Income Taxes 2013

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2013

2013 Accounting for Variable Interest Entities

Second edition,

June 2015

This publication has been prepared for general information on matters of interest only, and does not

constitute professional advice on facts and circumstances specific to any person or entity. You should

not act upon the information contained in this publication without obtaining specific professional

advice. No representation or warranty (express or implied) is given as to the accuracy or

completeness of the information contained in this publication. The information contained in this

material was not intended or written to be used, and cannot be used, for purposes of avoiding

penalties or sanctions imposed by any government or other regulatory body.

PricewaterhouseCoopers LLP, its members, employees, and agents shall not be responsible for any

loss sustained by any person or entity who relies on this publication.

The content of this publication is based on information available as of May 31, 2013. Accordingly,

certain aspects of this publication may be superseded as new guidance or interpretations emerge.

Financial statement preparers and other users of this publication are therefore cautioned to stay

abreast of and carefully evaluate subsequent authoritative and interpretative guidance that is issued.

This publication has been updated to reflect new and updated authoritative and interpretive guidance

since the 2012 edition. See Appendix A for a Summary of noteworthy revisions.

“Portions of FASB Accounting Standards Codification®

, copyrighted by the Financial Accounting

Foundation, 401 Merritt 7, Norwalk, CT 06856, are reproduced with permission.”

Dear Clients and Friends:

The overall accounting model for income taxes has been in place for many years, yet

the accounting for income taxes continues to pose many challenges for preparers,

users, and auditors. Among those challenges are the tax accounting rules for valuation

allowance, intraperiod allocation, business combinations, and foreign operations.

PwC is pleased to offer this comprehensive guide on the accounting for income taxes.

It is intended to assist you in interpreting the existing literature in this complex area

of accounting by bringing together all of the key guidance into one publication. It

provides several comprehensive examples to help navigate the guidance, and offers

our perspective throughout, based on both analysis of the guidance and our

experience in applying it.

This guide is intended to clarify the fundamental requirements involved in the

accounting for income taxes and to highlight key points that should be considered

before and after transactions are undertaken. We hope you will find in these pages the

information and insights needed to work with greater confidence and certainty when

applying the accounting model for income taxes.

PricewaterhouseCoopers LLP

PwC

Table of contents

Chapter 1: Scope of ASC 740

1.1 Scope of ASC 740 .............................................................. 1-3

1.1.1 In general (ASC 740-10-15-3) ............................................ 1-3

1.1.2 Scope exceptions (ASC 740-10-15-4) ................................. 1-3

1.2 Defining a “tax based on income” ..................................... 1-4

1.2.1 In general ......................................................................... 1-4

1.2.1.1 Withholding taxes—entities that withhold taxes for the benefit

of others .............................................................................................. 1-4

1.2.1.2 Withholding taxes—entities that receive dividends, interest,

royalties or other income ................................................................... 1-5

1.2.2 Application of guidance to specific tax jurisdictions

and tax structures ............................................................ 1-5

1.2.2.1 Higher of an income-based or capital-based computation ............... 1-5

1.2.2.2 Gross receipts tax ............................................................................... 1-7

1.2.2.3 Single business tax ............................................................................. 1-8

1.2.2.4 Texas margin tax ................................................................................ 1-9

1.2.2.5 Private foundation—excise tax on net investment income ............... 1-9

1.2.2.6 The American Jobs Creation Act of 2004 tonnage tax ...................... 1-10

1.2.3 Credits and other tax incentives ....................................... 1-11

1.2.4 Attributes of taxes not based on income ........................... 1-13

1.2.4.1 Timing differences inherent in the computation of taxes not

based on income ................................................................................. 1-13

1.2.4.2 Tax credit carryforwards for tax regimes not based on income ........ 1-13

1.3 Accounting by jurisdiction (separate calculation versus

blended rate) .................................................................... 1-14

1.4 Applicability of ASC 740 to an entity’s legal form .............. 1-15

1.4.1 Single-member and multiple-member limited liability

companies (under U.S. tax law) ........................................ 1-15

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1.4.2 Partnerships .................................................................... 1-15

1.4.2.1 Investments in partnerships .............................................................. 1-15

1.4.2.2 General application of ASC 740 to the separate financial

statements of partnerships ................................................................ 1-16

1.4.2.2.1 Master limited partnerships .............................................................. 1-17

1.4.2.2.2 Real estate investment trusts (REITs) and regulated investment

companies (RICs) ............................................................................... 1-17

