regulation Sec. 301.7701-3 (the check-the-box regulations), certain eligible foreign entities may elect to be disregarded as entities separate from their parents (hereafter referred to as foreign disregarded entities). As a result of the check-the-box election, the earnings of a foreign disregarded entity that is owned directly by a U.S. entity will, like those of a branch, be taxable in the United States as earned.

In many foreign jurisdictions, a resident corporation must pay a withholding tax upon a distribution of earnings to its nonresident shareholder(s). Since disregarded entities are often corporations under local law, the applicability of withholding tax on distributions will generally depend on whether the entity is regarded or disregarded for U.S. tax purposes. Although the distributing entity remits the withholding tax to the local tax authority (reducing the amount received by the parent), under the local tax statutes, the tax is generally assessed on the recipient of the distribution.

In the case of a foreign disregarded entity, no outside basis exists (from the perspective of U.S. tax law) because the foreign entity is viewed as a division of the parent as a result of the U.S. check-the-box election. In the case of a foreign regarded entity, its parent might still have no taxable temporary difference in its investment in the foreign entity because (1) all the unremitted earnings have already been taxed in the parent’s tax jurisdiction (e.g., 100 percent of the unremitted earnings of a foreign subsidiary were taxable to its U.S. parent as Subpart F income or GILTI in such a way that the financial reporting carrying amount and the tax basis are equal) or (2) CTA losses have reduced the financial reporting carrying value without a corresponding reduction in its tax basis.

Even when no taxable temporary difference exists (either in the assets of a disregarded entity or in the shares of a regarded entity), the foreign entity may have earnings that could be distributed to its parent, at which time withholding taxes would be imposed by the local tax authority.

We believe that there are two acceptable views on determining whether a parent should recognize a DTL for withholding taxes that are within the scope of ASC 740 and that would be imposed by the local tax authority on a distribution from a disregarded entity or foreign subsidiary: (1) the parent jurisdiction view and (2) the foreign jurisdiction view.

3.4.13.1 View 1 — Parent Jurisdiction Perspective

ASC 740-10-25-2 states, in part:

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: . . .

b. A deferred tax liability or asset shall be recognized for the estimated future tax effects attributable to temporary differences and carryforwards. [Emphasis added]

Further, ASC 740-10-55-24 states:

Deferred tax liabilities and assets are measured using enacted tax rates applicable to capital gains, ordinary income, and so forth, based on the expected type of taxable or deductible amounts in future years. For example, evidence based on all facts and circumstances should determine whether an investor’s liability for the tax consequences of temporary differences related to its equity in the earnings of an investee should be measured using enacted tax rates applicable to a capital gain or a dividend. Computation of a deferred tax liability for undistributed earnings based on dividends should also reflect any related dividends received deductions or foreign tax credits, and taxes that would be withheld from the dividend. [Emphasis added]

Under the parent jurisdiction view, a parent would apply ASC 740-10-55-24 by considering the withholding tax as a tax that the parent would incur upon the reversal of a U.S. jurisdiction taxable temporary difference that is attributable to unremitted earnings.

In the case of a disregarded entity, since (1) no outside basis difference exists (because the foreign entity is viewed as a division of the parent as a result of the U.S. check-the-box election) and (2) the earnings of the foreign disregarded entity are taxed in the parent’s jurisdiction as they are generated, there is generally no taxable temporary difference related to the net assets of the disregarded entity (i.e., the net assets that arose on account of unremitted earnings have a tax basis since the income of the disregarded entity was recognized for U.S. tax purposes as earned). In the absence of a U.S. taxable temporary difference for which a DTL can be recognized, a DTL cannot be recognized for the future withholding tax. Under this view, the withholding tax would be recognized in the period in which the actual withholding tax arises (as a current tax expense).

Similarly, a regarded foreign subsidiary would be unable to recognize a DTL when (1) all of its unremitted earnings have already been taxed by the United States (e.g., 100 percent of the unremitted earnings were taxable as Subpart F income or GILTI in such a way that the financial reporting carrying amount and the tax basis are equal) or (2) CTA losses have reduced the financial reporting carrying value without a corresponding reduction in its tax basis. Without a U.S. taxable temporary difference, the requirement under ASC 740-10-55-24 for an entity to consider withholding taxes (when recording a DTL for a basis difference related to unremitted earnings expected to be reduced by remittances) would appear not to be applicable.

However, if an outside basis difference does exist in the parent’s investment in the foreign subsidiary, the parent would apply ASC 740-10-55-24 when measuring the DTL to be recognized (i.e., it would include a DTL for the withholding tax).

3.4.13.2 View 2 — Foreign Jurisdiction Perspective

ASC 740-10-30-5 states, in part:

Deferred taxes shall be determined separately for each tax-paying component (an individual entity or group of entities that is consolidated for tax purposes) in each tax jurisdiction.

Accordingly, from the perspective of the local jurisdiction (i.e., the disregarded entity or subsidiary), two separate and distinct taxpayers exist: (1) the distributing entity (which is generally viewed as a taxable legal entity in the local jurisdiction) and (2) the parent. Under the foreign jurisdiction view, the local jurisdiction taxes the distributing entity on its earnings as they occur, and it taxes the parent entity only when those “already net of tax” earnings are distributed. An entity that applies this view evaluates each jurisdiction and considers the perspective of the jurisdiction that is actually taxing the recipient (i.e., the local jurisdiction imposing the withholding tax) when determining whether the parent has a taxable temporary difference. From the perspective of the local jurisdiction, the parent has a financial reporting carrying amount in its investment in the distributing entity that is greater than its local tax basis (i.e., from the perspective of the local jurisdiction, the entities have a “parent-corporate subsidiary” relationship since the election to disregard the entity is applicable only in the parent’s jurisdiction and is not relevant in the local jurisdiction). Therefore, from a local jurisdiction perspective, an “outside” taxable temporary difference equal to the amount of such unremitted earnings that would be subject to withholding tax exists and, in accordance with ASC 740-10-55-24, the measurement of the DTL should reflect withholding taxes to be incurred when that taxable temporary difference reverses.

Under this view, even in the case of a disregarded entity, the indefinite reversal criteria would be considered and, if the reversal of the taxable temporary difference is not foreseeable, no deferred taxes should be recognized.

3.4.13.3 Determining the Income Tax Effects of Distributions of Previously Taxed Earnings and Profits in a Single-Tier or Multi-Tier Legal Entity Structure

In some cases, a remittance of foreign earnings to the parent may trigger tax consequences in multiple jurisdictions. For example, a U.S. parent may have an investment in a foreign subsidiary that has unremitted earnings that, upon remittance, may give rise to a withholding tax in the foreign jurisdiction (a DTL) and an FTC or deduction for the withholding taxes in the U.S. parent’s federal jurisdiction (a DTA). In addition, a consolidated group may have a multi-tiered structure that includes intermediate legal entities or “HoldCos” in between a parent and its foreign subsidiaries.

In these instances, questions generally arise about how to measure the deferred taxes related to a distribution. We believe that if a company’s policy prohibits disaggregation of the U.S. parent’s outside basis in the investee into multiple components to book a DTA or DTL (see Section 3.4.12A), two different approaches can be used to measure (1) the withholding tax liability at the foreign subsidiary level and (2) the corresponding foreign tax deduction or credit at the U.S. parent level.

One approach is to consider the various tax consequences of a distribution, regardless of jurisdiction. This view is consistent with the guidance in ASC 740-10-55-24, which states, in part, that the “[c]omputation of a deferred tax liability for undistributed earnings . . . should also reflect any related dividends received[,] deductions or foreign tax credits, and taxes that would be withheld from the [distribution].” Under this approach, an entity aggregates all tax consequences of the distribution, regardless of the jurisdiction in which they are recognized, when assessing whether there is an overall DTA or DTL with respect to the U.S. parent’s outside basis difference (i.e., whether there is an overall net DTL to record). In situations in which the U.S. parent has a taxable outside basis difference with respect to its investment in the foreign subsidiary, and there is an overall DTL, the tax impact would be recorded (for single-tier entities).11 While there would be an added level of complexity for multi-tier entities, we believe that this view would still be acceptable if the U.S. parent can represent that such earnings will move all the way “up the chain” (i.e., from the second-tier subsidiary, to the HoldCos in between, to the U.S. parent) in the same period so that the U.S. parent cannot be left with a “naked” DTA (e.g., a DTA for an unborn FTC) related to an overall taxable outside basis temporary difference in its investment in HoldCo as of the end of the year.

A second approach would be to consider the tax consequences of the distribution on a jurisdiction-by-jurisdiction basis. Under this approach, a foreign tax deduction or credit would not be considered as part of the measurement of the withholding tax liability because they exist in different jurisdictions. Rather, in the case of withholding tax obligations at a second-tier or lower foreign subsidiary jurisdiction, a foreign tax deduction or credit could only be recorded if the U.S. parent, in fact, had a deductible temporary difference in its investments in the first-tier foreign subsidiary12 or, in the case of a withholding tax obligation at a first-tier foreign subsidiary jurisdiction, if the foreign tax deduction or credit is a direct consequence of the withholding tax liability itself (e.g., the “state/federal” effect in a single-tier entity).

3.4.14 Withholding Taxes — Foreign Currency Considerations

While foreign withholding taxes are generally considered a liability of the investor rather than the investee (i.e., are attributable to the investor’s outside basis difference), such taxes will ultimately be payable to the foreign government in local currency and, provided that the investor’s functional currency is different from the investee’s local currency, represent foreign-currency-denominated liabilities of the investor.

When the investor is a U.S. entity, the amount of a non-USD-denominated, foreign withholding tax liability will change as a result of fluctuations in the corresponding exchange rate between the U.S. parent (i.e., the USD) and the applicable local currency of the first-tier foreign subsidiary. Because the U.S. parent is the primary obligor, such a liability is not recorded by the first-tier foreign subsidiary and is therefore not subject to translation. Accordingly, the impact of fluctuations between the reporting currency of the U.S. parent and the functional currency of the first-tier foreign subsidiary should be recorded through continuing operations of the U.S. parent as the related liability is remeasured in each reporting period in accordance with ASC 830-20.

Questions have arisen related to how a first-tier foreign subsidiary (or foreign corporate joint venture that is essentially permanent in duration) should account for fluctuations in the value of a foreign withholding tax liability related to earnings of a second-tier foreign subsidiary (or foreign corporate joint venture that is essentially permanent in duration) (the “second-tier foreign subsidiary”) that are not indefinitely reinvested when the first-tier foreign subsidiary has the same local and functional currency as that of the second-tier foreign subsidiary, which is not the reporting currency.

Because the withholding tax liability is denominated in the same currency as the first-tier foreign subsidiary’s functional currency, the amount of the withholding tax liability on the functional currency books of the first-tier foreign subsidiary will not change as a result of exchange rate fluctuations. Accordingly, the related liability would not be remeasured in each reporting period, and the first-tier foreign subsidiary would not record transaction gain or loss in accordance with ASC 830-20. However, because the first-tier foreign subsidiary is the primary obligor, such a liability is recorded by the first-tier foreign subsidiary and is therefore subject to translation. Accordingly, the impact of fluctuations between the reporting currency of the U.S. parent and the functional currency of the first-tier foreign subsidiary should be recorded as a CTA through other comprehensive income (OCI).

If the first-tier foreign subsidiary has a functional currency that is different from (1) the local currency of the second-tier foreign subsidiary or (2) the reporting currency, the reporting entity needs to account for the fluctuations in the value of a foreign withholding tax liability related to the earnings of a second-tier foreign subsidiary. The amount of a foreign withholding tax liability denominated in the local currency of the second-tier foreign subsidiary will change as a result of fluctuations in the corresponding exchange rate between the applicable local currencies of the first-tier foreign subsidiary and the second-tier foreign subsidiary. Accordingly, the impact of fluctuations between the functional currencies of the first-tier foreign subsidiary and the second-tier foreign subsidiary should be recorded through continuing operations of the first-tier foreign subsidiary as the related liability is remeasured in each reporting period in accordance with ASC 830-20. In addition, because the first-tier foreign subsidiary is the primary obligor, such a liability is recorded by the first-tier foreign subsidiary and is therefore subject to translation. Accordingly, the impact of fluctuations between the reporting currency of the parent and the functional currency of the first-tier foreign subsidiary should be recorded as a CTA through OCI.

3.4.15 Tax Consequences of Investments in Pass-Through or Flow-Through Entities

Generally, “pass-through” or “flow-through” entities (e.g., partnerships and LLCs that have not elected to be taxed as corporations) are not taxable. Rather, the earnings of such entities pass through or flow through to the entities’ owners and are therefore reported by the owners in accordance with the governing tax laws and regulations. See ASC 740-10-55-226 through 55-228 for examples illustrating when income taxes are attributed to a pass-through entity or its owners.

Further, while ASC 740 does provide for certain exceptions to the recognition of deferred taxes for basis differences related to investments in certain subsidiaries, those exceptions historically have not been applied to pass-through or flow-through entities since those types of entities were not subsidiaries as defined before the issuance of ASU 2010-08. Rather, at the time FASB Statement 109 (codified in ASC 740) was issued, APB Opinion 18 (codified in ASC 323) defined a subsidiary as “a corporation which is controlled, directly or indirectly, by another corporation.”

An investor in a pass-through or flow-through entity should determine the deferred tax consequences of its investment. Because pass-through or flow-through entities are not subject to tax, an investor should not recognize deferred taxes on the book and tax basis differences associated with the underlying assets and liabilities of the entity (i.e., “inside basis differences”) regardless of how the investor accounts for its interest in the entity (e.g., consolidation, equity method, or cost method13). Rather, because any taxable income or tax losses resulting from the recovery of the financial reporting carrying amount of the investment will be recognized and reported by the investor, the investor’s temporary difference should be determined by reference to the investor’s tax basis in the investment itself.

Often, this outside basis difference will fully reverse as the underlying assets and liabilities are recovered and settled, respectively. However, differences can exist between the investor’s share of inside tax basis and the investor’s outside tax basis in the investment, leading to a temporary difference that will generally not reverse as a result of the operations of the entity (a “residual” temporary difference). Nonetheless, because that residual temporary difference will still ultimately be recognized as additional taxable income or loss upon the dissolution of the partnership (if the dissolution is taxable) or will be attached to the assets distributed in liquidation of the investor’s interest (if the dissolution is nontaxable), the recognition of deferred taxes related to an investment in a pass-through or flow-through entity should always take into account (and reconcile back to) the entirety of the outside basis difference.

Two acceptable approaches have developed in practice for measuring the DTA or DTL to be recognized for an outside basis difference related to an investor’s investment in a consolidated pass-through or flow-through entity: (1) the outside basis approach and (2) the look-through approach.

Under the outside basis approach, measurement of the DTA or DTL is based on the entirety of the investor’s outside basis difference in the pass-through or flow-through entity investment without regard to any of the underlying assets or liabilities. While it is easy to perform this computation, application of the outside basis approach can result in certain additional practice issues. For example, an outside basis difference would generally be considered capital in character under a “pure” outside basis approach because such an approach assumes that (1) the investment will be recovered when it is disposed of in its entirety and (2) the interest in a pass-through or flow-through entity is capital in nature. However, as discussed above, the recovery and settlement of the pass-through or flow-through entity’s individual assets and liabilities through normal operations of the entity will result in (1) reversal of the temporary difference before the investor disposes of the investment, (2) the pass-through of income or loss to the owner that is ordinary rather than capital in character, or (3) both. Among other things, the assumed timing of reversal and the character of the resulting income or loss may have an effect on the investor’s conclusions about the tax rate to be applied to the temporary difference and whether a valuation allowance against the investor’s DTAs is needed. Accordingly, for the reasons noted above, even those investors applying an outside basis approach for measurement should generally consider the recovery and settlement of the pass-through or flow-through entity’s underlying assets and liabilities, respectively, when assessing character and scheduling.

Under the look-through approach, the investor would “look through” and notionally match up its outside temporary difference with its share of inside temporary differences for purposes of (1) applying ASC 740’s exceptions to deferred tax accounting and (2) determining the character (capital versus ordinary) and resulting reversal patterns used for assessing the applicable tax rate or realizability of DTAs. Only the residual difference (if any) would take its character and reversal pattern exclusively from the investment itself. For example, under this approach, the portion of the investor’s outside basis temporary difference that is notionally attributed to “inside” nondeductible goodwill or the pass-through entity’s own investment in a foreign corporate subsidiary (with unremitted earnings that are indefinitely reinvested) would be identified and the applicable exception in ASC 740 would be applied (i.e., no DTL would be recorded for that portion of the investor’s outside basis temporary difference).

The look-through approach recognizes that because the pass-through or flow-through entity is consolidated, (1) the assets and liabilities of the pass-through or flow-through entity are actually being reported by the investor in the investor’s financial statements and (2) the investor is the actual taxpayer when the pass-through or flow-through entity’s underlying assets and liabilities are recovered and settled, respectively. Accordingly, measuring the outside basis difference under the look-through approach results in the recognition of deferred taxes in a manner consistent with the characteristics of the underlying assets and liabilities that will be individually recovered and settled, respectively.

