Accounting for Transferable Tax Credits
Overview
Entities can generate tax credits by engaging in various specific activities,
including investing in or producing certain clean energy products. A tax credit
is a benefit that can reduce income taxes payable on a dollar-for-dollar basis.
In some jurisdictions, certain tax credits, or some portion thereof, can be
transferred (i.e., sold) to unrelated third-party taxpayers. Entities may elect
to sell these transferable credits because they have determined that they will
achieve a better economic benefit (e.g., present value benefit) by doing so.
In recent years, the number and types of available tax credits
have increased significantly, particularly in the United States. The CHIPS Act
and the Inflation Reduction Act, which were signed into law in August 2022,
introduced a number of tax-related provisions. These include a plethora of clean
energy tax incentives in the form of tax credits, some of which contain a
transferability provision, a direct-pay option (e.g., allowing an entity to
elect to treat the tax credits as a direct payment against its income tax
liability and claim a refund for any resulting overpayment), or both.
Given the recent increase in the availability of transferable credits, questions
have arisen related to the applicable accounting treatment for both an entity
that generates such credits and an entity that purchases them.
We believe that regardless of its intent, if an entity generates transferable
credits, those credits should remain within the scope of ASC 7401 if they (1) can be used only to reduce an income tax liability either for
the entity that generated such liability or the entity to which it is
transferred and (2) would never be refundable by the government. While we
believe that accounting for the credits under ASC 740 would be the most
appropriate treatment, on the basis of feedback received from the FASB staff, we
understand that it would also be acceptable for an entity to account for
transferable credits outside the scope of ASC 740 since the entity generating
the credits does not need taxable income to monetize them.
Entities that do not account for transferable credits in
accordance with ASC 740 may consider such credits to be a form of government
assistance. Because there has been no specific, authoritative U.S. GAAP guidance
on recognizing and measuring government assistance received by business
entities,2 different approaches have been used for such recognition and measurement,
and multiple models may be acceptable related to the timing and amount of
government assistance reflected in an entity’s financial statements. See the
Accounting for
Transferable Credits Under the Government Grant Model section for
further details related to using a government grant model to account for
transferable credits outside the scope of ASC 740 (e.g., the framework in IAS
20,3 ASC 958-605, or ASC 450-30).
A transferable credit generally may be transferred only one time (e.g., as
discussed in Internal Revenue Code Section 6418), and the entity that purchases
it can only use the credit to reduce its own income tax liability. Therefore,
the purchaser would account for the transferable credit under ASC 740. See the
Accounting for the Purchase of Transferable
Credits section for further details.
The accounting considerations discussed in this publication apply to taxable
entities. Additional considerations may apply to nontaxable entities (e.g.,
partnerships) that buy or sell transferable tax credits. Consultation with
appropriate accounting advisers is encouraged.
Transferor’s Accounting
As discussed above, entities have used two acceptable approaches
in practice to account for the initial recognition of transferable tax credits
(i.e., the initial accounting for the transferor). That is, they have accounted
for such credits (1) under ASC 740 or (2) as a government grant. Entities should
select one method as an accounting policy and apply it consistently. Each
approach is discussed below.
Accounting for Transferable Credits Under ASC 740
If an entity has elected to account for transferable credits
in accordance with ASC 740, the entity that generates the credits would
apply the recognition and measurement criteria in ASC 740.4 An entity will initially recognize the transferable credit after all
the applicable requirements of the tax law are met. If an entity plans to
retain the credit for its own use, the entity will record a deferred tax
asset (DTA), which is then assessed for realizability.
