04 January 2018 SEC staff provides guidance on accounting for the effects of US tax reform The Securities and Exchange Commission (SEC) staff issued Staff Accounting Bulletin (SAB) 118 1 to provide guidance for companies that have not completed their accounting for the income tax effects of the Tax Cuts and Jobs Act in the period of enactment, which is the period that includes December 22, 2017. The SEC staff acknowledged the challenges companies may face in accounting for the effects of the Act by their financial reporting deadlines and said the guidance is intended to help companies provide investors with timely, decision-useful information. The SEC staff noted that Accounting Standards Codification (ASC) 740, Income Taxes, doesn't address these challenges and said clarification was needed to address uncertainty or diversity in views about the application of ASC 740 in the period of enactment. "Allowing entities to take a reasonable period to measure and recognize the effects of the Act, while requiring robust disclosures to investors during that period, is a responsible step that promotes the provision of relevant, timely, and decision-useful information to investors," SEC Chief Accountant Wesley Bricker said. SAB 118 applies only to the application of ASC 740 in connection with the Act and should not be relied upon for other changes in tax law. The SEC staff also issued Compliance and Disclosure Interpretation (C&DI) 110.02 to answer questions companies have raised about certain Form 8-K filing requirements. For details on the provisions of the Act, see Tax Alert 2017-2130. For details on accounting and financial reporting considerations related to the Act, see Tax Alert 2017-2134. ASC 740 requires companies to account for the effects of changes in income tax rates and laws on deferred tax balances (including the effects of the Act's one-time transition tax on certain foreign earnings) in the period in which the legislation is enacted. The financial statement effects of a change in tax law are recorded as a component of income tax expense related to continuing operations. In issuing the guidance, the SEC staff said it was clarifying the application of ASC 740 for companies that may encounter situations in which they do not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting under ASC 740 for the reporting period in which the Act was enacted. Accounting for the effects of the Act SAB 118 provides the following guidance: — Accounting for income tax effects is completed — When reporting the effects of the Act on the enactment date, a company must first reflect in its financial statements the income tax effects of the Act for which the accounting under ASC Topic 740 is complete. These completed amounts will not be provisional amounts. — Accounting for income tax effects is incomplete but the company has a reasonable estimate — If a company's accounting for certain income tax effects of the Act is incomplete but it can determine a reasonable estimate of those effects, the SEC staff said that it will not object to a company including the reasonable estimate in its financial statements. The staff said it would not be appropriate for a company to exclude a reasonable estimate from its financial statements if one had been determined. The reasonable estimate should be included in a company's financial statements in the first reporting period in which a company is able to determine the estimate. The estimate would be reported as a provisional amount in the financial statements during a "measurement period." 2 Provisional amounts could include, for example, reasonable estimates that give rise to new current or deferred taxes based on certain provisions of the Act, as well as adjustments to current or deferred taxes that existed prior to the Act's enactment date. — Accounting for income tax effects is incomplete and the company doesn't have a reasonable estimate — If a company does not have the necessary information to determine a reasonable estimate to include as a provisional amount, the SEC staff said that it would not expect a company to record provisional amounts in its financial statements for the income tax effects for which a reasonable estimate cannot be determined. In these cases, the SEC staff said a company should continue to apply ASC 740 (e.g., when recognizing and measuring current and deferred taxes) based on the provisions of the tax laws that were in effect immediately prior to the Act being enacted. That is, the staff does not believe a company should adjust its current or deferred taxes to account for the income tax effects of the Act until the first reporting period in which a reasonable estimate can be determined. Implications The Act's one-time transition tax requires companies that have deferred recognizing income taxes on certain foreign earnings and profits earned in prior periods (i.e., asserted indefinite reinvestment) to now pay income taxes on those earnings. If a company previously asserted indefinite reinvestment, we believe the company could continue to follow its existing accounting until it has the necessary information to determine a reasonable estimate for the transition tax. |
The measurement period begins in the reporting period that includes the Act's enactment date and ends when a company has obtained, prepared and analyzed the information needed to complete the accounting requirements under ASC 740. The measurement period should not extend beyond one year from the enactment date (i.e., the measurement period must be completed by 22 December 2018). During the measurement period, the staff said it expects companies to act in good faith to complete the accounting under ASC 740. Initial and subsequent reporting of provisional amounts Any provisional amounts or adjustments to provisional amounts included in a company's financial statements during the measurement period (including the period of enactment) should be included in income from continuing operations as an adjustment to tax expense or benefit in the reporting period the amounts are determined. During the measurement period, a company may need to reflect adjustments to its provisional amounts if it obtains, prepares or analyzes additional information about facts and circumstances that existed as of the enactment date that, if known, would have affected the income tax effects initially reported as provisional amounts. A company may also need to report additional