When the look-through approach is applied, however, any residual difference between the total of the investor’s share of the pass-through or flow-through entity’s inside tax basis and the investor’s outside tax basis related to the investment would still need to be taken into account. As noted above, while this component of the outside basis difference often would not become taxable or deductible until sale or liquidation of the entity, a DTA or DTL would generally be recorded because there is no available exception to apply. In some instances, however, it may be appropriate to apply, by analogy, the exception to recognizing a DTA in ASC 740-30-25-9. While it is more difficult to perform computations under the look-through approach than under the outside basis approach, application of the look-through approach can potentially alleviate some of the aforementioned practice issues regarding character and scheduling that result from applying the outside basis approach.

The approach selected to measure the deferred tax consequences of an investment in a pass-through or flow-through entity would be considered an accounting policy that should be consistently applied to all similar investments. In addition, given the complexities associated with applying either alternative, consultation with appropriate accounting advisers is encouraged in these situations.

3.4.16 Accounting for the Tax Effects of Contributions to Pass-Through Entities in Control-to-Control Transactions

ASC 810-10-45-22 provides examples of transactions in which a parent’s ownership in a subsidiary changes but the parent retains control of the subsidiary. Specifically:

A “parent purchases additional ownership interests in its subsidiary.”
A “parent sells some of its ownership interests in its subsidiary.”
A “subsidiary reacquires some of its ownership interests” held by a nonaffiliated entity.
A “subsidiary issues additional ownership interests” to a nonaffiliated entity.

When the parent maintains control over the subsidiary, the parent accounts for changes in its ownership interest as equity transactions. See Section 12.4.1.

When there are subsequent contributions by either the controlling interest or the noncontrolling interest to the pass-through entity, recognition of a gain or loss in equity by the controlling shareholder will typically create an additional basis difference that will need to be addressed (i.e., the controlling interest’s basis for financial and income tax reporting purposes may change by different amounts). Further, under the look-through approach, additional complexities can arise because of the applicable income tax regulations governing the allocation to partners of items of income, gain, loss, or deduction for U.S. tax purposes.14 For example, such transactions can often result in residual outside basis differences (i.e., the investor’s outside tax basis will not equal its share of the inside tax basis) that will usually not be deductible or taxable until a sale or taxable liquidation of the partnership (e.g., distribution of cash following a sale of the partnership’s assets).

Typically, an investor accounts for changes in the measurement of deferred taxes on its investment in a pass-through entity that result from a control-to-control transaction in equity in accordance with the intraperiod tax allocation guidance in ASC 740-20-45-11. If the investor uses the look-through approach in measuring deferred taxes on its investment in the pass-through entity, such changes would include the impact of any residual outside basis difference. If the residual outside basis difference represents future deductible amounts, the investor must consider its policy on applying ASC 740-30-25-9, by analogy, to its investment in the pass-through entity.

Example 3-29

On January 1, 20X9, Company A contributes a recently acquired business (net assets including cash, subject to debt) with a fair value and financial reporting and income tax bases of $20 million to Partnership P for an 80 percent interest in P, and Company B contributes cash of $5 million for a 20 percent interest in P. Partnership P is a pass-through entity and is not subject to income taxes in any jurisdiction in which it operates. Company A uses the look-through approach in measuring deferred taxes with respect to investments in consolidated pass-through entities. At the time of the contribution, A’s outside basis for financial and income tax reporting purposes are $20 million and $20 million, respectively. Company B’s and A’s share of inside bases held by the investment upon formation were as follows:

During 20X9, P generates $12.5 million of income through normal operations for both financial and income tax reporting purposes and makes no distributions. Company A’s outside basis for financial and income tax reporting purposes are $30 million and $30 million, respectively. Company B’s and A’s share of inside bases held by the investment are as follows:

As of December 31, 20X9, P has appreciated in value to $80 million; assume such appreciation is attributable entirely to P’s goodwill. Further assume that on December 31, 20X9, B contributes an additional $20 million to P. The contribution decreases A’s ownership to 64 percent,15 which results in A’s having a financial reporting basis of $36.8 million16 in its investment in P. As a result of the contribution, A must recognize a control-to-control gain of $6.8 million ($36.8 million – $30 million) for financial statement reporting purposes; essentially A transitions from owning 80 percent of P’s $37.5 million net book value17 to owning 64 percent of P’s $57.5 million net book value after the contribution.

Immediately after the $20 million contribution by the noncontrolling interest holders, B’s and A’s shares of inside bases held by the investment would be as follows:

However, the contribution does not affect A’s tax basis in its investment in P, which creates a taxable temporary difference of $6.8 million and a DTL of $1.7 million. In this case, the allocation method chosen in accordance with the applicable income tax regulations will affect only whether the $6.8 million becomes taxable over time through certain partnership allocations18 or not until the ultimate sale or taxable liquidation of the partnership; in either case, a DTL is required.

Assume a 25 percent tax rate. Company A will make the following consolidated journal entry to recognize the contribution made by the noncontrolling interest holders:

Example 3-30

Assume the same facts as in the example above except that on December 31, 20X9, Company A (not Company B) contributes an additional $20 million to Partnership P. The contribution increases A’s ownership to 84 percent.19 As a result of the contribution, A must recognize a control-to-control loss of $1.7 million (A has paid a $1.7 million premium above book value to acquire the additional interest); essentially A transitions from owning 80 percent of P’s $37.5 million net book value20 to owning 84 percent of P’s $57.5 million net book value after the contribution. Company A’s basis in P for financial reporting purposes increases by $18.3 million; however, its basis for income tax reporting purposes increases by the entire $20 million contribution, resulting in a deductible temporary difference of $1.7 million.

Because there is a difference between the fair value and adjusted tax basis of the property owned by the partnership at the time of A’s additional contribution, consideration needs to be given to whether, as a matter of tax law, A will be allocated deductions equal to the fair value of its contribution of $20 million. If the partnership’s allocation method (the remedial method in this case since the goodwill has no tax basis in the hands of the partnership) under the applicable income tax regulations will allocate such deductions to A, A should record a DTA for the deductible temporary difference given that such a difference will close through normal business operations. Company A’s outside book and tax basis are $48.3 million and $50 million, respectively. Company B’s and A’s share of inside bases held by the investment would be as follows:

Assume a 25 percent tax rate. The resulting entry to record the control-to-control loss in equity would be as follows:

If the partnership’s allocation method will not allocate A deductions equal to its $20 million contribution (i.e., the “traditional method” in this case since the goodwill has no tax basis in the hands of the partnership), such a deductible temporary difference will reverse only upon P’s sale or taxable liquidation. Company A should consider the application of ASC 740-30-25-9, by analogy, to such a residual temporary difference. A summary of A’s outside basis and related look-through temporary differences in its investment in such a case would be as follows:

If A applied ASC 740-30-25-9 by analogy, A would record the entry for the control-to-control loss as follows:

3.4.17 Other Considerations

3.4.17.1 Consideration of the VIE Model in ASC 810-10 in the Evaluation of Whether to Recognize a DTL

For VIEs, an analysis of voting rights may not be effective in the determination of control. Under the VIE model in ASC 810-10, a reporting entity could be determined to have a controlling financial interest in a VIE, and thus consolidate the VIE, if the reporting entity has (1) the power to direct the activities that most significantly affect the VIE’s economic performance and (2) the obligation to absorb losses of (or right to receive benefits from) the VIE that could potentially be significant to the VIE. A reporting entity that consolidates a VIE is known as the primary beneficiary.

When accounting for a VIE under ASC 740, the reporting entity must consider both inside and outside basis differences.

When determining whether an exception to recording an outside basis difference applies to the primary beneficiary’s investment in a VIE, the reporting entity should carefully consider the facts and circumstances. The primary beneficiary should not assume that its controlling financial interest (through which it has the power to direct the activities that most significantly affect the VIE’s economic performance) also gives it the power to direct all of the activities of the VIE that are relevant to the determination of whether an exception to recording an outside basis difference is applicable (e.g., when and if the VIE will distribute earnings, the manner in which the primary beneficiary will recover its investment, and so forth). Provided that the criteria for an exception are met, a primary beneficiary of a VIE may apply the outside basis exceptions.21 However, meeting some of these exceptions may be challenging. When determining which party has the power to control decisions regarding the distribution of earnings, for example, an entity should consider how the VIE is controlled (i.e., through contract or governing documents rather than voting interests) and the rights of other parties to the arrangement.

3.4.17.2 Recognition of a DTA or DTL Related to a Subsidiary Classified as a Discontinued Operation

ASC 740-30-25-9 states that “[a] deferred tax asset shall be recognized for an excess of the tax basis over the amount for financial reporting of an investment in a subsidiary or corporate joint venture that is essentially permanent in duration only if it is apparent that the temporary difference will reverse in the foreseeable future.” This criterion (i.e., a reversal of a temporary difference in the foreseeable future) would be met no later than when the “held-for-sale” criteria in ASC 360-10-45-9 are met. The same criterion should apply to the recognition of a DTL related to an excess of financial reporting basis over outside tax basis of an investment in a subsidiary. In other words, the deferred tax consequences of temporary differences related to investments in foreign subsidiaries that were not previously recognized as a result of application of the exception in ASC 740-30-25-18(a) should be recognized when it becomes apparent that the temporary difference will reverse in the foreseeable future.

Similarly, the potential tax consequences of basis differences related to investments in domestic subsidiaries that were not previously recognized because (1) the tax law provides a means to recover the reported amount of the investment in a tax-free manner, and (2) the entity had previously expected that it would ultimately use those means, should be accrued when it becomes apparent that the reversal of those basis differences will have a future tax consequence.

The tax effects of the recognition of DTAs and DTLs for preexisting outside basis differences when an investee meets the criteria to be classified as held for sale generally will give rise to an “out-of-period” adjustment in the current period (see Section 6.2.4 for further information on out-of-period adjustments and Section 6.2.4.1 for guidance on the intraperiod allocation of such adjustments resulting from the recognition of an outside basis difference associated with a subsidiary classified as a discontinued operation).

Note that if the unrecognized outside basis difference DTL will close through a GILTI inclusion, entities that have elected to treat GILTI as a current-period expense, as discussed in Section 3.4.10.1, would recognize the tax expense in the period in which the tax is incurred. In other words, recognition of the tax expense may not coincide with the held-for-sale date, as described above.

3.4.17.3 State Tax Considerations

In recognizing outside basis differences associated with various investments, entities should pay close attention to certain state tax considerations. ASC 740-30-25-7 and 25-8 provide guidance on assessing whether the outside basis difference of an investment in a domestic subsidiary is a taxable difference. This assessment should be performed on a jurisdiction-by-jurisdiction basis. Accordingly, the outside basis difference of an investment in a domestic subsidiary that is not a taxable difference for federal purposes would also need to be assessed at the state level.

An entity should consider the following factors in applying the guidance in ASC 740-30-25-7 and 25-8 at the state level:

Whether tax-free liquidation is permitted in the applicable state jurisdictions. See Section 3.4.3 for further discussion of tax-free liquidations.
Whether the parent files a separate, combined, or consolidated return in the state jurisdiction and whether intra-entity transactions (e.g., dividends) are eliminated when subsidiaries are combined or consolidated in that state return.
Whether a dividends received deduction is available in the state jurisdiction or whether federal taxable income is used as the starting point for the state tax liability calculation and is unadjusted for dividends received deductions taken on the federal return. A dividends received deduction is a deduction on an income tax return for dividends paid from a subsidiary to a parent.

See Section 3.3.4.6 for a discussion of further considerations related to certain state matters, including optional future tax elections in the measurement of DTAs and DTLs.

Example 3-31

Subsidiary B, a 90 percent owned subsidiary of Entity A, operates in only one state (State C), which does not permit a tax-free liquidation in accordance with ASC 740-30-25-7. Entity A is taxable in C. Subsidiary B is consolidated in A’s federal return. The only outside basis difference in B relates to $1,000 of unremitted earnings, which A expects to be remitted as dividends. For federal income tax purposes, since A holds more than 80 percent of B, A can deduct 100 percent of the dividends it receives from B (i.e., the dividends received deduction). State C does not adjust federal taxable income for the dividends received deduction. In this example, the unremitted earnings of B to A would not create a temporary difference on which A should record a DTL.

Example 3-32

Assume the same facts as in the example above except that State C adjusts federal income for the dividends received deduction. For federal purposes, Entity A can still deduct 100 percent of the dividends it receives from Subsidiary B; thus, no temporary difference exists for federal tax purposes. However, because C adjusts federal income for the dividends received deduction, a temporary difference exists for state income tax purposes on which A should record a DTL because state tax law does not provide a means by which the reported amount of the investment can be recovered tax free.

Footnotes

There may be situations in which the reversal of the excess of financial reporting over tax basis is apparent because of future global intangible low-taxed income (GILTI) inclusions (e.g., excess of financial reporting over tax basis inside the controlled foreign corporation [CFC]); see Section 3.4.10.

Reduced to 37.5 percent for taxable years beginning after December 31, 2025.

An SFC includes all CFCs and all other foreign corporations (other than passive foreign investment companies) in which at least one domestic corporation is a U.S. shareholder.

Net tax liability under IRC Section 965 is the excess, if any, of the taxpayer’s net income tax for the taxable year in which the IRC Section 965 inclusion amount is included over such taxpayer’s net income tax for the taxable year, excluding (1) the IRC Section 965 amount and (2) any income or deduction properly attributable to a dividend received by such U.S. shareholder from any deferred foreign income corporation.

Additional disaggregation may be appropriate in situations in which a portion of the outside basis difference is related to intra-entity loans (see Section 9.7), basis differences that will reverse because of Subpart F inclusions (see Section 3.4.8), or GILTI inclusions (see Section 3.4.10).

Presentation of the component parts would still be disaggregated (i.e., a DTA in the United States would not be net on the balance sheet against a foreign withholding tax DTL).

In the case of an unborn FTC, the U.S. parent would also need to represent that the associated earnings will move all the way “up the chain” in a manner similar to the example above.

With certain exceptions, ASU 2016-01 eliminated the cost method. Exceptions include (1) QAHPs that are not eligible for the equity method and elect not to use the proportional amortization method and (2) investments in Federal Home Loan Bank and Federal Reserve Bank stock issued to member financial institutions.

Treasury regulations promulgated under IRC Section 704(c) account for the difference between the fair value and the adjusted tax basis in property at the time they are contributed to the partnership. In addition, such regulations can result in adjustments in certain other situations, including when the fair value of property owned by the partnership is in excess of its adjusted tax basis at the time of a contribution to the partnership.

(80 percent × $80 million [fair value of the company]) ÷ ($80 million [fair value of the company] + $20 million contribution) = 64 percent.

($37.5 million + $20 million) × 64 percent = $36.8 million.

$25 million (initial GAAP basis) + $12.5 million (20X9 income) = $37.5 million.

IRC Section 704(c), as noted in footnote 14, applies to reverse IRC Section 704(c) layers created as a result of a revaluation. Upon the contribution of $20 million by B, the partners revalued the partnership property. Under IRC Section 704(c), use of the “remedial method” will generally result in the $6.8 million’s becoming taxable over time, whereas use of the “traditional method” will generally result in the $6.8 million’s becoming taxable upon the ultimate sale or taxable liquidation of the partnership since the goodwill has no tax basis in the hands of the partnership.

(80 percent × $80 million [fair value of the company]) + $20 million contribution ÷ ($80 million [fair value of the company] + $20 million contribution) = 84 percent.

$25 million (initial GAAP basis) + $12.5 million (20X9 income) = $37.5 million.

While the exception in ASC 740-30-25-7 refers to a “more-than-50-percent-owned domestic subsidiary,” the exception was written at a time when the usual condition for control was ownership of a majority (over 50 percent) of the outstanding voting stock. Accordingly, we believe that an entity is not automatically prohibited from applying that exception simply because it owns less than 50 percent of the VIE.

Chapter 4 — Uncertainty in Income Taxes

4.1 Overview and Scope

As discussed in Chapter 1, an entity’s overall objectives in the accounting for income taxes are to (1) “recognize the amount of taxes payable or refundable for the current year” and (2) “recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.” The total tax provision includes current tax expense (benefit) (i.e., the amount of income taxes paid or payable [or refundable] for a year as determined by applying the provisions of the enacted tax law to the taxable income or the excess of deductions over revenues for that year) and deferred tax expense (or benefit) (i.e., change in DTAs and DTLs during the year). The total tax expense reported in the financial statements should reflect the income tax effects of tax positions on the basis of the two-step process in ASC 740-10, recognition (step 1) and measurement (step 2). The recognition and measurement requirements of ASC 740 should be applied only to uncertainties in income taxes and do not apply to non-income taxes such as sales tax, value-added tax, and payroll tax.

See Section 11.4 for a discussion of the accounting for uncertainty in income taxes in business combinations.

4.1.1 UTB Decision Tree and Assumptions in Recognition and Measurement

The decision tree below provides an overview of the process for recognizing the benefits of a tax position under ASC 740.

