Agenda. December 1, 2010

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2 Agenda General deferred tax accounting General UTP accounting The new UTP schedule required by the IRS Recent China Tax Law Updates - Cir 698 Taxation on oversea indirect equity transfer - Cir 157 CIT treatment for NHTEs - Cir 59 & Public Notice 4 CIT treatment for corporate restructuring IFRS & CAS status updates SEC Recent Comment on income tax disclosure Q & A 2

3 General Deferred Tax Accounting 3

4 Top restatement Issues for FY 10 Stock Compensation Revenue Recognition Liabilities, Payables, Re Income Taxes Financial Instruments Depreciation, Depletion, Debt, Warrants & Equity Consolidation, Foreign Cash Flows Balance Sheet Affiliate Transactions Accounts/Loans

5 Mechanics of Tax Provision Current Tax Provision (Tax Return) and changes in ASC (FIN 48) liabilities Deferred Tax Provision (changes in net deferred taxes including changes in VA) + = Income Tax Expense (F/S Provision) Current Taxes Payable or Receivable/Noncurrent Taxes Payable (Balance Sheet) Deferred Tax Asset or Liability (Balance Sheet) Income Statement Deferred Provision Total Provision Current Provision 5

6 Tax Provision Process Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Step 7 Adjust pretax income for permanent differences. Identify all temporary differences and carryforwards. Calculate the current income tax expense or benefit. Recognize deferred tax assets and liabilities. Assess and adjust for changes in ASC (FIN 48) reserve. Evaluate the need for a valuation allowance for gross deferred tax assets. Calculate the deferred income tax expense or benefit. 6

7 Overview of Deferred Tax It is important to identify any basis differences that may exist between US GAAP and Tax. This is why basis difference analyses are often performed in two steps: - Identify US GAAP-to-Local GAAP basis differences - Identify Local GAAP-to-Tax basis differences US GAAP Local GAAP Local Tax 7

8 Deferred tax - Permanent Differences Vs. Temporary Differences Permanent Differences (not exhaustive) Excessive entertainment expenses Employee commercial insurance Staff welfare expenses and labor union fees above deductible limit Non-deductible penalties Donation to non-charity organization or charitable donations above deductible limit Sponsor fee Management Fee Temporary Differences (not exhaustive) Excessive advertisement expenses Depreciation of fixed assets Amortisation of intangible assets Accrued expenses / contingent liabilities Provisions Deductible assets losses Staff education expenses above deductible limit Assets carried at fair value (e.g. financial assets) Asset revaluation increments Investment gain/loss captured under equity method 8

9 Deferred Taxes Balance Sheet Approach & Inherent Assumption Illustrated Facts: At December 31, 2010, a building used in a company s manufacturing operations has: - Net book value: $1,000 - Net tax value: $600 - Fair market value: $3,000 Questions a) What is the amount of deferred tax asset or liability that the company should record for the building (assuming 25% statutory tax rate)? b) Would the answer be different if the company asserts that it plans to sell the building in the near future? 9

10 Deferred Taxes Balance Sheet Approach & Inherent Assumption Illustrated (cont.) Answers: a) The amount of deferred tax liability that the company should record is $100, or the difference between the net book and tax value times the statutory tax rate of 25% b) No, the answer would not be different ASC (FAS 109, 11), states in part: An assumption inherent in an entity's statement of financial position prepared in accordance with generally accepted accounting principles (GAAP) is that the reported amounts of assets and liabilities will be recovered and settled, respectively. Based on that assumption, a difference between the tax basis of an asset or a liability and its reported amount in the statement of financial position will result in taxable or deductible amounts in some future year(s) when the reported amounts of assets are recovered and the reported amounts of liabilities are settled. 10

11 Changes in Tax Laws and Rates Companies must recognize the effects of tax law or rate changes in income tax from continuing operations in the period that includes the enactment date If changes are enacted after year-end but before issuance of financial statements, consideration should be given to disclosing the effect on existing deferred tax assets and deferred tax liabilities in the year-end financial statements Important to have a process for tracking changes Financial statement tax impact of any changes may be well in advance of impact on current tax 11

