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Financial Reporting Alert 18-1 — Frequently asked questions about tax reform

Published on: Jan 03, 2018

Download PDF(Updated January 8, 2018)

Introduction

On December 22, 2017, President Trump signed into law the tax legislation commonly known as the Tax Cuts and Jobs Act (the “Act”).1 Under ASC 740,2 the effects of new legislation are recognized upon enactment, which (for federal legislation) is the date the president signs a bill into law. Accordingly, recognition of the tax effects of the Act is required in the interim and annual periods that include December 22, 2017.

Shortly after enactment, however, the SEC staff issued SAB 118,3 which provides guidance on accounting for the Act’s impact. Under SAB 118, an entity would use something similar to the measurement period in a business combination. That is, an entity would recognize those matters for which the accounting can be completed, as might be the case for the effect of rate changes on deferred tax assets (DTAs) and deferred tax liabilities (DTLs). For matters that have not been completed, the entity would recognize provisional amounts to the extent that they are reasonably estimable, adjust them over time as more information becomes available, and disclose this information in its financial statements.

While only public registrants are subject to SAB 118, we believe that it would be reasonable to apply its guidance on ASC 740 in financial statements issued by entities that are not SEC registrants.

This Financial Reporting Alert contains frequently asked questions (FAQs) about how an entity should account for the tax effects of the Act in accordance with ASC 740. While the answers to the FAQs reflect our views at this time, the FASB will meet on January 10, 2018, to decide whether to add a narrow-scope project to its agenda to address the reclassification of certain tax effects that are stranded in accumulated other comprehensive income. At the meeting, the FASB staff also will give the Board an update on implementation issues for which current views are diverse, such as discounting, global intangible low-taxed income (GILTI), the base erosion anti-abuse tax (BEAT), and the use of SAB 118 by private companies and not-for-profit entities. Accordingly, our views are subject to change on the basis of this possible additional guidance or further developments in practice. We also plan to frequently update this document to reflect developments as they occur and as additional questions surface.

Change in Corporate Tax Rate

The Act reduces the corporate tax rate to 21 percent, effective January 1, 2018, for all corporations. Because ASC 740-10-25-47 requires the effect of a change in tax laws or rates to be recognized as of the date of enactment, all corporations, regardless of their year-end, must adjust their DTAs and DTLs as of December 22, 2017. The effect of changes in tax laws or rates on DTAs or DTLs is allocated to continuing operations as a discrete item rather than through the annual effective tax rate (AETR).

1.1 For calendar-year-end entities, what is the impact of the change in the corporate tax rate on DTAs and DTLs that exist as of the enactment date?

DTAs and DTLs that exist as of the enactment date and are expected to reverse after the Act’s effective date (January 1, 2018, for calendar-year-end entities) should be adjusted to the new statutory tax rate of 21 percent. Any DTAs and DTLs expected to reverse before the Act’s effective date should not be adjusted to the new statutory tax rate.

1.2 If some deferred tax balances are attributable to items of pretax comprehensive income or loss other than continuing operations (e.g., discontinued operations, other comprehensive income, or items charged or credited directly to equity), should the adjustment for the effect of the tax rate change still be allocated to continuing operations?

Yes. Under ASC 740-10-45-15, the tax effects of changes in tax laws or rates are allocated to income from continuing operations irrespective of the source of the income or loss to which the deferred tax item is related. In a manner consistent with ASC 740-10-30-26, the tax effects of items not included in continuing operations that arose before the enactment date are measured on the basis of the enacted rate at the time the transaction was recognized. (For more information, see Sections 3.65 and 3.66 of Deloitte’s A Roadmap to Accounting for Income Taxes.) However, at its January 10, 2018, meeting, the FASB will decide whether to add a narrow-scope project to its agenda to reconsider this guidance, so further developments are possible.

1.3 How should a reporting entity compute its temporary differences as of the enactment date when measuring its DTAs and DTLs?

A reporting entity should calculate temporary differences by comparing the relevant book and tax basis amounts as of the enactment date. To determine book basis amounts as of the enactment date, the reporting entity should apply U.S. GAAP on a year-to-date basis up to the enactment date. For example:

  • Any book basis accounts that must be remeasured at fair value under U.S. GAAP would be adjusted to fair value as of the enactment date (e.g., certain investments in securities or derivative assets or liabilities).
  • Book balances that are subject to depreciation or amortization would be adjusted to reflect current period-to-date depreciation or amortization up to the enactment date.
  • Account balances such as pension and other postretirement assets and obligations for which remeasurement is required as of a particular date (and for which no events have occurred that otherwise would require an interim remeasurement) would not be remeasured as of the enactment date (i.e., no separate valuation is required).
  • Any book basis balances associated with share-based payment awards that are classified as liabilities would be remeasured (on the basis of fair value, calculated value, or intrinsic value, as applicable) as of the enactment date. In addition, for those share-based payment awards that ordinarily would result in future tax deductions, compensation cost would be determined on the basis of the year-to-date requisite service rendered up to the enactment date.

