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15.2 Uncertain tax positions—scope and unit of account
Publication date: 31 Mar 2023
us Income taxes guide
ASC 740 provides guidance for recognizing and measuring tax positions taken or expected to be taken in a tax return. The guidance in ASC 740 applies to taxes (and thus uncertain tax positions) that are “based on income.” It should not be applied by analogy to non-income-based taxes, such as sales taxes, value-added taxes, or property taxes. Entities have historically applied ASC 450, Contingencies, to the recognition of non-income-based tax exposures.
15.2.1 Uncertain tax positions—entities within scope
The guidance related to the recognition and measurement of uncertain tax positions within ASC 740 is applicable to business entities, not-for-profit organizations, pass-through entities, and entities whose tax liability is subject to 100% credit for dividends paid (such as investment trusts and registered investment companies). It applies to all jurisdictions and all tax positions accounted for under ASC 740, regardless of the nature of the entity or taxing jurisdiction. Therefore, the requirements of ASC 740 are applicable to tax positions taken by a not-for-profit or governmental entity, including those that would affect the amount of unrelated business income taxes. The requirements of ASC 740 may also be applicable to certain S corporations that have converted from C corporation status and have recorded deferred taxes related to built-in gains.
Additionally, a non-US parent entity may file US GAAP consolidated financial statements that include both non-US and US subsidiaries. The parent entity must calculate the impact of applying ASC 740's guidance for recognition and measurement of unrecognized tax benefits for the group as a whole (i.e., for all income tax jurisdictions) because the guidance is applicable to all positions accounted for under ASC 740, regardless of the taxing jurisdiction.
Finally, foreign registrants and non-issuer foreign businesses that follow their local GAAP and present a footnote reconciling their local GAAP to US GAAP for US regulatory filing purposes are required to apply the recognition and measurement criteria in ASC 740 to determine net income and shareholders’ equity in accordance with US GAAP.
15.2.1.1 Uncertain tax positions in a business combination
In a taxable business combination, positions may be taken in allocating the acquisition price and in filing subsequent tax returns that are expected to be challenged by the taxing authority. Similarly, in nontaxable business combinations, there may be uncertainties about the tax basis of individual assets or related to the pre-acquisition tax returns of the acquired business.
Entities should record income tax-related uncertainties acquired in a business combination in accordance with the recognition and measurement criteria of ASC 805-740.
Adjustments to uncertain tax positions made subsequent to the acquisition date are recognized in earnings, unless they qualify as measurement period adjustments. Measurement period adjustments are recorded first as an adjustment to goodwill, then as a bargain purchase. A measurement period adjustment is an adjustment within the measurement period that relates to facts and circumstances that existed at the acquisition date.
See TX 10.7 for further discussion on the treatment of income tax uncertainties in a business combination.
15.2.1.2 Uncertain tax positions in separate financial statements
ASC 740-10-30-27 addresses the preparation of separate financial statements of a subsidiary and requires that entities adopt a method for allocating taxes to the subsidiary that is “systematic, rational, and consistent with the broad principles established by this Subtopic.” Accordingly, we believe that entities should include uncertain tax positions when preparing separate financial statements. See TX 14 for guidance on accounting for separate entity financial statements.
15.2.2 Identifying uncertain tax positions
ASC 740 defines the term “tax position.”
Excerpt from FASB master glossary—Tax position
A position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. A tax position can result in a permanent reduction of income taxes payable, a deferral of income taxes otherwise currently payable to future years, or a change in the expected realizability of deferred tax assets. The term tax position also encompasses, but is not limited to:
- A decision not to file a tax return
- An allocation or a shift of income between jurisdictions
- The characterization of income or a decision to exclude reporting taxable income in a tax return
- A decision to classify a transaction, entity, or other position in a tax return as tax exempt
- An entity’s status, including its status as a pass-through entity or a tax-exempt not-for-profit entity.
The average corporate tax return will include numerous positions taken in the ordinary course of business that are subject to significant and varied interpretation. Due to the complexities of many tax systems and today’s business environment, we believe that almost all entities will have some uncertain tax positions in open tax years. Uncertain positions do not just relate to positions that have an ultimate effect on income tax expense. They may include issues that impact other line items, such as the allocation of purchase price to assets and liabilities acquired in business combinations and issues related to share-based payments. They may also relate to positions that have no current year impact on the income statement, such as a fully reserved net operating loss (NOL) carryforward.
Entities will need to identify and assess all significant uncertain positions in all tax years that are still subject to assessment or challenge under relevant tax statutes.
15.2.2.1 Decision not to file a tax return
An entity’s decision not to file a tax return in a jurisdiction where it might have nexus in a particular US state or a permanent establishment in a foreign tax jurisdiction is considered a tax position.
If the entity is unable to support the technical sustainability of its position at the prescribed recognition threshold, it must recognize a liability for the amount of the benefit that it realized from its unfiled tax return (i.e., by not filing and consequently not paying tax, the entity essentially realizes the benefit of taking this position). The entity must also recognize interest and any penalties, even though it has not been audited by the taxing authority. If the entity is able to support the technical sustainability of its position, it will need to measure the benefit as the largest amount that is cumulatively greater than 50% likely to be sustained upon settlement. If the amount measured is less than the full benefit of not filing returns, the difference is reflected as a liability.
In jurisdictions where failing to file a tax return prevents the statute of limitations from commencing, it is possible that the liability may never reverse, enabling interest and penalties to accrue in perpetuity. This would not eliminate the need to recognize a liability under ASC 740. If, when assessing nexus, the jurisdiction in question has a widely understood practice of pursuing back-taxes for a limited number of years, the entities subject to that jurisdiction should apply the “administrative practices” accommodation described in ASC 740-10-25-7(b) by accruing taxes, interest, and penalties (if applicable) for those years. TX 15.3.1.4 discusses the application of administrative practice and precedent to the recognition of a liability for an unrecognized tax benefit, while TX 15.6.2 discusses the application of administrative practice and precedent to interest and penalties.
