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11.2 Accounting for the outside basis of investments
Publication date: 31 Dec 2023
us Income taxes guide
The determination of whether a temporary difference should be recorded for outside basis differences depends on a number of factors. These include the legal form of the investee/subsidiary entity and its tax status (e.g., partnership, branch, controlled foreign corporation), whether it is domestic or foreign, and, in some cases, the reporting entity’s (investor’s) intentions with respect to its investment in the entity.
11.2.1 Distinguishing outside and inside bases
A company’s basis in its own assets and liabilities (e.g., accruals, intangible assets, property, plant, and equipment) is referred to as “inside basis.” A parent’s basis in the stock of its subsidiary is considered “outside basis.” An outside basis difference is the difference between a parent’s tax basis in the stock of the subsidiary and the book basis in its investment. In considering the parent’s outside basis in a subsidiary, it is important to note that “parent” does not necessarily mean the ultimate parent. The parent could be a subsidiary that owns another subsidiary. Outside basis differences need to be considered at every level of an organization’s legal entity structure. Figure TX 11-1 further demonstrates the concept of outside basis difference.
Figure TX 11-1
Outside versus inside basis differences
Outside versus inside basis differences
An outside basis difference may be created as a result of unremitted earnings. The parent's book basis in the subsidiary is increased by the subsidiary's earnings that have been included in consolidated net income, but that have not been remitted to the parent. There is generally no corresponding increase in the parent's tax basis in the subsidiary's stock if the subsidiary is not consolidated for tax purposes unless the tax law provides for taxation of the subsidiary's earnings immediately (for example, in the US, Subpart F and GILTI are aspects of the tax law that immediately tax a foreign subsidiary’s earnings). The resulting excess book-over-tax basis is a temporary difference if it will result in tax upon its reversal. Typically, reversal of the outside basis difference will occur through the subsidiary's payment of dividends, the parent's sale of the subsidiary's stock, liquidation of the subsidiary, or a merger of the subsidiary into the parent. Even though the parent's investment in the consolidated subsidiary does not appear as a separate asset in the parent's consolidated balance sheet, for the purposes of applying ASC 740, any outside basis difference must still be considered.
In addition to unremitted earnings, other events and transactions can result in an outside basis difference. These may include, but are not limited to, cumulative foreign currency translation adjustments (CTA), changes in a parent’s equity in the net assets of a subsidiary resulting from transactions with noncontrolling shareholders (i.e., the subsidiary’s capital transactions and transactions between parent and noncontrolling shareholders), movements in other components of the subsidiary’s other comprehensive income, such as unrealized gains or losses on available-for-sale debt securities, changes in the outside tax basis that sometimes arise in business combinations and reorganizations, and other changes in the subsidiary’s equity.
11.2.2 Domestic or foreign classification—outside basis differences
The classification of a subsidiary as either foreign or domestic can impact the accounting for the outside basis difference of a subsidiary or corporate joint venture. For example, ASC 740-30-25-5 and ASC 740-30-25-7 require that deferred taxes be provided on a book-over-tax (taxable) outside basis difference in a domestic subsidiary unless “the tax law provides a means by which the reported amount of that investment can be recovered tax-free and the entity expects that it will ultimately use that means.” However, deferred taxes on a book-over-tax outside basis difference in a foreign subsidiary or foreign corporate joint venture that is permanent in duration must be recorded unless the entity can substantiate an assertion that this basis difference will not reverse in the foreseeable future (see ASC 740-30-25-17 to ASC 740-30-25-18).
We believe that companies should look to the relevant tax law in the jurisdiction of the parent that holds the investment to determine whether the investment should be classified as foreign or domestic. For example, if a subsidiary of a US parent is treated as a domestic subsidiary under US tax law, it should be accounted for under ASC 740 as a domestic subsidiary regardless of where it is physically domiciled.
11.2.2.1 Tiered foreign subsidiaries—outside basis differences
Whether a subsidiary is domestic or foreign is determined at each level in the corporate structure. Accordingly, a second-tier foreign subsidiary owned by a first-tier foreign subsidiary in the same country would be a domestic subsidiary for purposes of applying the recognition provisions in ASC 740-30. Thus, a first-tier foreign subsidiary would have to provide deferred taxes for the outside basis difference of a second-tier subsidiary domiciled in the same country, assuming it does not meet any of the exceptions applicable to a domestic subsidiary.
Example TX 11-1 illustrates the determination of whether a subsidiary is domestic or foreign in a tiered foreign subsidiary structure.
EXAMPLE TX 11-1
Differentiating domestic and foreign subsidiaries
Differentiating domestic and foreign subsidiaries
US Parent P1 owns 100% of UK subsidiary S1. UK subsidiary S1 owns 100% of UK subsidiary S2 and Swiss subsidiary S3.
