accounting for income taxes - complex matters 12 17 09

scaling complex scaling complex rules….

A ti f I T & Accounting for Income Taxes & Uncertainty in Income Taxes

Katherine Morris, CPADecember 2009

AgendaAgendaUncertainty in Income TaxesAccounting for Income Taxes RecentAccounting for Income Taxes – Recent Developments & Hot Topics

FAS141R – Business CombinationsValuation AllowancesAPB Opinion 23FIN18 I t i T R tiFIN18 – Interim Tax ReportingAccounting for Convertible Debt under APB 14-1

DisclaimerDisclaimer

To ensure compliance with Treasury Department regulations, any tax advice that may be contained in this communication (includingtax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Service Code or applicable state or local tax law provisions or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.

Material discussed in this presentation is meant to provide general information and should not be acted on without professional advice tailored to your firm’s or company’s individual needs.

Uncertainty in Income Taxes -AgendaAgenda

A Technical Overview

Getting Started

Documentation

Reporting & DisclosuresReporting & Disclosures

Audit Ready or Not?

Potential Issues

solitary facts…

Accounting for I T Income Tax Uncertainties

No more delays…delays…

FASB confirms the effective date for applying

Accounting StandardsAccounting Standards Codification Topic 740

[ASC 740] on accounting for uncertainty in income

taxes [aka FIN 48] is effective for nonpublic companies for fiscal years beginning afteryears beginning after December 15, 2008.

October 1, 2009

HighlightsHighlightsEffective for US GAAP financials

Nonpublic* Companies: Periods beginning after December 15, 2008Effective for 2009 calendar year companies*Nonpublic:

C C tiC-CorporationS-CorporationPartnershipNon Profit Organization

Public Companies:Periods beginning after December 15, 2006

Requires all material income tax positions q pfor all open tax years to be reviewed

Now Applies to Nonprofits & Pass-ThroughsNow Applies to Nonprofits & Pass ThroughsExamples:

Pass-ThroughsDoes the S-Corporation have a valid S-Corporation election? Is the partnership a valid partnership; is it operated like a partnership?Is the Partnership or S-Corporation filing in all states and payingIs the Partnership or S-Corporation filing in all states and paying income taxes that are not passed to owners?Have foreign taxes to partnerships or their investments been considered?

Non ProfitsIs the nonprofit entity meeting the requirements of its tax exempt status?Have articles been submitted to the IRS for changes in the businessHave articles been submitted to the IRS for changes in the business over the years—i.e., is tax-exempt status current?Does the nonprofit entity have any unrelated business income not previously reported?

GuidanceGuidanceASC 740 [FIN 48]

Applies only to “income taxes”Note: FAS 5 still applies to all other taxes

Review all income tax positions for all open tax yearsAssume all tax positions will be auditedaudited

Accrue “tax benefit” if:It is “more likely than not” that the tax position will be sustained in auditp

DiscloseChanges in tax position in income tax footnoteExpected changes in next 12 months

How to: 2-Step ProcessHow to: 2 Step Process

Recognition:M t b “ lik l th t”

More likely than not?

Must be “more likely than not” (MLTN) of being sustained in an audit to record the benefit of the positionAssume you will be auditedAssume you will be auditedIf MLTN standard is not met, the item is an “uncertain tax position”If not MLTN, go to next step … measurementmeasurement

Measurement:If a position is recognizable, the amount recognized must be the Possible Outcome Cumulative Probability

What probable outcome > 50%?

amount recognized must be the largest amount of tax benefit that is greater than 50% likely of being realized

Possible Outcome Cumulative Probability

$ 100 5%

$ 60 55%

$ 20 95%

The Fruits of Your Labor:BenefitsBenefits

Audit ready for US GAAPDue diligence ready for exit strategyCentralizes tax mattersCentralizes tax mattersTax planning opportunities identifiedAvoids surprises

applying the rules…

Getting Startedg

ProcessProcessPhase I: Discovery

Auditor’s expectationsCorporate counsel?Scope pMaterialityOpen tax years – tax statutesData collectionData collectionInventory tax positions

Process: DiscoveryProcess: DiscoveryObjective: to demonstrate completeness and that all material tax positions were considered.material tax positions were considered.

Considerations: Significant accounting policies during all open tax yearsSignificant events during all open tax years – e.g.,

i iti t t i t l i tmergers, acquisitions, restructuring, tax planning, etc.Tax treatment of items

Sample Deliverables: Phase I - DiscoveryPhase I Discovery

Significant Accounting Policy / Significant Events

Footnote Reference / Year to which

pertains

Tax Accounting Policy-How Treated for Tax

1 Revenue Recognition …

2 Research & Development …

3 Acquisitions/Mergers ….

Sample Deliverables: Phase I Inventory Tax PositionsPhase I - Inventory Tax PositionsDescribe tax positions

in all open tax yearsTax Year Tax Jurisdiction

(Federal, State,

Categorize as Significant,

Complex, Non

Tax (Benefit) or Accrual

Amount ,Foreign)

p ,Complex, Highly

Certain

1

2

Total

Process: Document decision process from review of all tax positions; categorize positions and quantify the impact of positionspositions and quantify the impact of positions

Use Subject Matter ExpertsUse Subject Matter ExpertsFederalIRS Practice & ProceduresIRS Practice & ProceduresInternationalTransfer PricingTransfer PricingR&D CreditSALTSALTCompensation & Benefits

Get your pencils sharpenedsharpened…

D t tiDocumentation

Deliverables: ProcessProcess

Phase II: Documentation

Technical merit of tax positionsJurisdictions

FederalStateInternationalI t t & ltiInterest & penalties

Current period activityAssumptions

Sample Deliverables: Phase II -Documentation Supporting a Tax PositionDocumentation Supporting a Tax PositionTax Year:

Tax Jurisdiction: Insert tax jurisdiction.

