FEI Detailed Summary of FASB Issues FIN 48 on Uncertainty in Income Taxes
July 13, 2006
On July 13, 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, (“FIN 48"), entitled, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109". Note: FASB Statement 109 (FAS 109) is "Accounting for Income Taxes." Concurrently, FASB issued a FASB staff position (FSP) relating to income taxes, (FSP) No. FAS 13-2, "Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction."
FASB’s summary of FIN 48 notes that differences between tax positions recognized in the financial statements and tax positions taken in the tax return (referred to commonly as “book” vs. “tax”) will generally result in: (a) an increase in a liability for income taxes payable or a reduction of an income tax refund receivable, (b) a reduction in a deferred tax asset or an increase in a deferred tax liability, or (c) both of the above.
FASB issued FIN 48 to address concerns about a diversity in practice in financial reporting relating to tax positions with uncertainty. “When a position is taken in a tax return that reduces the amount of income taxes paid to a taxing authority, the enterprise realizes an immediate economic benefit,” states FASB’s summary. “However,” continues FASB’s summary, “considerable time can elapse before the acceptability of that tax position is determined.”
To address concerns about relevance and comparability in financial reporting, FIN 48 “requires the affirmative evaluation that it is more likely than not, based on the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns.”
Further, FASB notes, “if a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.” Additionally, FIN 48 establishes guidance for “derecognition” of previously recognized deferred tax items, and sets forth disclosure requirements.
FIN 48 is the final Interpretation issued by FASB following FASB’s consideration of comment letters received on its earlier Exposure Draft issued under a slightly different name, “Accounting for Uncertain Tax Positions.” The importance of this name change reflects FASB’s position on the scope of the standard, as explained in paragraph B12 of the basis for conclusions section of FIN 48:
“In its redeliberations, the Board considered whether to apply the provisions of this Interpretation to all income tax positions or some subset of income tax positions, specifically, uncertain tax positions. The Board concluded that limiting the application to only uncertain tax positions, or tax positions with specified attributes, would create a rules-based standard that would result in inconsistent application and would add complexity to the accounting guidance for income taxes. The Board does not anticipate that this Interpretation will have a significant effect on how enterprises account for tax positions that are routine business transactions that are clearly more likely than not of being sustained at their full amounts upon examination (see the example in paragraphs A19 and A20). Accordingly, the Board decided that this Interpretation should broadly apply to all tax positions.” (highlighting added)
Key points noted in FASB’s summary of FIN 48 (or from FIN 48 as noted below):
· Effective date: fiscal years beginning after December 15, 2006. This effective date applies to all enterprises, public and nonpublic.
- Earlier application is encouraged “if the enterprise has not yet issued financial statements, including interim financial statements, in the period this Interpretation is adopted.”
· Transition: FIN 48, paragraph 23 states:
o “The cumulative effect of applying the provisions of this Interpretation shall be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that fiscal year, presented separately.
o The cumulative-effect adjustment does not include items that would not be recognized in earnings, such as the effect of adopting this Interpretation on tax positions related to business combinations.
o The amount of that cumulative-effect adjustment is the difference between the net amount of assets and liabilities recognized in the statement of financial position prior to the application of this Interpretation and the net amount of assets and liabilities recognized as a result of applying the provisions of this Interpretation.”
o Further, paragraph 24 of FIN 48 states, “An enterprise shall disclose the cumulative effect of the change on retained earnings in the statement of financial position as of the date of adoption. This disclosure is required only in the year of adoption.”
· Recognition and measurement in two-step process:
o "More likely than not" criteria for recognition - "The enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the enterprise should presume that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information."
Ø NOTE: Paragraph 10 of FIN 48 states, “If the more-likely-than-not recognition threshold is not met in the period for which a tax position is taken or expected to be taken, an enterprise shall recognize the benefit of the tax position in the first interim period [emphasis added] that meets any one of the following three conditions:
a. The more-likely-than-not recognition threshold is met by the reporting date.
b. The tax matter is ultimately settled through negotiation or litigation.
c. The statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired.”
