David C. Holmes, CPA
The Financial Accounting Standards Board (FASB) recently released guidance on how companies should present unrecognized tax benefits on their financial statements when they also have a net operating loss (NOL), similar tax loss or tax credit to carry forward. The guidance, found in Accounting Standards Update (ASU) No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, affects the presentation of current and deferred income taxes on balance sheets for both public and private companies.
The term “unrecognized tax benefit” generally refers to the difference between a tax position taken or expected to be taken on a company’s income tax return and the benefit recognized on its financial statements. The difference reflects the fact that the company is taking an uncertain tax position that has yet to be resolved through an audit or litigation.
Until now, FASB hasn’t provided explicit guidance on how financial statements should present an unrecognized tax benefit when an NOL carryforward, similar tax loss or tax credit carryforward exists. FASB says the result has led to “a diversity in practice” in the presentation.
Some companies use the “gross presentation” approach: They present the unrecognized tax benefit as a liability — unless the benefit is directly associated with a tax position taken in a tax year that results in, or resulted in, the recognition of an NOL or tax credit carryforward for that year and the carryforward hasn’t been used.
Others companies take a “net presentation” approach: They present unrecognized tax benefits for an NOL or tax credit carryforward as a reduction of a deferred tax asset in certain circumstances.
New presentation rules
FASB’s objective in developing the new guidance was to eliminate the diversity in practice and to increase the comparability of financial statements among companies. Accordingly, under ASU 2013-11, companies generally must show an unrecognized tax benefit, or a portion of an unrecognized tax benefit, for an NOL carryforward, similar tax loss or tax credit carryforward as a reduction of a deferred tax asset.
However, the company should present the unrecognized tax benefit as a liability and not as a reduction of a deferred tax asset if:
• The carryforward or tax loss isn’t available on the financial statement date to settle any additional income tax liability that would result from the disallowance of the tax position under the applicable tax law, or
• The applicable tax law doesn’t require the company to use — and the company doesn’t intend to use — the carryforward or tax loss to settle additional income taxes resulting from the disallowance of the tax position.
The assessment of whether a carryforward or tax loss is “available” is based on the unrecognized tax benefit and deferred tax asset (that is, the carryforward or tax loss) that exist at the financial statement date. The assessment should be made presuming the tax position will be disallowed on the financial statement date.
For example, a company shouldn’t evaluate whether the carryforward or tax loss expires before the statute of limitations on the tax position or whether the carryforward or tax loss may be used prior to the unrecognized tax benefit being settled. (But the company should consider limitations as of the financial statement
date on the use of deferred tax assets, such as limitations on the use of an NOL because of an alternative minimum taxation system.)
A company that uses a classified statement of financial position must classify an unrecognized tax benefit that’s presented as a liability as a current liability — or reduce the amount of an NOL carryforward or amount refundable — if the company anticipates the payment or receipt of cash within one year or, if longer, the operating cycle.
The guidance doesn’t require any new recurring disclosures because it doesn’t affect the recognition or measurement of uncertain tax positions. Further, the currently required tabular reconciliation of the gross amount of unrecognized tax benefits will provide public company financial statement users with relevant information about the unrecognized tax benefits offset against NOL carryforwards, similar tax losses or tax credit carryforwards.
FASB believes that the rules outlined in ASU 2013-11 will better reflect the manner in which a company would settle any additional income tax liability resulting from the disallowance of a tax position on the financial statement date when NOL carryforwards, similar tax losses or tax credit carryforwards exist.
The new rules mean that companies must pay close attention to the applicable law regarding the character of unrecognized tax benefits and their carryforward attributes. A company can “net” unrecognized tax benefits against deferred income taxes related to carryforwards or tax losses only if the carryforward or loss would be used to offset the taxable income or tax generated on the settlement of the unrecognized tax benefit.
The applicable tax law might not, for example, allow foreign tax credit carryforwards to offset unrecognized tax benefits that wouldn’t generate appropriate foreign source income upon settlement. If so, a company can’t net a foreign tax credit carryforward.
The guidance also means that companies will need to accrue interest for most unrecognized tax liabilities shown on their balance sheets. Previously, companies could present a gross unrecognized tax benefit liability that didn’t accrue interest if there was a carryforward attribute that could be used to offset the liability should the uncertain tax position be disallowed. Under ASU 2013-11, though, most unrecognized tax benefit liabilities on the balance sheet will be those that can’t be offset by carryforwards.
The amendments in ASU 2013-11 are effective for public companies for fiscal years, and interim periods within those years, beginning after Dec. 15, 2013. For private companies, the new rules are effective for fiscal years, and interim periods within those years, beginning after Dec. 15, 2014.
The rules should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Early adoption and retrospective application are both permitted. If you have questions about whether the new requirements affect you or how to comply with them, we’d be pleased to help.
For more information on this topic or any questions, please contact David Holmes at DHolmes@cshco.com.
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