1.4.3 State income taxes ............................................................ 1-18

1.4.3.1 Separate calculation versus blended rate .......................................... 1-18

1.4.3.2 Treatment of apportionment factors ................................................. 1-18

1.4.3.2.1 Changes in state income tax rates caused by changes in how

a state apportions income .................................................................. 1-18

Chapter 2: Objectives and basic principles

2.1 Objectives of ASC 740 ....................................................... 2-4

2.2 Basic principles ................................................................ 2-5

2.3 Exceptions to the basic principles ..................................... 2-5

2.3.1 “Outside basis” differences and U.S. steamship

exceptions ........................................................................ 2-5

2.3.2 Leveraged leases (ASC 740-10-25-3(c)) ............................. 2-6

2.3.2.1 Purchased leveraged leases ................................................................ 2-6

2.3.3 Nondeductible goodwill (ASC 740-10-25-3(d)) .................. 2-6

2.3.4 Tax effects of intra-entity transactions

(ASC 740-10-25-3(e)) ........................................................ 2-7

2.3.4.1 In general ............................................................................................ 2-7

2.3.4.1.1 Deferred charge differentiated from deferred tax asset .................... 2-9

2.3.4.1.2 Quantifying the amount of tax deferred under

ASC 740-10-25-3(e) ........................................................................... 2-9

2.3.4.1.3 Intra-entity intellectual property migration arrangements .............. 2-10

2.3.4.2 Certain exceptions in the application of ASC 740-10-25-3(e) ........... 2-12

2.3.4.2.1 Intra-entity sale of subsidiary stock................................................... 2-12

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2.3.4.2.2 Intra-entity transfers reported at predecessor basis ......................... 2-14

2.3.5 Certain foreign exchange amounts

(ASC 740-10-25-3(f)) ........................................................ 2-15

2.4 Other considerations ........................................................ 2-15

2.4.1 Discounting ...................................................................... 2-15

2.4.2 Volatility .......................................................................... 2-17

2.4.3 Need for judgment ........................................................... 2-18

Chapter 3: Temporary differences

3.1 Temporary difference—defined ........................................ 3-6

3.2 Examples of temporary differences .................................. 3-8

3.2.1 Business combinations (ASC 740-10-25-20(h)) ................. 3-8

3.2.2 Indexation (ASC 740-10-25-20(g)) .................................... 3-8

3.2.2.1 Temporary differences related to U.K. buildings .............................. 3-8

3.2.3 Temporary differences related to investment tax

credits (ASC 740-10-25-20(e) and (f)) ............................... 3-12

3.2.3.1 Foreign investment tax credits and grants ........................................ 3-22

3.2.3.2 Effect on leases ................................................................................... 3-23

3.2.4 Debt instruments ............................................................. 3-23

3.2.4.1 Contingently convertible debt ............................................................ 3-23

3.2.4.2 Convertible debt and call option ........................................................ 3-24

3.2.4.3 Debt instruments with temporary differences that may not

result in future deductible amounts .................................................. 3-26

3.2.4.4 Convertible debt with a beneficial conversion feature and

detachable warrants ........................................................................... 3-26

3.2.4.5 Tax implications of induced conversions of convertible debt ........... 3-27

3.2.5 Low-income housing credits ............................................. 3-28

3.2.6 Synthetic fuels projects .................................................... 3-29

3.2.7 Subsidies related to Medicare Part D ................................ 3-30

3.2.8 IRC Section 162(m) limitation .......................................... 3-31

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3.3 Basis differences that will reverse with no tax

consequence ..................................................................... 3-32

3.3.1 Excess cash surrender value of life insurance ................... 3-32

3.4 Issues to be considered in identifying temporary

differences ....................................................................... 3-32

3.4.1 Basis differences that are not accounted for under

the basic model for deferred taxes .................................... 3-33

3.4.2 Temporary differences where reversal might not

occur in the foreseeable future ......................................... 3-34

3.4.3 Consideration of settlement at book carrying value .......... 3-34

3.4.4 Temporary differences not identified with an asset

or a liability ...................................................................... 3-34

3.4.5 U.S. federal temporary differences relating to state

income taxes .................................................................... 3-35

Chapter 4: Recognition and measurement

4.1 Basic approach for deferred taxes .................................... 4-3

4.2 Applicable tax rate ........................................................... 4-6

4.2.1 General considerations .................................................... 4-6

4.2.2 Graduated tax rates .......................................................... 4-7

4.2.3 Determining the applicable rate ....................................... 4-8

4.2.4 Complexities in determining the applicable tax rate ......... 4-10

4.2.4.1 Ordering effects .................................................................................. 4-10

4.2.4.2 Undistributed earnings ...................................................................... 4-11

4.2.4.3 Special deductions .............................................................................. 4-12

4.2.4.4 Tax holidays ........................................................................................ 4-13

4.2.4.5 Nonamortizing/nondepreciating assets ............................................ 4-17

4.2.4.6 “Worthless” deferred tax assets ......................................................... 4-19

