According to ASC 740-10-25-7(b), the assessment of whether an entity can sustain a position should be based on the technical merits of the position, including consideration of “administrative practices and precedents.” Administrative practices and precedents represent situations in which a tax position could be considered a technical violation of tax law, but it is widely known, well understood, and a consistent practice of the taxing authority (with full knowledge of the position being taken) to nonetheless accept the position. When asserting that a particular administrative practice or precedent is applicable to a particular tax position, an entity should presume that the taxing authority will examine the position using the same information that is available to the entity.

While administrative practices and precedents do not need to be sanctioned by taxing authorities in formal regulation or letter ruling, it should be clear (through the taxing authorities’ well-known past actions or declarations) that a tax position is more-likely-than-not to be sustained (if examined), despite its apparent conflict with the enacted tax law. Unless it becomes known that the taxing authority will no longer accept a particular administrative practice, preparers should consider these practices in forming their conclusions as to whether a position has satisfied the recognition threshold.

The following ASC paragraphs describe an administrative practice related to asset capitalization.

Use of the administrative practices and precedents accommodation should be limited and considered only if a tax position might be deemed a technical violation of the tax law or if there is compelling evidence that the taxing authority has and is expected to accept the tax position as an administrative accommodation.

A particular agent or examiner within a taxing authority may historically have accepted a position that is generally not accepted by other agents auditing other taxpayers in similar businesses. Regardless of how a particular agent has treated an item in the past, the recognition step requires that tax positions be evaluated on the technical merits of the position. The historical action of one agent or examiner would not represent a consistent administrative practice that is “widely understood” and hence would not generally be relevant in determining whether the recognition threshold has been met.

Many jurisdictions offer amnesty programs or limit the tax they assess in past periods for taxpayers that voluntarily come forward and admit noncompliance in previous years. However, the administrative practice or precedent that may be available to self-reporting entities for nexus-related issues may not be available to those entities that fail to come forward and are subsequently identified by the taxing authority. Accordingly, it would not be appropriate for an entity that has no intention of coming forward to consider an administrative practice made available to those that do come forward, unless there is substantial evidence that they will be treated the same way as those that self-report.

In general, an entity may have some form or combination of legal, structural, or commercial ties to a jurisdiction (e.g., employees, inventory, fixed assets, commissionaire arrangements, contract manufacturing arrangements). An entity with such ties could potentially have nexus, and would therefore be required to file a tax return under the tax laws of the relevant jurisdiction. Absent an applicable administrative practice, a nexus position (i.e., a decision not to file a tax return in a particular jurisdiction if nexus potentially exists) that does not meet the recognition threshold would require the accrual of tax, interest, and penalties for the entire period in which nexus could be asserted by the taxing authority.

However, as a matter of administrative convenience, some jurisdictions have limited the number of years for which an entity would be required to file back tax returns. Under ASC 740-10-25-7, that practice should be considered in management’s decision to record tax, interest, and/or penalties.

ASC 740-10-55-94 through ASC 740-10-55-95 provide the following example about the use of administrative practices and precedents within the context of nexus.

ASC 740 defines a temporary difference as the difference between the tax basis of an asset or liability and its reported amount in the financial statements. ASC 740’s recognition and measurement criteria are applicable to temporary differences between book and tax bases, even if the only uncertainty is the timing of the position taken for tax purposes. For example, assume that an entity deducts for tax purposes the entire balance of an intangible asset in the year of an acquisition. For book purposes, the entity amortizes the intangible asset over five years (leading to a deferred tax liability). While the ultimate deduction of the asset is certain under the relevant tax law, the timing related to whether the deduction can be taken in full in the year of the acquisition is uncertain. Uncertain tax positions relating to temporary differences do not generally affect the aggregate amount of taxes payable over time. However, they can generate an economic benefit by delaying the payment of tax to future periods. Thus, an uncertain tax position associated with the timing of the tax payment can result in an exposure for interest and penalties.

Uncertain tax positions that relate only to timing (i.e., when, not whether, an item of income or expense is included in a tax return) are automatically deemed to meet the more-likely-than-not recognition threshold under ASC 740-10-25-6. See examples 9 and 10 in ASC 740-10-55-110 through ASC 740-10-55-116 for an illustration of the application of the guidance to timing-related uncertainties.

Example TX 15-2 illustrates the recognition of uncertain tax positions that relate only to timing.

EXAMPLE TX 15-2
Recognition of timing-related uncertain tax positions

Company A incurs $100 in repairs and maintenance expenses. For financial statement purposes, Company A expenses the costs as incurred and plans to take the entire $100 as a deduction on its current-year tax return. However, Company A believes that the taxing authority would require straight-line amortization of the $100 expenditure over four years. Therefore, if the as-filed tax position (i.e., the full deduction claimed in the current-year tax return) is not sustained, Company A would be entitled to only a $25 deduction in the current year with the remaining $75 of deductions taken over the next three years. Company A is a profitable taxpayer in the current year, and has a 20% tax rate in this jurisdiction. For purposes of this example, interest is ignored.

How should Company A compute its liability for unrecognized tax benefits and calculate its deferred taxes?

Company A has no book basis because it fully expensed the associated costs when incurred. The tax basis would be $75 (the cost of $100 less the current-year permitted deduction of $25). At the reporting date, Company A has a $75 deductible temporary difference and would record the resulting deferred tax asset of $15 ($75 × 20%).

