Significant differences continue to exist between the International Accounting Standards Board's (IASB) and the Financial Accounting Standards Board's (FASB) income tax accounting models, notwithstanding ongoing convergence efforts. While an Exposure Draft (ED) was issued by the IASB in 2009, which would have eliminated a significant portion of these differences, the ED ultimately was abandoned and the scope of the income tax accounting project narrowed. In 2010, the IASB updated its project status by publishing an amendment to IAS 12 and suspending its other work on income taxes. A more fundamental review of income tax accounting may be considered by the IASB after 2011.
This publication includes a comparative summary between standards within its appendix and provides a closer look at seven significant differences --- tax basis, initial recognition, intercompany transactions, accounting for uncertain tax positions, allocating income taxes, share-based compensation, and investment in subsidiaries.
The tax basis of an asset or liability is one of the key elements in determining deferred tax assets (DTAs) and deferred tax liabilities (DTLs). A company determines DTAs and DTLs by comparing the book carrying amount of an asset or liability to the tax basis of that asset or liability, and then applying the applicable tax rate to the resulting difference.
Determining the tax basis of an asset or liability may appear straightforward, but it can be one of the more difficult aspects of calculating deferred taxes.
The term "tax basis" of an asset or liability is itself an area of difference between IFRS and US GAAP. By way of background, ASC 740 does not specifically define the term "tax basis;" however, it is presumed to be the amount used for tax purposes. On the other hand, under IAS 12, the term "tax base" is used and defined as discussed below.
For purposes of this article, the term "tax basis" will be used interchangeably with "tax base."
Under IAS 12, the tax base of an asset is defined as the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. Additionally, the standard defines the tax base of a liability as its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue that is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods.
The tax base should reflect the tax consequences of the method that, as of the balance sheet date, the company believes it will ultimately use to recover or settle the carrying amount of a particular asset or liability. In other words, understanding what will happen for tax purposes once the asset is eventually recovered (or the liability is settled) is critical to determining the tax base.
For example, if management expects to recover the carrying value of a piece of equipment by using the equipment, the tax base is what management anticipates the tax deduction will be for the depreciation of that asset. If management expects to recover the carrying value by selling the equipment, the tax base is what management anticipates the tax deduction will be when it sells the asset.
If management expects to recover the carrying value of an asset in a dual manner (e.g., use the asset and then sell it), the tax base, tax rate, and related deferred taxes for the asset should reflect the dual manner of recovery. In such cases, the tax consequences of, and the temporary differences that result from, recovering a portion of the asset through use should be determined separately from the tax consequences of, and the temporary differences that result from, recovering a portion of the asset through sale. The company would have to apply the appropriate tax base and rate to each portion of the asset.
In December 2010, the IASB amended IAS 12 to introduce an exception to the existing principle for the measurement of deferred tax assets or liabilities arising on investment property measured at fair value. The amendment introduces a rebuttable presumption that investment property measured at fair value will be recovered entirely by sale. Accordingly, any associated deferred tax assets or liabilities would be measured based on the assumption that the investment property will be recovered through sale. US GAAP currently does not permit investment property to be measured at fair value, nor is there a similar rebuttable presumption on the measurement of deferred taxes arising on investment property measured at fair value.
One last note on tax base, if management expects to recover or settle assets or liabilities without tax consequences, the tax basis equals the carrying amount.
The tax basis of an asset or liability is the amount used for tax purposes. For example, in the case of a depreciable asset, tax basis is not solely limited to the amounts that are deductible through depreciation but also includes any amounts under tax law that would be deductible upon sale or liquidation of the asset.
Assume that a company acquires property (land and building). The fair value of the building is C100. The property is held for the purpose of generating rental income. The company intends to sell the property after eight years, although the building has a useful life of 10 years. The tax law does not allow deductions for depreciation of the building, but it does allow capital deductions of C100 when the building is sold. The residual value of the building is expected to be C20 when it is sold. The company is subject to a 40% ordinary tax rate and a 20% capital tax rate. The deferred tax accounting under IFRS and US GAAP is compared as follows.
Under IAS 12, management needs to determine the portion of the asset's carrying value that will be recovered through use and the portion that will be recovered through sale. Management then needs to determine the tax consequences of, and the temporary differences arising from, the portion recovered through use and the portion recovered through sale.
