FASB Discusses Simplifications to Accounting for Income Taxes
At its meeting on April 10, 2019, the FASB decided to add a project to its agenda regarding simplifications to accounting for income taxes. The Board tentatively decided on the scope of the project, which is part of its Simplification Initiative. In its initial discussion of this topic, the FASB noted that “accounting for income taxes has consistently been among the top areas of restatements over the last several years,” and is, therefore, worth considering further for simplification.
As part of its project proposal, the FASB received feedback related to simplifying the accounting for income taxes in a comment letter submitted by several public accounting firms as well as suggestions received from preparers and practitioners. The Board’s tentative decisions, organized by topic, are summarized below. Unless otherwise noted, the Board decided that each amendment should be applied prospectively.
Simplification Suggestions
Intraperiod Tax Allocation Exception to Incremental Approach
Under current U.S. GAAP, the tax effect of income from continuing operations should be determined without considering the tax effect of items that are not included in continuing operations, such as discontinued operations or other comprehensive income. An exception to this approach is described in ASC 740-20-45-7, which requires that “all items . . . be considered in determining the amount of tax benefit that results from a loss from continuing operations.” This exception only applies when there is a current period loss from continuing operations.
To reduce cost and complexity as well as diversity in practice, the Board tentatively decided to remove the exception in ASC 740-20-45-7.
Ownership Changes in Investments — Changes From a Subsidiary to an Equity Method Investment
ASC 740-30-25-15 provides guidance on situations in which an investment in common stock of a subsidiary changes such that it is no longer a subsidiary. If the parent entity did not previously recognize income taxes on its undistributed earnings because of the exception in ASC 740-30-25-18(a) (i.e., because of an assertion of indefinite reinvestment), the current requirement under U.S. GAAP that no deferred taxes be recognized on that portion of the basis difference until it becomes apparent that such undistributed earnings will be remitted (i.e., deferred taxes are not automatically recognized) applies.
The Board tentatively decided to remove the exception in ASC 740-30-25-15 that restricted recognition of a deferred tax liability on the portion of the outside basis difference that existed before the subsidiary became an equity method investment. Accordingly, an entity may now need to recognize current tax expense to recognize a deferred tax liability related to the equity method investment when the subsidiary becomes an equity method investment. This guidance creates consistency with current U.S. GAAP that disallows an equity method investor from asserting indefinite reinvestment of earnings to avoid recording deferred taxes on its outside basis differences. The Board decided that any amendments should be applied using a modified retrospective approach.
Ownership Changes in Investments — Changes From an Investment to a Subsidiary
ASC 740-30-25-16 provides guidance on situations in which a foreign equity method investment becomes a subsidiary. This guidance states that the deferred tax liability previously recognized for a foreign investment cannot be derecognized when the investment becomes a subsidiary, unless dividends received from the subsidiary exceed earnings from the subsidiary after the date it became a subsidiary. This is this case regardless of whether an exception under ASC 740-30-25-18(a) applies.
The Board tentatively decided to remove the exception in ASC 740-30-25-16 that freezes the deferred tax liability on the outside basis difference that existed before the investment became a subsidiary. Accordingly, an entity may need to reverse a deferred tax liability and recognize a tax benefit if it asserts indefinite reinvestment of earnings of the subsidiary. This treatment results in consistency among all of the entity’s subsidiaries for which indefinite reinvestment is asserted. The Board decided that any amendments should be applied using a modified retrospective approach.
Interim Period Accounting for Enacted Changes in Tax Law
Stakeholder feedback indicated that the guidance on recognizing the income tax effects of an enacted change in tax law in an interim period is not clear. More specifically, ASC 740-10 requires that the tax effect of a change in tax law or rates on deferred tax accounts and taxes payable or refundable for prior years be recognized in the period that includes the enactment date. ASC 740-270-25-5, however, states that the effect of a change in tax law or rates on taxes currently payable or refundable for the current year is recorded after the effective date and no earlier than the enactment date. Because the guidance in ASC 740-270-25-5 appears inconsistent with the guidance in ASC 740-10, diversity in practice has developed.
The Board tentatively decided to amend ASC 740-270-25-5 to require that the effects of an enacted change in tax law be reflected in the computation of the annual effective tax rate (AETR) in the first interim period that includes the enactment date of the new legislation. In addition, the examples in ASC 740-270-55-44 through 55-49 will also be amended to reflect the change.
Hybrid Tax Regimes
“Hybrid” tax regimes are tax jurisdictions that impose the greater of two taxes — one that is based on taxable profit and one that is based on items other than income. While ASC 740 does not apply to taxes that are based on items other than income, ASC 740-10-15-4 specifies that in the context of a franchise tax that is based on capital, if there is a tax based on income that is greater than the tax that is based on capital, then that excess is subject to the guidance in ASC 740. The FASB noted that practitioners indicate that the current guidance on hybrid tax regimes increases the cost and complexity of applying ASC 740, particularly when the amount related to the non-income tax is not significant.
