Guide to Accounting for Income Taxes

717 Pages·2015·2.74 MB·English

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June 2015
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Copyright © 2014 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member fi rm, and may
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constitute professional advice on facts and circumstances specific to any person or entity. You should
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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 May 31, 2013. 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certain aspects of this publication may be superseded as new guidance or interpretations emerge.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 2012 edition. See Appendix A for a Summary of noteworthy revisions.
“Portions of FASB Accounting Standards Codification®, copyrighted by the Financial Accounting
Foundation, 401 Merritt 7, Norwalk, CT 06856, are reproduced with 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 valuation
allowance, intraperiod allocation, business combinations, and foreign operations.
PwC is pleased to offer this comprehensive guide 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. It
provides several comprehensive examples to help navigate the guidance, and offers
our perspective throughout, based on both analysis of the guidance and our
experience in applying it.
This guide is intended to clarify the fundamental requirements involved in the
accounting for income taxes and to highlight key points that should be considered
before and after transactions are undertaken. We hope 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 LLP

Table of contents
Chapter 1: Scope of ASC 740
1.1 Scope of ASC 740 .............................................................. 1-3
1.1.1 In general (ASC 740-10-15-3) ............................................ 1-3
1.1.2 Scope exceptions (ASC 740-10-15-4) ................................. 1-3
1.2 Defining a “tax based on income” ..................................... 1-4
1.2.1 In general ......................................................................... 1-4
1.2.1.1 Withholding taxes—entities that withhold taxes for the benefit
of others .............................................................................................. 1-4
1.2.1.2 Withholding taxes—entities that receive dividends, interest,
royalties or other income ................................................................... 1-5
1.2.2 Application of guidance to specific tax jurisdictions
and tax structures ............................................................ 1-5
1.2.2.1 Higher of an income-based or capital-based computation ............... 1-5
1.2.2.2 Gross receipts tax ............................................................................... 1-7
1.2.2.3 Single business tax ............................................................................. 1-8
1.2.2.4 Texas margin tax ................................................................................ 1-9
1.2.2.5 Private foundation—excise tax on net investment income ............... 1-9
1.2.2.6 The American Jobs Creation Act of 2004 tonnage tax ...................... 1-10
1.2.3 Credits and other tax incentives ....................................... 1-11
1.2.4 Attributes of taxes not based on income ........................... 1-13
1.2.4.1 Timing differences inherent in the computation of taxes not
based on income ................................................................................. 1-13
1.2.4.2 Tax credit carryforwards for tax regimes not based on income ........ 1-13
1.3 Accounting by jurisdiction (separate calculation versus
blended rate) .................................................................... 1-14
1.4 Applicability of ASC 740 to an entity’s legal form .............. 1-15
1.4.1 Single-member and multiple-member limited liability
companies (under U.S. tax law) ........................................ 1-15
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1.4.2 Partnerships .................................................................... 1-15
1.4.2.1 Investments in partnerships .............................................................. 1-15
1.4.2.2 General application of ASC 740 to the separate financial
statements of partnerships ................................................................ 1-16
1.4.2.2.1 Master limited partnerships .............................................................. 1-17
1.4.2.2.2 Real estate investment trusts (REITs) and regulated investment
companies (RICs) ............................................................................... 1-17
1.4.3 State income taxes ............................................................ 1-18
1.4.3.1 Separate calculation versus blended rate .......................................... 1-18
1.4.3.2 Treatment of apportionment factors ................................................. 1-18
1.4.3.2.1 Changes in state income tax rates caused by changes in how
a state apportions income .................................................................. 1-18
Chapter 2: Objectives and basic principles
2.1 Objectives of ASC 740 ....................................................... 2-4
2.2 Basic principles ................................................................ 2-5
2.3 Exceptions to the basic principles ..................................... 2-5
2.3.1 “Outside basis” differences and U.S. steamship
exceptions ........................................................................ 2-5
