ASC 740 CURRENT ISSUES - BDO USA, LLP · BDO USA, LLP, a Delaware limited liability partnership, is...

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ASC 740CURRENT ISSUES

Practical Issues Impacting Income Tax Provisions

ASC 740 – Practical Issues Impacting Income Tax Provisions 2

With You Today

DANIEL NEWTONTax Partner – ASC 740 Technical Practice LeaderNational Tax Office

[email protected]


Income Taxes – Increased Risk


Increased Scrutiny For Taxes

Tax Expense/Benefit/Deferral Other ASC 740 Issues

Disclosure Year 2012 2013 2014 2015 2016 2017 2018

Tax/Expense Restatements 113 103 114 95 104 84 54

Total Restatements 854 876 857 757 686 573 516

% of All Restatements 13.2% 11.8% 13.3% 12.5% 15.2% 14.7% 10.5%

Source: 2018 Financial Restatements; An Eighteen Year Comparison published August 2019 by Audit Analytics.

Tax continues to be one of the top accounting issues resulting in restatements.

“Consists of errors or irregularities in approach, understanding or calculation associated with various forms of tax obligations or benefits. Many of these restatements relate to foreign tax, specialty taxes or planning issues. Some deal with failures to identify appropriate differences between tax and book adjustments.”

Financial Restatements:

ASC 740 – Practical Issues Impacting Income Tax Provisions5

Critical Audit Matters


Critical Audit Matters (CAMs)

• In October 2017 the SEC approved a new PCAOB standard intended to enhance the auditor reporting model

• The new model will now require the audit report to disclose in the report matters arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and relates to:

accounts or disclosures that are material to the financial statements AND

involved especially challenging ,subjective, or complex auditor judgement

• A CAM will include the following four elements in the audit report:Identification of the CAM Description of how the CAM was

addressed in the audit

Description of the principal considerations that lead the auditor to determine the matter was a CAM

Reference to the financial statements or disclosures


CAMs (cont’d)

• Reporting of CAMs are effective for: • Audits for fiscal years ending on or after June 30, 2019 for large accelerated

filers• For audits of fiscal years ending on or after December 15, 2020 for all other

companies who are required to report CAMs• Reporting CAMs is not required for audits of broker dealers reporting under the

Securities and Exchange Act of 1934 Rule 17a-5,employee stock purchase, savings or other similar plans and emerging growth companies.


CAM – Income Tax Cycle

- Any CAM’s within the income tax cycle should be defined to a specific element within the income tax provision

Tax & Audit should

conduct assessment together

Risk Assessment / Planning

Substantive Procedures

Specific Element(s) of Income Tax Provision

CAM guidance re: taxes


CAMs – Income Tax Examples

• Income Tax was identified as a CAM during dry runs by 57% of certain large accelerated filers based on a recent Intelligize CAM Survey report (9/10/19)

• Recent Tax CAMs addressed the following issues: Uncertain Tax Positions – Microsoft Corp. Realizability of the deferred tax assets – Atlassian Corp PLC Assessment of gross unrecognized tax benefits – Ubiquiti Inc. Realizability of deferred tax assets – Quinstreet, Inc. Assessment of disallowance calculations related to executive compensation

limitations (IRC §162(m)) – K12 Inc.• As noted earlier, tax-related CAMs should focus on a specific area of the income

tax provision process.


Proposed ASUs


ASC 740 Simplification


ASC 740 Simplification

• At its April 10th Board meeting the FASB decided to add to its agenda a project regarding simplifications to accounting for income taxes

• Project is part of the Board’s Simplification Initiative• The FASB had noted that accounting for income taxes has been among the top

areas of restatement over the last several years (13-15 % of all restatements)• Based on feedback from accounting firms as well as suggestions from preparers

and practitioners the Board identified certain requirements that had less relevance given tax reform as well as other requirements which were complex and prone to errors


ASC 740 Simplification (cont’d)

The Board decided to remove the following exceptions in Topic 740, Income Taxes:• Exception to the incremental approach for intraperiod tax allocation when

there is a loss from continuing operations and income or a gain from other items (for example, discontinued operations or other comprehensive income)

• Exception to the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment

• Exception to the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary (therefore, an entity would have the ability to assert indefinite reinvestment for the entire basis difference of a subsidiary)

• Exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year.



The board also decided the following:• An entity should recognize a franchise tax that is partially based on income in

accordance with Topic 740 and account for any incremental amount as a non-income-based tax.

• An entity should evaluate when a step up in the tax basis of goodwill should be considered part of the initial recognition of book goodwill and when it should be considered a separate transaction.

• An entity should be permitted to forgo the allocation of consolidated current and deferred tax expense to legal entities that are not subject to tax in their separate financial statements.

