Tax accounting considerations for financial reporting
CFOs need to be prepared for tax accounting surprises during interim or year-end financial reporting due to the COVID-19 pandemic.
The COVID-19 global pandemic has strained economies, triggered sweeping government policy and stimulus responses, and also redefined business models. Tax policy initiatives continue to evolve in response to COVID-19-induced budget shortfalls. In addition, accounting standard setters continue to release new standards and guidance to improve the quality of financial reporting. These factors combine to pose significant challenges for companies in their interim or year-end financial reporting.
As companies get closer to their financial reporting period, here are 10 considerations that CFOs need to think about to manage the impact of the COVID-19 pandemic.
1. Does the company have the capacity and infrastructure to timely complete its interim and annual provision calculations given the remote working requirements?
Many companies are facing logistical, information technology and personnel challenges in adjusting to evolving workplace restrictions. Remote workers may not have direct access to vital accounting and tax records that are necessary for preparing the income tax provision calculations. CFOs therefore need to critically review their capabilities to meet the financial reporting requirements, including assessing the people, process and technology implications of an extended workplace restriction.
2. Do existing internal controls related to income tax provision address additional risks associated with the COVID-19 pandemic?
Many income tax-related internal control deficiencies can be attributed to material non-routine transactions with a high degree of complexity. For example, the assessment of foreign tax exposures due to potential permanent establishments (PE). Due to the COVID-19 pandemic, employees temporarily stranded outside of their country of employment may give rise to unanticipated PE exposures for the company in overseas countries, which may not be addressed by current controls. CFOs need to review if new or different process documentation and controls are needed, depending on the nature and extent of the additional risks associated with the pandemic impacting the company.
3. Are there material changes in the company’s overall deferred tax position that require new or different assessments of the recognition or realisation of deferred tax assets?
Companies with historically consistent profitable operations may not have been required to perform analysis related to the recognition or realisability of deferred tax assets. With the weak economic environment, many companies with losses from operations will need to assess the recognition of deferred tax assets. The initial assessment of the deferred tax accounting for these losses may require a complex analysis involving judgement and scepticism. CFOs should therefore review additional procedures that may be required related to any deferred tax assets generated during the current downturn.
4. Will the financial statement impact from the COVID-19 pandemic materially alter its historic forecasts used to support deferred tax assets?
Projections of future income should be updated to reflect the revised economic outlook as significant impairments or changes in consumer preference may significantly impact the business outlook and hence profitability. Companies that expect to be in a loss position based on revised forecasts should consider this negative evidence about the realisabilty of deferred tax assets and that previously recognised deferred tax assets may need to be re-evaluated. CFOs should anticipate the additional time and complexity associated with updating projections as this will be a focus for the external auditors.
5. What are the tax provision implications associated with an expected financial statement impairment charge?
An impairment charge can impact tax provision depending on the nature of the asset being impaired (such as goodwill, tangible property and intangible property) and the overall deferred tax position. For example, in Singapore, impairment loss on trade receivables is tax-deductible only in the future unless it is in respect of credit-impaired trade receivables. Given the diversity of the potential tax accounting impacts, each asset impairment will require an independent assessment to determine the requisite tax provision impact.
6. Are there specific tax provision implications associated with the recent decline in the company’s 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 and remeasurement. For example, in Singapore, stock options granted could result in deferred tax assets because such expenses would be deductible in the future when incurred (and provided certain conditions are met). If the stock price is impacted due to the bearish market, this may result in write-down of deferred tax assets previously recognised and thus have immediate consequences in the financial statements.
7. Are there specific income tax disclosures related to COVID-19 that the company should consider?
The required disclosures related to income taxes have not necessarily changed. However, the application of existing disclosure requirements in the current environment may result in additional disclosures. Disclosures related to overall financial condition, capital resources, cash flow, liquidity or uncertainty around accounting estimates may have elements that are related to income tax positions. For example, under the current pandemic environment, companies may have limitations on future income projections, which could lead to a material change in deferred tax recognition from prior years. Based on the materiality of the change in deferred tax positions, comprehensive disclosure to enable users of the financial statements to understand the effects of the pandemic and related events on its income tax accounts may be required.
8. Is the company able to make a reliable estimate(s) of the effective tax rate(s) based on projected income for interim tax provision?
The interim tax provision is generally measured based on one or more estimated annual tax rates for the year, depending on the accounting framework. CFOs of companies with financial year straddling across 2020 and 2021 will need to ask critical questions about the future to make realistic estimates of effective tax rates on projected 2020/2021 income and understand the impact of tax reliefs offered as part of government stimulus plans.
9. If the company is considering bringing cash back from overseas operations, when would a change in plans be recognised in the income tax provision?
Historically, many companies have used special exceptions in the accounting literature to not record deferred taxes on unrepatriated earnings from foreign subsidiaries. This generally require an evaluation of the company’s expectation of future repatriation rather than looking to the specific date of an actual repatriation. Companies considering changes in their repatriation strategy due to cash flow needs should assess whether the revised strategy will result in a change to deferred tax accounting.
10. Should the various governmental tax stimulus or incentive programs be accounted for as a component of income tax expense or reported elsewhere in the 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 new or 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 such as extension of tax filing deadlines.
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 not be treated as such. For example, a government grant that is related to assets could be presented by deducting the grant in arriving at the carrying amount of the asset for financial reporting versus a tax basis that may not change based on local tax rules – and this results in deferred tax recognition for basis difference.
The above provides an overview of the areas of consideration that will impact companies’ tax accounting and reporting. As companies prepare for financial reporting close under remote work conditions, planning and communication are imperative to avoid last-minute surprises and the need to redo the work that has been done.
CFOs should consider preparing detailed closing calendars and timelines with clear roles and responsibilities, as well as contingency plans for late information or disrupted communications. It is particularly important to coordinate well with external auditors and advisors for upcoming interim or year-end reporting to ensure that expectations are met.
The co-authors of this article are Chai Wai Fook, EY Asean Government & Public Service Leader and Ed Raza, Director, Tax Accounting Risk Advisory Services from Ernst & Young Tax Services Limited Hong Kong.