4.2.4.7 Dual-rate jurisdictions ....................................................................... 4-19

4.2.4.8 Hybrid tax systems ............................................................................. 4-22

4.2.4.9 Foreign-branch operations ................................................................ 4-22

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4.2.4.10 Aggregating computations for separate jurisdictions ....................... 4-23

4.2.5 Alternative minimum tax considerations ......................... 4-23

4.2.5.1 AMT—general background ................................................................ 4-23

4.2.5.2 The interaction of AMT with ASC 740 accounting ............................ 4-24

Chapter 5: Valuation allowance

5.1 Assessing the need for a valuation allowance ................... 5-5

5.1.1 Evidence to be considered ................................................ 5-5

5.1.2 Weighting of available evidence ....................................... 5-8

5.1.3 Cumulative losses and other negative evidence ................ 5-9

5.1.3.1 General – revised June 2015 .............................................................. 5-9

5.1.3.2 Examples of situations where positive evidence outweighed

significant negative evidence ............................................................. 5-14

5.1.4 Assessing changes in the valuation allowance ................... 5-17

5.2 SEC staff views on disclosure and valuation allowance

assessments – revised June 2015 ...................................... 5-17

5.3 Other considerations ........................................................ 5-19

5.3.1 Evaluating the effect of a restructuring ............................ 5-19

5.3.2 Determining the need for a valuation allowance in a

business combination ....................................................... 5-18

5.3.3 Going-concern uncertainty – revised June 2015 ............... 5-20

5.4 Sources of taxable income ................................................ 5-21

5.4.1 Taxable income in prior carryback years if carryback

is permitted under the tax law .......................................... 5-22

5.4.1.1 Special considerations for carrybacks ............................................... 5-22

5.4.1.1.1 Liabilities for unrecognized tax benefits as a source of taxable

income ................................................................................................ 5-22

5.4.1.1.2 Carrybacks that free up credits .......................................................... 5-23

5.4.1.1.3 Carryback availability that may not be used ...................................... 5-25

5.4.2 Future reversals of existing taxable temporary

differences ....................................................................... 5-26

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5.4.2.1 Deferred tax liabilities on indefinite-lived intangible assets—

“naked credits” ................................................................................... 5-30

5.4.3 Tax-planning strategies .................................................... 5-32

5.4.3.1 Tax-planning strategies defined......................................................... 5-33

5.4.3.1.1 Tax-planning strategies in jurisdictions where NOL

carryforwards never expire ................................................................ 5-37

5.4.3.2 Examples of common tax-planning strategies .................................. 5-39

5.4.3.2.1 Sales of appreciated assets ................................................................. 5-39

5.4.3.2.2 Sale-leaseback .................................................................................... 5-44

5.4.3.2.3 LIFO reserves ..................................................................................... 5-45

5.4.3.2.4 Shifting tax-exempt portfolios ........................................................... 5-46

5.4.3.2.5 Noneconomic tax-planning strategies ............................................... 5-47

5.4.3.3 Costs to implement a tax-planning strategy ...................................... 5-49

5.4.3.4 Examples of actions that do not qualify as tax-planning

strategies ............................................................................................ 5-52

5.4.3.4.1 Excluding a loss subsidiary from tax consolidation .......................... 5-52

5.4.3.4.2 Acquiring a profitable entity .............................................................. 5-52

5.4.3.5 In summary ........................................................................................ 5-52

5.4.3.6 Issues in evaluating tax-planning strategies...................................... 5-54

5.4.3.6.1 Time value of money .......................................................................... 5-54

5.4.3.6.2 Unrecognized tax benefits .................................................................. 5-54

5.4.3.6.3 Separate statements of subsidiary ..................................................... 5-54

5.4.3.7 Consistent use in different jurisdictions ............................................ 5-55

5.4.4 Future taxable income exclusive of reversing

temporary differences and carryforwards ........................ 5-55

5.4.4.1 General ............................................................................................... 5-55

5.4.4.2 Considerations when projecting and scheduling future taxable

income other than reversals of existing temporary differences ........ 5-56

5.4.4.2.1 Originating temporary differences in future projections .................. 5-56

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5.4.4.2.2 Projecting future pretax book income ............................................... 5-57

