Expert Access Seminar Series: Tax Accounting 101 September 14, 2011

Transcription

1 Expert Access Seminar Series: Tax Accounting 101 September 14, 2011

2 Introduction to Tax Accounting Robin DarrenCaicco Speake (905) (416) Chantal Ernesto Copithorn Basso (905) Sheri Gauthier (905) November 25, 2008

3 Agenda Section one: Section two: Section three: Section four: Section five: Section six: Section seven: Differences in GAAP and impact on tax provision Deferred income taxes Current taxes Effective tax rate reconciliation Tax Contingencies Valuation Allowances Accounting for Research and Development Tax Incentives 3

4 Objective: 1. Provide refresher on basic tax accounting concepts 2. Highlight some advanced tax accounting areas 3. Highlight differences and similarities between US GAAP and IFRS and ASPE This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, an Ontario limited liability partnership, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. 4

5 Accounting for Income Taxes Differences in GAAP Approach is essentially the same across US GAAP, IFRS and ASPE Based on balance sheet approach (deferred taxes) - Entity recognizes a deferred tax asset or liability for the difference between accounting and tax attributes - Deductible / Taxable Temporary Difference: essentially the same definitions Recognition Criteria for Deferred Tax Asset: probable (IFRS) standard generally interpreted the same as more likely than not standard (US GAAP and ASPE). 5

6 Accounting for Income Taxes Differences in GAAP Deferred tax assets and liabilities are calculated using the expected tax rate when the temporary difference is expected to reverse IAS 12 and ASPE include concept of the substantively enacted rate, whereas US GAAP requires use of enacted legislation IASB has cited guidance in EIC 111 as an example of how to determine substantively enacted tax rate 6

7 Impact on Income Tax Provision Computation of taxable income is based on the provisions of the Income Tax Act (ITA) Income from business or property is the taxpayer s profit from that business or property Profit is not defined in subsection 9(1) of the ITA, therefore interpretation has developed through jurisprudence. 7

8 Impact on Income Tax Provision CRA Views? They have not expressed any concerns regarding the move to IFRS with respect to the computation of taxable income/profit New accounting standards are not law and as such, should not change how the CRA interprets and applies the Act New accounting standards will be taken into consideration when the CRA interprets and applies the Act in a given situation CRA has also provided confirmation that US GAAP may also be appropriate for tax purposes in certain circumstances Understand impact on taxable income adjustments 8

9 Impact on Income Taxes Consider Impact on Balance Sheet Thin capitalization definition of debt/equity (CRA silent to date w.r.t. balance sheet impact of IFRS adoption) Rate of Quebec Research and Development Wage Tax Credit depends on an asset test Enhanced SR&ED refund / Claw-back for small business deduction for CCPCs use certain balance sheet measures Provincial capital tax implications (becoming less relevant as few provinces now have capital tax) 9

10 Questions? 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

11 Deferred Income Taxes 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

12 Deferred Income Taxes Concept of Deferred Taxes 4-Step Process 1. Accounting basis and tax basis 2. Deferred Income Taxes Proof 3. Apply the appropriate tax rate 4. Consider valuation allowances Deferred Income Taxes: Income Statement 12

13 Deferred Income Taxes Concept of Deferred Taxes Cash taxes payable not a fair presentation of real tax burden May be tax benefit or cost when assets or liabilities realized in future Key: Difference between tax basis and accounting basis Common differences: - Capital assets - Intangible assets - Pension plans - Losses 13

14 Deferred Income Taxes Example: Deferred Taxes In Practice Company A owns a building that has an accounting value of $4 million and a tax basis of $3.5 million, which means there is a temporary difference of $0.5 million. The company s tax rate is 40%. Implications if the building was sold tomorrow for its accounting value: Accounting gain? Gain/recapture for tax purposes? Taxes payable? Therefore, there is a deferred tax? 14

