On The Horizon: Impact of tax reform – accounting for tax effects of foreign subsidiaries

Contents Current reporting issue       Impact of tax reform: accounting for tax effects of foreign subsidiaries

FASB       Proposal would expand list of interest rates permitted for hedge accounting
      Comment process for proposed taxonomy updates amended

SEC       Commission issues interpretive guidance on cybersecurity disclosures
      Interim final rule and FAQs published on investment company liquidity risk management       programs

IASB issues update on February meetings

Current reporting issue Impact of tax reform: accounting for tax effects of foreign subsidiaries The Tax Cuts and Jobs Act of 2017 (the Act) subjects unrepatriated foreign earnings to a mandatory one-time transition tax (see NDS 2018-03, Accounting and financial reporting implications of the Tax Cuts and Jobs Act of 2017).

The firm has received a number of inquiries related to the impact of the Act on an entity’s indefinite reinvestment assertion for investments in foreign subsidiaries and joint ventures (often referred to as an “APB 23 assertion”). Some of the questions include

  • Should an entity change its assertion that foreign accumulated earnings are indefinitely reinvested because those earnings may have already been subject to the one-time transition tax on accumulated earnings and profits under the Act?
  • What continuing outside-basis differences may give rise to a continuing indefinite reinvestment assertion?
  • Can an entity continue to assert that estimating the unrecognized deferred tax liability associated with taxable outside-basis differences is impracticable?

The Act does not change existing guidance related to how an entity should account for and disclose the income tax effects of its investments in certain foreign entities. The guidance in ASC 740-30-25-3, Income Taxes: Other Considerations or Special Areas, includes a presumption that all undistributed earnings of a subsidiary will be transferred to the parent entity and that an entity must have specific, definite plans in order to overcome this presumption. Further, ASC 740-30-25-17 includes guidance on the evidence that is needed for a parent entity to assert that undistributed earnings are invested indefinitely. An entity that makes an APB 23 assertion would not provide for income taxes on those undistributed earnings until (1) those earnings are either repatriated or deemed repatriated, or (2) the entity can no longer make an APB 23 assertion. When either one of those conditions exists, the entity would recognize a deferred tax liability related to the excess amount of book-over-tax basis in the investment (called the “taxable outside-basis difference”). The outside-basis difference may comprise accumulated earnings, business combination–basis differences, foreign-currency-translation adjustments, and other items.

Entities still need to apply the guidance in ASC 740-30-25-3 when accounting for the tax effects of taxable outside-basis differences related to their investments in certain foreign entities, in spite of the fact that earnings and profits (E&P), typically a significant component of the outside-basis difference, may have already been subject to tax as a result of the one-time transition tax.

Entities should not determine whether they can make an APB 23 assertion, or change their current assertion, based solely on the fact that a significant portion of the outside-basis differences may have already been taxed under the Act.

For certain entities, there may be other outside-basis differences associated with U.S. investments in foreign entities (other than E&P) resulting from business combinations, cumulative-translation adjustments, and other items. Entities still need to evaluate these other outside-basis differences and determine whether they intend to make an APB 23 assertion or whether they should provide for future income taxes on these differences. Additionally, the assertion should be evaluated on an entity-by-entity, tier-by-tier basis, resulting in an APB 23 assertion for non-U.S. investments in subsidiaries and joint ventures.

An entity will still need to evaluate its assertion related to the continued reinvestment of the E&P that was subject to the one-time transition tax. This is important because entities that are no longer asserting indefinite reinvestment may be subject to additional tax, including withholding, foreign, state, or local taxes, on these earnings if repatriated. An entity that can no longer make an APB 23 assertion should provide for these additional taxes, regardless of whether it ultimately repatriates any of the outside-basis difference.