The expected residual value of C20 implies that management expects to recover C80 of the carrying value through use. Under IAS 12, the tax base of the portion of the asset to be recovered through use is zero because no tax deductions are available for depreciating the property. The carrying value of the asset recovered through use will result in tax payments that are higher than those that would arise if there were tax deductions in use. The zero tax base results in a taxable temporary difference of C80 and a DTL of C32 (C80 * 40%).
Management expects to recover C20 through the sale of the asset, and a capital deduction of C100 will be available for tax purposes. This expected recovery results in a deductible temporary difference of C80. The resulting DTA of C16 (C80 * 20%), which represents a potential capital loss upon disposal, should be assessed for recoverability under IAS 12. Recognition of the DTA may be precluded because of the capital nature of the deduction.
Under US GAAP, although the depreciation is not deductible for tax purposes, the cost of the asset will be deductible when it is sold. At the time of the acquisition, both the book basis and the tax basis (as determined under the tax law) are C100, and no temporary difference exists. As the building is depreciated for financial reporting purposes, the book basis decreases and a deductible temporary difference is created. The deduction under the tax law is available only upon sale of the asset, so the relevant tax rate is the rate applicable to the sale. Realizability of this DTA will need to be considered and a valuation allowance may be necessary because of the capital nature of the DTA.
Temporary differences can arise when a company initially recognizes an asset or liability. Such differences often arise in a business combination when the assets and liabilities are recorded at their fair values but the tax bases do not change.
Temporary differences can also arise when an asset is acquired outside a business combination, if the amount attributed to the asset for tax purposes is different from the financial statement carrying amount. One example of when this might happen is when a government provides an incentive for the investment, such as additional depreciation for tax purposes.
Under IAS 12, no deferred tax is recognized in a transaction that (1) is not a business combination and (2) affects neither accounting profit nor taxable profit at the time of the transaction. Thus the impact of any differences between book and tax base is recognized as it is realized for tax purposes.
Under ASC 740, a company determines the assigned value of an asset acquired outside a business combination and the related DTA or DTL by running simultaneous equations.
Assume that a company acquires the shares of an entity that has a single asset. The purchase is not a business combination. The transaction does not affect comprehensive income, equity, or taxable profit.
The consideration paid was C100. The tax basis of the asset is the same as the previous owner's tax basis, which is zero. The tax rate is 40%.
The following observations can be made about the two accounting approaches:
The company would record the asset at the amount of consideration paid (C100). Deferred taxes would not be recorded. |
|
Asset |
100 |
Cash |
(100) |
Because the asset would be depreciated with no corresponding tax benefit, the company's effective tax rate would be impacted. |
The company would record the asset at an amount determined by using a simultaneous equation. The company would initially record a DTL of C40 |
|
Asset |
167 |
Cash |
(100) |
DTL |
(67) |
As the asset is depreciated, the company would reverse the DTL, thereby reflecting a "normalized" tax rate in connection with the book depreciation charge. |
Companies that are included in a set of consolidated financial statements often have transactions with other companies that are included in those consolidated financial statements. For example, a subsidiary may sell inventory to a sister company, or a parent may transfer intellectual property to its subsidiary. This section refers to such transactions as intercompany transactions.
There is often an income tax consequence if an intercompany transaction is between companies that are not included in the same consolidated, combined, or unitary tax return.
In general, the profit the seller realizes on the sale is taxed currently by the seller's local taxing authorities. For the buyer, the tax basis of the asset is typically the amount the buyer paid. In the consolidated financial statements, the profit on the intercompany sale is eliminated and the asset is carried at the value it originally had before the intercompany sale. In this situation, a deductible temporary difference is created because the tax basis of the asset in the buyer's jurisdiction is higher than the carrying amount in the consolidated financial statements.
For the most part, IFRS and US GAAP have the same basic approach to accounting for income tax: Record current tax charges (benefits) in the period incurred, and record deferred tax charges (benefits) in the period that the temporary difference arises. The two sets of guidance diverge, however, when it comes to intercompany transactions.
For intercompany transfers of assets, any associated current and deferred taxes are recognized at the time of the transaction.
