SEC and Tax Reform, SAB 118

January 2018

Summary

The enactment of the most significant U.S. income tax legislation in 30 years is now final. 
On Friday, December 22, 2017, President Trump signed into law the “Tax Cuts and Jobs Act” legislation or the “Act.”

For U.S. Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS), the enactment date is December 22, 2017.

Under ASC 740, Income Taxes, reporting entities are required to recognize the effect(s) of the Act on current and deferred income taxes in the enactment period’s financial statements.

For calendar year reporting entities, the enactment period is the fourth quarter of the 2017 annual reporting period. For fiscal year reporting entities, the enactment period is the fiscal quarter within which the December 22 enactment date falls, e.g., second quarter for a June 30 fiscal year reporting entity.
 

Details

On the same date as the president signed the Act into law, the SEC staff issued guidance in the form of Staff Accounting Bulletin (SAB) No. 118 to address concerns about reporting entities’ ability to timely comply with the accounting requirements to recognize all of the effect(s) of the Act in the period of enactment.   

1. SAB 118 outlines the approach companies may take if they determine that the necessary information is not available (in reasonable detail) to evaluate, compute, and prepare accounting entries to recognize the effect(s) of the Act by the time the financial statements are required to be filed. Companies may use this approach when the timely determination of some or all of the income tax effect(s) from the Act is incomplete by the due date of the financial statements.   

SAB 118 also prescribes disclosures that reporting entities must provide in these circumstances.   
 
The guidance in SAB 118 is strictly limited to the financial reporting consequences from the Act and cannot be applied by analogy, nor used to comply with financial reporting of other tax legislation, e.g., a tax law change in a foreign country.

2. The framework provided in SAB 118 necessitates making a determination whether the assessment and quantification of a particular income tax effect(s) is “incomplete” by the due date of the financial statements.   
Income tax effect(s) that are considered “complete” by the due date of the financial statements must be reported in the enactment period financial statements.
 
If the assessment and quantification of some or all of the income tax effect(s) are incomplete by the due date of the financial statements, a reporting entity should determine whether a “reasonable estimate” can be made.
 
A reporting entity must record a reasonable estimate in the first period in which it is possible to determine a reasonable estimate.  Under SAB 118, reasonable estimates are considered “provisional amounts” that have to be updated when additional information becomes available and the evaluation and computation of the additional information is complete. 
 
A reporting entity must act in good faith and update provisional amounts as soon as more information becomes available, evaluated and prepared, during a measurement period that cannot exceed one year from the enactment date. Initial reasonable estimates and subsequent changes to provisional amounts should be reported in income tax expense or benefit from continuing operations in the period in which they are determined. 
 
Any income tax effect(s) that are unrelated to the Act cannot be treated nor reported as measurement period adjustments. 
 
If a reasonable estimate (with respect to one or more items) cannot be made by the due date of the enactment period financial statements, a reporting entity should apply the provisions of ASC 740 to the item(s) by applying the tax law in effect prior to the enactment of the new tax law.            

3. There are two illustrative examples in SAB 118.

Under Example 1, a reporting entity has historically asserted an indefinite reinvestment of foreign earnings and thus not provided in the financial statements a deferred tax liability for the latent U.S. tax effect. The passage of the Act now causes the entity to owe a U.S. tax at different rates on the undistributed accumulated earnings and profits. The entity concludes, based on its facts and circumstances, that it is unable to develop a reasonable estimate of the tax on accumulated foreign income by the due date of the financial statements which include the enactment period. In this fact pattern, the reporting entity does not recognize the effect of the final tax on accumulated foreign earnings in the financial statements which include the enactment period. Instead, the entity would recognize a reasonable estimate in a subsequent period if one can be determined and continue to revise it until final determination of the tax liability is complete. However, the measurement period cannot exceed 12 months from the enactment period. 

Under a modified Example 1(a), the entity is able to determine and recognize a reasonable estimate of the tax liability in the financial statements which include the enactment period. In a subsequent period (within the measurement period), the entity obtains, analyzes and prepares the necessary information to complete the determination of the final tax and the accounting, resulting in an adjustment to the provisional amount.       

Under Example 2, a reporting entity with deferred tax assets as of the enactment date is able determine the income tax rate remeasurement effect by the financial statements’ filing due date. However, the entity cannot determine a reasonable estimate of the valuation allowance impact that could arise due to certain provisions of the Act. In a subsequent period, the entity is able to obtain, analyze and prepare information that is necessary to complete the valuation allowance assessment, and thus is able to conclude the accounting and determine that no change in valuation allowance is required due to provisions of the Act.

