9 minute read 7 Apr 2020
Businessman video conferencing desk

Income tax provision and COVID-19: 10 better questions CFOs should be asking

By

David Northcut

EY Global Director – Tax Accounting and Risk Advisory Services

35 years of experience at EY focusing on Tax.

9 minute read 7 Apr 2020
Related topics Tax Tax accounting COVID-19

From projecting effective tax rates to possible expanded disclosures, tax accounting professionals are adjusting to the economic impact.

The COVID-19 virus pandemic has brought an abrupt end to an historic global economic expansion and now businesses are trying to understand the economic impact of closed borders, social distancing and economic stimulus programs being adopted by governments to blunt the effects.

Tax accountants in particular will be busy making adjustments to the tax provisions of businesses as these impacts are more fully understood. Here are 10 questions every CFO and tax accounting professional should be asking about what they should be doing now, next and beyond. We've divided them into three categories:

Managing the logistics of remote working

Managing the tax provision during the crisis

Managing tax provisions in a changed environment

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Chapter 1

Managing the logistics of remote working

Regardless of where the work is being done, tax professionals must meet deadlines and standards.

Like every other business, many tax executives are working from home. And, while this isn’t exactly business as normal, there is still normal business to conduct. Chiefly, deadlines must be met and internal controls must be maintained.

1. Do we have the capacity and infrastructure to timely complete our interim and/or annual provision calculations given the remote working requirements?   

Many companies are facing logistical, IT and personnel challenges in adjusting to evolving workplace restrictions.  Many remote workers may not have access to critical accounting and tax records necessary to prepare the income tax provision calculations.  IT limitations may also restrict or delay critical activities necessary for remote preparation and review procedures.  Companies should critically review their capabilities to meet their various filing requirements, including an assessment of the people, process and technology implications of an extended workplace restriction.

Some regulatory agencies have granted extensions of time for certain public filings when companies are unable to meet a filing deadline due to circumstances related to COVID-19.  Companies should monitor the various regulatory agencies to whom they report to assess whether similar extensions will be granted.

2. Does our existing framework of internal controls related to our income tax provision address additional risks associated with COVID-19?

Many income tax-related internal control deficiencies can be attributed to material non-routine transactions with a high degree of complexity.  Similar challenges exist when historical controls are applied in the midst of significant changes in the underlying processes. These challenges are further complicated when teams are working and meeting virtually.

The temporary shift to remote work locations could result in the need for new or different process documentation and controls depending on the nature and extent of the changes in the underlying tax processes, judgments, estimates and work environments. In addition to changes driven by remote work activities, companies should also anticipate circumstances where historical expectations, metrics and correlations no longer provide appropriate information used in the execution of internal controls. Companies should carefully evaluate their existing tax provision control framework to consider the impact of both the economic and process changes related to COVID-19.

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Chapter 2

Managing the tax provision during the crisis

The pandemic could very well bring material changes in deferred tax positions.

Beyond adjusting to new remote working conditions, tax professionals and CFOs must deal with the immediate input of the economic consequences of the COVID-19 pandemic. This means reporting any material changes in deferred tax positions, for example, as well as knowing if there are any new disclosures to be made.

3. Do we have material changes in our overall deferred tax position that require us to make new or different assessments of the recognition or realization of deferred tax assets?

Companies with historically consistent profitable operations may not have been required to perform extensive analysis related to the recognition or realizability of deferred tax assets. Given the current global economic environment, many companies will be faced with a substantial increase in the amount of deferred tax assets associated with losses from operations during the COVID-19 downturn. The initial assessment of the deferred tax accounting for these losses may be a complex analysis involving significant judgement and substantial additional procedures.

Companies should review their historic processes related to the recognition or realization of deferred tax assets to address additional procedures that may be required related to any significant deferred tax assets generated during the COVID-19 downturn.

4. Will the financial statement impact of COVID-19 cause us to be in a cumulative book loss or otherwise materially alter our historic forecasts used to support our deferred tax assets?

Companies that rely on projections of future income to support the recognition or realization of deferred tax assets that arose during recent economic downturns may face deferred tax charges as a result of adjusting existing deferred tax assets or increasing a valuation allowance (depending on the accounting framework). Projections of future income should be updated to reflect the revised economic outlook. Such projections should be aligned with other projections used elsewhere in the financial statements.

Significant impairments or operating losses may reduce or eliminate the ability to rely on future projections of income. Companies that expect to be in a cumulative loss position based on revised forecasts that reflect the effects of COVID-19 should consider this negative evidence about the realizability of deferred tax assets. Previously recognized deferred tax assets may need to be re-evaluated if underlying projections can no longer be considered or if there are material changes to the historic projections. Companies relying on projections of future income should anticipate the additional time and complexity associated with updating projections in the midst of an uncertain economic environment.

