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FASB Exposure Draft on Uncertain Tax Positions
On July 14, 2005, the Financial Accounting Standards Board (FASB) issued an exposure draft of a proposed interpretation of FASB Statement No. 109, Accounting for Income Taxes, addressing Accounting for Uncertain Tax Positions.1 This interpretation is intended to reduce perceived inconsistencies in applying the accounting rules for income tax contingencies.
Overview Companies have followed a variety of approaches, ranging from evaluating potential loss to recording only positions probable of being sustained, and various positions in between. The exposure draft adopts the most conservative approach, by requiring that each tax position be evaluated as to its likelihood of being sustained. Basically, tax positions will include deductions, credits and items excluded from income. The proposed interpretation employs a dual-threshold approach for recognizing the benefits of tax positions and their continued recognition.
Initial Recognition To initially recognize a benefit (e.g., an asset or the nonrecording of a liability) in the tax provision, it must be probable that the position would be sustained on its merits. The probability that a taxing authority would either not audit or identify the issue cannot be taken into account. The term probable has the same meaning as in FASB Statement No. 5the future event or events are likely to occur. The definition of probable continues to be the subject of much discussion. The FASB has made it clear that probable does not mean more likely than not; in its view, probable is a higher threshold. Although the FASB does not believe that tax opinions are required or appropriate in all instances, it noted that an unqualified should prevail tax opinion from a qualified expert, for which all conditions are objectively verifiable, may help to demonstrate that the probable threshold has been met. This seems to indicate that the term probable means a 70%-or-greater likelihood.
Derecognition In any subsequent period, if it becomes more likely than not that a tax position would not be sustained on audit, the benefit must be derecognized, by recording an income tax liability or reducing a deferred tax asset.
Measurement Once it is determined that a benefit for a tax position may be recognized (as described above), the amount must be determined based on the best estimate of the amount that will be sustained. The best estimate is defined as the single most likely amount in a range of possible estimated amounts. For example, if a company believes that its position would be sustained on litigation, but typically settles with the taxing jurisdiction to avoid the expense and hazards of litigation, it would record the most likely settlement amount as the benefit.
Classification Liabilities recognized as a result of applying the interpretation will not generally be deemed deferred tax liabilities, because they do not arise from a taxable temporary difference. A liability will be classified as a current liability to the extent the item is expected to be paid within one year or the operating cycle. This may be difficult for companies to determine, because the timing of the payment often depends on resolving a controversy with a taxing jurisdiction and other variables beyond the businesss control.
Effective Date and Transition The interpretation is proposed to be effective for years ending after Dec. 15, 2005, thereby affecting tax contingency analysis beginning with all 2005 calendar-year-end corporations; early adoption is encouraged. The FASB believes that an assessment of the current and previous tax positions can be accomplished in connection with the preparation of 2004 returns. The interpretations provisions must be applied to positions in all open tax years. Only positions that meet the probable threshold on the adoption date will be recognized (or continue to be recognized). In other words, all tax positions for all open years must be reevaluated in applying the new interpretation. The cumulative effect of applying the interpretations provisions will be reported as a change in accounting principle as of the end of the period in which adopted.
Recommended Action As proposed, this interpretation will be effective for 2005 calendar-year-end companies. Income tax contingency accounting practices employed by corporations have been varied; many may find that some information for tax positions reported on returns is not readily available. Businesses should quickly inventory the tax positions taken in all reported years and evaluate which ones will require significant analysis to substantiate the level of confidence that a position will be sustained, and estimate the amount to be sustained. Many companies may find that the analysis of tax positions and documentation are insufficient to evaluate the GAAP consequences of the proposed interpretation. The exposure draft can be downloaded from the FASBs website, at http://www.fasb.org/draft/ed_prop_interp_utp.pdf.
1For background, see Guertin, Tax Clinic, Tax Contingency Reporting, 36 The Tax Adviser 254 (May 2005). |