1.4 Given that the enactment date may be close to, but does not coincide with, the end of a reporting period, may an entity measure the effect by using temporary differences and the resulting deferred tax balances as of the end of the reporting period?

No. Subject to materiality, an entity should adjust DTAs and DTLs for the effect of a change in tax laws or rates as of the enactment date even if such date does not coincide with the end of a financial reporting period.

1.5 How should the tax effects of adjustments to book and tax bases up to the enactment date be allocated among the components of comprehensive income?

The tax effects of year-to-date activity before enactment would be allocated in accordance with the intraperiod tax allocation guidance in ASC 740-20.

1.6 Are the calculations for fiscal-year-end entities the same as those discussed in FAQ 1.1?

Not exactly. Given the mechanics of Internal Revenue Code (IRC) Section 15,4 we believe that the change in tax rate resulting from the Act will be administratively effective for a fiscal-year-end entity at the beginning of the entity’s fiscal year. Accordingly, in a manner consistent with the guidance in ASC 740-270-55-50 and 55-51, the applicable tax rates for deferred tax balances are as follows:

  • For balances expected to reverse after the enactment date and within the current fiscal year, the applicable rate is the “blended tax rate” (see FAQ 1.7 below), which will be effective for the fiscal year.
  • For balances not expected to reverse within the current fiscal year, the applicable rate is the new statutory tax rate of 21 percent, which will be effective for the first fiscal year beginning after January 1, 2018.

1.7 What is meant by the “blended tax rate,” and how is it calculated?

For the period that includes enactment, the blended tax rate should be determined in accordance with IRC Section 15 and therefore based on the applicable rates before and after the change and the number of days in the period within the taxable year before and after the effective date of the change in tax rate.

As illustrated in the table below, the domestic federal statutory tax rate (blended tax rate) for all non-calendar-year-end entities with the same fiscal year-end will be the same, regardless of income (or projected income used for interim reporting). It is assumed in the table that the entities’ fiscal year-end is March 31, 2018, and the effective date of the new tax rate is January 1, 2018.

1.8 Since a fiscal-year-end entity will also have to calculate an AETR for its current fiscal year, how should the change in tax rate be factored into its AETR (exclusive of any adjustment for permanent items) for interim periods ending after the enactment date?

In a manner consistent with the guidance in IRC Section 15 discussed above, such an entity should use its blended tax rate to calculate the U.S. federal tax expense/benefit to include in its AETR computation. The new AETR would then be applied to pretax income or loss for the year to date at the end of the interim period that includes the enactment date, and for all subsequent interim periods in the year.

1.9 What rate should a fiscal-year-end company use as the statutory tax rate when preparing rate reconciliation disclosures as required by ASC 740-10-50-11?

The entity should use the blended tax rate as explained in FAQ 1.7.

Modification of Net Operating Loss Carryforwards

The Act modifies aspects of current law regarding net operating loss (NOL) carryforwards. Under current law, NOLs generally have a carryback period of 2 years and a carryforward period of 20 years. For NOLs incurred in years subject to the new rules, the Act eliminates, with certain exceptions, the NOL carryback period and permits an indefinite carryforward period. The amount of the NOL deduction is limited to 80 percent of taxable income, which is computed without regard to the NOL deduction.

2.1 Should a taxable temporary difference associated with an indefinite-lived asset be considered a source of taxable income to support realization of an NOL with an unlimited carryforward period? What if a deductible temporary difference is expected to reverse into an NOL with an unlimited carryforward period?

A taxable temporary difference associated with an indefinite-lived asset is generally considered to be a source of taxable income to support realization of an NOL with an unlimited carryforward period. This would also generally be true for a deductible temporary difference that is scheduled to reverse into an NOL with an unlimited carryforward period. However, because the Act includes restrictions on the ability to use NOLs with unlimited carryforward periods (i.e., NOLs arising in years subject to the new rules are limited in use to 80 percent of taxable income), only 80 percent of the indefinite-lived taxable temporary difference would serve as a source of taxable income. See Section 4.27 of Deloitte’s A Roadmap to Accounting for Income Taxes for more information.

Deemed Repatriation Transition Tax (IRC Section 9655)

A U.S. shareholder of a specified foreign corporation (SFC)6 must include in gross income, at the end of the SFC’s last tax year beginning before January 1, 2018, the U.S. shareholder’s pro rata share of certain of the SFC’s undistributed and previously untaxed post-1986 foreign earnings and profits (E&P). A foreign corporation’s E&P are taken into account only to the extent that they were accumulated during periods in which the corporation was an SFC (referred to below as a “foreign subsidiary”). The amount of E&P taken into account is the greater of the amounts determined as of November 2, 2017, or December 31, 2017, unreduced by dividends (other than dividends to other SFCs) during the SFC’s last taxable year beginning before January 1, 2018.

