KPMG highlights key challenges that companies are facing with the enactment of US tax reform.
From the IFRS Institute - February 28, 2018
Due to all of the moving parts of tax reform and the speed at which it was passed, the enactment of US tax reform has many companies scrambling to analyze the impact on their financial reporting. Determining historical earnings and profits for subsidiaries outside of the US and modeling future tax earnings is not an easy task, but it remains key to properly estimating the financial reporting effects. At the same time, this provides an opportunity for companies to rethink their operations, cash flow streams and financial structures to shape the company’s tax structure for the future.
Global companies experience changes in tax laws on a regular basis. However, the impact of H.R. 1, originally known as the Tax Cuts and Jobs Act, on companies that operate in the United States is a once-in-a-generation event from a tax perspective and should not be underestimated.
Many IFRS preparers, particularly US subsidiaries of a foreign parent, have turned their immediate attention to their December 31, 2017 financial reporting. One of the most pressing consequences of tax reform is the accounting for the effects of the change in corporate rate resulting in remeasurement of their deferred tax positions, as of the enactment date of the tax reform: December 22, 2017.
Global companies are also starting to take a fresh look at their organizational structures and operations. In particular, the tax reform includes many international provisions that create new tax consequences for income earned in subsidiaries outside of the United States. The base erosion anti-abuse tax (BEAT), for example, will partially disallow deductions for certain related party transactions. The annual interest and executive compensation deductions will also be limited.
Not only are companies analyzing whether they should reorganize globally, companies are also looking at various ways to recapitalize through debt and equity transactions, manage their global cash flows, evaluate tax status in non-US jurisdictions, and adjust their global supply chains.
But why is implementation so challenging? KPMG professionals share their insights and steps that companies are currently taking to respond to the situation.
Reflecting the effects of tax reform in the financial statements
The tax reform triggered immediate accounting and financial reporting effects on its enactment. The accounting community rapidly embraced the challenge but issues remain open.
One particular challenge for IFRS preparers relates to backwards-tracing, which means recording the change in deferred taxes consistently with the items they relate to – in profit or loss, other comprehensive income or equity. While the backwards-tracing requirement is not new under IFRS, the supporting documentation from when the initial entries were recorded may take time to analyze. Additionally, companies are performing robust scheduling exercises, to understand their overall deferred tax position, including realizability of deferred tax assets.
The changes to net operating loss (NOL) utilization including the carryforward period, executive compensation limitation, as well as international provisions like global intangible low-taxed income tax (GILTI) and BEAT have become particularly challenging for preparers. Larry Lemoine, KPMG Partner – US Tax Paris, fields questions from preparers from tracking and reporting their NOL baskets pre- and post-enactment date as well as how the executive compensation arrangements may change how companies issue and account for share-based payment awards.
Larry observed that “companies are asking several questions on the 2018 effective tax rate and how that will look given all the moving parts. It’s challenging for preparers to make estimates when the assessment and modeling is not yet completed.”
IFRS preparers can be affected by the deemed mandatory repatriation portion of tax reform. In particular, we believe IFRS preparers in the United States that have downstream subsidiaries in foreign jurisdictions will be impacted. In such situations, one of the biggest challenges in the near term is the deemed mandatory repatriation and the calculation of the related liability. The deemed mandatory repatriation liability is a tax on company’s foreign earnings accumulated under legacy US tax laws. For companies with large operations in their non-US subsidiaries, this transition tax can be very significant.
“Many companies are getting their arms around their historical earnings and profits (E&P)” said Greg Bocchino, KPMG Partner – Business Tax Services. “The struggle with determining the E&P is having the documentation necessary to support your liability” commented Jenna Summer, Managing Director – KPMG Washington National Tax. “Many companies didn’t recognize deferred taxes on temporary differences related to foreign subsidiaries because they historically concluded these differences were not probable to reverse in the foreseeable future. In those situations, documentation may prove difficult given the number of years that have passed. Further, global companies may find it challenging to understand the complexities around what goes into their E&P in each jurisdiction.”