If, on the other hand, an entity intends to subsequently transfer a credit to
a third party, it must make accounting policy elections regarding where it
will classify the gain or loss in the income statement and whether it will
consider anticipated sales proceeds when assessing the realizability of the
DTA. As part of a technical inquiry, the FASB staff communicated that the
most appropriate method would be to reflect any gain or loss resulting from
the sale of the credit as a component of the tax provision. An entity that
chooses to recognize gain or loss within the tax provision must make another
election regarding whether to factor the expected sales proceeds of the
credit into the assessment of the realizability of the DTA. When an entity
includes the expected sales proceeds in the assessment of the DTA, it would
initially recognize the DTA (net of the valuation allowance) in an amount
equal to the amount expected to be realized (i.e., the expected sales
proceeds). It would then recognize any difference between the expected and
actual sales proceeds as a component of income tax expense in the period the
transfer occurs. An entity that elects not to include the expected proceeds
in its assessment of the DTA should assess realizability by using the
traditional four sources of taxable income.
As an alternative to the above approach, an entity may elect
to recognize any gain or loss as a component of pretax earnings. Under this
policy election, the entity should initially recognize a DTA and assess it
for realizability in a manner consistent with the sources of income cited in
ASC 740-10-30-18 (i.e., excluding any expected sales proceeds). That is, if
an entity’s policy is to reflect the gain or loss in pretax earnings, it
would not be appropriate for the entity to consider the expected sales
proceeds when assessing realizability of the related DTA.
See Appendix A for a decision tree that
summarizes the impacts of accounting for transferable credits under ASC
740.
Example 1
Transferor A develops a small wind electric system,
and construction begins January 1, 20X5.
Construction is completed January 1, 20X6, on which
date the system is placed into service. Transferor A
incurred $2,000 of costs, which it capitalized
during 20X5, and is eligible to receive a 6 percent
nonrefundable transferable tax credit (i.e., a $120
transferable credit) on its investment once the
system is placed into service. The asset’s useful
life is 10 years.
Because A does not expect to have
taxable income for the next few years, it determined
that it would be beneficial to sell the transferable
credit. On the date the system was placed into
service, A estimated that it would receive $110 in
proceeds.
Transferor A determined that it would account for the
transferable credit under ASC 740 by using the
flow-through method. When assessing the
realizability of the credits in its DTA, A
considered the expected proceeds and elects to
account for the gain or loss on the sale as a
component of the tax provision.
On January 1, 20X7, A enters into an agreement with
Purchaser B to sell the $120 credit for $113, which
is $3 more than A had expected. Control of the
credit was transferred on this date.
Below are the resulting journal
entries. For simplicity, any impact associated with
a statutory reduction in the tax basis is
ignored.
Accounting for Transferable Credits Under the Government Grant Model
An entity that elects to account for transferable credits as government
grants must apply its accounting policy election on the treatment of other
forms of grants to such credits. In practice, entities have often analogized
to IAS 20 when accounting for government grants, but some have analogized to
ASC 450-30 or ASC 958-605 (even though government grants to for-profit
entities are specifically excluded from its scope).5
The paragraphs below address how an entity should account for transferable
credits by analogizing to IAS 20, which entities commonly apply in practice
to account for such credits that are outside the scope of ASC 740. Further,
as noted in the Government Grants
Project section, there are many similarities between IAS 20
and the FASB’s proposed ASU on the recognition, measurement, and
presentation of government grants.
As indicated in paragraph 23 of IAS 20, transferable credits
recognized by analogy to IAS 20 are considered nonmonetary assets. Under
this guidance, such credits would typically be measured at fair value (but
note that entities may also initially measure an asset grant at a nominal
value6). The transferable credit would be initially recognized when there is
“reasonable assurance” that the entity will comply with the grant’s
conditions and that the grant will be received (i.e., earned). The
“reasonable assurance” threshold under IFRS® Accounting Standards
is not defined; however, when entities apply this framework under U.S. GAAP,
practice often defines the term in a manner similar to the “probable”
threshold under ASC 450-20. After determining that a grant is recognizable,
an entity must assess whether the grant is related to an asset or to
income.