The U.S. shareholder’s income inclusion is offset by a deduction designed to generally result in an effective U.S. federal income tax rate of either 15.5 percent or 8 percent. The 15.5 percent rate applies to the extent that the SFCs hold cash and certain other assets (the U.S. shareholder’s “aggregate foreign cash position”), and the 8 percent rate applies to the extent that the income inclusion exceeds the aggregate foreign cash position.

The Act permits a U.S. shareholder to elect to pay the net tax liability interest free over a period of up to eight years.

3.1 Should an entity that is required to include post-1986 foreign earnings in its current-year taxable income but elects to pay the one-time deemed repatriation transition tax (under IRC Section 965) over a period of up to eight years classify the tax as a DTL or a current/noncurrent income tax payable?

In the period of enactment, a U.S. shareholder should record a current/noncurrent income tax payable for the transition tax due. ASC 210 provides general guidance on the classification of accounts in statements of financial position. An entity should classify as a current liability only those cash payments that management expects to make within the next 12 months to settle the transition tax. The installments that the entity expects to settle beyond the next 12 months should be classified as a noncurrent income tax payable.

3.2 If an entity elects to pay the one-time deemed repatriation transition tax over the eight-year period, should the income tax payable be discounted?

Although ASC 740-10-30-8 clearly prohibits discounting of DTAs and DTLs, it does not address an income tax liability payable over an extended period. In the absence of explicit guidance in ASC 740, we believe that an entity would need to consider ASC 835-30. Specifically, we note the following:

  • ASC 835-30 is generally applied to “exchange transactions” rather than nonreciprocal transactions.
  • ASC 835-30-15-3(e) notes that the guidance in ASC 835-30 does not apply to “[t]ransactions where interest rates are affected by the tax attributes or legal restrictions prescribed by a governmental agency (for example, industrial revenue bonds, tax exempt obligations, government guaranteed obligations, income tax settlements).”
  • Because the amount of the deemed repatriation transition tax is inherently subject to uncertain tax positions, measurement of the ultimate amount to be paid is potentially subject to future adjustment.

Accordingly, we do not believe that the deemed repatriation transition tax should be discounted. However, we are aware that views on this topic are diverse; therefore, practitioners should monitor the FASB’s January 10, 2018, meeting for potential developments related to this issue.

3.3 Depending on the year-ends of a U.S. entity and its foreign subsidiaries, the deemed repatriation transition tax may or may not be reported on the current-year tax return. If the deemed repatriation transition tax will not be reported on the current-year tax return, should the liability for the one-time deemed repatriation transition tax be limited to the amount that corresponds to the entity’s outside basis difference in the foreign subsidiary, or should the entire amount be recorded?

In general, we believe that the recognition of a liability related to a foreign subsidiary should be limited to the amount that corresponds to the entity’s outside basis difference in the foreign subsidiary. However, we believe that it would be acceptable to record the entire amount of the deemed repatriation transition tax in the period of enactment given the unique circumstances presented in this FAQ (i.e., the amount due is calculated by reference to the greater of the E&P amounts determined as of November 2, 2017, or December 31, 2017 — that is, E&P related to past transactions — and will simply be payable in a subsequent year).

3.4 If the deemed repatriation transition tax will not be reported on the current-year tax return, should the entity classify the one-time deemed repatriation transition tax as a DTL or a noncurrent income tax payable?

On the basis of the unique nature of tax reform and the mandatory one-time deemed repatriation income inclusion, we believe that the deemed repatriation transition tax liability may be classified as a noncurrent income tax payable.

3.5 With the Act’s establishment of a participation exemption system of taxation, does an entity still need to consider whether the outside basis differences in its foreign subsidiaries (and foreign corporate joint ventures that are essentially permanent in duration) are indefinitely reinvested?

Yes. Even under the new tax system, an entity may still be subject to income tax on its foreign investments (e.g., foreign exchange gains or losses on distributions, capital gains on sale of investment, foreign income taxes, and withholding taxes) and should consider whether it needs to record any deferred taxes on outside basis differences in foreign investments. In making this determination, an entity should consider its outside basis differences at each level in the organization chart, starting with the subsidiary at the lowest level in the chain.

3.6 If an entity changes its indefinite reinvestment assertion with respect to its investment in a foreign subsidiary (or corporate joint venture that is essentially permanent in duration) because it now intends to distribute earnings subject to the deemed repatriation transition tax, may the entity change its historic accounting policy and approach for determining the DTL for withholding taxes that are within the scope of ASC 740?