12 What is the Appropriate Accounting for a Tax Holiday? Issues to consider: What period to account for the effect of the holiday period - When an application is filed if approval is not needed/assured under the law and steps required are perfunctory - When a formal letter is received because approval process is subjective What tax rate to apply to temporary differences that reverse during the holiday period - Use the enacted tax rate expected to apply and consider any contingent requirements (e.g., retroactively revoking benefits if failed to maintain requirements) How to account for NOLs during the holiday period - The rate to apply to the NOLs depends on the particular laws in the jurisdiction - Use the normal rate for the NOLs expected to be utilized before the start of the holiday period - Use the holiday rate (e.g., zero rate) for the NOLs expected to be utilized in the holiday period 12

13 Valuation Allowance The more likely than not standard (i.e. > 50% probability) applies when considering the realizability of deductible temporary differences or tax attributes Judgmental weighing of positive and negative evidence is necessary 13

14 ASC (APB 23) Presumption of repatriation Presumes unremitted earnings will be repatriated Repatriation of earnings account for a temporary difference unless the investment can be recovered on a tax-free basis May overcome presumption If satisfy indefinite reversal criteria 14

15 Asserting Indefinite Reversal under ASC (APB 23) Sufficient evidence must show that the subsidiary has invested or will invest the undistributed earnings indefinitely or that the earnings will be remitted in a tax-free manner Assertion must be applied on an entity-by-entity basis Specific plans that support the assertion must be documented and maintained Not sole responsibility of tax department requires involvement of treasury, controller, and senior financial management 15

16 Common areas overlooked in tax accounting Provision to return adjustments Lack of detailed deferred tax analysis when a company has surplus tax losses Acquisition accounting Applicable tax rate Central journals & GAAP adjustments tax effecting adjustments Impairment Balance Sheet basis GAAP? Adjustments Income Statement basis 16

17 General UTP Accounting 17

18 Uncertain Tax Positions Current Accounting The current guidance, issued in June of 2006 as ASC (FIN 48), prescribed a comprehensive accounting model standardizing how entities should recognize, measure, classify, and disclose uncertain tax positions Effective dates: - Public companies effective for fiscal years beginning after December 15, Non-public companies deferral available for certain entities to years beginning after December 15,

19 Uncertain Tax Positions Scope The guidance for benefits related to UTPs under ASC (FIN 48) applies to taxes based on income only Applicable to business entities, not-for-profit organizations and pass-through entities Applicable to all tax positions taken or expected to be taken on tax returns (including amended returns and refund claims) in all taxing jurisdictions (federal, state and foreign) Exposures related to non-income taxes, such as property, VAT and sales taxes should continue to be accounted for under ASC

20 Basics to Remember Uncertain Tax Benefits A tax benefit is recognized only if a tax position is MLTN of being sustained solely on its technical merits A tax benefit is recognized at the largest amount that is MLTN to be realized (probability analysis) Benefits not recognized are generally recorded as a liability for financial reporting purposes Be attentive of differences related to interplay between deferred tax assets and valuation allowances Subsequent recognition, derecognition and measurement is based on management's best judgment given the facts, circumstances, and information available at the reporting date 20

21 Uncertain Tax Positions Six Steps Prepare disclosures Step 6 Accrue interest and penalties Step 5 Determine classification Step 4 Measure benefit to be recognized Step 3 Evaluate tax position for recognition Step 2 Identify tax positions and determine unit of account Step 1 21

22 Uncertain Tax Positions Cumulative Probability A company takes a UTP in its tax return for a deduction of $100. The positions meets the MLTN recognition threshold. The company determines the following possible outcomes and the probability of each: Amount of tax benefit Individual probability Cumulative probability $100 15% 15% $80 20% 35% $60 20% 55% $40 30% 85% $20 15% 100% The benefit to be recognized in the financial statements is $60 because that is the greatest amount that is MLTN to be realized. 22

23 Uncertain Tax Positions Disclosures Uncertain tax benefits (UTBs) related disclosures [ASC ] (a) Tabular reconciliation of UTBs at the beginning and end of the year (b) Amount of UTBs that would impact the effective tax rate (c) (d) Amount of interest and penalties recognized in the income statement and balance sheet Amount of UTBs that may significantly change within 12 months of the reporting date ( early warning disclosure ) (e) Description of open tax years by major jurisdiction Policy on classification of interest and penalties Note: Accounting Standards Update ( ASU ) provides that non-public companies are not subject to disclosures required by ASC (a) and (b) 23

