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News Analysis: Accounting Disclosures Post-TCJA

Posted on Nov. 26, 2018

Congress makes tax laws, but accounting guidelines are mostly left for the Financial Accounting Standards Board, a private rulemaking body, to determine. As a result, the many international tax law amendments enacted by the Tax Cuts and Jobs Act (P.L. 115-97) don’t necessarily result in any immediate changes to how companies should calculate their tax liabilities or determine their deferred tax assets or liabilities in their financial statements, nor how they should provide supplemental disclosures about their tax liabilities. The SEC’s accounting guidelines for companies traded on the U.S. stock exchanges generally follow FASB’s guidelines, which set rules for generally accepted accounting principles.

At a November 14 meeting, FASB suggested it was unlikely to change the rules for how companies should calculate and disclose their tax liabilities as a result of the TCJA; in the meantime, taxpayers face challenges in navigating the intersection of the TCJA and accounting principles. For many, it’s been difficult, as reflected in numerous earnings calls and quarterly earnings releases.

The SEC has provided temporary relief to companies in the form of a special exemption from the general standards of measurement and reporting for a one-year term. But there’s been little discussion of the extent to which the international tax law changes should lead to larger changes in accounting standards, even though many of those rules are clearly due for reexamination. That’s partly because of the large role played by Accounting Principles Board Opinion No. 23 — regarding a taxpayer’s intention to indefinitely reinvest foreign earnings — in calculating companies’ global effective tax rates before tax reform.

It’s also unclear whether FASB’s long-running income tax disclosure project, which was moving in fits and starts in the direction of requiring companies to disclose additional information about foreign earnings, cash, and taxes paid by country, will result in important changes to disclosure requirements. But at the same time, efforts for greater country-by-country disclosures by companies in the environmental, social, and governance (ESG) front, could mean that the quality and quantity of information companies disclose about their income tax liabilities will be overhauled in coming years.

Short-Term Guidance

Under Accounting Standards Codification (ASC) Topic 740, the effects of new laws are required to be recognized as soon as the president signs a bill. President Trump signed the TCJA on December 22, 2017, so companies must recognize any of its tax effects as of that date. For many companies, meeting that requirement simply wasn’t feasible because the changes occurred immediately before year-end and the start of preparing 2017 earnings reports and came with little regulatory and interpretive guidance. To help companies, the SEC on December 22 issued Staff Accounting Bulletin 118 giving them wide leeway in deciding how to reconcile ordinary accounting rules that apply to calculating and disclosing income tax liabilities and reporting deferred tax assets and liabilities for measuring the TCJA’s impact.

According to SAB 118, a company that hasn’t completed its accounting for the effects of the TCJA can report provisional amounts based on reasonable estimates; it can adjust those amounts for up to one year, based on a reasonable estimate of how the TCJA will ultimately be interpreted. In short, the SEC basically acknowledged — especially in the absence of regulatory guidance — that it couldn’t hold companies responsible for figuring out what all the law changes meant for accurately determining current-year tax liabilities and the impact on deferred tax assets and liabilities.

FASB also issued some limited guidance to help companies figure out how to address TCJA changes in their financial statements. It addressed specific questions regarding the calculation of tax liabilities resulting from the global intangible low-taxed income and base erosion and antiabuse tax regimes, as well as the repatriation tax.

FASB addressed whether an entity should recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years, or whether GILTI taxes should be included in the year incurred. That regime poses challenges to the rules for accounting for deferred taxes because the tax liability can be determined only on an aggregate basis at the U.S. shareholder level. Because of the disconnect between accounting rules and the tax law changes, FASB concluded that companies could prepare financial statements based on either application of the accounting rules, as long as they adequately disclosed the method used.

FASB also discussed whether deferred tax assets and liabilities should be measured at the regular statutory tax rate or the lower BEAT rate when the taxpayer expects to be subject to the BEAT. It concluded that an entity subject to the BEAT should measure deferred tax assets and liabilities using the regular statutory tax rate, because measuring a deferred tax liability at the lower BEAT rate wouldn’t reflect the amount an entity would ultimately pay. Further, FASB said any incremental effect of the BEAT should be recognized in the year that tax is incurred.

Companies Struggle

Taxpayer uncertainty over how to interpret the new law is evident in recent earnings releases and call transcripts. Those releases also demonstrate that GILTI has had an unexpected — and often negative — effect for companies, in many cases resulting in higher tax rates than foreseen by either managers or investors.

A few examples illustrate the trend. In industrial company Parker Hannifin’s fiscal 2019 first-quarter earnings call November 1, when asked about the company’s projected tax rate for fiscal 2019, the CFO explained that “as we are finalizing our calculations related to tax reform, specifically the GILTI tax, which is very complex
. . . we’ve built in a 24 percent rate for the rest of the year to compensate.” That projected rate is close to the federal corporate statutory rate plus an average blended state rate, reflecting convergence between statutory and effective rates.

