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13.2 Translation of foreign deferred taxes
Publication date: 31 Mar 2023
us Income taxes guide
When the local currency is the functional currency, the local currency-denominated income tax assets and liabilities, including foreign deferred tax assets and liabilities as well as liabilities for uncertain tax positions, are translated at current rates under ASC 830. The translation results are generally reported in CTA.
Additionally, so-called “top-side” and consolidating accounting entries should be evaluated to determine whether such entries should be considered as part of the foreign entity’s books. If they are part of the foreign entity’s books, those accounts must be remeasured in the functional currency and then translated to the reporting currency using the current rate method of translation. Such accounting entries may include acquisition accounting adjustments or unrecognized tax benefits relating to uncertain tax positions of the foreign operation.
13.2.1 Translation adjustments in outside basis difference
Translation adjustments typically represent a portion of the outside basis difference related to a parent’s investment in a foreign subsidiary. These adjustments, in general, reflect the gains and losses associated with the translation of a foreign subsidiary’s financial statements from its functional currency into the reporting currency. ASC 830-30-45-21 states that deferred taxes shall not be provided on translation adjustments when deferred taxes are not provided on unremitted earnings under the indefinite reversal exception discussed in ASC 740-30-25-17. However, if deferred taxes are not provided on unremitted earnings because it is expected that their repatriation will result in no additional US tax because of foreign tax credits or dividends received deductions, it may still be necessary to provide for deferred tax on translation adjustments.
When determining whether to record income taxes for translation adjustments, as well as how the tax would be estimated, the following points should be considered:
- The evaluation should first be made on a foreign operation by foreign operation basis. Then, circumstances may indicate that operations will be aggregated by tax jurisdiction for tax planning and measurement purposes.
- Even though all local currency assets and liabilities affect the translation adjustment, the measurement of the tax should be directly related to the portion of equity that is expected to be remitted. If a return of both capital and retained earnings is contemplated, it may be appropriate to consider whether the capital portion is likely to be taxed as a capital gain and will not trigger any foreign tax credits as no local taxes would typically have been paid with respect to the currency effects.
- Companies should also consider whether the translation adjustments will result in ordinary or capital gain or loss. Different tax rates may apply, and the assessment of whether realization of deferred tax assets is more likely than not may be affected. Further, potential utilization of foreign tax credits and applicable foreign tax withholdings need to be considered in determining the measurement of deferred taxes.
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