A grant related to an asset received by an entity has
conditions that are tied to the acquisition or construction of long-lived
assets or inventory. An entity may elect an accounting policy of initially
recognizing such a grant as either deferred income or a reduction in the
asset’s carrying amount. If the entity classifies the grant as deferred
income, it will recognize the grant in the income statement over the useful
life of the depreciable asset associated with it (e.g., as an offset against
depreciation expense) or when the inventory is disposed of. If the entity
classifies the grant as a reduction in the asset’s carrying amount, the
associated asset will have a lower carrying value and a lower amount of
depreciation over time or the carrying amount of the inventory will be
lower. An entity must use judgment to determine how to classify the
transferable credit because the facts and circumstances will dictate whether
classification as an intangible asset or another asset, or some other
classification, is appropriate. Further, with respect to nondepreciable
assets, paragraph 18 of IAS 20 specifies the following:
Grants related to non-depreciable assets may also require the
fulfilment of certain obligations and would then be recognised in profit
or loss over the periods that bear the cost of meeting the obligations.
As an example, a grant of land may be conditional upon the erection of a
building on the site and it may be appropriate to recognise the grant in
profit or loss over the life of the building.
An income grant is a grant that is not related to assets.
Under IAS 20, an entity may present the receipt of such a grant in the
income statement either as (1) a credit to income or (2) a reduction in the
related expense that the grant is intended to defray. The main objective of
the accounting for government grants under IAS 20 is for an entity to
recognize a grant in the same period or periods in which it recognizes the
corresponding costs in the income statement. Therefore, an entity should
assess the specific requirements that it must meet to receive or retain any
grant from the government.
See Appendix B for a decision tree that summarizes the impacts
of accounting for transferable credits under the government grant model
(i.e., outside the scope of ASC 740).
Example 2
Assume the same facts as in Example 1, except that
Transferor A has elected to use the government grant
model. The fair value of the grant is equal to the
amount that A expects to receive from selling the
credit. Transferor A also obtains reasonable
assurance related to meeting the conditions
associated with the grant and the likelihood that it
will receive such grant on January 1, 20X6.
Below are A’s journal entries (1) if it elected to
deduct the grant from the carrying amount of the
asset and (2) under the deferred income approach,
assuming that A recorded the grant separately within
other income.
Reduced Carrying Value Approach
Deferred Income Approach
Insurance
When a buyer acquires transferable credits, it typically
assumes any validity risk associated with them. That is, the buyer would be
responsible for any additional tax liabilities (including interest and
penalties) if any purchased credits are deemed to be wholly or partially
invalidated by the Internal Revenue Service (IRS). A seller (i.e., the
transferor) may or may not indemnify the buyer against such risks. For
example, a transferor may agree to refund amounts to the buyer if a sold
credit is later invalidated by the IRS. Alternatively, the transferor may
purchase an insurance policy on behalf of the buyer under which a
third-party insurance company will compensate the buyer if the IRS
determines that a purchased credit is invalid.
If a transferor is obligated to purchase insurance in
connection with the sale of transferable credits to avoid being primarily
responsible for losses resulting from the invalidation of credits, the
transferor would be expected to treat the policy as a separate unit of
account. That is, the proceeds from the sale of the credits to the buyer
might need to be allocated to both (1) the credits and (2) the obligation to
provide insurance. Further, the transferor must determine whether it is the
principal or an agent for the sale of the insurance policy (if the policy is
being purchased on behalf of the buyer).
If the insurance policy is purchased by the seller but names
the purchaser as the insured party, the seller would need to consider
whether its role was to arrange for the insurance to be provided directly to
the buyer (as an agent). If so, the seller would account for the policy on a
net basis; that is, the seller would allocate the proceeds paid by the buyer
to both the insurance and the credit and would reflect the cost of the
insurance as a reduction to the proceeds received from the sale.