The guidance in ASC 740-30-50-2(c) requires entities to disclose the amount of the unrecognized deferred tax liability related to outside-basis differences that are essentially permanent in duration, unless it is not practicable to determine this amount. When impracticable, an entity should consider disclosing the reason why this determination is not practicable. Entities that have made this assertion in previous periods will need to re-evaluate whether the determination is practicable in light of the significant effort made to determine E&P subject to the one-time transition tax and the generally less complex calculations required to estimate the liability. Additionally, entities should continue to disclose the other components required by ASC 740-30-50-2 for which no disclosure exception applies.

FASB Proposal would expand list of interest rates permitted for hedge accounting The Board issued a proposed ASU, Inclusion of the Overnight Index Swap (OIS) Rate Based on the Secured Overnight Financing Rate (SOFR) as a Benchmark Interest Rate for Hedge Accounting Purposes, , which would expand the list of U.S. benchmark interest rates permitted in hedge accounting.

The amendments would allow all entities that elect to apply hedge accounting under ASC 815, Derivatives and Hedging, to use the OIS rate based on SOFR as a U.S. benchmark interest rate in addition to the four eligible U.S. benchmark interest rates.

The proposal would also add the following definition of the SOFR OIS rate to the ASC Master Glossary:

The fixed rate on a U.S. dollar, constant-notional interest rate swap that has its variable-rate leg referenced to the Secured Overnight Financing Rate (SOFR) (an overnight rate) with no additional spread over SOFR on that variable-rate leg. That fixed rate is the derived rate that would result in the swap having a zero fair value at inception because the present value of fixed cash flows, based on that rate, equates to the present value of the variable cash flows.

The Board will determine the effective date of the proposed amendments, including whether the effective date should coincide with the effective date of ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, after it considers stakeholders’ feedback on the proposal.

Entities would apply the proposed amendments prospectively for qualifying new or redesignated hedging relationships entered into on or after the date of adoption.

Comments on the proposed ASU are due March 30.

Comment process for proposed taxonomy updates amended The FASB announced that stakeholders can now comment on individual proposed improvements to the 2018 GAAP Financial Reporting Taxonomy using the comment period for proposed ASUs instead of submitting cumulative comments on proposed updates during a 60-day comment period in September and October each year. As a result, proposed taxonomy improvements for proposed ASUs will have formal comment periods concurrent with the issuance of the proposed ASUs.

Therefore, comments on the proposed taxonomy improvements related to the following proposed ASUs are due on April 7 and April 22, respectively:

  • Leases (Topic 842): Targeted Improvements
  • Derivatives and Hedging (Topic 815): Inclusion of the Overnight Index Swap (OIS) Rate Based on the Secured Overnight Financing Rate (SOFR) as a Benchmark Interest Rate for Hedge Accounting Purposes

SEC Commission issues interpretive guidance on cybersecurity disclosures On February 20, the Commission approved an Interpretive Release, Commission Statement and Guidance on Public Company Cybersecurity Disclosures, to provide guidance to public operating companies when preparing disclosures about cybersecurity risks and incidents. The release does not apply to other regulated entities under the federal securities laws, such as registered investment companies, investment advisers, brokers, dealers, exchanges, and self-regulatory organizations.

The interpretive guidance reinforces and expands upon the Division of Corporation Finance (CorpFin) staff’s Disclosure Guidance, Topic No. 2: “Cybersecurity, issued in 2011. The Commission addresses two new topics in its release, stressing the importance of companies’ policies and procedures around the timely disclosure of cybersecurity risks and incidents, as well as the application of insider trading prohibitions within the cybersecurity context. More specifically, the release notes the following guidance:

  • Disclosure controls and procedures: Companies are required to establish and maintain appropriate and effective disclosure controls and procedures that enable them to accurately and timely disclose material events, including those related to cybersecurity. The guidance encourages companies to adopt comprehensive policies and procedures related to cybersecurity and to assess their compliance regularly. Also, companies should ensure that the disclosure controls and procedures are sufficient enough to escalate the relevant information to appropriate personnel when cybersecurity risks and incidents do exist.
    In addition, management should consider whether there are deficiencies in disclosure controls and procedures that would render them ineffective to the extent that cybersecurity risks or incidents pose a risk to a company’s ability to record, process, summarize, and report information that is required to be disclosed in filings.
  • Insider trading: Companies are encouraged to consider how their codes of ethics and insider trading policies take into account and prevent trading on the basis of material nonpublic information related to cybersecurity risks and incidents.
  • Regulation FD and selective disclosure: Companies should make timely disclosures of material, nonpublic information regarding cybersecurity risks and incidents, and refrain from making selective disclosures to ensure compliance with Regulation FD.