5.5 Scheduling future taxable income .................................... 5-65

5.5.1 When is it necessary? ....................................................... 5-65

5.5.1.1 General approach to scheduling ........................................................ 5-65

5.5.1.2 Patterns of temporary difference reversals ....................................... 5-66

5.5.1.2.1 Depreciable and amortizable assets ................................................... 5-67

5.5.1.2.2 Assets and liabilities measured at present value ............................... 5-69

5.5.1.2.3 Deferred foreign taxes ........................................................................ 5-76

5.5.1.2.4 Tax return accounting method changes ............................................ 5-77

5.5.1.2.5 Deferred revenue or income .............................................................. 5-78

5.5.1.2.6 Sale-leasebacks ................................................................................... 5-78

5.5.1.2.7 Reserves for bad debts and loan losses .............................................. 5-78

5.5.1.2.8 Inventory reserves .............................................................................. 5-79

5.5.1.2.9 Reserves for litigation ........................................................................ 5-79

5.5.1.2.10 Warranty reserves .............................................................................. 5-79

5.5.1.2.11 Stock appreciation rights ................................................................... 5-79

5.5.1.2.12 Other ................................................................................................... 5-79

5.5.2 Examples of scheduling .................................................... 5-81

5.5.2.1 Example of scheduling future taxable income ................................... 5-81

5.5.2.2 Example of unused deduction ............................................................ 5-82

Chapter 6: A change in valuation allowance

6.1 Recording the effects of changes in valuation—in

general ............................................................................. 6-3

6.2 Changes in valuation allowance in specific areas .............. 6-4

6.2.1 Changes in valuation allowance—business

combinations ................................................................... 6-4

6.2.1.1 Establishment of a valuation allowance against an acquired

company’s deferred tax assets at the time of acquisition .................. 6-4

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6.2.1.2 Changes to the acquired deferred tax assets in a period

subsequent to a business combination .............................................. 6-4

6.2.1.3 Changes in the acquirer’s valuation allowance at the time of a

business combination......................................................................... 6-4

6.2.1.4 Effects of tax law changes on a valuation allowance recorded

against acquired tax benefits in a business combination .................. 6-5

6.2.1.5 Ordering of recognition of tax benefits .............................................. 6-5

6.2.2 Changes in valuation allowance related to items of

other comprehensive income ........................................... 6-5

6.2.3 Changes in valuation allowance resulting from

transactions among or with shareholders ........................ 6-5

6.2.3.1 NOL carryforward limitation following an initial public offering ..... 6-6

6.2.4 Transactions between entities under common control ..... 6-6

6.2.5 Changes in valuation allowance in spin-off transactions ... 6-6

6.2.5.1 Recording an increase to a parent’s valuation allowance when a

subsidiary is spun off in a nontaxable transaction ............................ 6-6

6.2.5.2 Recording a valuation allowance on a subsidiary’s assets when a

spin-off creates the need for a valuation allowance .......................... 6-6

6.2.6 Changes in valuation allowance when restating prior￾period presentation for discontinued operations ............. 6-7

Chapter 7: Change in tax laws or rates

7.1 Determining the enactment date ...................................... 7-2

7.2 Distinguishing between interpretive and legislative

regulations ....................................................................... 7-3

7.3 Accounting for rate changes ............................................. 7-3

7.4 Interim-period considerations ......................................... 7-6

7.4.1 Computing deferred taxes in an interim period ................ 7-7

7.4.2 Retroactive tax rate change .............................................. 7-8

7.4.3 Retroactive changes in tax laws or rates following

adoption of an accounting standard ................................. 7-8

7.4.4 Leveraged leases .............................................................. 7-11

7.5 Valuation allowances ....................................................... 7-11

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7.5.1 Valuation allowances relating to assets acquired in a

prior business combination .............................................. 7-12

7.6 Disclosure requirements – revised June 2015 .................. 7-12

7.7 Changes in tax methods of accounting .............................. 7-12

7.7.1 Transition to new accounting method .............................. 7-13

7.7.1.1 Positive §481(a) adjustments ............................................................. 7-13

7.7.1.2 Negative §481(a) adjustments ........................................................... 7-14

7.7.2 Timing .............................................................................. 7-14

7.7.2.1 Voluntary changes from proper accounting methods ....................... 7-14

7.7.2.2 Voluntary changes from improper accounting methods ................... 7-14

7.7.3 Unrecognized tax benefit considerations .......................... 7-15

7.7.3.1 Interest and penalties ......................................................................... 7-15

7.7.4 Involuntary changes from improper accounting

methods ........................................................................... 7-16