Tax Position: Describe the ta positionTax Position: Describe the tax position.

Unit of Account: Describe the selected unit of account.

Does the tax position meet the “more likely than not” recognition threshold: Meets / Does Not Meet Recognition Criteria.recognition threshold:Why does the tax position meet or fail to meet the “more likely than not” recognition threshold:

Qualitative Law Analysis: Include the technical merits of the tax position applied to the facts and circumstances of the tax position.

Amount recorded in the tax return: $

Income tax expense for the current fiscal period: $

Income tax expense for the prior fiscal period(s): $

Current tax liability recorded: $

Noncurrent tax liability recorded: $

Deferred taxes on item: $

Liability for unrecognized tax benefit at the balance-sheet $Liability for unrecognized tax benefit at the balance sheet date:

$

Support amounts recorded for the unrecognized tax benefit:

Measurement: Calculate the largest amount of benefit that is greater than 50 percent likely of being realized/i.e., probability tables.

Measurement – Assess the Probability of OutcomesOutcomes

Possible Estimated Outcome

Individual Probability of Occurring

Cumulative Probability

of OccurringOutcome Occurring of Occurring

$ 100 10% 10%

$ 80 20% 30%

$ 60 25% 55%$ 60 25% 55%

$ 50 20% 75%

$ 40 10% 85%

$ 20 10% 95%$ 20 10% 95%

$ 0 5% 100%

•NOTES: •$60 is the largest amount of benefit > than 50% likely of being realized upon settlement•$60 is the largest amount of benefit > than 50% likely of being realized upon settlement•$40 would be recorded on the balance sheet as an “unrecognized tax benefit” ($100 - $60)

Process: Document measurement process using a probability table or some other source of measurement.

Sample Deliverables: Phase II - Recognition & MeasurementPhase II Recognition & Measurement

JURISDICTION: Federal

Description of Identified Uncertain Tax Positions in Current Period

Tax (Benefit) or Accrual –

Amount to be Reported

Recognition Criteria Met?

“Measurement”

1

2

lTotal

Process: Document decision process on recognition criteria – MLTN or not? –and document results from the measurement step i e the amount to beand document results from the measurement step – i.e., the amount to be reported.

Sample Deliverables: L d Sh tLead Sheet

Analytical Summary:Jurisdiction/ FAS 5 @ FIN 48 @ Amount of Explanation of change /Jurisdiction/

CategoryFAS 5 @ 12/31/08

FIN 48 @ 1/01/09

Amount of Change

Explanation of change / workpaper reference

FederalState & LocalInternational

Total TaxesTotal TaxesInterestPenaltiesT t lTotal:

Taxes, Interest, Penalties

Process: Summarize changes since last reporting period; disclose whether there is an impact.

the bottom line…

Reporting & gDisclosures

Cumulative Effect AdjustmentCumulative Effect AdjustmentRecord cumulative effect as an adjustment to the opening balance of retained earningsp g gInclude:

Tax liability upon adoptionR f d l i t i l d dRefund claims not previously recorded Interest and penalties on UTPs

Exclude: Items that would not be recognized in earnings

e.g., business combination adjustments to goodwillTiming differences fully offset by changes in DTA & DTLTiming differences fully offset by changes in DTA & DTL

Required Disclosures –Nonpublic CompaniesNonpublic Companies

Total interest & penaltiesASC Section 740-10-50-15(c)( )

12-month look forwardNature of uncertainties and events that are reasonably possible of occurring in the next 12 months that would cause a significantof occurring in the next 12 months that would cause a significant increase or decrease in the amounts of unrecognized tax benefits

ASC Section 740-10-50-15(d)ASC Section 740 10 50 15(d)

Open statutesDescription of tax years that remain subject to examination by

j t j i di timajor tax jurisdictionsASC Section 740-10-50-15(e)

Disclosures –NOT Required for Nonpublic CompaniesNOT Required for Nonpublic Companies

Tabular RollforwardTotal unrecognized tax benfitsTotal unrecognized tax benfitsThat the adoption of [FIN 48] had no material effect on their financial statementsEffective for periods ending after September 15, 2009

ASC Section 740-10-50-15(a) and 740-10-50-15(b)(paragraphs 21(a) and 21(b) of Interpretation 48)

Audit SettlementAudit SettlementIssue

When is an uncertain tax position “settled”?A li tiApplication

FSP FIN 48-1, “Definition of Settlement in FASB Interpretation No. 48,” issued May 2007

Guidance:Guidance:Position must be effectively settled and meet 3 conditions

Completion of examCompany does not intend to appeal/litigateCompany does not intend to appeal/litigateRemote likelihood that taxing authority would examine/re-examine tax position

Take AwayEven though FIN 48-1 issued in 2007, uncertainty and disputes around “settlement” still exists; support positions taken

Settlement is Limited to Examined Return Year(s)Year(s)

IssueCompany completes an exam and fails to identify anCompany completes an exam and fails to identify an uncertain tax position in that year’s tax return

Take AwaySettlement provides no new evidence about the technical merits of similar tax positions in other years’ tax returns

lost in the ildwilderness…

FIN 48 Potential IIssues

Valuation Allowance on DTAs Not a Substitute for Analysis of FIN 48Substitute for Analysis of FIN 48

GuidanceDTAs should be established for all deductible temporary p ydifferences, NOLs and CreditsRecord DTAs gross and then consider need for VAVA may be required if future realization is in doubt due toVA may be required if future realization is in doubt due to insufficient future taxable income