During its fiscal 2019 first-quarter earnings call, Tapestry Inc. projected a fiscal 2019 rate of 19 to 20 percent, noting that “the increase over prior year is due primarily to the introduction of a new tax regime requiring a current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations known as GILTI.” The luxury brand company had earlier projected a 21 to 22 percent rate, and said the lower rate projection resulted from “additional clarification around the impact of the GILTI provision,” as well as expected benefits from foreign-derived intangible income (and other benefits).

In some cases, GILTI appears to be resulting in an effective tax rate higher than a blended federal plus state rate. For example, in Hain Celestial’s fiscal 2018 fourth-quarter earnings call held in August, an analyst said the company’s projected effective tax rate of 27 to 28 percent for 2019 was a bit higher than he would’ve expected. The CFO replied that the company’s lack of a large foreign tax credit balance to offset GILTI was affecting the rate. And in its fiscal 2018 third-quarter earnings call, Vishay Intertechnology Inc. projected a normalized effective tax rate for the year of about 28 percent, higher than the federal rate of 21 percent plus a blended state rate, because of the continued impact of GILTI, BEAT, and the limitation on interest expense deductibility.

The fiscal 2019 second-quarter earnings call of Jeld-Wen Holding shows some of the even more harmful effects of GILTI. In the August call, the company projected a 2018 effective rate of 31 to 35 percent, saying that without GILTI, its “effective book tax rate would be 23 to 27 percent.” Crocs too has projected a 39 percent rate for fiscal 2019, which it said was essentially tied to GILTI.

As companies begin to calculate full-year earnings, observers can expect similar adjustments to earnings projections. Treasury guidance on GILTI and FTCs is expected soon, but even generally taxpayer-favorable rules will likely negatively affect some companies.

The FASB Disclosure Project

A History

Many investors and analysts believe that disclosure rules fail to provide investors with sufficient information about companies’ future potential tax liabilities associated with foreign operations. Thus, for several years FASB has been looking to improve companies’ disclosures of foreign taxes, foreign earnings, and foreign cash holdings.

In 2014 FASB issued a proposed concepts statement announcing a project on income tax disclosures. As part of that project, disclosure requirements for income taxes were evaluated for modifications.

The ASC 740 update proposed in September 2015 would have required companies to disclose additional income tax information in their financial statements, including information disaggregated between domestic and foreign income (or loss) from continuing operations; income tax expense (or benefit) from continuing operations; income taxes paid; the amount of income taxes paid to any country that is significant to total income taxes paid; and the aggregate of cash, cash equivalents, and marketable securities held by foreign subsidiaries.

In June 2016 FASB completed initial deliberations on those disclosure requirements. Although it had previously decided to require companies to disaggregate the cumulative amount of indefinitely reinvested foreign earnings for any country that represented at least 10 percent of the total cumulative amount, it reversed that decision and instead decided to require disclosure of the aggregate of cash, cash equivalents, and marketable securities held by foreign subsidiaries. The next month, FASB issued a proposed accounting standards update that included amendments for rules on indefinitely reinvested foreign earnings — including those disclosure requirements. Most of the comments on the proposed disclosures conditionally agreed that the amendments would result in more effective and useful information about income taxes.

A large minority, however, questioned the disclosure of cash held by foreign subsidiaries. Investors worried that they couldn’t determine the full potential tax exposure that permanently reinvested earnings might face if subject to some form of repatriation. But commenters also opposed proposals to disaggregate foreign and domestic income taxes paid and to do so by significant country. Some said the disclosure of taxes paid by a significant country is out of context without disclosing revenues, expenses, tax rates, and other income tax information for that country and expressed concerns that disclosure might cause competitive harm. Others noted that it would be costly to require CbC reporting, in part because it’s not compiled using the same controls that apply to financial reporting.

Commentators also said that disclosing tax paid by significant jurisdiction wouldn’t provide useful information or predictive value for users because, for example, tax payments for individual jurisdictions are affected by items unrelated to current-year profit or loss, such as book-tax differences, audit settlements, refunds, and estimated payments. Further, timing of payments varies by jurisdiction, they noted.

During a January 2017 meeting, FASB discussed comments received on the proposed accounting standard update but made no technical decisions; instead, it scheduled a public roundtable meeting on the disclosure framework. Following the roundtable, FASB said it planned to direct staff to conduct additional outreach regarding the proposed disclosure requirements for income taxes.

That project was essentially put on hold, given the possibility of major tax reform. Now that tax reform has happened, reconsideration of those disclosures is back on the table. FASB met November 14 to discuss the proposed disclosures and decided to reissue an exposure draft for consideration. During a lively discussion, some board members questioned the value of information provided in the tax disclosure footnote, noting that many investors said they rarely use that information because it’s too complex.

