Focusing on tax accounting issues affecting businesses today

January–March 2015


Introduction

Andrew Wiggins
+44-(0)-121-232-2065
andrew.wiggins@uk.pwc.com


The Global tax accounting services newsletter is a quarterly publication from PwC's Global Tax Accounting Services (TAS) 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 the activity of the Financial Accounting Standards Board (FASB), including an exposure draft on intra-entity asset transfers and balance sheet classification of deferred taxes, an update on the status of the uncertain tax position project of the International Financial Reporting Standards (IFRS) Interpretation Committee, highlights of the 2014 American Institute of Certified Public Accountants (CPAs) conference, and developments with country-by-country reporting.

We also draw your attention to some significant tax law and tax rate changes that occurred around the globe during the quarter ended March 2015.

Finally, in the tax accounting refresher section we discuss the determination of which accounting standards apply to various types of taxes or tax systems. We also discuss some of the differences in the accounting treatment of these taxes under US GAAP and IFRS.

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.


In this issue

Accounting and reporting updates

Recent and upcoming major tax law changes

Tax accounting refresher

Contacts and primary authors

Accounting and reporting updates

This section offers insight into the most recent developments in accounting standards, financial reporting, and related matters, along with the tax accounting implications.

The FASB activity update

Overview

During the first quarter of 2015, the FASB issued an exposure draft on two proposed accounting standards updates: intra-entity asset transfers and balance sheet classification of deferred taxes. The exposure draft is part of the Board's simplification initiative aimed at reducing complexity in accounting standards.

The comment period for the exposure draft will end on 29 May 2015. Stakeholders are encouraged to provide comments on the proposals.

In addition, the FASB agreed to issue an exposure draft on tax accounting for stock compensation (see the Q4 of 2014 newsletter for the background) that would include the following revisions to the current guidance:

The exposure draft on the tax accounting for stock compensation is expected to be issued in April–May 2015. Stakeholders will have the opportunity to provide feedback during a 60-day comment period.

Exposure draft on intra-entity asset transfers and balance sheet classification of deferred taxes

On 22 January 2015, the FASB issued an exposure draft on two proposed accounting standards updates: intra-entity asset transfers and balance sheet classification of deferred taxes.

The proposed guidance in both standards would achieve convergence with IFRS on these topics.

Intra-entity asset transfers

Existing GAAP for intra-entity asset transfers is an exception to the principle of comprehensive recognition of current and deferred income taxes. Currently, the buyer and the seller in a consolidated reporting group are generally required to defer the income tax consequences of intra-entity asset transfers when the profits from such transfers are eliminated in consolidation. For example, upon an intra-entity transfer of inventory, the seller is required to defer the tax expense on the profit from the transfer and the buyer is prohibited from recognising the deferred tax benefit on the inventory's increased tax basis. Both the seller's tax expense and the buyer's tax benefit are recognised when the inventory is sold to an outside party. In the case of a transfer of long-lived assets, recognition of the seller's tax expense and the buyer's tax benefit generally occurs in one or more subsequent periods.

Under the exposure draft, the exception would be eliminated and, as a result, the seller's tax expense on the profit from the transfers of assets and the buyer's deferred tax benefit on the increased tax basis would be recognised when the transfers occur. As proposed, this would result in the recognition of the tax consequences of intra-entity transfers even though the pre-tax profit is eliminated in consolidation. The FASB believes the proposed simplification will reduce diversity in practice and result in more transparent decision-useful information, which in many cases will more closely align with tax cash flows.

Balance sheet classification of deferred taxes

Currently, US GAAP requires the deferred taxes for each tax-paying jurisdiction of an entity to be presented as a net current asset or liability and net non-current asset or liability. This requires a jurisdiction-by-jurisdiction analysis of deferred taxes and the underlying classification of the assets and liabilities to which they relate. To simplify presentation, it is proposed that all deferred tax assets and liabilities be classified as non-current on the balance sheet. The proposed guidance would not affect the existing requirement to offset the deferred tax liabilities and assets of each tax-paying jurisdiction. As a result, each jurisdiction will now only have one net non-current deferred tax asset or liability.

What's next?

The comment period for the exposure draft will end on 29 May 2015. Stakeholders are encouraged to provide comments on the proposals. After considering comments received, the FASB should determine next steps later this year.

As proposed, the standards would be effective for annual and interim periods beginning after 15 December 2016, for public business entities, with no option to early adopt. For all other entities, the standards would be effective for annual periods beginning after 15 December 2017, and interim periods in annual periods beginning after 15 December 2018. Early adoption would be permitted for non-public companies, but not before the effective date for public business entities. Early adoption, if chosen, would need to be applied to both standards.