tax effects during the measurement period that were not initially reported as provisional amounts, if it obtains, prepares or analyzes additional information about facts and circumstances that existed as of the enactment date. Any income tax effects of events unrelated to the Act should not be reported as measurement period adjustments. Hence, companies will need to make sure they have procedures in place to distinguish between changes to provisional amounts that are related to the Act and transactions entered after the enactment date. For example, a company may enter into a business combination after the enactment date. The tax accounting consequences of the business combination, including the effects on a company's pre-business combination tax attributes (e.g., realizability of deferred tax assets) will need to be considered separately from any changes in provisional amounts related to the accounting for the tax consequences of the Act. Implications While SAB 118 does not address interim reporting during the measurement period, we believe the effects of initially recording provisional amounts related to the enactment date effects of the Act and making adjustments to those amounts, if significant, should be recognized as discrete events similar to the accounting for tax law changes in the period of enactment. Accordingly, companies should not allocate the effect of changes in the enactment date provisional amounts to subsequent interim periods by adjusting the estimated annual effective tax rate. |
SAB 118 does not specify how a company should determine whether it can make a reasonable estimate. A company will need to determine whether a reasonable estimate can be made based on its facts and circumstances. This includes the availability of records to complete the necessary calculations, technical analysis of the new tax law and finalization of its accounting analysis, including its assessment of how certain provisions of the Act may affect its outside basis differences related to foreign subsidiaries. To help companies with their accounting during the measurement period, SAB 118 provides the following examples. Each example assumes the company has only one foreign subsidiary. A company that has more than one foreign subsidiary may reach different conclusions for each subsidiary, depending on the facts and circumstances, including the availability of information necessary to complete the analysis. | Excerpt from SAB 118 | Example 1 — Analysis is incomplete and company cannot reasonably estimate provisional amounts Prior to the reporting period in which the Act was enacted, Company X did not recognize a deferred tax liability related to unremitted foreign earnings because it overcame the presumption of the repatriation of foreign earnings.3 Upon enactment, the Act imposes a tax on certain foreign earnings and profits at various tax rates. Based on Company X's facts and circumstances, it was not able to determine a reasonable estimate of the tax liability for this item for the reporting period in which the Act was enacted by the time that it issued its financial statements for that reporting period; that is, Company X did not have the necessary information available, prepared, or analyzed to develop a reasonable estimate of the tax liability for this item (or evaluate how the Act will impact Company X's existing accounting position to indefinitely reinvest unremitted foreign earnings). As a result, Company X would not include a provisional amount for this item in its financial statements that include the reporting period in which the Act was enacted, but would do so in its financial statements issued for subsequent reporting periods that fall within the measurement period, beginning with the first reporting period falling within the measurement period by which the necessary information became available, prepared, or analyzed in order to develop the reasonable estimate, and ending with the first reporting period within the measurement period in which Company X was able to obtain, prepare, and analyze the necessary information to complete the accounting under ASC 740. |
| Excerpt from SAB 118 | Example 1a — Analysis is incomplete and company can reasonably estimate provisional amounts Assume a similar fact pattern as Example 1; however, Company Y was able to determine a reasonable estimate of the income tax effects of the Act on its unremitted foreign earnings for the reporting period in which the Act was enacted. Company Y, therefore, reported a provisional amount for the income tax effects related to its unremitted foreign earnings in its financial statements that included the reporting period the Act was enacted. In a subsequent reporting period within the measurement period, Company Y was able to obtain, prepare, and analyze the necessary information to complete the accounting under ASC 740, which resulted in an adjustment to Company Y's initial provisional amount to recognize its tax liability. |
| Excerpt from SAB 118 | Example 2 — Analysis is incomplete and company may need to recognize a valuation allowance Company Z has deferred tax assets (assume Company Z was able to comply with [ASC 740] and re-measure its deferred tax assets based on the Act's new tax rates) for which a valuation allowance may need to be recognized (or released) based on application of certain provisions in the Act. If Company Z determines that a reasonable estimate cannot be made for the reporting period [in which] the Act was enacted, no amount for the recognition (or release) of a valuation allowance would be reported. In the next reporting period (following the reporting period in which the Act was enacted), Company Z was able to obtain, prepare, and analyze the necessary information in order to determine that no valuation allowance needed to be recognized (or released) in order to complete the accounting under ASC 740. |
