On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act of 2017 (the “Act”), which makes extensive changes to the U.S. tax laws and includes a variety of provisions that will affect businesses. In response to certain provisions of the Act, the Staff of the Securities and Exchange Commission (the “SEC”) has provided disclosure guidance on (1) whether the re-measurement of a deferred tax asset to account for the tax effects of the Act trigger a disclosure obligation under Item 2.06 of Form 8-K, and (2) how and when to present the income tax effects in a registrant's financial statements for the reporting period in which the Act went into effect when the accounting remains incomplete. This Memorandum summarizes the recent SEC guidance.
Does the re-measurement of a deferred tax asset to account for certain income tax effects of the Act trigger a filing requirement under Item 2.06 of Form 8-K?
Item 2.06 of Form 8-K provides that if a registrant concludes that generally accepted accounting principles (“GAAP”) require a material charge for impairment to one or more of its assets, it must disclose, among other things, the date on which the material charge is required, a description of the impaired assets, the circumstances that led to its concluding that a charge for impairment is in fact required, and, if or once available, an estimate of the amount of the impairment charge. The SEC recognizes that registrants may be particularly concerned with whether the re-measurement of a deferred tax asset to account for the impact of a change in tax rate or laws under the Act will require a registrant to file an Item 2.06 Form 8-K to the extent the re-measurement results in a material impairment. To address this concern, the SEC issued Compliance and Disclosure Interpretation, Question 110.021 (the “C&DI”), which provides that the re-measurement of a deferred tax asset to reflect the impact of a change in tax rate or tax law is not an impairment under ASC Topic 7402 and does not trigger a Form 8-K requirement under Item 2.06.
In addition, and as further described below, the C&DI also clarifies that when complying with the newly issued SAB 118 (discussed below), registrants using the measurement period approach to determine that an impairment has occurred as a result of changes made by the Act may rely on the Instruction to Item 2.06 of Form 8-K and disclose the impairment, or a provisional amount for a possible impairment in lieu thereof as permitted by SAB 118, in its next periodic report on From 10-K or From 10-Q.3
How should a registrant present the income tax effects in its financial statements for the reporting period in which the Act went into effect when the accounting remains incomplete?
In Staff Accounting Bulletin No. 1184 (“SAB 118”), the SEC clarifies the application of ASC Topic 740 to registrants’ accounting of the income tax effects of the Act. As noted above, ASC Topic 740 provides accounting and disclosure guidance on accounting for income taxes under GAAP and addresses a variety of topics, including the recognition of taxes repayable or refundable, the recognition of deferred tax liabilities and assets, and the accounting for income taxes upon a change in tax laws or tax rates. However, the SEC notes that ASC Topic 740 does not cover certain circumstances in which registrants must account for the income tax effects of the Act, and has issued SAB 118 to specifically address the circumstance where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting under ASC Topic 740 for certain income tax effects of the Act by the time the registrant issues financial statements for the reporting period that include the Act’s enactment date of December 22, 2017. For registrants with calendar year ends, SAB 118 may first be relied upon in their next Annual Report on Form 10-K.
SAB 118 provides that insofar as a registrant’s accounting for certain income tax effects of the Act is incomplete, but those effects can be determined to a reasonable estimate, the SEC would not object if the registrant included such a reasonable estimate in its financial statements. However, the SEC would object to a registrant’s omission of a reasonable estimate in its financial statements if a reasonable estimate has been determined. Accordingly, the SEC directs each impacted registrant to include such reasonable estimates in its financial statements in the first reporting period in which the registrant is able to determine the reasonable estimate, and to report such a reasonable estimate as a provisional amount during the period when the accounting for the income tax effects of the Act remain incomplete, which the SEC refers to as the “measurement period.” The measurement period begins in the reporting period during which the Act was enacted, and ends when the registrant has obtained, prepared, and analyzed the information necessary to complete the accounting requirements under ASC Topic 740. In all cases, the measurement period should end no later than the one-year anniversary of the enactment date, or December 22, 2018. If a reporting company does not have the necessary information to provide a reasonable estimate of certain income tax effects of the Act, the SEC expects the registrant not to use related provisional amounts in its financial statements. The SEC believes that no registrant should adjust its current or deferred taxes to reflect the tax effects of the Act until it can determine a reasonable estimate. Once the accounting of the income tax effects of the Act can be determined, such accounting is considered complete and the resulting amounts must be included in the registrant’s financial statements for the period that includes the enactment date of the Act.
In addition, SAB 118 also provides that, for so long as a registrant may account for certain income tax effects of the Act under the measurement period approach (i.e., when the accounting remains incomplete), the registrant should disclose certain information about the items for which the accounting under ASC Topic 740 is incomplete, including:
- qualitative disclosures of the income tax effects of the Act for which the accounting was incomplete;
- disclosures of items reported as provisional amounts;
- disclosures of existing current or deferred tax amounts for which the income tax effects of the Act have not been completed;
- the reason why the initial accounting is incomplete;
- the additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC Topic 740;
- the nature and amount of any measurement period adjustments recognized during the reporting period;
- the effect of measurement period adjustments on the effective tax rate; and
- when the accounting for the income tax effects of the Act has been completed.
The changes to the U.S. tax laws are far reaching and affect businesses in a variety of ways. The guidance discussed above shows a recognition by the SEC that registrants may need additional time to interpret and apply the new laws to their businesses and their impact on financial statements. As registrants continue to assess the impact of the Act, registrants should be mindful of their disclosure obligations. In addition to the disclosure obligations and SEC relief discussed above, registrants should consider whether updates to other aspects of their disclosure are appropriate, such as risk factors, trends in MD&A and non-GAAP financial measures, among others. With many registrants’ fiscal years just completed, a registrant’s Annual Report on Form 10-K will present the first opportunity to update many aspects of a registrant’s disclosures to account for the impact of the new U.S. tax laws.