ASC 740: Q3 2021 provision considerations

TAX ALERT | October 03, 2021

Authored by RSM US LLP

The world of tax is once again abuzz with discussions of major proposed tax law changes included in the reconciliation package making its way through Congress. The package is likely to be revised slightly in the coming weeks as Congress negotiates over the details to ensure there are enough votes to send the package to the President’s desk for enactment. Issues like the proposed 26.5% top corporate tax rate continue to be a point of contention for some Democrats, whose votes will be key in securing passage. However, despite these disagreements, many in Washington expect the reconciliation package will be enacted before the end of the calendar year. As deliberations continue on what might ultimately be included in the final bill, companies should continue to carefully monitor the legislation and begin evaluating how the proposals may impact their current and future tax liabilities. Under ASC 740, changes in tax law should be reflected in the year of enactment, accordingly, if the reconciliation package is enacted prior to Dec. 31, 2021, even where many of the changes are effective for years beginning on or after Jan. 1, 2022, companies will need to evaluate the effect on their deferred tax assets and liabilities.

House Ways and Means

The reconciliation package proposed by the House Ways and Means Committee on Sept. 13, 2021, includes a variety of new spending, offset by a series of tax increases for wealthy individuals and changes to the corporate tax rate. Unless otherwise noted, the corporate changes, once enacted, would generally be effective for tax years beginning after Dec. 31, 2021. For more information on the reconciliation package proposal, please refer to alert: House Ways and Means releases reconciliation tax payfors.

One of the major changes for corporations is a return to graduated corporate tax rates with an increase in the top corporate tax rate to 26.5% for business with taxable income in excess of $5 million, 21% for income between $400,000 and $5 million and 18% for taxable income below $400,000. 

The proposal also modifies the effective dates of several previously enacted provisions, including a delay in the effective date of required research and experimentation capitalization and an acceleration of the expansion of rules under section 162(m) for highly compensated employees. Those rules would expand the current group of covered employees to include the five highest paid employees (whether they are officers or not) Under the Tax Cuts and Jobs Act, companies are required to capitalize and amortize expenditures under section 174 for tax years beginning after Dec. 31, 2021. If enacted, the reconciliation package will delay required capitalization until tax years beginning after Dec. 31, 2025. The American Rescue Plan Act of 2021, passed earlier this year, included an expansion of section 162(m) compensation limitations for highly compensated employees of public companies. The expansion was set to take effect for years beginning after Dec. 31, 2026, but under the proposed legislation would take effect for years beginning after Dec. 31, 2021.

Interest expense carryforwards under section 163(j) would be significantly revised if the proposed reconciliation package is enacted. Companies would be limited to a five-year carryforward for disallowed business interest expense, a substantial change to the currently indefinite carryforward. Interest expense would be treated as allowed for a deduction on a first-in, first-out basis. The five-year expiration period would apply for interest paid or incurred in taxable years beginning after Dec. 31, 2021. This change could have significant implications for future interest carryforwards and result in a reduced likelihood that taxpayers will be able to realize the deferred tax benefit of the carryforward. 

The proposed legislation includes a variety of changes for multinational corporations, including an increase in the BEAT rate, an acceleration of the reduction in the FDII deduction and changes to GILTI, including plans to calculate GILTI on a country-by-country basis. Additionally, the legislation would introduce a new limitation on interest deductions for multinationals under a new section 163(n). Corporations subject to the new limitation would be limited to the lesser of allowable interest under section 163(n) or section 163(j).  

The current bill in the House differs from the Administration’s Green Book released this spring, and from the Senate Finance discussion draft. As deliberations continue in the coming weeks, the question of whether the proposal will be embraced by both the House and the Senate remains to be seen. While these proposed tax changes should not be reflected in tax provisions until enacted, it is strongly recommended that taxpayers consider the impact these changes may have for their calendar year-end provision if enacted before Dec. 31, 2021. 

Updates from the Financial Accounting Standards Board

FASB issued two additional accounting standards updates during the third quarter of 2021, however, neither of these relate directly to ASC 740. FASB is still deliberating over the much-anticipated accounting standards update regarding enhanced income tax provision disclosure requirements. 

State and Local update

The Multistate Tax Commission issued guidance in August that provides specific examples of internet activities that are or are not deemed to be doing business in a state. The guidance could result in significant state tax liabilities going forward for companies that sell tangible personal property online. Once states begin adopting the guidance, companies will need to assess whether their activities are still protected under P.L. 86-272, if new state filings are required going forward or if a reserve for unrecognized tax benefits is required as a result of a decision to not file a tax return. For more information on the guidance, please refer to alert: MTC adopts new P.L. 86-272 guidance: What you need to know. 