Historically, we have accepted the following two approaches for determining whether a parent should recognize a DTL for withholding taxes that would be imposed by the local tax authority on a distribution:

  • Parent jurisdiction approach — A parent would apply ASC 740-10-55-24 by treating the withholding tax as a tax that the parent would incur upon the reversal of a taxable temporary difference in the parent’s jurisdiction that is attributable to its investment in the foreign subsidiary. The parent would be unable to recognize a DTL when the financial reporting carrying value of the investment does not exceed the tax basis in the investment as determined by application of tax law in the parent’s jurisdiction. However, if an outside basis difference does exist in the parent’s investment in the foreign subsidiary, the parent would apply ASC 740-10-55-24 when measuring the DTL to be recognized.
  • Subsidiary jurisdiction approach — An entity considers the perspective of the jurisdiction that is taxing the recipient (i.e., the local jurisdiction imposing the withholding tax) when determining whether the parent has a taxable temporary difference. From the perspective of the local jurisdiction, the parent has a financial reporting carrying amount in its investment in the distributing entity that is greater than its local tax basis (i.e., from the perspective of the local jurisdiction, the IRC Section 965(a) transition income inclusion that increased the tax basis is not relevant in the local jurisdiction). Therefore, there is an “outside” taxable temporary difference and, in accordance with ASC 740-10-55-24, the measurement of the DTL should reflect withholding taxes to be incurred when the taxable temporary difference reverses.

These approaches would continue to be appropriate for determining whether a parent should recognize a DTL for withholding taxes after the effective date of the tax law change. For more information about the two approaches, see Section 3.06 of Deloitte’s A Roadmap to Accounting for Income Taxes.

Note that the tax effect of any change in the indefinite reinvestment assertion (e.g., a withholding tax DTL) would be considered an indirect effect of tax reform for purposes of the disclosure required under ASC 740-10-50-9(g).

3.7 Should an entity consider the one-time deemed repatriation income inclusion to be a source of income when analyzing the realization of DTAs in the year of the inclusion?

Yes. An entity should consider the one-time deemed repatriation income inclusion to be a source of taxable income when analyzing the realization of DTAs. The entity should verify that the one-time deemed repatriation income inclusion coincides with the timing of the deductions and other benefits associated with the DTAs.

For more information about sources of taxable income that may enable realization of a DTA, see Section 4.22 of Deloitte’s A Roadmap to Accounting for Income Taxes.

Global Intangible Low-Taxed Income

Although the Act generally eliminates U.S. federal income tax on dividends from foreign subsidiaries of domestic corporations, it creates a new requirement that certain income (i.e., GILTI) earned by controlled foreign corporations (CFCs) must be included currently in the gross income of the CFCs’ U.S. shareholder. GILTI is the excess of the shareholder’s “net CFC tested income” over the net deemed tangible income return (the “routine return”), which is defined as the excess of (1) 10 percent of the aggregate of the U.S. shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income.

A deduction is permitted to a domestic corporation in an amount equal to 50 percent of the sum of the GILTI inclusion and the amount treated as a dividend because the corporation has claimed a foreign tax credit as a result of the inclusion of the GILTI amount in income (“IRC Section 787 gross-up”). If the sum of the GILTI inclusion (and related IRC Section 78 gross-up) and the corporation’s foreign-derived intangible income (FDII) (see FAQ 5.1) exceeds the corporation’s taxable income, the deductions for GILTI and for FDII are reduced by the excess. As a result, the GILTI deduction can be no more than 50 percent of the corporation’s taxable income (and will be less if the corporation is also entitled to an FDII deduction).

As illustrated below, there are significant complexities associated with the possible recognition of deferred taxes related to GILTI. In addition, views are diverse regarding whether and, if so, how deferred taxes would be recorded. The FAQs in sections 4 and 5 below frame some of the common implementation issues we are aware of and reflect some of our tentative thinking; however, practitioners should monitor the FASB’s January 10, 2018, meeting for potential developments related to these issues.

4.1 Is a company required to record U.S. deferred taxes for investments in foreign subsidiaries and corporate joint ventures that are essentially permanent in duration (collectively, “foreign investments”) if it does not expect to have a U.S. inclusion in taxable income under the GILTI provision and is otherwise indefinitely reinvested?

No. If a GILTI inclusion is not expected in future years, no U.S. deferred taxes would be recorded.

4.2 If a company expects to have a U.S. inclusion in taxable income under the GILTI provision in future years, should it record a U.S. DTL related to the foreign investment?

It depends. If the financial reporting basis in the investment exceeds the tax basis, we tentatively believe that the company should determine whether the outside basis difference will reverse in a taxable manner through recognition of income as a result of the GILTI provision. In making this determination, the company should consider how the inside basis differences will reverse and whether such reversals will result in a GILTI inclusion. See Section 8.03A of Deloitte’s A Roadmap to Accounting for Income Taxes for more details.

4.3 How should an entity measure the DTL related to its outside basis differences in foreign investments that will reverse as a result of a GILTI inclusion?

