Focusing on tax accounting issues affecting businesses today
July - September 2014
The Global tax accounting services newsletter is a quarterly publication from PwC's Global Tax Accounting Services Group. It highlights issues that may be of interest to tax executives, finance directors, and financial controllers.
In this issue, we provide an update on income tax accounting topics added to the Financial Accounting Standards Board's (FASB) agenda, amendments proposed to International Accounting Standard 12 Income Taxes (IAS 12), the most recent International Financial Reporting Standards (IFRS) Interpretation Committe's guidance on some tax-related matters, and the country-by-country reporting template presented by the Organisation for Economic Co-operation and Development (OECD) at the recent G20 meeting in Australia.
We also draw your attention to some significant tax law and tax rate changes that occurred around the globe during the quarter ended 30 September 2014.
Finally, we discuss key tax accounting and reporting considerations in relation to transfer pricing.
This newsletter, tax accounting guides, and other tax accounting publications are also available on our new TAS to Go app, which can be downloaded globally via App Stores.
If you would like to discuss any items in this newsletter, tax accounting issues affecting businesses today, or general tax accounting matters, please contact your local PwC team or the relevant Tax Accounting Services network member listed at the end of this document.
Readers should not rely on the information contained within this newsletter without seeking professional advice. For a thorough summary of developments, please consult with your local PwC team.
Accounting and reporting updates
Recent and upcoming major tax law changes
Tax accounting refresher
Contacts and primary authors
During its Agenda Prioritisation meeting on 13 August 2014, the Financial Accounting Standards Board (FASB or Board) added the following two income tax accounting topics to its agenda as part of its broader simplification initiative:
The Board also asked the staff to perform additional research on potentially eliminating the intraperiod tax allocation rules by having income tax expense reported as a single line item.
The Board also held a pre-agenda discussion meeting on 10 September 2014 to provide preliminary feedback to the staff on the research project in relation to accounting for stock compensation. The Board asked the staff to perform additional research to consider various alternatives with respect to the accounting for tax benefit shortfalls and windfalls. The analysis will include a comparison with the IFRS treatment and will be presented in an upcoming meeting, in which the Board will decide whether to add these topics to its agenda.
On 13 August 2014, the FASB held a decision-making meeting with the purpose of prioritising the Board's upcoming technical agenda. The Board voted on various topics throughout the meeting. Consideration was given to several potential topics related to income taxes which could reduce complexity.
The push for the consideration of these topics came from several sources. The sources included feedback from the Financial Accounting Foundation’s (FAF) Post-Implementation Review completed November 2013, an agenda request submitted with respect to the intercompany transaction exception, and stakeholders' ideas communicated in response to the Board's Simplification Initiative.
The FASB staff performed additional research and outreach on all of the above. The staff presented the Board with specific topics relating to the following eight areas of accounting for income taxes under ASC 740:
Many of the issues presented to the Board were recently highlighted in PwC's Point of view: Accounting for income taxes – A case for simplification. The Board voted to add two income tax topics to the upcoming agenda and requested that additional research be performed on a third topic.
In addition to the topics discussed at the meeting, the FASB staff noted that potential changes to income tax disclosures would be considered as part of the overall review of disclosures in the Disclosure Framework Project.
The Board agreed to add the possible elimination of the exception for recognising deferred taxes on certain intercompany transactions, specifically the transfer of assets under ASC 740-10-25-3(e), to its technical agenda. The FAF identified the exception as an area that was challenging for preparers during its Post-Implementation Review. The exception does not exist under IFRS and was to be eliminated as part of the ultimately abandoned short-term tax convergence project.
Additionally, the Board added to its agenda consideration of whether all deferred tax assets and liabilities should be classified as non-current. The Board noted that if this classification of deferred tax assets and liabilities was adopted it would also eliminate the complexity around the allocation of a valuation allowance between current and non-current (a topic also presented by the staff). Classification of all deferred taxes as non-current would be consistent with IFRS.
The Board asked the FASB staff to undertake additional research to consider whether the FASB should either have a separate project for possible elimination of intraperiod tax allocation, or have that be considered as part of a larger comprehensive project on performance reporting.
The Board noted that the complexity around the exception to the application of the intraperiod tax allocation rules that applies when losses from continuing operation offset gains in other components, as well as the so-called 'backwards tracing' (both presented by the staff), would no longer be an issue if intraperiod tax allocation was eliminated.
During its meeting on 10 September 2014, the Board also asked the staff to perform additional research on certain topics in relation to accounting for stock compensation. These topics included:
The analysis will include a comparison with the IFRS treatment and will be presented in an upcoming meeting, when the Board will decide whether to add these topics to its agenda.