Under ASC 740, a buyer is prohibited from recognizing DTAs related to an intercompany transfer of assets. Any income tax effects to the seller (including taxes paid and tax effects of any reversal of temporary differences) that result from an intercompany sale are recorded on the balance sheet as a deferred charge and recognized upon sale to a third party or as the transferred property is amortized or depreciated.
The following example illustrates the impact of the difference between IFRS and US GAAP in accounting for the income tax consequences of intercompany transactions. For the sake of simplicity, the effect of currency translation is ignored in the example.
CoA and CoB are fully owned subsidiaries of the same parent. CoA sells inventory to CoB for C150, with a profit of C50. Before selling the inventory to CoB, CoA had no temporary difference related to the inventory. The seller's tax rate is 40%. The buyer's tax rate is 30 percent. The profit of C50 on the intercompany sale of inventory is eliminated in the consolidated financial statements. The taxing authority in CoA's jurisdiction will tax the profit in the period of sale to CoB. CoB's tax basis in the inventory is C150, the amount paid by CoB.
The group has a current tax payable of C20 (C50 profit x 40% rate) in CoA's jurisdiction as a result of the transaction. The group also now has tax basis in the inventory of C150 in CoB's jurisdiction, which exceeds the consolidated book basis of C100 by C50. This results in a potential DTA of C15 (C50 basis difference x 30% rate).
In a subsequent reporting period the inventory is sold to a third party for C170. The group has a current tax payable of C6 (C20 profit x 30% rate) in CoB's jurisdiction from selling the inventory.
The following income tax accounting entries are reflected in the consolidated financial statements when the inventory is sold from CoA to CoB:
Current tax expense |
C20 |
Income tax payable |
(C20) |
To record the current tax due in the seller's jurisdiction. |
|
DTA |
C15 |
Deferred tax expense |
(C15) |
To record the DTA in the buyer's jurisdiction. |
Deferred charge (balance sheet) |
C20 |
Income tax payable |
(C20) |
To defer the current tax charge due in the seller's jurisdiction. The deferred charge is a balance sheet account. |
The following income tax accounting entries are reflected in the consolidated financial statements when the inventory is sold outside the consolidated group:
Deferred tax expense |
C15 |
DTA |
(C15) |
To reverse the DTA in the buyer's jurisdiction. |
|
Current tax expense |
C6 |
Income tax payable |
(C6) |
To record the current tax expense in the buyer's jurisdiction. |
Income tax expense |
C20 |
Deferred charge (balance sheet) |
(C20) |
To expense the deferred charge in the seller's jurisdiction. |
|
Current tax expense |
C6 |
Income tax payable |
(C6) |
To record the current tax expense in the buyer's jurisdiction. |
Ultimately, once the inventory has been sold outside the consolidated group, the consolidated financial statements under both IFRS and US GAAP will reflect the following items, in respect of the intercompany transaction:
If the statutory rates in the seller's and buyer's jurisdictions are the same, there is typically no net impact on reported results. If the tax rates are not the same, the difference between IFRS and US GAAP is in the timing of the recognition of the intercompany sale's income tax consequences.
Under IFRS, the income tax consequences of the intercompany transaction are reflected when the intercompany sale occurs. Although the profit from recovering the asset from a third party has not yet been recognized at the time of sale, the entity has nonetheless incurred/received an economic tax charge/benefit. Therefore, the effective tax rate is affected immediately, at the time of the intercompany sale.
Under US GAAP, the parent company (1) defers the income tax consequences of the intercompany sale until the item is sold outside the group and (2) matches the income tax consequences to the profit from the third-party sale. In the case of an amortizable asset, such as intellectual property, a parent company that reports under US GAAP matches the income tax consequences of the intercompany sale to the property's "recovery through use," as the property is amortized. Therefore, the impact on the effective tax rate (i.e., the tax rate "arbitrage") occurs either at the time of the third-party sale or over time as the property is amortized.
Companies that transition to IFRS will adjust their first IFRS balance sheet so that amounts they had recognized under US GAAP reflect the recognition and measurement guidance under IFRS. For a company reporting under US GAAP, there might be income tax consequences from intercompany transactions that have been deferred. The company would write off that amount when it adjusts the opening IFRS balance sheet on the transition date. The company would also record deferred taxes not previously recorded under US GAAP, to reflect temporary differences created by intercompany transactions. The offset for both entries would be recorded against retained earnings.