We developed the following example of another situation that might arise. Illustration 1 — Analysis is incomplete and company can reasonably estimate provisional amounts related to the one-time transition tax but cannot reasonably estimate tax effects of remaining outside basis difference | Facts Assume a similar fact pattern to Example 1, but assume that Company W was able to determine a reasonable estimate of the income tax effects of the Act on its unremitted foreign earnings for the reporting period in which the Act was enacted as it relates to the one-time transition tax (i.e., the tax due based on accumulated earnings and profits subsequent to 1986). Company W did not have the necessary information available, prepared or analyzed to develop a reasonable estimate of the tax liability, if any, for its remaining outside basis difference including any deferred tax accounting that may be required due to other provisions in the Act beyond the one-time transition tax, including how that accounting may be affected by Company W's ongoing accounting position to indefinitely reinvest unremitted foreign earnings. Analysis Company W reported a provisional amount for the income tax effects of the one-time transition tax in its financial statements that included the reporting period the Act was enacted. In a subsequent reporting period within the measurement period, Company W was able to obtain, prepare, and analyze the necessary information to complete the accounting under ASC 740 for the one-time transition tax, and Company W adjusted the provisional amount it had previously reported to recognize its tax liability. Company W was not able to determine a reasonable estimate of the tax liability, if any, under the Act for its remaining outside basis difference (or evaluate how the Act will affect Company W's existing accounting position to indefinitely reinvest unremitted foreign earnings) in the reporting period in which the Act was enacted by the time that it issued its financial statements for that reporting period. As a result, Company W would not include a provisional amount for this item in its financial statements that include the reporting period in which the Act was enacted, but would do so in its financial statements issued for subsequent reporting periods that fall within the measurement period, beginning with the first reporting period falling within the measurement period by which the necessary information became available, prepared, or analyzed in order to develop the reasonable estimate, and ending with the first reporting period within the measurement period in which Company W was able to obtain, prepare, and analyze the necessary information to complete the accounting under ASC 740. |
In addition to the disclosures required by ASC 740, SAB 118 requires companies to disclose information about the material financial reporting effects of the Act for which the accounting under ASC 740 is incomplete, including: — Qualitative information about the income tax effects of the Act for which the accounting is incomplete
— The items reported as provisional amounts
— Existing current or deferred tax amounts for which the income tax effects of the Act have not been completed
— The reason the initial accounting is incomplete
— The additional information that needs to be obtained, prepared or analyzed to complete the accounting requirements under ASC 740
— The nature and amount of any measurement period adjustments recognized during the reporting period SAB 118 also requires companies to disclose the following information about material financial reporting effects of the Act, which companies will likely disclose in reporting periods after the period in which the Act was enacted: — The effect of measurement period adjustments on the effective tax rate
— Disclosures of when the accounting for the income tax effects of the Act has been completed Illustration 2 — Disclosures a calendar year-end company might make in the period of enactment about incomplete accounting | A calendar year-end company that has not yet completed its accounting might make the following disclosures in the notes to its financial statements for the period ended December 31, 2017. This is a simple example that addresses only federal income tax effects and doesn't reflect other disclosures required by ASC 740. Depending on its facts and circumstances, a company will need to provide more information. Disclosures should be sufficiently detailed for a reader to understand the status of a company's accounting for the tax effects of the Act (i.e., effects for which the accounting is complete, effects for which the accounting is incomplete but a reasonable estimate can be made, and effects for which the accounting is incomplete and no provisional amounts have been recorded) and the additional information needed to complete the accounting under ASC 740. Example disclosure The Tax Cuts and Jobs Act was enacted on December 22, 2017. The Act reduces the US federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign-sourced earnings. At December 31, 2017, we have not completed our accounting for the tax effects of enactment of the Act; however, in certain cases, as described below, we have made a reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax. In other cases, we have not been able to make a reasonable estimate and continue to account for those items based on our existing accounting under ASC 740, Income Taxes. For the items for which we were able to determine a reasonable estimate, we recognized a provisional amount of $XXXX, which is included as a component of income tax expense from continuing operations. Provisional amounts Deferred tax assets and liabilities: We remeasured certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%. However, we are still analyzing certain aspects of the Act and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded related to the remeasurement of our deferred tax balance was $XXXXX. Foreign tax effects: The one-time transition tax is based on our total post-1986 earnings and profits (E&P) for which we have previously deferred from US income taxes. We recorded a provisional amount for our one-time transition tax liability for XX of our foreign subsidiaries, resulting in an increase in income tax expense of $XXX. We have not yet completed our calculation of the total post-1986 foreign E&P for these foreign subsidiaries. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when we finalize the calculation of post-1986 foreign E&P previously deferred from US federal taxation and finalize the amounts held in cash or other specified assets. No additional income taxes have been provided for any remaining undistributed foreign earnings not subject to the transition tax and any additional outside basis difference inherent in these entities as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any remaining undistributed foreign earnings not subject to the transition tax and additional outside basis difference in these entities (i.e., basis difference in excess of that subject to the one-time transition tax) is not practicable, but the related cumulative temporary difference as of December 31, 2017 was $XX. We have not made sufficient progress on the E&P analysis for the remaining XX of our foreign subsidiaries to reasonably estimate the effects of the one-time transition tax and, therefore, have not recorded provisional amounts. We continued to apply ASC 740 based on the provisions of the tax laws that were in effect immediately prior to the Act being enacted. Because we had previously determined these amounts were indefinitely reinvested, no deferred taxes have been recorded. It is impracticable to determine unrecognized deferred tax liabilities related to these entities, but the cumulative temporary difference as of December 31, 2017 was $XX. |