We believe that there could be three acceptable approaches to measuring the DTL related to an entity’s outside basis differences in foreign investments. These approaches, which would be similar to the approaches currently used to determine the amount of compensation that should be tax-effected under IRC Section 162(m),8 are as follows:

  • Incremental tax rate approach — An entity would consider the taxable income related to reversing temporary differences to be the last dollars of taxable income (i.e., it would not qualify as part of the routine return unless future income was expected to be less than the routine return), and the incremental statutory tax rate would be used to measure the DTL. That is, if future income was equal to or exceeded the routine return in the year the temporary differences reverse, the tax rate used to measure the DTL would be 21 percent.
  • Actual tax rate approach — An entity would not consider future book income when measuring the DTL related to its outside basis in foreign investments. Rather, all assets and liabilities would be assumed to be recovered and settled, respectively, at the financial statement carrying value in accordance with ASC 740-10-25-20, resulting in “tested income” equal to the inside book/tax basis differences. A portion of the tested income may not result in a taxable inclusion because it represents a routine return. Therefore, a portion of the outside basis difference might not represent a taxable temporary difference. A DTL, measured at the 21 percent statutory tax rate, would be recorded for the portion of the remaining outside basis difference related to the deemed net tested income (i.e., tested income equal to the inside book/tax basis differences less routine return) that represents a taxable temporary difference.
  • Pro rata approach — The beneficial zero percent rate applicable to routine returns would be allocated on a pro rata basis between reversal of existing temporary differences and future income.

The approach an entity selects would be an accounting policy election that, like all other such elections, would be applied consistently. However, we do not believe that an entity would be required to have the same policy for GILTI and IRC Section 162(m).

4.4 Would branch accounting be an acceptable alternative if substantially all of an entity’s income will be taxable as a GILTI inclusion?

Unlike a branch, a CFC that will have substantially all of its income taxable in the United States as a result of a GILTI inclusion still has an outside tax basis that is relevant in certain instances, such as a sale or distribution. Accordingly, it would appear that measurement of deferred taxes should factor in the outside basis difference. However, as a practical matter, if the outside tax basis and the aggregate inside tax basis are the same, application of the incremental approach, coupled with an approach that is not limited by ASC 740-30-25-9 as described in FAQ 4.5 below, may often produce substantially similar results. Further, even if the outside tax basis and the aggregate inside tax basis are not the same, application of the ASC 740 outside basis difference exceptions might still produce similar results, aside from disclosure considerations (i.e., we currently believe that any residual outside basis difference should be appropriately accounted for if not indefinitely reinvested or disclosed if indefinitely reinvested).

4.5 Is a company required to record a DTA related to an excess of tax basis over book basis in a foreign investment (i.e., a deductible outside basis difference), or does the exception in ASC 740-30-25-9 apply to a deductible outside basis difference in a foreign investment that is expected to have a U.S. inclusion as a result of the GILTI provision?

ASC 740-30-25-9 states that a DTA “shall be recognized for an excess of the tax basis over the amount for financial reporting of an investment in a subsidiary or corporate joint venture that is essentially permanent in duration only if it is apparent that the temporary difference will reverse in the foreseeable future.” Because “reverse” has been interpreted to mean that the amount will actually result in a deduction on a tax return, a DTA has generally been recognized for a foreign investment only if the investment will be sold within one year or one business cycle. We currently believe that if a company does not intend to sell an investment that would result in an actual deduction on the company’s tax return, the company would not be required to record a DTA solely as a result of the enactment of the GILTI provision. If there is symmetry between the inside and outside basis difference in the foreign investment, recovery and settlement of the foreign investment’s underlying assets and liabilities, respectively, at their financial reporting carrying value would result in a tax loss, which would not result in a tax deduction (or carryforward) on the U.S. tax return since the GILTI provision can result only in incremental U.S. taxable income and not a reduction to U.S. taxable income.

However, because the Act’s GILTI provision creates a new category of Subpart F inclusions that may often cause a deductible outside basis difference to partly or wholly reverse and directly affect the GILTI inclusion, not recording a DTA in these circumstances may distort the financial statements. Therefore, we currently believe that recording a DTA may be an acceptable alternative approach if the underlying inside basis differences were expected to (1) reverse in a period in which the parent has a GILTI inclusion and (2) result in a reversal of the outside basis difference.

The decision tree on the next page illustrates our current thinking regarding the process for determining the deferred tax accounting for outside basis differences in foreign investments as a result of the GILTI provision.

For more information, see Sections 8.02, 8.03, and 8.03A of Deloitte’s A Roadmap to Accounting for Income Taxes.

4.6 Is a company required to record a DTL if the excess of the financial reporting carrying value over the outside tax basis in a foreign investment exceeds the aggregate inside basis differences?

It depends. The company would assess whether the residual outside basis difference represented a taxable temporary difference and, if so, whether such basis difference was indefinitely reinvested. See FAQ 3.5.

Deduction for FDII

In addition to the immediate inclusion of GILTI, the Act allows a domestic corporation a deduction for a portion of the FDII and GILTI. The amount of the deduction is dependent, in part, on U.S. taxable income. The percentage of income that can be deducted is reduced in taxable years beginning after December 31, 2025.

5.1 How should companies account for the FDII deduction and the GILTI deduction?

We believe that these deductions are analogous to the special deductions cited in ASC 740-10-25-37 and should be accounted for as such.

For more information, see Section 4.17 of Deloitte’s A Roadmap to Accounting for Income Taxes.

