Complexities can arise when a reporting entity has to compute a tax provision considering the effects of short-period financial statements as a result of a change in fiscal year. We believe there are two alternatives, as illustrated in Example TX 16-8.
EXAMPLE TX 16-8
Calculation of an income tax provision for short-period financial statements due to a change in fiscal year
On July 15, Company ABC sold 100% of the stock of Subsidiary B to an unrelated third-party. In accounting for the acquisition, the acquirer will record Subsidiary B's net assets at fair value in accordance with
ASC 805,
Business Combinations. For tax purposes, the net assets will be recorded at carry-over basis.
Company ABC has a December 31 year-end for both financial reporting and income tax purposes. Historically, Subsidiary B was included in the consolidated income tax return of Company ABC. After the sale, Subsidiary B changed its year-end to June 30 for both financial reporting and income tax purposes to coincide with its new parent's year-end. Company ABC will be required to include the taxable income for Subsidiary B through July 15 in its tax return for the year-ended December 31.
In connection with the sale transaction, Subsidiary B is required to prepare stand-alone financial statements. Subsidiary B has historically calculated its income tax provision using the separate return method. Subsidiary B anticipates that it will file a registration statement in the near future and, therefore, is preparing its financial statements in accordance with SEC reporting requirements. Accordingly, Subsidiary B will be required to report audited results for the transition period from January 1 through June 30.
How should Subsidiary B calculate its income tax provisions for the six-month transition period ended June 30?
Analysis
We believe there are two acceptable approaches:
Approach A: Subsidiary B could treat the six-month period ended June 30 as an interim period and calculate its income tax provision using an estimated annual ETR in accordance with
ASC 740-270. The basis for this approach is that as of June 30, there has been no change in the tax reporting period (that is, Subsidiary B’s tax year-end is still December 31). Accordingly, the income tax provision would be based on the tax reporting period.
Approach B: Subsidiary B could treat the six-month period ended June 30 as a discrete period and calculate its income tax provision as if it would be filing a short-period return as of June 30. The basis for this approach is that for financial reporting purposes, the six-month period ended June 30 is being treated as a discrete period (i.e., a six-month annual period). Accordingly, the income tax provision would be based on the financial reporting period (in this case, the transition period).
Under either approach, Subsidiary B would need to prepare footnote disclosures as of June 30 for audited financial statements as required by
ASC 740 and
Regulation S-X, Rule 4-08. Accordingly, if Approach A is selected, Subsidiary B would need to estimate its individual temporary differences using an approach described in
TX 10.5.2, which provides guidance for determining temporary differences in an interim period in a business combination.
We believe that the above alternatives could also apply in a similar set of facts when after the sale there is no change in financial reporting or tax year, but Subsidiary B is required to split its financial statements into two separate periods, such as a when Subsidiary B elects to apply push-down accounting in separate company financial statements. Approach A would continue to seem acceptable. Approach B also seems acceptable because push down accounting could essentially be viewed as the termination of the old accounting reporting entity and the creation of a new one.