Take AwayA valuation allowance is not an appropriate way to handle tax benefits that do not meet the recognition or measurement thresholdsCompanies are required to examine tax issues where had full Valuation Allowances (VA) on deferred tax assets (DTAs)

No Netting of Cross Jurisdictional Tax IssuesIssues

Guidance Gross-up deferreds when have a full VA and uncertain tax liabilities

Examples: Federal exposures and state benefits T f i i d b fit f diff t j i di tiTransfer pricing exposures and benefits from different jurisdictions

Multinational companies may have used historical blended foreign tax rate

R&D labs may be located in one countryR&D labs may be located in one countryManufacturing plants in other countries

Take AwaysPresent tax positions separately at a level no higher than a jurisdictional levelCannot offset exposure in one jurisdiction with related tax b fit f thbenefits from another

Recognize BenefitsRecognize BenefitsGuidance

FIN 48 applies to refund claimsFIN 48 applies to refund claims Recognize and measure benefits using the FIN 48 criteria, not as a contingent gain under FAS 5

T k ATake AwayConsider the impact of refund claims

Retained earnings at the time of adoptiong pIncome tax benefit in future periods

a tangled web of a tangled web of complex matters…

Accounting for I TIncome Taxes

Accounting for Income Taxes – Recent Developments/Hot TopicsDevelopments/Hot Topics

FAS141R – Business CombinationsValuation AllowancesValuation AllowancesAPB Opinion 23FIN18 – Interim Tax ReportingFIN18 Interim Tax ReportingAccounting for Convertible Debt under APB 14-1

lnew rules…

Business C bi tiCombinations

Methods of Accounting for Business CombinationsCombinationsDevelopment of current guidance has been a multi-phased process

Issued June 2001 SFAS 142 (ASC 350, 730 323, 205, 280): Goodwill and Other Intangible AssetsSFAS 141: Business CombinationsS S C

Issued December 2007 SFAS 141R (ASC 805) B i C bi ti ( i d)SFAS 141R (ASC 805): Business Combinations (revised)

Effective for years beginning after 12/15/08

SFAS 142 (ASC 350, 730 323, 205, 280): Goodwill and Other Intangible AssetsGoodwill and Other Intangible Assets

Key ProvisionsDo not amortize goodwill and other indefinite lived assetsAnnual impairment reviewAmortize tangible assets using a method that reflects consumption or usagegProvides a model and methodology to test for and measure goodwill impairment

SFAS 141R (ASC 805-10-5, 10&15) Business CombinationsBusiness Combinations

141R adoption represents the first convergence between FASB and IASBbetween FASB and IASBApplicable for all years beginning after December 15, 2008Prospective treatment for all acquisitions after the adoption date, and for transactions consummated

i t th d ti d t i t i it tiprior to the adoption date in certain situations:Changes in valuation allowance and Acquired tax contingenciesAcquired tax contingencies

SFAS 109 (ASC 740): Business Combinations Business Combinations

General Rule, Paragraph 30: (ASC 740-25-3&4)Each identified asset and liability is assigned its respective fair value

Refer to SFAS 141R (ASC 805-10-5,10&15)

A deferred tax liability (DTL) or asset (DTA) is established for the difference between book and tax bases resulting from the purchase price allocation and for any carryforwards

DTAs may include future benefits of NOLs and tax credit carryforwardsca y o a ds

The need for a valuation allowance on DTAs must be separately assessedassessed

“Identified” Intangibles:Separate Recognition CriteriaSeparate Recognition Criteria

SFAS 141R (ASC 805-10-5, 10&15): Recognize intangible assets, apart from goodwill, where the intangible asset or right is separable

t f blor transferable

Examples:Contractual or legal rights (regardless of whether rights are separable or transferable)

Separable or transferable asset or right (e.g., can be sold, rented, licensed, transferred or exchanged)

Identified IntangiblesIdentified IntangiblesIllustrative list:

Market-related intangiblestrademarks, tradenames, internet domain names, non-compete agreements

Customer-related intangiblescustomer lists, customer relationships, order backlog

Artistic-related intangiblesmovies, books, music, newspapers, photos

Contract-based intangiblesroyalty agreements, supply contracts, employment agreements, broadcast rights

Technology-based intangiblessoftware, patents, databases, trade secrets, formulas

Identified IntangiblesIdentified IntangiblesRecord DTA/DTL for basis differences related to identified intangible assetsIdentified Intangibles = Temporary difference regardless of availability of a tax deductionIntangible assets not meeting the “separate recognition criteria” are classified as goodwill (e.g., assembled workforce)

Purchase Price Accounting Example: DTLPurchase Price Accounting Example: DTLFacts:

Target stock is acquired by Corporation X on 03/31/2009 for $1,500. Identified intangibles (market-related and customer-related intangibles) are recorded for book purposesIdentified intangibles (market-related and customer-related intangibles) are recorded for book purposes

under FAS 141R (ASC 805-10-5, 10&15) for $600.

Assumptions:No section 338 election40% ff ti t t40% effective tax rate$-0- tax basis in the intangibles held by Target

FAS 109, Para 30 Book Tax Difference DTLFAS 109, Para 30 Book Tax Difference DTLIdentified Intangibles $600 $-0- $600

Tax Rate x 40% = $240

Journal Entry:Dr. Goodwill $240

Cr. Deferred Tax Liability $240y

Purchase Price Accounting Example: DTAPurchase Price Accounting Example: DTAFacts:

Target stock is acquired by Corporation Y on 03/31/2009 for $950. Identified intangibles (market-related and customer-related intangibles) are recorded for book purposesIdentified intangibles (market-related and customer-related intangibles) are recorded for book purposes

under FAS 141R (ASC 805-10-5, 10&15) for $300.