The Board decided to not make any changes to the guidance for earnings determined to be indefinitely reinvested in foreign subsidiaries.
Additionally, the Board decided against adding topics associated with presenting deferred tax assets and liabilities separately (i.e., removing jurisdictional netting) and additional guidance for assessing valuation allowances.
Accounting for income taxes continues to be a complex, challenging area of financial accounting. Users of financial statements continue to look for decision-useful information on cash flows and risks related to income taxes. Preparers and auditors continue to struggle with the cost and complexity of compliance.
The steps recently taken by the FASB and the ongoing efforts of the FASB staff may lead to significant near-term improvements.
Organisations should continue to watch for further developments as the FASB works through the tax accounting topics along with those which will be considered in the Disclosure Framework Project.
On 20 August 2014, the International Accounting Standards Board (IASB) published the Exposure Draft on Recognition of Deferred Tax Assets for Unrealised Losses (Proposed amendments to International Accounting Standard 12 Income Taxes (IAS 12)).
The Exposure Draft proposes guidance on how to account for deferred tax assets related to debt instruments measured at fair value when the fair value of the instrument falls, creating unrealised losses.
The issue originated from a submission to the IFRS Interpretations Committee (IFRIC). In response, the IFRIC recommended that the IASB should amend IAS 12 (see the Q1 2014 newsletter for the background).
The IASB proposes to confirm and clarify the following:
The proposed amendments will have limited retrospective application for entities already applying IFRS. This is so that restatements of the opening retained earnings or other components of equity of the earliest comparative period presented should be allowed but not be required.
Full retrospective application would be required for first-time adopters of IFRS.
The Exposure Draft is open for comment until 18 December 2014. After considering the comments the IASB will decide whether to proceed with the proposed amendments to IAS 12.
During the third quarter of 2014 the IFRIC considered the following tax-related issues:
Below we outline the IFRIC’s conclusions on these issues.
The IFRIC received a request to clarify the recognition of a tax asset in the situation in which tax laws require an entity to make an immediate payment when a tax examination results in an additional charge, even if the entity intends to appeal against the additional charge. In the situation described by the submitter, the entity expects, but is not certain, to recover some or all of the amount paid. The IFRIC was asked to clarify whether IAS 12 is applied to determine whether to recognise an asset for the payment, or whether the guidance in IAS 37 Provisions, Contingent Liabilities and Contingent Assets should be applied.
The IFRIC discussed this issue previously (see the Q1 2014 newsletter) and during its meeting in July 2014 decided that it should consider separately the question of recognition and the question of measurement of assets and liabilities in the situation in which tax position is uncertain.
The question of recognition of assets and liabilities in the situation in which tax position is uncertain was discussed by the IFRIC in July 2014. The IFRIC noted that:
The IFRIC understood that the reference to IAS 37 in paragraph 88 of IAS 12 in respect of tax-related contingent liabilities and contingent assets may have been understood by some to mean that IAS 37 applied to the recognition of such items. However, the IFRIC noted that paragraph 88 of IAS 12 provides guidance only on disclosures required for such items, and that IAS 12, not IAS 37, provides the relevant guidance on recognition, as described above.
On the basis of this analysis, the IFRIC noted that sufficient guidance exists. It concluded that the agenda criteria are not met and decided to remove from its agenda the issue of how current income tax, the amount of which is uncertain, is recognised.
The IFRIC noted that one of the principal issues in respect of uncertain tax positions is how to measure related assets and liabilities.
During its meeting in July 2014, the IFRIC asked the staff to prepare a discussion paper that analyses the question of how to measure assets and liabilities in the situation in which tax position is uncertain. In particular, the IFRIC asked the staff to analyse how detection risk and probability should be considered in the measurement of tax assets and liabilities in such situations.
During its meeting in September 2014, the IFRIC discussed several aspects of measurement of assets and liabilities on uncertain tax positions. It tentatively decided to proceed with this project, subject to further analysis and deliberations. In particular, the IFRIC requested the staff to prepare a proposal with respect to:
The IFRIC also discussed whether detection risk should be reflected in the measurement of tax assets and liabilities arising from uncertain tax positions. It concluded that an entity should assume that the tax authorities would examine the amounts reported to them and have full knowledge of all relevant information (i.e., it should assume a 100% detection risk).
The staff will present the additional analysis requested by the IFRIC at a future meeting (expected to be in November 2014).
