ASC 740: Q2 2023 provision considerations

ARTICLE | July 06, 2023

Authored by RSM US LLP

Executive summary: Q2 2023 provision considerations

At the midpoint of 2023, resilience, not recession is the primary takeaway for the US economy for the first half of the year. While business conditions have remained resilient, companies continue to be impacted by inflation, higher wage costs and the recent disruption among small and regional banks that play a vital role in the middle market, which may pose risks for the months to come. Read more about the state of the middle market economy with thoughts from RSM’s chief economist in About that recession: Resilience now, risks ahead. While the US economy is holding firm, corporations are still challenged with the ever-evolving tax landscape. The following update provides insight on federal, state and international tax laws and an update from the recent income tax disclosure requirements proposed by the Financial Accounting Standards Board.

Income tax provision considerations for the second quarter of 2023

Corporate Alternative Minimum Tax

The IRS and Treasury issued Notice 2023-42 on June 7, 2023 that provides relief from the additional tax under section 6655 in connection with the application of the new Corporate Alternative Minimum Tax (CAMT). Corporations continue to face significant challenges in determining their CAMT liability under section 55 given the lack of additional regulatory guidance, which moved the IRS to grant estimated tax relief to tax years beginning before Jan. 1, 2024. During the relief period, a taxpayer will not incur penalties on estimated tax installments to the extent the penalty relates to amounts attributable to CAMT. Companies are still required to pay their CAMT liability by the due date of the corporation’s tax return. Notice 2023-42 provides specific filing guidance to avoid a penalty notice.

Section 174 Required Capitalization of R&D Costs

The requirement to capitalize research and development costs under section 174 has now been in effect for some time. While the House continues to propose tax packages that could retroactively restore expensing of R&D costs, extended due dates for tax returns for 2022 will soon be here, requiring companies to file returns reflecting capitalization regardless of whether additional regulatory guidance is provided by the IRS. Read about some of the frequently asked questions around required capitalization in FAQ: Capitalization and amortization of R&D costs under new section 174 rules. M&A activity may also be impacted by section 174. Read more about some of the potential considerations in: M&A considerations resulting from the new required tax treatment of R&D Costs.

Direct Pay and Transferability of Energy Credits

On June 14, 2023, the IRS and Treasury issued proposed regulations for direct pay and transferability of energy credits. Under the proposed guidance, a direct-pay election is made on the taxpayer’s original annual tax return. The proposed regulations provide guidance for transferrable credits on how to make a valid transfer between taxpayers and specifies that credits that have been transferred under section 6418 are ineligible for direct pay and cannot be transferred more than once. Under ASC 740, refundable credits where a taxpayer can use the credits without regard to taxable income, such as credits eligible for direct pay, generally fall outside the scope of ASC 740. The FASB staff indicated in a recent technical inquiry that transferable credits fall within the scope of ASC 740, however there continues to be diversity in practice regarding accounting for nonrefundable transferrable credits. Read more about the recent proposed regulations on the energy credits in RSM’s article: IRS and Treasury release guidance on the monetizing energy credits.

Updates from the Financial Accounting Standards Board (FASB)

The FASB did not issue any additional accounting standard updates (ASUs) during the second quarter of 2023, with just two accounting standard updates issued year-to-date.

The comment period on the proposed ASU regarding additional income tax disclosures ended on May 30, 2023. Read more about the proposed modifications to income tax disclosures in our article: ASC 740: FASB proposes new income tax disclosures. The feedback provided to the FASB via comment letters has highlighted significant concerns from preparers of financial statements about the additional requirements, noting that there may be significant efforts required to comply with the requirements. The FASB has been holding meetings with various stakeholders, including a recent meeting with the Private Company Council (PCC) on June 19, 2023 as elements of the proposed disclosures are also intended to apply to private companies. The PCC generally agreed with the proposed update to income tax disclosures, however, there was debate on the proposed 5% threshold for disaggregation of cash taxes paid by jurisdiction, qualitative vs. quantitative disclosure requirements by jurisdiction, and the time frame for private companies to implement the proposed ASU. These concerns largely echo those highlighted in comment letters. FASB is still in the process of gathering information from the comment letters and will hold another meeting later this summer to share their analysis and next steps with the intention of releasing a final ASU in the fourth quarter of 2023.

State tax

There were several significant state tax law changes in the second quarter of 2023, including changes to tax rates, apportionment methodologies and updates to conformity with the Internal Revenue Code. Read more about state and local tax considerations in our companion alert: State tax law changes for the second quarter 2023.

International tax

Pillar two

As of June 30, 2023, approximately 20 countries have come forward with proposed legislative changes to adopt the objectives of Pillar Two into their domestic tax laws. Although the agreement on the global minimum tax mostly requires conformity to the OECD model rules, those rules also leave room for variations in implementation. Ultimately, companies will need to evaluate the laws that are enacted for impacts on their income tax provision and reflect those impacts in the period in which the legislation is enacted.

Australia

The Australian Taxation Office has released a ruling on when certain labor costs incurred in the creation or construction of capital assets are required to be capitalized. The ATO maintains its view that certain labor costs, particularly for constructing or creating capital assets, are considered capital in nature and cannot be immediately deducted.