24 UTB Tabular Reconciliation Uncertain tax benefits (UTBs) related disclosures [ASC (a)] (a) (a)(1) (a)(2) (a)(3) (a)(4) A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, which shall include: The gross amounts of the increases and decreases in unrecognized tax benefits as a result of the tax positions taken during a prior period The gross amounts of increases and decreases* in unrecognized tax benefits as a result of tax positions taken during the current period The amounts of decreases in the unrecognized tax benefits relating to settlements with taxing authorities Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations * Should include current year increases only. Drafting flaw subsequently codified As noted on the previous slide, this disclosure is not applicable by nonpublic companies 24

25 Uncertain Tax Positions Changes in Recognition and Measurement An entity shall recognize the benefit of a tax position that was previously not recognized if : 1. the MLTN recognition threshold is met by the reporting date 2. the tax position is effectively settled through examination, negotiation or litigation 3. the statute of limitation for the relevant taxing authority to examine and challenge the tax position has expired A benefit previously recognized should be derecognized in the first period in which it no longer meets the MLTN recognition threshold 25

26 Effectively Settled ASC (FIN 48 10(b)) Three conditions must exist for a tax position to be considered effectively settled: - The taxing authority has completed its examination procedures including all appeals and administrative reviews that the taxing authority is required and expected to perform for the tax position - The enterprise does not intend to appeal or litigate any aspect of the tax position included in the completed examination - It is remote that the taxing authority would examine or reexamine any aspect of the tax position presuming it has full knowledge of all relevant information 26

27 New Information vs. Change in Judgment A tax position that meets the recognition threshold - Requires the existence of new information for the associated tax benefit to be remeasured (ASC (FIN 48 12) - Does not need to be effectively settled to be remeasured A remeasurement should not occur on the basis of a new evaluation or new interpretation by management of information - That was available in a previous financial reporting period, - Nor should it occur solely on the basis of the taxing authority not reviewing a specific tax position during the examination Of course, the effective settlement of those tax positions that meet the recognition threshold would constitute new information for purposes of remeasurement 27

28 The New UTP Schedule Required by the IRS 28

29 IRS Schedule UTP - Timeline JAN 2010 FEB 2010 MAR 2010 APR 2010 MAY 2010 JUN 2010 JUL 2010 AUG 2010 SEP 2010 January 26, 2010 IRS releases Announcement March 5, 2010 IRS releases Announcement Deadline extended for comments March 29 June 1, 2010 April 19, 2010 IRS releases: Announcement Draft Schedule UTP Draft Schedule UTP instructions June 1, 2010 Comment period ends September 9, 2010 IRS issued Notice of Proposed Rulemaking September 24, 2010 IRS issued: Final Schedule UTP and final instructions Announcement Overview of changes from draft instructions to final instructions Announcement Expansion of IRS policy of restraint Directive to IRS field personnel setting forth the IRS s planned treatment of Schedule UTP by examiners and other IRS personnel 29

30 Who Must File Schedule UTP Files one of the following forms: A company must file if it: - Form 1120, U.S. Corporation Income Tax Return - Form 1120 F, U.S. Income Tax Return of a Foreign Corporation - Form 1120 L, U.S. Life Insurance Company Income Tax Return - Form 1120 PC, U.S. Property and Casualty Insurance Company Income Tax Return Has assets equal to or exceeding - TY2010 $100 million - TY2012 $ 50 million - TY2014 $ 10 million Issued (or a related party issued) audited financial statement (including those filed under U.S. GAAP and IFRS) that covers all or a portion of the company s operations for the company s tax year Has one or more tax positions that must be reported on Schedule UTP 30

31 What Uncertain Tax Positions Must Be Disclosed? Recorded a reserve in audited financial statements No reserve recorded because company expects to litigate position No reporting if tax position is immaterial or sufficiently certain under applicable financial accounting standards Probability of settling with the IRS is <50% Intend to litigate MLTN to prevail on merits in litigation Tax position taken on a return would result in adjustment to a line item on that return if not sustained Based on the unit of account used to prepare the audited financial statements If multiple tax positions affect a single line on the return, each position must be reported separately 31

32 Elements of Disclosure Pass through EIN Major tax position Ranking Timing Codes Transfer pricing or other Code section UTP disclosure Concise description 32

33 Recent China Tax Law Updates 33

34 PRC Taxation on Overseas Indirect Equity Transfers Guoshuihan [2009] No. 698 ( Circular 698 ): The State Administration of Taxation ( SAT ) issued Circular 698 on December 10, 2009 to scrutinize indirect transfers by non-prc Tax Resident Enterprises ( Non-TREs ) of their equity interests in PRC companies by disposing the shares in offshore Special Purpose Vehicles ( SPVs ). Circular 698 imposes a reporting obligation on certain indirect transfers. It stipulates how to apply General Anti-Avoidance Rule ( GAAR ) provisions based on the assessment of the documents and information reported by the Non-TRE investors. 34