Base Erosion Anti-Abuse Tax

For tax years beginning after December 31, 2017, a corporation is potentially subject to tax under the BEAT provision if the controlled group of which it is a part has sufficient gross receipts and derives a sufficient level of “base erosion tax benefits.” Under the BEAT, a corporation must pay a base erosion minimum tax amount (BEMTA) in addition to its regular tax liability after credits. The BEMTA is generally equal to the excess of (1) a fixed percentage of a corporation’s modified taxable income (taxable income determined without regard to any base erosion tax benefit related to any base erosion payment, and without regard to a portion of its NOL deduction) over (2) its regular tax liability (reduced by certain credits). The fixed percentage is generally 5 percent for taxable years beginning in 2018, 10 percent for years beginning after 2018 and before 2026, and 12.5 percent for years after 2025. However, the fixed percentage is 1 percentage point higher for banks and securities dealers (i.e., 6, 11, and 13.5 percent, respectively).

6.1 What tax rate should companies that are subject to the BEAT provisions use when measuring temporary differences?

We believe that the BEAT system can be analogized to an alternative minimum tax (AMT) system. ASC 740 notes that when alternate tax systems like the AMT exist, deferred taxes should still be measured at the regular tax rate. Because the BEAT provisions are designed to be an “incremental tax,” an entity can never pay less than its statutory tax rate of 21 percent. Like AMT preference items, related-party payments made in the year of the BEMTA are generally the BEMTA’s driving factor. The AMT system and the BEAT system were both designed to limit the tax benefit of such “preference items.” Further, as was the case under the AMT system, an entity may not know whether it will always be subject to the BEAT tax, and we believe that most (if not all) taxpayers will ultimately take measures to reduce their BEMTA exposure and therefore ultimately pay taxes at or as close to the regular rate as possible. Accordingly, while there is no credit under the Act such as the one that existed under the AMT regime, we believe that the similarities between the two systems are sufficient to allow BEAT taxpayers to apply the existing AMT guidance in ASC 740 and measure deferred taxes at the 21 percent statutory tax rate. (See ASC 740-10-30-8 through 30-12 and ASC 740-10-55-31 through 55-33.) However, we are aware that views on this topic are diverse; thus, practitioners should monitor the FASB’s January 10, 2018, meeting for potential developments related to these issues.

Corporate AMT

The corporate AMT has been repealed for tax years beginning after December 31, 2017. Taxpayers with AMT credit carryforwards that have not yet been used may claim a refund in future years for those credits even though no income tax liability exists.9 Companies can continue using AMT credits to offset any regular income tax liability in years 2018 through 2020, with 50 percent of remaining AMT credits refunded in each of the 2018, 2019, and 2020 tax years and all remaining credits refunded in tax year 2021.

7.1 If a valuation allowance has been recorded on the DTA for AMT credit carryforwards, should the valuation allowance be released?

Yes. Since the AMT credit will now be fully refundable regardless of whether there is a future income tax liability before AMT credits, the benefit of the AMT credit will be realized. Therefore, any valuation allowance should be released, and an income tax benefit should be recognized.

7.2 Now that existing AMT credit carryovers are refundable, how should an entity present the AMT credits in the balance sheet?

Because an entity may either apply an AMT credit carryforward against its future income tax liability or receive a refund if it never has taxable income, we would accept either presentation as long as it is accompanied by appropriate disclosure.

7.3 If the amount is presented as a receivable, and given that it will be collected over a period of longer than 12 months, should the amount be discounted?

No. As discussed in FAQ 3.2, ASC 740 prohibits discounting, but only in the context of DTAs and DTLs. Accordingly, in the absence of explicit guidance in ASC 740, we believe that ASC 835-30 would need to be considered, and in accordance with our conclusion above regarding the deemed repatriation transition tax, we do not believe that the amount, even if presented as a receivable, should be discounted. However, we are aware that views on this topic are diverse; thus, practitioners should monitor the FASB’s January 10, 2018, meeting for potential developments related to these issues.

Other Topics Affected by Tax Reform

Non-GAAP Financial Measures

8.1 May companies adjust their non-GAAP financial measures related to the impact of tax reform?

Non-GAAP financial measures are commonly used, since many registrants assert that such measures are meaningful and provide valuable insight into the information that management considers important in running the business. While many non-GAAP financial measures are expressed on a pretax basis (e.g., EBITDA), others are expressed on a post-tax basis (e.g., adjusted net income, adjusted EPS). For example, registrants may seek to adjust post-tax non-GAAP measures related to the impact of tax reform.

Registrants may also elect to make non-GAAP adjustments related to discrete amounts that affect income from, for example, (1) the adjustment of deferred taxes upon the change in corporate tax rates or (2) the recognition of incremental tax expense related to foreign earnings previously considered to be indefinitely reinvested abroad and not subject to U.S. taxation. If such adjustments are not misleading as described in Section 100 of the SEC’s May 2016 Compliance and Disclosure Interpretations (C&DIs), they may be permissible depending on the registrant’s specific facts and circumstances.

