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16.4 Income statement presentation of income taxes
Publication date: 30 Oct 2021 (updated 30 Sep 2023)
us Financial statement presentation guide
Total income tax expense or benefit for the year generally equals the sum of total income tax currently payable or refundable (i.e., the amount calculated in the income tax return) and the total deferred tax expense or benefit, adjusted for any unrecognized tax benefits. This section discusses the appropriate presentation of income tax expense or benefit items in the financial statements.
16.4.1 Deferred tax expense or benefit
The total deferred tax expense or benefit for the year generally equals the change between the beginning-of-year and end-of-year balances of deferred tax accounts on the balance sheet (i.e., assets, liabilities, and valuation allowance). In certain circumstances, however, the change in deferred tax balances is reflected in other accounts. For example, some adjustments to deferred tax balances are recorded through other comprehensive income, such as balances related to pensions or available-for-sale debt investments. Other circumstances are described below.
When a business combination has occurred during the year, deferred tax liabilities and assets, net of the valuation allowance, are recorded at the date of acquisition as part of the purchase price allocation. When an asset or a group of assets is acquired other than as part of a business combination, and the amount paid is different from the tax basis of the asset(s), the tax effect is generally recorded as an adjustment to the book carrying amount of the related asset(s) as described in ASC 740-10-25-51 and may require the use of the simultaneous equation method. Refer to TX 10.12.1 for further discussion.
Changes in deferred tax balances resulting from foreign currency exchange rate changes may or may not be classified as a tax expense or benefit.
- When the US dollar is the functional currency, revaluations of foreign deferred tax balances are reported as either transaction gains and losses or, if considered more useful, as deferred tax expense or benefit, as described in ASC 830-740-45-1. If reported as deferred tax expense or benefit, the transaction gain or loss must still be included in the aggregate transaction gain or loss for the period required to be disclosed under ASC 830-20-45-1.
- When the foreign currency is the functional currency, revaluations of foreign deferred tax balances are included in cumulative translation adjustments. The revaluations of the deferred tax balances are not identified separately from revaluations of other assets and liabilities.
- Foreign withholding taxes related to the reversal of outside basis differences are technically a liability of the parent, and therefore, they are the parent’s foreign currency transactions. As a result, if foreign withholding taxes are being recorded related to the outside basis difference in a foreign subsidiary, the related transaction gains and losses caused by changes in the exchange rate should be accounted for as transaction gains and losses. Refer to TX 13 for further discussion.
16.4.2 Income statement presentation of interest and penalties
In accordance with ASC 740-10-45-25, the decision as to whether to classify interest expense related to income taxes as a component of income tax expense or interest expense is an accounting policy election. Penalties are also allowed to be classified as a component of income tax expense or another expense classification (e.g., selling, general and administrative expense) depending on the reporting entity’s accounting policy.
Reporting entities are required to disclose their policy and the amount of interest and penalties charged to expense in each period, as well as the amounts accrued on the balance sheet for interest and penalties. Any change in the classification of interest or penalties is a change in accounting principle subject to the requirements of ASC 250, Accounting Changes and Error Corrections, and therefore must be a change to a preferable accounting method (see FSP 30).
Although ASC 740 does not provide guidance on the balance sheet classification of accrued interest and penalties, we believe that it should be consistent with the income statement classification. If the reporting entity’s accounting policy election is to classify interest and penalties as “above the line” income statement items (i.e., included in pretax income or loss), the accrued balance sheet amounts should not be included with the tax balance sheet accounts. Instead, they should be included with accrued interest and/or other accrued expense.
ASC 740 is also silent on the classification of interest income received as it relates to income taxes. We believe that the classification of interest income should be consistent with the reporting entity’s treatment of interest expense (i.e., either as a component of tax expense or as a pretax income line item).
Questions may arise as to whether the disclosure of total tax-related interest should be net of any interest income and of any potential tax benefit associated with an interest deduction. We believe that interest expense should be disclosed on a gross basis. However, if a reporting entity also wishes to disclose the amount of interest income it recorded in connection with tax overpayments, and any tax benefits generated from interest deductions, it would not be precluded from doing so.
16.4.3 Presentation of changes in tax laws, rates, or status
Reporting entities should include adjustments to deferred tax balances related to enacted changes in tax laws, tax rates, or tax status in income from continuing operations, regardless of whether the deferred tax balances originated from charges or credits to another category of income (e.g., discontinued operations or other comprehensive income).
When rate changes are enacted with retroactive effects, ASC 740-10-30-26 specifies that the current and deferred tax effects of items not included in income from continuing operations that arise during the current year, but before the date of enactment, should be measured based on the enacted rate at the time the transaction was recognized for financial reporting purposes. The adjustment that results from remeasuring these items because of the tax rate change should be reflected in income from continuing operations in the period of enactment.
Example FSP 16-1 illustrates the effect of a change in tax law and the appropriate intraperiod allocation.