Management should also consider the impact that accounting and disclosure requirements for intercompany transactions will have on systems and processes. In particular, companies will benefit from having a process in place to track the temporary differences that arise in the buyer's jurisdiction as a result of intercompany transactions and to determine when such temporary differences have reversed.
Because income tax laws are complex and are subject to differing interpretations, there may be uncertainty about whether a company will ultimately sustain a position it has taken on a tax return.
IAS 12 does not explicitly address the accounting for uncertain tax positions. In practice, companies reporting under IAS 12 generally record liabilities for uncertain tax positions that are not probable to be sustained by using either a probability-weighted-average approach or a single-best-estimate approach.
Under a single-best-estimate approach, highly certain positions may result in a full benefit being recognized. Under a probability-weighted-average approach, some level of reserve may be recorded. |
||
Assume that Entity A takes a deduction for an uncertain tax position that results in a potential tax benefit of C100 and that management is 80% certain the entity will sustain the position. |
||
Potential benefit |
Individual probability |
Probability- weighted calculation |
C100 |
80% |
C80 |
0 |
20% |
0 |
|
C80 |
|
Under a single-best-estimate approach, Entity A would recognize the full benefit (C100) of the tax deduction. Under a probability-weighted-average approach, Entity A would recognize a C80 tax benefit and a C20 liability. |
Under a single-best-estimate approach, positions with a significant amount of uncertainty may result in a full liability being recognized. Under a probability-weighted-average approach, some level of benefit may be recorded. |
||
Assume that management was 80% certain the tax position would not be sustained. |
||
Potential benefit |
Individual probability |
Probability- weighted calculation |
C100 |
20% |
C20 |
0 |
80% |
0 |
|
C20 |
|
Under a single-best-estimate approach, Entity A would recognize no tax benefit and a C100 liability. Under a probability-weighted-average approach, Entity A would recognize a C20 tax benefit and a C80 liability. |
US GAAP provides explicit guidance on uncertain tax positions. In ASC 740, the FASB requires that a company evaluate its tax positions by using a two-step process:
ASC 740 requires companies to use a so-called "cumulative-probability" approach. In particular, a tax position that meets the recognition threshold is measured at the largest amount of benefit that has more than a 50% likelihood of being realized upon settlement. No benefit is recorded for tax positions that do not meet the recognition threshold.
ASC 740 requires that changes in measurement be based on new information. Assume, for example, that a taxpayer obtains favorable new information supporting a tax position that has not met the recognition threshold. Unless the new information would cause the tax position to meet the recognition threshold, the company would wait until the position is settled (or "effectively settled") before recognizing the benefit.
Assume that Entity A takes a deduction for an uncertain tax position that results in a potential tax benefit of C100 and that it believes the position has only a 20% chance of being sustained. |
||
Potential benefit |
Individual probability |
Probability- weighted calculation |
C100 |
20% |
C20 |
0 |
80% |
0 |
|
C20 |
|
Under ASC 740, the tax position would not meet the recognition threshold. Therefore, Entity A would recognize no tax benefit and a C100 liability. |
Assume Entity A takes a deduction for an uncertain tax position that results in a tax benefit of C1,000. The tax position meets the ASC 740 recognition threshold. Entity A estimates the probability of potential outcomes as follows:
Potential benefit |
Individual probability |
Probability- weighted calculation |
Cumulative probability |
C1,000 |
15% |
C150 |
15% |
800 |
20% |
160 |
35% |
600 |
20% |
120 |
55% |
400 |
30% |
120 |
85% |
200 |
15% |
30 |
100% |
|
|
C580 |
|
Under ASC 740, Entity A would recognize the largest amount of tax benefit that has a likelihood of greater than 50% in this case, a tax benefit of C600, with a corresponding liability of C400.
Although IAS 12 does not provide specific guidance in this area, we believe companies may recognize a tax benefit under IAS 12 by using the probability-weighted-average of the expected outcomes (C580), or the single-best-estimate of the most likely outcome (30% individual probability). Under a single-best-estimate approach, Entity A would recognize a tax benefit of C400 and a C600 liability.