Form 8-K filing requirements The SEC staff issued C&DI 110.02 in response to questions it has received from companies regarding whether the remeasurement of a deferred tax asset (DTA) to reflect the new tax rates or other provisions of the Act would trigger an obligation to file a Form 8-K under Item 2.06, Material Impairments. The C&DI states that the remeasurement of a DTA to reflect the effect of a change in tax rate or tax laws is not an impairment under ASC 740 and wouldn't trigger the reporting requirement. However, the enactment of new tax rates or tax laws could have financial reporting implications, including whether it is more likely than not that the DTA will be realized. In the C&DI, the SEC staff also noted that registrants employing the measurement period approach described in SAB 118 and concluding that an impairment has occurred (e.g., a valuation allowance) for the period that includes the enactment date due to changes resulting from the enactment of the Act may rely on the Instruction to Item 2.06, which exempts registrants from filing a Form 8-K if the conclusion is made in connection with the preparation, review or audit of financial statements to be included in the next periodic report to be filed. In those situations, registrants must disclose the impairment, or a provisional amount with respect to that possible impairment, in the next timely filed report. Implications While the C&DI provides clarification of Item 2.06 of Form 8-K, companies should continue to discuss Form 8-K reporting requirements with their securities counsel regarding the effects the Act may have on their reporting requirements. |
Foreign private issuers reporting under IFRS The SEC staff also said it would not object to a foreign private issuer reporting under IFRS applying a measurement period solely for purposes of completing the accounting requirements for the income tax effects of the Act under International Accounting Standard 12, Income Taxes. Investment companies affected by the Act The SEC's Division of Investment Management issued guidance in IM Information Update 2017-07 in which the SEC staff confirmed that investment companies can rely on SAB 118 for purposes of calculating their net asset value (NAV) and reporting measurement period adjustments. The SEC staff also reminded investment companies to make disclosures, where applicable, about any material effects of the Act on their NAV calculations and information about material provisions for which the accounting is incomplete. Such disclosures could be made in a press release, on a website or in another reasonable manner. Non-SEC financial statements SAB 118 applies to any financial statements filed with or furnished to the SEC. However, we believe SAB 118 clarifies the guidance in ASC 740 for a unique circumstance, and it would also be appropriate for other entities applying US GAAP 4 to follow the SAB. We believe that an entity that is not an SEC filer that elects to follow the guidance in SAB 118 would also need to consider the disclosure requirements when preparing its financial statements in the period of enactment and during the measurement period. Internal control considerations Companies need to evaluate whether changes to their existing processes and controls are necessary to address the financial reporting effects of implementing both the Act and SAB 118. That is, companies need effective internal controls to make sure that the accounting implications of the transition and future tax provision calculations are accurately recorded in their financial statements. In addition to the overall effect of the Act on the income tax accounts, key areas requiring controls include the processes for estimating and finalizing provisional amounts, calculating the one-time transition tax, tracking outside basis differences after enactment, determining the timing of the reversal of temporary differences, assessing the realizability of deferred tax assets and carryforwards, calculating any minimum taxes and making disclosures. Contact Information
For additional information concerning this Alert, please contact:
| Tax Accounting and Risk Advisory Services | | • Angela Evans | (404) 817-5130 | | • Joan Schumaker | (212) 773-8569 | | • Anya Parkhurst | (404) 541-7910 | | • Dan Petrak | (330) 255-5286 | | • David Northcut | (214) 969-8488 | | • George Wong | (212) 773-6432 | | • Jason Zenk | (703) 747-1636 | | • John M. Wright | (212) 773-1042 | | • John Vitale | (212) 773-1437 | | • Matt Rychlicki | (713) 750-8442 | | • Paul Caccamo | (305) 415-1443 | | • Peter DeVisser | (919) 791-1677 | | • Ricci Obert | (614) 232-7625 | | International Tax Services | | • Jennifer Cobb | (713) 750-1334 |
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1 SAB 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act. 2 SAB 118 says, "The staff was informed, in part, by the measurement period guidance applied in certain situations when accounting for business combinations under ASC Topic 805, Business Combinations. The measurement period guidance in ASC paragraph 805-10-25-13 addresses situations where the initial accounting for a business combination is incomplete upon issuance of the financial statements that include the reporting period the business combination occurred." 4 Examples of instances in which nonpublic entities have applied SEC staff guidance include the application of the full cost method (Rule 4-10(c) of Regulation S-X) to oil and gas exploration costs, and the application of SAB 101, Revenue Recognition in Financial Statements. Document ID: 2018-0021 |