Entities would be required to apply a modified retrospective transition approach, with a cumulative catch-up adjustment to opening retained earnings in the period of adoption for the intra-entity asset transfers standard. Prospective transition would be required for the balance sheet classification of deferred taxes standard.

Proposed exposure draft on tax accounting for stock compensation

On 4 February 2015, the FASB decided to issue an exposure draft related to potential improvements and simplifications to the current accounting for stock-based compensation. The exposure draft is expected to be issued in April–May 2015.

The Board voted to include two income tax accounting changes related to stock-based compensation.

The first proposed change would require the recognition of all windfalls and shortfalls within income tax expense (windfalls occur when a stock-based award results in a larger tax deduction than the amount of compensation recorded for book purposes, whereas shortfalls occur when the award results in a smaller tax deduction than the related book charge). This would replace the current guidance, which records windfalls in equity and allocates the tax effects of shortfalls between equity and income tax expense. This change will also eliminate the necessity of maintaining a windfall 'pool'.

The change included the staff's recommendation to remove the current requirement that cash taxes payable must be reduced in order to record a windfall. The staff had also considered potential convergence with IFRS but concluded that convergence would not result in simplification.

The second proposed change eliminates the current requirement to display the gross amount of windfalls as an operating outflow and financing inflow in the cash flow statement. The FASB staff noted that this presentation does not reflect actual cash flows, and represents the only exception from single-line presentation of taxes within operating cash flows.

The exposure draft will propose prospective application of the windfalls/shortfalls change, and modified retrospective transition (i.e., cumulative catch-up adjustment) for the elimination of the cash taxes payable reduction requirement for windfalls. Retrospective application will be proposed for the change in the presentation of windfalls in the cash flows statement.

The FASB decided to wait until comments are received on the exposure draft before deciding on the effective date.

Takeaway

The steps recently taken by the FASB and the ongoing efforts of the FASB staff are intended to reduce the complexity of accounting for income taxes. Organisations should be proactively evaluating the implications of the changes being proposed in these tax accounting areas.

Consideration should be given to responding to the exposure draft on intra-group asset transfers and balance sheet classification of deferred tax assets and the proposed exposure draft on tax accounting for stock compensation once it is issued.

The IFRS IC project on uncertain tax positions

Draft interpretation

As mentioned in the Q4 of 2014 newsletter, the IFRS IC decided to proceed with developing guidance in the form of an interpretation for the measurement of uncertain tax positions (UTPs).

During the first quarter of 2015, the IFRS IC reviewed the proposed draft interpretation and tentatively decided the following:

  1. The scope of the draft interpretation should include guidance on the impact of tax uncertainties on the accounting for deferred tax as well as current tax.
  2. The draft interpretation should include guidance on disclosures. This guidance should require an entity to disclose the method that is used to reflect tax uncertainties in the measurement of current and deferred tax. It should also refer to the guidance in IAS 1 Presentation of Financial Statements on the disclosure of judgments and estimates, and its relevance to the accounting that would be required by the draft interpretation.
  3. An entity should apply the interpretation prospectively, recognising the cumulative effect of initially applying the interpretation in retained earnings at the start of the reporting period in which an entity first applies the interpretation. However, retrospective application would be permitted. The entity should disclose which method of transition it has applied.

One of the tentative decisions made by the IFRS IC at a previous meeting was that an entity should assume that the tax authorities would examine the amounts reported to them and have full knowledge of all relevant information. At this meeting, the IFRS IC asked the staff to consider the implication of that assumption on the derecognition of current and deferred tax assets and liabilities. After further consideration, the staff will determine whether an additional analysis needs to be presented to the IFRS IC.

Takeaway

The ongoing efforts of the IFRS IC and its staff may lead to significant near-term improvements.

Organisations should continue to watch for further developments as the IFRS IC works through this project.

Highlights of the 2014 AICPA conference

Overview

The 2014 AICPA National Conference on current Securities and Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB) developments held in December 2014 included representatives from regulatory and standard-setting bodies, auditors, users, preparers, and industry experts.

The conference highlighted themes of disclosure effectiveness, the importance of financial statement comparability across companies, and the need for simplification. Each of these themes supported the overall focus on providing decision-useful information to users of financial statements.

Disclosure effectiveness

The SEC staff encouraged registrants to take actions to make disclosures more effective. This can be done by streamlining disclosures, eliminating generic language in areas such as risk factors and legal proceedings, avoiding duplication (e.g., between critical accounting policies and summary of significant accounting policy disclosures), and making greater use of hyperlinks and cross-referencing where applicable and appropriate.