If the insurance policy represents insurance of the seller’s
own risk and no payout would be subsequently passed along to the buyer, or
if the buyer is the named beneficiary (but the seller is still primarily
responsible to the buyer for any losses resulting from the invalidation of
credits), we believe that the seller typically would conclude that it should
separately record the cost of the insurance policy as an expense. That is,
none of the proceeds received or receivable in connection with the sale of
the credits would be allocated to the insurance policy.
Other Indemnification
When a transferor indemnifies a buyer against credit
invalidation risk (irrespective of whether the transferor has insured its
risk), the entity should determine whether to account for the conditional
obligation to pay amounts to the buyer as a guarantee within the scope of
ASC 460. If the conditional obligation to repay amounts to the buyer is not
a guarantee within the scope of ASC 460, such obligation would give rise to
variable consideration and, as a result, the seller could record a refund
liability (reflecting its conditional obligation to refund consideration to
the buyer). This would affect the gain or loss recorded on the sale of the
credits.
Transfer of Control
Selling a transferable credit will typically result in the
derecognition of the credit from the entity’s balance sheet, and the
presentation of any gain or loss on the income statement will depend on the
entity’s accounting policy elections discussed above. The sale of a
transferable credit is not explicitly discussed in ASC 740 or other GAAP,
but ASC 610-20 applies to the gains or losses recognized upon the sale and
derecognition of nonfinancial assets. ASC 610-20-15-2 states, in part, that
the scope of ASC 610-20 specifically includes intangible assets:
Except as described in paragraph 610-20-15-4, the
guidance in this Subtopic applies to gains or losses recognized upon the
derecognition of nonfinancial assets and in substance nonfinancial
assets. Nonfinancial assets within the scope of this Subtopic include
intangible assets, land, buildings, or materials and supplies and may
have a zero carrying value.
When an entity applies IAS 20 by analogy, we believe that it
is appropriate for the entity to consider a transferable credit to be a
nonmonetary asset (which is similar to a nonfinancial asset) and, therefore,
to apply ASC 610-20 when derecognizing such credit. ASC 610-20-25-5 through
25-7 provide guidance on when an entity should derecognize a nonfinancial
asset. Such guidance states that an entity must first determine that the
contract with the other party meets the criteria in ASC 606-10-25-1 and
identify all distinct nonfinancial assets within the sale. We believe that
an entity should carefully consider whether any conditions precedent to the
close of the sale, which would otherwise make the transfer and sale
agreement cancellable, have been satisfied. That is, for the criteria in ASC
606-10-25-1 to be met, the agreement must be noncancellable. An entity then
derecognizes the nonfinancial asset when control transfers to the purchasers
in accordance with ASC 606-10-25-30, which addresses an entity’s
satisfaction of a performance obligation at a point in time.
Note that to transfer control of a credit, an entity must
first have control of such credit. That is, the relevant credit must have
already been generated and the selling entity must have the present ability
to direct the use of and obtain the benefit from it. The entity must also
consider whether it has met the applicable criteria for recognizing (i.e.,
earning) the credit under either ASC 740 or the government grant model
(depending on its policy election). Therefore, if an entity has not
recognized the transferable credit (i.e., since the entity does not control
it), no credit could be sold and therefore no gain or loss would be
recorded. If an entity receives cash proceeds for the sale of credits that
have not yet been recognized, we believe that a liability (e.g., a deposit
liability) should be recorded for any cash consideration received until the
recognition (and derecognition) criteria have been met.
When derecognizing transferable credits, an entity may need to use
significant judgment to determine when control has been transferred to the
purchaser. In accordance with ASC 606-10-25-25, “[c]ontrol of an asset
refers to the ability to direct the use of, and obtain substantially all of
the remaining benefits from, the asset.” ASC 606-10-25-30 provides the
following five indicators of when control of an asset transfers:
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“The entity has a present right to payment for the asset.”
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“The customer has legal title to the asset.”
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“The entity has transferred physical possession of the asset.”
