Accounting Issues with Investments in Foreign Subsidiaries

Transcription

1 Accounting Issues with Investments in Foreign Subsidiaries Tax Executives Institute May 7, 2012

2 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment e t or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 1

3 Overview Inside/outside basis differences Investment in subsidiaries and equity method investments Exceptions to income tax recognition Domestic subsidiaries Foreign subsidiaries (formerly APB Opinion 23 exception) 2

4 Inside basis vs. Outside basis Inside Basis Differences: Arise from differences between the financial statement carrying amounts and tax basis of a subsidiary s s (domestic and foreign) assets and liabilities. Outside Basis Differences: Arise from differences between the financial statement carrying amount and the tax basis of the parent company s investment in the stock of the subsidiary 3

5 Foreign vs. Domestic Subsidiary Determining whether a subsidiary is Domestic or Foreign Assessment should be determined at each subsidiary level by reference to the subsidiary s immediate parent. 4

6 Domestic vs. Foreign Subsidiary Example U.S. Parent owns German Subsidiary, German Subsidiary owns French Subsidiary 1 and French Subsidiary 1 owns French Subsidiary 2 Which subsidiaries are domestic and which are foreign? U.S. Parent German Subsidiary French Subsidiary 1 French Subsidiary 2 5

7 Investments in domestic subsidiaries No taxable temporary difference should be recorded if: Law provides a means by which the subsidiary may be recovered tax-free, and The company expects it will ultimately use that means If less than requisite ownership percentage for tax-free recovery, potential to anticipate acquisition of additional interest Parent company expects to acquire more shares Acquisition would not result in a significant cost If no tax-free options exist due to current ownership, assess intent with respect to timing of settlement of minority interest 6

8 Investments in foreign subsidiaries Taxable outside basis differences Outside basis differences result from: Undistributed earnings Accumulated subsidiary losses Foreign currency translation gains and losses included in equity Business combinations Gains recognized on the issuance of stock by the subsidiary Will result in future taxable or deductible amounts when: Dividends paid Stock of the subsidiary is sold Subsidiary is liquidated Subsidiary is merged into the parent company 7

9 Investments in foreign subsidiaries Outside basis differences ASC establishes a presumption that all undistributed earnings of a subsidiary will be transferred to the parent company Exception (FASB ASC and 25-18a) (APB Opinion 23) Applies to excess of financial carrying amount over the tax basis of investment Not applicable to inside basis differences Applicable only to foreign subsidiaries and foreign corporate joint ventures Not applicable to investments accounted for under the equity method unless the investee meets the definition of foreign corporate joint venture 8

10 Investments in foreign subsidiaries Outside basis differences (continued) Criteria to apply Plan to reinvest earnings indefinitely Intent and ability to permanently reinvest Remitted in a tax free manner Will not reverse in foreseeable future Variable Interest Entities (VIEs) 9

11 ASC considerations Policy may differ by subsidiary Treatment of Subpart F income Continued reinvestment of prior earnings when future earnings may be repatriated Impact of fixed dividend payments Foreign branches Not limited to U.S. jurisdiction Plans to sell subsidiary 10

12 ASC considerations Supporting indefinite reinvestment In order to support an indefinite reinvestment of earnings, example documentation may include: Significant inter-company or third party debt which would require cash Details of plant expansion to be undertaken Acquisitions planned Documentation of advertising or promotion campaign planned Providing funding for other group members Debt covenants restricting dividend payments Additional borrowing plans Past activities of the entity The company s supporting assertions for indefinite reinvestment of earnings should not be inconsistent with other financial statement assertions 11

13 Investments in subsidiaries Foreign or domestic Excess tax basis Excess tax basis related to outside basis difference for both domestic and foreign subsidiaries ASC No deferred tax asset unless basis difference reverses in foreseeable future Generally recognize deferred tax liabilities Foreseeable future generally believed to be within one year ASC held for sale criteria useful in this context Existing committed plan Ability to immediately execute the transaction Active program to locate a buyer Transaction is probable and likely to be completed within a year Marketing the entity at a reasonable price Unlikely that significant changes to the plan will be made 12