SEC staff's tax accounting areas of focus

The SEC staff will continue asking questions regarding valuation allowances, the realisability of deferred tax assets, and indefinite reinvestment assertions. In addition, the SEC staff will increase its focus in 2015 on income tax expense and income tax disclosures in management's discussion and analysis (MD&A).

Areas of focus are expected to include instances where tax rates appear unusual relative to the expected statutory rate, effective tax rates are volatile, or effective tax rates do not change because material changes in components are offsetting.

The SEC staff also expects to see disclosures in MD&A that do not simply repeat the components of the rate reconciliation. Material offsetting components should be described individually. Foreign earnings and associated taxes are also expected to gain additional comments, as the staff is aware of investors' desire for greater transparency in this area.

Lastly, the SEC staff may question generic language that refers to taxes being potentially impacted by changes in the mix of foreign earnings. Registrants can enhance disclosures in this area by including additional details about statutory and effective rates in the significant countries in which the company operates.

Standard setting update

Representatives of the FASB and International Accounting Standards Board (IASB) provided an update on their joint accounting standard setting activities. That included recently issued IFRS 9, Financial Instruments, and IFRS 15, Revenue from Contracts with Customers. In relation to the joint leases project, the FASB and IASB noted that it is expected to be completed in 2015. However neither the FASB nor IASB staff was willing to estimate its effective date.

The FASB's financial instrument classification and measurement project is also expected to be completed in 2015, following re-deliberation of impairment of equity method investments and the transition and effective date. Other projects the FASB recently added to its technical agenda include hedging, the definition of a business, goodwill, and the separation of identifiable intangible assets. The status of each project was consistent with existing public information.

New revenue recognition standard

Application of the new standard and the increased use of estimates and management judgments may result in the need for new processes and controls.

As companies work to implement the new revenue standard, management should be conscious of its obligation to disclose material changes to internal control over financial reporting on a quarterly basis. This is particularly relevant when newly designed or redesigned controls are implemented in advance of adoption, yet impact current period financial reporting.

IFRS

Many presenters emphasised the importance of IFRS due to the significant amount of foreign debt and equity securities held by US investors. It was noted that more than half of the world's largest companies report under IFRS. As a result, a significant number of US companies are regularly compared to peers that use IFRS, which has raised investors' knowledge and comfort with IFRS.

While there was no definitive announcement on the use of IFRS by domestic registrants, it was suggested that one possible alternative would be to allow domestic issuers to submit supplemental IFRS-based financial information on a voluntary basis. Discussions around this alternative are preliminary and stakeholder input is sought on the form of possible supplemental information (e.g., key metrics, reconciliation from US GAAP, or full financial statements) as well as whether the information should be subject to some level of auditor assurance.

Internal control over financial reporting

Similar to last year, it has been reiterated that not all material weaknesses are being properly identified, evaluated, and disclosed. The low number of material weaknesses in the absence of a restatement or other known material error may imply that the 'could factor' or the potential exposure is not being correctly evaluated.

The SEC staff continues to believe that the top-down, risk-based approach described in its interpretive guidance to management on implementing Section 404 of Sarbanes-Oxley is typically most effective for determining whether any material weaknesses exist.

The SEC staff emphasised that describing the accounting error is not the same as describing the control deficiency. In order to understand, describe, and appropriately remediate a deficiency, management should consider the nature of the control deficiency, its impact, cause, and how it was identified. The actual error is only the starting point for evaluating the severity of a deficiency, and that the potential impact—the 'could factor'—must be considered as well.

PCAOB's inspection results and findings

The PCAOB discussed the nature of findings identified during the most recent inspection cycle. Overall results across the inspected firms were mixed. Certain firms made improvements in audit quality, as evidenced by a progressive decrease in the number of findings, while other firms had results consistent with prior inspection cycles, both in quantity and subject matter. Findings continue to be noted related to revenue recognition, inventory, goodwill and intangible assets, business combinations, and internal control over financial reporting (ICFR). The most prevalent source of deficiencies continues to be ICFR.

The PCAOB focus on the involvement of non-US firms in the audits of SEC registrants is increasing. This includes a focus on controls within an audit firm's global network and a planned increase in enforcement activity involving non-US audit firms. This increased focus was driven, in part, by recent inspection results on work performed by non-US audit firms.

While the PCAOB will continue to conduct a risk-based scoping approach that considers the results of past inspections, expected areas of focus in 2015 include the following:

  1. controls in business processes associated with business combinations
  2. income taxes, particularly as profits in low-tax jurisdictions grow
  3. the valuation of hard-to-value financial instruments
  4. the impact of falling oil prices on financial reporting risks
  5. whether management and the auditor properly considered how significant transactions are reflected in the statement of cash flows

Country-by-country reporting developments

Overview

The Organisation for Economic Cooperation and Development (OECD) recently released, and the G20 Finance Ministers approved, the country-by-country (CbC) reporting implementation package and other guidance on complying with certain recommendations originating from the OECD's base erosion and profits shifting (BEPS) action plan.

