ASC 740 contains minimal explicit guidance on the accounting for deferred taxes associated with investments in partnerships or other “flow-through” entities (e.g., LLCs). We believe that deferred taxes related to an investment in a foreign or domestic partnership (and other flow-through entities that are taxed as partnerships, such as multi-member LLCs) should be based on the difference between the financial statement amount of the investment and its tax basis (i.e., its outside basis difference). This is the case regardless of whether the book investment in the partnership is accounted for using the fair value or equity method or is subject to full or proportionate consolidation. Broadly, the rationale for this view is that the entity itself is not subject to tax so the notion of providing deferred taxes on the “inside” basis differences of the underlying assets and liabilities is inconsistent with the nature of the entity. Deferred taxes should be based on the tax consequences, including (1) 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) associated with the investor’s/partner’s expected method of recovering its book investment in the partnership and (2) the character of taxable income that the recovery will generate (e.g., ordinary versus capital gain). Furthermore, if an entity is treated as a partnership or other pass-through entity by its parent for tax purposes, the parent cannot utilize the indefinite reversal exception in ASC 740-30-25-17 to avoid recording a deferred tax liability on the outside basis difference unless the partnership applies the look through approach. Refer to section TX 11.7.1 for further details.

11.7.1 Exceptions for partnership and other flow-through entities

Different views exist regarding if and when deferred taxes should be provided on the portion of an outside basis difference in a partnership that is attributable to nondeductible goodwill in the partnership. For example, assume that an entity contributes the net assets of one of its subsidiaries to a partnership, and that those assets include nondeductible goodwill. Because nondeductible goodwill, by definition, has no tax basis, a portion of the “outside” basis difference is essentially a permanent difference—i.e., it will reverse without a tax consequence. Some believe that deferred taxes should be recognized on the entire outside basis difference consistent with the general model for recognizing deferred taxes for investments in these entities. Others believe that the portion attributable to nondeductible goodwill should be excluded from the deferred tax liability recorded on the outside basis difference because no deferred tax liability was recognized for that goodwill prior to its contribution to the partnership (i.e., a look through approach). Still others take the view that the look through approach would only apply in cases where the partnership is controlled and consolidated by the investor. Acknowledging this diversity in practice and that each view has merit, we do not object to any of these practices.
Other exceptions to the comprehensive model of recognition should also be evaluated if a look through approach is being applied. These may include the indefinite reversal exception in ASC 740-30-25-17 or the exception to recognizing a deferred tax asset in ASC 740-30-25-9, both of which might be applied with regard to a foreign subsidiary owned by a partnership.
Questions have arisen as to whether the “reverse in the foreseeable future” guidance in ASC 740-30-25-9 applies to potential deferred tax assets for outside basis differences in a partnership investment. Read literally, this guidance would not apply because it is limited to a subsidiary or corporate joint venture that is essentially permanent in duration. However, in situations in which the investor entity controls the partnership, it may be appropriate to consider this guidance by analogy. For example, if all or a portion of the outside excess tax basis in the partnership is expected to be realized only through sale of the investment, it may be appropriate to suspend recognition of the related deferred tax asset until a sale is contemplated in the foreseeable future. The decision to analogize to ASC 740-30-25-9 should be applied consistently.
When assessing the realizability of a deferred tax asset related to an investment in a partnership, it is important to remember that the deferred tax asset represents a potential future tax loss that is often capital in nature. Under existing US tax law, future taxable income of a similar nature (i.e., capital gains) would be necessary to realize the benefit of the capital loss that underlies the deferred tax asset.
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