Allocating income tax expense (or benefit) to the various components of comprehensive income and equity is arguably one of the most challenging aspects of accounting for income taxes.
Both IAS 12 and ASC 740 include allocation methodologies; however, those methodologies significantly differ. One of the more significant differences is the allocation of an income tax expense (or benefit) that is recorded in one year and relates to an event that occurred in a prior year.
The IAS 12 approach to allocating income tax expense (or benefit) is quite simple to articulate and the conceptual basis is easy to understand. The income tax expense or benefit follows the pre-tax item, regardless of the period in which each is recorded. This is often referred to as a "backwards tracing" approach.
While the IAS 12 approach is relatively easy to understand, it can be quite difficult to apply. For example, a company has several DTAs for which the company has recognized zero benefit (i.e., realization of the benefit is not "more likely than not"). If in a subsequent period the company determines it can realize a portion of the DTAs, management will need to determine which portion relates to items recognized outside the income statement.
The IAS 12 backwards tracing approach can also be challenging when a rate change is enacted. That is because it can be difficult to determine which portion of the effect of the rate change relates to items recognized outside the income statement.
The ASC 740 approach is more difficult to articulate and can be complicated to apply. Under that approach, management first computes the total tax expense (or benefit), and then computes the tax expense (or benefit) attributable to continuing operations. After that, management allocates among the other financial statement components the difference between the total tax expense (or benefit) and the amount allocated to continuing operations.
This approach is further complicated by exceptions to the general process.
Using the OCI example from the preceding Allocating income taxes under IAS 12 section, under ASC 740 the reversal of the valuation allowance would not be backwards traced to OCI. In determining where in the financial statements to record the tax benefit derived from releasing the valuation allowance, management must look to the reason behind the release. If management determines that the DTA was realizable because of projections about income in future years, the benefit will be recorded in continuing operations. However, if the company realized the DTA by using income in the current period, the company would record the benefit in the same location as the pre-tax income that allowed for realization. The ASC 740 approach also requires that companies record certain other tax effects (e.g., changes in tax laws or rates) in continuing operations, which helps reduce complexity to a degree by eliminating the need to determine where the original tax effect was recorded.
Companies may award their employees with share-based compensation. There are a number of forms by which this compensation may be awarded. Significant differences under IFRS and US GAAP exist for both the pre-tax accounting and the deferred tax accounting.
Pursuant to IAS 12 and IFRS 2, the measurement of DTAs is based on an estimate of the future tax deduction, if any, for the award measured at the end of each reporting period (i.e., measurement of DTAs is adjusted each period based on the fair value of the equity awards).
The tax benefit of an award is recorded to the income statement to the extent it does not exceed the tax effect of the cumulative book compensation expense. Any excess tax benefit (i.e., tax benefit that exceeds the cumulative recognized expense multiplied by the tax rate) is recorded in equity. To the extent the tax benefit is less than the cumulative book compensation expense, the deferred tax impact is recorded in the P&L unless there are prior credits to equity for the specific award. IFRS 2 does not include the concept of a pool of windfall tax benefits to offset shortfalls.
Under ASC 740 and ASC 718, deferred taxes are recorded as compensation expense is recognized for book purposes. Changes in the fair value of an award do not impact the measurement of DTAs or result in any adjustment prior to settlement or expiration.
Upon settlement of an award, "windfalls" (excess tax benefits) are recorded in equity and "shortfalls" are recorded as a reduction of equity to the extent the company has accumulated windfalls in its pool of windfall tax benefits. In the event the company does not have accumulated windfalls, shortfalls are recorded to income tax expense.
Assume on January 1, 2007 that Entity A grants a stock option to an employee with an exercise price of C500 (which equals the fair value of the underlying share) and a fair value of the stock option at the grant date of C360. The option contains a cliff vesting term of 3 years. The fair value of the underlying share is as follows: C500 as of December 31, 2007, C590 as of December 31, 2008, and C880 as of December 31, 2009. The employee exercises the option on March 15, 2010 at an intrinsic value of C320. There is C20 available pool of windfall tax benefits. The assumed tax rate is 40%.