The table below summarizes the framework an entity uses when applying the two-step process of recognition and measurement under ASC 740-10.

Step 1 — Recognition	Step 2 — Measurement
The position will be examined	Same
The examiner will have full knowledge of all relevant information	Same
Offsetting or aggregating tax positions should not be considered	Same
The evaluation should be based solely on the position’s technical merits	The evaluation should be based on all relevant information available on the reporting date
It should be assumed that the position will be resolved in a court of last resort	The conclusion should be based on the amount the taxpayer would ultimately accept in a negotiated settlement with the tax authority

4.1.2 Consideration of Tax Positions Under ASC 740

ASC 740 applies to all tax positions in a previously filed tax return or tax positions expected to be taken in a future tax return. A tax position can result in a permanent reduction of income taxes payable, a deferral of income taxes otherwise currently payable to future years, or a change in the expected realizability of DTAs.

The definition of “tax position” in ASC 740-10-20 also lists the following examples of tax positions that are within the scope of ASC 740:

“A decision not to file a tax return” (e.g., a decision not to file a specific state tax return because nexus was not established).
“An allocation or a shift of income between jurisdictions” (e.g., transfer pricing).
“The characterization of income or a decision to exclude reporting taxable income in a tax return” (e.g., interest income earned on municipal bonds).
“A decision to classify a transaction, entity, or other position in a tax return as tax exempt” (e.g., a decision not to include a foreign entity in the U.S. federal tax return).
“An entity’s status, including its status as a pass-through entity or a tax-exempt not-for-profit entity.”

Uncertainties related to tax positions not within the scope of ASC 740, such as taxes based on gross receipts, revenue, or capital, should be accounted for under other applicable literature (e.g., ASC 450).

4.1.2.1 Tax Positions Related to Entity Classification

Many entities are exempt from paying taxes because they qualify as either a tax-exempt (e.g., not-for-profit organization) or a pass-through entity (e.g., Subchapter S corporation, partnership), or they function similarly to a pass-through entity (e.g., REIT, RIC). To qualify for tax-exempt or pass-through treatment, such entities must meet certain conditions under the relevant tax law.

According to the definition of a tax position in ASC 740-10-20, a decision to classify an entity as tax exempt or as a pass-through should be evaluated under ASC 740 for recognition and measurement. In some situations, it may be appropriate for the entity to consider how the administrative practices and precedents of the relevant tax authority could affect its qualification for tax-exempt or pass-through treatment.

For example, a Subchapter S corporation must meet certain conditions to qualify for special tax treatment. If the Subchapter S corporation violates one of these conditions, it might still qualify for the special tax treatment under a tax authority’s widely understood administrative practices and precedents. Sometimes, however, these administrative practices and precedents are available only if an entity self-reports the violation. In assessing whether self-reporting affects an entity’s ability to avail itself of administrative practices and precedents, the entity should consider whether relief would still be as readily available if, before self-reporting, the tax authority contacts the entity for an examination. If an entity has the ability to pursue relief, and the likelihood of relief is not compromised even if, before self-reporting, the tax authority makes contact for an examination, then the entity can rely on these administrative practices and precedents for recognition purposes because such administrative practices and precedents are not contingent upon self-reporting. However, if relief were no longer available, or the likelihood of relief were compromised had the tax authority contacted the entity for examination before self-reporting, then the administrative practice would be contingent upon self-reporting, and the entity would not be able to rely on these administrative practices and precedents for recognition purposes until the violation had actually been self-reported.

4.1.2.2 Unit of Account

Each individual tax position must be analyzed separately under ASC 740. ASC 740-10-25-13 states that an entity’s determination of what constitutes a unit of account for its individual tax position “is a matter of judgment based on the individual facts and circumstances.” To determine the unit of account, the entity should consider, at a minimum, (1) the manner in which it prepares and supports its income tax return and (2) the approach it expects the tax authorities will take during an examination. The entity may also consider:

The composition of the position — whether the position is made up of multiple transactions that could be individually challenged by the tax authority.
Statutory documentation requirements.
The nature and content of tax opinions.
The history of the entity (or reliable information about others’ history) with the relevant tax authority on similar positions.

The determination of the unit of account to which ASC 740 is applied is not an accounting policy choice; rather, it is a factual determination that is based on the facts and circumstances for the tax position being considered. Every tax position (e.g., transaction, portion of transaction, election, decision) for which a tax reporting consequence is reported in the financial statements is within the scope of ASC 740 and is, therefore, a possible unit of account to which ASC 740 applies. The unit of account is determined by evaluating the facts and circumstances of the tax position.

Once determined, the unit of account for a tax position should be the same for each position and similar positions from period to period unless changes in facts and circumstances indicate that a different unit of account is appropriate.

Changes in facts and circumstances that could cause management to reassess its determination of the unit of account include significant changes in organizational structure (e.g., sale of a subsidiary), recent experience with tax authorities, a change in tax law, and a change in the regulatory environment within a jurisdiction.

Although ASC 740-10-55-87 through 55-89 acknowledge that changes in a unit of account may occur, such changes are expected to be infrequent. Further, if a change in unit of account is caused by something other than a change in facts and circumstances, it may be an indication that ASC 740 was applied incorrectly in prior periods.

A change in judgment regarding the appropriate unit of account that does not result from the correction of an error should be treated as a change in estimate and applied prospectively.

Chapter 5 — Valuation Allowances

5.6 Going-Concern Opinion as Negative Evidence

PCAOB AS 2415 and AICPA AU-C Section 570 require an explanatory paragraph in the auditor’s report when the auditor concludes that “substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time remains.” In addition, ASC 205-40 requires an entity’s management to evaluate whether conditions or events raise substantial doubt about the entity’s ability to continue as a going concern and, if so, “whether its plans that are intended to mitigate those [relevant] conditions and events, when implemented, will alleviate substantial doubt.” In circumstances in which (1) management has identified conditions or events that raise substantial doubt that has not been alleviated by management’s plans and (2) an explanatory paragraph has been added to the auditor’s report, a valuation allowance would often be recorded for all DTAs whose realization is not assured by either offsetting existing taxable temporary differences or carryback to open tax years. However, in some circumstances, such as when the immediate cause of the going-concern uncertainty may not be directly related to the entity’s as-adjusted earnings history (e.g., a financing issue caused by a nonrecurring event or other short-term liquidity hurdle), a full valuation allowance may not be required. Entities must apply significant judgement in these situations and are encouraged to consult with their accounting advisers.

The fact that (1) management has not identified conditions or events that raise substantial doubt, (2) management has identified conditions or events that raise substantial doubt but has determined its plans alleviate the substantial doubt, or (3) a going-concern explanatory paragraph is not included in the auditor’s report does not automatically constitute positive evidence about the realization of DTAs. Similarly, when an entity concludes that it must record a valuation allowance for all or part of its DTAs, a going-concern problem may not necessarily exist. For example, an entity that generates sufficient positive cash flows to service its debt and support the book value of its assets (i.e., the entity’s assets are not impaired), but that is experiencing financial reporting losses (i.e., recent cumulative losses), would have negative evidence about the realization of DTAs. In this case, the positive evidence may not be sufficient to overcome the negative evidence; thus, the entity would provide a valuation allowance for all or part of its DTAs. However, the auditor may conclude, on the basis of positive cash flows and other factors, that it is not necessary to provide a going-concern reference in the auditor’s report, and management may likewise conclude that conditions or events do not raise substantial doubt about the entity’s ability to continue as a going concern.

Chapter 6 — Intraperiod Allocation

Chapter 7 — Interim Reporting

Chapter 8 — Accounting for Income Taxes in Separate Financial Statements

8.5 Valuation Allowance in Separate or Carve-Out Financial Statements

See Chapter 5 for a general discussion of valuation allowances under ASC 740. The manner in which valuation allowances are accounted for in separate or carve-out financial statements depends on whether income taxes are allocated by using the separate-return or the parent-company-down method (see Section 8.3 for further discussion of each method):

8.5.1 Separate-Return Method

If the separate-return method is used to allocate taxes in separate or carve-out financial statements, the separate or carve-out entity’s DTAs should be assessed for realizability on the basis of available evidence related to only the operations of the separate or carve-out entity. Therefore, if that entity has negative evidence (e.g., cumulative losses in recent years), it would be difficult to support a conclusion that a valuation allowance is not necessary, irrespective of the available evidence at the consolidated group level (e.g., a history of profitable operations of the consolidated filing group level).

If, however, an entity has modified the separate-return method for realizability of its DTAs (as discussed in Section 8.3.1.1.1), the entity may consider evidence at the consolidated group level when determining whether a valuation allowance is needed. An entity that files separate or carve-out financial statements with the SEC and modifies the separate-return method (in this manner or another way) that is also required to provide pro forma financial statements would be required to include, in its pro forma income statement, a tax provision (and valuation allowance assessment) determined by using the separate-return method. See Section 4.4 of Deloitte’s Roadmap Initial Public Offerings for more information about pro forma financial information and when it must be presented.

8.5.2 Parent-Company-Down Method

If the parent-company-down method is used to allocate taxes in separate or carve-out financial statements, the determination of the need for a valuation allowance in the separate or carve-out financial statements depends on whether a valuation allowance was recognized in the consolidated financial statements. In other words, if a valuation allowance is required at the parent-company level, a valuation allowance is also required in the financial statements of the stand-alone group member. If no valuation allowance is necessary at the parent-company level, no valuation allowance should be provided in the separate or carve-out financial statements.

8.7 Disclosures Required in the Separate Financial Statements of a Member of a Consolidated Tax Return

ASC 740-10

50-17 An entity that is a member of a group that files a consolidated tax return shall disclose in its separately issued financial statements:

The aggregate amount of current and deferred tax expense for each statement of earnings presented and the amount of any tax-related balances due to or from affiliates as of the date of each statement of financial position presented
The principal provisions of the method by which the consolidated amount of current and deferred tax expense is allocated to members of the group and the nature and effect of any changes in that method (and in determining related balances to or from affiliates) during the years for which the above disclosures are presented.

50-17A An entity that is both not subject to tax and disregarded by the taxing authority that elects to include the allocated amount of current and deferred tax expense in its separately issued financial statements in accordance with paragraph 740-10-30-27A shall disclose that fact and provide the disclosures required by paragraph 740-10-50-17.

For general disclosure requirements related to the accounting for income taxes, see Chapter 14. ASC 740-10-50-17 contains disclosure requirements specific to separate financial statements of a member of a consolidated filing group. Further, ASC 740-10-50-17A requires an entity that is not subject to tax and is disregarded by the taxing authority to disclose that an allocation of income taxes has been made in the separate financial statements.

8.7.1 Disclosures in Separate or Carve-Out Financial Statements to Be Included in a Filing With the SEC

The disclosures required by ASC 740-10-50-17 help financial statement users understand how current and deferred income taxes were allocated, as required by ASC 740-10-30-27, to a member in its separate financial statements. The disclosures also help inform users about how that allocation method differs, if at all, from the terms of any tax-sharing agreements of the member, its parent, and its affiliates.

However, as SAB Topic 1.B.1 states, the disclosures do not provide information needed to help financial statement users understand “what the effect on income would have been if the registrant had not been eligible to be included in a consolidated income tax return with its parent.” For example, the disclosures required by ASC 740-10-50-17 do not describe either the (1) nature of DTAs and DTLs, NOLs, and tax credit carryforwards or (2) uncertain tax positions of the consolidated return group that are attributable to the assets, liabilities, operations, and tax positions of the member.

Therefore, while it is not clear in ASC 740-10-50-17, we believe that the separate financial statements of a member that will be included in a filing with the SEC should generally provide the disclosures required by ASC 740-10-50-17 in addition to the disclosures required by ASC 740-10-50-2 through 50-16, particularly in situations in which a method other than the parent-company-down approach is used to compute the tax allocation included in the financial statements. We believe that the same is true for carve-out financial statements that will be included in a filing with the SEC.

In addition, as discussed in Section 8.3.2, a pro forma income statement reflecting a tax provision calculated on a separate-return basis is required if the separate or carve-out financial statements include an allocation of current and deferred income taxes that uses a method other than the separate-return method.

8.7.2 Disclosures in Separate or Carve-Out Financial Statements That Will Not Be Included in a Filing With the SEC

If a member’s separate or carve-out financial statements will not be included in a filing with the SEC, the disclosures required by ASC 740-10-50-17 may be provided in lieu of those required by ASC 740-10-50-2 through 50-16. However, we do not believe that this is preferable for the reasons discussed above. Further, such financial statements may need to provide income tax disclosures other than those specifically required by ASC 740-10-50-17 when, for example, income tax matters affecting a member or carve-out entity are critical to users’ understanding of the financial statements. The circumstances under which additional disclosures should be provided in such financial statements are a matter of judgment, and consultation with accounting advisers is recommended.

8.7.3 Disclosures in Abbreviated Separate or Carve-Out Financial Statements

See Section 8.2.5 of this Roadmap, Section 5.2.3 of Deloitte’s Roadmap Carve-Out Financial Statements, and Section 1.5 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions for further discussion of when abbreviated financial statements may be appropriate.

When abbreviated separate or carve-out financial statements of a business acquired or to be acquired are prepared with no income tax allocation, an entity should disclose in the footnotes to the historical abbreviated statements that no allocation of income tax has been made. It may also be appropriate to include an explanatory paragraph in the independent accountant’s report that (1) indicates that no income tax expense or benefit has been recognized in the statement of revenues and expenses and (2) provides a reference to the appropriate footnote that further discusses the matter.

Chapter 9 — Foreign Currency Matters

9.2 Remeasurement

An entity’s functional currency is determined by considering each of the economic factors in ASC 830-10-55. After considering these factors, management may determine that an entity’s functional currency is the currency of the jurisdiction in which the entity operates (i.e., the local currency). Management may also conclude, on the basis of the facts and circumstances, that the functional currency is that of another jurisdiction (e.g., a U.K. subsidiary of a U.S. parent might have a local currency of pounds sterling, a functional currency of euros, and a reporting currency of U.S. dollars).

Each balance sheet and income statement account must be measured in an entity’s functional currency for financial reporting purposes. Therefore, if an asset or liability or transaction is denominated in a currency other than the functional currency (e.g., local currency), it must be remeasured from that currency into the functional currency. In addition, if an entity’s books and records are not maintained in the functional currency, the entity must remeasure each balance sheet and income statement account into the functional currency. Therefore, an entity’s book basis in an asset or liability is also established in its functional currency.

ASC 830 provides the following guidance on the rate to be used in remeasuring local currency balance sheet and income statement amounts:

Description	Exchange Rate
Monetary assets and liabilities	Current exchange rate
Nonmonetary assets and liabilities	Historical exchange rate
Revenue and expense items	Weighted-average or historical exchange rate

See Section 4.3.1 of Deloitte’s Roadmap Foreign Currency Matters for interpretative guidance on distinguishing monetary assets and liabilities from nonmonetary assets and liabilities.

Remeasurement of various balance sheet and income statement items by using different exchange rates will generally cause the balance sheet to not balance; unlike the translation adjustment, the adjustment required to bring the balance sheet into balance is usually recorded through the income statement as a remeasurement gain or loss, or often referred to as a transaction gain or loss.

Regardless of an entity’s functional currency for financial reporting purposes, its tax return is generally prepared in the local currency. Therefore, an entity’s tax basis in an asset or liability is also typically established in the local currency. As a result, the remeasurement gains and losses noted above generally never enter into the tax computation in the local jurisdiction and, hence, represent a permanent difference, as discussed in more detail below.

Example 9-1

Remeasurement — Monetary

Entity S is a foreign subsidiary of Entity X. The functional currency (FC) of S is the euro, which is not the local currency (LC). Assume the following:

On January 1, 20X1, S obtains a 500,000 LC loan from a third party (i.e., monetary liability) when the exchange rate is 1 LC to 1 FC.
Entity S’s tax basis in the loan is 500,000 LC on January 1, 20X1.
On December 31, 20X1, the exchange rate is 1 LC to 2 FC.
For simplicity, assume that the liability balance has not changed.

On December 31, 20X1, S remeasures the liability from its local-currency-denominated value of 500,000 LC to 1 million FC. The remeasured value results in an unrealized pretax remeasurement loss of 500,000 FC for financial reporting purposes. However, there is no change in book/tax basis difference, as determined in the currency relevant for tax purposes, since the amount required to settle the liability (500,000 LC = 1 million FC ÷ 2) and the tax basis (500,000 LC) has not changed. Therefore, although the fluctuations in the exchange rate resulted in a pretax loss for financial reporting purposes, S would not record any deferred taxes (i.e., remeasurement loss represents a permanent item since it is not deductible for income tax reporting purposes).

Connecting the Dots

Temporary differences should be determined on the basis of the currency in which the tax return will be filed. Because the tax return is generally prepared in the local currency (and taxable income therefore is determined in the local currency), an entity generally must also calculate the temporary differences in the local currency to determine the amount that will ultimately result in an increase or decrease to taxes payable in future years.