7.7.5 Other considerations ........................................................ 7-16

Chapter 8: Change in the tax status of an entity

8.1 General rule for changes in tax status ............................... 8-3

8.2 Loss of nontaxable status ................................................. 8-4

8.3 Switching tax status .......................................................... 8-4

8.3.1 Switching to nontaxable status ......................................... 8-4

8.3.2 Switching to taxable status ............................................... 8-5

8.4 Post-1986 S corporation elections/built-in gains .............. 8-6

8.4.1 Deferred tax liability after the change to

S corporation status ......................................................... 8-7

8.4.2 Tax-planning actions ........................................................ 8-8

8.4.3 Financial statement reporting .......................................... 8-9

8.5 Increase in tax basis upon the conversion of a

partnership to a corporation ............................................ 8-9

8.6 Business combination considerations .............................. 8-10

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8.6.1 S corporation election invalidated by acquisition by

C corporation ................................................................... 8-10

8.6.2 Common-control merger involving an S corporation ........ 8-10

8.6.3 Change in tax status as part of a business combination

– revised June 2015 .......................................................... 8-11

8.7 REIT conversion ............................................................... 8-11

8.7.1 Effective date of a REIT conversion .................................. 8-11

Chapter 9: Regulated entities

(Refer to PwC’s Accounting and financial reporting guide for Utilities and power

companies, 2013 edition)

Chapter 10: Business combinations

10.1 Overview .......................................................................... 10-3

10.2 Determine the tax structure of the transaction and tax

status of the entities involved in the business

combination ..................................................................... 10-5

10.2.1 Determining whether the business combination is

taxable or nontaxable ....................................................... 10-5

10.2.2 Identifying the tax status of the entities involved .............. 10-5

10.3 Determine financial statement and tax bases of the net

assets acquired ................................................................. 10-6

10.3.1 Determining tax bases in a taxable transaction................. 10-6

10.3.2 Determining tax bases in a nontaxable transaction .......... 10-6

10.4 Identify and measure temporary differences .................... 10-7

10.4.1 Basic methodology for recognition of deferred taxes on

acquired temporary differences and tax benefits .............. 10-7

10.4.2 Expected manner of recovery or settlement ..................... 10-8

10.4.3 Deferred taxes related to outside basis differences ........... 10-8

10.4.4 Recording the tax effect of contingencies and contingent

consideration in business combinations ........................... 10-11

10.4.4.1 Contingencies and contingent consideration—taxable

transactions ........................................................................................ 10-14

10.4.4.2 Contingencies and contingent consideration—nontaxable

transactions ........................................................................................ 10-18

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10.4.5 Deferred taxes related to research and development

activities ........................................................................... 10-21

10.4.6 Deferred taxes related to acquisition-related costs ........... 10-22

10.4.7 Identifying the applicable tax rate to calculate deferred

tax assets and liabilities .................................................... 10-23

10.5 Identify acquired tax benefits ........................................... 10-24

10.5.1 Realization test for the acquired tax benefits .................... 10-24

10.5.2 Evaluating future combined results subsequent to the

business combination ....................................................... 10-25

10.5.3 Considering the acquirer’s taxable differences as a

source of realization ......................................................... 10-25

10.5.4 Limitation of tax benefits by law ....................................... 10-26

10.5.5 Changes to the acquired deferred tax assets after the

business combination ....................................................... 10-27

10.5.6 Changes in the acquirer’s deferred tax balances related

to acquisition accounting ................................................. 10-28

10.5.7 Business combinations achieved in stages ........................ 10-30

10.6 Consider the treatment of tax uncertainties ..................... 10-33

10.6.1 Recording tax uncertainties ............................................. 10-34

10.6.2 Subsequent resolution of tax uncertainties in a business

combination ..................................................................... 10-34

10.7 Deferred taxes related to goodwill .................................... 10-35

10.7.1 Excess of tax-deductible goodwill over book goodwill ....... 10-36

10.7.2 Recognition of a deferred tax asset for excess tax￾deductible goodwill .......................................................... 10-36

10.7.3 Situations in which the iterative formula may not apply ... 10-39

10.7.4 Excess of book goodwill over tax-deductible goodwill ....... 10-39

10.7.5 Recognition of deferred tax liabilities related to tax￾deductible goodwill subsequent to the acquisition date .... 10-39

10.7.6 Deferred tax liabilities related to tax-deductible

goodwill and indefinite-lived intangible assets—source

of taxable income ............................................................. 10-40