Are S1, S2 and S3 domestic or foreign subsidiaries?
Analysis
S1 is a foreign subsidiary with respect to P1. An outside basis difference related to P1's investment in S1 represents an outside basis in a foreign subsidiary and the accounting for the outside basis difference should be evaluated using the exceptions available to foreign subsidiaries (see TX 11.4).
S2 is a domestic subsidiary of S1. Therefore, the exceptions to comprehensive recognition of outside basis differences related to domestic subsidiaries applies to S1's investment in S2 (see TX 11.3).
S3 is a foreign subsidiary of S1. An outside basis difference related to S1’s investment in S3 represents an outside basis in a foreign subsidiary and the accounting for the outside basis difference should be evaluated using the exceptions available to foreign subsidiaries (see TX 11.4).
11.2.3 Corporate joint ventures—outside basis differences
The indefinite reversal exception in ASC 740-30-25-17 for the temporary difference arising from earnings in foreign subsidiaries that have not yet been remitted (paid as a dividend or otherwise distributed) to their parent (commonly referred to as “unremitted earnings”) also applies to a taxable outside basis temporary difference in a foreign corporate joint venture that is essentially permanent in duration. To qualify as “essentially permanent in duration,” the joint venture cannot have a life limited based on the terms of the joint venture agreement or resulting from the nature of the venture or other business activity. See ASC 323-10-20 for the definition of a corporate joint venture.
11.2.4 Overview of deferred taxes for outside basis differences
The following tables summarize the recognition of deferred taxes on outside basis differences.
Subsidiary |
Deferred tax asset |
Deferred tax liability |
|---|---|---|
Domestic 1
|
Recognize a deferred tax asset only if it is apparent that the temporary difference will reverse in the foreseeable future. See TX 11.5. 2
|
Recognize a deferred tax liability unless the reported amount of the investment can be recovered tax free without significant cost, and the entity expects to ultimately use that means of recovery. See TX 11.3.2. 2
|
Foreign
|
Recognize a deferred tax asset only if it is apparent that the temporary difference will reverse in the foreseeable future. See TX 11.5. 2
|
1 Different accounting applies to outside basis differences that arose in fiscal years prior to December 15, 1992. See TX 11.3.
2 In cases where an entity’s status changes from equity method investee to subsidiary, refer to TX 11.9.2 for guidance on any previously recognized deferred tax asset or liability.
Corporate joint venture |
Deferred tax asset |
Deferred tax liability |
|---|---|---|
Foreign
|
Recognize a deferred tax asset only if it is apparent that the temporary difference will reverse in the foreseeable future. See TX 11.5.
|
1 Different accounting applies to outside basis differences that arose in fiscal years prior to December 15, 1992. See TX 11.3.
Investment (other than a joint venture) |
Deferred tax asset |
Deferred tax liability |
|---|---|---|
Fair value method
|
Differences between the fair value and the tax basis of the investment represent temporary differences for which deferred taxes should be provided.
|
|
Measurement alternative 3
|
Differences between the carrying amount and the tax basis of the investment represent temporary differences for which deferred taxes should be provided.
|
|
2 When an entity’s status changes from a subsidiary, refer to TX 11.9.2 for guidance with respect to any previously unrecognized deferred tax asset or liability.
3 May only be used when the equity method is not applied, and there is not a readily determinable fair value.
Partnership or other flow-through entity |
|
|---|---|
Foreign or domestic
|
A deferred tax asset or liability should generally be recorded. See TX 11.7.
|
Foreign operations–special considerations |
|
|---|---|
Foreign branches
|
Generally, income and losses generated by a foreign branch are subject to taxation in both the foreign and domestic jurisdictions currently. When this is the case, deferred taxes should be recorded for both jurisdictions. The deferred taxes recorded in the parent’s domestic jurisdiction should also include the domestic tax effects of the foreign temporary differences, similar to the federal tax effect on state deferred taxes. See TX 11.10.1.
|
Subpart F income
|
The US subpart F rules can result in current US taxation of certain amounts of otherwise unremitted earnings of a foreign subsidiary. Accordingly, for a foreign subsidiary that generates subpart F income, US deferred taxes should be recognized for temporary differences that will generate subpart F income upon reversal. See TX 11.10.2.
|
GILTI
|
The US GILTI provisions result in a current taxable inclusion of certain foreign earnings. Entities can elect to recognize deferred taxes for basis differences that are expected to reverse as GILTI in future years. See TX 11.10.3.
|
Pillar Two
|
The GloBE minimum tax is an alternative minimum tax as discussed in ASC 740. Accordingly, reporting entities would not recognize or adjust deferred tax assets and liabilities for the estimated future effects of Pillar Two taxes. Rather, the tax would be accounted for as a period cost impacting the effective tax rate in the year in which the GloBE minimum tax obligation arises. See TX 4.3.7.
|
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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