The CbC reporting implementation package recommends that multinationals with revenues above Euro 750 million (approximately USD 790 million) file the previously agreed reporting template along with a master file and local file as part of their transfer pricing documentation (see the Q3 of 2014 newsletter for more details on the template) for fiscal years (i.e., consolidated reporting periods for financial statement purposes) beginning on or after 1 January 2016. This means that tax administrations could begin exchanging the first CbC report information in 2017.

Jurisdictions should require CbC reporting from ultimate parent entities of multinationals resident in their country and should also exchange this information on an automatic basis with the relevant qualifying jurisdictions in which the multinational operates.

It was also agreed and emphasised that confidentiality of CbC information has to be protected.

In detail

The CbC reporting implementation package follows the OECD's September 2014 report (see the Q3 of 2014 newsletter for more information), and provides guidance on reporting requirements and timing of the CbC reports, safeguards, and a framework around the inter-governmental exchange process.

Scope

All multinationals are required to file the CbC report except those with annual consolidated group revenue in the immediately preceding fiscal year of less than Euro 750 million.

The guidance recommends that no exemptions be provided by industry or for non-corporate and non-public entities. With regard to investment funds, the OECD will provide future guidance on the different forms of consolidation and the consequences of those forms. There is also special mention of reporting requirements for multinationals with income derived from international transportation or inland waterway transportation in which taxing rights are covered by specific treaty provisions.

Timing

The implementation package recommends requiring the filing of CbC reports for fiscal years beginning on or after 1 January 2016. A report would have to be filed within one year of the end of the relevant fiscal year. For example, a calendar year-end company will be required to file a CbC report for the 31 December 2016 fiscal year by 31 December 2017.

Conditions and safeguards

The implementation package proposed necessary conditions and safeguards regarding obtaining and use of the CbC report, which are described below.

Confidentiality – The required protection and confidentiality procedures should be in place in each jurisdiction to preserve confidentiality of the CbC report. These protections should be at least equivalent to those that would apply if the information were delivered to the country under the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, a tax information exchange agreement (TIEA) or a tax treaty that meets certain internationally agreed standards. Such protections specifically include limitation of the use of the information and rules on the persons to whom the information may be disclosed.

Given the above confidentially guidelines, it is surprising that the UK Labour party announced its intention to make CbC reports publicly available, if they win the next election.

Multinationals should pay close attention to any such deviations from the OECD's CbC reporting guidelines in the countries of their operation.

Consistency – There should be a 'best efforts' provision for jurisdictions to adopt the standard template mentioned above. Countries should adopt no less and no more.

Appropriate use – The purpose of the CbC report is to assess high-level transfer pricing risk and other BEPS-related risks. The OECD states that jurisdictions shall not propose adjustments to income on the basis of an income allocation formula based solely on the CbC report, though further enquiries into the multinationals' transfer pricing arrangements or into other tax matters in the course of an audit may be made. In the case of any adjustment based on an income allocation solely as a result of the CbC report, the jurisdiction's competent authority will promptly concede the adjustment in any relevant competent authority proceeding.

Government exchange of CbC reports

The framework for government-to-government exchange of CbC reports is for jurisdictions to require in a timely manner CbC reporting from the ultimate parent entities of multinationals and to exchange this information on an automatic basis with the jurisdictions in which the relevant multinational operates (provided those jurisdictions meet the above-mentioned necessary conditions and safeguards). A secondary mechanism through local filings or by moving the obligation to the next-tier parent country is appropriate when:

The framework for government-to-government exchange of CbC reports is for jurisdictions to require in a timely manner CbC reporting from the ultimate parent entities of multinationals and to exchange this information on an automatic basis with the jurisdictions in which the relevant multinational operates (provided those jurisdictions meet the above-mentioned necessary conditions and safeguards). A secondary mechanism through local filings or by moving the obligation to the next-tier parent country is appropriate when:

Countries participating in the BEPS project have agreed to develop an implementation package for government-to-government exchange of CbC reports including developing key elements of domestic legislation and secondary mechanisms, and implementing arrangements for the automatic exchange of CbC reports under international agreements with the above-mentioned necessary conditions and safeguards.

What's next?