Some registrants may also consider adjustments that attempt to depict a “normalized” tax rate between comparable periods to enhance comparability of periods before and after tax reform. For example, a registrant might use a non-GAAP presentation to apply a lower tax rate to a period before enactment as if the new rates were in effect at that time (e.g., applying a post-reform effective tax rate to prior-year pretax earnings to create comparability to 2018 net income). In deciding whether to present such a measure, a registrant should evaluate whether the measure could be misleading as described in the SEC’s C&DIs, including whether it could be considered to be an “individually tailored” accounting principle as described in C&DI Question 100.04.

For more information, see Section 4.3 of Deloitte’s A Roadmap to Non-GAAP Financial Measures.

Form 8-K Filing Requirements and Considerations

8.2 Will the Act trigger any Form 8-K filing requirements or other Form 8-K considerations?

For certain taxpayers, there may be a material reduction in DTAs and a corresponding charge to net income as a result of the Act. Registrants have questioned whether this would be considered a material impairment, which would trigger the requirement to file a Form 8-K under Item 2.06.10 The SEC recently issued C&DI Question 110.02, which clarifies that reduction of a DTA as a result of the rate change would not be considered an impairment. C&DI Question 110.02 also acknowledges that the Act may affect an entity’s assessment of whether its DTAs will be realized and notes that if the measurement date approach prescribed by SAB 118 is applied, the entity may still disclose the impairment in its next periodic report in accordance with Item 2.06 of Form 8-K.

Note that notwithstanding the above, a registrant may decide on the basis of its specific facts and circumstances to file a Form 8-K under another item (e.g., Item 8.0111) to disclose the Act’s material effects.

Compensation and Share-Based Payment Awards

IRC Section 162(m) limits the tax deductibility of certain types of compensation paid to the CEO as well as a company’s four other highest paid officers (referred to collectively as the “covered employees”). Specifically, only the first $1 million in compensation, whether cash or stock-based, paid to a covered employee is deductible for tax purposes in a given year. Compensation that is performance-based has not historically been subject to this limitation.

The Act modifies IRC Section 162(m) by (1) expanding which employees are considered covered employees by including the chief financial officer, (2) providing that if an individual is a covered employee for a taxable year beginning after December 31, 2016, the individual remains a covered employee for all future years, and (3) removing the exceptions for commissions and performance-based compensation. These changes do not apply to compensation stemming from contracts entered into on or before November 2, 2017, unless such contracts were materially modified on or after that date. Compensation agreements entered into and share-based payment awards granted after this date will be subject to the revised terms of IRC Section 162(m).

8.3 Do the changes to IRC Section 162(m) affect the accounting for deferred taxes related to share-based payment awards issued to covered employees?

Yes. The DTA recorded for share-based payment awards granted after November 2, 2017, could be less than what would have been recorded under prior law. For example, since the Act eliminates the exclusion of performance-based compensation, deferred taxes may be recorded only on awards granted after November 2, 2017, to the extent that performance-based compensation will not be limited.

We generally do not expect DTAs related to share-based payment awards that arose on or before November 2, 2017, to be affected by the Act, but companies are encouraged to consult with their accounting and tax advisers if questions arise.

8.4 Do the changes to IRC Section 162(m) affect the accounting policy used to account for deferred taxes in cases in which it is expected that some or all compensation paid to an employee will be limited by IRC Section 162(m)?

No. We believe that there are three approaches commonly applied in practice regarding the accounting for deferred taxes in cases in which compensation is expected to be limited by IRC Section 162(m). These approaches are as follows:

  • Deductible compensation is allocated to cash compensation first — A DTA would not be recorded for stock-based compensation if cash compensation is expected to exceed the limit.
  • Deductible compensation is allocated to earliest compensation recognized for financial statement purposes — Because stock-based compensation is typically expensed over a multiple-year vesting period but deductible when fully vested or exercised, and cash-based compensation is generally deductible in the period it is expensed for financial statement purposes, stock-based compensation is generally considered the earliest compensation recognized for financial statement purposes, and a DTA for stock-based compensation would be recorded up to the deductible limit.
  • Limitation is allocated pro rata between stock-based compensation and cash compensation — A partial DTA may result on the basis of the expected ratio of stock-based compensation to cash compensation.

The choice of which approach to apply is a policy election that should be applied consistently. While the Act modifies IRC Section 162(m), we believe that the above approaches remain acceptable. Accordingly, companies should continue to apply the accounting policy they have previously elected.

8.5 If an entity modifies a compensation agreement, must it comply with the Act’s updated IRC Section 162(m) limitations?

It depends. The Act contains explicit wording indicating that material modifications made to a compensation agreement on or after November 2, 2017, will cause the agreement to become subject to the updated requirements of IRC Section 162(m). Judgment may be required in the determination of whether a modification is material. Further, if a modified compensation agreement is related to a share-based payment award, companies will need to consider whether the modification guidance in ASC 718-20 should be applied (see FAQ 8.4).

Modifications made before November 2, 2017, may also result in a tax consequence. While modifications made before November 2, 2017, will not cause compensation to be subject to the revised requirements in IRC Section 162(m), the language in IRC Section 162(m) that existed before the Act’s revisions indicates that as a result of any modification to a performance-based award, the award will become subject to the legacy IRC Section 162(m) limitations on deductibility.