5. What are the tax provision implications associated with an expected financial statement impairment charge? 

A financial statement impairment can have a wide range of impacts on the tax provision depending on the nature of the asset being impaired (e.g. goodwill, tangible property and intangible property), the company’s historic accounting policies, and the overall deferred tax position. Given the diversity of the potential tax accounting impacts, each asset impairment will require an independent assessment to determine the requisite tax provision impact. Companies should review any historical tax accounting policies and anticipate incremental time to address the complex tax accounting implications associated with asset impairments.

6. Are there specific tax provision implications associated with the recent decline in our stock price? 

Companies with significant stock-based compensation plans may experience deferred tax charges following the recent market declines. The nature and extent of these potential charges will vary based on the underlying accounting framework as well as the specific profile of the individual stock compensation plan.

Calculation of deferred taxes related to stock-based compensation plans can be quite complex and require significant inputs. The remeasurement and/or write-off of historic deferred tax assets may have immediate consequences in the interim financial statements. Companies with significant stock-based compensation-related deferred tax assets should anticipate incremental complexities as part of their interim and annual review of the tax accounts.

7. Are there specific income tax disclosures related to COVID-19 that we should consider?

The required disclosures related to income taxes have not necessarily changed; however, the application of existing disclosure requirements in a post-COVID-19 environment may result in significant additional disclosures. Disclosures related to overall financial condition, capital resources, cash flow, liquidity, asset recovery or uncertainty around accounting estimates may have elements that are related to income tax positions. In addition, changes in the tax profile may require specific disclosures related to deferred tax asset recognition/realization, determination of interim tax provisions, and repatriation of unremitted earnings. Companies should carefully consider the COVID-19 related impact on their tax profile as part of the broader disclosure requirements.

8. Are we able to make a reliable estimate(s) of our effective tax rate(s) based on projected 2020 income? 

The interim tax provision is generally measured based on one or more estimated annual tax rates for the year, depending on the accounting framework. The forecasted income for the year is one of the critical inputs into the calculation may present unique challenges in preparing the forecast of income for 2020 and the related tax rate calculation.

Additional complexities may arise when the accounting framework requires estimated tax rate by jurisdiction, particularly when the group includes subsidiaries with losses for which the benefit cannot be recognized. Many of these challenges will be more pronounced for the quarter ending March 31, while others will continue throughout the year. Different or separate calculations may be necessary for each jurisdiction if a company is unable to make a reliable forecast of either its income for the year or its estimated annual tax rate.

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Chapter 3

Managing tax provisions in a changed environment

The only certainty is that the situation – and the right treatments to address it – will change.

Eventually, the COVID-19 crisis will subside, but the economic effects will linger. From making realistic estimates of effective tax rates on projected 2020 income to understanding the tax relief offered as part of government stimulus plans, tax executives will need to be asking critical questions about the future.

9. We are considering bringing cash back from some of our overseas operations. When would a change in our plans be recognized in our income tax provision?

Historically, many companies have taken advantage of special exceptions in the accounting literature to avoid recording deferred taxes on un-repatriated earnings from foreign subsidiaries.  The specific requirements for such treatment vary based on the underlying accounting framework but generally require an evaluation of the company’s expectation of future repatriation rather than looking to the specific date of an actual repatriation.

Companies that are considering changes in their repatriation strategy should carefully review the underlying accounting framework to assess whether the revised strategy will result in a current change in the deferred tax accounting. These calculations represent some of the most complex tax accounting scenarios and may require significant additional time and expertise to complete.

 10. Are the various governmental tax stimulus/incentive programs being enacted in response to COVID-19 accounted for as a component of our income tax expense or reported elsewhere in our financial statements?

The nature and extent of tax stimulus and incentives provided in response to COVID-19 is wide-ranging and very fluid.  Many of these incentive programs are the result of specific changes in the income tax laws while others are unrelated to the calculation of the income tax but may be administered through the income tax return filing process. Changes in tax law and income tax credits are treated as a component of the income tax provision, but other forms of governmental stimulus may be treated as a component of pre-tax income.

The specific nature of each incentive should be independently assessed to determine whether it is properly reported as a component of the income tax provision or elsewhere in the financial statements. The specific dates of enactment or substantial enactment of any tax law changes should be carefully monitored to ensure reporting in the appropriate period.

This article was first published in Bloomberg Daily Tax Report on 14 April 2020.

Summary

As businesses adjust to the economic disruptions caused by COVID-19, tax accountants need to be thinking about what they need to do now, next and beyond.

About this article

By

David Northcut

EY Global Director – Tax Accounting and Risk Advisory Services

35 years of experience at EY focusing on Tax.

Related topics Tax Tax accounting COVID-19