15 Deferred Income Taxes Example: Deferred Taxes In Practice Company A owns a movie theatre that has an accounting value of $4 million and a tax basis of $3.5 million, which means there is a temporary difference of $0.5 million. The company s tax rate is 40%. Implications if the building was sold tomorrow for its accounting value: Accounting gain nil Gain/recapture for tax purposes $500,000 Taxes payable $200,000 Therefore, there is a deferred tax liability of $200,

16 Deferred Income Taxes Quiz: Asset or Liability 1. Development costs are capitalized for accounting purposes, but deducted for tax purposes when incurred. 2. Revenue is received in advance and deferred for accounting, but is included in taxable income on a cash basis. 3. A liability for pension costs is recognized for accounting when the service is provided, but is only deductible for tax when the contributions are funded. 4. The net book value of certain assets is higher than the UCC of those assets. 16

17 Deferred Income Taxes Quiz: Asset or Liability 1. Development costs are capitalized for accounting purposes, but deducted for tax purposes when incurred. DT Liability 2. Revenue is received in advance and deferred for accounting, but is included in taxable income on a cash basis. DT Asset 3. A liability for pension costs is recognized for accounting when the service is provided, but is only deductible for tax when the contributions are funded. DT Asset 4. The net book value of certain assets is higher than the UCC of those assets. DT Liability 17

18 Deferred Income Taxes 4 -step Approach 1. Accounting basis and tax basis 2. Deferred Income Taxes Proof 3. Apply the appropriate tax rate 4. Consider valuation allowances 18

19 Deferred Income Taxes Step 1: Accounting Basis and Tax Basis Accounting values - Financial statements - Trial balance Tax values - Tax returns - Other calculations 19

20 Deferred Income Taxes Example: Tax Basis Item Accrued liabilities of $1,000 relating to bonuses which will not be paid within 180 days of year-end. Accrued liability of $1,000, which relates to a fine payable. Tax basis?? Loss carryforwards of $1,000.? Loss carryback of $500.? On acquisition, an asset was restated from its carrying value of $500 to its fair value of $1,000.? 20

21 Deferred Income Taxes Example: Tax Basis Item Accrued liabilities of $1,000 relating to bonuses which will not be paid within 180 days of year-end. Accrued liability of $1,000, which relates to a fine payable. Tax basis $0 $1,000 Loss carryforwards of $1,000. $1,000 Loss carryback of $500. $0 On acquisition, an asset was restated from its carrying value of $500 to its fair value of $1,000. $500 21

22 Deferred Income Taxes Step 2: Deferred Income Taxes Proof Reconcile change in temporary differences from prior year to temporary differences in 3-column schedule. 22

23 3 Column Approach Revisited Accounting Tax Temporary NIBT per f/s $100 $100 +/- Reconciling items: 50% of meals & entertainment Depreciation 30 (30) CCA (40) 40 Total $125 $115 $10 Tax expense (30% tax rate) $37 $34 $3 23

24 Example: Fixed Assets Future Income Taxes Proof Capital assets prior year Depreciation/CCA Capital assets current year Accounting Tax Temporary Future Tax at 30% $250 $220 $30 $9 (30) (40) $10 $ $40 $12 24

25 Deferred Income Taxes Step 3: Apply the appropriate tax rate Rate(s) expected to be in effect when the differences reverse Consider: Changing tax rates Substantively enacted vs. enacted Subject to tax in more than one province 25

26 Deferred Income Taxes Step 4: Consider valuation of DTA Must consider whether deferred tax assets can be realized, and amount that should be recognized for accounting purposes. Factors to consider include: More likely than not / probable Evidence of potential realization Tax planning strategies 26

27 Deferred Income Taxes Deferred Income Taxes: Income Statement Future tax expense generally equals change in net balance sheet position of future assets and liabilities for the year Exceptions: Business acquisitions Capital transactions Certain financing expenses - 20(1)(e) 27

28 Deferred Income Taxes Example: Deferred Income Tax Expense At Dec 31, total deferred tax assets are $420,000 and total deferred tax liabilities are $100,000. At the end of the prior year, total deferred tax assets were $250,000 and total deferred tax liabilities were $50,000. During the year, on June 1, the company acquired deferred tax assets of $100,000. Future tax rate is 40%. What is the future tax expense or recovery for the year? 28

