December can be a busy month. The holidays and the decorating, the airports and the travelling, and — for some tax departments — preparing for the year-end income tax provision crunch soon to come.
In preparing for this upcoming crunch, there are many things to consider. This article addresses several key items that deserve careful consideration as part of your year-end process. Although the concepts inherent in each of the items are not new, our current economic environment, the increased scrutiny on income tax provisions by both financial auditors and the taxing authorities, and the continued time and resource constraints on tax departments all heighten the importance of addressing each one.
At the heart of each of these items is the need to properly communicate (both within your company and with your external financial auditors), update and document. Successfully addressing each of these core activities will help the beginning to the new year to be a smooth and less stressful one, at least for your income tax provision.
Key Year-end Income Tax Provision Considerations
By no means an exhaustive list, below are several “key” year-end income tax provision items that should be given careful consideration as part of your year-end process.
The first one is such a basic concept — one that applies to all sorts of relationships and yes, even to your income tax provision. Yet it is often neglected. I am referring to communication.
In order to have a comprehensive income tax provision process, one that incorporates all relevant corporate events, operations, business strategy and other tax-sensitive information, the lines of communication between the tax department and other stakeholders in a company must be open and operating on all cylinders.
Although many aspects of the income tax provision calculation are best understood and managed by the tax department (some of which are discussed below, such as tracking and analyzing the impact of tax law developments), the tax department cannot operate in a vacuum. In addition to having good communications with the accounting department, the tax department should be involved in discussions with key corporate departments or functions (e.g., treasury, legal, corporate development, finance and executive management) about corporate events, operations and strategy. For everything from key transactions, corporate reorganizations, ownership changes (which might trigger a IRC Section 382 limitation), business projections, international business activities, and cash management activities, needs and plans, to legal issues and the like, there can be significant tax implications that must be incorporated into the income tax provision on a timely basis.
So remember, communication is a critical element of a successful tax department and the preparation of an accurate income tax provision.
Incorporate Recent Tax Law Changes
In 2010, there have been a number of key federal, state and international tax developments that must be considered during the preparation of your company’s income tax provision. Some of the most recent and consequential developments for your year-end income tax provision are highlighted below.
U.S. Federal Tax Law Changes
With time running out for the current lame duck Congress to act on the tax extenders package, tax departments should keep a watchful eye on Washington. Although Democrats have widely criticized the recent agreement between President Obama and Republicans, significant corporate tax provisions are likely to be enacted before the end of the year.
While most of the discussion by the media has focused on this legislation from an individual tax perspective, many of the tax provisions impact businesses. The most noteworthy ones that may affect your 2010 income tax provision include:
- A 100 percent bonus depreciation deduction for property placed in service after September 8, 2010 and before January 1, 2012; and
- Retroactive extension of the research and development credit and new markets tax credit for 2010 and 2011.
Other significant tax law developments during 2010 that should be taken into account as part of your year-end income tax provision (if not already done so during prior interim periods in which they were enacted) include the increase in the Section 199 deduction and recent U.S. federal international tax provisions.
Changes to U.S. international tax provisions included in the Education Jobs and Medicaid Assistance Act (H.R. 1586) enacted in August could have a significant impact on multinational corporations’ cash taxes, as well as financial statements and related disclosures. Some key items in the legislation include significantly limiting the use of foreign tax credits by U.S. companies and repealing the 80/20 rules. For further discussion of these provisions, please review Tax Advisor Weekly issues and .
U.S. State Tax Law Changes
Many U.S. states, just like the U.S federal government, are facing budget shortfalls and are therefore looking at new and creative ways to increase their tax revenue.
