Companies with unrecognized tax benefits have been without explicit guidance on how to properly report such items on their financial statements in some circumstances. The existing guidance on how companies should account for uncertainty in income taxes doesn’t specifically address how a company should present unrecognized tax benefits on their financial statements when they also have a net operating loss (NOL), similar tax loss, or tax credit to carry forward. The lack of guidance has resulted in different treatments by different companies.
The recently released Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, clarifies the presentation of current and deferred income taxes on balance sheets for both public and private companies.
The need for guidance
An "unrecognized tax benefit" is the difference between a tax position that a company takes, or expects to take, on its income tax return and the benefit it recognizes on its financial statements. The difference stems from the fact that the company is taking an uncertain tax position that hasn’t yet been resolved through an audit or litigation.
In the past, FASB hasn’t provided explicit guidance on how a company should present an unrecognized tax benefit on its financial statements when an NOL carryforward, similar tax loss, or tax credit carryforward exists. As a result, FASB says, "a diversity in practice" in the presentation has occurred.
Some companies apply the "gross presentation" approach. These companies report the unrecognized tax benefit as a liability — unless the benefit is directly associated with a tax position taken in a tax year that results in, or resulted in, the recognition of an NOL or tax credit carryforward for that year and the carryforward hasn’t been used.
Other companies have taken a "net presentation" approach. They report unrecognized tax benefits for an NOL or tax credit carryforward as a reduction of a deferred tax asset in certain circumstances.
The new standard
The new guidance is intended to eliminate the diversity in practice and increase the comparability of financial statements among companies. Under ASU 2013-11, therefore, companies generally must present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, for an NOL carryforward, similar tax loss, or tax credit carryforward using the "net presentation" approach as a reduction of a deferred tax asset.
Exceptions to the net presentation approach exist. According to FASB, the company should present the unrecognized tax benefit using the "gross presentation" approach as a liability and not as a reduction of a deferred tax asset if:
- The carryforward or tax loss isn’t available on the financial statement date to settle any additional income tax liability that would result from the disallowance of the tax position under the applicable tax law, or
- The applicable tax law doesn’t require the company to use — and the company doesn’t intend to use — the carryforward or tax loss to settle additional income taxes resulting from the disallowance of the tax position.
The determination of whether a carryforward or tax loss is "available" is based on the unrecognized tax benefit and deferred tax asset (that is, the carryforward or tax loss) that exist at the financial statement date. The assessment should presume that the tax position will be disallowed on the financial statement date.
For example, a company shouldn’t evaluate whether the carryforward or tax loss expires before the statute of limitations on the tax position or whether the carryforward or a tax loss can be used prior to the unrecognized tax benefit being settled. (But the company should consider limitations on the use of deferred tax assets that exist as of the financial statement date, such as limitations on the use of an NOL because of an alternative minimum taxation system.)
A company that uses a classified statement of financial position must classify an unrecognized tax benefit presented as a liability as a current liability — or reduce the amount of an NOL carryforward or amount refundable — if it expects the payment or receipt of cash within one year or, if longer, the operating cycle.
ASU 2013-11 doesn’t impose any new recurring disclosure requirements because it doesn’t affect the recognition or measurement of uncertain tax positions. It’s believed that the tabular reconciliation of the gross amount of unrecognized tax benefits currently required will provide public company financial statement users with the information they need about the unrecognized tax benefits offset against NOL carryforwards, similar tax losses, or tax credit carryforwards.
FASB believes that the rules outlined in ASU 2013-11 will better reflect the way a company would actually settle any additional income tax liability due to the disallowance of a tax position on the financial statement date when NOL carryforwards, similar tax losses, or tax credit carryforwards exist.
What it means for your company
Once the new rules take effect, you’ll need to focus on the applicable tax law regarding the character of unrecognized tax benefits and their carryforward attributes. You can only "net" unrecognized tax benefits against deferred income taxes related to carryforwards or tax losses if you would use the carryforward or loss to offset the taxable income or tax generated on the settlement of the unrecognized tax benefit.
The applicable law may have restrictions on the use of NOLs or other carryforwards. For example, it might limit the use of a carryforward to a specified percentage of current-year taxable income.
Prepare for effective dates
For public companies, ASU 2013-11 provisions are effective for fiscal years, and interim periods within those years, beginning after Dec. 15, 2013. For private companies, the new rules are effective for fiscal years, and interim periods within those years, beginning after Dec. 15, 2014.
Apply the rules prospectively to all unrecognized tax benefits that exist at the effective date. Early adoption and retrospective application are both permitted.
If your company has unrecognized tax benefits on its financial statements when it also has an NOL, similar tax loss, or tax credit to carry forward, the guidance from FASB ASU 2013-11 will clarify the appropriate accounting treatment under accounting principles generally accepted in the United States of America (GAAP).