Assumptions:No section 338 election40% ff ti t t40% effective tax rate$500 historic tax basis in the intangibles held by Target

FAS 109, Para 30 Book Tax Difference DTAS 09, a a 30 oo a e e ceIdentified Intangibles $300 $500 $200

Tax Rate x 40% = $80

Journal Entry:Dr. Deferred Tax Assets $80

Cr. Goodwill $80

FAS 141R – (ASC 805): Business Combinations - GoodwillBusiness Combinations Goodwill

If Purchase Price > FV Assets; Excess = Goodwill

Intangible assets not meeting the “separate recognition criteria” are classified as goodwill (e.g., g g ( g ,assembled workforce)

SFAS 109: Business Combinations (cont’d.) SFAS 109: Business Combinations (cont d.) 3 Exceptions where DTA or DTL is not recorded at purchase (Paragraph 30) (ASC 740-25-3&4)purchase (Paragraph 30) (ASC 740 25 3&4)

1. Goodwill not deductible for tax purposes2. Acquired APB Opinion 23 (ASC 740 & 942) differences3. Leveraged Leases

Tax Deductible Goodwill – 141R (ASC 805-10-5, 10&15)10 5, 10&15)

If tax deductible goodwill, separate into two components:First Component

Lesser of "book" goodwill or "tax" goodwillDifference between the book and tax basis in future years is temporary difference

Second Component - RemainderIf book goodwill > tax goodwill - a tax benefit is never recognized (permanent difference)If tax goodwill > book goodwill –141R(ASC 805-10-5,10&15) amends Statement 109 (ASC 740), stating that excess tax goodwill meets the definition of a temporary difference.

A DTA m st be recogni ed at the acq isition dateA DTA must be recognized at the acquisition date

Tax Deductible GoodwillTax Deductible GoodwillFirst, divide goodwill into two components:

Book goodwill = tax goodwillBook goodwill tax goodwillGenerally will create a deferred tax liability in subsequent reporting periods when tax benefits are

li drealizedBook goodwill > tax goodwill

Existing rules apply (e g “no change”)Existing rules apply (e.g., no change )Goodwill impairment charge for financial reporting treated as a "permanent difference"

(FAS 109 (ASC 740), Paragraph 264 - 269) (805-740-35-2&3, 805-740-55, 805-740-30-3), )

FAS 141R –Tax Deductible Goodwill > Book GoodwillTax Deductible Goodwill Book Goodwill

N DTA i bli h d

Under 141(R)Under 141(R) (ASC 805(ASC 805--1010--5,10&15)5,10&15) Under 141Under 141

Record DTA at acquisitionDTA first reduces goodwill down to zero

(DR: DTA: CR: Goodwill)

No DTA is established at acquisition dateImpact goodwill when tax benefit realized( )

DTA > Goodwill: record as bargain purchase

(DR: DTA: CR: P&L – Bargain Purchase)

As tax deductible goodwill is realized, benefit recorded to:1. Acquisition goodwill1. Acquisition goodwill2. Other non-current intangible

assets3. Reduce income tax expense

(Note: This example ignores whether Valuation Allowance (VA) required to be recorded for sake of illustration)

Excess Tax Deductible GoodwillExcess Tax Deductible GoodwillFASB observed calculation as follows for initial recording of DTA

(Tax Rate / (1 – Tax Rate)) * “Preliminary Temporary Difference”

“Preliminary Temporary Difference” is the excess of the tax goodwillPreliminary Temporary Difference is the excess of the tax goodwill over the book goodwill

Consistent with treatment under IAS 12

Excess Tax Deductible Goodwill – ExampleExcess Tax Deductible Goodwill ExampleFacts:

Acquiring company purchases 100% of the assets of Target $Goodwill of $40M is recorded for financial reporting purposes

$50M of goodwill is recorded for tax purposes

Assumption:40% ff ti t t40% effective tax rate

DTA to record =$10M * (.40/(1 - .40) = $6.67M

Acquiring Co records the following assets:Acquiring Co. records the following assets:Goodwill $33.3M ($40M - $6.67M)

Deferred Tax Asset $6.67M

Goodwill ImpairmentGoodwill ImpairmentAllocation subsequent impairment to the two components of goodwill using one of the followingcomponents of goodwill using one of the following methods:

Specific IdentificationSystematic and Rational

Tax Deductible GoodwillCh i t diff fl t d i d f dChanges in temporary difference reflected in deferred taxes

Non-Deductible GoodwillNon Deductible GoodwillNo tax benefit recordedTreated as a permanent difference

SFAS 141R:Negative Goodwill Negative Goodwill

Purchase price < FMV of net acquired assets


Purchase price FMV of net acquired assets

All negative goodwill recognized as an extraordinary gain.

