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16.2 Basic method of computing an interim tax provision
Publication date: 31 Mar 2023
us Income taxes guide
At each interim period, a company is required to estimate its forecasted full-year effective tax rate. That rate is applied to year-to-date ordinary income or loss in order to compute the year-to-date income tax provision. In order to compute the annual ETR, a company needs to estimate its full year ordinary income and its total tax provision, including both current and deferred taxes. When a company is subject to tax in multiple jurisdictions, one overall (i.e., worldwide) estimated annual ETR is developed and applied to consolidated ordinary income/(loss) for the year-to-date period, with certain exceptions and limitations as discussed later in this chapter.
If management is unable to estimate a portion of its ordinary income, but is otherwise able to reliably estimate the remainder, ASC 740-270-25-3 provides that the tax applicable to that item be reported in the interim period in which the item occurs. Examples of such items may include, but are not limited to, foreign exchange gains or losses and changes in the fair value of certain equity method investments that are required to be recognized in the income statement in accordance with ASC 321, Investments – Equity Securities.
This guidance addresses the issue of how and when income tax expense (or benefit) is recognized in interim periods and distinguishes between elements that are recognized through the use of an estimated annual effective tax rate applied to measures of year-to-date operating results, referred to as ordinary income (or loss), and specific events that are discretely recognized as they occur.
The tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur.
If an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated shall be reported in the interim period in which the item is reported.
Since the tax effects of current-year ordinary income receive different interim accounting treatment than the tax effects of other types of income during the same period, the definition of ordinary income is important. The glossary in ASC 740-270-20 defines these terms.
Definitions from ASC 740-270-20
Ordinary income (or loss): Ordinary income (or loss) refers to income (or loss) from continuing operations before income taxes (or benefits) excluding significant unusual or infrequently occurring items. Discontinued operations, and cumulative effects of changes in accounting principles are also excluded from this term. The term is not used in the income tax context of ordinary income versus capital gain. The meaning of unusual or infrequently occurring items is consistent with their use in the definition of the terms unusual nature and infrequency of occurrence.
Infrequency of occurrence: The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates (see paragraph 225-20-60-3).
Unusual nature: The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates (see paragraph 225-20-60-3).
The language in ASC 740-270-25-2 makes it clear that the estimated annual ETR only applies to the tax effect of ordinary income. Other events and/or transactions may occur that relate to continuing operations, but do not represent “ordinary income” or tax effects thereon. The tax effects of such events are accounted for discretely in the interim period in which they occur and should not be included in the derivation of the company’s estimated annual ETR. However, the pre-tax income and tax effects of some “non-operating” items, for example gains or losses from the disposal of fixed assets or the tax benefit of dividends-received deductions, as long as they are not considered unusual or infrequent, should be incorporated into the calculation of the estimated annual ETR.
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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