The inherent assumption in ASC 740 regarding the accounting for temporary differences is that assets will be recovered and liabilities will be settled at their respective book basis, which is determined in the entity’s functional currency. Therefore, if the functional currency is different from the local currency, changes in the exchange rate will also change the amount of local currency revenues necessary to recover or settle the book basis of an asset or liability; however, the local currency tax basis will not have changed. In addition, because temporary differences (i.e., the deductible/taxable difference between the book basis and tax basis) must be determined in the local currency (provided that it is also the tax return currency), fluctuations in exchanges will affect the book basis of an asset or liability when calculated in the local currency.

The income tax accounting for nonmonetary and monetary assets and liabilities is discussed in further detail in the next sections.

9.2.1 Nonmonetary Assets and Liabilities

When the functional currency is not the local currency, an entity is required to remeasure, for financial reporting purposes, nonmonetary assets and liabilities (e.g., PP&E) from the local currency into the functional currency by using the historical exchange rate (i.e., the exchange rate that was in effect when the transaction was executed). By using the historical exchange rate to remeasure nonmonetary assets and liabilities, the entity achieves the same result it would have achieved had it entered into the related transactions in its functional currency. Therefore, fluctuations in exchange rates will neither increase nor decrease the carrying amount of nonmonetary assets and liabilities (and will not give rise to remeasurement gains and losses for financial reporting purposes).

Under ASC 740, it is assumed that assets will be recovered and liabilities will be settled at their respective financial reporting carrying amounts. Therefore, if the exchange rate changes after a nonmonetary asset or liability is acquired or incurred, respectively, the amount of local currency needed to recover the asset or settle the liability will also change. However, the tax basis of the asset or liability will not change because it would have been established when the asset was acquired or the liability was incurred (in the local currency). Therefore, changes in the exchange rate result in a difference between the amount of local currency needed to recover the functional-currency-denominated carrying value and the local currency tax basis.

ASC 740-10-25-3(f) prohibits “recognition of a deferred tax liability or asset for differences related to assets and liabilities that, under Subtopic 830-10, are remeasured from the local currency into the functional currency using historical exchange rates and that result from changes in exchange rates or indexing for tax purposes.” In other words, deferred taxes are not recorded for basis differences related to nonmonetary assets and liabilities that result from changes in exchange rates.

Although this basis difference technically meets the definition of a temporary difference under ASC 740, the FASB concluded that accounting for it as a temporary difference would result in the recognition of deferred taxes on exchange gains and losses that are not recognized in the income statement under ASC 830. For this reason, the FASB decided to prohibit recognition of the deferred tax consequences for those differences.

However, entities are still required to record deferred taxes for differences between the local currency tax basis and the local currency book basis that do not arise from changes in exchange rates or indexing for tax purposes (e.g., when a nonmonetary asset is depreciated over different periods or at different rates for book and tax purposes). The deferred taxes for these types of basis differences are determined in the local currency and then remeasured into the functional currency at the spot rate because deferred taxes are considered a monetary asset or liability.1 See Example 9-3 for an illustration of this concept.

Example 9-2

Temporary Differences Not Recognized Under ASC 740

Entity S is a foreign subsidiary of Entity P. The FC of S is USD, which is not the LC. Assume the following:

On January 1, 20X1, S purchases a piece of equipment for 500,000 LC when the exchange rate is 1 USD to 1.25 LC (i.e., FC book basis is 400,000 USD).
The equipment is depreciable on a straight-line basis over 10 years for both financial reporting and tax purposes.
The foreign tax basis and book basis in the asset is 500,000 LC (the amount paid to acquire the asset). Therefore, no temporary difference exists at the time of purchase.
The exchange rate on December 31, 20X1, is 1 USD to 1.5 LC.
The tax rate in S’s jurisdiction is 30 percent.

In this example, if S were to sell the equipment for its functional currency book basis of $360,000 ($400,000 historical cost less $40,000 of accumulated depreciation) as of December 31, 20X1, S would not recognize any book gain or loss in its functional currency financial statements. However, S would realize a taxable gain of 90,000 LC in its local tax return, as illustrated in the following table:

The difference between the local-currency-denominated hypothetical sale proceeds and the tax basis meets the definition of a temporary difference. However, because ASC 740-10-25-3(f) prohibits the recognition of deferred taxes associated with differences related to nonmonetary assets and liabilities that are caused by changes in the exchange rate, S should not record deferred taxes for the 90,000 LC basis difference.

In this example, there are no other differences between the local currency book basis and the local currency tax basis of the equipment that would give rise to deferred taxes.

Example 9-3

Temporary Differences Recognized Under ASC 740

Assume the same facts as in the example above, except:

The equipment is depreciated over five years for tax purposes.
The weighted-average exchange rate during 20X1 is 1 USD to 1.35 LC.

As of December 31, 20X1, Entity S measures the deferred taxes related to the equipment, as illustrated in the following table (all amounts are in local currency):

As indicated above, S recognizes a DTL of 15,000 LC (30% of 50,000 LC) as of December 31, 20X1, related to the equipment for the difference between the local currency book basis and local currency tax basis caused by the difference in depreciation methods. The DTL is then remeasured into the functional currency at the reporting-date spot rate. In addition, S recognizes a deferred tax expense of 15,000 LC in 20X1 as a result of the increase in the DTL, which is then remeasured into the functional currency at the weighted-average exchange rate in effect during 20X1. The difference between these two amounts results in a foreign currency transaction gain during 20X1, as illustrated in the following table:

In accordance with ASC 830-740-45-1, S may present the transaction gain as a deferred tax benefit (as opposed to a transaction gain above the line) if that presentation is considered more useful. If the transaction gain is reported in that manner, it would still be included in the aggregate transaction gain or loss for the period to be disclosed as required by ASC 830-20-45-1.

9.2.2 Indexing of the Tax Basis

In addition to fluctuations in the exchange rate, basis differences may arise for nonmonetary assets and liabilities as a result of indexing that is permitted or required under the local tax law. Specifically, certain countries (especially those with economies that are considered highly inflationary) may permit or require taxpayers to adjust the tax basis of an asset or liability to take into account the effects of inflation. The inflation-adjusted tax basis of an asset or liability would be used to determine the future taxable or deductible amounts.

ASC 740-10-25-3(f) prohibits the recognition of a DTL or DTA for tax consequences of “differences related to assets and liabilities that, under Subtopic 830-10, are remeasured from the local currency into the functional currency using historical exchange rates and that result from changes in exchange rates or indexing for tax purposes” (emphasis added).

As discussed in Section 9.2, under ASC 830, assets and liabilities are remeasured when the local currency and the functional currency are not the same. The exception in ASC 740-10-25-3(f) applies only with respect to nonmonetary assets and liabilities when the parent remeasures the foreign entity’s financial statements from the local currency into the functional currency (i.e., by using historical exchange rates). Because DTAs and DTLs are considered to be monetary assets and liabilities,2 the prohibition in ASC 740-10-25-3(f) would not apply to the indexation of NOL carryforwards, if permitted by the tax law. If the foreign entity’s local currency is the functional currency (i.e., subject to translation rather than remeasurement), the guidance in ASC 740-10-25-3(f) does not apply. The foreign entity would recognize the deferred tax effects of any indexing, and the parent would then translate the resulting deferred taxes into the reporting currency. The example below illustrates this concept.

Example 9-4

Assume that Entity X reports under U.S. GAAP in USD and has operations in a foreign country in which the local currency is the functional currency. Under the foreign jurisdiction’s tax law, the tax basis of depreciable assets increases in accordance with a particular index. That increase is 10 percent at the end of 20X1, and X is therefore able to deduct additional depreciation in current and future years. Further, at the end of 20X1, the basis of depreciable assets is 1,000 FC units for financial reporting purposes and 1,100 FC units for tax purposes after indexing is taken into account. In addition, the foreign tax rate is 50 percent, and the current exchange rate between the foreign currency and the USD is 2 FC to $1.

Entity X would establish a DTA related to the indexation of the tax basis. The DTA is measured in accordance with foreign tax law and is determined on the basis of the deductible temporary difference between the financial reporting basis of the asset (1,000 FC) and the indexed tax basis (1,100 FC). Thus, at the end of 20X1, X would record a DTA of 50 FC ([1,100–1,000] × 50%) in the foreign currency books of record. That DTA would be translated as $25 (50 FC × 0.5) on the basis of the current exchange rate.

Note that in accordance with ASC 740-10-25-3(f), if the functional currency is different from the local currency, the DTA related to the indexed tax basis would not be recognized.

9.2.3 Monetary Assets and Liabilities When the Reporting Currency Is the Functional Currency

As stated above, the exception in ASC 740-10-25-3(f) does not apply to assets and liabilities that are remeasured by using current exchange rates (referred to as “monetary assets and liabilities”). However, when a foreign entity’s functional currency is different from the local currency (e.g., the functional currency is the reporting currency of its parent), the foreign entity’s deferred tax accounting for monetary assets and liabilities depends on whether the asset or liability is denominated in the local currency or the reporting currency.

9.2.3.1 Local-Currency-Denominated Monetary Assets and Liabilities

When a monetary asset or liability is denominated in an entity’s local currency, it must be remeasured into the entity’s functional currency each period by using the current exchange rate for financial reporting purposes. Therefore, when the reporting currency is the functional currency, monetary assets and liabilities denominated in the local currency must be remeasured into the reporting currency at the then-current exchange rate. Fluctuations in the exchange rate between the local currency and the reporting currency will result in (1) changes in the financial-reporting carrying value of the monetary asset or liability and (2) transaction gains and losses for financial reporting purposes.

However, although a pretax gain or loss is recognized for financial reporting purposes, there will be no current or deferred tax expense or benefit. This is because the exchange rate fluctuations will not result in taxable income or loss when the asset is recovered or the liability is settled since the local currency is used to determine taxable income (i.e., those gains and losses exist only when the asset or liability is measured in the functional currency). Further, these exchange rate fluctuations do not contribute to any difference between the book and tax basis of the asset or liability when the book basis is measured in the local currency. Therefore, there are no current or deferred tax consequences related to the transaction gains and losses. Thus, such gains or losses will be permanent items that affect the ETR (i.e., pretax income or loss with no related tax expense or benefit).

Example 9-5

Local-Currency-Denominated Debt

Entity A, a foreign entity located in Canada, has a U.S. parent that uses the USD as its reporting currency. In accordance with ASC 830, A determines that its functional currency is the reporting currency of its parent (USD) and not the local currency, the Canadian dollar (CAD). Entity A’s currency for income tax reporting purposes is the CAD. On September 30, 20X5, A obtains a loan for CAD 100 million from its U.S. parent when the exchange rate is USD 1 to CAD 1.25. The exchange rate on December 31, 20X5, is USD 1 to CAD 1.33.

On September 30, 20X5, the date of the borrowing, A records the loan at its USD-equivalent value of USD 80 million (CAD 100 million ÷ 1.25). Entity A’s tax basis in the borrowing is the initial amount borrowed of CAD 100 million (i.e., the tax basis is the local-currency-denominated amount).

On December 31, 20X5, A remeasures the liability from its local-currency-denominated value of CAD 100 million into USD by using the exchange rate in effect on that date. The remeasured value of USD 75 million (CAD 100 million ÷ 1.33) results in an unrealized pretax transaction gain of USD 5 million for financial reporting purposes, which is the difference between the financial statement carrying value (in USD) on September 30, 20X5, and that on December 31, 20X5.

However, on December 31, 20X5, there is no unrealized gain for tax purposes because there is no difference between the amount required to settle the liability (CAD 100 million) and the tax basis of the liability (CAD 100 million). Since taxable income is determined by using CAD and the loan is denominated in CAD, the balance is unchanged from its original tax basis of CAD 100 million and there is no unrealized gain for tax corresponding to the gain for financial reporting. Therefore, although the fluctuation in the exchange rate resulted in a pretax gain for financial reporting purposes, A would not record any deferred taxes.

Observation

As discussed above, A will have pretax gain or loss on a separate-company basis but will not have any corresponding tax expense or benefit. On a consolidated basis, because the loan is denominated in CAD, there will be an equal and offsetting pretax gain or loss for the U.S. parent. So, on a consolidated basis, there will be no net pretax gain or loss. While such a pretax gain or loss will not have any tax effects for A (since A’s tax return is filed in CAD), there will be a tax effect related to the U.S. parent’s pretax amount since the parent uses USD in filing its tax return. The U.S. parent will have a deferred tax effect related to the CAD-denominated loan since the USD amount required to settle the loan fluctuates from the tax basis of the liability (the USD equivalent of the CAD 100 million when the loan is entered into). In summary, there will be no pretax gain or loss on a consolidated basis (there are equal and offsetting pretax amounts) and no Canadian tax effect for A; however, there will be a tax effect for the U.S. parent, which will affect the ETR.

9.2.3.2 Reporting-Currency-Denominated Monetary Assets and Liabilities

Unlike the local-currency-denominated monetary assets and liabilities discussed above, monetary assets or liabilities denominated in an entity’s reporting currency do not need to be remeasured for financial reporting purposes since they are already denominated in the functional currency. Therefore, in such cases, currency fluctuations do not give rise to pretax transaction gains or losses for financial reporting purposes.

However, fluctuations in the exchange rates will create a difference between the book and tax basis of the asset or liability when the local-currency equivalent of the reporting-currency book basis is compared with the local-currency tax basis. Therefore, although no pretax gain or loss is recognized for financial reporting purposes, current or deferred taxes may be required. Whether a current or deferred tax is required in this situation depends on whether the entity will be taxed on a realized or unrealized basis, as explained below:

Realized basis (or “settlement approach”) — The gain or loss is included in taxable income only on the date the asset is recovered or the liability is settled. The amount of gain or loss is calculated by comparing the initial tax basis of the asset or liability with its tax basis when the asset or liability is recovered or settled, respectively. The initial tax basis of the asset or liability is generally the local-currency equivalent of the reporting-currency carrying value, determined by using the spot rate on the transaction date. The tax basis of the asset or liability upon settlement is generally the local-currency equivalent of the reporting-currency carrying value, determined by using the spot rate on the settlement/recovery date.
Unrealized basis (or “mark-to-spot approach”) — The unrealized gain or loss is included in taxable income each year. The amount of unrealized gain or loss is calculated by comparing the initial tax basis of the asset or liability with its tax basis at the end of each year. The initial tax basis is determined in the same manner as the initial tax basis determined under the settlement approach described above. The tax basis of the asset or liability at the end of each year is generally the local-currency equivalent of the reporting-currency carrying value, determined by using the spot rate in effect at the end of the year.

If a foreign entity is taxed under the settlement approach, it is necessary to calculate a temporary difference and related DTL or DTA as of the end of each reporting period. The amount of deferred taxes required is equal to the difference between the initial tax basis of the asset or liability (in local currency) and the local-currency equivalent of the financial-statement carrying value, determined by using the exchange rate in effect at the end of the year and multiplied by the enacted tax rate expected to apply.

Conversely, for jurisdictions that tax unrealized foreign exchange gains or losses under the mark-to-spot approach, there will generally be no temporary difference since the entire unrealized amount will be included in taxable income as it arises and a corresponding current tax expense or benefit will be recognized.

Because any tax expense or benefit (whether current or deferred) will not have a corresponding pretax book amount, the related tax expense or benefit will generally affect the ETR that should be appropriately disclosed in the footnotes to the financial statements.

Example 9-6

Reporting-Currency-Denominated Debt

Assume the same facts as in Example 9-5, except that the loan is for 100 million denominated in USD, instead of CAD, and Entity A’s tax rate is 30 percent.

On September 30, 20X5, the date of the borrowing, A records the loan at its USD-equivalent value of USD 100 million. Entity A’s initial tax basis in the loan is CAD 125 million, the local-currency equivalent of the amount borrowed, which is calculated by using the exchange rate in effect on the date of the borrowing (USD 100 million × 1.25).

On December 31, 20X5, the financial-reporting carrying value of the loan is still USD 100 million since the loan is denominated in the functional currency. However, the local-currency-equivalent value of the loan has changed to CAD 133 million as a result of the fluctuation in the exchange rate. Therefore, the change in the exchange rate has created an unrealized tax loss of CAD 8 million (equal to the difference between the book and tax basis of the loan when converted into the local currency).

If A is taxed under the settlement approach, it would record a DTA of CAD 2.4 million, which is equal to the tax effect of the difference between the tax basis of the loan and the local-currency-equivalent value on December 31, 20X5, or (CAD 125 million – CAD 133 million) × 30%. The DTA would be recognized, subject to realizability, at the average exchange rate (to determine the amount to recognize as an income tax benefit) and would then be remeasured at the exchange rate in effect on December 31, 20X5; any difference between the two amounts would be included in the income statement. Under ASC 830-740-45-1, A may present the transaction gain or loss that results from remeasuring the DTA as deferred tax expense or benefit (as opposed to foreign-currency transaction gain or loss) if such presentation is considered more useful. If reported in that manner, that transaction gain or loss is still included in the aggregate transaction gain or loss for the period, which is disclosed in accordance with ASC 830-20-45-1.

