BNA's banking report notes today the Tax Executives Institute's letter to FASB to urge a one-year delay (from Dec. 15, 2006 to Dec. 15, 2007) in implementation of the new FIN 48 accounting standard for reporting uncertain tax positions. Subscribers to BNA should be able to access the story at this link. The TEI letter itself is available on the TEI website at this link.
The TEI letter describes the impetus for FIN 48 as follows.
What is now FIN 48 can be traced to a December 2003 speech at the AICPA Conference on SEC Developments, where an SEC staff member expressed concern about the application of FAS 109 to “tax advantaged transactions,” and questioned whether tax assets should be recognized when the benefit may not be realized. In a March 2004 roundtable discussion involving representatives of the Big Four accounting firms, SEC, and FASB staff, the participants discerned significant “diversity in practice” in the recognition of tax benefits associated with aggressive transactions. On this basis, the FASB concluded during its July 27, 2004, meeting that an interpretation of FAS 109 should be developed to address the treatment of uncertain tax positions.1 An exposure draft of the proposed interpretation was released for comment on July 14, 2005, and a roundtable discussion was held on October 10, 2005. Subsequently, the exposure draft was modified incrementally via re-deliberations at Board meetings from December 2005 through May 2006. FIN 48 was released July 13, 2006, and is effective for fiscal years beginning after December 15, 2006.
The new standard applies a more-likely-than-not test to determine whether tax benefits are recognized in a financial statement. The following excerpt from the FASB summary at the beginning of the FIN 48 document explains how the new standard works to recognize and derecognize tax positions.
This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accountingfor Income Taxes. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
The evaluation of a tax position in accordance with this Interpretation is a two-step
process. The first step is 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 has full knowledge of all relevant information. The second step is
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.
Differences between tax positions taken in a tax return and amounts recognized in the
financial statements will generally result in one of the following:
a. An increase in a liability for income taxes payable or a reduction of an income tax
b. A reduction in a deferred tax asset or an increase in a deferred tax liability
c. Both (a) and (b).
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. 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.
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. 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.
Obviously, this new standard has a potential to highlight to the IRS a company's aggressive tax positions that do not meet the more-likely-than-not standard. Derecognition because of failure to meet the threshold would suggest that either a more conservative analysis or some new court or regulatory authority has shed light on the aggressive nature of the transaction and revealed that it is not more likely than not to succeed. The first statement that is filed under the new standard may well also reveal a good deal about the aggressiveness of company's tax positions. This is a good development, in line with recommendations I have long made for shedding more light on corporate tax behavior (Putting SEC Heat on Tax Risk and Corporate Tax Shelters).
What are the arguments for delaying implementation? The TEI letter focuses on the hassle of getting the information in line for large companies with multijurisdictional operations who, in switching from the contingency approach to the more-likely-than-not (MLTN) approach, "must analyze their entire inventory of tax positions." It argues that companies need sufficient time to analyze the new rules and obtain relevant advice about correct reporting, and that FASB has overlooked the work that is "tantamount to, and as challenging as, re-filing an income tax return in every jurisdiction for every open tax year."
While I don't doubt that companies will have to work to satisfy the implementation deadlines, I think the TEI is overstating the burden. First, most companies' tax departments are well aware of positions that do not have a more than 50% likelihood of being sustained on the merits. Those are the cases where internal memoranda are written or external "penalty-protection" tax advice is sought and where considerable discussion takes place about the advisability of the transaction. Second, the more likely than not standard already applies to corporate tax shelters under the Internal Revenue Code and relates to disclosure requirements, so companies should already have evaluated their tax positions in light of those rules. Finally, even more telling in light of TEI's claim that companies need time to seek advice, the IRS offered a program of FIN 48 expedited review to assist companies in making their FIN 48 filings. See this legal firm's tax advisory about the pros and cons of using the IRS program. The program has had apparently had few takers. see this.