Year-end |
2007 |
2008 |
2009 |
Book compensation expense |
C120 |
C120 |
C120 |
Tax benefit in P&L @ 40% |
C48 |
C48 |
C48 |
Cumulative tax effect on compensation charge |
C48 |
C96 |
C144 |
Intrinsic value multiplied by % service received |
C0 |
||
DTA @ 40% (IFRS) |
C0 |
C24 |
C152 |
Cumulative tax benefit P&L (IFRS) |
C0 |
C24 |
C144 |
Cumulative tax benefit equity |
C0 |
C0 |
C8 |
Upon exercise in 2010 under IFRS, the cumulative tax P&L benefit of C128 (C320 * 40%) is less than the cumulative book compensation charge of C380 and as such the entire actual tax benefit is recorded to the income statement. The prior C8 of excess tax benefit previously recorded to equity is reversed and the remaining shortfall of C16 (C144 - C128) charged to P&L.
Upon settlement under ASC 740, the C20 windfall pool of tax benefits is used to offset the C16 shortfall.
There are notable differences between IFRS and US GAAP for which companies should be aware when accounting for share-based compensation. As a result of these differences, companies reporting under IFRS will generally have greater volatility in their deferred tax accounts over the life of the awards due to the related adjustments for stock price movements in each reporting period. Whereas, companies reporting under US GAAP could potentially have greater volatility arising from the variation between the estimated deferred taxes recognized and the actual tax deductions realized.
Temporary differences may arise between (1) the carrying amount of investments in subsidiaries and associates or interests in joint ventures, and (2) the tax basis of those investments or interests.
These differences are typically referred to as outside basis differences. They can occur for various reasons, including unremitted earnings, impairment of the investment, and changes in foreign exchange rates. Accounting for these outside basis differences can be complex.
With regard to taxable temporary differences, both IFRS and US GAAP grant an exception to recording a DTL for an outside basis difference. The exception in IAS 12, however, is broader than the exception under US GAAP because it applies to all foreign and domestic subsidiaries, associates, and joint ventures. Under IAS 12, if the following two criterion are met, an entity would not record DTLs for outside basis differences:
With regard to deductible temporary differences, under IAS 12 a DTA should be recorded on an outside basis difference only if it is probable that the temporary difference will reverse in the foreseeable future.
Under ASC 740 a number of factors go into determining whether deferred taxes should be recorded for outside basis differences. Those factors include: the form of ownership of the interest (e.g., subsidiary or corporate joint venture as opposed to equity or cost-method investee); whether the entity is domestic or foreign; and management's intentions.
DTLs are recorded for domestic subsidiaries and joint ventures unless the reported amount of the investment can be recovered tax-free without significant cost. In the US, investments in domestic subsidiaries can often be recovered in a tax-free manner.
ASC 740-10-25-3 provides guidance on recording DTLs on outside basis differences of foreign subsidiaries and foreign joint ventures that are essentially permanent. Under the indefinite reinvestment assertion, there is a presumption that the undistributed earnings of a foreign subsidiary will be transferred to the parent company and be subject to income taxes in the parent company's jurisdiction. Unless the company can overcome that presumption, it should recognize a DTL. A company may overcome the presumption if it can demonstrate its intent and ability to delay indefinitely the reversal of the temporary difference (e.g., by indefinitely reinvesting the undistributed earnings).
Similar to IAS 12, under ASC 740 DTAs for outside basis differences for domestic or foreign subsidiaries and joint ventures are recorded only if it is apparent that the temporary difference will reverse in the foreseeable future; the starting presumption for a DTA is that it might not be recorded.
While differences between IAS 12 and ASC 740 exist, the tax accounting considerations in this area, on the whole, have a number of similarities in practice. Often times application of the exceptions under both standards results in a similar answer in the financial statements.
As discussed within this publication, there are a number of areas for which there is divergence between IAS 12 and ASC 740. Additionally, we have included for reference a comparative summary of select key differences between the standards within the appendix. Consideration of these differences will assist management in assessing the potential implications to financial reporting and planning. While the United States does not currently have a definite plan of conversion to IFRS, countries around the world continue to adopt IFRS. As this happens, accounting and tax planning will be impacted and changes will need to be understood and communicated.