29 Deferred Income Taxes Example: Deferred Income Tax Expense At Dec 31, total deferred assets are $420,000 and total deferred tax liabilities are $100,000. At the end of the prior year, total deferred tax assets were $250,000 and total deferred tax liabilities were $50,000. During the year, on June 1, the company acquired deferred tax assets of $100,000. Future tax rate is 40%. What is the deferred tax expense or recovery for the year? Deferred tax recovery of $20,

30 Questions? 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

31 Current Taxes 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

32 Current Tax Expense Taxable Income Temporary and Non-Temporary Differences 3 Column Approach Statutory Tax Rate 32

33 Current Tax Expense Taxable Income Accounting income +/- Tax Adjustments - Permanent differences - Temporary differences = Net income for tax purposes - Other adjustments (non capital losses utilized) = Taxable income - Apply income tax rate - Less any applicable credits (e.g., ITC, FTC) = Current Income Tax Payable 33

34 Current Tax Expense Temporary and Non-Temporary Differences Temporary difference Generally, items not included in accounting/taxable income in current period, but will be deducted or included in accounting/taxable income Is the difference between accounting basis and tax basis of an asset or liability Non-temporary difference Items that will never be allowable deductions or additions to taxable income or items that aren t included in accounting income 34

35 Current Tax Expense Quiz: Temporary or Not 1. Capital cost allowance 2. Depreciation 3. Meals and entertainment 4. Provincial capital taxes paid 5. Membership fees to golf club 6. Pension expense 35

36 Current Tax Expense Quiz: Temporary or Not 1. Capital cost allowance Temporary 2. Depreciation Temporary 3. Meals and entertainment Non - temporary 4. Provincial capital taxes paid Non - temporary 5. Membership fees to golf club Non - temporary 6. Pension expense Temporary 36

37 Current Tax Expense Three-Column Approach Accounting Tax Temporary NIBT per f/s $100 $100 +/- Reconciling items: 50% of meals & entertainment Depreciation 30 (30) CCA (40) 40 Total $125 $115 $10 Tax expense (30% tax rate) $37 $34 $3 37

38 Current Tax Expense Statutory Tax Rate Determined based on: Type of company What province the company operates in See publication: Tax Facts and Figures: Canada 2011 Also find updates on Tax News Network 38

39 Current Taxes Payable Current Taxes Payable Continuity Typically organized by year and tax jurisdiction Prior year activity Tax return to provision true up Final payments / refunds Interest paid / received Reassessments paid Penalties paid Current year activity Current tax expense Installments Tax Reserves 39

40 Effective Tax Rate Reconciliation Rate Reconciliation Purpose of Rate Reconciliation Common Reconciling Items Calculating the Rate of Reconciling Items 40

41 Effective Tax Rate Reconciliation Purpose of Rate Reconciliation Total tax expense divided by NIBT = effective tax rate (ETR) Rate reconciliation: Demonstrates reasonableness of ETR Compares ETR to statutory rate 41

42 Effective Tax Rate Reconciliation Common Reconciling Items Non-deductible expenses (Permanent Differences) Rate adjustments Change in valuation allowance Difference in future income tax rates Tax rate changes Adjustments to tax reserves Adjustments to prior year amounts (Permanent book to filing) 42

43 Effective Tax Rate Reconciliation Calculating the Rate of Reconciling Items Can express each item on a $ basis, or as % of NIBT Should provide comparatives to prior years so watch groupings If company has a full valuation allowance (i.e. no DTA has been recognized) benefit of current year losses not recognized or change in valuation allowance may be a significant component 43

44 Effective Tax Rate Reconciliation Exercise: Rate Reconciliation Net income before taxes is $125,000. Tax expense is $52,700. Statutory rate is 36%. Tax reserves were increased by $5,000. Non-temporary add-backs were estimated at $10,000. Total temporary differences at the beginning of the year were $45,000, resulting in future tax liabilities of $16,000. Tax rates used for future taxes decreased by 2% during the year. Net Income? Statutory rate?? Tax rate changes?? Change in tax reserves?? Non-deductible expenses?? Effective rate?? 44