Unlike other reports initially provided in the form of discussion drafts, no request for comments is included for the CbC reporting implementation package. This indicates that most of the package is in final form, with the exception of a comprehensive package to be provided by April 2015 addressing the key elements of domestic legislation requiring the ultimate parent entity of a multinational to file the CbC report in its jurisdiction of residence and implementing arrangements for the automatic exchange of the CbC reports under international agreements.

For many OECD countries there may be a need to implement CbC reporting 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 CbC reporting. In fact, the UK became the first country to release the draft legislation to enable the introduction of CbC reporting in the UK (see UK tax law changes below). Australia, Belgium, and Spain also announced their commitment to implement the OECD's CbC reporting guidelines.

Takeaway

The Euro 750 million threshold for producing a CbC report is welcome news. On the other hand, multinationals affected by the CbC reporting regime, have very limited time to ensure their ability to comply with the CbC reporting requirements. Such multinationals should review the newly released guidance to consider how the rules apply to them and to assess what internal systems and process changes will be required for CbC reporting. In particular, multinationals should evaluate the capacity of their corporate information systems and controls to generate the level of financial detail that the OECD believes should be readily available to multinational taxpayers. It is also important that grey areas are considered including how to report for Controlled Foreign Companies, investment and minority interests, and special purpose vehicles. It may also be useful to conduct a 'dry run' CbC testing to identify any process and data deficiencies and perform a risk assessment. Given the strategic nature of the disclosures it is recommended that a wide variety of stakeholders are involved including tax, finance, public and investor relations.

Although a more comprehensive implementation package is promised by the OECD in April 2015, that guidance appears to focus largely on the key elements of domestic legislation that may be required in certain jurisdictions for CbC filing by the parent company and arrangements for the automatic exchange of information. As such, multinationals should get ready for the CbC reporting now.

Recent and upcoming major tax law changes

This section focuses on major changes in the tax law that may be of interest to multinational companies and can be helpful in their tax accounting considerations. It is intended to increase readers' awareness of the main global tax law changes during the quarter, but does not offer a comprehensive list of tax law changes that should be considered for financial statements.

Notable enacted tax rate changes

Country Prior rate New rate
Japan (ETR) 35.64% 33.10% / 32.34%1
United Kingdom (Diverted Profits Tax) N/A 25%2
1 The effective tax rate (ETR) in Japan has been reduced over two years. For Tokyo and other metropolitan areas the rate has been reduced from 35.64% to 33.10% for tax years beginning on or after 1 April 2015, and to 32.34% for tax years beginning on or after 1 April 2016. The rate reduction was enacted on 31 March 2015.
2Diverted Profits Tax (DPT) is a new tax in the UK charged at 25% on profits that are considered to be artificially diverted from the UK. This tax was substantively enacted on 25 March 2015 and enacted on 26 March 2015. It is applicable from 1 April 2015.

Other important tax law changes

Click each circle to review


Australia

During the first quarter of 2015, the following key measures were enacted in Australia:

In addition, the Australian government released revised exposure draft legislation for the third and final element of the Investment Manager Regime (IMR 3). Broadly, the revised exposure draft would exempt foreign funds from Australian tax on Australian-source gains. The revised draft also addresses a number of industry concerns regarding previous exposure drafts, by better aligning the draft IMR 3 provisions with the UK's Investment Manager Exemption (IME) equivalent.

Belgium

During the first quarter of 2015, the European Commission (EC) opened an in-depth investigation into a Belgian tax provision, which allows group companies to substantially reduce their corporation tax liability in Belgium on the basis of 'excess profit' tax rulings. The rulings allow multinational entities in Belgium to reduce their corporate tax liability by 'excess profits' that result from the advantage of being part of a multinational group.

The EC noted that the Belgian provision might not be in compliance with EU State aid rules (see the Q4 of 2014 newsletter for a background on State aid). The EC also expressed concerns that the 'excess profit' determined under rulings (i.e., the deductions that a company can claim, for example, for intra-group synergies or economies of scale) significantly overestimate the actual benefits of being in a multinational group. Lastly, the EC reached an initial conclusion that the 'excess profit' tax system could not be justified by the need to prevent double taxation.

In a separate development, the Belgian Constitutional Court (BCC) asked the European Court of Justice to rule whether the Belgian fairness tax violates EU law.

The fairness tax was introduced in 2013 and is a separate assessment, imposed at a 5.15% rate, on dividends distributed by large Belgian companies or Belgian branches of foreign companies. The fairness tax applies if notional interest deductions or tax loss carryforwards offset the taxpayer's taxable basis for the relevant tax period.

The BCC's request is particularly relevant to taxpayers that have been liable for fairness tax. In addition, the outcome may be relevant to non-Belgian taxpayers because other EU member states have introduced, or are considering introducing, similar tax rules.

