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ASC 740-270 requires the use of an estimated annual effective tax rate to compute the tax provision for ordinary income in all jurisdictions during an interim period (refer to TX 16.4 for computing the estimated annual ETR). As discussed in TX 16.2, whether a reliable estimate of ordinary income or loss or the related tax can be made is a matter of judgment. ASC 740-270-25-3 provides that the tax applicable to items that cannot be estimated be reported in the interim period in which the item occurs. The tax effect of these items is therefore excluded from the annual ETR and recognized discretely.
There are, however, two situations in which ASC 740 provides an exception to the use of a worldwide ETR.

ASC 740-270-30-36

If an entity that is subject to tax in multiple jurisdictions pays taxes based on identified income in one or more individual jurisdictions, interim period tax (or benefit) related to consolidated ordinary income (or loss) for the year to date shall be computed in accordance with the requirements of this Subtopic using one overall estimated annual effective tax rate with the following exceptions:
a. If in a separate jurisdiction an entity anticipates an ordinary loss for the fiscal year or has an ordinary loss for the year to date for which, in accordance with paragraphs 740-270-30-30 through 30-33, no tax benefit can be recognized, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). A separate estimated annual effective tax rate shall be computed for that jurisdiction and applied to ordinary income (or loss) in that jurisdiction in accordance with the methodology otherwise required by this Subtopic.
b. If an entity is unable to estimate an annual effective tax rate in a foreign jurisdiction in dollars or is otherwise unable to make a reliable estimate of its ordinary income (or loss) or of the related tax (or benefit) for the fiscal year in a jurisdiction, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). The tax (or benefit) related to ordinary income (or loss) in that jurisdiction shall be recognized in the interim period in which the ordinary income (or loss) is reported. The tax (or benefit) related to ordinary income (or loss) in a jurisdiction may not be limited to tax (or benefit) in that jurisdiction. It might also include tax (or benefit) in another jurisdiction that results from providing taxes on unremitted earnings, foreign tax credits, and so forth.
See Example 5, Cases A; B; and C ([ASC] 740-270-55-39 through 55-43) for illustrations of accounting for income taxes applicable to ordinary income if an entity is subject to tax in multiple jurisdictions.

State and municipal income tax jurisdictions are subject to the same exceptions with respect to what can be included in the consolidated worldwide ETR.
The estimated annual ETR approach can yield unconventional results (such as a negative ETR or an ETR exceeding 100%). Nevertheless, apart from ASC 740-270-30-18 (discussed in TX 16.2) and the specific exceptions noted in ASC 740-270-30-36 (discussed in TX 16.5.1 and TX 16.5.2), ASC 740-270 provides no flexibility in the requirement to apply the ETR approach.