45 Effective Tax Rate Reconciliation Exercise: Rate Reconciliation Net income before taxes is $125,000. Tax expense is $52,700. Statutory rate is 36%. Tax reserves were increased by $5,000. Non-temporary add-backs were estimated at $10,000. Total temporary differences at the beginning of the year were $45,000, resulting in future tax liabilities of $16,000. Tax rates used for future taxes decreased by 2% during the year. Net Income 125,000 Statutory rate 45, % Tax rate changes (900) (0.72%) Change in tax reserves 5, % Non-deductible expenses 3, % Effective rate 52, % 45

46 Questions? 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

47 Tax Contingencies & Uncertain Tax Positions 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

48 Tax Contingencies IFRS Treatment IAS 12 does not specifically address IAS 37 is not considered to apply to income taxes Acceptable approaches include: - Single best estimate approach - Weighted average probability May consider uncertain tax position on issue by issue basis or on combined basis Approach must be applied consistently Page 48

49 Tax Contingencies ASPE Treatment ASPE different practices considered acceptable: Contingency approach (ASPE 3290) Best estimate approach Probable asset approach More likely than not approach Approach should be consistently applied Page 49

50 Tax Contingencies US GAAP Treatment Prescribed approach to assessment of Uncertain Tax Positions (UTP s) under ASC (Formerly FIN 48) Evaluation of a tax position is a two-step process 1. Recognition is it more likely than not that a tax position will be sustained, based on technical merits? 2. Measurement largest amount of benefit that is greater than 50% likely of being realized upon settlement Detection by a tax authority is assumed Page 50

51 Tax Contingencies US GAAP Measurement probability table Possible Estimated Outcome Probability of Occurring Cumulative Probability of Occurring $100 5% 5% Page 51

52 Tax Contingencies Measurement probability table: multi-gaap Possible Estimated Outcome Probability of Occurring Cumulative Probability of Occurring Weightedprobability method $100 5% 5% $ $ $ $ $0 US GAAP : $60 = cumulative probability greater than 50% (i.e. 55% in example) Best estimate: $80 = highest probability of single estimate Weighted-average: $51 = sum of estimates multiplied by probabilities Page 52

53 Questions? 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

54 Valuation Allowance 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

55 Valuation of Deferred Tax Assets IFRS Recognition of Deferred Tax Asset Recognize a Deferred Tax Asset in the balance sheet when it is probable that the future economic benefits will flow to the entity; Probable is not defined in IAS 12, but generally interpreted to mean the same as more likely than not (i.e. +50%) No concept of Valuation Allowance under IFRS Valuation Allowance remains relevant under US GAAP and ASPE Page 55

56 Valuation of Deferred Tax Assets What affects the valuation of deferred tax asset? Changes in business environment (i.e. are we out of the woods?) Changes in tax law or tax rates Sources of taxable income include - Carry backs - Reversals of existing taxable temporary differences - Tax planning strategies - Future taxable income Page 56

57 Valuation of Deferred Tax Assets Available approaches GAAP Approach Probability of Realization IFRS Probable < 50% Valuation Allowance Required Record up to amt probable US More Likely Than Not < 50% Yes Canadian More Likely Than Not < 50% Yes Page 57

58 Questions? 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

59 Accounting for R&D Tax Credits 2008 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

60 Accounting for R&D Tax Incentives Types of Incentives Accounting issues arise in respect of : Treatment of R&D Costs Treatment of Tax Credits 60

61 Accounting for R&D Tax Incentives R&D Costs Accounting Alternatives under various GAAP: Capitalize and Amortize Recognize in income statement as incurred 61

62 Accounting for R&D Tax Incentives Temporary Difference for R&D Costs Temporary Differences to consider: a. R&D costs capitalized for accounting b. R&D costs not claimed for income tax purposes (i.e. SR&ED pools) 62