On Sept. 14, 2021, Florida announced a reduction in the corporate income/franchise tax rate from 4.458% to 3.535% for taxable years beginning on or after Jan.1, 2021, but before Jan. 1, 2022. The tax rate is set to return to 5.5% for taxable years beginning on or after Jan. 1, 2022. The rate change is a result of previously enacted legislation that automatically reduces rates based on certain revenue triggers. 

Read more about this rate change, the guidance from the MTC and other important state and local tax law changes in the alert: State tax law changes for the third quarter of 2021.

International tax

Australia 

The Australian Commissioner of Taxation has provided guidance on the effective lives of various fixed assets acquired on or after July 1, 2021 with TR 2021/3, which can be used to calculate the depreciation of fixed assets for tax purposes. The Commissioner has reviewed the effective life of assets and introduced rates for assets in the salt harvesting and horse training industries, which weren’t previously specified. 

The Australia’s compulsory superannuation guarantee rate increased from 9.5% to 10%, effective July 1, 2021. The superannuation guarantee dictates a minimum percentage of earnings an employer needs to pay into an employee’s super fund. This will affect all entities with Australian employees earning more than $450 per month. 

Hong Kong

The Comprehensive Avoidance of Double Taxation Agreement (CDTA) with Georgia signed in October 2020 will come into force after the completion of the relevant ratification procedures on July 1, 2021. The CDTA will have an effect, in respect of Hong Kong tax, for any year of assessment beginning on or after April 1, 2022. The agreement provides for reduced withholding rates on certain income streams will allow for a credit for taxes paid in Georgia by Hong Kong companies against the tax payable in Hong Kong on the same income. Georgia companies will also be allowed a deduction from the tax payable on taxes paid in Hong Kong on the same income.

Hong Kong has now entered into CDTA with more than 40 jurisdictions. 

India

The Taxation Law Amendment Bill, 2021 received Presidential asset Aug. 13, 2021, amending the indirect transfer provision in section 9 of Income Tax Act, originally introduced in the 2012 Union Budget. The retroactive application to transfers prior to 2012 was largely contested. Under the amendment, indirect transfer provision will now apply only on a prospective basis to transfers after May 28, 2012. 

Netherlands

As part of Budget Day 2022, the Netherlands announced several legislative proposals. These proposals relate to changes in the Dutch corporate income tax rules relating to transfer pricing mismatches, corporate income tax rates and carry-forward loss relief rules. In addition, under the proposal, reverse hybrid entities would be treated as Dutch tax residents for Dutch corporate income tax and withholding tax purposes. Please note that these legislative proposals are still subject to parliamentary debate and are expected to be enacted during the fourth quarter of 2021. Taxpayers should monitor and await additional information on these anticipated changes. 

United Kingdom

Reform of hybrid and other mismatches rules

The UK introduced rules to counteract tax mismatches arising from transactions involving hybrid entities or instruments from Jan. 1, 2017, impacting many international businesses with presence in the UK, including through UK permanent establishments and through UK subsidiaries that are disregarded entities for US tax purposes.

Several changes intended to clarify the rules and mitigate disproportionate outcomes were recently enacted in Finance Act 2021. Notable amendments include clarification of the treatment of income of UK companies subject to the US GILTI regime, mitigation of compliance requirements for transactions involving diversely held funds, mitigation of counteractions for transactions involving certain tax-exempt organisations and a relaxation of the rules for offsetting certain amounts for which a deduction is available in both the UK and another jurisdiction.

In particular, it should be noted that the relaxation of the rules for offsetting such double deduction amounts can be applied retrospectively so long as an election is made, and amendments are included in a tax return by Dec. 31, 2021. Businesses with UK permanent establishments and disregarded subsidiary entities should urgently review their position with a view to benefiting from the more favourable treatment by the deadline.

Further changes to the hybrid and other mismatches rules to mitigate disproportionate outcomes have been proposed for a future finance bill and are also expected to apply retrospectively.

Uncertain tax treatments

The UK intends to implement a new requirement for large businesses (with UK turnover exceeding £200m and/or UK balance sheet total exceeding £2bn) to disclose uncertain tax positions adopted in tax returns submitted covering corporate and personal income taxes, and value added tax where the tax affected by the uncertain treatment exceeds £5m in a 12 month period. Tax treatments will be regarded as uncertain if: provision is made for them in the financial statements; the treatment conflicts with the UK tax authority’s published interpretation of the relevant law; or, it is likely that a court would determine the treatment to be incorrect. Exemptions from notification will apply in certain, limited circumstances.

The regime will apply to returns due for submission on or after April 1, 2022. This means, for example, that companies with an April 30 year end may be required to disclose positions adopted in the year to April 30, 2021, with notification due on April 30, 2022. Affected businesses should therefore review their position and implement procedures to ensure that uncertain tax treatments are identified and notified on a timely basis.