Australia has also released draft legislation that may be relevant to multinational entities, including certain items related to Pillar Two. The following items are proposed and may impact future quarters:

Draft legislation has been released to reform Australia’s Thin Capitalisation Rules. Broadly, these rules will require taxpayers to calculate their entitlement to tax deductions based on an earnings-approach, rather than the current asset approach. The new rules are expected to apply from July 1, 2023.

Draft legislation has been released seeking to deny a tax deduction for Significant Global Entity taxpayers who make payments for intangible to a low or no tax jurisdiction. The proposed definition of a payment for an intangible is broad, intending to catch as many transactions as possible. A low or no tax jurisdiction is a jurisdiction where the lowest rate of corporate income tax under that country’s laws is 15% or less. The relevant Government Minister also has the power to determine that a country is a low or no tax jurisdiction.

The Australian Government has announced its proposed start dates for Pillar Two, with the Income Inclusion Rule and the 15% domestic minimum tax proposed to apply to income years commencing on or after Jan. 1, 2024, and the Undertaxed Profits Rule applying from Jan. 1, 2025.

Brazil

Brazil published Law No. 14,596/23 which changes the Brazilian transfer pricing legislation to align with OECD guidelines. Regulations are expected to be issued in August and the new rules will become mandatory in 2024, with companies have the option to apply the rules in 2023. One goal of the new transfer pricing legislation was to comply with rules for the recognition of foreign tax credits in the United States, since the disparity in the transfer pricing legislation of the two countries represented an obstacle.

Germany

On March 20, 2023, Germany presented the first draft of a law to implement the Pillar Two, Global Minimum Tax Directive in German tax law. The planned regulations are to apply as early as 2024. In June 2023, the German Bundestag and Bundesrat passed the Act on the Implementation of Directive (EU) 2021/2101 with regard to the Disclosure of Income Tax Information, the so-called implementation of a public Country-by-Country Reporting (public CbCR) into national law. With the implementation of the requirements of the EU Directive, multinational companies and groups with consolidated sales revenue in excess of €750M that are either based in Germany or have subsidiaries/branches of a certain size in Germany, will have to disclose certain income tax information.

Netherlands

As of Jan. 1, 2023, a new tax law is available that will allow for a one-off accelerated depreciation of 50% to certain business assets that are purchased in 2023 and placed in service before Jan. 1, 2026. After the one-off accelerated depreciation of 50% of the purchase value, the regular depreciation term for Dutch corporate tax purposes should apply to the remainder of the fiscal book value.

For the determination if a business asset is a designated business asset, the following assets are not eligible business assets:

• Buildings.
• Ships.
• Airplanes.
• Motorcycles and mopeds.
• Automobiles that are not fully electric and not used for business purposes.
• Intangible assets.
• Business assets that are mainly made available through leases.
• Business assets on which already are subject to accelerated depreciation based on a different rule.

The Dutch Ministry of Finance released a “Spring Note” On April 28, 2023, clarifying the tax treatment of these assets.

Spain

At the end of 2022, Spain published several tax laws to be applied in the fiscal year 2023 or, in some cases, in the fiscal year 2022:

• For tax periods beginning on or after Jan. 1, 2023, a reduced tax rate of 23% is introduced for entities with a net turnover of less than €1M in the immediately preceding tax period if they are not considered as an asset-holding entity.
• For tax periods beginning on or after Jan. 1, 2023, the taxable income of tax groups will be determined considering the positive tax income plus 50% of the negative tax losses of each of the entities of the tax group. Unused tax losses will be recovered over ten years.
• The deduction limits for investments in Spanish and foreign film productions and audio-visual series are increased from 10 to 20 million euros. In the case of TV series, the deduction will be determined per episode and the limit will be €10M for each episode produced.
• The Start-up Law, in force since Dec. 23, 2022, establishes a taxation at 15% during the first fiscal year in which the start-up company (in the terms defined in the law) obtains a positive taxable base and in the following three years. It also establishes that there is no obligation to make instalment payments during the first two years with a positive taxable income.

United Kingdom

Finance (No. 2) Bill 2022-23 (the Bill) passed its third reading in the House of Commons on June 20, 2023, meaning that it is now ‘substantively enacted’ for the purposes of certain accounting frameworks including UK and international accounting standards. The Bill will be enacted into UK law over the coming weeks, after it has passed through the House of Lords and received royal assent. The impact of the Bill should be reflected in income tax provisions for entities reporting under US accounting standards where the relevant period ends after the Bill has received royal assent. Relevant changes introduced by the Bill include:

• the introduction of the OECD’s ‘pillar two’ global minimum tax rate rules in the UK (including an associated domestic top-up tax), with effect for periods beginning on or after Dec. 31, 2023;
• changes to the UK’s enhanced tax reliefs for expenditure by companies on research and development, most of which take effect for accounting periods beginning on or after April 1, 2023; and
• the introduction of temporary ‘full expensing’ in respect of certain capital expenditure on plant and machinery by companies incurred between April 1, 2023 and March 31, 2026. 

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This article was written by Al Cappelloni, Darian A. Harnish, Rocky Stout and originally appeared on 2023-07-06.
2022 RSM US LLP. All rights reserved.
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