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“The customer has the significant risks and rewards of ownership of the asset.”
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“The customer has accepted the asset.”
To transfer a tax credit, the seller first generates the
credit and completes a prefiling to obtain a registration number from the
IRS. The seller identifies a transferee (i.e., a buyer) and gives such
entity all the documentation it needs, including the credit’s registration
number, to claim the credit on its tax return. Both the seller and buyer of
the credit must then complete a transfer election statement, which describes
the terms of the credit and requires each entity to provide certain
representations. Finally, the entities will file their tax returns and
attach their transfer election statements.
The process used to transfer a tax credit may be different from the approach
undertaken to transfer other nonfinancial assets and in-substance
nonfinancial assets. In practice, certain of the indicators in ASC
606-10-25-30 are more complex to analyze than others, and they may be more
relevant for a sale of a transferable credit. Each indicator is discussed
below.
Present Right to Payment — ASC 606-10-25-30(a)
While it is important to analyze a present right to payment for the
transferable credit, the possession of such right is often not
sufficient evidence that control of the transferable credit has passed
on to the purchaser. This is because the entity may be entitled to
payment before the purchaser is able to direct the use of and obtain the
benefit from the credit. The point in time at which an entity has a
present right to payment may differ between transfers and depends on
when during the sale process the entities agree that payment should
occur. However, if an entity does not have a present right to payment,
this may be an indicator that the control of the credit has not
transferred.
Legal Title — ASC 606-10-25-30(b)
Legal title to an asset is typically evidence of an
ownership claim for that asset. For transferable credits, claim of
ownership may be demonstrated by the presentation of a fully executed
transfer election statement. Because of the nature of such credits, the
ownership claim may not transfer upon the contract’s signing; instead,
it would transfer upon the completion of the transfer election statement
by both parties to the transaction.
Entities will need to carefully evaluate whether the
transfer of a claim of ownership is sufficient evidence that control has
transferred. This is because control refers to the ability to direct the
use of and obtain the benefit from an asset. For a transferable credit,
the benefit to the buyer is ultimately its ability to satisfy a tax
obligation to the federal government. Accordingly, although transfer
election forms may have been provided to a buyer, both transferors and
purchasers still must consider whether they must perform other
activities to complete the transfer and allow the purchaser to realize
the benefit (e.g., file tax returns with the election statement
attached). If the remaining activities are deemed administrative and
perfunctory, a transferor may conclude that control of a tax credit has
transferred before the final activities necessary for the buyer to
realize the benefit have been performed.
Physical Possession —ASC 606-10-25-30(c)
Physical possession of the transferable credit is not a
relevant indicator since transferable credits are intangible assets.
Risks and Rewards — ASC 606-10-25-30(d)
Since there are numerous points at which a transferor
may relinquish control during the sale process, it is important to
consider whether any risks or rewards remain with the transferor.
Rewards of ownership of a tax credit are typically transferred to the
customer upon execution of the transfer election statement and when any
remaining seller activities are deemed perfunctory. These are the points
in time at which the purchaser can claim the credit and obtain the
benefit (i.e., a reduction of taxes owed). Determining when the
purchaser has obtained the risks of ownership of the asset can be more
complex. As discussed further in the Purchaser’s Accounting section,
sellers may indemnify the buyer if a recapture event or other
disallowance occurs. A recapture event generally arises when a
disposition of an asset that resulted in a tax credit occurs within a
period prescribed by the IRS or other taxing jurisdiction. A recapture
event causes repayment of some or all of the tax credit to the
government in the tax year of the disposition. If an indemnity clause is
included in the agreement between the transferor and purchaser, the
transferor would be required to pay the purchaser the amount of the
credit that was repaid to the government.