• An entity should reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date.



• The Board also decided to make Codification improvements for income taxes related to employee stock ownership plans and investments in qualified affordable housing projects accounted for using the equity method.

• The Board decided to exclude from the scope of the project an issue involving the accounting for nondeductible goodwill by private companies.



The Board affirmed its initial decisions at a meeting on September 4, 2019. In addition, the Board decided that an entity should apply the amendments as follows:• Either retrospectively or modified retrospective for franchise taxes that are

partially based on income (changed from initial retrospective recommendation)• Retrospectively for the election to forgo the allocation of consolidated taxes

to legal entities that are not subject to tax in their separate financial statements

• Using a modified retrospective approach for ownership changes to a foreign equity method investment or subsidiary

• Prospectively for all other amendments to Topic 740.


Disclosure Framework


Disclosure Framework

On, March 25th, the FASBI issued a proposed Accounting Standard Update (ASU), Disclosure Framework-Changes to the Disclosure Requirements for Income Taxes:• This proposed ASU is a revision to an exposure draft which was issued on July

26,2016• The amendments in the ASU will apply to all entities that are subject to income

taxes• Certain of the disclosures would only be applicable to public business entities as

that term is defined in the Master Glossary of the Codification• Comments were received on May 31, 2019


Disclosure Framework (cont’d)

As proposed all entities would need to disclose:• Income (or loss) from continuing operations before income tax expense (or

benefit) and before intra-entity eliminations disaggregated between domestic and foreign

• Income tax expense (or benefit) from continuing operations disaggregated between federal, state, and foreign

• Income taxes paid disaggregated between federal, state, and foreign.



The following disclosures would be required for PBEs only: • The line items in the statement of financial position in which the unrecognized

tax benefits are presented and the related amounts of such unrecognized tax benefits

• The amount and explanation of the valuation allowance recognized and/or released during the reporting period –requires an explanation of what increases were and what decreases were and not merely a statement regarding that there was a net change-SEC Regulation S-X 210.12-09, Valuation and Qualifying Accounts requires registrants to provide a schedule ( basically a rollforward ) on valuation reserves if that information is not disclosed elsewhere in the financial statements. See subsequent slide for sample disclosure and rollforward.

• The total amount of unrecognized tax benefits that offsets the deferred tax assets for carryforwards ( see subsequent slide for further discussion).



The proposed ASU would:• Modify the existing rate reconciliation requirement for PBEs to be consistent

with U.S. Securities and Exchange Commission (SEC) Regulation S-X 210.4-08(h), Rules of General Application—General Notes to Financial Statements: Income Tax Expense.

• That regulation requires separate disclosure for any reconciling item that amounts to more than 5 percent of the amount computed by multiplying the income before tax by the applicable statutory federal income tax rate.

• The reconciliation may be presented in percentages or in reporting currency amounts.

• The proposed amendments would further modify the requirement to explainthe change in an amount or a percentage of a reconciling item from year to year (see subsequent slide for an example).- Do percentages make sense?—sensitive to variations in pre tax income

• An entity other than a public business entity shall disclose the nature of significant reconciling items but may omit a numerical reconciliation.



The amendments in this proposed Update would reduce diversity in practice by explicitly requiring a PBE to disclose: • The amounts of federal, state, and foreign carryforwards (tax effected before

any valuation allowance) by time period of expiration for each of the first five years after the reporting date, a total for any remaining years, and a total for carryforwards that do not expire.

• The valuation allowance associated with the total tax-effected amounts of federal, state, and foreign carryforwards.

• The total amount of unrecognized tax benefits that offsets the deferred tax asset attributable to carryforwards in accordance with paragraph 740-10-45-10A.

• An entity other than a public business entity would be required to disclose the total amounts of federal, state, and foreign credit carryforwards and the total amounts of other federal, state, and foreign carryforwards (not tax effected), separately for those carryforwards that do not expire and those that do expire, along with their expiration dates (or a range of expiration dates).


The proposed amendments in the ASU would:• Eliminate the requirement for all entities to (1) disclose the nature and

estimate of the range of the reasonably possible change in the unrecognized tax benefits balance in the next 12 months or (2) make a statement that an estimate of the range cannot be made

• Remove the requirement to disclose the cumulative amount of each type of temporary difference when a deferred tax liability is not recognized because of the exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures.

• Clarify that the disclosure of income taxes paid during the period under Topic 230, Statement of Cash Flows, is required for interim periods.

• Clarify that income taxes on foreign earnings that are imposed by the jurisdiction of domicile shall be included in the amount for that jurisdiction of domicile ( currently there is diversity in practice—relates to withholding taxes).