A comparative summary of select key differences between IAS 12 and ASC 740 is outlined in the table below.
Area |
IAS 12 |
ASC 740 |
Tax basis |
Tax basis is based on the expected manner of recovery. Assets and liabilities may have a dual manner of recovery (e.g., through use and through sale). In that case, the carrying amount of the asset or liability is bifurcated, resulting in more than a single temporary difference related to that item. |
Tax basis is a question of fact under the tax law. In the case of an asset, it is determined by the amount that is depreciable for tax purposes as well as the amount that would be deductible upon sale or liquidation of the asset. |
Intercompany transfers of assets |
Any associated current and deferred taxes are recognized at the time of the transaction. |
The buyer is prohibited from recognizing a deferred tax asset for any difference between the tax basis of the assets and their cost as reported in the consolidated financial statements. Any income tax effects to the seller (including taxes paid and tax effects of any reversal of temporary differences) that result from an intercompany sale are deferred and recognized upon sale to a third party or as the transferred property is amortized or depreciated. |
Foreign nonmonetary assets |
Deferred taxes are recognized on the difference between the carrying amount, which is determined using the historical rate of exchange and the tax basis, which is determined using the exchange rate on the balance sheet date. |
Deferred taxes are not recognized for foreign currency movements or for the effects of indexation related to nonmonetary assets and liabilities that are remeasured at historical exchange rates for financial reporting purposes. |
Share-based compensation |
Measurement of the DTA is based on the expected tax deduction. Unless the deduction is fixed, the deduction is estimated based on the current share price as of the reporting date. The tax effect of any actual or estimated deduction exceeding the compensation charge is recorded in equity. If the actual or estimated tax deduction is less than or equal to cumulative share-based compensation expense, the tax effect is recorded only in the income statement. |
Measurement of the DTA is based on the compensation cost recognized for financial reporting purposes. The DTA is not adjusted for changes in stock price. The tax effect of any tax benefit exceeding the DTA is recorded in equity. This is typically determined when the deduction is taken. If the tax benefit is less than the DTA, the shortfall is recorded as a direct charge to shareholders' equity (to the extent of the available windfall pool) and as a charge to income tax expense thereafter. |
Investments in entities: DTL on outside basis difference |
A company will not record a DTL on an outside basis difference if certain criteria are met. The exception applies to domestic and foreign subsidiaries, branches, and associates, and to interests in joint ventures. In general, the exception is conditioned on (1) the company's ability to control the reversal of the temporary difference and (2) the probability that the temporary difference will not reverse in the foreseeable future. |
A company will not record a DTL on an outside basis difference if certain criteria are met. The exception applies only to foreign subsidiaries and foreign joint ventures (that are essentially permanent in duration). To qualify for the exception, companies must overcome the presumption that earnings will be remitted to the parent and result in a tax liability. Companies must have specific plans and evidence of their intent and ability to indefinitely reinvest the earnings and avoid reversal of the temporary difference. Additionally, if an investment in a domestic subsidiary or joint venture can be recovered tax-free without significant costs, no DTLs would be recorded. |
Initial recognition exception: A temporary difference may arise upon initial recognition of an asset or liability. If the transaction is (1) not a business combination and (2) affects neither accounting profit nor taxable profit at the time of the transaction, special consideration is necessary. |
No deferred tax is recognized in a transaction that (1) is not a business combination and (2) affects neither accounting profit nor taxable profit at the time of the transaction. |
In asset purchases that are not business combinations, a DTA or DTL is recorded, with the offset generally recorded against the assigned value of the asset. The "simultaneous equations" method is used to determine the amount of the DTA or DTL. |
Allocation of income tax expense (benefit) to financial statement components |
A full "backwards tracing" approach is used. Income tax expense is recognized in the income statement unless the tax arises from a transaction or event that is recognized outside the income statement (e.g., in equity), regardless of the period in which the tax expense or benefit is recognized. |