Indemnity clauses could result in the transferor’s
retention of some level of risk related to the credits sold. Such risk
could include having to meet ongoing requirements for the credit to
remain valid. An entity would need to consider any such retained risk
when determining whether and, if so, when control of the credits has
transferred to the buyer. However, if the remaining risks associated
with the validity or realizability of the credits are insignificant
(e.g., there is a remote likelihood that a credit would be invalidated),
a transferor’s indemnification might not affect whether control of the
credits has transferred.
Customer Acceptance — ASC 606-10-25-30(e)
A purchaser may receive the registration number of the
credit and any other documentation it needs to claim the credit, but
this does not necessarily mean that the entity has accepted the credit.
An entity must carefully consider the terms of the contract between the
purchaser and seller to determine whether other conditions must be
satisfied (e.g., buyer due diligence) before transferred credits are
deemed accepted by the purchaser. The entity should also carefully
consider any of the purchaser’s rights related to obtaining a refund of
consideration transferred.
As noted above, an entity may need to use significant judgment to
determine when control of the transferable credit is relinquished by the
seller and obtained by the purchaser. Given the complexity involved, we
encourage entities to consult with their accounting advisers.
Government Grants Project
On November 19, 2024, the FASB issued a proposed ASU that would
add guidance to ASC 832 on the recognition, measurement, and presentation of
government grants. In the absence of such guidance, many companies have
analogized to other guidance, including IAS 20 or ASC 958-605, when accounting
for such grants. In developing the proposed ASU’s recognition and measurement
framework, the FASB largely leveraged the guidance in IAS 20.
Unlike IAS 20, the FASB’s proposed guidance in ASC 832 excludes
grants of intangibles. Accordingly, it is uncertain whether entities would be
able to account for transferable credits by analogizing to the proposed guidance
or whether the FASB intended a different outcome (i.e., all nonrefundable
transferable credits would be accounted for under ASC 740 rather than by using a
government grant model). A possible outcome of the proposed ASU would be a
requirement to treat transferable tax credits as monetary grants, in which case
entities would no longer be allowed to record the grants at a nominal amount
since the grants would have to be recorded at fair value. Alternatively,
entities could still be allowed to analogize to IAS 20 for these credits.
Entities that generate transferable credits will need to assess the final ASU,
when issued, and consult with their accounting advisers regarding the treatment
of transferable credits.
Purchaser’s Accounting
Accounting for the Purchase of Transferable Credits
As discussed above, a transferable credit generally may be
transferred only one time. In such instances, the entity that purchases the
transferable credit can only use it to reduce its own income tax liability
and would therefore account for the credit under ASC 740.
When a tax credit is transferred, the purchase price may
often be at a discount from the credit amount. An entity that purchases a
transferable credit should generally record a DTA for the amount of tax
credits purchased and a deferred credit for the amount of the discount
(i.e., the difference between the amount paid and the DTA recognized in
accordance with ASC 740). Such deferred credit does not represent a deferred
tax liability, and the DTA would be assessed for realizability under ASC 740
in a manner similar to any other DTA. The deferred credit will be reversed
and recognized as an income tax benefit in proportion to the deferred tax
expense recognized upon utilization of the associated DTA (i.e., as the
credits are used on the tax return). The example below illustrates this
guidance.
Example 3
Assume that Company A is a calendar-year-end entity.
During the year ended December 31, 20X1, A purchased
$2,000 of tax credits from Company B for $1,800 in
cash. Under the tax law, the credits can only be
transferred once. Company A expects to use $1,000 of
the tax credits in its tax return for 20X1 and the
remaining $1,000 of credits in its tax return for
20X2.
Before considering the utilization of the credits,
assume that A had recorded an income tax liability
of $1,000 and $5,000 for the years ended December
31, 20X1 and 20X2, respectively. Thus, the
utilization of the $1,000 of tax credits in each
year is expected to reduce A’s current tax liability
to zero in 20X1 and to $4,000 in 20X2. Below are the
journal entries that A would record in 20X1 and
20X2.