SAB 118 states that reporting entities should provide financial statement disclosures about material impact(s) from the Act for which the ASC 740 accounting is incomplete, including:  
(a) Qualitative disclosures of the income tax effects of the Act for which the accounting is incomplete;
(b) Disclosures of items reported as provisional amounts;
(c) Disclosures of existing current or deferred tax amounts for which the income tax effects of the Act have not been completed;
(d) The reason why the initial accounting is incomplete;
(e) The additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC Topic 740;
(f) The nature and amount of any measurement period adjustments recognized during the reporting period;
(g) The effect of measurement period adjustments on the effective tax rate; and
(h) When the accounting for the income tax effects of the Act has been completed.

5. A Foreign Private Issuer reporting under IFRS may apply the approach outlined in SAB 118 solely for the purpose of completing the income tax accounting for the effect(s) of the Act as required by International Accounting Standard (IAS) 12, Income Taxes.    

The staff also issued a Compliance & Disclosure Interpretation, which confirms that the remeasurement of a deferred tax asset to incorporate the effects of newly enacted tax rates or other provisions of the Act does not trigger an obligation to file under Item 2.06 of Form 8-K.
 

BDO Insights

The issuance of SAB 118 is a significant development intended to assist reporting entities in complying with the requirements in ASC 740. 

While SAB 118 indicates the measurement period may be up to 12-months (e.g., December 2017 to December 2018 for calendar year entities), reporting entities cannot wait to gather, assess and evaluate information and compute the necessary entries until the end of the measurement period. SAB 118 merely provides relief when the information needed to recognize some or all of the income tax effect(s) of the Act (and only this Act) is incomplete by the filing date.        

We expect that a considerable information gathering and evaluation work may be required to determine whether a reasonable estimate with respect to one or more effect can be made by the due date of the financial statements. Reporting entities must make a reasonable effort and act in good faith to determine specific income tax effect(s) and complete the ASC 740 current and deferred tax accounting. This will require exercising sound professional judgment based on the particular facts and circumstances. 

For example, a reporting entity whose accumulated foreign income has been considered permanently reinvested might be able to determine a reasonable estimate of the final tax on accumulated foreign income if it has few foreign subsidiaries, a simple legal entity reporting system, few differences between reported U.S. GAAP retained earnings and U.S. earnings and profits (a tax law measurement of income), and readily available foreign cash and cash equivalent information.  The reporting entity might update the provisional amount and complete the ASC 740 accounting in a subsequent period as it is collects, evaluates, analyzes, and computes the impacts from foreign taxes paid on the accumulated income, foreign tax credits, foreign withholding tax, and the potential foreign currency translation effect on the final tax liability.  The disclosures provided in the initial and subsequent periods would be consistent with the disclosure requirements in SAB 118.

Conversely, a reporting entity whose accumulated foreign income has been considered permanently reinvested for accounting might not initially be able to determine a reasonable estimate of the final foreign tax liability if it has many foreign subsidiaries, a very complex holding structure (e.g., divisional reporting, holding companies, etc.), significant differences between reported U.S. GAAP retained earnings and U.S. earnings and profits (e.g., material purchase price step-up and certain U.S. tax elections to amortize purchase price for earnings and profits), a complex foreign intercompany treasury structure, and a complex foreign tax reporting structure with many foreign tax returns. Under this circumstance, the reporting entity would comply with the ASC 740 requirements as if the tax law in effect prior December 22, 2017, continues to apply (i.e., it would continue to assert accumulated foreign income is permanently reinvested) until subsequent period(s) in which it is able to determine a reasonable estimate and/or the final tax liability and complete the ASC 740 accounting. The disclosures provided in the initial and subsequent periods would be consistent with the disclosure requirements in SAB 118.

Reporting entities must support and document their rationale for why some or all effects are incomplete, why reasonable estimates cannot be made, measurement period adjustments, and final determinations of provisional amounts. The level and extent of documentation will depend on the particular entity’s facts and circumstances. However, it is expected to be consistent with the level and extent of disclosures required under SAB 118.
 

For questions related to matters discussed above, please contact:
 
Assurance    
Yosef Barbut
National Accounting Partner
  Adam Brown
Partner - National Director of Accounting

   
Jeff Lenz
Partner - National SEC Department
   

   
Tax    
Michael Williams
National Tax Partner - ASC 470
 
  Paul Heiselmann
National Managing Partner - Specialized Tax Services

   
Matt Becker
National Tax Office Managing Partner