The IFRIC received a request to clarify the accounting for deferred tax in the consolidated financial statements of the parent, when a subsidiary has only one asset within it (the asset inside) and the parent expects to recover the carrying amount of the asset inside by selling the shares in the subsidiary (the shares).
The IFRIC noted that:
The IFRIC also noted that these paragraphs require a parent to recognise both the deferred tax related to the shares and the assets within the subsidiary, if:
The IFRIC noted that several concerns were raised with respect to the current requirements in IAS 12. However, analysing and assessing these concerns would require a broader project than the IFRIC could perform on behalf of the IASB.
Consequently, the IFRIC decided not to take the issue onto its agenda but instead to recommend to the IASB that it should analyse and assess these concerns in its research project on Income Taxes (updates in relation to the status of the project will be posted on the IFRS site here).
On 16 September 2014, the OECD released the final template for country-by-country reporting (CBCR template) and a number of other reports on the Base Erosion and Profit Shifting (BEPS) Action Plan.
The CBCR template was adopted by the OECD’s Committee on Fiscal Affairs on 25-26 June 2014 after months of work by OECD staff, representatives of the Revenue Authorities of the OECD and certain non-member countries in working parties. Consultations also took place with input from other, particularly developing, countries and various supranational bodies including the European Commission, United Nations and International Monetary Fund as well as business and civil society organisations.
During their meeting in Australia on 20-21 September 2014, Finance Ministers of the G20 countries accepted the CBCR template and committed to finalising all action items in 2015.
As mentioned in the Q2 2014 newsletter, the CBCR template will be a separate document from the transfer pricing master and local files. The country-by-country information is to be reported to tax authorities at a high level and for risk assessment purposes only.
There are a few substantive changes from the earlier draft released by the OECD in January 2014. The report now confirms that the data points to be reported for all tax jurisdictions in which a multinationals subject to tax are:
It appears that the template is designed to highlight those low-tax jurisdictions where a significant amount of income is allocated without some 'proportionate' presence of employees. What this means in practice is that there will be pressure to assure that profit allocations to a particular jurisdiction are supported by an appropriately qualified number of employees who are able to make a 'substantial contribution' to the creation and development of intangibles.
There remain concerns regarding the confidentiality of this data and, despite guidance from the OECD to the contrary, the potential for adjustments by tax administrations based on a formulary apportionment approach leading to many more transfer pricing controversies.
The OECD also noted that some countries (for example, Brazil, China, India, and other emerging economies) would like to add further data points to the template such as interest, royalty, and related party service fees. These data points will not be included in the template at this point, but the OECD has agreed that they will review the implementation of this new reporting by 2020 and decide whether there should be additional or different data reporting. A concern in this context is that there may well be a desire to expand CBCR, particularly in developing countries. That is, the emerging market economies that implement CBCR could well require the reporting of interest, royalty, and related party service fees. They could also require CBCR for any company doing business in their jurisdiction, regardless of where the multinational parent entity is located. The availability of the data to requesting countries will also be considered in the OECD's review of the implementation of CBCR.
The OECD does not yet have absolute consensus on the arrangements for the sharing of country-by-country information although they are seeking to finalise these arrangements by January 2015. This would include confidentiality issues with indications that information will only be exchanged pursuant to treaty or tax information exchange agreement provisions.
The CBCR template will be presented to the G20 Leaders meeting in Brisbane in November 2014.
As mentioned in the Q2 2014 newsletter, the OECD will continue to work on implementation and filing issues and report on these matters at the beginning of 2015.
For many OECD countries there may be a need to implement CBCR through changes to domestic law before it could fully come into effect. However, it is clear that there is a strong commitment from countries to implement CBCR. In fact, on 20 September 2014 the UK became the first country to formally commit to implementing the CBCR template.
Taxpayers will need to take account of the speed of the above developments, as well as the work which remains in progress, as they frame their response.
Given the lead time generally required to prepare internal systems and processes for CBCR and the level of funding and change that may be required, it is critical that taxpayers begin to assess now whether their current information and accounting systems will allow them to comply with the above CBCR requirements and with any subsequent information requests from tax authorities.