2.3.2 Leveraged leases (ASC 740-10-25-3(c)) ............................. 2-6
2.3.2.1 Purchased leveraged leases ................................................................ 2-6
2.3.3 Nondeductible goodwill (ASC 740-10-25-3(d)) .................. 2-6
2.3.4 Tax effects of intra-entity transactions
(ASC 740-10-25-3(e)) ........................................................ 2-7
2.3.4.1 In general ............................................................................................ 2-7
2.3.4.1.1 Deferred charge differentiated from deferred tax asset .................... 2-9
2.3.4.1.2 Quantifying the amount of tax deferred under
ASC 740-10-25-3(e) ........................................................................... 2-9
2.3.4.1.3 Intra-entity intellectual property migration arrangements .............. 2-10
2.3.4.2 Certain exceptions in the application of ASC 740-10-25-3(e) ........... 2-12
2.3.4.2.1 Intra-entity sale of subsidiary stock................................................... 2-12
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2.3.4.2.2 Intra-entity transfers reported at predecessor basis ......................... 2-14
2.3.5 Certain foreign exchange amounts
(ASC 740-10-25-3(f)) ........................................................ 2-15
2.4 Other considerations ........................................................ 2-15
2.4.1 Discounting ...................................................................... 2-15
2.4.2 Volatility .......................................................................... 2-17
2.4.3 Need for judgment ........................................................... 2-18
Chapter 3: Temporary differences
3.1 Temporary difference—defined ........................................ 3-6
3.2 Examples of temporary differences .................................. 3-8
3.2.1 Business combinations (ASC 740-10-25-20(h)) ................. 3-8
3.2.2 Indexation (ASC 740-10-25-20(g)) .................................... 3-8
3.2.2.1 Temporary differences related to U.K. buildings .............................. 3-8
3.2.3 Temporary differences related to investment tax
credits (ASC 740-10-25-20(e) and (f)) ............................... 3-12
3.2.3.1 Foreign investment tax credits and grants ........................................ 3-22
3.2.3.2 Effect on leases ................................................................................... 3-23
3.2.4 Debt instruments ............................................................. 3-23
3.2.4.1 Contingently convertible debt ............................................................ 3-23
3.2.4.2 Convertible debt and call option ........................................................ 3-24
3.2.4.3 Debt instruments with temporary differences that may not
result in future deductible amounts .................................................. 3-26
3.2.4.4 Convertible debt with a beneficial conversion feature and
detachable warrants ........................................................................... 3-26
3.2.4.5 Tax implications of induced conversions of convertible debt ........... 3-27
3.2.5 Low-income housing credits ............................................. 3-28
3.2.6 Synthetic fuels projects .................................................... 3-29
3.2.7 Subsidies related to Medicare Part D ................................ 3-30
3.2.8 IRC Section 162(m) limitation .......................................... 3-31
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3.3 Basis differences that will reverse with no tax
consequence ..................................................................... 3-32
3.3.1 Excess cash surrender value of life insurance ................... 3-32
3.4 Issues to be considered in identifying temporary
differences ....................................................................... 3-32
3.4.1 Basis differences that are not accounted for under
the basic model for deferred taxes .................................... 3-33
3.4.2 Temporary differences where reversal might not
occur in the foreseeable future ......................................... 3-34
3.4.3 Consideration of settlement at book carrying value .......... 3-34
3.4.4 Temporary differences not identified with an asset
or a liability ...................................................................... 3-34
3.4.5 U.S. federal temporary differences relating to state
income taxes .................................................................... 3-35
Chapter 4: Recognition and measurement
4.1 Basic approach for deferred taxes .................................... 4-3
4.2 Applicable tax rate ........................................................... 4-6
4.2.1 General considerations .................................................... 4-6
4.2.2 Graduated tax rates .......................................................... 4-7
4.2.3 Determining the applicable rate ....................................... 4-8
4.2.4 Complexities in determining the applicable tax rate ......... 4-10
4.2.4.1 Ordering effects .................................................................................. 4-10
4.2.4.2 Undistributed earnings ...................................................................... 4-11
4.2.4.3 Special deductions .............................................................................. 4-12
4.2.4.4 Tax holidays ........................................................................................ 4-13
4.2.4.5 Nonamortizing/nondepreciating assets ............................................ 4-17
4.2.4.6 “Worthless” deferred tax assets ......................................................... 4-19
