The Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU)¹ that will require companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory² (e.g., intangible assets) in the period in which the transfer occurs.

That's a change from today's guidance, which requires companies to defer the income tax effects of intercompany transfers of assets until the asset has been sold to an outside party or otherwise recognized (e.g., depreciated, amortized, impaired). The new guidance will require companies to defer the income tax effects only of intercompany transfers of inventory.

Key considerations

The new standard requires companies to recognize the income tax effects of intercompany sales or transfers of assets, other than inventory, in the income statement as income tax expense (or benefit) in the period the sale or transfer occurs. The exception to recognizing the income tax effects of intercompany sales or transfers of assets remains in place for intercompany inventory sales and transfers.

The Master Glossary of the Accounting Standards Codification (ASC) describes inventory as tangible personal property that is awaiting sale (the merchandise of a trading concern and the finished goods of a manufacturer), goods in the course of production (work in process) and goods to be consumed directly or indirectly in production (raw materials and supplies). Long-term assets subject to depreciation (or amortization) accounting, or goods which, when put into use, will be classified as long-term assets do not meet the definition.

Under the new guidance, companies will evaluate whether the tax effects of intercompany sales or transfers of non-inventory assets should be included in their estimates of annual effective tax rates by using existing interim guidance on income tax accounting.

Effective date and transition

The new guidance is effective for public business entities (PBEs) for annual periods beginning after December 15, 2017 (i.e., 2018 for a calendar-year entity), and interim periods within those annual periods. For all other entities, the guidance is effective for annual periods beginning after December 15, 2018 (i.e., 2019 for a calendar-year entity), and interim periods the following year. Early adoption is permitted for all entities as of the beginning of an annual period (i.e., early adoption is permitted only in the first interim period).

The guidance requires companies to apply a modified retrospective approach with a cumulative catch-up adjustment to opening retained earnings in the period of adoption (i.e., January 1, 2018, for calendar-year PBEs). That is, in the period of adoption, companies will write off any income tax effects that had been deferred (i.e., prepaid) from past intercompany transactions involving non-inventory assets to opening retained earnings.

In addition, companies will record deferred tax balances with an offset to opening retained earnings for amounts that they haven't recognized under today's guidance but will be recognized under the new guidance. Any deferred tax assets recorded upon adoption will need to be assessed for realizability under ASC 740. If a valuation allowance on those deferred tax assets is necessary on the date of adoption, that allowance will be recorded with an offset to opening retained earnings.

Companies will have to disclose in the year of adoption the nature of and reason for the change in accounting principle and certain quantitative information about the effects of the change in accounting principle.

Implications

Entities should take the following steps now to prepare for adoption of this new guidance, given the amount of effort they may need to expend to implement major new standards on revenue recognition, leases and credit impairment over the next few years:

— Identify non-inventory intra-entity transactions for which the asset will remain in the consolidated group at the date of adoption (i.e., a prepaid asset related to the non-inventory intra-entity transaction exists just before adoption). Also, identify any deferred tax balances that should be recognized and determine the prepaid assets to be reversed upon adoption.

— Consider whether any valuation allowances are needed on any recognized deferred tax assets that are not realizable.

— Consider the need for changes to financial reporting processes and controls to track and record temporary differences arising from intra-entity transfers after adoption.

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RELATED RESOURCES

— For more information about EY's Tax Accounting services, visit us at www.ey.com/US/TaxAccounting
— For more information about EY's Tax Accounting University education program for clients, visit us at www.ey.com/TAU

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ENDNOTES

¹ ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory.

² As defined by the ASC Master Glossary.