Conversely, if A is taxed under the mark-to-spot approach, it would recognize a taxable loss of CAD 8 million and should record a CAD 2.4 million reduction in current tax payable and a CAD 2.4 million income tax benefit.

Observation

In this example, there will be no pretax income for either A or the U.S. parent, nor will there be such income in consolidation (since A, the U.S. parent, and the consolidated financial statements use USD). Further, the U.S. parent in this example (unlike the U.S. parent in Example 9-5) will have no tax effect since the loan is denominated in USD and the U.S. parent files its tax return in USD. However, A will have a tax effect (either current or deferred, depending on Canadian tax law) related to the loan, since it files its tax return in CAD but the loan is denominated in USD.

In summary, in both examples, there is no consolidated pretax gain or loss. (In Example 9-5, there are equal and offsetting pretax amounts; in this example, because the loan is denominated in USD, there is no pretax gain or loss in either A or the U.S. parent.) In each example, there is a tax effect in the consolidated financial statements (and that tax effect affects the ETR, since there is a tax effect with no corresponding pretax amount; however, see Section 9.7 for a possible exception). In Example 9-5, the loan is denominated in CAD and thus the tax effect is in the U.S. parent because the U.S. parent bears the foreign exchange fluctuation risk. However, in this example, the loan is denominated in USD; therefore, the tax effect is in A because A bears such fluctuation risk.

Footnotes

In accordance with paragraph 54 of FASB Statement 52 (not codified).

Paragraph 54 of FASB Statement 52 (not codified).

9.4 Cumulative Translation Account Overview

Under ASC 830-30, all financial statement elements must be translated from the functional currency to the reporting currency by using a current exchange rate, which ASC 830-30-45-4 defines as “the rate as of the end of the period covered by the financial statements or as of the dates of recognition in those statements in the case of revenues, expenses, gains, and losses.” For practical reasons, ASC 830 permits the use of weighted-average exchange rates or other methods that provide a reasonable approximation of the rates in effect on the date of recognition.

The following is a summary of the exchange rates used in the translation process:

9.4.1 Recognition of Deferred Taxes for Temporary Differences Related to the CTA

As stated above, under foreign currency guidance in ASC 830, assets, liabilities, revenues, expenses, gains, and losses of a foreign subsidiary whose functional currency is the local currency are translated from that foreign currency into the reporting currency by using current exchange rates. Translation adjustments recognized as part of this process are not included in the determination of net income but are reported as a separate component of shareholders’ equity (the CTA). After a change in exchange rates, the translation process often creates basis differences in amounts equal to the parent entity’s translation adjustment because it changes the parent’s financial reporting amount of the investment in the foreign entity but the parent’s tax basis in that entity generally does not change.

A DTA or DTL may be required when an entity recognizes translation adjustments as a result of an exchange rate change if the parent entity is accruing income taxes on its outside basis difference in a particular investment (note that a CTA can be recorded on both the capital and undistributed earnings of the investment, as illustrated in the example below). However, ASC 830-30-45-21 states, in part, that if “deferred taxes are not provided for unremitted earnings of a subsidiary, in those instances, deferred taxes shall not be provided on translation adjustments.” In other words, if all or a portion of the earnings are not indefinitely reinvested and the related temporary differences will reverse within the foreseeable future (i.e., the earnings will be repatriated to the parent), translation adjustments associated with such unremitted earnings will affect the deferred taxes to be recorded. Conversely, if the earnings are indefinitely reinvested and the requirements in ASC 740-30 for not recording deferred taxes on unremitted earnings of a foreign subsidiary have been met, deferred taxes on the translation adjustments are similarly not recorded.

Example 9-7

Assume that Entity X, a calendar-year U.S. entity whose reporting currency is USD, has a majority-owned subsidiary, S, located in the United Kingdom, and that S’s functional currency is the British pound. In addition, assume that as of December 31, 20X1, S’s net assets subject to translation under ASC 830 are 1,100 British pounds, the exchange rate between USD and the British pound is 1 to 1, X’s tax basis in S’s common stock is $1,000, and S had $100 in unremitted earnings for 20X1. Further assume that, in a manner consistent with ASC 830-10-55-10 and 55-11, the calculation of $100 in unremitted earnings was based on “an appropriately weighted average exchange rate for the period,” which was also 1 to 1.

Moreover, assume that on December 31, 20X2, S’s common stock subject to translation is unchanged at 1,000 British pounds, S’s undistributed earnings for 20X2 are 200 British pounds (the total undistributed earnings as of December 31, 20X2, are 300 British pounds), and the weighted-average exchange rate during the year between USD and the British pound remained at 1 to 1. As of December 31, 20X2, however, the exchange rate is 2 to 1. Thus, X’s investment in S is translated at $2,600, and the CTA account reflects a $1,300 pretax gain. Entity X has the intent and ability to indefinitely reinvest undistributed earnings of S (inclusive of the CTA). Thus, in accordance with ASC 740-10-25-3(a)(1), no DTL is recognized on the portion of the outside basis difference related to the undistributed earnings of S (inclusive of the CTA). Further, in accordance with ASC 830-30-45-21, no deferred taxes are provided on the translation adjustments related to the common stock.

However, if X does not have the intent and ability to indefinitely reinvest S’s earnings (although X believes that its original investment in S is considered indefinite under ASC 740-30), a DTL should be recorded for the portion of the outside basis difference related to unremitted earnings, including the $300 translation adjustment on the earnings (on the basis of a weighted average of exchange rates for the period). However, X would not have to record a DTL for the $1,000 of CTA related to the 1,000 British pounds of common stock if the initial investment is indefinitely reinvested.

Note that after the enactment date of the 2017 Act, undistributed earnings may not give rise to a U.S. taxable outside basis difference because such earnings are/were immediately includable in an entity’s U.S. taxable income (whether as a result of (1) the entity’s deemed repatriation tax (see IRC Section 965) or (2) deemed repatriation as a GILTI inclusion or Subpart F inclusion in the year earned) or are eligible for the IRC Section 245A dividends received deduction when the entity is measuring the U.S. DTL. However, there may still be a future tax impact related to foreign currency fluctuations (see IRC Section 986(c)); therefore, if X is not indefinitely reinvested in S, the $1,300 gain recognized in CTA may represent a taxable temporary difference.

When a DTL or DTA related to a parent entity’s cumulative foreign currency translation adjustments is recognized, the tax consequences of foreign currency exchange translations are generally, in accordance with the intraperiod allocation rules, reported as a component of the CTA account in accordance with ASC 740-20-45-11(b).

See Chapter 6 for a detailed discussion of intraperiod allocation.

Chapter 10 — Share-Based Payments

10.3 Permanent Differences Resulting From Share-Based Payment Awards

As indicated in ASC 718-740-25-3, recognition of compensation cost for share-based payments that “ordinarily do not result in tax deductions” do not give rise to deferred taxes for financial accounting purposes. In addition, excess tax benefits and tax deficiencies result in permanent differences between the amount of cumulative compensation cost recorded for equity-classified share-based payments and the amount of the corresponding tax deduction taken for tax purposes as discussed in Section 10.2.4.1. Other circumstances that result in permanent differences are discussed in the next sections.

10.3.1 Equity- and Liability-Classified Awards That Do Not Ordinarily Result in a Tax Deduction

ASC 718-740-25-3 indicates that the cumulative amount of compensation cost for awards that would not ordinarily result in a future tax deduction under existing tax law does not represent a deductible temporary difference. No deferred taxes would be recorded for these awards unless a change in circumstances occurs. A common example of this type of an award is an ISO (see Section 10.1). When an entity issues an ISO, it will record compensation cost as the award is earned but will not receive a tax deduction upon the holder’s exercise of the award (i.e., a tax deduction will result only if the holder subsequently disposes of the shares in a disqualifying disposition). Thus, the resulting book expense is considered a permanent book-to-tax difference and will have the effect of increasing the issuing entity’s ETR.

10.3.2 Tax Benefits of Dividends on Share-Based Payment Awards

ASC 718-740

Tax Benefits of Dividends on Share-Based Payment Awards to Employees

45-8 An income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to grantees for any of the following equity classified awards shall be recognized as income tax expense or benefit in the income statement:

Nonvested equity shares
Nonvested equity share units
Outstanding equity share options.

As discussed further in Section 3.10 of Deloitte’s Roadmap Share-Based Payment Awards, the terms of some share-based payment awards permit holders to receive a dividend during the vesting period and, in some instances, to retain the dividend even if the award fails to vest. Such awards are commonly referred to as “dividend-protected awards.” Dividend payments made to grantees for dividend-protected awards should be charged to retained earnings to the extent that the awards are expected to vest. If an employee is entitled to retain dividends paid on shares that fail to vest, the dividend payment for dividend-protected awards that are not expected to vest should be charged to compensation cost.

For income tax purposes, dividends paid on such awards may result in a tax deduction and corresponding income tax benefit. The income tax benefit resulting from payment of dividends on (1) nonvested equity shares, (2) nonvested equity share units, and (3) outstanding equity share options should be recorded as an income tax benefit in the income statement. If the dividend is charged against retained earnings for pretax accounting purposes, a permanent difference will result.

10.6 Accounting Considerations for Valuation Allowances Related to Share-Based Payment DTAs

ASC 718-740

30-2 Subtopic 740-10 requires a deferred tax asset to be evaluated for future realization and to be reduced by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. Differences between the deductible temporary difference computed pursuant to paragraphs 718-740-25-2 through 25-3 and the tax deduction that would result based on the current fair value of the entity’s shares shall not be considered in measuring the gross deferred tax asset or determining the need for a valuation allowance for a deferred tax asset recognized under these requirements.

ASC 718-740-30-2 prohibits an entity from considering the current price of the grantor’s stock in the measurement of the DTA and adjusting the gross amount of the DTA to reflect the current price.

When an entity is evaluating the need for a valuation allowance, it should apply the guidance in ASC 740-10-30-17 through 30-23. That is, whether the entity needs to record a valuation allowance depends on whether it is more likely than not that there will be sufficient taxable income to realize the DTA. See Chapter 5 for a broader discussion of valuation allowance considerations.

Therefore, even if the award is deep out-of-the-money to a degree that its exercise is unlikely or the award’s intrinsic value on the exercise date is most likely to be less than its grant-date fair value, the entity should not record a valuation allowance unless and until it is more likely than not that future taxable income will not be sufficient to realize the related DTAs.

See Section 5.3.2.2.2 for a discussion of the effects of excess tax deductions for equity-classified share-based payment awards on the assessment of future taxable income.

Example 10-9

On January 1, 20X6, an entity grants 1,000 “at-the-money” employee share options, each with a grant-date fair-value-based measure of $7. The awards vest at the end of the third year of service (cliff vesting), have an exercise price of $23, and expire after the fifth year from the grant date. The entity’s applicable tax rate is 25 percent. On December 31, 20Y0, the entity’s share price is $5. The entity has generated taxable income in the past and expects to continue to do so in the future.

In each reporting period, the entity would record compensation cost on the basis of the number of awards expected to vest, the grant-date fair-value-based measure of the award, and the amount of services rendered. Contemporaneously, a DTA would be recorded on the basis of the amount of compensation cost recorded at the entity’s applicable tax rate. On December 31, 20Y0, even though the likelihood that the employee will exercise the award is remote (i.e., the award is “deep out-of-the-money”) and the DTA therefore will not be realized, the entity would not be allowed to write off any part of the gross DTA or to provide a valuation allowance against the DTA until the award expires unexercised (January 1, 20Y1) assuming there is sufficient future taxable income to realize that DTA on December 31, 20Y0. The entity would be able to record a valuation allowance against the DTA only when it is more likely than not that the entity will not generate sufficient taxable income to realize the DTA.

Chapter 11 — Business Combinations

11.4 Accounting for Uncertainty in Income Taxes in Business Combinations

Uncertain tax positions related to a business combination and subsequent changes to those positions require special consideration under ASC 805 during the initial measurement period and after a business combination.

ASC 805-740

11.4.1 Changes in Uncertain Income Tax Positions Acquired in a Business Combination

Before ASC 805 (formerly FASB Statement 141(R)), the acquirer generally recorded subsequent adjustments to uncertain tax positions arising from a business combination through goodwill, in accordance with EITF Issue 93-7, regardless of whether such adjustments occurred during the allocation period or thereafter. If goodwill attributable to the acquisition was reduced to zero, the acquirer then reduced other noncurrent intangible assets related to that acquisition to zero and recorded any remaining credit as a reduction of income tax expense.

An acquirer must record all changes to acquired uncertain tax positions arising from a business combination consummated before the adoption of Statement 141(R) in accordance with ASC 805-740-45-4, which requires that changes to an acquired tax position, or those that arise as a result of the acquisition (other than changes occurring during the measurement period that are related to facts and circumstances as of the acquisition date), be accounted for in accordance with ASC 740-10 (generally as an adjustment to income tax expense).

11.5 Valuation Allowances

In accordance with the guidance in ASC 740-10 and ASC 805-740, an acquirer recognizes DTAs and DTLs associated with the assets acquired and the liabilities assumed in a business combination. The acquirer also assesses whether a valuation allowance is required against some or all of the acquired DTAs when it is not more likely than not that such DTAs will be realized. This is generally done as part of purchase accounting. The business combination may also cause a change in judgment about the realizability of the acquirer’s DTAs.

Special consideration is required of a reporting entity when it is accounting for changes in a valuation allowance as of or after a business combination under ASC 805-740. The reporting entity should carefully consider the reason for the change in the valuation allowance, the DTAs to which the change in valuation allowance relates (i.e., whether they are the acquiree’s or the acquirer’s), and whether the information that caused the change in judgment existed before the acquisition date.

ASC 805-740

30-1 An acquirer shall measure a deferred tax asset or deferred tax liability arising from the assets acquired and liabilities assumed in a business combination in accordance with Subtopic 740-10. Discounting deferred tax assets or liabilities is prohibited for temporary differences (except for leveraged leases, see Subtopic 842-50) related to business combinations as it is for other temporary differences.

30-2 See Example 1 (paragraph 805-740-55-2) for an illustration of the measurement of deferred tax assets and a related valuation allowance at the date of a nontaxable business combination.

30-3 The tax law in some tax jurisdictions may permit the future use of either of the combining entities’ deductible temporary differences or carryforwards to reduce taxable income or taxes payable attributable to the other entity after the business combination. If the combined entity expects to file a consolidated tax return, an acquirer may determine that as a result of the business combination its valuation for its deferred tax assets should be changed. For example, the acquirer may be able to utilize the benefit of its tax operating loss carryforwards against the future taxable profit of the acquiree. In such cases, the acquirer reduces its valuation allowance based on the weight of available evidence. However, that reduction does not enter into the accounting for the business combination but is recognized as an income tax benefit (or credited directly to contributed capital [see paragraph 740-10-45-20]).

35-1 An acquirer may have a valuation allowance for its own deferred tax assets at the time of a business combination. The guidance in this Section addresses measurement of that valuation allowance and the potential need to distinguish the separate pasts of the acquirer and the acquired entity in the measurement of valuation allowances together with expected future results of operations. Guidance on the subsequent measurement of deferred tax assets or liabilities arising from the assets acquired and liabilities assumed in a business combination, and any income tax uncertainties of an acquiree that exist at the acquisition date, or that arise as a result of the acquisition, is provided in Subtopic 740-10.

35-2 Changes in the acquirer’s valuation allowance, if any, that result from the business combination shall reflect any provisions in the tax law that restrict the future use of either of the combining entities’ deductible temporary differences or carryforwards to reduce taxable income or taxes payable attributable to the other entity after the business combination.

35-3 Any changes in the acquirer’s valuation allowance shall be accounted for in accordance with paragraph 805-740-30-3. For example, the tax law may limit the use of the acquired entity’s deductible temporary differences and carryforwards to subsequent taxable income of the acquired entity included in a consolidated tax return for the combined entity. In that circumstance, or if the acquired entity will file a separate tax return, the need for a valuation allowance for some portion or all of the acquired entity’s deferred tax assets for deductible temporary differences and carryforwards is assessed based on the acquired entity’s separate past and expected future results of operations.

11.5.1 Accounting for Changes in the Acquirer’s and Acquiree’s Valuation Allowances as of and After the Acquisition Date

The table below summarizes the differences between accounting for changes in the acquiring entity’s valuation allowance and accounting for the acquired entity’s valuation allowances as of and after the acquisition date.

	Changes in Valuation Allowance as a Result of Facts and Circumstances That:
	Existed as of the Acquisition Date	Occurred After the Acquisition Date
Valuation allowance on the acquiring entity’s DTAs that existed as of the acquisition date	Generally, ASC 805-740-35-3 requires that changes in assumptions about the realizability of an acquirer’s valuation allowance as a result of a business combination be recorded separately from business combination accounting. Accordingly, all changes to an acquirer’s valuation allowance as the result of a business combination, whether as of the acquisition date or subsequently, should be recognized in income tax expense (or credited directly to contributed capital [see ASC 740-10-45-20]).
Valuation allowance on the acquired entity’s DTAs that existed as of the acquisition date	Record as part of the business combination (adjustment to goodwill) only if the change occurred in the measurement period and resulted from new information about facts and circumstances that existed as of the acquisition date. If, as a result of the adjustment, goodwill is reduced to zero, any additional amounts should be recognized as a bargain purchase in accordance with ASC 805-30-25-2 through 25-4. All other changes should generally be recorded as an adjustment to income tax expense (see ASC 805-740-45-2).	Generally, record as an adjustment to income tax expense (see ASC 805-740-45-2).