Pro-rata reduction to basis amounts assigned to acquired assets, other then excluded current assets and deferred tax assetsExcess remaining negative goodwill recognized as an extraordinary gain (very rare)extraordinary gain (very rare)

SFAS 141R – 1 Year Measurement PeriodSFAS 141R 1 Year Measurement PeriodPurchase Price Adjustments

Record asset allocation in the first reporting periodRecord asset allocation in the first reporting period subsequent to the acquisitionThe measurement period shall not exceed 1 year from the

i iti d tacquisition dateAdjustments: Allows retrospective adjustments accounted for under acquisition accounting (i.e., goodwill)q g ( , g )

New knowledge about facts and circumstances that existed as of the acquisition dateConsider materialityConsider materiality

Any adjustments outside the 1 year measurement period are recorded through the P&L

FAS 141R – Transaction Costs Not Capitalized in FVCapitalized in FV

Changes from 141 to 141R: Transactions costs are no longer part of the allocation ofTransactions costs are no longer part of the allocation of the purchase price under 141RNot capitalized; expense as incurred If currently deductible or amortizable for tax, record a DTA that reverses over time

Transaction CostsTransaction Costs

Under 141(R)Under 141(R) (ASC 805(ASC 805--1010--5 10&15)5 10&15) Under 141Under 141

Accounted for separately from Uncertainty related to

Under 141(R) Under 141(R) (ASC 805(ASC 805--1010--5,10&15)5,10&15) Under 141Under 141

the business combination Expense for books as incurredType of business (carryover

treatment when immediate recognition occursCertain costs incurred may be deductible for taxbasis or step-up) will determine

accounting, if information is available

be deductible for tax purposes but are treated as part of the cost/purchase price allocation for financial preporting purposesRecognized as a component of the acquisition

Transaction Costs - ExampleTransaction Costs Example

12/08 11/09 12/09 4/10

incur $3M trans Close deal &costs incur $7M costs

FactsCompany’s year end is 12/31Company s year end is 12/31Effective tax rate = 40%Deal Structure unknown at 12/31/09

12/31/2009Expense $3M of transaction costs for financial purposesRecord a DTA of $1.2M ($3M * 40%)

Transaction Costs – Example (cont.)Transaction Costs Example (cont.)2010 Tax Entries:

The company performs a transaction cost analysis and p y p ydetermines that $2M will be deductible for tax purposes in 2010

Assume a non-taxable transaction

2010 Tax Provision (Benefit) Computed:

Reverse DTA Established 1.2MRecord perm benefit for deductible portion (.8M)Total Tax Provision 4MTotal Tax Provision .4M

No benefit is recorded for permanent/non-deductible costs of $8M ($3M + $7M - $2M)($3M + $7M $2M)

Transaction Costs – Example (cont.)Transaction Costs Example (cont.)2010 Tax Entries:

Assume a taxable transaction

2010 Tax Provision (Benefit) Computed:

R DTA E t bli h d 1 2MReverse DTA Established 1.2MRecord perm benefit for deductible portion ( .8M)Establish DTA for capitalized Trans Costs (3.2M)*Total Tax Provision 2.8M

*A benefit is recorded for capitalized transaction costs of $8M ($3M + $7M - $2M) * 40%

Contingent Consideration/Subsequent Working Capital AdjustmentsWorking Capital Adjustments

Non-taxable acquisitionSubsequent P&L charges for contingent consideration is a permanent dj t t ( l t t t id b i )adjustment (relates to outside basis)

Taxable acquisitionSubsequent payments increase section 197 intangible basis, once payment is

d (di t d f i t t)made (discounted for interest)

Day 1 valuation determines component 1 vs. component 2 goodwill

Component 1 goodwill is adjusted for subsequent P&L chargesAdjust DTA/DTLAdjust DTA/DTLResults in a normalized tax provision rate

Contingent Consideration Contingent Consideration

Under 141(R)Under 141(R) (ASC 805(ASC 805 1010 5 10&15)5 10&15) Under 141Under 141

Determine the FV of all payments and record at

Amounts recorded as a component of the


payments and record at acquisition date, without regard to the likelihood of the payment

component of the acquisition once resolvedAlways adjusted goodwillSimilar treatment to tax

Initial recognition is recorded to goodwill, and any subsequent mark to market changes are

Similar treatment to tax typically

market changes are charged to the P&LSignificant deviation from tax treatment

Valuation Allowances in Business CombinationsCombinations

General Rule:Establish at time of business combinationEstablish at time of business combinationEvaluate evidence

Combined company’s past and expected future results of ti f th i iti d toperations as of the acquisition date

Consider tax law provisions that restrict future use of temporary differences (Section 382 limitations)

Subsequent Release of VA on Acquired VASubsequent Release of VA on Acquired VA

UnderUnder 141R141R (ASC 805(ASC 805 1010 5 10&15)5 10&15) Under 141Under 141

Within the measurement period?

Tax benefits recognized subsequent to acquisition

Under Under 141R 141R (ASC 805(ASC 805--1010--5,10&15)5,10&15) Under 141Under 141

pRecognize in GoodwillAs long as results from new information, that existed at the acquisition date

subsequent to acquisition applied in order to:

1. Reduce goodwill to zeroAfter the measurement period?

Recognize in P&LInclude release of VA on acquired DTA in future years in income

2. Reduce non-current intangibles related to acquisition to zero

3 Reduce income taxDTA in future years in income from continuing operations

3. Reduce income tax expense

Acquired Tax Uncertainties Acquired Tax Uncertainties


Record Uncertain tax iti t FV

Best estimate was d d t i iti if


positions at FVLower threshold for recognizing contingencies “ ”

recorded at acquisition if probable and estimable

“More likely than not” standard or contractual test is applied to determine if an accrual is warrantedaccrual is warranted

Adjustments to Acquired Tax Uncertainties Uncertainties

Under 141(R)Under 141(R) (ASC 805(ASC 805 1010 5 10&15)5 10&15) Under 141Under 141Within the measurement period?