For example, California’s recently enacted 2010-2011 budget has several corporate tax provisions that go into effect January 1, 2011 and that should be considered, including:
- Suspension of 2010 and 2011 net operating loss (NOL) deduction;
- Multistate corporations that do not elect to use the single sales factor apportionment must assign sales (other than those of tangible personal property) to where the greatest portion of income-producing activity is performed, based on the costs of performance; and
- Corporations will have California nexus if (a) the company is organized or commercially domiciled in California; (b) California sales are greater than the lesser of $500,000 or 25 percent of total sales; (c) California property is greater than the lesser of $50,000 or 25 percent of total property; or (d) California payroll is greater than the lesser of $50,000 or 25 percent of total payroll.
International Tax Law Changes
The year 2010 has also been a busy one from an international tax perspective. Major tax reform is being discussed overseas in countries such as Ireland and Italy that are dealing with major budget shortfalls due to the current economic climate. An example of recently enacted international tax legislation that you may need to consider includes the United Kingdom’s income tax rate change.
The U.K. enacted a rate reduction in July that reduced the corporate income tax rate from 28 percent to 27 percent. The new rate goes into effect on April 1, 2011. As a side note, look for other changes to the U.K.’s corporate tax structure to be enacted early in 2011. Some of these proposed changes include reducing the corporate income tax rate by 1 percentage point for the next three years so that by April 1, 2014 the rate would be 24 percent, as well as reducing the corporate tax rate to 20 percent for companies below a certain profit level and reducing the depreciation allowance for certain assets.
Each of the recently enacted federal, state and international tax law changes could have current or deferred tax consequences for your company that must be recognized in the period that includes the enactment date (usually the date the bill is signed into law). While those enacted during previous quarters should have been incorporated into your prior interim tax provision calculations, recent tax developments including those unfolding before year-end should be considered carefully.
Assess and Update Your ASC 740-10 (“FIN 48”) Reserves
With the recent issuance of the IRS’ final Schedule UTP requiring the disclosure of your company’s uncertain tax positions taken in tax years beginning on or after January 1, 2010, your FIN 48 reserves will take on increased importance. Given that the disclosures required by this new schedule are based largely on the reserves recorded in your 2010 audited financial statements, careful consideration should be given to your uncertain federal income tax positions and whether they require a FIN 48 reserve or whether an exception to recording a reserve is applicable (e.g., materiality, administrative practice, etc.).
Additionally, consideration should be given, to the extent possible, to making an accounting method change, seeking a tax opinion or participating in the Compliance Assurance Process (CAP) program, for example, to remove the uncertainty associated with a 2010 federal income tax position.
In addition, if a FIN 48 reserve exists, December might be a good time to revisit the disclosures that will be required of it as well as the processes in place to identify and document new uncertain tax positions. Also, keep in mind positions expiring because of the statute of limitations, changes in relevant tax authority, changes in interest and penalty rates, etc.
In any event, expect increased scrutiny by your financial auditors regarding your justification for not recording FIN 48 reserves. For further discussion of other considerations related to Schedule UTP, see Tax Advisor Weekly issues , , and .
Assess and Update Your Valuation Allowance Determinations
Another common year-end, as well as interim period, income tax provision consideration is the realizability of your company’s deferred tax assets. In fact, given the continued economic malaise, expect your financial auditor to focus on your valuation allowance determinations (both recording and/or release thereof).
As you are probably aware, gross deferred tax assets should generally be recorded with an offsetting valuation allowance to the extent it is “more likely than not,” based on both objective and subjective considerations, that it (or a portion thereof) will not be realized. For this purpose, realization depends on the existence of sufficient taxable income in the relevant jurisdiction and of the appropriate character within the relevant period.
This analysis should take into account all available evidence, both positive and negative, including historical information, currently available information, projections of future income and even information subsequent to the year-end close but before the release of the financial statements.
Relevant considerations in reaching a conclusion about the need for a valuation allowance include:
- Is your company forecasting future profit?
- Does your company have a history of losses?
- Are there reversing taxable temporary differences (i.e., reversing deferred tax liabilities) that can support the realization of the deferred tax assets? Bear in mind, however, that the timing of reversals should be assessed carefully. Also, beware of reversing taxable temporary differences related to indefinite-lived assets that cannot be used to support realization.