In general, a company allocates income tax to the financial statement category where the pre-tax item was recorded, except for certain changes in the recognition of income tax expense (benefit) that occur in a period after the pre-tax item is recognized (e.g., release or establishment of a valuation allowance or tax rate changes). "Backwards tracing" is generally prohibited. |
Enacted vs substantively enacted tax laws |
Changes in tax laws/rates are reflected when enacted or substantively enacted. |
Changes in tax laws/rates are reflected when enacted. |
Distributions to shareholders—distributed rate vs. undistributed rate |
A company would use the undistributed rate until it recognizes the dividend for financial reporting purposes. |
Treatment may depend on the facts. In jurisdictions where the distributed rate is lower, guidance requires use of the undistributed rate until the distribution occurs. |
Recognition of DTA |
Net approach: The company does not recognize assets unless it is probable (greater than 50%) that they will be realized. |
Gross approach: The company records the full DTA and reduces it by a valuation allowance if it is not more likely than not to be realized. |
Balance sheet classification |
DTAs and DTLs are classified as noncurrent in the balance sheet. Disclosures are required of DTAs and DTLs that are expected to reverse after more than 12 months. |
DTAs and DTLs are classified as current or noncurrent, based on the classification of the financial statement asset or liability generating the temporary difference. Deferred tax balances unrelated to financial statement assets and liabilities (e.g., net operating loss carryovers) are classified as current or noncurrent, based on their expected reversal dates. |
Uncertain tax positions |
There is no specific guidance. In practice, if the likelihood of a liability is greater than 50%, the company will record the liability measured as either a single best estimate or a weighted-average probability of the possible outcomes. |
For uncertain tax positions having technical merits that meet the "more likely than not" recognition threshold, the benefit is measured at the largest amount of tax benefit that has a greater than 50% likelihood of being realized. |
Uncertain tax position—disclosure |
Disclose assumptions about the future and the major sources of estimation uncertainty that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next year. |
Detailed disclosures specific to uncertain tax positions are required, including a roll-forward of unrecognized tax benefits. |
PwC is committed to helping companies navigate today's tax accounting issues. Our national and global network of specialized tax accounting resources can help you tackle a wide range of tax accounting needs. With that in mind, please visit www.pwc.com/us/tas to view our comprehensive library of tax accounting thought leadership, webcasts, and tools addressing the business and technical issues related to tax accounting.
For more information, please reach out to your local PwC partner and/or the primary author.
Jennifer Spang
Partner, National
Phone: 973.236.4757
Email: jennifer.a.spang@us.pwc.com
Kristin Dunner
Manager, Tax Accounting Services
Phone: 617.530.4482
Email: kristin.n.dunner@us.pwc.com
The contributions of Tami Van Tassell, David Beaver, and Bill Maloney to the original edition of this publication are also gratefully acknowledged.
PwC's US and Global Tax Accounting Services leadership team:
Ken Kuykendall
US Tax Accounting Services & Tax IFRS Leader
Phone: 312.298.2546
Email: o.k.kuykendall@us.pwc.com
Jennifer Spang
Partner, National
Phone: 973.236.4757
Email: jennifer.a.spang@us.pwc.com
Edward Abahoonie
Partner, National
Phone: 973.236.4448
Email: edward.abahoonie@us.pwc.com
Dean Schuckman
Global Tax Accounting Services Leader
Phone: 646. 471. 5687
Email: dean.schuckman@us.pwc.com
This publication was originally released in a series of nine articles during April 2009. In light of the continuing differences in income tax accounting between IAS 12 and ASC 740, we are releasing a refreshed publication to heighten awareness for financial reporting and planning considerations.
The Financial Accounting Standards Board (FASB) establishes US generally accepted accounting principles (US GAAP). The US GAAP standard on accounting for income taxes is Accounting Standards Codification 740, Income Taxes (ASC 740).
Per ASC 740-10-55-171 and 55-182, the simultaneous equation (where FBB is Final Book Basis and CPP is Cash Purchase Price) is:
FBB - [Tax Rate × (FBB - Tax Basis)] = CPP
(Tax Basis - FBB) × Tax Rate = DTA / DTL
The net DTA under IAS 12 is similar to the net DTA under ASC 740. However, IAS 12 does not use a "valuation allowance;" a DTA is recognized only if it is probable that the benefit will be realized. Under ASC 740, a company records the full DTA and then reduces it by a valuation allowance if it is more likely than not that the benefit, in whole or part, won't be realized.