Country | Prior rate | New rate |
Australia (carbon tax) | AU$24.15 per tone | N/A1 |
Australia (minerals resource rent tax) | 22.5% (effective rate) | N/A2 |
Bangladesh (CIT) | 37.5% | 35%3 |
Egypt (tax on capital gains and stock dividends) | N/A | 10%4 |
France (surtax) | 10.7% | 10.7%5 |
1 Carbon tax was fully repealed effective from 1 July 2014. The repeal was enacted on 17 July 2014. |
2Mineral resources rent tax was repealed effective 1 October 2014. The repeal was enacted on 5 September 2014. |
3This change was enacted on 1 July 2014 and is effective from that date. |
4A new 10% tax is imposed in Egypt on dividends and capital gains. This tax was enacted on 1 July 2014 and is effective from that date. |
5On 6 August 2014, France enacted a one-year extension of the 10.7% surtax on corporate income tax (resulting in a maximum corporate income tax rate of 38%) until 30 December 2016. This means that December year-end companies will be subject to the increased surtax until 31 December 2015. |
During the third quarter of 2014, the following tax measures were repealed in Australia:
During the third quarter of 2014, Canada introduced a legislative proposal to implement certain 2014 budget measures (see the Q1 2014 newsletter).
During the third quarter of 2014, the tax reform bill in Chile (see the Q1 2014 newsletter) was enacted with the following significant amendments:
During the third quarter of 2014, China’s State Administration of Taxation released a discussion draft on Administrative Measures on the General Anti-Avoidance Rule (GAAR) for public consultation.
The draft provides that a 'tax avoidance scheme' that is intended to obtain a tax benefit without reasonable commercial purpose shall be subject to a GAAR adjustment, and clarifies the main characteristics of a 'tax avoidance scheme.' It also sets out some important principles in the application of GAAR, and stipulates the adjustment methods where GAAR is triggered, and the relevant GAAR investigation procedures.
During the third quarter of 2014, the French tax authorities released final guidelines regarding the legislation enacted on 30 December 2013, targeting hybrid mismatch arrangements. The final guidelines confirm that disallowed interest will not be treated as a deemed distribution.
During the third quarter of 2014, Hong Kong enacted a tax provision that waives 75% of profits tax for 2013/14 subject to certain conditions.
During the third quarter of 2014 a Hungarian government’s decree on the development tax incentive was enacted. Companies once again may claim the development tax incentive for their investment projects. The new decree is designed to align Hungary’s development tax incentive rules with the European Commission’s new guidelines on regional state aid and a new General Block Exemption Regulation for the European Union (EU) budgetary period 2014-2020.
During the third quarter of 2014, measures announced in the Indian Budget 2014 were enacted in India. These included the following key corporate tax changes:
In addition, during the third quarter of 2014 the Delhi High Court issued a landmark ruling regarding the application of the Indian indirect transfer taxation provisions introduced in 2012 (those provisions followed the high-profile Vodafone case). These provisions specify that gains arising from the transfer of shares of a company incorporated outside India is taxable in India if the company's shares derive their value 'substantially' from assets located in India. The definition of ‘substantially’ was not included in the act, but has now been clarified by the Delhi High Court. The Court ruled that if 50% of an offshore company’s share value is derived from assets located in India this qualifies as ‘substantially’ for purposes of the indirect transfer tax provisions.
During the third quarter of 2014, the Mexican tax authorities enacted amendments to the Mexican Miscellaneous rules in force for 2014. These amendments introduce certain changes and clarifications to the Maquiladora regime that could affect Maquiladora entities that carry on certain auxiliary activities. In general, the new rules introduce more flexibility to the concept of ‘productive’ income and allow Maquiladora entities to engage in certain 'complementary' activities without jeopardising their qualified status.
During the third quarter of 2014 the Nigerian Federal Inland Revenue Service (FIRS) announced that it would no longer accept income tax returns filed by non-resident companies doing business in Nigeria unless the returns were accompanied by audited financial statements and tax and capital allowance computations.
During the quarter the Nigerian Tax Appeal Tribunal (TAT) ruled that upstream companies may deduct interest charges on related-party loans, provided the loans are obtained at arm’s length. The ruling was issued in a case brought before the TAT by an upstream oil and gas company against the Federal Inland Revenue Service. The decision provides clarity on the controversial issue of the deductibility of interest on related-party loans.
During the third quarter of 2014, the following tax measures were proposed in Poland:
During the third quarter of 2014, the limit on foreign ownership of Qatar Stock Exchange (QSE) listed companies was increased to 49% (previously the foreign ownership limit in most listed companies was 25%). This could result in increased foreign investor activity in the near future.
During the third quarter of 2014, the following tax measures were proposed in Slovakia:
During the third quarter of 2014, the following tax measures were proposed in South Korea:
During the third quarter of 2014, the Spanish government amended draft bills relating to a tax reform released in June 2014. These bills are now with the Parliament for approval.