16.5.1 Loss jurisdictions for which no benefit can be recognized

When a company operates in a jurisdiction that has generated ordinary losses on a year-to-date basis, or anticipates an ordinary loss for the full fiscal year, and no benefit can be recognized on those losses, ASC 740-270-30-36(a) requires the company to exclude that jurisdiction’s income (or loss) from the overall estimate of ETR. A separate ETR should be computed and applied to ordinary income (or loss) in that jurisdiction. In effect, any jurisdictions with losses for which no benefit can be recognized are removed from the base calculation of the ETR. If the reason that no benefit can be recognized is because the resulting net operating loss deferred tax asset is subject to a full valuation allowance, the separate ETR for that jurisdiction will often be zero.
We also believe that the use of the term no tax benefit is an absolute standard. If a company can record any benefit (e.g., carryback of current-year losses to offset income in prior years), the ETR approach should be used unless another exception applies.
Example TX 16-6 illustrates the treatment of withholding tax in an interim period income tax calculation for a reporting entity with operations in multiple jurisdictions.
EXAMPLE TX 16-6
Treatment of withholding tax in an interim period income tax calculation for a reporting entity with operations in multiple jurisdictions
Company ABC ("Parent") has operations in Jurisdiction A. Company ABC has a wholly owned subsidiary, Subsidiary B, with operations in Jurisdiction B. A distribution from Subsidiary B is subject to withholding tax in Jurisdiction B, for which Company ABC is the legal obligor. Company ABC does not consider the earnings of Subsidiary B to be indefinitely reinvested, and, therefore, records a deferred tax liability on the outside basis difference (e.g., the withholding tax) in its investment in Subsidiary B. For purposes of this example, ignore currency rate movements.
At the end of Q2, Subsidiary B has year-to-date ordinary income and anticipates ordinary income for the fiscal year. Company ABC's operations in the US have a year-to-date ordinary loss and an anticipated ordinary loss for the fiscal year. Company ABC has a full valuation allowance on its net deferred tax assets and therefore will not be included in the overall worldwide estimated ETR.
Should Company ABC's tax obligation to Jurisdiction B related to Subsidiary B's earnings be included in the worldwide ETR calculation?
Analysis
We believe there are two acceptable alternatives, as long as the method chosen is consistently applied.
Alternative A: Include Company ABC's obligation to Jurisdiction B in the worldwide ETR (i.e., look to the tax obligations by jurisdiction). Under this view, the withholding tax is considered separately from Company ABC's tax to Jurisdiction A on the earnings of Subsidiary B.
Each tax obligation component would be analyzed as follows:
Jurisdiction A (Parent)—The operations in Jurisdiction A are excluded from the worldwide ETR calculation due to there being a year-to-date ordinary loss for which no benefit may be recognized (i.e., a full valuation allowance is needed).
Jurisdiction B (Parent)—Company ABC is recording withholding tax related to Subsidiary B's earnings. Subsidiary B has year-to-date ordinary income and anticipates ordinary income for the fiscal year. This jurisdictional component is not in a year-to-date loss situation and should therefore be included in the worldwide ETR calculation.
Jurisdiction B (Subsidiary B)—Subsidiary B has year-to-date ordinary income and anticipates ordinary income for the fiscal year. Therefore, Subsidiary B should be included in the worldwide ETR calculation.
This alternative is supported by the jurisdictional discussion in ASC 740-270-30-36, which includes the following language: "an enterprise that is subject to tax in multiple jurisdictions pays taxes based on identified income in one or more individual jurisdictions…" This view is also supported by the general requirements of ASC 740-10-45-6 for financial statements to include the presentation of income taxes by tax-paying component within a particular tax jurisdiction. In this example, with regard to Company ABC's tax obligation to Jurisdiction B, the identified income is on the earnings of Subsidiary B (on which the tax is levied), and the tax-paying component is Parent, the legal obligor.
Alternative B: Include Company ABC's withholding tax to Jurisdiction B in Company ABC's separate income tax calculation and therefore exclude it from the worldwide ETR. Under this view, the withholding tax is considered a component of the measurement of Company ABC's tax expense on its investment in Subsidiary B.
Each component would be analyzed as follows:
Jurisdiction A and Jurisdiction B (Parent)—Jurisdiction A would be excluded from the worldwide ETR calculation due to there being a year-to-date ordinary loss for which no benefit may be recognized. Company ABC's obligation to Jurisdiction B would also be excluded from the worldwide ETR estimate.
Jurisdiction B (Subsidiary B)—Subsidiary B has year-to-date ordinary income and anticipates ordinary income for the fiscal year. Therefore, Subsidiary B would be included in the worldwide calculation.
Consistent with the discussion in ASC 740-10-55-24, Alternative B is supported by the fact that the withholding tax due to Jurisdiction B's taxing authority is considered a component of the Parent's measurement of taxes on its investment in Subsidiary B. ASC 740-10-55-24 provides that measurement should be based on expectations regarding tax consequences (e.g., capital gains or ordinary income). The computation of a deferred tax liability for undistributed earnings based on dividends should reflect any related dividends received deductions or foreign tax credits, and taxes that would be withheld from the dividend.
This analysis is further supported by ASC 740-270-30-36(b), which states that “the tax (or benefit) related to ordinary income (or loss) in a jurisdiction may not be limited to tax (or benefit) in that jurisdiction. It might also include tax (or benefit) in another jurisdiction that results from providing taxes on unremitted earnings, foreign tax credits, etc.”

16.5.1.1 Zero-rate jurisdictions & nontaxable entities

ASC 740-270 does not specifically address whether a jurisdiction that has a zero tax rate should be included in the ETR calculation. We believe there is conceptual support to either include or exclude zero-rate jurisdictions and are aware of diversity in practice in this area. We have identified three acceptable approaches:
Approach 1
: Always exclude pre-tax ordinary income or loss from a zero-rate jurisdiction from the ETR calculation. This view is premised on the theory that the income in a zero-rate jurisdiction is effectively tax-exempt. The exclusion of pre-tax income from a zero-rate jurisdiction is analogous to the optional treatment of tax-exempt income discussed in TX 16.3.4.1.
Approach 2
: Exclude pre-tax ordinary income or loss from a zero-rate jurisdiction from the ETR calculation if there is a year-to-date loss and/or if a loss is anticipated for the full fiscal year in that jurisdiction. The rationale for this view is based on the notion that a loss ultimately will not provide a tax benefit. Support for this view can be found in ASC 740-270-30-36(a), which requires the exclusion of jurisdictions with year-to-date losses if no tax benefit can be recognized for the year-to-date loss or for an anticipated full-year loss.
Approach 3
: Always include pre-tax ordinary income or loss from a zero-rate jurisdiction in the ETR calculation because the underlying principle in ASC 740-270 is that, absent a specific requirement or exception, all current-year ordinary income or loss should be included in the ETR calculation. This view only applies the exception in ASC 740-270-30-36(a) which requires the exclusion of jurisdictions with losses if no tax benefit can be recognized to taxable jurisdictions for which a valuation allowance may be necessary. This view is premised on the notion that the ETR approach is known to yield, at times, unconventional results in particular periods, yet there are only two specific exceptions to the full inclusion of all jurisdictions in the worldwide ETR computation.
The approach used should be applied consistently to all zero-rate jurisdictions of the reporting entity.
A question can also arise on how to treat ordinary income of a non-taxable entity. Practice in certain industries has been to exclude the non-taxable entity's ordinary income from the estimated annual ETR. For example, real estate investment trusts (REITs) are generally designed and function in a manner similar to non-taxable entities to the extent they distribute all of their income and meet certain other requirements. However, REITs often own subsidiaries that are subject to income tax (known as a taxable REIT subsidiary, or TRS). Most REITs determine their ETR by reference solely to the TRS income or loss and thereby effectively report the income of the REIT on a discrete basis.

