The Financial Accounting Standards Board's oversight organization announced May 20 that it will test a new review process for existing standards with an analysis of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes."
FIN 48, which was promulgated in November 2006, clarified the guidelines for accounting of uncertainty in income taxes on financial statements of enterprises per FASB Statement No. 109, Accounting for Income Taxes, and removes uncertain income tax positions from the guidance provided under FAS 5, Accounting for Contingencies. See August, “Understanding FIN 48: Accounting for Uncertainty in Income Taxes,” Business Entities (WG&L), May/Jun 2008.
It also applies to purchase accounting in connection with a business combination. Use of a valuation allowance described in FASB Statement 109, therefore, was eliminated as an appropriate substitute for the derecognition of a tax position. The requirement to assess a valuation allowance for deferred tax assets based on the sufficiency of future taxable income was left unchanged by FIN 48. This situation would arise, for example, where a company with a large NOL carryforward is not likely to produce a sufficient level of future taxable income to fully utilize the NOL within the applicable carryover period.
When a position is taken on a tax return that reduces the amount of income taxes payable even though another interpretation of current law can be made that would not reduce current income taxes payable, the enterprise realizes an immediate economic benefit. Under FIN 48, this benefit of a favorable tax position can be recognized in the current period when the position has a more likely than not (MLTN) chance of being upheld through court review despite the presence of contrary interpretations, and the benefit to ultimately be realized can be measured in accordance with applicable rules. Only the difference between the measured benefit and the reported benefit on the tax return is required to be added to the tax reserve. On the other hand, if the position on a particular item, i.e., a so-called “unit of account,” is determined to be less likely than not correct, the full amount of the tax liability, as well as projected interest and possible penalty, must be included in the reserve as a current liability (or reduction in the NOL carryforward or claimed tax refund) where the company anticipates making payment within one year or within the company's next operating business cycle. Non-current liabilities for fully or partially unrecognized tax positions are treated as a deferred tax liability to the extent unrecognized. Such book-tax adjustments will, in certain instances, affect the tax basis of one or more assets thereby differentiating book from tax depreciation - during the applicable recovery periods.
In many instances, partial or totally unrecognized tax positions may not later be derecognized, i.e., reduce the amount of the reserve or liability for uncertain taxes, until the statute of limitations has expired for the year in which the position was taken and the position has not been challenged by the taxing authority. Conversely, previously recognized tax positions that subsequently fail the MLTN recognition standard due to an intervening change in the law are required to be derecognized and charged to liabilities in the first subsequent financial reporting period in which such determination is made.
Where the MLTN standard is not satisfied (as discussed below), no economic benefit may be claimed and recognized for financial accounting purposes, i.e., a liability is booked or reflected on the financial balance sheet for the total amount of tax due, plus associated interest and penalties.
The Financial Accounting Foundation (FAF), the private-sector organization that oversees FASB, had determined over the last few years that the board required a formal process to monitor and address the issues that can arise after implementation of new accounting standards. The review will determine whether FIN 48 is accomplishing its purpose of providing useful financial information for management’s decision making process and evaluating the standard’s implementation and associated compliance costs.
Many companies filing GAAP financial statements have had to seek legal opinions from tax counsel on issues that present a degree of uncertainty as to wehter the position taken on the tax return can be recognized, and if so, what is its proper "measurement". Such opinions in turn raise questions of attorney-client privilege and work product protection. FIN 48 schedules are reported on financial statements as an aggregate account and adjustment, its the schedules and opinions that contain much more information that the IRS in the event of an audit may want to have the taxpayer produce.
The adoption of FIN 48 has not been without its detractors and perhaps those who want to see more relaxed standards re-introduced into GAAP are trying to gain a foothold to causing a return to the former standard used under FAS 109 for reporting uncertain tax liabilities. It may also be something that the International Accounting Standards Board wants to see eliminated so that conversion of GAAP into IFRS can be effectuated.
For a related development see August, "The Uncertain State of Uncertain Tax Positions", Business Entities (May/June 2011).