China

During the first quarter of 2015, China's State Administration of Taxation released new rules regarding the taxation of offshore indirect equity transfers. In particular, they clarify the concept of 'reasonable commercial purpose' and introduce safe harbour scenarios.

The rules introduce new challenges for both the foreign transferor and transferee of the offshore indirect transfer as now both must self-assess whether the transaction should be subject to corporate income tax (CIT) and whether to file or withhold CIT accordingly.

Although the rules are effective 3 February 2015, they also apply to transactions conducted prior to this date that have not received a tax assessment from the tax authorities.

Denmark

During the first quarter of 2015, the following tax measures were enacted in Denmark:

European Union

During the first quarter of 2015, the EC has presented a package of tax transparency measures as part of its agenda to tackle corporate tax avoidance and harmful tax competition in the EU. Central to this package is a proposal to introduce the automatic exchange of information on tax rulings between member states, which, if adopted, will apply from 1 January 2016. A number of other initiatives are underway including consideration of public disclosure of tax information by multinationals and reviewing the EU Code of Conduct on Business Taxation.

Greece

During the first quarter of 2015, Greece enacted a provision that introduces significant procedural requirements for deducting certain corporate expenses. Under the provision, corporate expenses paid to an individual or an entity would generally not be deductible if that individual or entity meets certain criteria (e.g., they are resident in a 'non-cooperative state' or in a country with a 'beneficial tax regime' as defined in the corporate income tax code). According to the new provision, in order for an expense to be deductible, taxpayers must pay a 26% 'withholding tax' and satisfy certain other requirements. Notably, the term 'withholding' is not accurate since the tax paid does not appear to reduce the income received by the foreign company.

The new provision includes many areas of uncertainty. Greece's Finance Minister is expected to issue a 'Ministerial decision', which should provide practical guidance for implementing the above provision.

India

During the first quarter of 2015, the Finance Minister of India presented the Indian Budget 2015, which included the following key proposals:

Ireland

During the first quarter of 2015, the Department of Finance of Ireland launched a public consultation on the new 'Knowledge Development Box' (KDB) regime announced in the Irish Budget 2015. They have requested submissions to be made on the design of the KDB with the goal of ensuring “it meets its key objective of being the most competitive in class within the agreed international parameters for fair tax competition in this area”. The consultation process will run until the beginning of April 2015.

Italy

In December 2014, Italy introduced a patent box regime based on the 'nexus approach' set out by the OECD. In the first quarter of 2015, the Italian government has extended the scope of the patent box through a Law Decree titled Investment Compact, which is due to be converted into law within 60 days of its publication in the official gazette on 24 January 2015.

The benefits of the patent box will be extended to trademarks, removing the stipulation that they have to be 'functionally equivalent to patents' although maintaining the requirement that the patent box applies to research and development (R&D) activities/costs. The number of instances in which it is necessary to obtain an Advance Pricing Agreement (APA) in order to take advantage of the regime will be reduced.

France

During the first quarter of 2015, the EC launched an infringement procedure against France regarding the 3% tax on dividend distributions as noncompliant with EU law. The 3% tax entered into force in 2012 and applies to dividends and other distributions (including deemed dividends for French tax purposes) paid by French companies or French branches of non-EU companies.

France may now respond to the objections raised by the EC. If the EC does not accept France's response, it may ask France to amend the 3% tax legislation and make the necessary changes to the French provisions to bring them into compliance with EU law.

Kazakhstan

During the first quarter of 2015, the US and Kazakhstan announced a mutual agreement between the countries' competent authorities establishing the eligibility of fiscally transparent entities (e.g., partnerships, limited liability companies (LLC), and Subchapter S corporations) for benefits under the US-Kazakhstan double tax treaty (DTT). The agreement states that fiscally transparent entities are entitled to DTT benefits and clarifies the procedures to apply for such benefits.

Luxembourg

During the first quarter of 2015, the Luxembourg tax authorities released circular LIR n 14/4, which includes more detailed guidance on the tax treatment of income derived by Luxembourg limited partnerships (Société en Commandite Simple - SCS) and Luxembourg special limited partnerships (Société en Commandite Simple Spéciale - SCSp). These entities are tax-transparent, and thus not subject to Luxembourg corporate income tax at the entity level. Instead, their partners are treated as carrying out the activities of the SCS or SCSp.

Singapore

During the first quarter of 2015, measures announced as part of the 2015 Budget were substantively enacted in Singapore. These included the following:

South Africa

During the first quarter of 2015, the South African government introduced domestic legislation that implements some of the expected recommendations of Action 4 of the BEPS project. The legislation limits deductible interest on debts owed to persons not subject to South African tax. The limitation will apply regardless of the debt's terms.