• Replace the term Public Entity with term Public Business Entity throughout the Topic 740 in accordance with ASU 2013-12, Definition of a Public Business Entity.




The amendments in this proposed Update would be applied prospectively. The effective date and whether early adoption of the proposed amendments should be permitted will be determined after the Board considers stakeholder feedback on the proposed amendments.


Reflections on Tax Reform


Domestic Issues


Net Operating Loss Carryovers

Tax Law Change ASC 740 Issues

• Tax loss carryovers would be limited to 80% of taxable income for losses arising in tax years beginning after December 31, 2017.

• The carryback provisions would be repealed for tax years ending after December 31, 2017.

• Companies that are in positions where the only source of income is the reversal of taxable temporary differences would need to assess whether the change in tax law would impact their valuation allowance assessment.

• “Naked Credits” – Could now be offset by post enactment losses which would include reversing deductible temporary differences to the extent they create a “loss” when scheduled.

• Be cognizant of reversal pattern of DTLs relating to short-lived intangibles (i.e., no tax basis) which might result in a situation where only 80% could be offset.

• Impact of Code Sec. 382, Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following an Ownership Change, must be considered in the scheduling process.


Net Operating Loss Carryovers (cont’d)

• One of the more difficult provisions of the TCJA. Requires detail scheduling in certain cases to determine the amount of deferred taxes to be recognized in the financial statements. Scheduling needs to take into account the provisions of the tax law including limitations e.g. Code Sec. 382.

• See examples that follow.


Assume a 25% tax rateBlunder Inc., a calendar year U.S. domestic C Corporation, had been realizing losses in prior years and is unable to reliably project future income. At 12/31/2018 Blunder has a pre 2018 net operating loss carryover of $1,000 which is limited pursuant to Code Sec 382 to $100 per year. In addition it has deferred tax assets of $200 which reverse ratably over the next two years and deferred tax liabilities which reverse straight line over the next four years. Since Blunder is not able to rely upon projected future income to support its current position it determined based upon the following that it should record a DTL of $ 200 at 12/31/18:

NOLs Example – Scheduling Example

Gross Amount Rate DTA/DTL

Pre 2017 NOL $1,000 25% 250

DTAs @ 12/31/18 200 25% 50

DTL - intangibles (2,000) 25% (500)

DTL - net $(200)


In assessing the company’s accounting it is clear that Blunder blundered since it failed to assess whether its temporary differences reversed within the same time frame, were of the same character of income and were within the same jurisdiction. The below would be more accurate in determining its deferred tax position:

NOLs (cont’d)

DTA (DTL) tax effected 12/31/18 2019 2020 2021 2022 Net

Pre 2017 NOL $250 $(25) $(25) $(25) $(25)

DTAs 50 (25) (25) - -

DTL - intangibles (500) 125 125 125 125

DTL - net $(200) $75 $75 $100 $100 $(350)

Proof:

Pre 2017 NOL $250

V.A. (150)

Recognized pre 2017 NOL 100

DTAs 50

DTLs (500)

Net DTL $(350)


Indefinite Lived Intangibles “Naked Credits” – Scheduling Example

12/31/2019 12/31/2019 12/31/2020 12/31/2021 12/31/2034 12/31/2035 12/31/2036 Total

Average Consolidated Pre-tax book income (los 0 0 0 0 0 0 0

Ded/(Tax) Temp

Reversing DeferredsAccrued Vacation 40,000 (40,000) - - - - - - (40,000) Bad Debt Reserve 5,000,000 (5,000,000) - - - - - - (5,000,000) Deferred Compensation 300,000 (15,789) (15,789) (15,789) (15,789) (15,789) (15,789) (15,789) (300,000) Deferred Gain 8,000,000 (800,000) (800,000) (800,000) (800,000) - - - (8,000,000) Deferred Rent 5,000,000 (1,000,000) (1,000,000) (1,000,000) (1,000,000) - - - (5,000,000) IRC Sec. 481 Adjustment (1,500,000) 750,000 750,000 - - - - 1,500,000 Intangible Assets 90,000,000 (6,000,000) (10,000,000) (9,000,000) (8,500,000) - - - (90,000,000) Other Accrued Liabilities 2,500,000 (2,500,000) - - - - - - (2,500,000) Prepaid Insurance (500,000) 500,000 - - - - - - 500,000 Qualified Film Expense (9,000,000) 7,000,000 2,000,000 - - - - - 9,000,000 Restricted Stock Expense 800,000 (600,000) (200,000) - - - - - (800,000) Fixed Assets 4,000,000 (2,000,000) (1,000,000) (500,000) (500,000) - - - (4,000,000) Installment sale (50,000,000) 50,000,000