35 Jiangdu Case - Observations The Jiangdu Case: A local-level state tax bureau in Jiangdu ( Jiangdu STB ) of Jiangsu Province collected a significant amount of PRC tax (RMB 173 million) on the transfer gain derived by a Non-TRE investor from indirectly transferring the equity of a PRC joint venture company ( JV ) through disposing its shares in a Hong Kong intermediate holding company. The first published case of a successful attack by the PRC tax authorities on indirect transfer since the issuance of Circular 698. Largest single sum of PRC withholding income tax collected by the PRC tax authorities of such nature. This shows that the PRC tax authorities are taking an aggressive approach to detect the indirect transfer and assess the commercial purpose and substance of such a transfer. Public announcements and media coverage are a few of the sources where tax authorities can collect information from. 35

36 Circular 698 and Jiangdu Case Tax Accounting Considerations Observations: It might be necessary to review the current ASC (FIN 48) reserve to determine if any adjustments need to be made in light of the Jiangdu Case. Review the tax treatments in their respective home jurisdictions and determine if PRC tax so paid will be eligible for the foreign tax credits or deductions in the home jurisdictions. It is possible that the tax paid may be regarded as voluntary tax and thus not be eligible for the foreign tax credit or deduction in the home jurisdiction of a Non-TRE. It is important to pay careful attention to tax related disclosures in financial statements and public announcements. 36

37 Transitional CIT Treatments for New/High Technology Enterprises Guoshuihan [2010] No. 157 ( Circular 157 ) It was issued in April 2010 to clarify the CIT treatments of tax incentives available to old enterprises established prior to promulgation of the new CIT law, especially those New/High Technology Enterprises ( NHTEs ). The Circular clarified the applicable CIT rate for NHTEs as well as preferential tax rate for certain projects under CIT regime. 37

38 CIT Treatments for NHTEs Tax Accounting Considerations Observations: It is important for old NHTEs to review and assess their eligibility for the transitional tax treatments or preferential tax treatment under the new Circular to determine the appropriate tax rate. A tax resident enterprise that does not qualify as an NHTE may receive income from certain preferential projects. The enterprise shall separately account for the current and deferred income taxes for these projects using the applicable tax rate for each project. As different in-charge local-level tax bureaus may interpret relevant tax rules differently, it is advisable for NHTEs to closely monitor the local implementation of such rules and assess the need for any ASC (FIN 48) reserve. 38

39 PRC Corporate Income Tax ( CIT ) Treatments for Corporate Restructuring Caishui [2009] No. 59 ( Circular 59 ): The SAT and Ministry of Finance ( MOF ) jointly issued Circular 59 in April 2009 Setting out the framework and rules for CIT treatments in relation to corporate restructuring A number of unclear issues, both technical and procedural 39

40 PRC Corporate Income Tax ( CIT ) Treatments for Corporate Restructuring Guojiashuiwuzongjugonggao [2010] No. 4 ( Public Notice 4 ): It was issued on July 26, 2010, under the title of The Administrative Measures of Corporate Income Tax Treatments for Corporate Restructuring which was effective from January 1, 2010 Public Notice 4 provides: - Detailed guidance on documentation and procedural requirements for all types of corporate restructuring under both the general tax treatments ( GTT ) and special tax treatments ( STT ) tax deferral treatment - Transitional requirements for corporate restructuring which took place in 2008, 2009 and up to the time of the release of the Notice - Clarification of a few issues, such as grandfathering of tax incentives, tax ramifications of breach of the STT criteria and limitation of tax loss carryforward, etc. 40

41 Circular 59 & Public Notice 4 Tax Accounting Considerations Observations: It is imperative to assess the ASC (FIN 48) implications of any transactions with STT election in light of new record-filing requirements and confirmation process by in-charge tax authorities. For transactions qualify as STT, it is important to determine the tax accounting implications including determination of beginning deferred tax balances, applicable tax rate, accounting for unused incentives and limitation on the utilization of tax loss carryforward. It is important to determine the tax accounting treatment of GTT transactions including step-up of tax basis. 41

