Often, parent entities have intercompany loans with their foreign subsidiaries that are of a long-term investment nature (that is, settlement is not planned or anticipated in the foreseeable future, as discussed in ASC 830-20-35-3(b)). Typically, these loans are either denominated in the functional currency of the parent or the functional currency of the subsidiary. Because of the difference between the functional currencies and the denomination of the loan, foreign currency translation adjustments arise. In general, currency gains and losses relating to intercompany loans are included in consolidated earnings. However, gains and losses on the remeasurement of loans that are designated as long-term are reclassified to CTA in consolidation. Consideration must be given to whether deferred taxes should be recorded on the gains and losses included in translation adjustments, particularly in light of any assertion of indefinite reversal under ASC 740-30-25-17. Consider Example TX 13-3.

EXAMPLE TX 13-3
Deferred taxes on the foreign currency gains and losses reported in CTA

Company X is a US multinational corporation and has several outstanding intercompany loans with one of its wholly-owned foreign subsidiaries, Subsidiary Y. The functional currency of Subsidiary Y is the local currency. Company X has asserted that the loans are of a long-term investment nature. Therefore, foreign currency gains and losses related to the loans are reported in CTA in the consolidated financial statements under ASC 830-20-35-3(b).

The intercompany loans can be divided into the following two categories:

Company X asserts and meets the indefinite reversal criteria under ASC 740-30-25-17 for its investment in Subsidiary Y.

Should deferred taxes be provided on the foreign currency gains and losses related to the loans and reported in CTA?

ASC 830-30-45-21 states that translation adjustments should be accounted for in the same way that temporary differences are accounted for under the provisions of ASC 740, except for translation adjustments related to foreign subsidiaries when deferred taxes are not provided on unremitted earnings under the indefinite reversal exception in ASC 740-30-25-17.

The intercompany loans and the related gains and losses on the loans denominated in the functional currency of Subsidiary Y (the local currency) should be viewed as a part of Company X’s net investment in Subsidiary Y (i.e., outside basis). The tax effects should be evaluated under the governing principles of the indefinite reversal criteria in ASC 740-30-25-17. Accordingly, if Company X is able to meet the indefinite reversal criteria under ASC 740-30-25-17, a deferred tax liability would not be recorded for a book-over-tax outside basis difference.

The gains and losses on intercompany loans denominated in the functional currency of Company X create a difference between the book basis and tax basis of the intercompany payable on Subsidiary Y’s books (i.e., inside basis difference). Deferred taxes should generally be provided on these types of temporary differences, and the tax benefit or expense should generally be recorded in CTA, subject to the intraperiod allocation rules of ASC 740-20. However, as the parent is asserting indefinite reversal of its outside basis difference in Subsidiary Y under ASC 740-30-25-17, it may be appropriate in limited circumstances not to record deferred taxes on the temporary differences related to the cumulative translation adjustments pursuant to ASC 830-30-45-21. This approach would be acceptable if the ultimate taxation of the foreign currency effects of the loan only occur upon repayment and if settlement is not planned or anticipated in the foreseeable future. Importantly, if any actions other than a cash remittance or repatriation could cause the foreign currency effects of the loan to become taxable, Company X would need to consider whether the taxable event can, in fact, be deferred indefinitely. Such actions might include modifying the terms of the loan or recapitalizing a portion of it.

In addition, any temporary difference resulting from an excess of tax-over-book outside basis difference would need to be evaluated under ASC 740-30-25-9. Under that guidance, a deferred tax asset is recorded only if it is apparent that the temporary difference will reverse in the foreseeable future.