14 Equity method investments Outside basis differences Often give rise to temporary differences because investments are accounted for under cost method for tax purposes Differences measured at investor level Exceptions to recognition of deferred tax liabilities and deferred tax assets generally do not apply Specific exceptions to recognition are: Taxable basis differences in foreign enterprises that arose when equity investment was a consolidated subsidiary Investment t in certain foreign corporate joint ventures Undistributed pre-1993 earnings of a domestic corporate venture 13

15 Outside basis differences summary Taxable temp difference Deductible Domestic Foreign Temp difference Subsidiary Tax free recovery and Essentially permanent in DTA prohibited, unless pre-1993 exception duration exception ASC apparent test met ASC (b) (a) (ASC ) Corporate joint venture Other equity methods VIEs Same rules as a subsidiary General rules of ASC 740; no exceptions Same rules as a subsidiary (control of how and when earnings are distributed must be considered) 14

16 Intraperiod allocation The deferred taxes recognized on temporary differences resulting from translation adjustments are charged or credited to the cumulative translation adjustment component of other comprehensive income as such temporary differences arise. ASC paragraphs through include an example of the recognition of deferred taxes on unremitted earnings and translation adjustments. In that example, deferred taxes for both the unremitted earnings and the translation adjustments are measured ed using a net tax rate that reflects ects foreign tax credits. It may also be acceptable to allocate foreign tax credits only to the unremitted earnings and to use the gross rate for measuring deferred taxes on the translation adjustments. 15

17 Example On January 1, 20X2, Parent Company, a U.S. company, acquired all of the common stock of Company ABC Corp. for $1,000 in cash. ABC operates in a foreign tax jurisdiction; its functional currency is the local foreign currency. Parent Company s tax basis of the investment in the stock of ABC was $1,000 on January 1, 20X2. On January 1, 20X2, the exchange rate was FC 1 = U.S. $1. The average exchange rate for the year ended December 31, 20X2 and the exchange rate at December 31, 20X2 were e FC 1 = U.S. $1.10 and FC 1 = U.S. $1.15, respectively. e 16

18 Intraperiod allocation A summary of Company FS s balance sheet at December 31, 20X2 in the foreign currency and in U.S. dollars is presented below: FC $ Assets 2,000 2,300 Liabilities Stockholders equity: Common stock 1,000 1,000 Retained earnings Cumulative translation adjustment Total equity 1,200 1,380 Total liabilities and equity 2,000 2,300 17

19 Intraperiod allocation (continued) At December 31, 20X2, there is a taxable temporary difference in the U.S. tax jurisdiction of $380 between Parent Company s financial statement carrying amount of $1,380 and tax basis of $1,000 of the investment in the stock of ABC due to an increase in assets represented by undistributed earnings of $220 and the effect of the translation adjustment of $160. If the indefinite reversal criterion does not apply, the deferred tax liability on the basis difference would be recognized. Assume Parent Company has a 40% U.S. tax rate and ABC has generated e $20 of foreign tax. Parent company would make one of the following o entries es to recognize the deferred tax liability on its outside basis difference, based on company policy. 18

20 Intraperiod allocation (continued) ASC approach: Income tax expense ($220 x 36.84% (A)) 81 Cumulative translation adjustment ($160 x 36.84%) 59 Deferred tax liability (($380+20) x 40% $20) 140 With-and-without approach: Income tax expense (($220+20) x 40% $20) 76 Cumulative translation adjustment (residual) 64 Deferred tax liability (($380+20) x 40% $20) 140 (A) Represents the effective rate net of foreign tax credits. Computed as total tax of $132 divided by the outside basis difference of $

21 Questions? Ashby Corum Partner Washington National Tax (313)

22 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International ti Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered ed trademarks a or trademarks a of KPMG International.