EXAMPLE FSP 16-1
Presentation of the effects of a tax law change when prior year results are restated for discontinued operations
Presentation of the effects of a tax law change when prior year results are restated for discontinued operations
In the prior year, a provincial tax law was enacted in Country A which resulted in a charge to FSP Corp’s consolidated financial statements. This effect was appropriately recorded in tax expense from continuing operations in the financial statements for that fiscal year. In the current year, FSP Corp agrees to sell all of its operations in Country A and recasts Country A’s operations as a discontinued operation. The results from continuing operations no longer include any operations from Country A.
Should the effects of the tax law change that were originally recorded in continuing operations also be reclassified to discontinued operations?
Analysis
No. The effect of the change in tax law should be included in income from continuing operations for the period that includes the enactment date. Therefore, the amount of taxes associated with the discontinued operation should be the difference between the taxes previously reported in continuing operations and the amount of taxes allocated to continuing operations after the decision to dispose of Country A’s operations occurred, which would still include the impact of the tax law change.
See TX 12 for more information on intraperiod tax allocations.
16.4.4 Income taxes attributable to noncontrolling interests
The financial statement amounts reported for income tax expense and net income attributable to noncontrolling interests differ based on whether the subsidiary is a C-corporation or a partnership. The tax status of each type of entity causes differences in the amounts a parent would report in its consolidated income tax provision and net income attributable to noncontrolling interests.
A C-corporation is generally a taxable entity and is responsible for the tax consequences of its transactions. Therefore, a parent that consolidates a C-corporation includes the income taxes of the C-corporation, including the income taxes attributable to the noncontrolling interest, in its consolidated income tax provision. Net income attributable to the noncontrolling interest should equal the noncontrolling interest’s share of the C-corporation’s net income, which would include a provision for income taxes.
The legal liability for income taxes of a partnership generally does not accrue to the partnership itself. Instead, the investors are responsible for income taxes on their share of the partnership’s income. Therefore, a parent that consolidates a partnership only reports income taxes on its share of the partnership’s income in its consolidated income tax provision. This results in a reconciling item in the parent’s income tax rate reconciliation that should be disclosed. Net income attributable to the noncontrolling interest should equal the noncontrolling interest’s share of the partnership’s income, which would not include a provision for income taxes.
The guidance relating to partnerships is applicable to other pass-through entities, such as limited liability companies (if they elect to be taxed as a partnership) and subchapter S-corporations. Note that limited liability companies should follow the guidance for C-corporations if they elect to be taxed as such.
Example FSP 16-2 illustrates the presentation of income tax and net income attributable to noncontrolling interests when the subsidiary is a C-Corporation or partnership.
EXAMPLE FSP 16-2
Presentation of income tax and net income attributable to noncontrolling interest
Presentation of income tax and net income attributable to noncontrolling interest
FSP Corp has a 70% ownership interest in Subsidiary B. The other 30% is owned by an unrelated party. FSP Corp consolidates the financial statements of Subsidiary B. FSP Corp has pretax income from continuing operations of $500 for the year ended December 31, 20X1. This amount includes $200 of pretax income from continuing operations from Subsidiary B. FSP Corp’s tax rate for the period is 25%. For purposes of this example, the tax effects of any outside basis differences have been ignored, and Subsidiary B is assumed to have no subsidiaries of its own.
How should income tax expense and net income be determined and presented in the consolidated financial statements?
Analysis
Assuming Subsidiary B is a C-corporation with a 25% tax rate, income tax expense and net income would be calculated and presented as follows:
Income from continuing operations, before tax |
$500 |
Income tax expense |
125
|
Net income |
375 |
Less: Net income attributable to noncontrolling interest |
45
|
Net income attributable to FSP Corp |
$330 |
Assuming Subsidiary B is a partnership, income tax expense and net income would be calculated and presented as follows:
Income from continuing operations, before tax |
$500 |
Income tax expense |
110
|
Net income |
390 |
Less: Net income attributable to noncontrolling interest |
60
|
Net income attributable to FSP Corp |
$330 |
If the subsidiary is a partnership, income attributable to noncontrolling interest should be disclosed as a reconciling item in FSP Corp’s tax rate reconciliation.
16.4.5 Presentation of cash and other benefits not considered “income tax” benefits when using PAM
ASC 323-740 provides guidance when applying PAM, including the presentation of cash flows and other benefits that are not income tax benefits. PAM requires the initial cost of the tax equity investment less the expected residual value to be amortized in proportion to the tax benefits received over the period that the investor expects to receive the income tax credits and other income tax benefits. The initial cost is inclusive of unconditional future capital commitments (see “Delayed equity contributions” in TX 3.3.6.7) and the residual value is the expected proceeds upon exercise of a put or call option. This amortization (described in more detail in TX 3.3.6.4) is presented net of the related tax credits and other tax benefits within the income statement as a component of income tax expense (benefit). However, ASC 323-740-35-5 states that any non-income-tax-related benefits received from the investee (which could either be cash flow from operations or credits that are not considered income tax credits under ASC 740) should be included in pretax earnings when realized or realizable. Similarly, any gains or losses on the sale of the investment should also be included in pretax earnings at the time of sale.
1 Calculated as $500 x 25%
2 Calculated as ($200 – (200 x 25%)) x 30%
3 Calculated as ($500 – (200 x 30%)) x 25%
4 Calculated as $200 x 30%
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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