Goodwill Adjustments (i e true-Tax benefits recognized s bseq ent to acq isition

Under 141(R) Under 141(R) (ASC 805(ASC 805--1010--5, 10&15)5, 10&15) Under 141Under 141

Goodwill Adjustments (i.e., trueups) are permitted

After the measurement period?P&L

subsequent to acquisition applied in order to:

1 Reduce goodwill to zeroAdjustments based on new information that arose after the transaction date is an adjustment to income

1. Reduce goodwill to zero2. Reduce non-current

intangibles related to acquisition to zeroadjustment to income,

regardless of time frameacquisition to zero

3. Reduce income tax expense

In-Process Research and Development In Process Research and Development


Measured at FV and it li d d itt ff i

Measured at FV and d i di t l


capitalized and written-off in the future through amortization/impairment charges

expensed immediatelyETIF 96-7 Guidance –write-off the amount

chargesNon-taxable acquisitions –establish deferred tax liability at purchase date

assigned to R&D and establish no deferred taxes

liability at purchase dateCan potentially result in a naked credit

FAS 141R –Record DTA for Assumed Vested OptionsRecord DTA for Assumed Vested Options

Changes from 141 to 141R: Record DTA at the time of the business combination forRecord DTA at the time of the business combination for share-based replacement awardsExcess benefits or shortfalls are recorded in APIC

Summary of RulesSummary of Rules

Stock Stock Asset AssetStock or Asset Acquisition?

Basis

StockGAAPFMV

StockTax

Carryover

AssetGAAPFMV

AssetTaxFMV

Tax Attributes

Accounting M th d

N/A

N/A

y

Carryover

Carryover

N/A

N/A

Start Over

Elect NewMethods

Intangible Assets FMV N/A FMV FMV

Available Elections N/A Sec. 338 N/A Accounting Methods

Summary of 141(R) (ASC 805-10-5,10&15) Changesg

IssueIssue SFAS 141(R)SFAS 141(R) (ASC 805(ASC 805-- SFAS 141SFAS 1411010--5,10&15)5,10&15)

Negative Goodwill Record extraordinary gain for entire bargain purchase amount

Pro-rata reduction of long lived assets before extraordinary gain recorded

Transaction Costs Expense immediately as incurred Capitalize all costs as a component of p y p pthe purchase price

Contingent Consideration

Determine & record FMV at acquisition of all payments. Subsequent adjustments to P&L

Record contingent payments only when determinable and retroactive adjustment to purchase price

Changes to Valuation Allowance & Uncertainties

If outside of measurement period, all adjustments recorded to the P&L

Subsequent adjustments were recorded to goodwill, other intangibles, and then the P&L

In-Process R&D Determine FMV at acquisition and Determine FMV at acquisition and capitalize – Subject to amortization or impairment

immediately expense – DTL was not recorded

Equity Awards Record DTA at acquisition for all re-measured award, but not awards that expire at acquisition

No DTA recorded at acquisition, but subsequent adjustment to purchase price as the tax benefit is realizedawards that expire at acquisition price as the tax benefit is realized

t t?asset or not?…

Valuation AllAllowances

Valuation AllowancesValuation AllowancesBasic GuidanceDocumentationDocumentationNaked Credits Netting DTAs/DTLsNetting DTAs/DTLs Changing Valuation Allowances

Valuation Allowances (VA) –OverviewOverview

FAS 109 para 21 (ASC 740 10 30 17)FAS 109 para. 21 (ASC 740-10-30-17)The DTA should be reduced by a VA if, based on the weight of all available evidence, it is more likely thanweight of all available evidence, it is more likely than not (i.e., >50%) that some portion or all of the DTA will not be realized

Reduces the DTA to the amount that is more likely than not to be realized

Valuation Allowances – DocumentationValuation Allowances Documentation

IssuesLack of documentation of positive and negative evidenceSEC Comments with no contemporaneous support for need for / release of VA

Take AwaysManagement must contemporaneously examine support andManagement must contemporaneously examine, support and document rationale for changes in valuation allowancesAuditors need to retain and assess management’s support and documentation

Valuation Allowances –EvidenceEvidence

Negative EvidenceA history of operating losses or tax credit carryforwards expiringA history of operating losses or tax credit carryforwards expiring unused

Losses expected in early future years

Unsettled circumstances that if unfavorably resolved would adversely effect future operations and profit level

Valuation Allowances –Positive EvidencePositive Evidence

Examples of Positive EvidenceExisting contracts or firm sales backlog that would produce more than enough taxable income to realize the deferred tax assetsassets

An excess of appreciated asset value over the tax basis of the entity’s net assets in an amount sufficient to realize the deferred tax assetstax assets

Strong earnings history exclusive of the loss that generated the asset with evidence indicating that the loss is an aberration rather than a continuing condition

Observation: Some say at least 2 years of earnings

Valuation Allowances –Weighing EvidenceWeighing Evidence

Sources of IncomeSources of IncomeFuture reversals of taxable temporary differences

Future taxable income exclusive of reversing temporaryFuture taxable income exclusive of reversing temporary differences and carryforwards

Taxable income in carryback years if permittedy y p

Tax planning strategiesMust Be Prudent and Feasible

Valuation Allowances –Naked CreditsNaked Credits

GuidanceDTLs resulting from temporary differences that can be offset by existing reversing deductible temporary differencesdifferencesNOLs or credits may be considered a source of income to eliminate or reduce the need for a VA

IssueCompanies often net DTLs against DTAs to compute VAIndefinite lived intangibles and goodwill are not amortizedIndefinite-lived intangibles and goodwill are not amortized under FAS 142 DTL’s on indefinite lived intangibles create a “Naked C dit”Credit”

Valuation Allowances –Naked CreditsNaked Credits

Take AwaysyDTL from indefinite-lived intangibles cannot be used as a source of income to offset DTA when computing VASh DTA d FAS 109 b f ti VAShow DTAs gross under FAS 109, before computing VA Some believe that “permanent DTAs” (e.g., AMT credits that do not expire) can also be used to offset “permanent DTLs”