Year Ended December 31, 20X1
To recognize the initial purchase of the credits:
To recognize the expected
utilization of the credits in A’s 20X1 tax return
and the corresponding reversal of the deferred
credit:
Year Ended December 31, 20X2
To recognize the expected utilization of the credits
in A’s 20X2 tax return and the corresponding
reversal of the deferred credit:
The purchaser of transferable credits can only recognize the
credits when the more-likely-than-not recognition criteria in ASC 740 are
met. Because ASC 740 does not provide explicit guidance on the timing of
recognition for purchased transferable credits, the purchaser may consider
the factors discussed above regarding the transfer of control under ASC
610-20 when assessing whether control of the asset has been transferred from
the transferor to the purchaser. This would include consideration of the
specific terms of the contract associated with the purchased credits as well
as timing of the execution of the related transfer election statements. See
the Transfer of
Control section above for additional considerations. If
amounts are paid for credits before the recognition criteria are met, we
would expect such amounts to be reflected as a prepaid asset or a deposit.
Given the complex judgment that entities must apply in assessing the timing
of the transfer of control, consultation with appropriate accounting
advisers is encouraged.
Transaction Costs
An entity that purchases transferable credits may incur transaction costs,
including other direct costs, in connection with such purchase. While Case F
in ASC 740-10-55-199 through 55-201 addresses the purchase of future tax
benefits (e.g., transferable credits), such guidance does not explicitly
discuss the accounting for transaction costs incurred in connection with the
purchase. Rather, ASC 740-10-55-201 simply states that a deferred credit
should be recorded for the difference between the gross amount of the credit
and the “purchase price.” Given the lack of explicit guidance, we believe
that there are two acceptable views on determining the “purchase price” (and
hence the accounting for transaction costs):
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View 1 — Transaction costs are treated as additional consideration paid for the credits, in a manner similar to how transaction costs are accounted for as part of the cost of an asset acquisition. This reduces the amount of the deferred credit that is recorded upon purchase, thus decreasing the amount of income tax benefit that would otherwise have been recorded upon reversal of the deferred credit. Under no circumstances, however, should the purchased credit be recorded at an amount greater than the gross amount of the credit.
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View 2 — Transaction costs are treated separately from the purchase of the credits and are expensed as incurred within pretax income, in a manner similar to existing practice for other ancillary costs paid to entities other than taxing authorities (e.g., preparation and consulting costs) that are outside the scope of ASC 740.
Credit Insurance and Seller Indemnification
The purchaser of a transferable credit often obtains the risks of ownership
from the transferor (e.g., the purchaser would assume the risk of
underpaying taxes if the credits are invalidated by the IRS). To mitigate
this risk, the seller may purchase credit insurance on behalf of the buyer
and name the buyer as the insured party. Alternatively, the seller may
include indemnification clauses that protect the buyer from credit
recapture.
When sellers provide buyers with insurance from a third
party, buyers should treat the receipt of the credit and the receipt of the
insurance policy separately. For the insurance portion of the transaction,
an entity should look to ASC 720-20, which provides guidance on the scope of
insurance contracts. ASC 720-20-25-2 refers the insured entity to ASC
944-20-15, which provides guidance on whether the risk associated with a
loss has transferred to the insurer from the buyer. If an entity determines
that the risk has transferred and the purchased policy qualifies as
insurance under U.S. GAAP, the entity will record expenses in accordance
with ASC 720-20. Most insurance related to tax credits addresses risk
associated with the validity of the credit that has already been generated.
Because the risk is related to events or conditions that have already
occurred, the associated insurance would be considered retroactive since
there is no future event that governs whether a credit is valid. As a
result, the cost of the policy would be expensed upon initial recognition.
Additional considerations may be necessary if the insurance policy addresses
future invalidation events (e.g., credit recapture due to an invalidation
event triggered by the seller after the sale of the credits).