In addition, a number of measures announced as part of the 2014 Budget were enacted in the first quarter of 2015. These included the following:

During the first quarter of 2015, the Finance Minister also announced the 2015 Budget, which included the following key proposals:

Spain

During the first quarter of 2015, the Spanish government announced its intent to adopt the OECD's CbC reporting requirements. More details will follow as the draft Corporate Income Tax Regulations are issued, together with confirmation as to when they become effective.

United Kingdom

During the first quarter of 2015, the following measures were enacted in the UK:

In addition, the UK government published the draft legislation to enable the introduction of CbC reporting in the UK. The draft law confirms that the UK parented multinationals will be required to provide CbC tax-related data to HM Revenue & Customs (HMRC) and indicates how the implementing regulation is to be introduced. The draft law does not specify a proposed date for implementation, but it is expected that multinationals will be required to prepare the CbC reporting template for financial years beginning on or after 1 January 2016, which is consistent with the OECD's guidelines (see above).

United States

As mentioned under Kazakhstan heading above, there is now a mutual agreement between the US and Kazakhstan's competent authorities that establishes the eligibility of fiscally transparent entities for benefits under the US-Kazakhstan DTT.

Tax accounting refresher

In this section we discuss the determination of which accounting standards apply to various types of taxes or tax systems. We also discuss some of the differences in the accounting treatment of these taxes under US GAAP and IFRS.

Taxes based on income, taxes not based on income and 'hybrid' taxes

Overview

The principles, presentation, and disclosure requirements of the income tax accounting standards under US GAAP (ASC 740) and IFRS (IAS 12) are applicable to 'taxes based on income'. Although the literature does not clearly define this term, we believe that a 'tax based on income' is predicated on a concept of income less allowable expenses incurred to generate and earn that income.

The accounting for taxes that are not based on income would follow other accounting principles, including presentation 'above the line' rather than in income tax accounts.

It is not always easy to determine if a tax (wholly or partially) is based on income. As governments increasingly introduce new designs for taxation, such determinations have become more difficult. There is some perception, on the part of governments, that measures of 'income' alone can be too difficult to examine and may be susceptible to manipulation. Consequently, new or modified measures are introduced to help ensure that some other base captures what the governments expect as their fair share.

Taxes based on income

As mentioned, a tax based on income typically assumes a concept of income less allowable expenses incurred to generate and earn that income. That does not necessarily mean the tax base must include all income in order for it to be an income tax. For example, a tax on net investment income (i.e., applied to investment income less investment-related expenses) can be a tax on income, since it would employ the net income concept. Similarly, all expenses need not be taken into account in order for a tax to be considered a tax on income. Tax regimes in which revenues or receipts are reduced by only one category of expense may be considered an income tax.

A similar determination of whether a tax is based on income is also relevant for foreign tax credit purposes. For example, the US federal foreign tax credit is only available for foreign income taxes. Nonetheless, there can be differences as to whether a particular tax qualifies for foreign tax credit versus whether it is an income tax for accounting purposes.

Accounting treatment under US GAAP and IFRS

If a tax is considered to be a tax based on income, it will be subject to the income tax accounting standards ASC 740 and IAS 12.

Taxes not based on income

Examples of taxes that would generally not be viewed as being based on income include:

A gross receipts tax is generally based upon a jurisdiction's definition of 'taxable gross receipts'. In determining this tax base, many jurisdictions do not take into consideration any expenses or costs incurred to generate such receipts, other than perhaps stated cash discounts, bad debts, and returns and allowances.

Because the starting point of the computation of a gross receipts tax is not 'net' of expenses, a gross receipts tax would not appear to be a tax based on income. For example, insurance 'premium' taxes that are often levied in the US by states are not considered income taxes because they are primarily based on revenues or gross receipts.

However, in jurisdictions where the tax is calculated on modified gross receipts, reduced for certain operating costs (e.g., inventory, depreciation, materials and supplies, wages, and/or other expenditures), the tax could constitute a tax based on income.

Accounting treatment under US GAAP and IFRS

Taxes not based on income are reported as pre-tax items, rather than included in income tax accounts. They would typically be accrued during the period in which the current liability is considered to have arisen. In some circumstances, taxes incurred in connection with inventory transfers (e.g., VAT, excise taxes, customs duties) may be accumulated into inventory costing.

Taxes not based on income will not be subject to deferred tax accounting.