Indefinite Deferreds - - - - - - - - - - - - - - - -

Indefinite Intangible Assets (700,000,000) - - - - - - - - - - - - - - - -

(645,360,000) (9,705,789) (10,265,789) 38,684,211 (10,815,789) (15,789) (15,789) (15,789) (54,640,000) -

Estimated Taxable Income (Loss) (9,705,789) (10,265,789) 38,684,211 (10,815,789) (15,789) (15,789) (15,789) Projected 2018 loss (7,000,000) NOL CF (600,000,000) (616,705,789) (626,971,579) (588,287,368) (599,103,158) (661,608,421) (661,624,211) (661,640,000)

Valuation Allowance/ Net DTL:Pre 2018 NOLs (600,000,000) 2020 Usage Per Scheduling Exercise 38,684,211 DTAs w/out NOLs 54,640,000

Pre 2018 NOLs 600,000,000Pre 2018 NOLs - offsets by VA (561,315,789) 2018 projected NOL 7,000,000

Indefinite lived intangibles (700,000,000)"New NOLs" 61,640,000 Valuation allowance (561,315,789)Indefinite Lived DTL (700,000,000)Indefinite Lived DTL @ 80% (assumes Fed only) (560,000,000) Net DTL (599,675,789)Based on Scheduling Exercise, "New NOLs" can be supported by the Indefinite Lived DTL

Gross DTA (DTL)

DTA (DTL) before Attribute

12/31/2018 - Projected


168(k) Bonus ExpensingTax Law Change ASC 740 Issues

• The bill allows for 100% expensing for qualified assets placed in service after September 27, 2017 and before January 1, 2023.

• Expensing amounts are phased down between 2023 through 2026.

• Expands the definition of qualified property to include used property provided the taxpayer had not used the property and it is not acquired from a related party.

• Creates a larger temporary difference related to depreciation.

• Larger taxable temporary differences could give rise to a future source of income which may impact the ability to realize deferred tax assets in the future.

• Will states adopt or decouple – If decouple, will need a separate deferred for state depreciation.

Final regulations issued in September 2019.

Need to assure that properly elect out of bonus.

Can create issues with various limitations e.g. Code Sec 250 deductions for GILTI & FDII (see example that follows)

State issues and separate state deferreds for depreciation


100% Expensing Election (cont’d)Example

With Bonus Without Bonus

PBT (Includes $1,000 book depreciation) $2,000 $2,000

Bonus/regular depreciation ($5,000) ($200)

GILTI Income $8,000 $8,000

GILTI (Sec. 250 Deduction) ($4,000) ($4,000)

FDII($10,666x 37.5%)(Loss)-Income

($4,000)($3,000)

($4,000)$1,800

Add back income (post Code Sec 250 limit)Net Income

$5,8572,857

3,8005,600

Tax rate X 21% X 21%

Current expense 600 $1,176

Deferred expense $1,050 $42

Total expense $1,650 $1,218*Example does not take into account foreign tax credits.1) FDII addback ($13,666= excess 250 deduction (FDII ($10,666)+GILTI($8,000)-($5,000))x$10,666/18,666)X37.5%=$2,9282) GILTI addback ($13,666x($8,000/$18,666)x50%=$2,9293) FDII addback ($8,866x($10,666/$18,666))x 37.5%=$1,8994) GILTI addback ($8,866x($8,000/$18,666))x50%=$1,900

(1+2) (3+4)


162(m) Excessive Employee RemunerationTax Law Change ASC 740 Issues

• The Act eliminates the exceptions for commissions and performance based compensation thus classifying all compensation greater than $1M as subject to limitation.

• Expanded the definition of “covered employee” to include the CFO.

• Covered employee now means the CEO, CFO, plus the three highest compensated officers for the year.

• Adds a rule that once an employee is a “covered employee,” will always be a “covered employee”.

• Provisions are effective for tax years beginning after December 31, 2017.

• Awards that are subject to a written binding contract as of November 2, 2017 are grandfathered.

• Requires that any disallowed compensation due to IRC Sec. 162(m) provisions not be recognized for financial statement purposes.

• The revised 162(m) rules would now require that all compensation in excess of $1M be disallowed.

• Companies should determine what method they are using for disallowed compensation for reporting purposes:- Cash compensation first- Equity compensation first- Pro Rata Method

• Be cognizant of modifications to written binding agreements as of November 2, 2017 which could make the award no longer exempt from disallowance.