Subsequently, if a recapture event or other disallowance results in a loss
for the purchaser, the purchaser should increase its income taxes payable
and record an associated expense within the income tax provision. Any
insurance recovery and resulting receivable would be separately accounted
for and recorded in accordance with ASC 410-30 or the entity’s accounting
policies on insurance recoveries.
If the seller indemnifies the purchaser in the sale of a
transferable tax credit and a recapture event or another disallowance
subsequently occurs, we believe that the buyer should record a liability and
corresponding income tax expense. This is similar to a seller’s treatment in
situations in which the seller provided an insurance policy to the
buyer.
Rather than recording a recovery from the seller as a benefit in the income
tax provision, an entity should account for the recovery separately as a
gain within income from operations. This includes repayments by the insurer
or the seller that provided the purchaser with the indemnification.
Other Resources
For additional information, see the following Deloitte publications:
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Financial Reporting Alert on the accounting for tax credits under the CHIPS Act and the Inflation Reduction Act.
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Heads Up on the FASB’s proposed ASU on the recognition, measurement, and presentation of government grants.
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Income Taxes Roadmap, which includes a comprehensive discussion of income tax credits.
Appendix A — Decision Tree: Accounting Under ASC 740
The decision tree below
summarizes the accounting impacts of an entity’s elections related to the
initial recognition of transferable tax credits accounted for within the scope
of ASC 740.
Appendix B — Decision Tree: Accounting Under the Government Grant Model
The decision tree below
summarizes the accounting impacts of an entity’s elections related to the
initial recognition of transferable tax credits accounted for under the
government grant model (i.e., outside the scope of ASC 740).
Contacts
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|
Chris Chiriatti
Audit &
Assurance
Managing
Director
Deloitte &
Touche LLP
+1 203 761
3039
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Matt Himmelman
Audit &
Assurance
Partner
Deloitte &
Touche LLP
+1 714 436
7277
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|
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Tim Burns
Audit &
Assurance
Senior Manager
Deloitte &
Touche LLP
+1 862 505
9673
|
|
Michael Parducci
Audit &
Assurance
Senior Manager
Deloitte &
Touche LLP
+1 425 466
7474
|
Footnotes
1
For titles of FASB Accounting Standard Codification (ASC)
references, see Deloitte’s “Titles of Topics and Subtopics in
the FASB Accounting Standards
Codification.”
2
The FASB has issued a proposed Accounting Standards
Update (ASU) that would codify the accounting for
government grants under U.S. GAAP. See the Government Grants Project
discussion for more information.
3
International Accounting Standard (IAS) 20,
Accounting for Government Grants and Disclosure of Government
Assistance.
4
While transferable credits can take the form of an
investment tax credit (ITC) or a non-ITC, there is an additional
layer of complexity associated with transferable tax credits that
are considered ITCs. This is because ASC 740 permits entities to
make a policy choice between the “flow-through” and “deferral”
methods with respect to the initial recognition of an ITC. If an ITC
is expected to be sold instead of used by the generator and an
entity plans to use the deferral method, we suggest that the entity
consult with its accounting advisers regarding the treatment of the
transferable ITC.
5
While grants to for-profit entities are excluded from the scope of
ASC 958-605, ASU
2021-10 added ASC 832-10-15-4, which states that
the guidance in ASC 832 applies to entities that analogize to grant
or contribution models such as those addressed in IAS 20 or ASC
958-605. Further, paragraph BC17 in ASU 2021-10 acknowledges that
business entities may apply IAS 20 or ASC 958-605 by analogy to
grants of government entities. The same paragraph acknowledges that
transactions with government entities may also be accounted for in
accordance with other GAAP.
6
Paragraph 23 of IAS 20 allows entities to record
nonmonetary government grants and the assets at a nominal amount as
an alternative to recording them at their fair value. In such a
case, since both the asset and the grant would be recorded at or
near $0, nothing (or nearly nothing) would be recorded on the
balance sheet for either the asset or the grant.