63 Accounting for R&D Tax Incentives Canadian Income Tax Treatment High Level SR&ED pool is the available tax deduction consisting of: a) Current SRED expenditures b) Capital SRED expenditures Tax payers can choose how much they will claim for each year, therefore certain Provincial SR&ED pools may be different than Federal pools 63

64 Accounting for R&D Tax Incentives R&D Tax Credits Accrual For Accounting Purposes ASPE Accrue when reasonable assurance that they will be realized IFRS & US GAAP Accrue when more likely than not / probable Factors to consider: Prior year Audit history History of profitability Future profitability 64

65 Accounting for R&D Tax Incentives R&D Tax Credits Accrual for Accounting Purposes Alternatives 1) Cost reduction approach: R&D Tax Credits reduce R&D costs 2) Flow Through Approach: R&D Tax Credits reduce Tax Expense Canadian GAAP Must use 1) US GAAP and IFRS: policy choice, therefore either 1) or 2) If credit is fully refundable, independent of taxable income and income tax return then consider cost reduction approach 65

66 Accounting for R&D Tax Incentives Investment Tax Credits Treatment for Taxable Income Purposes Federal Taxable Income Federal Investment Tax Credits ( ITC ) Taxable in taxation year following the year they are utilized Provincial Tax Credits Generally, taxable in the year claimed Provincial Differences Federal ITC - included income in year following year of claim OITC - included in income in same year of claim, except portion earned on proxy amount is taxed in the year received ORDTC - included in income in year earned Quebec salary and wages R&D credit - included in income in year of claim 66

67 Accounting for R&D Tax Incentives Accounting for R&D Tax Incentives Example Facts: For current year, Taxpayer is planning to file a SR&ED Claim reporting the following items: SR&ED Current Expenditures: $4,000 SR&ED Capital Expenditures: $1,000 Federal ITC: $1,000 Assume: a) Company is profitable with a current tax liability well in excess of estimated federal ITCs. b) All current SR&ED costs are expensed for accounting purposes c) The company is a SEC registrant. 67

68 Accounting for R&D Tax Incentives Accounting for R&D Tax Incentives Example Steps to Address Tax Accounting Issues: 1) Prepare proposed journal entry for ITC 2) Using 3 column approach identify impact on temporary differences 3) Compute Future Income Tax Asset or Liability 68

69 Accounting for R&D Tax Incentives Accounting for R&D Tax Incentives Example Step One: 1) ITC earned Debit Current Tax Payable $1,000* Credit Current Tax Expense $1,000 * Calculated as 20% of total current and capital SR&ED expenditures In this example, Reasonable assurance exists regarding Company s ability to use Tax Credits 69

70 Accounting for R&D Tax Incentives Accounting for R&D Tax Incentives Example Step Two Taxable Income Adjustments: Accounting Tax Deferred Income Statement $10,000 $10,000 Addback Accounting Expense: SR&ED Current Exp. $4,000 ($4,000) SR&ED Capital Exp. $0 ($0) Deduct Qualifying SR&ED Exp: SR&ED Current Exp. ($4,000) $4,000 SR&ED Capital Exp. ($1,000) $1,000 ITC in Accounting Income $ 0 ($ 0) $ 0 Total Adjusted $10,000 $9,000 $1,000 70

71 Accounting for R&D Tax Incentives Accounting for R&D Tax Incentives Example Step 3 FIT Summary of Temporary Differences Accounting Tax Temp Diff Equipment * $1,000 $ 0 $1,000 SR&ED ITC Claimed ** $1,000 $ 0 $1,000 Total Tax l Temp Diff $2,000 $ 0 $2,000 * Equipment deducted for tax purposes as SR&ED expenditure, but was capitalized for accounting. Future amortization for accounting will not give rise to any further tax deduction. ** ITC claimed in the current year will be added to taxable income in the following year, therefore represents taxable temporary difference. 71

72 Generally applied approaches Refundable Non-refundable ASPE Above the line Above the line IFRS Above the line Choice US GAAP Above the line Tax Expense * *technically there may be choice under US GAAP Page 72

73 THANK YOU! This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP. All rights reserved. In this document, refers to PricewaterhouseCoopers LLP, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.