162(m) Excessive Employee Remuneration (cont’d)

Issues encountered include:• Monitoring grants to recently hired covered employees• Reviewing grants that have been grandfathered for modification• Scheduling the reversal of year end deferred tax asset to determine if when

it vests or is exercised that it will not be limited( issue always existed butmore focus with tax reform( ASC 740 concern whether you elect cash firstmethod, stock compensation first or pro rata method in assessing therealizability of the DTA))


Limitation on Deduction for InterestTax Law Change ASC 740 Issues

• The Act amends IRC Sec. 163(j) to allow a deduction for net business interest expense of any taxpayer to the extent it exceeds 30% of a businesses’ adjusted taxable income plus floor plan financing interest.

• Adjusted taxable income is computed without regard to deductions for any items not properly allocable to the trade or business, business interest expense or business interest income, net operating losses, 20% deduction for certain pass throughs and, in the case of tax years beginning before January 1, 2022, depreciation, amortization, and depletion.

• Complicated rules relating to partnership interests included.

• Provisions do not apply to a taxpayer that has annual gross receipts less than $25M for the three taxable years prior to the reporting year.

• Unused interest can be carried forward indefinitely.

• Effective for tax years beginning after December 31, 2017.

• Creates a new temporary difference which would need to be assessed for valuation allowance considerations.

• Need to obtain data from partnerships in order to prepare the calculation (if applicable).


Limitation on Deduction for Interest (cont’d)

• In practice could be one of the most if not the most complicated issues from an ASC 740 and tax return perspective

• Proposed regulations were issued in December,2018 (over 450 pages of reading enjoyment), rules are complicated

• Certain view for loss companies that will now become profitable due to 163(j) limit that a valuation allowance could be released with respect to NOLs based on the projected income in spite of the fact that the entity could be creating additional 163(j) limitation which will need to be reserved for

• In addition have seen profitable companies that are leveraged now required to set up a VA on the 163(j) limited interest since unable to project utilization (requires extensive analysis and modeling)

• 30% limitation needs to be considered in ASC 740 analysis including relying solely on reversing taxable temporary differences (unlimited carryover period allows for offset versus a naked credit subject to the 30% limitation)

• See examples that follow


Limitation on Deduction for Interest (163(j))

Interest Limitation

Projected Income With IRC 163(j) Limitation

Assumptions: 1) Full valuation allowance on $5,000 of gross NOL carryover as of 12/31/20172) Projected loss of $1,000 per year3) Projected 163(j) disallowance per "Tax Cuts and Jobs Act" of $3,000 per year. 4) Unable to project ever being able to use the 163(j) amount.5) Assume 21% tax rate

2018 2019 2020 2021Projected Loss (1,000) (1,000) (1,000) (1,000) 163(j) - originating 3,000 3,000 3,000 3,000 Allowable Interest Deduction (600) (600) (600) (600) Pre-NOL Taxable Income 1,400 1,400 1,400 1,400 NOL C/F Utilization (1,400) (1,400) (1,400) (800) Taxable Income - - - 600 Rate 21% 21% 21% 21%

Tax -$ -$ -$ 126$

In the above example, the originating 163(j) deduction does generate taxable income which will absorb the NOL carryovers. However, even thoughthe NOL carryovers have been realized, there is no incremental benefit in theinstant situation since there is no ability to project the utilization of the originating deductible temporary difference (i.e., 163(j) limitation).

Sheet1

Interest Limitation

Projected Income With IRC 163(j) Limitation

Assumptions:

1) Full valuation allowance on $5,000 of gross NOL carryover as of 12/31/2017

2) Projected loss of $1,000 per year

3) Projected 163(j) disallowance per "Tax Cuts and Jobs Act" of $3,000 per year.

4) Unable to project ever being able to use the 163(j) amount.

5) Assume 21% tax rate

2018201920202021

Projected Loss(1,000)(1,000)(1,000)(1,000)

163(j) - originating3,0003,0003,0003,000

Allowable Interest Deduction(600)(600)(600)(600)

Pre-NOL Taxable Income1,4001,4001,4001,400

NOL C/F Utilization(1,400)(1,400)(1,400)(800)

Taxable Income---600

Rate21%21%21%21%

Tax$ -$ -$ -$ 126

In the above example, the originating 163(j) deduction does generate

taxable income which will absorb the NOL carryovers. However, even though

the NOL carryovers have been realized, there is no incremental benefit in the

instant situation since there is no ability to project the utilization of the

originating deductible temporary difference (i.e., 163(j) limitation).


Limitation on Deduction for Interest (163(j))

Example 2

2018 2019 2020 2021Projected Loss (1,000) (1,000) (1,000) (1,000) 163(j) - originating 3,000 3,000 3,000 3,000 Allowable Interest Deduction (600) (600) (600) (600) Pre-NOL Taxable Income 1,400 1,400 1,400 1,400 NOL C/F Utilization (1,400) (1,400) (1,400) (800) Taxable Income - - - 600 Rate 21% 21% 21% 21%

Tax -$ -$ -$ 126$

In this example, which is identical to the one above, certain firmswould ignore the fact that there is no incremental benefit and would release the valuation allowance as of 12/31/2017 since the NOLs areable to be utilized.