- "Greater than 50% likely" criteria for measurement: "A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement."
o Current liabilities: An enterprise that presents a classified statement of financial position should classify a liability for unrecognized tax benefits as current to the extent that the enterprise anticipates making a payment within one year or the operating cycle, if longer.
o Deferred tax liability: An income tax liability should not be classified as a deferred tax liability unless it results from a taxable temporary difference (that is, a difference between the tax basis of an asset or a liability as calculated using this Interpretation and its reported amount in the statement of financial position). This Interpretation does not change the classification requirements for deferred taxes.”
o Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met.
o Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. Use of a valuation allowance as described in Statement 109 is not an appropriate substitute for the derecognition of a tax position. The requirement to assess the need for a valuation allowance for deferred tax assets based on the sufficiency of future taxable income is unchanged by this Interpretation.
· Interim reporting: Paragraph 4 of FIN 48 notes:
“The term tax position as used in this Interpretation refers to a position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods.”
· See also the reference to “first interim period” under “recognition and measurement,” above (citing paragraph 10 of FIN 48)
· Definition of “tax position:” Paragraph 4 of FIN 48 states:
“A tax position can result in a permanent reduction of income taxes payable, a deferral of income taxes otherwise currently payable to future years, or a change in the expected realizability of deferred tax assets. The term tax position also encompasses, but is not limited to:
a. A decision not to file a tax return
b. An allocation or a shift of income between jurisdictions
c. The characterization of income or a decision to exclude reporting taxable income in a tax return
d. A decision to classify a transaction, entity, or other position in a tax return as tax exempt.”
· Changes in judgment:
o “A change in judgment that results in subsequent recognition, derecognition, or change in measurement of a tax position taken in a prior annual period (including any related interest and penalties) shall be recognized as a discrete item in the period in which the change occurs. The provisions of paragraphs 35 and 38 in Statement 109 that pertain to intraperiod tax allocation are not changed by this Interpretation.” (Para. 13, FIN 48)
o “A change in judgment that results in subsequent recognition, derecognition, or change in measurement of a tax position taken in a prior interim period within the same fiscal year is an integral part of an annual period and, consequently, shall be reflected pursuant to the provisions of paragraph 19 of APB Opinion No. 28, Interim Financial Reporting, and FASB Interpretation No. 18, Accounting for Income Taxes in Interim Periods.” (Para. 14, FIN 48)
· Interest and Penalties:
o “When the tax law requires interest to be paid on an underpayment of income taxes, an enterprise shall begin recognizing interest expense in the first period the interest would begin accruing according to the provisions of the relevant tax law. The amount of interest expense to be recognized shall be computed by applying the applicable statutory rate of interest to the difference between the tax position recognized in accordance with this Interpretation and the amount previously taken or expected to be taken in a tax return.” (Para. 15, FIN 48)
o “If a tax position does not meet the minimum statutory threshold to avoid payment of penalties (considering the factors in paragraph 7 of this Interpretation), an enterprise shall recognize an expense for the amount of the statutory penalty in the period in which the enterprise claims or expects to claim the position in the tax return. If penalties were not recognized when the position was initially taken, the expense shall be recognized in the period in which the enterprise’s judgment about meeting the minimum statutory threshold changes. Previously recognized interest and penalties associated with tax positions that subsequently meet one of the conditions in paragraph 10 of this Interpretation shall be derecognized in the period that condition is met.” (Para. 16, FIN 48)
· Disclosures: The following disclosures are required by FIN 48 (paragraphs 20, 21 of FIN 48):
Ø The entity’s policy on classification of interest and penalties in accordance with paragraph 19 of FIN 48 is to be disclosed in the footnotes to the financial statements.
Ø The following must be disclosed at the end of each annual reporting period presented:
a. A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, which shall include at a minimum:
(1) The gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during a prior period
(2) The gross amounts of increases and decreases in unrecognized tax benefits as a result of tax positions taken during the current period
(3) The amounts of decreases in the unrecognized tax benefits relating to settlements with taxing authorities
(4) Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations
b. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate
c. The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position
d. For positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date:
(1) The nature of the uncertainty
(2) The nature of the event that could occur in the next 12 months that would cause the change
(3) An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made
e. A description of tax years that remain subject to examination by major tax jurisdictions.
FASB Interpretation No. 48, “Accounting for Uncertainty in Tax Positions - an Amendment of FAS 109” (FIN 48)
· FASB Press Release
· FASB FIN 48:
· FASB Summary
FSP No. 13-2, “, "Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction."
See also other summaries prepared by accounting firms, available on this FEI webpage.
Updated July 17, 2006 by Edith Orenstein (eorenstein@FinancialExecutives.org), Director, Technical Policy Analysis, Financial Executives International (FEI). This summary does not represent FEI opinion, unless specifically noted above.