Companies would apply other accounting literature, which might include the guidance set forth in ASC 450, Contingencies, and IAS 37, Provisions, Contingent Liabilities and Contingent Assets. In assessing uncertainty involving non-income based tax exposures, we believe assessments should be performed assuming the taxing authority is fully aware of relevant facts (i.e., without considering the risk of detection).

'Hybrid' taxes

Certain jurisdictions impose taxes that are computed as the higher/lower of a tax based on income or a tax applied to a gross amount, which is not considered income (such as revenue or capital). These are often referred to as 'hybrid taxes'.

Characterisation of hybrid taxes (partly or entirely) as a tax based on income is often complicated.

An example of a hybrid tax within the US is the Texas 'margin tax'. This tax is assessed on an entity's Texas-sourced 'taxable margin' that equals the lesser of:

  1. 70% of an entity's total revenue, or
  2. 100% of its total revenue less, at the taxpayer's annual election, (a) cost of goods sold or (b) compensation, as those terms are defined in the law.

The first measure of 70% of an entity's total revenue would not be equivalent to income (i.e., income less expenses). However, in the second measure, revenues are reduced by either cost of goods sold or compensation. As such, tax calculated based on this measure would generally be considered a tax based on income.

It seems reasonable to expect that a majority of companies will pay tax on the second measure, as it is likely to produce a smaller taxable margin than the '70% of total revenue'. As such, Texas margin tax should generally be considered as a tax based on income.

Although the measure of 70% of an entity's total revenue would not be equivalent to income, it can be viewed as a maximum-threshold measure within a broader income tax structure. This therefore should not impact the characterisation of the tax as a tax based on income.

Another example of a hybrid tax is the Colombian 'equality tax' (CREE in the Spanish acronym), which functions in addition to the regular income tax. CREE tax is determined by applying 9% to a base defined as the greater of:

  1. CREE regular taxable income (broadly, gross revenue reduced by ordinary and necessary expenses, interest, and depreciation), or
  2. 3% of net equity.

Under US GAAP, such a hybrid tax is considered an income tax only to the extent of its portion that exceeds the tax based on the amount not considered income. And only that portion is presented as income tax expense in any given year.

For example, if a tax based on income is $100 and a tax based on capital (or net equity) is $80 then only $20 would be subject to ASC 740. In a reverse situation, where a tax based on income is $80 and a tax based on capital is $100, no portion of the tax will be accounted for under ASC 740. Similarly, where a tax based on income is $100 and a tax based on capital is $100, no amount would be accounted for under ASC 740.

The above alternative tax calculations raise questions on how ASC 740 should be applied in determining the applicable tax rate that is used to compute deferred tax assets and liabilities.

In measuring deferred taxes, an entity should base the applicable rate on the incremental expected tax rate for the year that the temporary difference is expected to reverse.

Another acceptable approach would be to use the applicable rate that the statute prescribes for the income-based computations, unless the reversals of temporary differences are what cause the income-based tax to exceed the capital-based computation.

Accounting for hybrid taxes is not specifically addressed within IFRS.

Applying the principles in IAS 12 to the accounting for hybrid taxes, entities can adopt either one of the following approaches and apply it consistently:

Deferred taxes should be recognised and measured according to that classification.

Contacts

For more information on the topics discussed in this newsletter or for other tax accounting questions, including how to obtain copies of the PwC publications referenced, contact your local PwC engagement team or your Tax Accounting Services network member listed here.

Global and United Kingdom

Andrew Wiggins
+44-(0)-121-232-2065
andrew.wiggins@uk.pwc.com

EMEA

Kenneth Shives
+32-(2)-710-4812
kenneth.shives@be.pwc.com

Asia Pacific

Terry SY Tam
+86-(21)-2323-1555
terry.sy.tam@cn.pwc.com

Latin America

Marjorie Dhunjishah
+1-(703)-918-3608
marjorie.l.dhunjishah@us.pwc.com

Tax accounting leaders in major countries

Country Name Telephone Email
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
Nicole Inglis
+1-(416)-869-2328
+1-(604)-806-7781
spence.n.mcdonnell@ca.pwc.com
nicole.f.inglis@ca.pwc.com
China Terry SY Tam +86-(21)-2323-1555 terry.sy.tam@cn.pwc.com
France Marine Gril-Gadonneix +33-(1)-56-57-43-16 marine.gril-gadonneix@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

Primary authors

Andrew Wiggins
+44-(0)-121-232-2065
andrew.wiggins@uk.pwc.com
Edward Abahoonie
+1-973-236-4448
edward.abahoonie@us.pwc.com
Steven Schaefer
+1-(973)-236-7064
steven.schaefer@us.pwc.com
Katya Umanskaya
+1-(312)-298-3013
ekaterina.umanskaya@us.pwc.com