* For simplicity, It has been assumed that depreciation/amortization has been deducted/added back to the loss and no interest income exists.

Sheet1

Example 2

2018201920202021

Projected Loss(1,000)(1,000)(1,000)(1,000)

163(j) - originating3,0003,0003,0003,000

Allowable Interest Deduction(600)(600)(600)(600)

Pre-NOL Taxable Income1,4001,4001,4001,400

NOL C/F Utilization(1,400)(1,400)(1,400)(800)

Taxable Income---600

Rate21%21%21%21%

Tax$ -$ -$ -$ 126

In this example, which is identical to the one above, certain firms

would ignore the fact that there is no incremental benefit and would

release the valuation allowance as of 12/31/2017 since the NOLs are

able to be utilized.

* For simplicity, It has been assumed that depreciation/amortization has been deducted/

added back to the loss and no interest income exists.


Limitation on Business Interest Deduction (163(j))

• Projected income and rate assuming facts of the previous example. Except now in Q1 of 2018 the facts remain the same.

• In the first example there would be no benefit since NOL carryover would be replaced by the originating 163(j) deduction. Thus the deferred tax asset at the BOY and EOY are $0 due to the full valuation allowance position.

• In the second scenario for 2018 projections an expense of $294 would be recorded since $1,400 of the NOL carryover would have been absorbed by the taxable income of $1,400 without any benefit being recorded for the 163(j) interest.

Analysis of Expense

• In either case this entity would be excluded from the calculation of the estimated annual rate pursuant to ASC 740-270-30-36 since no tax benefit can be realized. This entity would prepare its own annual effective tax rate and would apply that rate to its y-t-d Income/(loss) in accordance with the subtopic.

Replacement Theory Benefit Theory

BOY DTA $0 $1,050

Current Year Movement 0 (294)

EOY DTA $0 $756



Beta Company (Company) , a US corporation , has been in a loss position for both financial reporting and tax purposes for the last 3 years.

However, in 2018 the Company generates taxable income due the application of Internal Revenue Code Section(IRC) 163(j) ,limitation on business interest.

Beta's deferred tax asset (DTA) and liability (DTL) position as of December 31,2018 is as follows:

DTA(DTL)

Net operating loss carryover(NOL)--pre 2018 $5,000

163(j) limitation 4,000

Bad debt reserve 100

Property, plant & equipment (PPE) -9,000

Indefinite lived intangible -7,000

Net DTL -6,900

The pre-2018 NOLs are not subject to limitation pursuant to IRC 382,limitation on net operating loss carryovers and certain built-inlosses following an ownership change for the first example and are limited to $150 per year in the second example. The net operating losses expire ratably between 2034-2037.



The bad debt deduction is expected to reverse the following year while the DTL for the PP&E will reverse ratably over the next 5 years.

The following is the analysis the Company would perform to determine its ending deferred tax position for 2018:

Deferred tax position REVERSALS12/31/2018 12/31/2019 12/31/2020 12/31/2021 12/31/2022 12/31/2023 Indefinite Final DTL

PPE -9,000 1,800 1,800 1,800 1,800 1,800

Bad debt reserve 100 -100

Indefinite lived intangible -7,000 7,000

163(j) interest 4,000 -510 -540 -540 -540 -540 -1330

Income(loss) -11,900 1,190 1,260 1,260 1,260 1,260 5,670

NOL 5,000 -1190 -1260 -1260 -1,260 -30 0

Income(loss)/DTA(DTL) -6,900 0 0 0 0 $1,230 5,670 6900

The above example illustrates that Beta is able to support its deferred tax assets solely with the reversal of taxable temporary differencespursuant to ASC 740-10-30-18a and thus will recognize a DTL of $6,900. Since the Company is able to support the realization of its deferred

tax assets with the revesal of its taxable temporary difference it is not necessary to consider other evidence as as outlined in ASC 740-10-30-18.