To reduce cost and complexity, the Board tentatively decided to amend ASC 740-10-15-4(a) to state that if there is an amount that is based on taxable profit, it should be included in the tax provision, with any incremental amount recorded as non-income-based tax. This amendment would effectively reverse the order of determining the type of tax as compared to current U.S. GAAP. The Board further decided that the amendments should be applied retrospectively.
Separate Financial Statements of Single Member LLCs
ASC 740-10-30-27 requires that “the consolidated amount of current and deferred tax expense for a group that files a consolidated tax return . . . be allocated among the members of the group when those members issue separate [company] financial statements.” The guidance does not further state which entities would be considered “members” of the group for the purpose of determining whether taxes should be allocated to an entity. For example, the guidance does not specify whether taxes should be allocated to nontaxable entities, such as disregarded single member LLCs (SMLLCs).
The Board tentatively decided to clarify that legal entities that are not subject to tax (e.g., disregarded SMLLCs) should not be required to allocate amounts of consolidated current and deferred taxes in their separate financial statements, unless the entity elected to do so as a policy choice. If the entity’s policy is to allocate taxes to such entities, appropriate disclosure of this policy should be included in the financial statements. The Board further decided that the amendments should be applied retrospectively.
Tax Basis Step-Up in Goodwill Obtained in a Transaction That Is Not a Business Combination
In a business combination that results in the recognition of goodwill in accordance with ASC 805, amounts assigned to goodwill may be different for income tax purposes compared to the amounts used for financial reporting. Under current U.S. GAAP, a deferred tax asset is recognized when the tax basis of goodwill exceeds the book basis of goodwill. When the book basis of goodwill exceeds the tax basis of goodwill, ASC 805 prohibits recognition of a deferred tax liability.
After a business combination, certain transactions or events such as payments to the government may increase the tax basis of the entity’s assets, including goodwill. If a subsequent step-up in the tax basis of goodwill relates to the portion of goodwill from a prior business combination for which a deferred tax liability was not initially recognized, ASC 740-10-25-54 prohibits recognition of a deferred tax asset for the step-up in tax basis, “except to the extent that the newly deductible goodwill amount exceeds the remaining balance of book goodwill.”
Stakeholders noted that current guidance in U.S. GAAP does not necessarily result in outcomes that are reflective of the economics of the underlying transactions. For example, an entity may sacrifice a net operating loss carryforward in exchange for tax basis in goodwill. In this case, economically, the entity has exchanged one asset for another.
The Board tentatively decided to remove the guidance in ASC 740-10-25-54 that prohibits recognition of a deferred tax asset for a step-up in tax basis. Instead, the Board proposed a model that requires the entity to (1) determine whether the step-up in tax basis relates to the initial recognition of goodwill or a separate transaction and (2) consider a list of factors that would indicate whether the tax basis step-up transaction should be considered a separate transaction. If the step-up is related to the initial recognition of goodwill, a deferred tax asset would not be recorded. If the step-up is related to a subsequent transaction, a deferred tax asset would be recognized. The Board further decided to add factors that would assist in this determination.
Year-to-Date Loss Limitation in Interim Period Tax Accounting
Under the interim period income-tax model, an entity is generally required to calculate its best estimate of the AETR for the full fiscal year at the end of each interim reporting period and to use that rate to calculate income taxes on a year-to-date basis. ASC 740-270-30-28 provides additional guidance for situations in which an entity incurs a loss on a year-to-date basis that exceeds the anticipated loss for the year. This represents an exception to the general guidance in ASC 740-270.
Stakeholders provided mixed feedback on the usefulness of the exception and the outcomes it yields. However, stakeholders acknowledged that application of this exception is complex and prone to errors. The Board tentatively decided to remove the exception in ASC 740-270-30-28.
Accounting for Nondeductible Goodwill by Private Companies
The Board decided to exclude from the project an issue involving deferred tax accounting for nondeductible goodwill by private companies.
Codification Improvements
The Board tentatively agreed to make improvements to the Codification topics below.
Income Statement Presentation of Tax Benefits of Tax-Deductible Dividends
Once effective, ASU 2016-091 will amend ASC 718-740-45-7 to state that “the tax benefit of tax-deductible dividends on allocated and unallocated employee stock ownership plan shares shall be recognized in the income statement” (emphasis added). ASC 718-740-45-7 currently states that the relevant tax benefit should be recognized in income taxes allocated to continuing operations. Other topics in the Codification that address this topic use the language that is currently in ASC 718-740-45-7.
Impairment of Investment in Qualified Affordable Housing Projects Accounted for Using the Equity Method
ASC 323-740-55-8 includes an example of the accounting for an investment in qualified affordable housing projects using the equity method. The example indicates that the investment becomes impaired in Year 9 and that impairment is measured on the basis of the remaining tax credits allocable to the investor; however, the impairment assessment (specifically, the year in which the impairment occurs) is incorrect on the basis of the revised facts that were used when the example was amended in ASU 2014-01.2
Next Steps
The Board requested that the staff draft a proposed ASU for vote by written ballot with a comment period of 45 days.
See the meeting handout and summary of tentative Board decisions for additional information.
Footnotes
1
FASB Accounting Standards Update (ASU) No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
2
FASB Accounting Standards Update No. 2014-01, Investments — Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects.