National Professional Services Group

Guide to Accounting for Income Taxes2009

pwc

This publication has been prepared for general information on matters of interest only, and does not constitute professional advice on facts and circumstances specific to any person or entity. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication. The information contained in this material was not intended or written to be used, and cannot be used, for purposes of avoiding penalties or sanctions imposed by any government or other regulatory body. PricewaterhouseCoopers LLP, its members, employees, and agents shall not be responsible for any loss sustained by any person or entity who relies on this publication. The content of this publication is based on information available as of April 30, 2009. Accordingly, certain aspects of this publication may be superseded as new guidance or interpretations emerge. Financial statement preparers and other users of this publication are therefore cautioned to stay abreast of and carefully evaluate subsequent authoritative and interpretative guidance that is issued. This publication has been updated to reflect new and updated authoritative and interpretive guidance since the November 30, 2008 update to the 2007 edition. It has TM also been updated to reflect the new FASB Accounting Standards Codification , which was launched on July 1, 2009 and is effective for interim and annual periods ending after September 15, 2009. See Appendix B for a Summary of Noteworthy Revisions.

Portions of FASB Accounting Standards Codification, copyright by Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, are reproduced by permission.

Dear Clients and Friends: The overall accounting model for income taxes has been in place for many years, yet the accounting for income taxes continues to pose many challenges for preparers, users, and auditors. Among those challenges are the tax accounting rules for intraperiod allocation, business combinations, and foreign operations. PricewaterhouseCoopers is pleased to offer this comprehensive manual on the accounting for income taxes. It is intended to assist you in interpreting the existing literature in this complex area of accounting by bringing together all of the key guidance into one publication, providing several comprehensive examples to help navigate the guidance, and offering our own perspective throughout, based on both analysis of the guidance and experience in applying it. While this publication is intended to clarify the fundamental requirements involved in the accounting for income taxes and to highlight key points that should be considered before transactions are undertaken, needless to say it cannot substitute for a thorough analysis of the facts and circumstances surrounding proposed transactions and of the relevant accounting literature. Nonetheless, we trust that you will find in these pages the information and insights needed to work with greater confidence and certainty when applying the accounting model for income taxes.

PricewaterhouseCoopers

Table of Contents

Chapter 1: 1.1 1.1.1 1.1.2 1.2 1.2.1 1.2.1.1 1.2.1.2 1.2.2 1.2.2.1 1.2.2.2 1.2.2.3 1.2.2.4 1.2.2.5 1.2.3 1.2.3.1 1.2.3.2 1.3

Scope of ASC 740

1-1

Scope of ASC 740 ........................................................................... 1 - 4 In General (ASC 740-10-15-3)...................................................................... 1 - 4 Scope Exceptions (ASC 740-10-15-4) ........................................................ 1 - 4 Defining a Tax Based on Income.................................................. 1 - 4 In General ...................................................................................................... 1 - 4 Withholding Taxes - Entities That Withhold Taxes for the Benefit of Others............................................................................................................. 1 - 5 Withholding Taxes - Entities That Receive Dividends, Interest, Royalties or Other Income ............................................................................................. 1 - 5 Application of Guidance to Specific Tax Jurisdictions and Tax Structures .............................................................................................. 1 - 6 Higher of an Income-Based or Capital-Based Computation......................... 1 - 6 Gross-Receipts Tax ....................................................................................... 1 - 8 Single Business Tax ....................................................................................... 1 - 8 Texas Margin Tax........................................................................................... 1 - 9 Private FoundationExcise Tax on Net Investment Income .......................... 1 - 9 Attributes of Taxes Not Based on Income................................................. 1 - 10 Timing Differences Inherent in the Computation of Taxes Not Based on Income ........................................................................................... 1 - 10 Tax Credit Carryforwards for Tax Regimes Not Based on Income ............... 1 - 10 Accounting by Jurisdiction (Separate Calculation versus Blended Rate) ................................................................................. 1 - 11 Applicability of ASC 740 to an Entitys Legal Form ......................... 1 - 12 Single-Member and Multiple-Member Limited Liability Companies (under U.S. Tax Law) ............................................................... 1 - 12 Partnerships.................................................................................................. 1 - 12 Investments in Partnerships........................................................................... 1 - 12 General Application of ASC 740 to the Separate Financial Statements of Partnerships............................................................................ 1 - 13 Master Limited Partnerships .......................................................................... 1 - 13 Real Estate Investment Trusts (REITs) and Regulated Investment Companies (RICs) .......................................................................................... 1 - 14 State Income Taxes ..................................................................................... 1 - 14 Separate Calculation versus Blended Rate ................................................... 1 - 14 Treatment of Apportionment Factors............................................................. 1 - 14 Changes in state income tax rates caused by changes in how a state apportions income ................................................................................ 1 - 15

1.4 1.4.1 1.4.2 1.4.2.1 1.4.2.2 1.4.2.2.1 1.4.2.2.2 1.4.3 1.4.3.1 1.4.3.2 1.4.3.2.1

Chapter 2: 2.1 2.2

Objectives and Basic Principles

2-1

Objectives of ASC 740..................................................................... 2 - 5 Basic Principles .............................................................................. 2 - 5

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2.3 2.3.1 2.3.2 2.3.2.1 2.3.3 2.3.4 2.3.4.1 2.3.4.1.1 2.3.4.1.2 2.3.4.2 2.3.4.2.1 2.3.4.2.2 2.3.5 2.4 2.4.1 2.4.2 2.4.3

Exceptions to the Basic Principles ................................................. 2 - 6 Outside Basis Differences and U.S. Steamship Exceptions................. 2 - 6 Leveraged Leases (ASC 740-10-25-3(c)).................................................... 2 - 6 Purchased Leveraged Leases........................................................................ 2 - 7 Nondeductible Goodwill (ASC 740-10-25-3(d))........................................... 2 - 7 Tax Effects of Intra-entity Transactions (ASC 740-10-25-3(e))................ 2 - 7 In General (ASC 740-10-25-3(e)).................................................................... 2 - 8 Deferred Charge Differentiated from Deferred Tax Asset.............................. 2 - 9 Quantifying the Amount of Tax Deferred under ASC 740-10-25-3(e) ........... 2 - 9 Certain Exceptions in the Application of ASC 740-10-25-3(e) ...................... 2 - 9 Intra-entity Sale of Subsidiary Stock ............................................................. 2 - 9 Intra-entity Transfers Reported at Predecessor Basis................................... 2 - 11 Certain Foreign Exchange Amounts (ASC 740-10-25-3(f))....................... 2 - 11 Other Considerations ...................................................................... 2 - 12 Discounting ................................................................................................... 2 - 12 Volatility ......................................................................................................... 2 - 14 Need for Judgment ...................................................................................... 2 - 14

Chapter 3: 3.1 3.2 3.2.1 3.2.2 3.2.2.1 3.2.3 3.2.3.1 3.2.3.2 3.2.4 3.2.4.1 3.2.4.2 3.2.4.3 3.2.4.4 3.2.4.5 3.2.5 3.2.6 3.2.7 3.2.8 3.3 3.3.1 3.4 3.4.1 3.4.2 3.4.3

Temporary Differences

3-1

Temporary DifferenceDefined...................................................... 3 - 7 Examples of Temporary Differences ............................................... 3 - 9 Business Combinations (ASC 740-10-25-20(h)) ........................................ 3 - 9 Indexation (ASC 740-10-25-20(g)) ............................................................... 3 - 9 Temporary Differences Related to U.K. Office Buildings............................... 3 - 10 Temporary Differences Related to Investment Credits (ASC 740-10-25-20(e) and (f)) ...................................................................... 3 - 13 Foreign Investment Credits and Grants......................................................... 3 - 15 Effect on Leases............................................................................................. 3 - 16 Debt Instruments.......................................................................................... 3 - 16 Contingently Convertible Debt....................................................................... 3 - 16 Convertible Debt and Call Option ........................................................... 3 - 17 Debt Instruments with Temporary Differences that May Not Result in Future Deductible Amounts ........................................................................... 3 - 18 Convertible Debt with a Beneficial Conversion Feature and Detachable Warrants...................................................................................... 3 - 19 Tax Implications of Induced Conversions of Convertible Debt ..................... 3 - 20 Low-Income Housing Credits ..................................................................... 3 - 21 Synthetic Fuels Projects.............................................................................. 3 - 21 Subsidies under the Medicare Prescription Drug Act of 2003 ................ 3 - 22 IRC Section 162(m) Limitation .................................................................... 3 - 23 Basis Differences That Will Reverse with No Tax Consequence ..... 3 - 23 Excess Cash Surrender Value of Life Insurance....................................... 3 - 24 Issues to Be Considered in Identifying Temporary Differences ...... 3 - 24 Basis Differences That Are Not Accounted for Under the Basic Model for Deferred Taxes............................................................................ 3 - 25 Temporary Differences Where Reversal Might Not Occur in the Foreseeable Future ...................................................................................... 3 - 25 Consideration of Settlement at Book Carrying Value .............................. 3 - 26

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3.4.4 3.4.5

Temporary Differences Not Identified with an Asset or a Liability ........ 3 - 26 U.S. Federal Temporary Differences Relating to State Income Taxes................................................................................................ 3 - 26

Chapter 4: 4.1 4.2 4.2.1 4.2.2 4.2.3 4.2.4 4.2.4.1 4.2.4.2 4.2.4.3 4.2.4.4 4.2.4.5 4.2.4.6 4.2.4.7 4.2.4.8 4.2.4.9 4.2.4.10 4.2.5 4.2.5.1 4.2.5.2 4.2.5.3

Recognition and Measurement

4-1

Basic Approach for Deferred Taxes ................................................ 4 - 4 Applicable Tax Rate ........................................................................ 4 - 6 General Considerations ............................................................................... 4 - 7 Graduated Tax Rates ................................................................................... 4 - 7 Determining the Applicable Rate................................................................ 4 - 9 Complexities in Determining the Applicable Tax Rate............................. 4 - 10 Ordering Effects ............................................................................................. 4 - 10 Undistributed Earnings................................................................................... 4 - 11 Special Deductions ........................................................................................ 4 - 11 Tax Holidays................................................................................................... 4 - 13 Nonamortizing/Nondepreciating Assets ........................................................ 4 - 16 Worthless Deferred Tax Assets................................................................... 4 - 18 Dual-Rate Jurisdictions .................................................................................. 4 - 18 Hybrid Tax Systems ....................................................................................... 4 - 21 Foreign-Branch Operations............................................................................ 4 - 21 Aggregating Computations for Separate Jurisdictions.................................. 4 - 22 Alternative Minimum Tax Considerations.................................................. 4 - 22 AMTGeneral Background ........................................................................... 4 - 22 The Interaction of AMT with ASC 740 Accounting ........................................ 4 - 23 Other AMT Systems ....................................................................................... 4 - 27

Chapter 5: 5.1 5.1.1 5.1.2 5.1.3 5.1.3.1 5.1.3.2 5.1.4 5.2

Valuation Allowance

5-1

Assessing the Need for a Valuation Allowance ............................... 5 - 6 Evidence to Be Considered......................................................................... 5 - 6 Weighting of Available Evidence ................................................................ 5 - 8 Cumulative Losses and Other Negative Evidence.................................... 5 - 9 General ........................................................................................................... 5 - 9 Examples of Situations Where Positive Evidence Outweighed Significant Negative Evidence........................................................................ 5 - 12 Assessing Changes in the Valuation Allowance ....................................... 5 - 14 SEC Staff Views on Disclosure and Valuation Allowance Assessments.................................................................. 5 - 15 Other Considerations ...................................................................... 5 - 16 Evaluating the Effect of a Restructuring.................................................... 5 - 16 Going-Concern Uncertainty ........................................................................ 5 - 17 Sources of Taxable Income ............................................................. 5 - 18 Taxable Income in Prior Carryback Years If Carryback Is Permitted Under the Tax Law ..................................................................... 5 - 18 Special Considerations for Carrybacks ......................................................... 5 - 19 Liabilities for Unrecognized Tax Benefits as a Source of Taxable Income ... 5 - 19 Carrybacks That Free Up Credits .................................................................. 5 - 19

5.3 5.3.1 5.3.2 5.4 5.4.1 5.4.1.1 5.4.1.1.1 5.4.1.1.2

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5.4.1.1.3 5.4.2 5.4.2.1 5.4.3 5.4.3.1 5.4.3.1.1 5.4.3.2 5.4.3.2.1 5.4.3.2.2 5.4.3.2.3 5.4.3.2.4 5.4.3.2.5 5.4.3.3 5.4.3.4 5.4.3.4.1 5.4.3.4.2 5.4.3.5 5.4.3.6 5.4.3.6.1 5.4.3.6.2 5.4.3.6.3 5.4.3.7 5.4.4 5.4.4.1 5.4.4.2 5.4.4.2.1 5.4.4.2.2 5.5 5.5.1 5.5.1.1 5.5.1.2 5.5.1.2.1 5.5.1.2.2 5.5.1.2.3 5.5.1.2.4 5.5.1.2.5 5.5.1.2.6 5.5.1.2.7 5.5.1.2.8 5.5.1.2.9 5.5.1.2.10 5.5.1.2.11 5.5.1.2.12 5.5.2 5.5.2.1 5.5.2.2

Carryback Availability That May Not Be Used............................................... 5 - 21 Future Reversals of Existing Taxable Temporary Differences ................ 5 - 22 Deferred Tax Liabilities on Indefinite-Lived Intangible AssetsNaked Credits............................................................................... 5 - 24 Tax-Planning Strategies .............................................................................. 5 - 25 Tax-Planning Strategies Defined ................................................................... 5 - 26 Tax-Planning Strategies in Jurisdictions Where NOL Carryforwards Never Expire ................................................................................................... 5 - 30 Examples of Common Tax-Planning Strategies ............................................ 5 - 31 Sales of Appreciated Assets .......................................................................... 5 - 31 Sale-Leaseback.............................................................................................. 5 - 35 LIFO Reserves ................................................................................................ 5 - 36 Shifting Tax-Exempt Portfolios ...................................................................... 5 - 37 Noneconomic Tax-Planning Strategies ......................................................... 5 - 38 Costs to Implement a Tax-Planning Strategy ................................................ 5 - 39 Examples of Actions That Do Not Qualify as Tax-Planning Strategies ......... 5 - 40 Excluding a Loss Subsidiary from Tax Consolidation ................................... 5 - 40 Acquiring a Profitable Enterprise ................................................................... 5 - 40 In Summary .................................................................................................... 5 - 41 Issues in Evaluating Tax-Planning Strategies ................................................ 5 - 42 Time Value of Money...................................................................................... 5 - 42 Unrecognized Tax Benefits ............................................................................ 5 - 42 Separate Statements of Subsidiary ............................................................... 5 - 42 Consistent Use in Different Jurisdictions....................................................... 5 - 42 Future Taxable Income Exclusive of Reversing Temporary Differences and Carryforwards .................................................................. 5 - 44 General ........................................................................................................... 5 - 44 Considerations When Projecting and Scheduling Future Taxable Income Other than Reversals of Existing Temporary Differences ................. 5 - 45 Originating Temporary Differences in Future Projections.............................. 5 - 45 Projecting Future Pretax Book Income.......................................................... 5 - 46 Scheduling Future Taxable Income ................................................. 5 - 53 When Is It Necessary? ................................................................................. 5 - 53 General Approach to Scheduling................................................................... 5 - 53 Patterns of Temporary Difference Reversals ................................................. 5 - 54 Depreciable and Amortizable Assets ............................................................. 5 - 55 Assets and Liabilities Measured at Present Value ......................................... 5 - 57 Deferred Foreign Taxes.................................................................................. 5 - 63 Tax Return Accounting Method Changes...................................................... 5 - 64 Deferred Revenue or Income ......................................................................... 5 - 65 Sale-Leasebacks............................................................................................ 5 - 65 Reserves for Bad Debts and Loan Losses .................................................... 5 - 65 Inventory Reserves......................................................................................... 5 - 66 Reserves for Litigation ................................................................................... 5 - 66 Warranty Reserves ......................................................................................... 5 - 66 Stock Appreciation Rights ............................................................................. 5 - 66 Other............................................................................................................... 5 - 66 Examples of Scheduling .............................................................................. 5 - 67 Example of Scheduling Future Taxable Income ............................................ 5 - 67 Example of Unused Deduction ...................................................................... 5 - 69

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Chapter 6: 6.1 6.2 6.2.1 6.2.1.1 6.2.1.2 6.2.1.3 6.2.1.4 6.2.1.5 6.2.2 6.2.3 6.2.3.1 6.2.4 6.2.5 6.2.5.1 6.2.5.2 6.2.6

A Change in Valuation Allowance

6-1

Recording the Effects of Changes in Valuation - In General ............. 6 - 3 Changes in Valuation Allowance in Specific Areas........................... 6 - 4 Changes in Valuation Allowance Business Combinations.................... 6 - 4 Establishment of a Valuation Allowance Against An Acquired Companys Deferred Tax Assets at the Time of Acquisition ......................... 6 - 4 Changes to the Acquired Deferred Tax Assets in a Period Subsequent to a Business Combination ................................................................................ 6 - 4 Changes in the Acquirers Valuation Allowance at the Time of a Business Combination ................................................................................................... 6 - 5 Effects of Tax Law Changes on a Valuation Allowance Recorded Against Acquired Tax Benefits in a Business Combination........................... 6 - 5 Ordering of Recognition of Tax Benefits........................................................ 6 - 5 Changes in Valuation Allowance Related to Items of Other Comprehensive Income............................................................................... 6 - 5 Changes in Valuation Allowance Resulting from Transactions Among or With Shareholders...................................................................... 6 - 5 NOL Carryforward Limitation Following an Initial Public Offering.............. 6 - 6 Transactions between Entities under Common Control.......................... 6 - 6 Changes in Valuation Allowance in Spin-Off Transactions ..................... 6 - 6 Recording an Increase to the Valuation Allowance by the Parent Enterprise When a Subsidiary Is Spun Off in a Nontaxable Transaction ........ 6 - 6 Recording a Valuation Allowance on a Subsidiarys Assets When a Spin-Off Creates the Need for a Valuation Allowance................................... 6 - 7 Changes in Valuation Allowance When Restating Prior-Period Presentation for Discontinued Operations................................................ 6 - 7

Chapter 7: 7.1 7.2

Change in Tax Laws or Rates

7-1

Determining the Enactment Date.................................................... 7 - 3 Distinguishing Between Interpretive and Legislative Regulations ..................................................................................... 7 - 3 Accounting for Rate Changes ......................................................... 7 - 4 Interim-Period Considerations ........................................................ 7 - 6 Computing Deferred Taxes in an Interim Period ...................................... 7 - 7 Retroactive Tax Rate Change .................................................................... 7 - 7 Retroactive Changes in Tax Laws or Rates Following Adoption of an Accounting Standard ......................................................................... 7 - 8 Leveraged Leases ........................................................................................ 7 - 10 Valuation Allowances ...................................................................... 7 - 11 Valuation Allowances Relating to Assets Acquired in a Prior Business Combination: Adjustments in the Period of Enactment and Subsequent Releases........................................................................... 7 - 11 Disclosure Requirements................................................................ 7 - 11 Changes in Tax Accounting Methods .............................................. 7 - 12

7.3 7.4 7.4.1 7.4.2 7.4.3 7.4.4 7.5 7.5.1

7.6 7.7

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7.7.1 7.7.1.1 7.7.1.2 7.7.2 7.7.2.1 7.7.2.2 7.7.2.3 7.7.3 7.7.3.1 7.7.4

Transition to New Accounting Method ...................................................... 7 - 12 Positive 481(a) Adjustments......................................................................... 7 - 13 Negative 481(a) Adjustments ....................................................................... 7 - 13 Timing ............................................................................................................ 7 - 13 Voluntary Changes from Proper Accounting Methods.................................. 7 - 13 Voluntary Changes from Improper Methods ................................................. 7 - 14 Involuntary Changes from Improper Accounting Methods ........................... 7 - 14 Unrecognized Tax Benefit Considerations................................................ 7 - 15 Interest and Penalties..................................................................................... 7 - 15 Other Considerations................................................................................... 7 - 15

Chapter 8: 8.1 8.2 8.3 8.3.1 8.3.2 8.4 8.4.1 8.4.2 8.4.3 8.5

Change in the Tax Status of an Enterprise

8-1

General Rule for Changes in Tax Status ......................................... 8 - 3 Loss of Nontaxable Status .............................................................. 8 - 4 Switching Tax Status ...................................................................... 8 - 4 Switching to Nontaxable Status ................................................................. 8 - 4 Switching to Taxable Status ....................................................................... 8 - 4 Post-1986 S Corporation Elections/Built-in Gains .......................... 8 - 6 Deferred Tax Liability After the Change to S Corporation Status........... 8 - 6 Tax-Planning Actions................................................................................... 8 - 8 Financial Statement Reporting ................................................................... 8 - 8 Increase in Tax Basis upon the Conversion of a Partnership to a Corporation ............................................................................. 8 - 8 Business Combination Considerations ........................................... 8 - 9 S Corporation Election Invalidated by Acquisition by C Corporation..... 8 - 9 Common-Control Merger Involving an S Corporation ............................. 8 - 9 Change in Tax Status as Part of a Business Combination ...................... 8 - 10 Other Illustrations of Changes in Tax Status................................... 8 - 10 The American Jobs Creation Act of 2004 Tonnage Tax........................... 8 - 10 Effective Date of a REIT Conversion .......................................................... 8 - 11

8.6 8.6.1 8.6.2 8.6.3 8.7 8.7.1 8.7.2

Chapter 9: 9.1

Regulated Enterprises

9-1

The Regulatory Process and Recording of a Regulatory Asset/Liability ................................................................................. 9 - 3 Changes in Tax Rates ..................................................................... 9 - 6 Adjustments to Regulatory Asset/Liability ................................................ 9 - 6 Changes in Tax Rates when No Regulatory Asset was Originally Recorded ..................................................................................... 9 - 7 Deferred or Unamortized Investment Tax Credit (ITC) .................... 9 - 8 Interim Financial Reporting............................................................. 9 - 8

9.2 9.2.1 9.2.2

9.3 9.4

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Chapter 10: Business Combinations 10.1 10.1.1 10.1.2 10.2 10.2.1 10.2.2 10.3 10.3.1 10.3.2 10.4 10.4.1 10.4.2 10.4.3 10.4.3.1 10.4.3.2 10.4.4 10.4.5 10.4.6 10.4.7

10 - 1

Overview and Changes in Key Provisions from Prior Standards ..... 10 - 4 Overview........................................................................................................ 10 - 4 Changes in Key Provisions from Prior Standards .................................... 10 - 5 Determine the Tax Structure of the Transaction and Tax Status of the Entities Involved in the Business Combination ..................... 10 - 6 Determining if the Business Combination Transaction Is Taxable or Nontaxable .................................................................................................... 10 - 7 Identifying the Tax Status of the Entities Involved ................................... 10 - 7 Determine Financial Statement and Tax Bases of the Net Assets Acquired ......................................................................................... 10 - 7 Determining Tax Bases in a Taxable Transaction .................................... 10 - 8 Determining Tax Bases in a Nontaxable Transaction .............................. 10 - 8 Identify and Measure Temporary Differences ................................. 10 - 8 Basic Methodology for Recognition of Deferred Taxes on Acquired Temporary Differences and Tax Benefits .................................................. 10 - 8 Expected Manner of Recovery or Settlement ........................................... 10 - 9 Recording the Tax Effect of Contingencies and Contingent Consideration in Business Combinations ................................................. 10 - 10 Contingencies and Contingent Consideration - Taxable Transactions ........ 10 - 12 Contingencies and Contingent Consideration - Nontaxable Transactions ... 10 - 15 Deferred Taxes Related to Outside Basis Differences............................. 10 - 17 Deferred Taxes Related to Research and Development Activities......... 10 - 18 Deferred Taxes Related to Acquisition-Related Costs ............................ 10 - 19 Identifying the Applicable Tax Rate to Calculate Deferred Tax Assets and Liabilities ................................................................................... 10 - 20 Identify Acquired Tax Benefits ........................................................ 10 - 21 Realization Test for the Acquired Tax Benefits......................................... 10 - 21 Evaluating Future Combined Results Subsequent to the Business Combination.................................................................................................. 10 - 22 Considering the Acquirers Taxable Differences as a Source of Realization .................................................................................................... 10 - 22 Limitation of Tax Benefits by Law .............................................................. 10 - 23 Changes to the Acquired Deferred Tax Assets after the Business Combination.................................................................................................. 10 - 24 Changes in the Acquirers Deferred Tax Balances Related to Acquisition Accounting................................................................................ 10 - 25 Business Combinations Achieved in Stages ............................................. 10 - 25 Consider the Treatment of Tax Uncertainties ................................. 10 - 28 Recording Tax Uncertainties ...................................................................... 10 - 28 Subsequent Resolution of Tax Uncertainties in a Business Combination.................................................................................................. 10 - 29 Deferred Taxes Related to Goodwill................................................ 10 - 30 Excess of Tax-Deductible Goodwill over Book Goodwill......................... 10 - 30 Recognition of a Deferred Tax Asset for Excess Tax-Deductible Goodwill ........................................................................................................ 10 - 31 Situations in which the Iterative Formula May Not Apply ........................ 10 - 33

10.5 10.5.1 10.5.2 10.5.3 10.5.4 10.5.5 10.5.6 10.5.7 10.6 10.6.1 10.6.2

10.7 10.7.1 10.7.2 10.7.3

Table of Contents / vii

10.7.4 10.7.5 10.7.6 10.7.7 10.7.7.1 10.7.8 10.7.9 10.8 10.8.1 10.8.2

Excess of Book Goodwill over Tax-Deductible Goodwill......................... 10 - 33 Recognition of Deferred Tax Liabilities Related to Tax-Deductible Goodwill Subsequent to the Acquisition Date .......................................... 10 - 34 Deferred Tax Liabilities Related to Tax-Deductible Goodwill and Indefinite-Lived Intangible Assets - Source of Taxable Income ............. 10 - 34 Deferred Tax Considerations in Testing Goodwill for Impairment ......... 10 - 34 Deferred Tax Accounting for a Goodwill Impairment .................................... 10 - 36 Disposal of Goodwill .................................................................................... 10 - 39 Bargain Purchase ......................................................................................... 10 - 41 Recording the Tax Effects of Transaction with Noncontrolling Shareholders................................................................................... 10 - 43 Direct Tax Impact of a Transaction with Noncontrolling Shareholders................................................................................................. 10 - 43 Indirect Tax Impacts of a Transaction with Noncontrolling Shareholders................................................................................................. 10 - 44 Transactions Under Common Control ............................................. 10 - 46 Accounting and Reporting by the Receiving Entity .................................. 10 - 46 Basis of Transfer ............................................................................................ 10 - 46 Procedural Guidance for Presenting a Change in Reporting Entity .............. 10 - 47 Other Considerations ...................................................................... 10 - 49 Asset Acquisitions and Nonmonetary Exchanges.................................... 10 - 49 Fresh Start Accounting................................................................................ 10 - 50 LIFO Inventories Acquired in a Nontaxable Business Combination ....... 10 - 50 Questions and Answers - Additional Implementation Guidance...... 10 - 52

10.9 10.9.1 10.9.1.1 10.9.1.2 10.10 10.10.1 10.10.2 10.10.3 10.11

Chapter 11: Outside Basis Differences and Other Special Areas 11.1 11.1.1 11.1.2 11.1.2.1 11.1.2.2 11.1.3 11.1.4 11.1.4.1 11.1.4.2

11 - 1

11.1.4.3

11.1.4.4

11.1.4.5 11.1.4.5.1

Accounting for the Outside Basis of Investments ........................... 11 - 5 Difference Between Outside and Inside Bases......................................... 11 - 5 Domestic Versus Foreign Subsidiaries ...................................................... 11 - 6 Classification as Domestic or Foreign ........................................................... 11 - 6 Tiered Foreign Subsidiaries............................................................................ 11 - 7 Overview of Potential Deferred Tax Assets and Liabilities Related to Outside Basis Differences ...................................................................... 11 - 8 Potential Deferred Tax Liabilities, Domestic Subsidiaries, and Domestic Corporate Joint Ventures........................................................... 11 - 11 In General ....................................................................................................... 11 - 11 Domestic Subsidiaries and Domestic Corporate Joint Ventures: Excess Book-Over-Tax Outside Basis Differences That Arose in Fiscal Years Beginning On or Before December 15, 1992 ...................................... 11 - 11 Domestic Subsidiaries: Excess Book-Over-Tax Outside Basis Differences That Arose in Fiscal Years Beginning After December 15, 1992........................................................................................ 11 - 12 Domestic, 50-Percent-or-Less-Owned Investees: Excess Book-Over-Tax Outside Basis Differences That Arose in Fiscal Years Beginning After December 15, 1992 ......................................... 11 - 12 Exception for Domestic Subsidiaries Under ASC 740-30-25-7 .................... 11 - 13 Ability and Intent to Recover Tax-free the Investment in the Domestic Subsidiary ...................................................................................... 11 - 13

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11.1.4.5.2 11.1.4.5.3 11.1.4.5.4 11.1.4.6 11.1.5 11.1.5.1 11.1.5.2 11.1.5.3 11.1.5.4 11.1.5.5 11.1.5.6 11.1.5.7 11.1.5.8 11.1.6 11.1.7 11.1.8 11.1.8.1 11.1.8.2 11.1.9 11.1.10 11.1.10.1 11.1.10.2 11.1.10.3 11.1.10.4 11.1.10.5 11.1.10.6 11.2 11.3 11.4 11.5 11.5.1 11.5.2 11.5.3 11.5.4 11.5.4.1 11.5.4.2 11.5.5 11.5.5.1 11.5.5.2

Meaning of Significant Cost Under ASC 740-30-25-8 ............................... 11 - 14 Potential State Tax Considerations................................................................ 11 - 15 Consideration of Lower-Tier Foreign Subsidiaries Owned by a Domestic Subsidiary ...................................................................................... 11 - 16 Special Considerations for Savings & Loan Associations and Stock Life Insurance Companies ................................................................... 11 - 17 Potential Deferred Tax Liabilities, Foreign Subsidiaries, and Foreign Corporate Joint Ventures .............................................................. 11 - 19 Outside Basis Differences: Undistributed Earnings and Other Differences ........................................................................................... 11 - 19 Indefinite Reversal Exception......................................................................... 11 - 20 Partial Reinvestment Assertion ...................................................................... 11 - 21 Evidence Required ......................................................................................... 11 - 21 Effect of Distributions Out of Current-Year Earnings on an Indefinite Reversal Assertion.......................................................................................... 11 - 22 Effect of Change in an Indefinite Reversal Assertion..................................... 11 - 23 Inside Basis Differences That Meet the Indefinite Reversal Criteria.............. 11 - 24 Indefinite Reversal Exception and Purchase Accounting .............................. 11 - 24 Foreign Corporate Joint Ventures That Are Not Permanent in Duration..................................................................................................... 11 - 25 Measuring the Tax Effect of Outside Basis Differences (Domestic and Foreign) ............................................................................... 11 - 25 Potential Deferred Tax Assets on Subsidiaries, Corporate Joint Ventures, and Equity Investees (Foreign and Domestic) ......................... 11 - 28 In General ....................................................................................................... 11 - 28 Recognition of Deferred Tax Assets on Foreign Tax Credits Prior to Meeting the Establishing Criteria Under Tax Law.......................................... 11 - 29 Partnerships and Other Flow-Through Entities ........................................ 11 - 31 Other Issues Related to Accounting for Outside Basis Differences....... 11 - 33 Considerations Related to Variable Interest Entities...................................... 11 - 33 Changes from Investee to Subsidiary and from Subsidiary to Investee........ 11 - 34 Changes in a Parents Equity in the Net Assets of a Subsidiary Resulting from Transactions with the Non-Controlling Shareholders ........................... 11 - 36 Tax-to-Tax (Inside Versus Outside Tax) Basis Differences............................ 11 - 37 Equity Method Investees................................................................................ 11 37 Going-Concern Uncertainty ........................................................................... 11 37 Certain Bad Debt Reserves for U.S. S&L Associations.................... 11 - 38 Policyholders Surplus Account of Stock Life Insurance Companies ...................................................................................... 11 - 39 Deposits in Statutory Reserve Funds by U.S. Steamship Enterprises ..................................................................................... 11 40 Tax Effects of Changes in Foreign Exchange Rate ......................... 11 - 40 Translation of Foreign Deferred Taxes ...................................................... 11 - 40 Transaction Gains and Losses.................................................................... 11 - 41 Translation Adjustments on Outside Basis Differences .......................... 11 - 41 Hedging ......................................................................................................... 11 - 42 Hedging an Investment in a Foreign Subsidiary ............................................ 11 - 42 Hedging a Deferred Tax Balance ................................................................... 11 - 42 U.S. Dollar Functional Currency ................................................................. 11 - 42 Nonmonetary Assets and Liabilities............................................................... 11 - 42 Monetary Assets and Liabilities ..................................................................... 11 - 45

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11.5.6 11.5.6.1 11.5.6.2 11.5.7 11.5.8 11.6 11.6.1 11.6.2 11.6.2.1 11.6.2.2 11.6.2.3

Indexed NOLs in Highly Inflationary Economies....................................... 11 - 46 Switching to a Highly Inflationary Economy .................................................. 11 - 46 Economies That Are No Longer Highly Inflationary ...................................... 11 - 47 Intraperiod Allocation as it Applies to the CTA Account ......................... 11 - 47 Deferred Taxes on Intercompany Loans with Foreign Subsidiaries....... 11 - 48 Accounting for Branch Operations and Subpart F Income .............. 11 - 50 Branch Operations ....................................................................................... 11 - 50 U.S. Subpart F Income: Income from Foreign Subsidiaries That Cannot Be Deferred ..................................................................................... 11 - 56 In General ....................................................................................................... 11 - 56 Indefinite Reversal Exception and Potential Future Subpart F Income......... 11 - 57 Indefinite Reversal and Subpart Fs Previously Taxed Income ..................... 11 - 58

Chapter 12: Intraperiod Tax Allocation 12.1 12.2 12.2.1 12.2.2 12.2.2.1 12.2.2.2 12.2.2.2.1 12.2.2.2.2 12.2.2.2.3 12.2.3 12.2.3.1 12.2.3.2 12.2.3.2.1 12.2.3.2.2 12.2.3.2.3 12.2.3.2.4 12.2.3.2.5 12.2.3.2.6 12.2.3.3 12.2.3.3.1 12.2.3.3.2 12.2.3.3.3 12.2.3.3.4

12 - 1

Level of Application ........................................................................ 12 - 7 The Basic Model ............................................................................. 12 - 7 Step 1: Compute Total Tax Expense or Benefit ........................................ 12 - 8 Step 2: Compute Tax Attributable to Continuing Operations.................. 12 - 8 Tax Effect of Current-Year Income from Pretax Continuing Operations....... 12 - 8 Other Items Specifically Allocated to Continuing Operations ....................... 12 - 15 Changes in Tax Laws or an Enterprises Tax Status ..................................... 12 - 15 Change in Indefinite Reversal Assertion for Foreign Subsidiary.................... 12 - 16 Changes in the Valuation Allowance.............................................................. 12 - 17 Step 3: Allocate the Remaining Portion of Tax Expense or Benefit to Other Components ..................................................................... 12 - 30 Determining the Individual Effects on Income Tax Expense or Benefit......... 12 - 31 Treatment of Specific Components Other than Continuing Operations ....... 12 - 38 Intraperiod Allocation for Equity Items Other than Items of Comprehensive Income ................................................................................. 12 - 38 Items of Other Comprehensive Income ......................................................... 12 - 39 Dividends........................................................................................................ 12 - 48 Discontinued Operations................................................................................ 12 - 48 Complexities in Accounting for Windfall Benefits under ASC 718 ................ 12 - 50 Tax Effect of Changes in Accounting Principle.............................................. 12 - 54 Miscellaneous Intraperiod Issues................................................................... 12 - 55 Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature ....................................................................... 12 - 55 Changes in Tax Basis Resulting from a Taxable Exchange between Entities under Common Control..................................................................... 12 - 56 Presentation of the Tax Effects of the Sale of Stock of a Subsidiary............ 12 - 56 Recording Valuation Allowances in Conjunction with a Spin-off Transaction....................................................................................... 12 - 58 Exception to the Basic ModelASC 740-20-45-7 ........................... 12 - 58 General Application of ASC 740-20-45-7 ................................................... 12 - 58

12.3 12.3.1

Chapter 13: Certain Quasi Reorganizations 13.1

13 - 1

General ........................................................................................... 13 - 3

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13.2

Pre-reorganization Tax Benefits ..................................................... 13 - 3

Chapter 14: Separate Financial Statements of a Subsidiary 14.1 14.1.1 14.1.2 14.1.3 14.2 14.3 14.4

14 - 1

Acceptable Methods ....................................................................... 14 - 4 Separate Return Method ............................................................................. 14 - 4 Benefits for Loss .......................................................................................... 14 - 5 Other Methods.............................................................................................. 14 - 5 Tax Allocation Versus Tax Sharing Arrangements........................... 14 - 6 Change in Method........................................................................... 14 - 7 Single-member and Multiple-member Limited Liability Companies......................................................................... 14 - 7 Disclosures ..................................................................................... 14 - 9 Impact of a Change in Tax Basis on Separate Historical Financial Statements ...................................................................... 14 - 9 Uncertain Tax Positions and Separate Financial Statements of a Subsidiary ................................................................................ 14 - 14 Carve-out Financial Statements...................................................... 14 - 15

14.5 14.6

14.7

14.8

Chapter 15: Financial Statement Presentation & Disclosure 15.1 15.1.1 15.1.2 15.1.3 15.1.4 15.2 15.3 15.3.1 15.3.2 15.3.3 15.3.4 15.4 15.5 15.5.1 15.5.1.1 15.5.1.2 15.5.1.2.1 15.5.1.2.2 15.5.1.2.3

15 - 1

Balance Sheet Presentation of Deferred Taxes .............................. 15 - 3 Principles of Balance Sheet Classification................................................ 15 - 3 Valuation Allowance and Balance Sheet Classification........................... 15 - 4 Offsetting and Multiple Jurisdictions ......................................................... 15 - 5 Contingencies and Uncertain Tax Positions ............................................. 15 - 5 Balance Sheet Disclosures ............................................................. 15 - 6 Income Statement Presentation...................................................... 15 - 11 Deferred Tax Expense or Benefit................................................................ 15 - 11 Interest and Penalties .................................................................................. 15 - 12 Professional Fees......................................................................................... 15 - 12 Change in Tax Laws, Rates, or Status ....................................................... 15 - 12 Income Statement Disclosures ....................................................... 15 - 14 Disclosures for Uncertain Tax Positions ......................................... 15 - 17 Annual Disclosures ...................................................................................... 15 - 17 Disclosure of Accounting Policy on Classification of Interest and Penalties......................................................................................................... 15 - 19 Tabular Reconciliation of Unrecognized Tax Benefits .................................. 15 - 19 Comprehensive Basis .................................................................................... 15 - 19 Disclosure of Gross Unrecognized Tax Benefits ........................................... 15 - 21 Interest and Penalties..................................................................................... 15 - 21

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15.5.1.2.4 15.5.1.2.5 15.5.1.3 15.5.1.4

15.5.1.5 15.5.1.6 15.5.2 15.6 15.7 15.8 15.8.1 15.8.2 15.8.3 15.8.4 15.8.5 15.8.5.1 15.8.5.2 15.8.5.3 15.9

Treatment of Deposits.................................................................................... 15 - 21 Required Information...................................................................................... 15 - 22 Unrecognized Tax Benefits That, If Recognized, Would Affect the Effective Tax Rate ......................................................................................... 15 - 24 Total Amount of Interest and Penalties Recognized in the Statement of Operations and Total Amount of Interest and Penalties Recognized in the Statement of Financial Position .......................................................... 15 - 25 Reasonably Possible Significant Changes in Unrecognized Tax Benefits That May Occur Within the Next 12 Months.................................................. 15 - 25 Tax Years Still Subject to Examination by a Major Tax Jurisdiction ............. 15 - 26 Interim Disclosures for SEC Registrants ................................................... 15 - 28 Income Tax-Related Disclosures for Stock Compensation ............. 15 - 30 Significant Risks & Uncertainties Disclosure ................................. 15 - 30 SEC Disclosures.............................................................................. 15 - 31 Additional Footnote Disclosures ................................................................ 15 - 31 Contractual Obligations Table .................................................................... 15 - 31 Interim Reporting (Form 10-Q Filings)........................................................ 15 - 32 Schedule II Requirement ............................................................................. 15 - 32 MD&A Disclosures ....................................................................................... 15 - 32 Effective Tax Rate .......................................................................................... 15 - 32 Accounting Estimates & Contingencies......................................................... 15 - 33 Realization of Deferred Tax Assets ................................................................ 15 - 33 Exemptions for Nonpublic Entities.................................................. 15 - 34

Chapter 16: Accounting for Uncertainty in Income Taxes 16.1 16.2 16.2.1 16.2.1.1 16.2.1.1.1 16.2.1.2 16.2.1.3 16.2.1.4 16.2.1.5 16.2.2 16.2.2.1 16.2.2.2 16.2.2.3 16.3 16.3.1 16.3.1.1 16.3.1.2 16.3.1.3 16.3.1.4

16 - 1

Background..................................................................................... 16 - 3 Scope .............................................................................................. 16 - 5 Entities Within the Scope of the Recognition and Measurement Criteria of ASC 740-10-05-6........................................................................ 16 - 5 Foreign Registrants ....................................................................................... 16 - 5 Non-U.S. Parent Entity................................................................................... 16 - 6 Recognition and Measurement of Uncertain Tax Positions in a Business Combinations ................................................................................................. 16 - 6 Separate Financial Statements ...................................................................... 16 - 6 Non-Income-based Taxes ............................................................................. 16 - 7 Indemnifications ............................................................................................. 16 - 7 Identifying Uncertain Tax Positions ........................................................... 16 - 10 Decision Not to File a Tax Return .................................................................. 16 - 11 Equity and Partnership Investments .............................................................. 16 - 11 Uncertain Tax Positions Relating to Temporary Differences ......................... 16 - 12 Recognition..................................................................................... 16 - 12 Unit of Account............................................................................................. 16 - 12 Consistency in a Tax Positions Unit of Account........................................... 16 - 14 Consideration of Offsetting Positions ............................................................ 16 - 15 A Single Unit of Account for Multiple Transactions That Are Similar ............ 16 - 15 Unit of Account for Multiple Transactions That Are Dissimilar ...................... 16 - 15

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16.3.2 16.3.2.1 16.3.2.2 16.3.2.3 16.3.2.4 16.3.2.5 16.3.2.5.1 16.3.2.5.2 16.3.2.6 16.3.2.7 16.3.2.8 16.3.2.9 16.3.2.10 16.3.2.11 16.3.2.11.1 16.4 16.4.1 16.4.1.1 16.4.1.2 16.4.1.3 16.4.1.4 16.4.1.5 16.4.2 16.4.2.1 16.4.3 16.4.4 16.5 16.5.1 16.5.2 16.5.3 16.5.3.1 16.5.3.2 16.5.3.3 16.5.3.4 16.5.4 16.5.5 16.5.6

Recognition Threshold for Uncertain Tax Positions................................. 16 - 16 More-likely-than-not Recognition Threshold ................................................. 16 - 17 Sources of Authoritative Tax Laws ................................................................ 16 - 19 Tax Opinions and External Evidence ............................................................. 16 - 21 Examination by Taxing Authority (Detection Risk) ......................................... 16 - 21 Administrative Practices and Precedents ...................................................... 16 - 22 Administrative Practices and Precedents Available to Entities that Self-report ............................................................................................... 16 - 23 Nexus-Related Administrative Practices and Precedents............................. 16 - 23 Assessing Recognition When Potentially Offsetting Positions Exist ............. 16 - 25 Assessing Recognition When Potentially Indirect Benefits Exist .................. 16 - 25 Uncertainties Regarding Valuation................................................................. 16 - 26 Timing Differences ......................................................................................... 16 - 27 Amended Returns and Refund Claims .......................................................... 16 - 29 Interaction with Valuation Allowance Assessment ........................................ 16 - 30 Tax-Planning Strategies ................................................................................. 16 - 32 Measuring the Tax Benefit to be Recorded..................................... 16 - 32 The Cumulative Probability Approach ....................................................... 16 - 33 Calculation of Individual Probability and Possible Outcomes ....................... 16 - 34 Consideration of Past Audit Experience ........................................................ 16 - 34 Use and Documentation of Cumulative Probability Table............................. 16 - 35 Highly Certain Tax Positions .......................................................................... 16 - 36 Binary Tax Positions....................................................................................... 16 - 36 Measurement and Transfer Pricing............................................................ 16 - 37 Contemporaneous Documentation................................................................ 16 - 37 Interrelationship of Measurement and Recognition................................. 16 - 38 The Implications of Should Level Tax Opinions..................................... 16 - 38 Changes in Recognition and Measurement in Subsequent Periods ........................................................................ 16 - 38 Considering the Impact of a Jurisdictions Dispute-Resolution Process ....................................................................... 16 - 42 Effective Settlement of a Tax Position ....................................................... 16 - 42 Other Considerations in the Tax Examination Process ........................... 16 - 47 Amended Return/Tax Receivable .................................................................. 16 - 47 Competent Authority ...................................................................................... 16 - 47 Relevance of Resolution Experience to Future Periods ................................ 16 - 48 Entities Not Subject to Audit by a Taxing Authority....................................... 16 - 48 Subsequent Derecognition.......................................................................... 16 - 48 Subsequent Events ...................................................................................... 16 - 49 Recording the Effects of Changes in Recognition and Measurement During the Year.................................................................... 16 - 50 Interest and Penalties ..................................................................... 16 - 50 Interest .......................................................................................................... 16 - 51 Interest Income on Uncertain Tax Positions .................................................. 16 - 51 Penalties........................................................................................................ 16 - 53 Accounting Policy Election for Classification of Interest and Penalties ................................................................................................ 16 - 55 Balance Sheet Classification .......................................................... 16 - 56 Background................................................................................................... 16 - 57

16.6 16.6.1 16.6.1.1 16.6.2 16.6.3

16.7 16.7.1

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16.7.1.1 16.7.2 16.7.2.1 16.7.2.2 16.8 16.8.1 16.9 16.9.1 16.10 16.10.1

SEC Required Balance Sheet Display of Liabilities for Unrecognized Tax Benefits .......................................................................................................... 16 - 57 Classification/Presentation of Liability for an Unrecognized Tax Benefit When NOL and Tax Credit Carryforwards Exist .......................... 16 - 58 Gross Presentation ..................................................................................... 16 - 59 Net Presentation ......................................................................................... 16 - 61 Disclosures ..................................................................................... 16 - 63 Annual Disclosures ...................................................................................... 16 - 63 Intraperiod Allocation ..................................................................... 16 - 64 Backwards Tracing ...................................................................................... 16 - 64 Documentation................................................................................ 16 - 65 Role and Use of Tax Opinion Letters ......................................................... 16 - 66

Chapter 17: Accounting for Income Taxes in Interim Periods 17.1 17.1.1 17.1.1.1 17.1.1.2 17.1.1.2.1 17.1.1.2.2 17.1.1.2.3 17.1.1.2.4 17.1.1.3 17.1.1.3.1 17.1.1.3.2 17.1.1.3.3 17.1.1.3.4 17.1.1.3.5 17.1.1.4 17.1.1.4.1

17 - 1

17.1.1.4.2 17.1.1.4.3 17.1.1.4.4 17.1.1.4.5 17.1.1.4.6 17.1.1.4.7 17.2 17.2.1 17.2.1.1 17.2.1.2 17.2.1.2.1 17.2.1.2.2 17.2.1.3

Method of Computing an Interim Tax Provision .............................. 17 - 4 Determining the Elements and Tax Effects of Ordinary Income............. 17 - 4 Definition of Tax (or Benefit) Related to Ordinary Income ............................. 17 - 4 Items Excluded from the Definition of Ordinary Income................................ 17 - 5 Significant Unusual or Infrequent Items......................................................... 17 - 5 Extraordinary Items ........................................................................................ 17 - 6 Discontinued Operations................................................................................ 17 - 7 Cumulative Change in Accounting Principle.................................................. 17 - 7 Limited Exceptions for Certain Items............................................................. 17 - 7 Tax-exempt Interest ....................................................................................... 17 - 7 Investment Tax Credits .................................................................................. 17 - 8 Leveraged Leases .......................................................................................... 17 - 8 Regulated Enterprises.................................................................................... 17 - 8 After-tax Equity Pickup for Investees Owned 50 Percent or Less ................ 17 - 9 Other Items That Do Not Represent the Tax Effect Attributable to Ordinary Income............................................................................................. 17 - 9 Subsequent Recognition, Derecognition, or Change in Measurement for an Uncertain Tax Position Arising in Prior Periods Due to a Change in Judgment or Interpretation of New Information............................................. 17 - 9 Interest and Penalties Recognized on Uncertain Tax Positions.................... 17 - 10 Change in Tax Law......................................................................................... 17 - 10 Change in Tax Status..................................................................................... 17 - 10 Certain Changes in the Assessment of the Realizability of Deferred Tax Assets............................................................................................................. 17 - 11 Change in Judgment about Unremitted Foreign Earnings and Other Outside-Basis Differences ............................................................................. 17 - 11 Change in Estimate Related to Prior-Year Tax Provision .............................. 17 - 11 Computing the Tax Provision Attributable to Ordinary Income ....... 17 - 15 Estimate Annual Effective Tax Rate ........................................................... 17 - 15 Methodology .................................................................................................. 17 - 15 Best Current Estimate .................................................................................... 17 - 16 General ........................................................................................................... 17 - 16 Treatment of Type II Subsequent Events on the ETR.................................... 17 - 16 Limitation on Benefits of Losses, Credits, and Rate Differentials in Loss Periods................................................................................................... 17 - 17

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17.2.2 17.2.2.1 17.2.2.2 17.2.2.2.1 17.2.2.2.2 17.3

Exceptions to the Use of the ETR Approach............................................. 17 - 19 Jurisdictions with Pretax Losses and No Tax Benefit Can be Recognized .. 17 - 20 Jurisdictions For Which a Reliable Estimate Cannot Be Made ..................... 17 - 20 General Overview ........................................................................................... 17 - 20 Computing a Tax Provision When a Reliable Estimate Cannot be Made ..... 17 - 23 Tax Effects Other than the Tax on Current-Year Ordinary Income ............................................................................................ 17 - 23 Intraperiod Allocation in Interim Periods ........................................ 17 - 24 General Overview ......................................................................................... 17 - 24 Subsequent Revisions ................................................................................. 17 - 24 Intraperiod Allocation That Reflects Discontinued Operations Prior to the Date on Which They are Classified as Held for Sale or Disposed Of .................................................................................................. 17 - 24 Changes in Valuation Allowance ................................................................ 17 - 25 Initial Recognition of Source-of-Loss Items .................................................. 17 - 28 Exception to the Basic Intraperiod Allocation Model............................... 17 - 28 Tax Accounting Considerations of Stock Based Compensation During Interim Periods................................................................................. 17 - 30 Other Complexities ......................................................................... 17 - 32 Business Combinations............................................................................... 17 - 32 Effects of Naked Credits on the Estimated Annual Effective Tax Rate................................................................................................................ 17 - 35 Different Financial Reporting and Tax Year-End ...................................... 17 - 35 When Disclosure of Components of Interim Tax Expense Is Required ........................................................................................................ 17 - 37 Disclosures ..................................................................................... 17 - 38

17.4 17.4.1 17.4.2 17.4.3

17.4.4 17.4.4.1 17.4.5 17.4.6

17.5 17.5.1 17.5.2 17.5.3 17.5.4

17.6

Chapter 18: Income Tax Accounting for Stock-Based Compensation 18.1 18.2 18.2.1 18.3 18.4 18.4.1 18.4.2 18.4.3 18.4.4 18.5 18.5.1 18.6 18.6.1

18 - 1

Introduction .................................................................................... 18 - 3 Background and Basics of Accounting for Stock-Based Compensation Under ASC 718 and ASC 740 ............................................ 18 - 3 Income Tax Accounting for Liability-Classified Awards .......................... 18 - 5 Accounting for Income Taxes Related to Various Awards............... 18 - 5 Income Tax Accounting for Nonqualified Stock Options ................. 18 - 5 Initial Recognition and Classification of a Deferred Tax Asset............... 18 - 5 Change in Tax Rates .................................................................................... 18 - 6 Employer Payroll Taxes ............................................................................... 18 - 6 Accounting for Options That Are Forfeited or Expire Unexercised ........ 18 - 6 Income Tax Accounting for Incentive Stock Options....................... 18 - 9 Disqualifying Dispositions ........................................................................... 18 - 9 Income Tax Accounting for Restricted Stock and Restricted Stock Units...................................................................................... 18 - 10 Initial Recognition and Classification of the Deferred Tax Asset ........... 18 - 11

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18.6.2 18.6.2.1 18.7 18.7.1 18.7.2 18.8

Measurement of Tax Deduction for Restricted Stock.............................. 18 - 11 IRC Section 83(b) Elections............................................................................ 18 - 11 Income Tax Accounting for Stock Appreciation Rights ................... 18 - 13 Cash-Settled SARs....................................................................................... 18 - 13 Stock-Settled SARs...................................................................................... 18 - 13 Accounting for the Tax Benefit of Dividends on Restricted Stock and Options........................................................................... 18 - 14 Modification of Awards ................................................................... 18 - 15 Pool of Windfall Tax Benefits .......................................................... 18 - 16 General Guidance......................................................................................... 18 - 16 Determining the Pool of Windfall Tax Benefits Using the Long-Form Method ...................................................................................... 18 - 18 Considerations for Equity-Classified Awards Granted Before but Settled After Adoption of ASC 718 Under the Long-Form Method......... 18 - 18 Nonqualified Stock Options - Long-Form Method ........................................ 18 - 19 Incentive Stock Options - Long-Form Method .............................................. 18 - 23 Restricted Stock - Long-Form Method.......................................................... 18 - 26 Determining the Pool of Windfall Tax Benefits Using the Short-Cut Method ........................................................................................ 18 - 26 Transition Considerations Under the Short-Cut Method............................... 18 - 28 Determining the Pool of Windfall Tax Benefits for Enterprises That Became Public Entities After the Effective Date of the Prior Standard but Before Adopting ASC 718 .................................................... 18 - 30 Determining the Pool of Windfall Tax Benefits for Prospective Adopters .................................................................................. 18 - 31 Determining the Tax Benefit from Awards with Graded Vesting and Separate Fair Values............................................................................. 18 - 32 Business Combinations, Equity Restructurings, and Separately Reporting Subsidiaries.................................................................... 18 - 32 Impact of Business Combinations, Equity Restructurings, Spin-offs, Equity-Method Investments, Majority-Owned Subsidiaries, and Bankruptcy on the Pool of Windfall Tax Benefits ..................................... 18 - 32 Pool of Windfall Tax Benefits for Separately Reporting Subsidiaries..... 18 - 33 Tax Effects of Awards Exchanged in a Business Combination .............. 18 - 33 Awards that Ordinarily Result in a Tax Deduction ......................................... 18 - 33 Equity-Classified Awards that Ordinarily Result in a Tax Deduction............. 18 - 34 Liability-Classified Awards that Ordinarily Result in a Tax Deduction........... 18 - 37 Awards that Do Not Ordinarily Result in a Tax Deductions........................... 18 - 37 Ongoing Accounting for Share-Based Awards Granted Prior to the Effective Date of ASC 805 ........................................................ 18 - 38 Example: Options Exchanged in a Business Combination Prior to the Effective Date of ASC 805 ..................................................................... 18 - 39 Fair Value of Options Exchanged................................................................... 18 - 40 Entry to Record Fair Value Allocated to Future Service ................................ 18 - 40 Requisite-Service-Period Entries ................................................................... 18 - 41 Exercised OptionOptions Vested at Closing Date ..................................... 18 - 41 Exercised OptionsOptions Unvested at Closing Date ............................... 18 - 42

18.9 18.10 18.10.1 18.10.2 18.10.3 18.10.3.1 18.10.3.2 18.10.3.3 18.10.4 18.10.4.1 18.10.5

18.10.6 18.10.7

18.11 18.11.1

18.11.2 18.11.3 18.11.3.1 18.11.3.1.1 18.11.3.1.2 18.11.3.2 18.12 18.12.1 18.12.1.1 18.12.1.2 18.12.1.3 18.12.1.4 18.12.1.5

xvi / Table of Contents

18.13 18.14 18.14.1 18.15 18.16 18.17 18.18 18.19 18.20 18.21 18.21.1 18.21.2

Net Operating Loss Carryforwards.................................................. 18 - 43 Valuation Allowances ...................................................................... 18 - 44 Accounting for Settlements When There Is a Valuation Allowance ....... 18 - 45 Uncertain Tax Positions .................................................................. 18 - 45 Intraperiod Tax Allocation ............................................................... 18 - 46 Interim Reporting ............................................................................ 18 - 46 Capitalized Compensation Cost ...................................................... 18 - 46 Multinational Enterprises................................................................ 18 - 50 Cost-Sharing Pool ........................................................................... 18 - 51 Income Tax Disclosures, Assumed Proceeds Under the Treasury Stock Method, and Cash Flow Statement Presentation .................. 18 - 52 Assumed Proceeds in the Computation of Dilutive EPS Under the Treasury Stock Method ............................................................................... 18 - 52 Cash Flow Statement Presentation............................................................ 18 - 53

Chapter 19: Income Tax Accounting: U.S. GAAP Comparison to IFRS 19.1 19.2 19.2.1 19.2.2

19 - 1

Short-Term Convergence................................................................ 19 - 3 Comparison Between U.S. GAAP and IFRS ..................................... 19 - 3 Comparison Between the U.S. GAAP and IFRS Income Tax Accounting Models ...................................................................................... 19 - 3 Differences in Interpretation ....................................................................... 19 - 9

Appendix A B The Model: Accounting for Income Taxes .......................... A - 1 Summary of Changes ......................................................... B - 1

Table of Contents / xvii

Executive Summary

Executive Summary / 1

Executive Summary Change: The one constant Benjamin Franklin once said that nothing in this world is certain but death and taxes. Had he been able to anticipate this centurys standard-setting activity, he might have phrased things somewhat differently. Nowadays, the only certainty about taxes is that things will change. Complexity Already complex, accounting for income taxes will become even more so as a result of new and forthcoming guidance here in the United States. The accounting model for income taxes has been around for some time - a fact that suggests companies have had sufficient time to fully acclimate themselves to the standards provisions. In the intervening years, however, the overall business environment has grown decidedly more complex. So too has accounting under U.S. generally accepted accounting principles (GAAP). The way that governments (local, federal and foreign) levy taxes is also more complex now. These factors have made the interpretation of the accounting model for income taxes particularly challenging. Complications Where there is complexity, there is the greater likelihood of complications. In recent years, controls around the accounting for income taxes have been a critical source of material weakness in companies internal controls over financial reporting. Accounting for income taxes has also been a primary reason for restating financial statements. Further complications may arise as U.S. GAAP begins to converge with International Financial Reporting Standards (IFRS). While the Securities and Exchange Commission (SEC) ponders whether it will allow U.S. companies to file financial statements prepared under IFRS, many practitioners will want to become familiar with the similarities and differences between the two frameworks. How this manual helps We have kept these factors very much in mind while writing this manual. Intended as a practice aid for PricewaterhouseCoopers engagement teams and other parties, this manual serves as a central location for the following information: A comprehensive summary of ASC 740 PwCs interpretation of that literature PwCs insights on accounting matters related to income taxes

In reading this manual, it is important to remember that under ASC 740, as under any principles-based standard, circumstances particular to a given situation might lead to an accounting conclusion that differs from the one arrived in a similar but not identical situation (or might lead to more than one supportable conclusion). We hope it is with this understanding that our readers will use this manual.

2 / Executive Summary

How this manual is organized The beginning chapters address the following matters: The basic model of ASC 740 (e.g., the scope, objectives, and basic principles) Identification of temporary differences Recognition and measurement of deferred tax assets and liabilities Establishment of a valuation allowance Accounting for changes in tax laws and tax status

The manual then moves on to some of the more complex areas of tax accounting: Business combinations Temporary differences on outside basis Intraperiod allocation

These three complex areas have in whole or in part been re-examined by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in their mutual effort to converge U.S. GAAP and IFRS. The final chapters of the manual deal with the following issues: Disclosure Separate financial statements of a subsidiary Interim reporting Tax accounting for share-based payments Accounting for uncertainty in income taxes Summary of differences in accounting for income taxes between U.S. GAAP

and IFRS As the environment continues to change, so will the content in this manual. This manual considers existing guidance as of April 30, 2009. Future editions will be released to keep pace with other significant developments. Subsequent editions will also provide practitioners with guidance on navigating the many complexities of accounting for income taxes, which we believe (with the same conviction that Franklin had about death and taxes) will only keep proliferating.

Executive Summary / 3

Chapter 1: Scope of ASC 740

Scope of ASC 740 / 1 - 1

Chapter Summary ASC 740, Income Taxes (ASC 740) addresses how companies should account for and report the effects of taxes based on income. While the scope of ASC 740 appears to be self-explanatory (i.e., ASC 740 applies to all income based tax structures), the unique characteristics of tax structures across the United States and the world can make it quite difficult to determine whether a particular tax structure is a tax based on income. Matters are further complicated when the determination involves the U.S. tax treatment of a structure such as a single-member limited liability company or entails applying the check the box rules for entity classification. This chapter looks at what would constitute a tax based on income and discusses the applicability of ASC 740 to various types of entities.

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Excerpts from ASC 740 ASC 740-10-15-2: The principles and requirements of the Income Taxes Topic are applicable to domestic and foreign entities in preparing financial statements in accordance with U.S. generally accepted accounting principles (GAAP), including not-for-profit entities (NFP) with activities that are subject to income taxes. ASC 740-10-15-3: The guidance in the Income Taxes Topic applies to: a. Domestic federal (national) income taxes (U.S. federal income taxes for U.S. entities) and foreign, state and local (including franchise) taxes based on income. b. An entity's domestic and foreign operations that are consolidated, combined, or accounted for by the equity method. ASC 740-10-15-4: The guidance in this Topic does not apply to the following transactions and activities: a. A franchise tax to the extent it is based on capital and there is no additional tax based on income. If there is an additional tax based on income, that excess is considered an income tax and is subject to the guidance in this Topic. See Example 17 (paragraph 740-10-55-139) for an example of the determination of whether a franchise tax is an income tax. b. A withholding tax for the benefit of the recipients of a dividend. A tax that is assessed on an entity based on dividends distributed is, in effect, a withholding tax for the benefit of recipients of the dividend and is not an income tax if both of the following conditions are met: 1. The tax is payable by the entity if and only if a dividend is distributed to shareholders. The tax does not reduce future income taxes the entity would otherwise pay. Shareholders receiving the dividend are entitled to a tax credit at least equal to the tax paid by the entity and that credit is realizable either as a refund or as a reduction of taxes otherwise due, regardless of the tax status of the shareholders.

2.

See the guidance in paragraphs 740-10-55-72 through 55-74 dealing with determining whether a payment made to a taxing authority based on dividends distributed is an income tax.

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1.1 1.1.1

Scope of ASC 740 In General (ASC 740-10-15-3) ASC 740's principles and requirements apply to domestic and foreign entities in preparing financial statements in accordance with U.S. generally accepted accounting principles (GAAP), including not-for-profit entities (NFP) with activities that are subject to income taxes, including the following: Domestic federal (national) income taxes (U.S. federal income taxes for U.S.

enterprises) and foreign, state, and local (including franchise) taxes based on income An enterprises domestic and foreign operations that are consolidated, combined,

or accounted for by the equity method In short, any income-based tax that an enterprise must pay to a governmental authority is subject to the provisions of ASC 740. It is also important to note that ASC 740 applies to all entities that are part of a reporting entity. It will be necessary, therefore, to consider the tax impact of other entities that interact with the companies that make up the financial reporting entity (e.g., equity-method investees and entities that are combined due to common control, or variable interest entities ( VIEs) required to be consolidated under ASC 810 Consolidation) not just the tax impact of consolidated subsidiaries. 1.1.2 Scope Exceptions (ASC 740-10-15-4) ASC 740 explicitly states that it does not address: A franchise tax to the extent it is based on capital and there is no additional tax

based on income (Section TX 1.2.2.1) A withholding tax for the benefits of the recipients of a dividend (Section TX

1.2.1.1) 1.2 1.2.1 Defining a Tax Based on Income In General As discussed above in Section TX 1.1.1, the principles of ASC 740 are applicable to taxes based on income. However, authoritative literature under U.S. GAAP does not clearly define the term tax based on income or specify characteristics that differentiate taxes based on income from taxes that are not. The legal definition of the tax structure (as an income tax or otherwise) is not determinative in an evaluation of whether a tax structure should be accounted for as a tax based on income. 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. That being said, the tax structure does not need to include all income statement accounts in order to be an income tax. A tax on a subset of the income statement, such as a tax on net investment income (which taxes investment income less investment-related expenses), would also appear to be a tax on income, since it would employ the net income concept. In general, practice has been that a "tax based on income" would

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even apply to tax regimes in which revenues or receipts are reduced by only one category of expense. To define income taxes, we look to the ASC Master Glossary, which defines income taxes as domestic and foreign federal (national), state, and local (including franchise) taxes based on income. ASC 740 establishes standards of financial accounting and reporting for the tax consequences of revenues, expenses, gains, or losses that are included in taxable income (ASC 740-10-05-01). The ASC Master Glossary defines taxable income as the excess of taxable revenues over tax deductible expenses and exemptions for the year as defined by the governmental taxing authority. Thus, we believe that implicit in ASC 740 is the concept that taxes on income are determined after revenues and gains are reduced by expenses and losses. Therefore, as discussed in Section TX 1.2.2.2, taxes based solely on revenues (e.g., gross-receipts tax) would not be subject to ASC 740. 1.2.1.1 Withholding Taxes - Entities That Withhold Taxes for the Benefit of Others ASC 740-10-15-4 indicates that a withholding tax for the benefit of the recipients of a dividend is not an income tax if both of the following conditions are met: The tax is payable by the entity if and only if a dividend is distributed to

shareholders. The tax does not reduce future income taxes the entity would otherwise pay. Shareholders receiving the dividend are entitled to a tax credit at least equal to the

tax paid by the entity and that credit is realizable either as a refund or as a reduction of taxes otherwise due, regardless of the tax status of the shareholders. This guidance indicates that if both of the above conditions are met, the withholding tax would not be considered an income tax of the entity that pays the dividend. We believe that this guidance would also apply to withholding taxes for the benefit of the recipients of interest, royalty or other payments if the above conditions are satisfied. If withholding taxes are determined to be income taxes, however, they would be subject to the accounting requirements of ASC 740. 1.2.1.2 Withholding Taxes - Entities That Receive Dividends, Inte