Valuation Allowances –Example of Indefinite-Lived Intangibles DTLExample of Indefinite Lived Intangibles DTL

Example:Current tax loss, full valuation allowance against the DTA for NOLsg

$1,000 of tax amortization on goodwill; no other book/tax differences

Tax rate = 40%

Provision = $400Current provision = $0

Deferred provision = $400Deferred provision $400

To establish the DTL for the basis difference in goodwill

The indefinite-lived asset temporary difference cannot be considered a f i t d th VAsource of income to reduce the VA

Total tax expense = $400

Valuation Allowances – No Netting of DTAs and DTLs from Different Jurisdictionsand DTLs from Different Jurisdictions

IssueDTLs from different jurisdictions cannot be considered as a jsource of income to reduce the amount of VA on DTA

ExampleUK DTA = $100; related to UK NOLs with full VAUK DTA = $100; related to UK NOLs with full VAUS Parent DTL = $(100), relating to depreciation on US assetsUK DTA $100

UK - Valuation Allowance (100)US DTL (100)Consolidated DTL $(100)

The US taxable temporary difference cannot be netted against UK DTA to reduce the UK valuation allowance

Valuation Allowances – When Does VA Change / When Can VA Be Released?Change / When Can VA Be Released?

Guidance: Report VA changes in the reporting period they occurReport VA changes in the reporting period they occur

Issue:Issue:Timing of when can release

When income begins or when history of earnings established?When carryback opportunity arises?When non profitable business disposed?

Valuation Allowances –When Can VA Be Released?When Can VA Be Released?

Take Aways:Take Aways: Document the analysis of evidenceSupport the triggering event

What was the triggering event?When occurs?

JudgmentJudgmentDevelop a preliminary plan on what criteria to base future VA reductions

l b l global operations…p

APB O i i 23APB Opinion 23

APB Opinion 23 Reporting Position –Consistency with Other PositionsConsistency with Other Positions

BackgroundA multinational corporation must compute deferred taxA multinational corporation must compute deferred tax assets and liabilities for all temporary differences that exist between the book and tax bases of its assets and liabilities (inside basis diff), as well as any temporary ( ) y p ydifference which may exist in the shares of the subsidiary held by the parent corporation (outside basis diff)

In the absence of an exception comprehensive deferredIn the absence of an exception, comprehensive deferred tax accounting applies

APB Opinion 23 Reporting PositionAPB Opinion 23 Reporting Position

General Rule:A DTL i t i d f t id b i diff l itA DTL is not recognized for outside basis differences unless it becomes apparent that temporary differences will reverse in the foreseeable future (i.e., repatriation of foreign earnings)

What gives rise to outside basis difference? Usually unrepatriated earnings (increases book basis, not tax). Not an all or nothing, can apply to a portion of E&P.Not an all or nothing, can apply to a portion of E&P.

OtherApplies solely to basis difference in the shares of stock of CFC,Applies solely to basis difference in the shares of stock of CFC, that is, the ‘outside basis’ difference, not to the internal assets/liabilities of the CFC. Internal basis differences of the CFC must always be accrued (if material)material).

APB Opinion 23 Reporting PositionAPB Opinion 23 Reporting PositionAPB 23 Exception vs. Election?

Not an election

Exception applies if the specific facts and circumstances twarrant

Based on a company’s ability and intent to control the l f t bl t diff (i threversal of a taxable temporary differences (i.e. the

outside basis difference in the stock of CFC due to unrepatriated earnings)

APB Opinion 23 Reporting PositionAPB Opinion 23 Reporting PositionConsistency Issues Between APB Opinion 23 Exception & Other Deferred Tax Positions

Future reversals of basis differences where the APB Opinion 23 Exception is in place cannot be considered when determining the net deferred tax balances and the resulting need for a valuation allowance.balances and the resulting need for a valuation allowance.

Future earnings that may result when dividends are paid or the foreign subsidiary is sold or liquidated cannot be considered to the extent that the APB 23 exception was in place for those earningsAPB 23 exception was in place for those earnings.

In summary treatment of tax consequences when the APB Opinion 23 Exception is in place must be consistently applied.

timing is thieverything…

FIN 18 – Interim R tiReporting

FIN 18 –Interim ReportingInterim Reporting

General RuleApply estimated annual effective tax rate (ETR) to the pp y ( )year-to-date ordinary income (or loss) from continuing operationsRevise estimated annual ETR at the end of each interimRevise estimated annual ETR at the end of each interim period based upon the best current estimate of the annual ETRAdd tax related to “discrete” eventsAdd tax related to discrete events

Infrequent, unusual, discontinued operations, extraordinary items, cumulative catch-up adjustments

IssueIssueDoes the event impact the estimated annual effective tax rate for the quarter/interim period computation?

FIN 18 – Interim Reporting Discrete EventsDiscrete Events

Discrete EventsExclude events during the quarter that do not relate to continuing operations or are unusual or infrequentRecognize in the period in which they occurExamples:

Settlement of a tax audit related to prior yearsSettlement of a tax audit related to prior yearsChange in tax law which requires retroactive adjustments that fall out of the current year (i.e., Re-enactment of R&D credit)credit).

FIN 18 – Interim ReportingLoss YTD / Forecasts IncomeLoss YTD / Forecasts Income

Issue: The Company has a loss year to dateIssue: The Company has a loss year-to-date but forecasts income; no valuation allowance

Results:Show tax benefit YTD; will offset future incomeShow tax expense in the future periods that reflect income

FIN 18 – Interim Reporting DisclosureDisclosure

Extraordinary items and Discontinued Operations yare disclosed net of tax in the year-end financial statements and in the interim financials

FIN 18 – Interim Reporting Discrete Events or Not?Discrete Events or Not?

