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.”