- Are there liabilities for uncertain tax positions that might support the realization of a deferred tax asset?
- Does your company have expiring tax benefits that will be unused?
- Are there prudent and feasible tax planning strategies available?
In addition to the above, is your company now in a position of having cumulative losses in recent years? If so, ASC 740 provides that justifying that a valuation allowance is not necessary is “difficult.” In such a case, you will need ample objective positive evidence to overcome this presumption.
Given that valuation allowance determinations require significant managerial judgment and consideration of potentially voluminous objective data, you should begin your analysis now and communicate with your company’s management to gather appropriate information and apprise them of the potential need for a valuation allowance.
You should also prepare documentation of your analysis and conclusions, as your financial auditors will undoubtedly scrutinize your valuation allowance analysis and test it independently. Having open dialogue and communication with your financial auditors early on in the provision process about your valuation allowance analysis might save some headaches later on.
Assess and Update Your ASC 740-30 (“APB 23”) Assertions
While most companies pay close attention to their domestic income taxing jurisdictions (federal, state and local), they may have less of a handle on their foreign jurisdictions. Perhaps that’s for a reason: maybe the foreign component of the income tax exposure is immaterial, maybe it is handled by someone else in another department or abroad, or maybe an Accounting Principles Board Opinion No. 23 (APB 23) assertion of indefinite reinvestment abroad is in place. Regardless, the foreign income tax arena is just as important as the domestic arena and should not be neglected. There could be significant tax “landmines” hidden in the shadows.
ASC 740 requires the recording of deferred taxes for differences in the book and tax basis of a company’s assets. Not only does this include fixed/operating assets, intangible assets, etc., it also includes assets such as investments in subsidiaries (i.e., inside and outside basis differences).
For example, a deferred tax liability should be recorded if a controlled foreign corporation (CFC) is expected to distribute earnings back to its U.S. parent (in fact, the presumption is that such earnings will be so distributed) — that is, of course, unless the U.S. parent asserts that such earnings will be indefinitely reinvested abroad pursuant to APB 23.
This APB 23 assertion is more than just a head nod from the tax department, however. It requires evidence of specific plans for reinvestment of undistributed earnings of a subsidiary that demonstrate remittance of the earnings will be postponed indefinitely. Similar to the valuation allowance discussion above, multiple parties should be involved in determining whether earnings of a foreign subsidiary are to be permanently reinvested, including the CFO, the treasury department and the operations department.
In evaluating whether the foreign earnings qualify for the indefinite reinvestment assertion, ASC 740-30-05-4 sets forth six critical factors:
- Financial requirements of the parent company;
- Financial requirements of the subsidiary;
- Operational and fiscal objectives of the parent company, long term and short term;
- Remittance restrictions imposed by governments;
- Remittance restrictions imposed by lease or financing agreements of the subsidiary; and
- Tax consequences of the remittance.
Of course, if based on these criteria 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 previously been recognized by the parent entity pursuant to an APB 23 assertion, the company should accrue current period income tax expense attributable to such remittance.
When making an APB 23 assertion determination, it is important to document your conclusion. Related disclosures must also be made, including reporting the amount of reinvested earnings and the associated tax that would be due if those earnings were repatriated (if “practicable”). Even though in many cases the related tax calculations may be justified as “impracticable” to calculate, some auditors might give you pushback. Therefore…document, document, document.
Alvarez and Marsal Taxand Says:
With just a few weeks left in the decade, there is still enough time to take proactive steps to be ahead of the game on your 2010 annual income tax provision and to develop or improve your related processes.
Again, good communication, continual assessment and updating of relevant tax law developments and key provision determinations, as well as documentation thereof, are critical to preparing an accurate income tax provision.
Addressing each of these prior to the year-end close crunch can help in making it a happy new year.
So if you are still looking for some good New Year’s resolutions when it comes to your income tax provision, you might consider the following: to communicate better, to update in a more timely way and to document thoroughly.
We would like to hear from you.
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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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