Examples:Discrete:

A law change occurs whereby the R&D credit is refreshed allowing the company to calculate credit on Qualified Research expenditures that occurred the last 6 months of the prior year and the first 6 months of the current yearCompany settles a tax audit from prior years resulting in a $600 assessment the company had previously reserved$600 assessment, the company had previously reserved $400Intangible asset impairment changes might be considered discrete if they are unusual or infrequentdiscrete if they are unusual or infrequent

FIN 18 – Interim Reporting Income from Continuing OperationsIncome from Continuing Operations

Examples of events that are reported as results from Continuing Operations (i.e., these are NOTdiscrete items):

Company hires additional employees in Q3 and grants ISO’s p y p y gforcing an adjustment to FAS 123R expense for the yearCompany releases valuation allowance based on current years’ earnings

debt or equity?…

Convertible Debt IInstruments

Convertible Debt InstrumentsConvertible Debt InstrumentsFSP APB 14-1 applies to:

Convertible debt Instruments that may be settled in cashConvertible debt Instruments that may be settled in cash upon conversion

Including partial cash settlementsWh h i i i NOT i d bWhere the conversion option is NOT required to be bifurcated from the debt hostAlso applies to Convertible preferred shares that are pp pmandatorily redeemable financial instruments classified as liabilities under FAS 150 (ASC 480-10-05)

Eff ti f fi l b i i ft D bEffective for fiscal years beginning after December 15, 2008

Convertible Debt InstrumentsConvertible Debt InstrumentsThe convertible debt instrument is recognized as two separate componentsseparate components

Component 1: DebtComponent 2: Equity – from allocating proceeds to the embedded conversion option

Convertible Debt InstrumentsConvertible Debt InstrumentsResults in book v. tax basis difference on Day 1

Tax basis of debt is unchangedTax basis of debt is unchangedBook basis of debt is decreased via FSP APB 14-1

Adjust APIC to offset deferred taxes

Convertible Debt InstrumentsDay 1 ExampleDay 1 Example

Example - (Appendix A4.) :Example (Appendix A4.) :Debit Credit

Cash Received 100,000Debt Discount (= Debt less NPV Principal & Interest) 40,260Debt Discount ( Debt less NPV Principal & Interest) 40,260

Debt 100,000Additional Paid in Capital-APIC 40,260

Additional Paid in Capital 16,104Deferred Tax Liability ($40,260 * 40%) 16,104

• Take Aways:• Recognize DTL at Day 1• Recognize deferred taxes for the basis difference from allocating proceeds to

the embedded conversion option as an adjustment to APIC

Convertible Debt InstrumentsConvertible Debt InstrumentsSubsequent Periods:

Recognize Deferred tax benefit as the debt discount isRecognize Deferred tax benefit as the debt discount is amortized to pretax income (i.e., Reduce DTL)

Book and tax interest deductions will varyT l it t d d t i t t l t th t fTax law may permit company to deduct interest equal to that of comparable nonconvertible fixed-rate debtInterest deductions in excess of the stated rate will be recaptured for tax purposes if the debt is retired or converted to stock with a valuetax purposes if the debt is retired or converted to stock with a value of less than the adjusted tax basis of the debt

Period income tax benefit would include:Current tax effect of deducting interestCurrent tax effect of deducting interestDeferred tax benefit from the reversal of the portion of the DTL

Reminder: Consider impact of DTL on VA

Convertible Debt InstrumentsConvertible Debt InstrumentsUpon Settlement

Recognize book gain (or loss) upon extinguishmentRecognize book gain (or loss) upon extinguishmentRecord a deferred tax expense (or benefit) related to book gain (or loss) Reverse any DTL that had been recorded to APIC

navigating the unknown…

Audit Ready or N t?Not?

Planning for your Auditor’s ReviewPlanning for your Auditor s ReviewAudit Objectives

CompletenessCompletenessAccuracySatisfying ObligationsSubstantial evidential matterDisclosuresM t’ t iManagement’s competency in area

Processes & ControlsProcesses & Controls

Planning for your Auditor’s ReviewPlanning for your Auditor s ReviewAuditor Concerns

Fraud or error risksFraud or error risksIncomplete analysisLack of documentation

fTiming of uncertain tax position misstatedMisstate deferred taxesMisstate DTA and VA

MaterialityAuditor defines audit expectations

Planning for your Auditor’s ReviewPlanning for your Auditor s ReviewPlanning meeting with your auditor

Objective: To understand the Audit expectations scope &Objective: To understand the Audit expectations, scope & approach

Audit Expectations for FIN 48Audit Expectations for FIN 48Has Company documented tax positions as to whether tax benefits can be recognized, the amountwhether tax benefits can be recognized, the amount and timing?

for items treated the same as bookwhere book and tax treatment differs

Audit Expectations for FIN 48Audit Expectations for FIN 48Points of discussion for FIN 48 review

All tax positions (what does this mean?)All tax positions (what does this mean?)Documentation (what will satisfy auditor reqmt?)Identifying key “units of account”MaterialityData management – access, electronic/hard copy?Ti liTimeline

Other Implementation ConsiderationsOther Implementation ConsiderationsPlanning

ResourcesResourcesInternal point personOutside service provider resource needed?

f SIdentifying Subject Matter Experts needed

Action ItemsAction ItemsFollow upCritical Deadlines

questions…questions…

Katherine D Morris CPAKatherine D. Morris, CPA(404) 317-1883

[email protected]

accounting for income taxes - complex matters 12 17 09

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