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11.5 Deferred tax assets related to outside basis
Publication date: 31 Dec 2023
us Income taxes guide
An excess of outside tax basis over outside book basis in a subsidiary or corporate joint venture that is essentially permanent in duration may give rise to a deductible temporary difference for which a deferred tax asset may need to be recognized. In these circumstances, under ASC 740-30-25-9, a deferred tax asset is recognized “only if it is apparent that the temporary difference will reverse in the foreseeable future.” The “foreseeable future” as used in ASC 740-30-25-9 is a finite horizon, in contrast to the indefinite reversal criteria of ASC 740-30-25-17. Although ASC 740 does not specifically define foreseeable future, we believe that it would generally be within the next year. Thus, to record a deferred tax asset for a foreign excess outside tax basis, management should be fully committed to a plan that would result in the reversal of the temporary difference, and not just exploring it as a possibility. In the case of a sale of a subsidiary, we believe that in most cases, such a deferred tax asset should be recognized when the held-for-sale conditions of ASC 360-10-45-9 are met.
It should be noted that the generation of future profits does not constitute “reversal” of an excess tax outside basis difference. ASC 740-10-25-20 defines a deductible temporary difference as a temporary difference that results in deductible amounts in future years when the related asset or liability is recovered or settled, respectively. Thus, “reversal” of a deductible temporary difference provides a tax deduction when the related asset is recovered. Future earnings may reduce the deferred tax asset but do not result in a tax deduction or benefit in the parent’s tax return.
Example TX 11-3 discusses the recognition of a deferred tax asset for a worthless stock deduction.
EXAMPLE TX 11-3
When to recognize a tax benefit for a worthless stock deduction
When to recognize a tax benefit for a worthless stock deduction
Company A, a US corporation, has a wholly-owned foreign subsidiary (FS). At December 31, 20X1, Company A’s book basis in FS was zero due to significant prior year losses; its tax basis in the shares of FS stock was $100 million. During Q4 of 20X1, discussions occurred concerning the viability of FS’s business plans leading to a decision to cease operations and liquidate FS. It was expected that the liquidation of FS would be consummated within the next year. In Q1 20X2, Company A made a “check-the-box” (CTB) election to treat FS as a disregarded entity retroactively effective on the last day of 20X1. The CTB election resulted in a deemed liquidation of FS for US federal income tax purposes, leading Company A to claim its $100 million tax basis in FS as a worthless stock deduction on the 20X1 tax return. The CTB election has no other US or foreign tax implications and FS has no inside basis temporary differences. At December 31, 20X1, management concluded that without the CTB election (or other process of liquidation), Company A would not have met the more-likely-than-not recognition threshold to recognize the tax benefit from the worthless stock deduction.
When should Company A recognize the tax benefit from the worthless stock deduction (Q4 20X1 or Q1 20X2)?
Analysis
The tax effects of excess tax-over-book basis in the stock of a subsidiary should be recognized when it becomes apparent that the temporary difference will reverse in the foreseeable future. In the context of a worthless stock deduction, this criterion would generally be met in the earliest period in which the investment is considered “worthless” for federal income tax purposes. There are various measures used to determine whether stock is worthless, as well as specific events that confirm stock worthlessness, including a bankruptcy, appointment of a receiver by a court, and liquidation. If the occurrence of one of these events is necessary to meet the more-likely-than-not recognition threshold under ASC 740-10-25-6, the ability of the company to control the occurrence of that event must be considered in assessing whether it is apparent that the temporary difference will reverse in the foreseeable future. The relevant question in this example, therefore, is whether Company A could have concluded that the FS stock was worthless absent the CTB election or could presume completion of the “confirming” event. If the stock was otherwise considered worthless as of December 31, 20X1, the fact that the CTB election was filed in Q1 20X2 as opposed to 20X1 should not change the timing of when the benefit is recognized. Absent regulatory or other restrictions, the liquidation of FS via a CTB election would be considered primarily within Company A’s control.
The filing date of the CTB election and the selected effective date are not determinative if the stock was otherwise considered worthless as of December 31, 20X1, and the company expected to complete all relevant administrative procedures shortly thereafter. If the company had selected an effective date in 20X2, it would still not change the fact that as of December 31, 20X1, it was apparent that the excess tax basis would reverse (i.e., become deductible) within the next year.
11.5.1 Deferred tax assets for potential foreign tax credits
One of the implications from repatriating foreign earnings is that the repatriations may trigger FTCs, which may be used by the entity to reduce its taxes in the year of the repatriation or carried forward as a tax credit to be used in a subsequent year.
However, a deferred tax asset generally should not be recognized for FTCs that are not yet includible on a tax return, even though they are expected to be generated by the future reversal of a taxable temporary difference. These credits, sometimes referred to as "unborn FTCs" are inherent in the measurement of the deferred tax liability but are not separately recognizable as deferred tax assets. A deferred tax asset for unborn FTCs would not be recognized if there is neither a temporary difference nor a tax attribute for the FTC as the conditions to establish the FTCs have not been met.
There may be an exception to this concept when, except for the actual repatriation of cash, all of the conditions (including a payment or liability for the foreign tax and the existence of sufficient earnings and profits) have been met to establish the credits. Even in this case, an entity must be able to assert that the FTCs will be generated in the foreseeable future, as stipulated in ASC 740-30-25-9 (i.e., the entity is committed to making the repatriation in the near term). Only then should an entity record a deferred tax asset related to the FTC prior to its actual generation on the tax return.
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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