Under ASC 805, a valuation allowance established against acquired DTAs is recorded as part of acquisition accounting (i.e., establishing the valuation allowance would generally result in an increase to goodwill). By contrast, under ASC 805-740-30-3, a change in the acquirer’s valuation allowance as a result of the business combination is recognized as a component of income tax expense (i.e., it is accounted for separately from the business combination). In addition, the impact of a change in a valuation allowance related to acquired DTAs as a result of facts and circumstances that occurred after the acquisition date is recognized as a component of income tax expense separately from the business combination.

Although a change in judgment related to an acquiring entity’s valuation allowance may appear to be linked to the business combination (e.g., the addition of an extra source of income to support realizability of DTAs), the impact should generally be recorded to income tax expense or benefit in the period of the change in judgment. For example, in some tax jurisdictions, tax law permits the use of deductible temporary differences or carryforwards of an acquiring entity to reduce future taxable income if consolidated tax returns are filed after the acquisition. Assume that as a result of a business combination, it becomes more likely than not that an acquiring entity’s preacquisition tax benefits will be realized. ASC 805-740-30-3 requires that changes in assumptions about the realizability of an acquirer’s valuation allowance, as a result of the business combination, be recorded separately from the business combination accounting. If, as of the acquisition date, realization of the acquiring entity’s tax benefits becomes more likely than not, reductions in the acquiring entity’s valuation allowance should be recognized as an income tax benefit (or credited directly to contributed capital — see ASC 740-10-45-20 and related guidance in Sections 6.2.2 and 6.2.3). Similarly, any subsequent changes to the acquiring entity’s valuation allowance will not be recorded as part of acquisition accounting (i.e., no adjustments to goodwill).

11.5.2 Assessing the Need for a Valuation Allowance as of and After the Acquisition Date

It may be complex for a reporting entity to determine whether DTAs — whether those of the acquiree or those of the acquirer — are more likely than not to be realized when the entity undertakes an acquisition. ASC 740-10-30-18 indicates that the future reversal of existing taxable temporary differences is one of four possible sources of taxable income that may be available to an entity for realizing a tax benefit for deductible temporary differences and carryforwards under the tax law. In some cases, acquired DTLs may represent a source of taxable income that supports the realizability of some or all of the benefit of either (1) the acquired DTAs or (2) the acquirer’s DTAs but is not sufficient to support both. In this circumstance, the guidance in ASC 805 and ASC 740 is not clear about whether the acquired DTLs should be first considered a source of taxable income in the evaluation of realizability of the acquired DTAs or the acquirer’s existing DTAs.

There are two acceptable methods that entities can use to determine how the source of taxable income from the future reversal of acquired DTLs should be allocated in the evaluation of the realizability of the acquired DTAs and the acquirer’s existing DTAs. The method an acquirer selects is an accounting policy decision that should be applied consistently. The acquirer should also provide appropriate disclosures, including information about benefits or expenses recognized for changes in its valuation allowance made in accordance with ASC 805-740-50-1.

Method 1: Assess acquired DTAs first — The acquirer first considers the acquired DTLs to be a source of taxable income for realization of the acquired DTAs. ASC 805-20-30-1 states that the “acquirer shall measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values.” Allocating the source of taxable income from the acquiree’s DTLs first to the realization of the acquiree’s DTAs is consistent with this principle. Any net residual source of taxable income from the acquiree’s DTLs remaining after the acquiree’s DTAs are taken into account would be considered a potential source of taxable income for the realization of the benefit of the acquirer’s existing DTAs. Any change in the acquirer’s valuation allowance is recognized in income tax expense.
Method 2: Assess on the basis of tax law ordering — Allocation of the source of taxable income from the acquiree’s DTLs is based on the tax law in the given jurisdiction. To determine whether the acquiree’s DTAs or the acquirer’s DTAs will be used to reduce taxable income that results from the reversal of the DTLs, the acquirer schedules the reversal of all temporary differences of both the acquirer and the acquiree on the basis of the applicable tax law. If such scheduling does not result in a determination, the acquirer should develop a systematic, rational, and consistent method for scheduling the reversal of the temporary differences. Under this method, a net DTL could be recorded through purchase accounting, and the entity could simultaneously recognize an income tax benefit for the release of the acquirer’s valuation allowance. The net DTL that is reflected in the acquisition accounting will commonly result in an increase of an asset (generally goodwill).

Under this method, it is assumed that the fair value measurement principle is not applied to DTAs and DTLs and that scheduling of the combined group’s DTLs and DTAs is a normal part of that valuation analysis by an acquirer. It is also assumed that immediately after the business combination, the valuation allowance determination is performed by using the combined group’s postacquisition positive and negative evidence (i.e., not solely the acquiree’s positive and negative evidence).

Example 11-26

This example illustrates the application of each method in a valuation allowance assessment.

Assume the following:

AC purchased TC in a nontaxable transaction.
AC will file a consolidated tax return that will include TC.
Before the acquisition, AC has a $1,000 NOL DTA with a $1,000 valuation allowance.
After the application of acquisition accounting, TC has a $600 NOL DTA and a $600 DTL.
Other than the $600 DTL, there are no other sources of taxable income for realizing the benefit of the consolidated group’s DTAs.
In accordance with tax law, the oldest available NOLs must be used first. There are no other limitations on the use of attributes.

The following table shows the years when the NOL carryforwards will expire:

The following table shows the years when the DTL will reverse:

Application of Method 1

TC records a DTA of $600 and a DTL of $600 as part of the acquisition accounting. There is no impact on AC’s deferred tax balances. AC’s final consolidated financial statements will reflect a $1,600 DTA, a $600 DTL, and a $1,000 valuation allowance.

Application of Method 2

Per tax law, AC’s older NOL DTAs must be used first; however, a portion of AC’s NOL DTAs will expire in 20X1 and 20X2 before the full reversal of the DTL. The $300 of taxable income that will result from reversal of the acquired DTL in 20X1 and 20X2 will be allocated as a source of income to support the realizability of AC’s NOL DTA. The $300 of taxable income that will result from reversal of the acquired DTL in 20X3 and 20X4 will be allocated as a source of income to support the realizability of TC’s NOL DTA.

The purchase price allocation for TC will therefore include a $600 DTA, a $600 DTL, and a $300 valuation allowance as part of the acquisition accounting. AC will reverse $300 of valuation allowance and record a corresponding income tax benefit of $300. AC’s final consolidated financial statements will reflect a $1,600 DTA, a $600 DTL, and a $1,000 valuation allowance.

Chapter 12 — Other Investments and Special Situations

12.5 Regulated Entities

ASC 980-740

Income Taxes Applicable to Regulated Entities

25-1 For regulated entities that meet the criteria for application of paragraph 980-10-15-2, this Subtopic specifically:

Prohibits net-of-tax accounting and reporting
Requires recognition of a deferred tax liability for tax benefits that are flowed through to customers when temporary differences originate and for the equity component of the allowance for funds used during construction
Requires adjustment of a deferred tax liability or asset for an enacted change in tax laws or rates.

25-2 If, as a result of an action by a regulator, it is probable that the future increase or decrease in taxes payable for (b) and (c) in the preceding paragraph will be recovered from or returned to customers through future rates, an asset or liability shall be recognized for that probable future revenue or reduction in future revenue pursuant to paragraphs 980-340-25-1 and 980-405-25-1. That asset or liability also shall be a temporary difference for which a deferred tax liability or asset shall be recognized.

25-3 Example 1 (see paragraph 980-740-55-8) illustrates recognition of an asset for the probable revenue to recover future income taxes.

25-4 Example 2 (see paragraph 980-740-55-13) illustrates adjustment of a deferred tax liability when the liability represents amounts already collected from customers.

12.5.1 Regulated Entities Subject to ASC 980

Regulated entities preparing financial statements under U.S. GAAP would apply ASC 740 when determining the tax amounts to record. In addition, ASC 980-740 relies on the general standards of accounting for the effects of regulation in ASC 980 and, in a manner consistent with those standards, requires recognition of (1) an asset when a DTL is recognized if it is probable that future revenue will be provided for the payment of those DTLs and (2) a liability when a DTA is recognized if it is probable that a future reduction in revenue will result when that DTA is realized.

ASC 980-740-25-1 prohibits net-of-tax accounting on the basis that commingling assets and liabilities with their related tax effects confuses the relationship among the various classifications in financial statements. Therefore, in accordance with ASC 980-740-25-1, regulated entities should adjust the reported net-of-tax amount of construction in progress and plant in service to the pretax amount.

12.6 Special Situations

12.6.1 Distinguishing a Change in Estimate From a Correction of an Error

A change in a prior-year tax provision can arise from either a change in accounting estimate or the correction of an error.

The primary source of guidance on accounting changes and error corrections is ASC 250. ASC 250-10-20 defines a change in accounting estimate as a “change that has the effect of adjusting the carrying amount of an existing asset or liability . . . . Changes in accounting estimates result from new information.” A change in a prior-year tax provision is a change in accounting estimate if it results from new information, a change in facts and circumstances, or later identification of information that was not reasonably knowable or readily accessible as of the prior reporting period. In addition, ASC 740-10-25-14 and ASC 740-10-35-2 state that the subsequent recognition and measurement of a tax position should “be based on management’s best judgment given the facts, circumstances, and information available at the reporting date” and that subsequent changes in management’s judgment should “result from the evaluation of new information and not from a new evaluation or new interpretation by management of information that was available in a previous financial reporting period.”

In contrast, ASC 250-10-20 defines an error in previously issued financial statements (an “error”) as an “error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of [GAAP], or oversight or misuse of facts that existed at the time the financial statements were prepared. A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error.” In determining whether the change is a correction of an error, an entity should consider whether the information was or should have been “reasonably knowable” or “readily accessible” from the entity’s books and records in a prior reporting period and whether the application of information at that time would have resulted in different reporting. The determination of when information was or should have been reasonably knowable or readily accessible will depend on the entity’s particular facts and circumstances.

Distinguishing between a change in accounting estimate and a correction of an error is important because they are accounted for and reported differently. In accordance with ASC 250-10-45-23, an error correction is typically accounted for by restating prior-period financial statements. However, ASC 250-10-45-17 specifies that a change in accounting estimate is accounted for prospectively “in the period of change if the change affects that period only or in the period of change and future periods if the change affects both.” Under ASC 250-10-50-4, if the change in estimate affects several future periods, an entity must disclose the “effect on income from continuing operations, net income (or other appropriate captions of changes in the applicable net assets or performance indicator), and any related per-share amounts of the current period.”

If the change to the prior-period tax provision is determined to be an error, the entity should look to ASC 250 for guidance on how to report the correction of the error. Additional guidance is also provided by SAB Topics 1.M (SAB 99) and 1.N (SAB 108).

An entity must often use judgment in discerning whether a change in a prior-year tax provision results from a correction of an error or a change in estimate.

The following are examples of changes that should be accounted for as changes in accounting estimate:

A change in judgment (as a result of a change in facts or circumstances or the occurrence of an event) regarding the sustainability of a tax position or the need for a valuation allowance.
The issuance of a new administrative ruling.
Obtaining additional information on the basis of the experience of other taxpayers with similar circumstances.
Adjusting an amount for new information that would not have been readily accessible from the entity’s books and records as of the prior reporting date. For example, to close its books on a timely basis, an entity may estimate certain amounts that are not readily accessible. In this case, as long as the entity had a reasonable basis for its original estimate, the subsequent adjustment is most likely a change in estimate.
Developing, with the assistance of tax experts, additional technical insight into the application of the tax law with respect to prior tax return positions involving very complex or technical tax issues. Because both tax professionals and the tax authorities are continually changing and improving their understanding of complex tax laws, such circumstances typically constitute a change in estimate rather than an error.
Making a retroactive tax election that affects positions taken on prior tax returns if the primary factors motivating such a change can be tied to events that occurred after the balance sheet date.
Deciding to pursue a tax credit or deduction retroactively that was previously considered not to be economical but that becomes prudent because of a change in facts and circumstances. Such a decision is a change in estimate if the entity evaluated the acceptability of the tax position as of the balance sheet date and analyzed whether the tax position was economical but concluded that it was not prudent to pursue this benefit. The decision would not be considered a change in estimate if the entity did not consider or otherwise evaluate the acceptability of the tax position as of the balance sheet date.

The following are examples of changes that should be accounted for as error corrections:

Intentionally misstating a tax accrual.
Discovering a mathematical error in a prior-year income tax provision.
Oversight or misuse of facts or failure to use information that was reasonably knowable and readily accessible as of the balance sheet date.
Misapplying a rule or requirement or the provisions of U.S. GAAP. One example is a situation in which an entity fails to record a DTA, a DTL, a tax benefit, or a liability for UTBs that should have been recognized in accordance with ASC 740 on the basis of the facts and circumstances that existed as of the reporting date that were reasonably knowable when the financial statements were issued.
Adjusting an amount for new information that would have been readily accessible from the entity’s books and records as of the prior reporting period. In assessing whether information was or should have been “readily accessible,” an entity should consider the nature, complexity, relevance, and frequency of occurrence of the item.

Chapter 13 — Presentation of Income Taxes

13.3 Income Statement

13.3.1 Classification of Interest and Penalties in the Financial Statements

ASC 740-10-45-25 permits an entity, on the basis of its accounting policy election, to classify interest (on an underpayment of income taxes) in the financial statements as either income taxes or interest expense and to classify penalties (related to a tax position that does not meet the minimum statutory threshold to avoid payment of penalties) in the financial statements as either income taxes or another expense classification.

An SEC registrant that changes its financial statement classification of interest and penalties should provide the disclosures specified by ASC 250-10-50-1 through 50-3. Such a change in accounting principle should be retrospectively applied beginning with the first interim period in the year of adoption. In addition, the SEC staff has indicated that a preferability letter is required for classification changes.

An entity’s balance sheet classification related to the accruals for interest and penalties (as part of accrued liabilities or as part of the liability for UTBs) must be consistent with the income statement classification (above the line or below the line). For example, an entity that classifies interest as a component of interest expense should classify the related accrual for interest as a component of accrued expenses. Likewise, an entity that classifies interest as a component of income tax expense should classify the related accrual for interest as a component of the liability for UTBs; however the amounts are classified, they should be presented separately from the UTB in the tabular rollforward required by ASC 740-10-50-15A.

13.3.2 Capitalization of Interest Expense

Interest expense recognized on the underpayment of income tax is not eligible for capitalization under ASC 835-20. ASC 835-20-30-2 indicates that the amount of interest cost to be capitalized is the amount that theoretically could have been avoided if expenditures for the asset had not been made. An entity has two alternatives: (1) repay existing borrowings or (2) invest in an asset. The entity could avoid interest cost by choosing to repay a borrowing instead of investing in an asset. Once the decision to invest in the asset is made, the relationship between the investment in the asset and the incurrence of interest cost makes the interest cost analogous to a direct cost in the asset (i.e., the two alternatives are linked).

The liability for UTBs recognized under ASC 740 is not a result of the investment alternatives above; rather, it is a result of a difference in the amount of benefit recognized in the financial statements compared with the amount taken, or expected to be taken, in a tax return. The liability for UTBs is not a borrowing, as contemplated in ASC 835-20, and should not be considered a financing activity. Therefore, the related interest expense should not be capitalized but should be expensed as incurred.

13.3.3 Interest Income on UTBs

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.

It is preferable for a public entity to present interest income attributable to an overpayment of income taxes as an element of nonoperating income, separately stated in the income statement or in a note to the financial statements as interest on refund claims due from tax authorities.

On the basis of informal discussions with the SEC staff, we understand that the staff currently does not have a view on this matter and may not object to an entity’s including interest income attributable to overpayment of income taxes as an element of its provision for income taxes. Accordingly, the SEC staff has advised us that if an entity’s accounting policy is to include interest income attributable to overpayment of income taxes within the provision for income taxes, this policy must be prominently disclosed and transparent to financial statement users. The SEC staff has also indicated that it believes that a public entity that has an accounting policy to include interest income or expense on overpayments and underpayments of income taxes should consistently display such amounts as income tax in the balance sheets, statements of operations, statements of cash flows, and other supplemental disclosures. Further, we believe that companies should present interest income in a manner consistent with the policy election related to interest expense on UTBs. See Section 14.4.4.1 for more information regarding disclosures related to interest income.

13.3.4 Presentation of Professional Fees

Entities often incur costs for professional services (e.g., attorney and accountant fees) related to the implementation of tax strategies,2 the resolution of tax contingencies, assistance with the preparation of the income tax provision in accordance with ASC 740, or other tax-related matters.