The draft bills’ principal changes include the following:
During the third quarter of 2014, the Swiss Federal Council published the draft legislative text of the Federal Law on Measures to Maintain the Competitiveness of Business Location Switzerland (Law on Swiss Corporate Tax Reform III or CTR III). This draft will be open for comments until 31 January 2015.
The key points of the consultation draft include the following:
During the third quarter of 2014, a law was enacted in the Ukraine that would eliminate certain corporate tax incentives from the country’s tax code. In particular:
During the third quarter of 2014, the following 2013 Budget proposals were enacted in the UK:
During the third quarter of 2014, the Internal Revenue Service (IRS) issued final regulations on the Section 174 deduction for research and experimentation (R&E) expenditures (T.D. 9680) that adopt, with certain modifications, the proposed regulations issued in September 2013.
The IRS also issued Notice 2014-44 to provide guidance regarding the application of the so-called disposition rule under Section 901 (m).
The IRS also released final regulations under Section 168 regarding disposals of tangible depreciable property, which modify the proposed disposition regulations that were issued in September 2013.
During the third quarter of 2014, the Treasury Department and the IRS issued final Section 861 regulations (TD 9676) regarding the allocation and apportionment of interest expense. These final regulations finalise temporary and proposed regulations without substantive change and do not make major modifications to the existing regulatory scheme.
The Treasury Department and the IRS also issued their 2014/2015 Priority Guidance Plan, including projects in relation to subpart F, inbound and outbound transactions, foreign tax credits and currency exchange regulations. In general, some projects are completed in the first year they appear on the business plan. Others carry over for several years while the Treasury and the IRS address other priorities or try to resolve technical or policy issues.
The topic of transfer pricing as it pertains to tax accounting and reporting is often associated with uncertain tax positions — that is, the extent to which tax reserves may need to be recorded due to uncertainty with tax return positions. However, other areas should also be considered, including valuation allowances, measuring deferred taxes on foreign earnings, business restructuring, presentation of tax information in financial statements and disclosures.
These and other key tax accounting and reporting considerations associated with transfer pricing are discussed below.
US GAAP Accounting Standards Codification 740, Income Taxes (ASC 740), provides guidance for recognising and measuring positions taken or expected to be taken in a tax return that directly or indirectly affect amounts reported in a company’s financial statements. The guidance provides a two-step model: Step 1 – A tax benefit is recognised only if it is more likely than not sustainable based upon its technical merits; and Step 2 – The tax benefit recognised is measured as the greatest amount that is more than 50% likely to be realised upon settlement with the taxing authority. Amounts unrecognised are often known as tax reserves.
The application of this accounting model requires significant judgment and is dependent upon the facts and circumstances. In some cases, tax positions arising from intercompany transactions may require assessment to determine whether the recognition threshold (Step 1) is met. Most transfer pricing positions, however, are considered to meet the recognition threshold; the uncertainty relates to the transaction’s valuation or pricing, which is addressed in the measurement process (Step 2).
Under IFRS IAS 12, when it is probable that an entity has incurred a liability, such liability is measured using either a weighted average probability approach, or at the single best estimate of the most likely outcome. The probability threshold under IAS 12 is generally interpreted as ‘more likely than not’, similar to ASC 740.
As mentioned in the accounting and reporting update section of this newsletter, the question of measurement of assets and liabilities in the situation in which tax position is uncertain is currently being considered by the IFRIC. The IFRIC asked the staff to analyse how detection risk and probability should be considered in the measurement of tax assets and liabilities in uncertain situations and present their conclusions at a future IFRIC meeting.
Determining the appropriate valuation or transfer price often leaves uncertainty. A transfer pricing analysis may produce a range of appropriate outcomes, yet the measurement process requires a company to determine which single outcome represents the greatest amount that is more than 50% likely (i.e., more likely than not threshold) to be accepted by the taxing authority.
The assessment of transfer pricing uncertainty should include consideration of the relevant tax laws, tax treaties, and any arrangements established with taxing authorities. Advance pricing agreements (APAs) may help mitigate or alleviate a company’s risk that its transfer pricing arrangement will be subject to challenge. Even when transfer pricing falls within an arm’s length range that is properly documented by the taxpayer, it may be appropriate for a company to record a reserve in its financial statements. This may occur when a company expects it will ultimately settle with the taxing authority at some other amount. In measuring the reserve to record, companies may need to consider the results of alternative transfer pricing methods in their analysis.