Company A would record the following journal entry:

The journal entry above records (1) the reduction of $20 in income taxes payable for the $100 maintenance deduction ($100 × 20% tax rate), (2) a current tax benefit for the tax effect of the deduction taken on the tax return that meets the recognition and measurement criteria of ASC 740 ($25 × 20% tax rate), (3) a deferred tax asset (and related deferred tax benefit) for the expected future deductible amount associated with the repairs and maintenance costs ($75 × 20% tax rate) determined pursuant to ASC 740’s recognition and measurement criteria (i.e., straight-line amortization over four years, with three years remaining as of the end of the current year), and (4) a liability for the tax effect of the amount deducted on the tax return that did not meet the recognition and measurement criteria of ASC 740 ($75 at a 20% tax rate).

Although an uncertain tax position is most commonly associated with a tax liability or the decrease of a tax asset, it can also be associated with cases that result in an increase of a tax asset (e.g., a tax receivable recorded as a result of the filing, or the intent to file, an amended return).

ASC 740 is applicable to all tax positions that were included on previously filed returns and are expected to be included on returns that have not yet been filed. This includes amended returns or refund claims that have not yet been filed as of the end of an accounting period. Generally, filing an amended return results in a tax receivable. When the filed (or expected-to-be-filed) amended return includes an uncertain tax position, the recognition, derecognition, and remeasurement of the receivable should be assessed under ASC 740's recognition and measurement criteria. We believe that the threshold for the recognition of the associated tax benefit should be the same, regardless of whether the accounting entry results in a tax receivable, a decrease in a liability for an unrecognized tax benefit, or a current tax payable. However, obtaining the tax benefit might involve additional procedural steps (e.g., in the US federal tax jurisdiction, approval by additional government authorities, such as the Joint Committee on Taxation that serves under the US Congress), which might affect the risk that an advantageous lower-level decision could be reversed.

When a refund claim or an amended return fails the requirement for recognition, the expected tax benefit (i.e., refund receivable) cannot be recognized in the financial statements. Similarly, a refund receivable recognized in a prior period would be derecognized if it fails the recognition threshold in the current period (i.e., the tax receivable asset would be reversed). However, the amount of the refund claim would still be included as an unrecognized tax benefit in the disclosures required under ASC 740-10-50-15. There may be instances in which an entity’s expectations and intentions regarding an amended return or refund claim are unclear. Such situations may require the use of professional judgment to determine whether, or to what extent, the amended return or refund claim can be considered when assessing recognition and measurement criteria.

Courts in some jurisdictions require that taxes in question be paid as a prerequisite to petition the court. If the taxpayer’s position meets the recognition threshold, the taxpayer should record an asset for the prepaid tax in excess of the previously-recorded unrecognized tax benefits and accrue interest income (if applicable). Example TX 15-3 illustrates this situation in further detail. Additionally, refer to TX 15.6.1 for further discussion of interest accruals associated with uncertain tax positions.

EXAMPLE TX 15-3
Payment for uncertain tax positions prior to final resolution

Company X has taken a position in its tax return that it believes is more-likely-than-not to be sustained. This position has no corresponding impact on deferred tax balances (i.e., it is a permanent item). By taking this position, Company X reduced its taxes payable by $100. After assessing several possible outcomes, Company X has determined the need for a $25 liability for its unrecognized tax benefits.

The taxing authority challenges the position and delivers a $100 assessment to Company X. Company X intends to appeal the assessment. However, the taxing authority requires the assessment to be paid before an appeal can be filed.

Does this payment change the assessment of the uncertain tax position under the ASC 740 model?

In the US, during an IRS examination, taxpayers may present claims for additional tax benefits that were not reported on the tax return under examination. Such claims arise from new information that was not available when the return under examination was filed. The IRS policy allows for claims to be submitted during the examination without requiring the filing of an amended return. However, documentation supporting the basis for the claim and the resulting impact on the tax liability must be presented to the IRS during the examination process.

Such claims constitute tax positions subject to ASC 740's recognition and measurement principles. If the application of ASC 740 would result in no or a partial benefit being reported for the claims, an uncertain tax benefit must be included in the required tabular reconciliation of uncertain tax positions until the tax benefits can be recognized or the statute closes. These unrecognized tax benefits should be included as an increase in the unrecognized tax benefits recorded for positions taken during the current year. The disclosure requirement begins when a taxpayer decides to present claims for additional tax benefits (refer to FSP 16.8 and FSP 16.8A for additional discussion of the disclosure requirements for uncertain tax benefits).

The recognition of an additional tax liability as a result of an uncertain tax position must be distinguished from the assessment of the need for a valuation allowance. The recognition of a liability for an unrecognized tax benefit stems from uncertainty about the sustainability of a tax position taken or expected to be taken on a tax return. The recognition of a valuation allowance stems from uncertainties related to whether taxable income will prove sufficient to realize sustainable tax positions. That is, uncertainties about sustaining tax positions relate to whether a tax liability or deferred tax asset exists. Uncertainties about sufficient taxable income relate to the realization of recorded deferred tax assets. Therefore, valuation allowances may not be used to replace a liability for unrecognized tax benefits.