42 IFRS & CAS Status Updates 42

43 IFRS Adoption and Conversion Key Asian Regions Local GAAP to IFRS Timeline Asian Pacific regions already adopted Australia Fiji Hong Kong Iraq Kuwait Lebanon Mongolia Nepal New Zealand Oman The People s Republic of China* and more KOREA Full adoption on or after 1 January THAILAND SET50 companies must adopt on or after INDIA Certain listed companies and companies with turnover over of US$200m must adopt on or after TAIWAN Phase 1 companies (e.g. listed companies & financial institutions supervised by the FSC) starting on 1 January Phase 2 companies (e.g. unlisted companies and credit card companies), optional early adoption from 1 January THAILAND SET100 companies must adopt on or after JAPAN Proposed adoption for listed companies from 2015/2016. TAIWAN Phase 2 companies starting on 1 January and beyond * The China Accounting Standards for listed companies are similar to IFRS but with a number of differences to reflect specific circumstances in the People s Republic of China. 43

44 Representative U.S. Timeline* Regulatory timeline 2010: SEC begins work on workplan for moving forward with IFRS in the U.S. 2011: SEC to decide whether to mandate IFRS If a company converts at December 31, 2015: January 1, 2013 Beginning of the first comparative IFRS year If mandated: December 31, 2015 annual financial statements issued using IFRS transition date U.S. GAAP financial statements (through third-quarter 2015) IFRS financial statements Dual reporting period reporting date IFRS assessment and preparation IFRS reporting * Representative timeline for illustrative purposes only. SEC to determine if and when conversion will be required in

45 IFRS Adoption and Conversion SEC Publishes Progress Report on IFRS Work Plan SEC published the first draft progress report on its Work Plan for global accounting standards on October 20, Observations - SEC is in the process of evaluating comprehensiveness and comparability of IFRS; - SEC is analyzing the feedback received from public comments to understand the impact on issuers; - Plan to meet with accounting firm, foreign regulators and others to understand the potential impact on audit quality, cost and competitiveness. What s next? - SEC expects to continue to report periodically on the status of the Work Plan until its expected decision in

46 IASB - Accounting for Income Taxes Joint Limited Scope Income Tax Accounting project added to agenda of both FASB and IASB FASB ceases working on the project October IASB discusses comments received on the IAS 12 exposure draft, many critical of proposals. Decides not to proceed with proposals in ED. July 2010 IASB decides to expose an exception for R/E measured at fair value, other proposals to follow March IASB issued an exposure draft to replace IAS 12 to improve and partially converge with U.S. GAAP March IASB adds limited scope project to address practice issues and to consider some proposals from ED that were positively received 46

47 New CAS by Foreign Investment Enterprises New China Accounting Standards ( CAS ) issued by the Ministry of Finance ( MOF ) on 15 February 2006 Application Guidance issued on 30 October 2006 Accounting Standard Interpretation No.1 to 4 issued from November 2007 to August 2010 Implementation Guidance of Accounting Standards issued on December 2008 and the Opinions of the Expert Task Force on the implementation of CAS. 47

48 Timetable of Adopting CAS by Foreign Investment Enterprise ( FIE ) No specific timetable from the MOF as of today Shanghai Municipal Bureau of Finance All of the non-listed medium and large enterprise in Shanghai should adopt CAS no later than In addition, at least 50% of them shall adopt CAS from (Hucaikuai[2010]No 8) 48

49 SEC Recent Comment on Income Tax Disclosure 49

50 SEC Recent Comment on Income Tax Disclosure Income taxes have been identified as the primary source of material weaknesses by the SEC for US listed groups Assess the recoverability of deferred tax assets Effective tax rate (ETR) reconciliation and forecast The SEC continue to focus on the transparency of disclosures by listed company 50

51 SEC Recent Comment on Income Tax Disclosure (cont.) On November 12, an SEC official said that the SEC is monitoring public company tax disclosures involving pretax foreign and domestic income and effective rate reconciliations and is finding some irregularities. - Regulation S-X of the Securities and Exchange Act of 1934 requires that a company's pretax income be divided between domestic and foreign income - However, not all companies are providing that information in a transparent manner (that investors should be able to determine the tax provision that corresponds with foreign income and the provision that corresponds with domestic income) - In its review of effective tax rate reconciliation disclosures, the commission has frequently seen a large item identified as a "tax rate differential" in public company financial statements resulting in comment letters where companies are asked what financial items are included in that caption -- whether it refers to a tax rate differential between foreign and domestic income, or if it includes other items as well 51

52 Questions? 52