Once all relevant information is identified and assessed, consideration should be given to the impact an uncertain transfer pricing position may have in other tax jurisdictions. An uncertain position taken in one jurisdiction may give rise to a corresponding tax position reducing taxable income in another jurisdiction where an affiliate resides. ASC 740 and, similarly, IAS 12 prohibit the offsetting or netting of a reserve in one jurisdiction against a potential tax overpayment (or receivable) in a separate jurisdiction. Companies should assess and record both the income tax liability and any potential asset separately (on a gross basis) in the financial statements. In some instances, the recording of an uncertain tax position may impact the amount of other taxes due.
When a company is under examination by a taxing authority, the status of the exam must be monitored continually to assess potential financial reporting changes. To the extent new information arises, a company must consider whether there should be a re-measurement of benefits. Impact of any re-measurement should be taken into account in the period when it occurs.
Reserves for positions taken in tax years that are not examined, and any corresponding assets recorded for other jurisdictions, would be reversed when the relevant statute of limitations expires.
An inherent assumption within the financial accounting model for income taxes is that the reported amounts of assets and liabilities reflected in a company’s financial statements will ultimately be recovered or settled.
Under IAS 12, deferred tax assets are recognised to the extent that it is probable (i.e., ‘more likely than not’) that sufficient taxable profits will be available to utilise the deductible temporary difference or unused tax losses. Valuation allowances are not allowed to be recorded. However, the amount (and expiry date, if any) of unprovided deferred tax needs to be disclosed.
ASC 740 requires companies to weigh all available evidence to determine whether all or some portion of deferred tax assets will be realised, and establish a valuation allowance when it is more likely than not that the assets will not be realised. It was previously confirmed by the IASB and the FASB, that there are no differences in the ‘more likely than not’ threshold under IFRS and US GAAP.
Evidence to be considered with respect to each tax jurisdiction includes historical information supplemented by information about future taxable income that is currently available. Forming a conclusion that a valuation allowance is not needed can prove challenging when there is negative evidence such as cumulative losses in recent years. For deferred tax assets in a jurisdiction in which significant revenues or costs arise from intercompany transactions, transfer pricing can be a key focal point.
The need for a valuation allowance may be overcome by the existence of sufficient future taxable income, which can be directly affected by transfer pricing arrangements. For example, a company may have flexibility to adjust its existing transfer pricing and allocate a greater percentage of profit to a jurisdiction with recent losses and deferred tax assets. Provided the adjusted transfer price continues to fall within the arm’s length range and is economically prudent, the change may constitute objective positive evidence supporting realisation of a company’s deferred tax assets. For companies that have APAs, the evidence may be strengthened by what is effectively third-party (taxing authority) verification.
Another source of taxable income for companies to consider when evaluating the realisability of deferred tax assets is tax reserves. For multinational companies with reserves for transfer pricing uncertainties, consideration should be given to whether settlement of the reserves would constitute a source of taxable income. That may depend on the period(s) in which additional taxable income would be reported in the relevant tax jurisdiction.
ASC 740 presumes that the undistributed earnings of a foreign subsidiary will ultimately be repatriated to the parent company. Under this general presumption, companies based in jurisdictions that apply a worldwide system of taxation (such as the United States) would record a home country deferred tax liability on the ‘outside basis’ difference in a foreign subsidiary. The outside basis difference represents the difference between a parent’s book and tax basis in a subsidiary, often including undistributed foreign earnings, currency translation, and other accounting adjustments. An exception, if met, allows a company to overcome the presumption that foreign earnings will be repatriated and forgo the recording of a tax liability for some or all of the outside basis difference.
Under IAS 12, an entity shall recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, except when a parent company is able to control the timing of reversal of the temporary difference, and it is probable that the temporary difference will not reverse in the foreseeable future.
For companies that record a deferred tax liability on the outside basis difference (i.e., investment in a subsidiary), consideration should be given to the impact of transfer pricing on the deferred tax calculation (for companies not recording a deferred tax liability, transfer pricing can impact the estimate of the unrecorded tax that may be disclosed). Transfer pricing will affect, for example, the amount of foreign taxes due in a given jurisdiction and the respective foreign tax credit that would arise upon repatriation. This might include foreign tax reserves recorded as a result of transfer pricing uncertainty. Transfer pricing can also affect the amount of taxable income that will result upon repatriation, as well as from categories of income that are ineligible for home country deferral (such as ‘Subpart F income’ under US tax law).
The computation of a company’s outside basis difference can also include book-tax differences associated with stock-based compensation. Consideration should be given to whether a parent and foreign subsidiary’s transfer pricing arrangements include the sharing of costs associated with stock-based compensation awards. If so, it may in effect give rise to a tax benefit that may need to be considered. In some circumstances, stock-based compensation awards can also reduce the outside basis difference, and thereby the measurement of the deferred tax liability.