The interpretive guidance also addresses the Commission’s views and expectations regarding specific disclosure of cybersecurity risks and incidents under the federal securities laws, as follows:

  • Materiality: Companies should provide timely and ongoing disclosures that are material and useful to investors, while avoiding boilerplate disclosures.
  • Risk factors: Companies should include relevant cybersecurity risks if those risks make investments in the company’s securities speculative or risky, including risks that arise in connection with acquisitions. Companies should also consider previous or ongoing cybersecurity incidents to provide the appropriate context within the risk factor disclosure.
  • Management’s discussion and analysis of financial condition and results of operations: Companies should include relevant discussion around the array of costs associated with cybersecurity issues, including costs of ongoing efforts and other consequences of incidents, if these costs are reasonably likely to have a material effect on the company’s results of operations, liquidity, or financial condition. Companies are expected to assess the impact of any incidents on reportable segments as well.
  • Description of business: Companies should provide appropriate disclosure if cybersecurity incidents or risks materially affect a company’s products, services, relationship with customer or suppliers, or competitive conditions.
  • Legal proceedings: Companies should disclose information relating to material pending legal proceedings that relate to cybersecurity issues.
  • Financial statement disclosures: Companies should maintain financial reporting and control systems that are designed to provide information about the range and magnitude of the financial impact of a cybersecurity incident on a timely basis as the information becomes available.
  • Board risk oversight: Companies should disclose the board of director’s involvement in the oversight of the risk management process related to cybersecurity risks, to the extent they are material to a company’s business.

In a statement on February 21, SEC Chairman Jay Clayton remarked that he has asked CorpFin to continue to monitor cybersecurity disclosures as part of their selective filing reviews, and that the SEC will continue to evaluate developments and consider feedback about whether any further guidance or rules are needed.

The interpretive release became effective February 26.

Interim final rule and FAQs published on investment company liquidity risk management programs On February 22, the SEC published an Interim Final Rule, Investment Company Liquidity Risk Management Programs; Commission Guidance for In-Kind ETFs, to extend the compliance date for certain aspects of the 2016 Final Rule, Investment Company Liquidity Risk Management Programs, among other things. The compliance date for implementation of the portfolio classification and certain related requirements has been extended to June 1, 2019 for larger fund groups, and to December 1, 2019 for smaller fund groups. Other provisions of the Final Rule will go into effect as originally scheduled.

The Interim Final Rule is effective 30 days after publication in the Federal Register.

Additionally, staff in the Division of Investment Management has updated the Investment Company Liquidity Risk Management Programs FAQs to address questions with respect to the liquidity classification process.

Responses to FAQs were prepared by, and represent the views of, the SEC staff. They are not rules, regulations, or statements of the Commission. The Commission has neither approved nor disapproved these interpretive FAQs.

IASB issues update on February meetings
All decisions reached at IASB meetings are tentative and may be changed or modified at future meetings. Board decisions become final only after completion of a formal ballot to issue a new Standard or Interpretation or to publish an Exposure Draft.

The IASB has issued the February 2018 Update summarizing the tentative decisions reached during its February public meetings. The Board discussed the following topics:

  • Disclosure initiative: principles of disclosure
  • Primary financial statements
  • Dynamic risk management
  • Business combinations under common control
  • Research program
  • Insurance contracts
  • Discussion papers and exposure drafts
  • Rate-regulated activities

© 2018 Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP On the Horizon provides information and comments on current accounting and SEC reporting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in this publication. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this publication. For additional information on topics covered in this publication, contact a Grant Thornton client-service partner.