4.2.4.7 Dual-rate jurisdictions ....................................................................... 4-19
4.2.4.8 Hybrid tax systems ............................................................................. 4-22
4.2.4.9 Foreign-branch operations ................................................................ 4-22
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4.2.4.10 Aggregating computations for separate jurisdictions ....................... 4-23
4.2.5 Alternative minimum tax considerations ......................... 4-23
4.2.5.1 AMT—general background ................................................................ 4-23
4.2.5.2 The interaction of AMT with ASC 740 accounting ............................ 4-24
Chapter 5: Valuation allowance
5.1 Assessing the need for a valuation allowance ................... 5-5
5.1.1 Evidence to be considered ................................................ 5-5
5.1.2 Weighting of available evidence ....................................... 5-8
5.1.3 Cumulative losses and other negative evidence ................ 5-9
5.1.3.1 General – revised June 2015 .............................................................. 5-9
5.1.3.2 Examples of situations where positive evidence outweighed
significant negative evidence ............................................................. 5-14
5.1.4 Assessing changes in the valuation allowance ................... 5-17
5.2 SEC staff views on disclosure and valuation allowance
assessments – revised June 2015 ...................................... 5-17
5.3 Other considerations ........................................................ 5-19
5.3.1 Evaluating the effect of a restructuring ............................ 5-19
5.3.2 Determining the need for a valuation allowance in a
business combination ....................................................... 5-18
5.3.3 Going-concern uncertainty – revised June 2015 ............... 5-20
5.4 Sources of taxable income ................................................ 5-21
5.4.1 Taxable income in prior carryback years if carryback
is permitted under the tax law .......................................... 5-22
5.4.1.1 Special considerations for carrybacks ............................................... 5-22
5.4.1.1.1 Liabilities for unrecognized tax benefits as a source of taxable
income ................................................................................................ 5-22
5.4.1.1.2 Carrybacks that free up credits .......................................................... 5-23
5.4.1.1.3 Carryback availability that may not be used ...................................... 5-25
5.4.2 Future reversals of existing taxable temporary
differences ....................................................................... 5-26
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5.4.2.1 Deferred tax liabilities on indefinite-lived intangible assets—
“naked credits” ................................................................................... 5-30
5.4.3 Tax-planning strategies .................................................... 5-32
5.4.3.1 Tax-planning strategies defined......................................................... 5-33
5.4.3.1.1 Tax-planning strategies in jurisdictions where NOL
carryforwards never expire ................................................................ 5-37
5.4.3.2 Examples of common tax-planning strategies .................................. 5-39
5.4.3.2.1 Sales of appreciated assets ................................................................. 5-39
5.4.3.2.2 Sale-leaseback .................................................................................... 5-44
5.4.3.2.3 LIFO reserves ..................................................................................... 5-45
5.4.3.2.4 Shifting tax-exempt portfolios ........................................................... 5-46
5.4.3.2.5 Noneconomic tax-planning strategies ............................................... 5-47
5.4.3.3 Costs to implement a tax-planning strategy ...................................... 5-49
5.4.3.4 Examples of actions that do not qualify as tax-planning
strategies ............................................................................................ 5-52
5.4.3.4.1 Excluding a loss subsidiary from tax consolidation .......................... 5-52
5.4.3.4.2 Acquiring a profitable entity .............................................................. 5-52
5.4.3.5 In summary ........................................................................................ 5-52
5.4.3.6 Issues in evaluating tax-planning strategies...................................... 5-54
5.4.3.6.1 Time value of money .......................................................................... 5-54
5.4.3.6.2 Unrecognized tax benefits .................................................................. 5-54
5.4.3.6.3 Separate statements of subsidiary ..................................................... 5-54
5.4.3.7 Consistent use in different jurisdictions ............................................ 5-55
5.4.4 Future taxable income exclusive of reversing
temporary differences and carryforwards ........................ 5-55
5.4.4.1 General ............................................................................................... 5-55
5.4.4.2 Considerations when projecting and scheduling future taxable
income other than reversals of existing temporary differences ........ 5-56
5.4.4.2.1 Originating temporary differences in future projections .................. 5-56
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