Multinational companies often undertake internal restructurings of their business operations. This can involve cross-border redeployment of assets, risks, and functions, all of which implicate transfer pricing. The accounting impact of restructurings can include tax consequences in both the transferring and receiving jurisdictions.
Under US GAAP, the income tax effects resulting from intercompany transfers of assets are generally not recognised immediately in the consolidated financial statements. Specifically, Consolidation subtopic ASC 810-10-45-8 defers taxes paid on intercompany profits on assets remaining within the consolidated group, and ASC 740-10-25-3(e) prohibits the recognition of a deferred tax asset for basis differences related to the intercompany profits (please note, the FASB is to consider whether the exception for recognising deferred taxes in certain intercompany transactions should be eliminated (see ‘Income tax accounting topics added to FASB’s agenda’ above)). If the arrangement constitutes the transfer of an asset, any net income tax consequences of the transfer are generally deferred and amortised to income over the period of economic benefit.
Under IFRS, any current and deferred taxes associated with intercompany transfers should be recognised at the time of the transaction. A temporary difference usually arises on consolidation as a result of retaining the pre-transaction carrying amount of the transferred asset while having its tax base according to the intragroup transaction price.
A deferred tax asset may also need to be recognised under IFRS, if under a ‘special tax ruling,’ a tax asset (e.g., a deemed intangible) is generated on the transfer of functions or assets of an entity, and this tax asset is depreciable for tax purposes. Under US GAAP no deferred tax asset may be recognised in this situation due to the above exemption.
Companies reporting under US GAAP should take care in determining the extent to which the deferral mentioned above applies — for example, whether the deferral would apply to any ‘exit taxes’. An exit tax may be imposed based on the value of assets deemed transferred to a different tax jurisdiction, or perhaps on the value of forgone future profits. The deferral principle would apply only to an exit tax that is considered a tax based on income. The deferral may also apply to uncertain income tax positions, such as uncertainty relating to the value of assets transferred. For companies not asserting indefinite reinvestment, the deferral may apply to a resulting re-measurement of the deferred tax liability.
Internal restructurings may involve a change in tax status for one or more of the entities involved, such as from non-taxable to taxable or vice versa. ASC 740 requires the tax effects of a change in tax status to be included in income from continuing operations at the date the change occurs. The deferral principle discussed above would not apply to these tax effects. A change in tax status is typically considered to occur on the date when approval is obtained for elective changes or the date the filing or election is made if approval is not required.
Businesses that prepare consolidated (or group) financial statements also often prepare separate financial statements for one or more subsidiaries or other business units. The preparation of separate company financial statements may arise from internal business needs, but often serve to meet the external requirements of regulators, investors, creditors, and tax authorities.
Intercompany transactions that were eliminated in the consolidated financial statements must often be reported in separate financials and adequately disclosed to ensure readers have decision-useful information. When related-party transactions represent a significant part of recurring operations between the separate reporting members and affiliates in the broader reporting group, a transfer pricing analysis could be a relevant factor to consider with respect to the measurements of pre-tax revenues or costs from those transactions.
Accordingly, measurement of revenues and costs would be assessed for reasonableness and consistency with a company’s transfer pricing methodologies. This may extend to intercompany transactions that are reported in a consolidated tax return with members of the broader reporting group. If transfer pricing methodologies were not previously established, an appropriate analysis may be warranted to support the separate company statements. Terms set forth in APAs would represent third-party evidence to be considered in measuring pre-tax revenues and costs. The respective income tax accounting would be applied based on the measurements recorded in the standalone pre-tax accounts.
Consideration should also be given to tax reserves and settlements with taxing authorities relating to transfer pricing. For companies with APAs, reserves may need to be considered in separate company statements when the business results fall outside the range of the agreed-upon financial metric. Tax reserves or settlements may give rise to an expectation (or agreement) with the related party to make a compensating payment or pricing adjustment. Whether such payments or adjustments are recorded in equity or the income statement will depend upon the facts and circumstances.
The impact of transfer pricing in financial reporting extends to other areas as well, including interim reporting, mergers and acquisitions, and disclosures.