It is not appropriate for an entity to include such costs as income tax expense or benefit in the financial statements. ASC 740 defines income tax expense (or benefit) as the sum of current tax expense (benefit) and deferred tax expense (benefit), neither of which would include fees paid to professionals in connection with tax matters.

Further, SEC Regulation S-X, Rule 5-03(b)(11),3 specifies that an entity should include only taxes based on income within the income tax expense caption in the income statement. Therefore, it is inappropriate to include professional fees within the income tax caption.

Footnotes

If a tax-planning strategy is identified to support realization of DTAs, the entity should consider the cost of implementing the strategy (inclusive of professional fees) when measuring the incremental benefit such a strategy would provide.

Rule 5-03 applies to commercial and industrial companies only. However, Regulation S-X, Rules 6-07 and Rule 7-04, contain similar guidance and apply to registered investment companies and insurance companies, respectively.

Chapter 14 — Disclosure of Income Taxes

14.1 Overview

This chapter outlines the income tax accounting disclosures that entities are required to provide in the notes to, and on the face of, the financial statements. Appendix D provides disclosure examples that may be helpful as the requirements outlined in this chapter are considered. Disclosure requirements related to certain special areas are addressed in other chapters of this Roadmap as follows:

Chapter 7 — interim tax reporting.
Chapter 8 — separate or carve-out financial statements (including abbreviated separate or carve-out financial statements).
Chapter 11 — the effects of a business combination on an entity’s valuation allowance.
Chapter 12 — noncontrolling interests, equity method investments, and QAHP investments, including specific exceptions in ASC 740 related to corporate joint ventures and changes in ownership of investees.

Changing Lanes

In December 2023, the FASB issued ASU 2023-09, which establishes new income tax disclosure requirements within ASC 740 in addition to modifying and eliminating certain existing requirements. The ASU’s amendments are intended to enhance the transparency and decision-usefulness of such disclosures. Under the new guidance, PBEs must consistently categorize and provide greater disaggregation of information in the rate reconciliation. The ASU also includes additional disaggregation requirements related to income taxes paid. The ASU’s disclosure requirements apply to all entities subject to ASC 740. PBEs must apply the amendments to annual periods beginning after December 15, 2024 (2025 for calendar-year-end PBEs). Entities other than PBEs have an additional year to adopt the guidance.

The disclosure guidance in this chapter reflects the requirements in ASC 740 before the adoption of ASU 2023-09. For more information about the enhanced disclosure requirements under the ASU, see Appendix B.

14.7 Pro Forma Financial Statements

14.7.1 Change in Tax Status to Taxable: Pro Forma Financial Reporting Considerations

In certain situations, an entity may be required to disclose, in the financial statements included in an SEC filing, pro forma information regarding a change in tax status. The objective of providing such information is to enable investors to understand and evaluate the continuing impact of a transaction (or a group of transactions) by showing how the transaction might have affected the registrant’s historical financial position and results of operations if the transaction had been consummated on an earlier date. If a transaction (or a group of transactions) includes a change in tax status, the impact of that change should be reflected in the pro forma financial information.

One example would be an entity (e.g., an S corporation) that changes its tax status in connection with an IPO. The financial statements presented in the registration statement for the periods in which the entity was a nontaxable entity are not restated for the effect of income tax. Rather, the entity must provide pro forma disclosures to illustrate the effect of income tax on those years.

Therefore, there may be certain income tax reporting considerations for an entity that changes its status from nontaxable to taxable. Paragraph 3410.1 of the SEC Financial Reporting Manual (FRM) states that if a registrant was formerly an S corporation, a partnership, or a similar tax exempt enterprise, it should present pro forma tax and EPS data for the following periods:

If necessary adjustments include more than adjustments for taxes, limit pro forma presentation to latest fiscal year and interim period
If necessary adjustments include only taxes, pro forma presentation for all periods presented is encouraged, but not required.

The pro forma information should be prepared in accordance with SEC Regulation S-X, Rule 11-02. The tax rate used for the pro forma calculations should normally equal the “statutory rate in effect during the periods for which the pro forma statements of comprehensive income are presented,” as stated in Section 3270 of the FRM. However, Section 3270 of the FRM also indicates that “[c]ompanies are allowed to use different rates if they are factually supportable and disclosed.”

If an entity chooses to provide pro forma information for all periods presented under the option in paragraph 3410.1(b) of the FRM, the entity should continue to present this information in periods after the entity becomes taxable to the extent that the earlier comparable periods are presented.

With respect to the pro forma financial information, any undistributed earnings or losses of an S corporation are viewed as distributions to the owners immediately followed by a contribution of capital to the new taxable entity. ASC 505-10-S99-3 states that these earnings or losses should therefore be reclassified to paid-in capital.

See Deloitte’s Roadmap Initial Public Offerings for additional guidance on pro forma financial information.

14.10 Disclosures Outside the Financial Statements — MD&A

The filings of public entities must include MD&A. Discussion and analysis of income taxes is an important part of an entity’s MD&A since income taxes can be a significant factor in the entity’s operating results. Such discussion should address the following (if material):

Critical accounting estimates — The determination of income tax expense, DTAs and DTLs, and UTBs inherently involves several critical accounting estimates of current and future taxes to be paid. Management should provide information about the nature of these estimates in MD&A.
Liquidity and capital resources — The SEC staff expects registrants to disclose (1) the amount of cash and short-term investments held by foreign subsidiaries that would not be available to fund domestic operations unless the funds were repatriated and (2) whether additional tax expense would need to be recognized if the funds are repatriated. Although we expect scenarios such as these to be less prevalent than they have been historically, an entity may still be subject to income tax on its foreign investments (e.g., foreign exchange gains or losses on distributions and withholding taxes).
Contractual obligations — See Section 14.4.5.

In addition to discussing the results of operations, SEC Regulation S-K, Item 303(a), requires entities to provide certain forward-looking information related to “material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.”

Many tax-related events and uncertainties may need to be elaborated on in MD&A. For instance, before the enactment of tax law proposals or changes to existing tax rules, an SEC registrant should consider whether the potential changes represent an uncertainty that management reasonably expects could have a material effect on the registrant’s results of operations, financial position, liquidity, or capital resources. If so, the registrant should consider disclosing information about the scope and nature of any potential material effects of the changes.

After the enactment of a new tax law, registrants should consider disclosing, when material, the anticipated current and future impact of the law on their results of operations, financial position, liquidity, and capital resources. In addition, registrants should consider providing disclosures in the critical accounting estimates section of MD&A to the extent that the changes could materially affect existing assumptions used in estimating tax-related balances.

The SEC staff also expects registrants to provide early-warning disclosures to help users understand various risks and how those risks potentially affect the financial statements. Examples of such risks include situations in which (1) the registrant may have to repatriate foreign earnings to meet current liquidity demands, resulting in a tax payment (e.g., withholding taxes) that may not be accrued for; (2) the historical effective tax rate is not sustainable and may change materially; (3) the valuation allowance on net DTAs may change materially; and (4) tax positions taken during the preparation of returns may ultimately not be sustained. Early-warning disclosures give investors insight into management’s underlying assumptions as well as the conditions and risks an entity faces before a material change or decline in performance is reported.

Appendix A — Implementation Guidance and Illustrations

Appendix B — FASB Issues ASU on Income Tax Disclosures

Appendix C — Glossary of Terms in the ASC 740 Topic and Subtopics

Appendix D — Sample Disclosures of Income Taxes

D.6 MD&A — Liquidity and Capital Resources2

Sample Disclosure

As of December 31, 20XX, the company has accumulated undistributed earnings of approximately $XXX million generated by foreign subsidiaries. Because $XXX million of such earnings have previously been subject to (1) the one-time transition tax on foreign earnings required by the 2017 Act or (2) the GILTI tax, any additional taxes due with respect to the repatriation of such earnings or the excess of the amount for financial reporting over the tax basis of our foreign investments would generally be limited to the tax effect of currency gains or losses recognized on repatriation, foreign withholding, and state taxes. We intend, however, to indefinitely reinvest these earnings and expect future U.S. cash generation to be sufficient to meet future U.S. cash needs.

For more information, see SEC Interpretation Release Nos. 33-8350, 34-48960, and FR-72 as well as SEC Regulation S-K, Item 303(b)(1).

Connecting the Dots

The SEC staff expects registrants to disclose the amount of cash and short-term investments held by foreign subsidiaries that would not be available to fund domestic operations unless the funds were repatriated. A registrant may disclose this information in the Cash and Investments section of its MD&A.

Footnotes

At the 2011 AICPA Conference, Nili Shah, deputy chief accountant in the SEC’s Division of Corporation Finance, and Mark Shannon, associate chief accountant in the SEC’s Division of Corporation Finance, discussed certain income tax matters in relation to registrants’ significant foreign operations. Ms. Shah indicated that when a registrant with significant amounts of cash and short-term investments overseas has asserted that such amounts are indefinitely reinvested in its foreign operations, the SEC staff would expect the registrant to provide the following disclosures in an MD&A liquidity analysis: (1) the amount of cash and short-term investments held by foreign subsidiaries that is not available to fund domestic operations unless the funds were repatriated; (2) a statement that the company would need to accrue and pay taxes if repatriated; and (3) if true, a statement that the company does not intend to repatriate those funds.

At the 2013 AICPA Conference, the SEC staff also reminded registrants when making the assertion of indefinitely reinvested foreign earnings, companies are required to disclose (1) the amount of the unrecognized DTL or (2) a statement that estimating an unrecognized tax liability is not practicable. In addition, the staff indicated that it evaluates the indefinite reinvestment assertion in taking into account registrants’ potential liquidity needs and the availability of funds in U.S. and foreign jurisdictions.

D.9 Interim Disclosures

Sample Disclosure

Our ETR from continuing operations was XX percent and XX percent for the quarter and nine months ended September 30, 20X2, respectively, and XX percent and XX percent for the quarter and nine months ended September 30, 20X1, respectively. The following items caused the quarterly or YTD ETR to be significantly different from our historical annual ETR:

During the third quarter and nine months ended September 30, 20X2, we recorded an income tax benefit of approximately $XX million as a result of a favorable settlement of uncertain tax positions in Jurisdiction X, which reduced the ETR by XX percent and XX percent, respectively.
During the nine months ended September 30, 20X1, we recorded an income tax benefit of approximately $XX million related to an increase in tax rates in Country X enacted in the third quarter, which increased the ETR by XX percent.

Sample Disclosure

We have historically calculated the provision for income taxes during interim reporting periods by applying an estimate of the AETR for the full fiscal year to “ordinary” income or loss (pretax income or loss excluding unusual or infrequently occurring discrete items) for the reporting period. We have used a discrete ETR method to calculate taxes for the fiscal three- and six-month periods ended June 30, 20X2. We determined that since small changes in estimated “ordinary” income would result in significant changes in the estimated AETR, the historical method would not provide a reliable estimate for the fiscal three- and six-month periods ended June 30, 20X2.

For more information on variations in customary income tax expense relationships, see ASC 740-270-50-1.

Appendix E — Differences Between U.S. GAAP and IFRS Accounting Standards

E.1 Background

ASC 740 is the primary source of guidance on the accounting for income taxes under U.S. GAAP, and IAS 12 is the primary source of such guidance under IFRS® Accounting Standards.1

In general, the income tax accounting frameworks in both U.S. GAAP and IFRS Accounting Standards require the application of a balance sheet model, and share the same basic objectives related to the recognition of (1) the amount of taxes payable or refundable for the current year and (2) DTAs and DTLs for future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.

However, differences remain between the accounting for income taxes under U.S. GAAP and that under IFRS Accounting Standards. The table below summarizes some of the significant differences and is followed by more detailed explanations of each difference as well as cross-references to other sections of the Roadmap.2 Note that this appendix should be used in conjunction with the Roadmap’s detailed interpretive guidance and with A13 of Deloitte’s iGAAP publication.

Subject	U.S. GAAP	IFRS Accounting Standards
Initial recognition exception	No “initial recognition” exception under U.S. GAAP.	Deferred tax is not recognized for taxable or deductible temporary differences that arise from the initial recognition of an asset or a liability in a transaction that (1) is not a business combination, (2) does not affect accounting profit or taxable income when the transaction occurs, and (3) does not give rise to equal taxable and deductible temporary differences when the transaction occurs. Changes in this unrecognized DTA or DTL are not subsequently recognized. The above guidance reflects amendments made to IAS 12 by the International Accounting Standards Board (IASB®) in May 2021 to clarify that the initial recognition exception does not apply to transactions that create offsetting taxable and deductible temporary differences. The amendments became effective for annual reporting periods beginning on or after January 1, 2023, with earlier application permitted. Before the adoption of the amendments: Deferred tax is not recognized for taxable or deductible temporary differences that arise from the initial recognition of an asset or a liability in a transaction that (1) is not a business combination and (2) does not affect accounting profit or taxable income when the transaction occurs. Changes in this unrecognized DTA or DTL are not subsequently recognized.
Recognition of DTAs	DTAs are recognized in full and reduced by a valuation allowance if it is more likely than not that some or all of the DTAs will not be realized.	DTAs are recognized at the amount that is probable (generally interpreted to mean more likely than not3) to be realized on a net basis (i.e., the DTA is written down, and an allowance is not recorded).
Tax laws and rates used for measuring DTAs and DTLs	Enacted tax laws and rates are used.	Enacted or “substantively” enacted tax laws or rates are used.
Uncertain tax positions	ASC 740 prescribes a two-step recognition and measurement approach under which an entity calculates the amount of tax benefit to recognize in the financial statements by (1) assessing whether it is more likely than not that a tax position will be sustained upon examination and (2) measuring a tax position that reaches the more-likely-than-not recognition threshold to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely to be realized upon settlement.	If an entity concludes that it is probable that the taxing authority will accept an uncertain tax treatment (including both the technical merit of the treatment and the amounts included in the tax return), recognition and measurement are consistent with the positions as taken in the tax filings. If the entity concludes that it is not probable that the taxing authority will accept the tax treatment as filed, the entity is required to reflect the uncertainty by using (1) the most likely amount or (2) the expected value. “Probable” is defined as “more likely than not.”
Tax consequences of intra-entity inventory sales	Tax effects of intra-entity transfers of inventory are deferred until the related inventory is sold or disposed of, and no deferred taxes are recognized for the difference between the carrying value of the inventory in the consolidated financial statements and the tax basis of the inventory in the buyer’s tax jurisdiction.	No such exception for intra-entity transfers of inventory exists. Any current and deferred tax expense from intra-entity transfers (inventory or otherwise) is recognized at the time of the transfer. Deferred taxes are recognized for the difference between the carrying value of the transferred asset in the consolidated financial statements and the tax basis of the transferred asset in the buyer’s tax jurisdiction, measured by using the statutory tax rate of the buyer’s tax jurisdiction (subject to realization criteria in IAS 12 if a DTA is recognized on the basis difference).
Foreign nonmonetary assets or liabilities for which the functional currency is not the local currency	No deferred tax is recognized on basis differences resulting from (1) changes in exchange rates (i.e., the difference between the carrying amount for financial reporting purposes, which is determined by using the historical rate of exchange, and the tax basis, which is determined by using the exchange rate on the balance sheet date) or (2) the indexing of basis for income tax purposes.	No similar guidance in IAS 12.
Special deductions (e.g., tax benefits for statutory depletion or special deductions for certain health benefit entities, small life insurance companies, or domestic production activities)	An entity is not permitted to anticipate tax benefits for special deductions when measuring the DTL for taxable temporary differences at the end of the current year. Instead, the entity should recognize such tax benefits for financial reporting purposes no earlier than the year in which they are available to reduce taxable income on the entity’s tax returns. In addition, the future tax effects of special deductions may nevertheless affect (1) the average graduated tax rate to be used for measuring DTAs and DTLs when graduated tax rates are a significant factor and (2) the need for a valuation allowance for DTAs.	No similar guidance in IAS 12.
Share-based compensation	For awards that ordinarily give rise to a tax deduction under existing tax law, deferred taxes are computed on the basis of compensation expense that is recognized for financial reporting purposes. Tax benefits in excess of or less than the related DTA are recognized in the income statement in the period in which the amount of the deduction is determined (typically when an award vests or, in the case of options, is exercised or expires).	For awards that ordinarily give rise to a tax deduction, deferred taxes are computed on the basis of the hypothetical tax deduction for the share-based payment corresponding to the percentage earned to date (i.e., the intrinsic value of the award on the reporting date multiplied by the percentage vested). Recognition of deferred taxes could be recorded through either profit or loss or equity.
Subsequent changes in deferred taxes (e.g., because of changes in tax laws, rates, status, or valuation allowance)	Generally allocated to continuing operations with limited exceptions (i.e., backwards tracing is generally prohibited, regardless of whether the associated tax expense or benefit was originally recognized outside of continuing operations [e.g., in equity]).	IAS 12 requires that the income tax expense or benefit is recognized in the same manner in which the asset or liability was originally recorded. That is, if the deferred taxes were originally recorded outside of profit or loss (e.g., in equity), subsequent changes to the beginning balance will be recorded in the same manner (i.e., backwards tracing is permitted).
Deferred taxes for outside basis differences — investment in a subsidiary or a corporate joint venture that is essentially permanent in duration	A DTL is generally not recognized for financial reporting basis in excess of tax basis in foreign subsidiaries and corporate joint ventures that are essentially permanent in duration unless the difference is expected to reverse in the foreseeable future. For financial reporting basis in excess of tax basis in domestic subsidiaries or corporate joint ventures, a DTL is generally not recognized if the basis difference arose in fiscal years on or before December 15, 1992, unless the temporary difference will reverse in the foreseeable future. However, a DTL must be recognized if the basis difference arose in fiscal years after December 15, 1992, “unless the tax law provides a means by which the investment in a domestic subsidiary can be recovered tax free” and the entity expects that it will ultimately use that means. A DTA is recorded with respect to investments in a subsidiary or corporate joint venture (domestic or foreign) that is essentially permanent in duration only if it is apparent that the temporary difference will reverse in the foreseeable future. Note that according to paragraph 64 of ASU 2015-10, “[t]his exception to recognizing deferred taxes is not applicable for partnerships (or other pass-through entities).”	A DTL is generally recognized for financial reporting basis in excess of tax basis of any form of investee (foreign or domestic, subsidiaries, branches, associates, and interests in joint arrangements) unless both of the following conditions are satisfied: (1) the parent is able to control the timing of the temporary difference’s reversal and (2) it is probable that the temporary difference will not reverse in the foreseeable future. A DTA is generally recognized for tax basis in excess of financial reporting basis of any form of investee to the extent that it is probable (generally interpreted to mean more-likely-than-not) that (1) the temporary difference will reverse in the foreseeable future and (2) taxable income will be available against which the temporary difference can be used. Note that there is no similar prohibition on applying the guidance to partnerships, although meeting the criteria may be difficult because of the flow-through nature of partnerships.
Deferred taxes for outside basis differences — equity method investee that is not a corporate joint venture (foreign and domestic) that is essentially permanent in duration	A DTL is recognized on the excess of the financial reporting basis over the tax basis of the investment. A DTA is recognized for the excess of the tax basis of the investment over the amount for financial reporting and must be assessed for realizability (in most jurisdictions, the loss would be capital in character).	A DTL is recognized on excess book over tax basis unless both of the following conditions are satisfied: (1) the holder of the investment can control the timing of the reversal and (2) it is probable that the difference will not reverse in the foreseeable future. A DTA is recognized only to the extent that (1) it is probable that the temporary difference will reverse in the foreseeable future and (2) there will be taxable income against which the temporary difference can be used.
Other exceptions to the basic principle that deferred tax is recognized for all temporary differences — leveraged leases	For a leveraged lease (commencing before the adoption of ASU 2016-02) exemption, no deferred tax is recognized under ASC 740. See ASC 840-30 for information about the tax consequences of leveraged leases. ASC 842 does not include guidance on leveraged leases. Entities are not permitted to account for any new or subsequently amended lease arrangements as leveraged leases after the effective date of ASC 842.	IFRS Accounting Standards do not address leveraged leases, thus there is no similar exception.
Reconciliation of actual and expected tax rate	Required for public companies only; expected tax expense is computed by applying the domestic federal statutory rates to pretax income from continuing operations. Nonpublic companies must disclose the nature of the reconciling items but are not required to provide the amounts.	Required for all entities applying IFRS Accounting Standards. Entities compute expected tax expense by applying the applicable tax rate(s) to accounting profit and must disclose the basis on which any applicable tax rate is computed.
Interim reporting	Entities are generally required to compute tax (or benefit) for each interim period by using one overall estimated AETR. The estimated AETR is computed by dividing the estimated annual tax (or benefit) into the estimated annual pretax ordinary income (or loss). Entities then apply the estimated AETR to YTD pretax ordinary income or loss to compute the YTD tax (or benefit). The interim tax expense (or benefit) is the difference between the YTD tax (or benefit) and prior YTD tax (or benefit).	To the extent practicable, a separate estimated average annual effective income tax rate is determined for each tax jurisdiction and applied individually to the interim-period pretax income of each jurisdiction. Similarly, if different income tax rates apply to different categories of income (such as capital gains or income earned in particular industries), to the extent practicable, a separate rate is applied to each individual category of interim period pretax income.
Allocation of consolidated tax expense to the separate financial statements of group members	The consolidated amount of current and deferred tax expense for a group that files a consolidated tax return is allocated among the members of the group when those members issue separate financial statements by using a method that is systematic, rational, and consistent with the broad principles of ASC 740. See Section 8.3 for further discussion of acceptable methods.	No similar guidance in IAS 12.