The Future

APB 23 was a crucial part of the pre-TCJA international tax regime. It allowed companies not to have to calculate, report, or disclose potential future U.S. tax liabilities associated with foreign earnings, as long as the company asserted that it planned to indefinitely reinvest those earnings. Given the wide gap between the U.S. federal corporate tax rate of 35 percent and most other countries’ lower corporate rates, that assertion allowed many companies to avoid having to report often large additional tax liabilities associated with foreign earnings. Meanwhile, investors’ desire for more transparency of that potential future tax liability had a lot to do with the push for greater information on foreign earnings and foreign taxes paid.

Following passage of the TCJA, APB 23 is still on the books as an accounting standard but has much more limited relevance when repatriation of foreign earnings should be exempt from future U.S. income tax. But there are still many places where repatriation can trigger additional tax liabilities, so the assertion remains relevant, including for any foreign withholding or state taxes (not all states will adopt the dividends received deduction in IRC section 245A) that may be triggered on repatriation. Repatriation can also trigger deferred foreign exchange gain or loss.

Those potential tax liabilities are not merely hypothetical. Their impact can be seen in recent earnings calls of companies such as eBay, which said the unrecognized deferred tax liability on its indefinitely reinvested foreign earnings of $200 million to $300 million would be approximately 24 percent of that amount. Cognizant Technology Solutions said that if it changed its assertion that its accumulated undistributed Indian earnings are indefinitely reinvested, it would expect to accrue additional tax expense at a rate of approximately 21 percent of cash available for distribution, which it said “could have a material adverse effect on [its] future effective income tax rate.” Johnson & Johnson similarly projected that the estimated effect of foreign local and withholding taxes on its indefinitely reinvested foreign earnings was approximately 2.5 percent of its effective rate.

Attempts to revisit the somewhat arbitrary nature of the APB 23 guidance have been occurring for years, and even advocates for change are skeptical that the TCJA will result in big modifications. In the meantime, the standard continues to force companies into making somewhat arbitrary determinations about future uses of foreign earnings to avoid — or trigger — large changes to their effective rates.

ESG Considerations

Possible changes to FASB disclosure requirements may also be driven by the larger forces of ESG investing.

An October 1 letter from business professors and investors and associated entities asked the SEC to initiate notice and comment rulemaking to develop a comprehensive framework requiring issuers to disclose identified ESG aspects of company operations. That petition highlights large asset managers’ calls for standardized ESG disclosure; discusses the importance of standardized ESG disclosure for companies and the competitive position of U.S. capital markets; points to existing rulemaking petitions, investor proposals, and stakeholder engagements in areas including tax; and highlights how those efforts suggest that it’s time for the SEC to bring coherence to this area.

The letter mentions a 2016 SEC concept release that asked what, if anything, should be changed regarding tax disclosures. It discusses a comment letter by the Financial Accountability and Corporate Transparency (FACT) Coalition that highlighted risks to investors created by what it referred to as “at best uncertain and often legally problematic [international tax] strategies” on the operations and earnings of many U.S. corporations. According to the FACT Coalition, the scope of fines and risks in tax jurisdictions worldwide indicates that investors need more information to evaluate the tax risks that companies are running. Finally, the coalition pointed to U.S. and EU CbC reporting requirements. It said investors lack access to information available to tax authorities, and that the growing use of offshore tax strategies, the international response to curb aggressive tax avoidance, and the potential tax liabilities for corporations engaged in those practices make that information material for investors.

According to the petition letter, comments in support of expanded sustainability disclosure show that investors and capital market professionals think the SEC must act to develop a mandatory rule for clear, consistent, comparable, and high-quality ESG disclosure. The letter says the TCJA’s move to a territorial tax system will open further uncertainties and risks regarding how and where revenues are booked.

Voluntary reporting initiatives are moving in similar directions. The Global Sustainability Standards Board (GSSB), a group of 15 members representing a range of perspectives on sustainability reporting, is developing globally accepted standards for sustainability reporting.

As part of that project, the GSSB is working to create new disclosures regarding tax and payments to governments, and a rough draft of a related standard was discussed during a stakeholder peer review earlier this year. It released an exposure draft November 13, will meet to discuss the draft November 29, and is expected to issue the draft for a 90-day public comment period December 12.

The proposals would incorporate a new standard on taxes and payments to governments with five specific disclosures, including management approach disclosures, such as management approach to taxes and payments to governments; tax governance, control, and risk management; and stakeholder engagement and management of concerns. Other proposed standards include disclosure of entities and activities by tax jurisdiction and CbC reporting.

Initiatives to require companies to provide more information about taxes paid to different jurisdictions continue in various forums.

Mindy Herzfeld is professor of tax practice at University of Florida Levin College of Law, of counsel at Ivins Phillips & Barker Chtd., and a contributor to Tax Notes International. Email: herzfeld@law.ufl.edu

Follow Mindy Herzfeld (@InternationlTax) on Twitter.

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