16.5.2 Jurisdictions for which a reliable estimate cannot be made

ASC 740-270-30-36(b) provides the following two situations in which a company should exclude a jurisdiction from the overall computations of the estimated annual ETR:
  • If a company operates in a foreign jurisdiction for which a “reliable estimate” of the annual ETR in terms of the parent entity’s functional currency cannot be made.
  • If a reliable estimate of ordinary income or the related tax expense/benefit for a particular jurisdiction cannot be made.
The first situation would arise when the exchange rate between the parent company’s functional currency and the foreign currency is highly volatile, which is relatively uncommon.
With respect to the second situation, determining whether an estimate is reliable requires the use of professional judgment. While there is a general presumption that entities will be able to make a reliable estimate, exceptional circumstances can exist in which a genuine inability to make a reliable estimate justifies exclusion of a jurisdiction from the worldwide ETR. This might be the case for a company that is anticipating only marginal pre-tax book profitability for the year, but has significant permanent differences that could result in wide variability in the tax expense (benefit) and, in turn, the ETR. In such cases, an estimate of the ETR might not be reliable. A company’s assertion that it cannot develop a reliable estimate should be consistent with its other disclosures and communications to its investors, creditors, and other financial statement users.
Example TX 16-7 illustrates an interim period calculation of the ETR involving a jurisdiction that anticipates an ordinary loss for the fiscal year.
EXAMPLE TX 16-7
Interim calculation of the ETR when a jurisdiction anticipates an ordinary loss for the fiscal year
Company ABC operates in and is subject to tax in two different jurisdictions. For the current fiscal year, management projects ordinary income in Jurisdiction A and ordinary loss in Jurisdiction B. Because Company ABC is a seasonal business, operating results are expected to vary from quarter to quarter. Company ABC expects to realize the full benefit of the losses in Jurisdiction B such that any resulting DTAs will not require a valuation allowance. Company ABC is able to make reliable estimates of ordinary income and loss for Jurisdictions A and B.
Based on the forecast, Company ABC determines that the estimated annual ETR is negative 5% and as such, management believes that application of the global estimated annual ETR produces counterintuitive results on a quarterly basis and proposes using a separate estimated annual ETR for each individual jurisdiction.
Is the alternative approach proposed by Company ABC’s management acceptable?
Analysis
No. If a company is subject to tax in multiple jurisdictions, ASC 740-270 requires that the interim period tax related to consolidated ordinary income be computed using one overall estimated annual ETR, unless one of the exceptions in ASC 740-270-30-36 applies. As neither is applicable in this fact pattern, Company ABC must apply the single ETR.

16.5.3 Effect of naked credits on the estimated annual ETR

“Naked credits” (see TX 5.5.1) occur when an indefinite-lived intangible asset has a book basis in excess of its tax basis as a result of tax amortization. Since the asset is not amortized for book purposes, the taxable temporary difference is not scheduled to reverse and can generally not be considered a source of income supporting realization of deferred tax assets in jurisdictions with expiring attributes. When a company is incurring losses and has a full valuation allowance, the increase of a deferred tax liability related to such basis difference will trigger a deferred tax expense for the current year. The impact of this “naked credit” should be included in a company’s ETR calculation whether the jurisdiction is included in an entity’s worldwide ETR calculation or excluded from the worldwide ETR calculation and treated as a separate jurisdiction with a standalone estimated annual ETR under ASC 740-270-30-36(a).
However, discrete treatment of this deferred tax expense is appropriate when the annual estimate of the tax rate is not considered a reliable estimate under ASC 740-270-30-36(b).
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