Footnotes

The IASB issued the IFRS for SMEs® Standard (the “SMEs Standard”) in July 2009. The SMEs Standard is a stand-alone standard and does not require preparers of private-entity financial statements to explicitly refer to full IFRS Accounting Standards. Section 29 of the SMEs Standard is the primary source of guidance on accounting for income taxes for entities applying the SMEs Standard. This appendix does not address the differences between Section 29 and IAS 12; accordingly, it also does not address the differences in the accounting for income taxes that might exist between U.S. GAAP and the SMEs Standard.

Differences are based on comparison of authoritative literature under U.S. GAAP and IFRS Accounting Standards and do not necessarily include interpretations of such literature.

While IAS 12 is silent with regard to the meaning of “probable” in the context of paragraph 24 of IAS 12, IAS 37 defines the term as “more likely than not.” The footnote to paragraph 23 of IAS 37 acknowledges that this definition is not necessarily applicable to other IFRS Accounting Standards. However, in the absence of any other guidance, the term probable should be considered to mean more likely than not. In March 2009, the IASB issued an exposure draft containing proposals for an IFRS Standard that would replace IAS 12. Although a replacement standard was not finalized, the exposure draft provided useful guidance on the meaning of “probable” because it used the term “more likely than not” and noted in the Basis for Conclusions that it was consistent with the term “probable” as used in IAS 37 and IFRS 3.

E.6 Tax Consequences of Intra-Entity Inventory Sales

Under U.S. GAAP, ASC 740-10-25-3(e) requires entities to use the consolidation guidance in ASC 810-10 to account for income taxes paid on intra-entity profits on inventory remaining within the group, and it prohibits the recognition of a DTA for the difference between the tax basis of the inventory in the buyer’s tax jurisdiction and its cost as reported in the consolidated financial statements (i.e., after elimination of intra-entity profit). Specifically, ASC 810-10-45-8 states that “[i]f income taxes have been paid on intra-entity profits on inventory remaining within the consolidated group, those taxes shall be deferred or the intra-entity profits to be eliminated in consolidation shall be appropriately reduced.”

The FASB has concluded that an entity’s income statement should not reflect a tax consequence for intra-entity sales of inventory in situations in which any profit (loss) is eliminated in consolidation. The current tax expense from the sale of inventory is deferred upon consolidation (as a prepaid income tax) and is not recorded until the inventory is sold to an unrelated party. In addition, under U.S. GAAP, the buyer is prohibited from recognizing deferred taxes for the temporary difference between the carrying amount of the inventory in the consolidated financial statements and its tax base. Other than for inventory, there are no differences between U.S. GAAP and IFRS Accounting Standards related to the income tax accounting of the tax consequences of intra-entity sales of other assets. See Section 3.5.6 for additional guidance.

Under IFRS Accounting Standards, there is no exception related to intra-entity transfers of inventory. Accordingly, current and deferred tax effects must be recognized for intra-entity sales in accordance with the general principles of IAS 12. For example, an intra-entity sale creates a temporary difference between the book carrying amount of the asset and its tax base. When intra-entity transactions occur between entities that are operating in different tax jurisdictions (e.g., foreign or state tax jurisdictions) or are subject to different tax rates, the rate applied to the temporary difference is the rate at which the difference is expected to reverse, which generally is that of the buyer’s tax jurisdiction. If the buyer’s tax rate is different from the seller’s tax rate, the deferred tax recognized may not entirely offset the current tax expense resulting from the intra-entity sale.

E.9 Share-Based Compensation

Under U.S. GAAP, the deferred tax recorded on share-based compensation is computed on the basis of the expense recognized in the financial statements for awards that ordinarily give rise to a tax deduction. Therefore, changes in an entity’s share price during the vesting period do not affect the DTA recorded on the entity’s financial statements.

All excess tax benefits (e.g., tax deduction on the award is in excess of cumulative compensation for financial reporting) and tax deficiencies (e.g., tax deduction on the award is less than cumulative compensation for financial reporting) are recognized as income tax expense or benefit in the income statement in the period in which the amount of the deduction is determined (typically when an award vests or, in the case of options, is exercised or expires).

See Chapter 10 for additional guidance on the ASC 740 accounting for deferred taxes resulting from share-based payment awards.

Under IFRS Accounting Standards, for awards that ordinarily give rise to a tax deduction, the deferred tax is computed on the basis of the expected tax deduction for the share-based payments corresponding to the percentage earned to date (i.e., the intrinsic value of the award on the reporting date multiplied by the percentage vested). Therefore, changes in share price do affect the DTA at period-end and result in adjustments to the DTA. If the amount of the estimated future tax deduction for awards exceeds the amount of the tax effect of the related cumulative compensation expense for financial reporting purposes, a portion of the tax deduction is deemed to be related to an equity item. The excess of the associated deferred tax is therefore recognized directly in equity. If the tax deduction received is less than the compensation expense, the DTA is reversed to profit or loss. If, on the other hand, no tax deduction is anticipated (e.g., because the share price has declined), the DTA is reversed to profit or loss or equity, or both, as appropriate, depending on how the deferred tax benefit was originally recorded.

Appendix F — Frequently Asked Questions About Pillar Two

Appendix G — Titles of Standards and Other Literature

Appendix H — Abbreviations

Abbreviation	Description
AC	acquiring company
AETR	annual effective tax rate
AFS	available for sale
AGUB	adjusted grossed-up basis
AICPA	American Institute of Certified Public Accountants
AMT	alternative minimum tax
AOCI	accumulated other comprehensive income
APB	Accounting Principles Board
APIC	additional paid-in capital
ASC	FASB Accounting Standards Codification
ASU	FASB Accounting Standards Update
BCF	beneficial conversion feature
BEAT	base erosion anti-abuse tax
BEMTA	base erosion minimum tax amount
CAD	Canadian dollar
CCF	cash conversion feature
CE	constituent entity
CEO	chief executive officer
CFC	controlled foreign corporation
CFO	chief financial officer
CFR	Code of Federal Regulations
CIMA	Chartered Institute of Management Accountants
CNIT	corporate net income tax
CPP	cash purchase price
CTA	cumulative translation adjustment
DTA	deferred tax asset
DTL	deferred tax liability
E&P	earnings and profits
ED	exposure draft
EITF	FASB’s Emerging Issues Task Force
EPS	earnings per share
ESOP	employee stock ownership plan
ESPP	employee stock purchase plan
ETR	effective tax rate
FAQ	frequently asked question
FASB	Financial Accounting Standards Board
FBB	final book basis
FCC	Federal Communications Commission
FDII	foreign-derived intangible income
FRM	SEC Division of Corporation Finance’s Financial Reporting Manual
FTC	foreign tax credit
GAAP	generally accepted accounting principles
GILTI	global intangible low-taxed income
GloBE	global anti-base erosion
HTM	held to maturity
IAS	International Accounting Standard
IASB	International Accounting Standards Board
IFRIC	IFRS Interpretations Committee
IFRS	International Financial Reporting Standard
IIR	income inclusion rule
IPO	initial public offering
IPTF	CAQ’s International Practices Task Force
IRC	Internal Revenue Code
IRS	Internal Revenue Service
ISO	incentive stock option
ITC	investment tax credit
LC	local currency
LICTI	life insurance company taxable income
LIFO	last in, first out
LLC	limited liability company
LTCE	low-taxed constituent entity
MD&A	Management’s Discussion and Analysis
MNE	multinational enterprise
NFP	not-for-profit entity
NOL	net operating loss
NQSO	nonqualified option
OCI	other comprehensive income
OECD	Organisation for Economic Co-operation and Development
OTTI	other-than-temporary impairment
PBE	public business entity
PCAOB	Public Company Accounting Oversight Board
PP&E	property, plant, and equipment
PTI	percentage of taxable income
QAHP	qualified affordable housing project
Q&A	question and answer
QBAI	qualified business asset investment
QDMTT	qualified domestic minimum top-up tax
R&D	research and development
REIT	real estate investment trust
RIC	regulated investment company
ROU	right of use
SAB	SEC Staff Accounting Bulletin
SAR	share appreciation right
SEC	U.S. Securities and Exchange Commission
SFAS	Statement of Financial Accounting Standards
SFC	specified foreign corporation
SUI	significant unusual or infrequently occurring
TC	target company
TTB	total tax benefit
UPE	ultimate parent entity
USD	U.S. dollar
UTB	unrecognized tax benefit
UTPR	undertaxed profits rule
VIE	variable interest entity
YTD	year to date

Appendix I — Roadmap Updates for 2024

The tables below summarize the substantive changes made in the 2024 edition of this Roadmap.

New Content

Section	Title	Description
11.3.6.7	GILTI Considerations in a Business Combination	Added new section (including Example 11-25) to address the impact of an acquired GILTI obligation in acquisition accounting. Renumbered subsequent examples.
Appendix B	FASB Issues ASU on Income Tax Disclosures	Added appendix to discuss ASU 2023-09 (and to replace discussion of the proposed ASU).
Appendix F	Frequently Asked Questions About Pillar Two	Added appendix to address FAQs related to the accounting impacts of Pillar Two.

Amended or Deleted Content

Section	Title	Description
On the Radar		Updated to reflect the status of FASB projects and other developments.
3.3.4.10	Consideration of AMT Regimes	Deleted discussion of the modification of refund claims for AMT credit carryforwards under the CARES Act because the guidance is no longer relevant.
3.4.11.1.1	Classification of Transition Tax Obligation in Periods Before Inclusion in the Income Tax Return	Deleted section because it is no longer relevant.
3.4.11.2	Measurement of Transition Tax Obligation in Periods Before Inclusion in the Income Tax Return	Deleted section because it is no longer relevant.
3.5.4.1	Recognition Date for Conversion to a REIT	Updated discussion to align with current practice.
3.5.9.3	AFS Securities	Clarified guidance on the treatment of unrealized gains and losses on debt and equity securities classified as AFS.
5.7.12	Accounting Considerations for Valuation Allowances Related to IRC Section 163(j) Carryforwards	Added Example 5-32 to illustrate how available sources of taxable income are quantified under the additive approach and the integrative approach. Renumbered subsequent example.
6.2.7.3.1.2	Income Tax Accounting Considerations Related to When a Subsidiary Is Deconsolidated: Stock Sale	Added Example 6-11 to illustrate the elimination of inside DTAs and DTLs in a stock sale.
7.3.2.1	Retroactive Changes in Tax Laws	Expanded discussion of circumstances in which an entity would not recognize the tax effect of a retroactive change in law by updating the AETR.
11.3.2.4	Impairment Testing	Updated to provide additional considerations related to impairment of tax-deductible goodwill.
11.3.2.4.2	Assigning Deferred Taxes to a Reporting Unit	Updated to provide additional discussion of the allocation of valuation allowances to a reporting unit.
12.2.1	Accounting for Temporary Differences Related to ITCs	Updated to address considerations in the determination of whether a tax credit qualifies for ITC accounting.
12.4.1	Accounting for the Tax Effects of Transactions With Noncontrolling Shareholders	Clarified guidance on the intraperiod allocation of direct effects of stock transactions with noncontrolling shareholders. Also, expanded Example 12-5 to include an illustration of the with-and-without intraperiod allocation calculation.
14.1	Overview	Added Changing Lanes to summarize amendments made by ASU 2023-09.
D.1	Background	Added Changing Lanes to summarize amendments made by ASU 2023-09.

	Matt Himmelman Audit & Assurance Partner Deloitte & Touche LLP +1 714 436 7277 mhimmelman@deloitte.com		Patrice Mano Partner Deloitte Tax LLP Washington National Tax +1 415 783 6079 pmano@deloitte.com
	Chris Barton Managing Director Deloitte Tax LLP Washington National Tax +1 703 885 6300 cbarton@deloitte.com		Mark Crowley Audit & Assurance Managing Director Deloitte & Touche LLP +1 203 563 2518 mcrowley@deloitte.com
	Krystle Kort Partner Deloitte Tax LLP Washington National Tax +1 415 783 6917 kkort@deloitte.com		Marla Lewis Audit & Assurance Partner Deloitte & Touche LLP +1 203 708 4245 marlalewis@deloitte.com
	Alice Loo Managing Director Deloitte Tax LLP Washington National Tax +1 415 783 6118 aloo@deloitte.com		James Webb Audit & Assurance Partner Deloitte & Touche LLP +1 415 783 4586 jwebb@deloitte.com