Investments accounted for under the equity method for financial reporting purposes, pursuant to ASC 323, Investments—Equity Method and Joint Ventures, are generally recorded at cost basis for tax purposes. As a result, as the investor’s share of an investee’s earnings are accrued for book purposes through application of the equity method, a temporary difference arises between the book and tax bases for these investments.
ASC 740-30-25-5(b) requires recognition of a deferred tax liability for the excess book-over-tax basis of an investment in a 50%-or-less-owned investee. Therefore, the outside book-over-tax basis in the investment should result in a deferred tax liability. In addition, because the additional “reverse in the foreseeable future” criterion in ASC 740-30-25-9 (see TX 11.5) does not apply to foreign or domestic unconsolidated investees, the outside tax-over-book basis for such an investment should generally result in a deferred tax asset.
ASC 740-30-25-18 provides an exception to recording a deferred tax liability for an outside basis difference in a corporate joint venture that is essentially permanent in duration. However, a corporate joint venture that is not permanent in duration is substantively the same as any other equity investment.
Based on ASC 740-10-55-24, the measurement of deferred tax liabilities and assets depends on the expected type of taxable or deductible amounts in future years. That is, it depends on how the investment, including the tax consequences of any foreign currency gains or losses, federal and state taxes, and foreign withholding taxes (see TX 11.4.1 and 11.8), will ultimately be realized (e.g., through dividends, sale, or liquidation). In providing deferred taxes, understanding the expected form of realization by the investor—dividends vs. capital gains—is often critical. See TX 11.8.2 for further discussion.
The outside basis difference is calculated by comparing the tax basis of the stock to the book basis of the investment. While determining the tax basis (i.e., cost) of the stock is generally straightforward, complexities often arise when applying the equity method to determine the book basis. EM 3.3 provides further guidance on this allocation process and determining the underlying equity in the net assets of the investee.
The results of the equity method investee are reported in investor’s financial statements net of the investee’s tax expense. Separately, any incremental investor tax expense or benefit related to the equity method investment is presented with the investor’s income tax expense or benefit. As these tax effects are those of the investor, not the investee, they should be recognized in the investor’s tax provision, not offset within the investor’s equity in net earnings of the investee.
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