Deferred tax position REVERSALS

12/31/2018 12/31/2019 12/31/2020 12/31/2021 12/31/2022 12/31/2023 Indefinite Final DTL

PPE -9,000 1,800 1,800 1,800 1,800 1,800

Bad debt reserve 100 -100

Indefinite lived intangible -7,000 7,000

163(j) interest 4,000 -510 -540 -540 -540 -540 -1330

Income(loss) -11,900 1,190 1,260 1,260 1,260 1,260 5,670

NOL 5,000 -150 -150 -150 -150 -150 0

Income(loss)/DTA(DTL) -6,900 1,040 1,110 1,110 1,110 $1,110 5,670 11,150

The above example illustrates that Beta is able to support its deferred tax assets solely with the reversal of taxable temporary differencespursuant to ASC 740-10-30-18a and thus will recognize a DTL of $11,150. Since the Company is able to support the realization of its Deferred tax assets with the reversal of its taxable temporary difference it is not necessary to consider other evidence as outlined in ASC 740-10-30-18.


International Issues ASC 740


• How are the earnings of a foreign company taxed to its US shareholdersafter tax reform?

• General Rule was – a U.S. taxpayer was not subject to taxation on the earnings of a foreign subsidiary until the earnings were distributed to the taxpayer with certain exceptions e.g. subpart F income

• Post Tax Reform U.S. Outside basis difference concerns – income recognition- Transition tax (Code Sec. 965) – One time tax on untaxed foreign earnings

- Complicated basis adjustment rules as outlined in final regulations issued in January 2019.

- Subpart F inclusions – virtually the same as under pre-tax reform and takes precedence over any other inclusions; tax basis adjusted for inclusion.

- GILTI inclusions (to be discussed further) – final and proposed regulations issued in June 2019 but did not address basis rules as had been done in the proposed regulations (reserved for future regulation)

Accounting for Outside Bases DifferencesOverview of U.S. Taxation of Foreign Earnings


Accounting for Outside Bases Differences Overview of U.S. Taxation of Foreign Earnings

• Code Sec. 245A – allows for the distribution on a tax free basis of residual income after the previous mandatory inclusions, does not create a basis adjustment for tax purposes but this portion of the outside basis difference (book vs tax) can be recovered tax free.

• Code Sec 956 (Investment in U.S. Property)- Proposed regulations issued in November 2018 and final regulations in May,2019 all but eliminates

the impact of Code Sec 956 – regulations limit the application of 956 to instances where an amount would be taxable after the application Code Sec. 245A- Fails holding period requirement in Code Sec. 245A- Hybrid dividend application in Code Sec 245A

- Still need controls in place to monitor this if either of above issues are applicable - Need to know client/company position

• Need to know and track book vs tax basis


Transition Tax Finalization – What’s Left?

• SAB 118 measurement period ended December 22, 2018• Transition tax with appropriate elections needed to be included in 12/31/17

tax returns (extended due date 10/15/18). Final regulations allow basis elections to be made or revoked within 90 days of the publication of the regulations in the Federal Register.

• ASC 740 Issues- Uncertain tax positions (Fin 48)- Basis issues- APB 23

- Withholding- Currency movement

- Code Sec 965 installment payments


Global Intangible Low-Tax IncomeTax Law Change ASC 740 Issues

• IRC Sec. 951A has been added to the law which taxes GILTI in a manner similar to Subpart F. Applies whether the income is distributed or not (specifically stated that it is not Subpart F income).

• GILTI = Net tested income over its “net deemed tangible income return.”

• “Net tested income”=Tested income over tested loss. For this purpose tested income generally includes gross income of the CFC other than:- ECI;- Subpart F income;- Amounts excluded from Subpart F

(954(b)(4)); - Dividends received from a related person

(954(d)(3)); and- Foreign oil & gas extraction income

(907(c)(1)).• Tested loss means the excess (if any) of

deductions (including taxes) properly allocable to the corporation’s gross income, determined without regard to the tested income exceptions over the amount of such gross income.

• Net deemed tangible income return equals 10% of the excess of the CFC’s qualified business asset investment (“QBAI”) over interest expense.

• For GILTI to have an ASC 740 consequence, a company must conclude that it will be a GILTI taxpayer.

• As discussed, the rules are complex and will require systems to be developed to track the necessary data to conclude whether the tax applies or does not apply.

• Needs to be considered for the 1st Q of 2018 (calendar year) and 2019 (fiscal year) companies in developing effective tax rate.

• Query whether companies should recognize deferred taxes for any outside basis differences that are expected to reverse as GILTI.- Unrealized GILTI analogous to unrealized

Subpart F income.- At the January 18, 2018 meeting, the FASB

staff concluded that companies could make a policy election to recognize or not recognize deferred taxes on underlying temporary differences that would reverse as GILTI.


Tax Law Change ASC 740 Issues

• QBAI is determined as the average of the aggregate of its adjusted bases as of the close of each quarter in specified property. Adjusted basis is determined using the alternative depreciation system under IRC Sec. 168(g).

• New IRC Sec. 250 would allow a deduction of 50% of GILTI for the tax years beginning after December 31, 2017 and before January 1, 2026 reduced to 37.5% for years thereafter.