Companies should be mindful of these potential outcomes when deciding how future compensation agreements will be structured or modified.

8.6 For share-based payment awards with performance conditions that are based on financial statement metrics, should a probability assessment be performed on the enactment date?

Yes. Financial statement metrics may change as a result of the Act, which may affect the probability that certain performance conditions will be met. Accordingly, performance conditions that are based on financial statement metrics should be reassessed. For example, compensation cost recognized for a share-based payment award with a performance condition tied to earnings and whose vesting was probable before the enactment date would be reversed if it is no longer probable that the award will vest as of the enactment date (see FAQ 1.3).

Certain Hedge Accounting Strategies

8.7 Does the change in tax law affect an entity’s hedging strategies?

If an entity is hedging foreign currency risk on an after-tax basis, as allowed under ASC 815-20-25-3(b)(2)(vi), any change in tax rates applicable to the hedging instrument could disrupt the balance of any related hedging relationship.

For example, assume that Entity ABC’s functional currency is the U.S. dollar (USD). Entity ABC has a subsidiary whose functional currency is the euro (EUR), and ABC has a USD/EUR forward contract designated as a hedge of EUR 65 million of its net investment in the foreign subsidiary. The forward contract has a notional amount of EUR 100 million because ABC had a tax rate of 35 percent, and it had designated that it was hedging on an after-tax basis.

Now assume that ABC’s tax rate changes to 21 percent as a result of a change in tax law. When the tax law becomes effective, the changes in fair value of the derivative on an after-tax basis will be based on 79 percent of the notional amount of the forward (i.e., EUR 79 million), compared with the designated hedged item, which is a EUR 65 million net investment in a foreign subsidiary. Entity ABC is now overhedged.

An entity should consider how this affects assessments of hedge effectiveness and measurements of ineffectiveness. In addition, it should consider whether it wants to dedesignate the existing hedging relationships, rebalance any existing hedges, and designate new hedging relationships.

Leveraged Leases

8.8 What is the Act’s effect on the accounting treatment for leveraged leases?

When a change in income tax rates is enacted, an entity should recalculate leveraged leases from inception and record any differences in current-period earnings. In accordance with ASC 840-30-35-41, the entity would record the effect of the tax rate change on a leveraged lease “in the first accounting period ending on or after the date on which the legislation effecting a rate change becomes law.”

Fair Value and Hypothetical Liquidation at Book Value Considerations

8.9 What income tax rate should an entity use when performing fair value measurements as of December 31, 2017?

When tax rates are an input in a fair value measurement (e.g., when the income approach is used on an after-tax basis), an entity should generally use the same assumption a market participant would use about the income tax rate that will be in effect when the projected cash flows are received. That rate is typically the statutory tax rate unless there is substantial evidence that another tax rate should be used. For additional information, see 820-10-35 (Q&A 44A), Income Tax Rate Used in Valuation Techniques, in Deloitte’s FASB Accounting Standards Codification Manual (available to subscribers of the Deloitte Accounting Research Tool (DART)).

8.10 Should a company that applies the hypothetical liquidation at book value (HLBV) for an equity method investment or the allocation of earnings to a noncontrolling interest consider the effects of enacted changes in tax rates before the date the enacted changes become effective?

No. Unlike a fair value measurement, the HLBV method is an approach to allocate earnings on the basis of how an investee (or subsidiary) would allocate current-period earnings to an equity method investor (or noncontrolling interest holder) if it were to liquidate at a particular point in time (i.e., as of a balance sheet date). Therefore, if an investee (or subsidiary) were to liquidate as of a balance sheet date before tax reform is effective (e.g., December 31, 2017, for calendar-year-end entities), the tax rates applied in the determination of the liquidation waterfall would not take into account new enacted rates that are not yet effective. Once the enacted rates become effective, a company applying the HLBV method will need to carefully consider the allocation provisions in contracts to determine the impact that those new rates have on the application of HLBV.

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1 H.R. 1/Public Law 115-97, “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”

2 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”

3 SEC Staff Accounting Bulletin No. 118.

4 IRC Section 15, “Effect of Changes.”

5 IRC Section 965, “Temporary Dividends Received Deduction.”

6 An SFC includes all controlled foreign corporations and all other foreign corporations (other than passive foreign investment companies) in which at least one domestic corporation is a U.S. shareholder.

7 IRC Section 78, “Dividends Received From Certain Foreign Corporations by Domestic Corporations Choosing Foreign Tax Credit.”

8 IRC Section 162(m), “Certain Excessive Employee Remuneration.”

9 Note that taxpayers should consider whether other limitations (e.g., IRC Section 383, "Special Limitations on Certain Excess Credits, Etc.") apply to their ability to claim a refund of AMT.

10 SEC Form 8-K, Item 2.06, “Material Impairments.”

11 SEC Form 8-K, Item 8.01, “Other Events.”

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