Stakes are high because an inaccurate estimate may prevent the timely payment of installments due and accelerate payment of the entire tax liability.
In this context, IFRS preparers will make their best estimates in recording the tax effects of tax reform and should be thinking about robust disclosure that is fully transparent to users. This includes clearly describing the provisions of tax reform impacting the financial statements, the basis for the estimates made and the sources of uncertainty.
Operational challenges – and opportunities
Other high-impact provisions that global companies are analyzing are the BEAT and the interest deduction cap. Because those measures limit deductions on related party payments, especially those made from the United States to their foreign operations, companies are trying to determine how they can best restructure organizationally.
Options include: changing where their operations are located, rethinking their financing structure and resulting intercompany debt agreements, or changing the manner in which they do business.
Jonathan Keller, KPMG Principal, International Tax, discussed how understanding the impact of the BEAT tax is not as simple as just understanding the mechanics of the tax itself. “In order for tax departments to appropriately do their tax planning, they need to build a flexible, interactive model that shows how the BEAT, GILTI, 163j interest deduction, as well as other provisions, interact. That is just the first stage to tax planning. Modelling requires innovation and skilled resources to know how to build the model in order to achieve meaningful results. Because of this, companies are looking to upgrade their internal skills and lean on their advisors.”
It is not just the BEAT, however, that may strain resources. Jenna observed, “the impact of tax reform is and will continue to be operationally challenging for companies. Resources are tight and although many times the tax groups are driving the impact assessment, they need support from treasury, legal, financial reporting, and their advisors. Once the modelling is done, there may be a downstream effect to resources in the future that companies haven’t had a chance to contemplate yet.”
The provisions of tax reform can be particularly complex to analyze and implement from a tax and financial reporting perspective, especially for global companies. As preparers continue to analyze the effects of US tax reform on their overall tax model, the resulting effect to operations and financial reporting will swiftly follow. Keeping apprised of implementation issues and challenges is the first step to effective financial reporting. Start the conversation now with your KPMG representatives.
Some of the key provisions of US tax reform include:
|Corporate rate||Enacted and substantively enacted on December 22, 2017, the tax reform reduces the corporate tax rate to 21%, effective January 1, 2018.|
|Tax on deemed mandatory repatriation||A company’s foreign earnings accumulated under legacy US tax laws are deemed repatriated. The tax on those deemed repatriated earnings is no longer indefinitely deferred, but may be paid over eight years.|
|GILTI||The tax reform introduces a new tax on global intangible low-taxed income (GILTI). GILTI is based on a US shareholder’s controlled foreign corporations’ (CFCs’) net income in excess of a return on tangible business property.|
|BEAT||The tax reform creates a base erosion anti-abuse tax (BEAT), which partially disallows deductions for certain related party transactions. BEAT will function like a minimum tax.|
|FDII||The law includes a deduction for a proportion of ‘foreign-derived intangible income’ to provide a lower effective tax rate on excess returns earned directly by a US corporation from foreign sales (including licenses and leases) or services.|
|Interest expense limitations||The tax reform includes interest expense provisions that limit annual interest deductions and the use of disallowed interest carryforwards.|
|Cost recovery provisions||There are cost recovery provisions included in the tax reform that accelerate depreciation on certain business assets.|
|AMT||The alternative minimum tax (AMT) tax regime is repealed under the tax reform. Existing AMT credit carryforwards are generally refundable by 2021.|
Other articles in this edition of IFRS Perspectives:
To understand the Act itself, KPMG Report on New Tax Law – Analysis and observations
KPMG’s IFRS Q&As, Tax reform in the United States – IFRS
KPMG’s US GAAP Q&As, Tax reform – Supplement to KPMG’s Handbook, Accounting for Income Taxes
KPMG’s dedicated website on US tax reform: kpmg.com/us/tax-reform
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