• Allows a deemed paid credit equal to 80% of GILTI inclusion amount over aggregate tested income multiplied by the aggregate tested foreign income taxes paid or accrued by all CFCs (GILTI is in its own separate tax credit basket and there is no carryover allowed).

• Effective for tax years beginning after December 31, 2017.

• Exception for high tax “kick out” is based upon effective rate – e.g., foreign taxes paid/accrued over E&P earnings and not based upon comparison of US vs. foreign statutory rates.

Global Intangible Low-Tax Income (cont’d)


GILTI

• For GILTI to have an ASC 740 consequence, a company must conclude that it will be a GILTI taxpayer.

• As discussed, the rules are complex and will require systems to be developed to track the necessary data to conclude whether the tax applies or does not apply.

• Needs to be considered /projected for quarterly reporting of in developing effective tax rate.

• Query whether companies should recognize deferred taxes for any outside basis differences that are expected to reverse as GILTI.

• Final regulations issues in June did not address basis issues and reserved this matter for a future regulation project.


GILTI (cont’d)

• Temporary differences impacting GILTI is analogous to unrealized Subpart F income.

• At the January 18, 2018 meeting, the FASB staff concluded that companies could make a policy election to recognize or not recognize US deferred taxes on foreign subsidiary temporary differences that would reverse as GILTI.

• Most companies do not provide US deferred taxes for temporary differences impacting GILTI

• Exception for high tax “kick out” is based upon effective rate – e.g., foreign taxes paid/accrued over E&P earnings and not based upon comparison of US vs. foreign statutory rates (in June proposed regulations were issued which would allow all high tax earnings and not just subpart F income to be excluded).


GILTI (cont’d)

Valuation allowance considerations

• GILTI earnings may provide a source of income for realization of US DTA’s which have a valuation allowance

• Reduction of some or all of V/A may be appropriate• Two policy elections available in determining v/a reduction:

1. Tax law ordering- if GILTI inclusions allow for NOL’s to be utilized, project out NOL utilization and reduce valuation allowance

2. With and without method- reduce V/A only if there is an incremental cash tax benefit due to NOL’s.

• Compute US tax on GILTI earnings with and without the NOL’s. If thereis less tax with the NOL’s , reduce V/A by such amount. Need toconsider FTC’s and section 250 deduction in this comparison.


Questions?


General Disclaimer:

These materials do not constitute tax or legal advice, and cannot be relied upon for purposes of avoiding penalties under the Internal Revenue Code. These materials may omit discussion of exceptions, qualification, definitions, effective dates, jurisdictional differences, and other relevant authorities and considerations. In no event should a reader rely on these materials in planning a specific transaction. BDO will not be responsible for any error, omission, or inaccuracy in these materials.

ASC 740�current issuesWith You TodayIncome Taxes – Increased RiskIncreased Scrutiny For TaxesCritical Audit MattersCritical Audit Matters (CAMs)CAMs (cont’d)CAM – Income Tax CycleCAMs – Income Tax ExamplesProposed ASUsASC 740 SimplificationASC 740 SimplificationASC 740 Simplification (cont’d)ASC 740 Simplification (cont’d)ASC 740 Simplification (cont’d)ASC 740 Simplification (cont’d)Disclosure FrameworkDisclosure Framework Disclosure Framework (cont’d)Disclosure Framework (cont’d)�Disclosure Framework (cont’d)Disclosure Framework (cont’d)Slide Number 23Disclosure Framework (cont’d)Reflections on Tax ReformDomestic IssuesNet Operating Loss CarryoversNet Operating Loss Carryovers (cont’d)NOLs �Example – Scheduling ExampleNOLs (cont’d)�Indefinite Lived Intangibles �“Naked Credits” – Scheduling Example168(k) Bonus Expensing100% Expensing Election (cont’d)�Example162(m) Excessive Employee Remuneration�162(m) Excessive Employee Remuneration (cont’d)�Limitation on Deduction for InterestLimitation on Deduction for Interest (cont’d)Limitation on Deduction for Interest (163(j))Limitation on Deduction for Interest (163(j))Limitation on Business Interest Deduction (163(j))Limitation on Business Interest Deduction (163(j))Limitation on Business Interest Deduction (163(j))Limitation on Business Interest Deduction (163(j))International Issues ASC 740Slide Number 45Accounting for Outside Bases Differences �Overview of U.S. Taxation of Foreign EarningsTransition Tax Finalization – What’s Left?� Global Intangible Low-Tax IncomeSlide Number 49GILTIGILTI (cont’d)GILTI (cont’d)Questions?General Disclaimer:

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