15.2.2.2 UTPs related to equity method investments
When assessing whether uncertain tax positions exist, the analysis may extend beyond the entities included in the consolidated financial statements. For example, a corporation that owns an interest in an entity that, for tax purposes, is classified as a partnership may use equity method accounting to account for its partnership interest. However, the corporation should analyze significant uncertain tax positions that exist within the partnership since positions taken by the partnership affect both the current and deferred tax provision of the corporate partner. That is, a corporate partner’s distributive share of partnership income or loss should be the share of partnership income or loss that can be recognized by the partner pursuant to ASC 740. US partnerships typically issue Schedule K-1s to its partners and report the partners’ distributive share of partnership income or loss. The difference between amounts reported on Schedule K-1 and amounts that should be reported pursuant to ASC 740 would represent unrecognized tax benefits.
Additionally, a reporting entity may have investments in other entities that are taxable as corporations and are accounted for under the equity method of accounting. While the entity is not required to separately disclose the uncertain tax positions of its equity method investees, it should consider analyzing any significant uncertain tax positions that may affect its investment in the equity method investee. Disclosures of significant uncertainties that may affect the corporate investor’s accounting for its equity investments may be appropriate.
15.2.3 Unit of account for uncertain tax positions
The unit of account defines the level at which a tax position should be analyzed. A tax exposure could have multiple elements or parts that are interrelated with varying implications on the expected tax benefits. Therefore, the selection of a unit of account (i.e., the appropriate level of disaggregation) can affect the amount of tax benefit that may be recognized in the financial statements. The unit of account is addressed in ASC 740-10-25-13.
The appropriate unit of account for determining what constitutes an individual tax position, and whether the more-likely-than-not recognition threshold is met for a tax position, is a matter of judgment based on the individual facts and circumstances of that position evaluated in light of all available evidence. The determination of the unit of account to be used shall consider the manner in which the entity prepares and supports its income tax return and the approach the entity anticipates the taxing authority will take during an examination. Because the individual facts and circumstances of a tax position and of an entity taking that position will determine the appropriate unit of account, a single defined unit of account would not be applicable to all situations.
For many tax exposures, the selection of the appropriate unit of account is intuitive (e.g., company-wide cost of meals and entertainment in a taxing jurisdiction). However, for some tax exposures, determining a unit of account can be a complex exercise that involves a number of different factors (e.g., different jurisdictions, activities, characteristics of the benefits).
To determine the appropriate unit of account, management should consider the facts and circumstances specific to each entity and position, including the tax return computation of a deduction, credit, or income generated by the position. An entity should also consider the audit approach that a taxing authority might take when examining the position and the entity’s audit experience related to the same or similar positions.
The significance of the exposure in relation to the overall tax return may impact the assessment of unit of account. A position that results in a tax return benefit that is significant within the context of the entity’s operations or key measures might suggest that a more disaggregated analysis should be performed.
ASC 740-10-55-83 through ASC 740-10-55-86 provides an example of how to apply the guidance on unit of account.
15.2.3.1 Consistency in a tax position’s unit of account
Once a unit of account for a given tax position has been determined, it should be applied consistently to that position from period to period, unless changes in circumstances suggest that a change in the analysis is warranted. Factors that might prompt management to change its assessment of the appropriate unit of account include, but are not limited to, changes in organizational structure and level of activity, changes in product line or service offering, changes in the regulatory environment, and experience with the taxing authority. These types of changes would be characterized as a change in estimate. See ASC 740-10-55-88 through ASC 740-10-55-89 for an example of when a change in the unit of account may be warranted.
15.2.3.2 Unit of account for UTPs for multiple similar transactions
An entity may have multiple transactions or positions that are similar and likely to be evaluated in aggregate by the relevant taxing authority. In certain cases, management’s assessment might support one unit of account for all of the transactions combined (e.g., the unit of account is 50 similar transactions analyzed as one). Management may be able to support a single unit of account if it concludes that the transactions are substantially the same in terms of (1) the expected tax benefits, (2) the relevant technical issues and uncertainties, and (3) the approach that a taxing authority will take during an examination (i.e., if a portfolio approach would be used). If using a portfolio approach, a taxing authority may reject certain individual positions that a filer takes as a means of settlement because they are precluded from negotiating a settlement on an individual position. Still, as long as the related positions are substantially the same, management may be able to support a single unit of account even though the taxing authority may choose to settle the components individually.
15.2.3.3 Unit of account for UTPs for multiple dissimilar transactions
An entity may take positions on multiple transactions that require a separate unit of account for each transaction. If all of the positions meet the requirements for recognition, but the taxing authority is expected to settle them in aggregate (i.e., a portfolio approach), entities may be inclined to use a single unit of account for measurement even though separate units of account were used for the recognition assessment. However, we believe that the unit of account should be the same for recognition and measurement of a tax position. When the appropriate unit of account is determined to be the individual transaction, the recognition and measurement steps should be applied to that discrete position.
A taxing authority’s portfolio approach to settlement can be viewed as another possible outcome in a range of possible outcomes used in the measurement analysis. For example, assume that a research credit has five individual tax positions that all meet the recognition threshold and are expected to be settled using a portfolio approach. The taxpayer expects to receive 80 cents on the dollar for those five positions in aggregate. Under this approach, 80% of each individual position would be separately recognized (i.e., you would assume each position will be settled at 80%). This is acceptable if there is evidence to suggest that the relevant taxing authority has accepted such a settlement approach in the past.
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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