The calculation of a company’s estimated annual effective tax rate (AETR) should reflect a company’s transfer pricing policies. Specifically, the calculation should include related-party transactions in the annual projections of pre-tax earnings, and the appropriate jurisdictional tax rates applicable to those transactions. For example, intercompany sales revenue should be allocated to the appropriate tax jurisdictions (e.g., foreign, domestic, state, and local) in accordance with a company’s transfer pricing arrangements, and the appropriate tax rates and apportionment percentages applied. Any required tax reserves relating to current-year transactions should be included in the AETR calculation. Throughout the course of the year, as the intercompany transactions change in volume or shift across jurisdictions, companies should update their AETR estimates accordingly.
When determining the appropriate book and tax values of assets acquired and liabilities assumed in a business combination, transfer pricing may play an important role. For example, in a taxable acquisition (wherein tax bases are adjusted to the purchase price), the tax valuations are prepared on a legal entity or tax-jurisdictional basis. Transfer pricing should be embedded within the tax valuations even though it may be less relevant to financial reporting valuations performed on a consolidated or reporting unit level. In addition, for tax and book purposes, an economic analysis is often used in determining an asset’s fair value based on the expected level of income (discounted cash flows) to be generated by that asset. The tax cash flows relating to an asset can depend upon the tax jurisdictions and respective tax rates applied to intercompany transactions involving the asset. Transfer pricing should also be considered in measuring deferred taxes recorded in acquisition accounting, assessing the need for a valuation allowance, and recording any required tax reserves.
Companies should consider the impact that transfer pricing may have on accounting estimates and assertions that may warrant disclosure in the financial statements. This becomes increasingly important due to disclosures recommended by the OECD in the CBCR template (see our comments above).
Income tax footnote disclosures might include a discussion of a transfer pricing strategy that serves as objective positive evidence in support of the realisation of a company’s deferred tax assets. Increases and decreases in the tabular reconciliation of unrecognised tax benefits related to transfer pricing uncertainties should be reported exclusive of corresponding benefits in other jurisdictions. Early warning disclosure may be warranted for possible near-term changes in uncertain transfer pricing positions.
U.S. Securities and Exchange Commission (SEC) registrants are required to discuss their current financial condition and expected changes in Management’s Discussion & Analysis of Financial Condition and Results of Operations (MD&A). Consideration should be given to the impact of transfer pricing in these discussions. That may include, for example, risks and uncertainties associated with transfer pricing policies that could impact liquidity or capital resources. Potentially significant consequences of legislative or regulatory proposals may be discussed. In some circumstances, material terms of APAs may warrant disclosure.
Andrew Wiggins +44-(0)-121-232-2065 andrew.wiggins@uk.pwc.com |
Kenneth Shives +32-(2)-710-4812 kenneth.shives@be.pwc.com |
Terry SY Tam +86-(21)-2323-1555 terry.sy.tam@cn.pwc.com |
Marjorie Dhunjishah +1-(703)-918-3608 marjorie.l.dhunjishah@us.pwc.com |
Country | Name | Telephone | |
Australia | Ronen Vexler | +61-(2)-8266-0320 | ronen.vexler@au.pwc.com |
Belgium | Koen De Grave | +32-(3)-259-3184 | koen.de.grave@be.pwc.com |
Brazil | Manuel Marinho | +55-(11)-3674-3404 | manuel.marinho@br.pwc.com |
Canada | Spence McDonnell | +1-(416)-869-2328 | spence.n.mcdonnell@ca.pwc.com |
China | Terry SY Tam | +86-(21)-2323-1555 | terry.sy.tam@cn.pwc.com |
France | Thierry Morgant | +33-(1)-56-57-49-88 | thierry.morgant@fr.landwellglobal.com |
Germany | Heiko Schäfer | +49-(69)-9585-6227 | heiko.schaefer@de.pwc.com |
Hungary | David Williams | +36-(1)-461-9354 | david.williams@hu.pwc.com |
Japan | Masanori Kato | +81-(3)-5251-2536 | masanori.kato@jp.pwc.com |
Mexico | Fausto Cantu | +52-(81)-8152-2052 | fausto.cantu@mx.pwc.com |
Netherlands | Jurriaan Weerman | +31-(0)-887-925-086 | jurriaan.weerman@nl.pwc.com |
United Kingdom | Andrew Wiggins | +44-(0)-121-232-2065 | andrew.wiggins@uk.pwc.com |
United States | David Wiseman | +1-(617)-530-7274 | david.wiseman@us.pwc.com |
Andrew Wiggins +44-(0)-121-232-2065 andrew.wiggins@uk.pwc.com |
Katya Umanskaya +1-(312)-298-3013 ekaterina.umanskaya@us.pwc.com |
Steven Schaefer +1-(973)-236-7064 steven.schaefer@us.pwc.com |