ASC 740-10-15-4 indicates that a withholding tax for the benefit of the recipients of a dividend is not an income tax of the entity that pays the dividend if certain conditions are met. We believe that this guidance would also apply to withholding taxes for the benefit of the recipients of interest, royalty, or other payments if those same conditions are satisfied.

Reporting entities that have taxes withheld by another entity from dividends, interest, royalties, or other income on their behalf must determine whether such withholding taxes are income taxes that must be accounted for in accordance with ASC 740.

In many cases, withholding taxes will be deemed to be income taxes of the entity that receives the dividends, interest, royalties, or other income. Withholding taxes are typically considered under local country laws, together with respective tax treaties, to be prepayments of (or in lieu of) local income taxes. In other words, the withholding taxes are essentially a substitute for a complete income tax calculation because the recipient of the payment (against which the tax is withheld) is outside the country and may not otherwise be required to file a local income tax return. If the entity that received the dividends, interest, royalties, or other income were to file an income tax return in the local jurisdiction, it would be able to claim the withholdings as a prepayment of its income taxes otherwise due in that jurisdiction. For US-based entities, such withholding taxes may generate foreign tax credits, and thus directly interact with the recipient entity’s US income tax computation. While the withholding taxes may be creditable against the US income tax liability, this alone does not determine if the withholding tax is an income tax that is within the scope of ASC 740. When a payor has not withheld taxes and the withholding tax would have qualified as an income tax, and the company does not record a tax liability, ASC 740’s requirements for the accounting for uncertain tax positions should be considered.

Certain expenditures may generate credits or other tax incentives under various governmental programs. These programs take many forms, including programs related to research and development, alternative fuels, renewable energy, and emissions allowances, and are often designed to foster infrastructure, research, and other targeted business investment. In some cases, these credits and incentives are transferable or refundable.

While credits and incentives often arise in the tax laws and may be claimed on a tax return, they may not be within the scope of ASC 740. A number of features can make them more akin to a government grant or subsidy. Therefore, each credit and incentive must be analyzed to determine whether it should be accounted for under ASC 740, whether, in substance, it constitutes a government grant, or whether another accounting framework may apply.

The application of income tax accounting is warranted if a particular credit or incentive can be monetized only through the existence of taxable income and an income tax liability. When credits are refundable regardless of whether an entity has taxable income or an income tax liability, we believe the benefit should generally be accounted for outside of the income tax model and presented within pre-tax income.

Some credits or other tax incentives may be refundable either through the income tax return or in some other manner (e.g., direct cash received from the government) at the option of the taxpayer. In the case of a refundable credit, regardless of the method a reporting entity chooses to monetize the benefit, the accounting would be outside the scope of ASC 740 if the monetization of the credit does not have a direct linkage to a reporting entity’s income tax liability. There are some credits that are refundable at the election of the taxpayer, as is the case for credits with a “direct-pay” option (wherein an eligible entity can elect to treat the amount of the credit as a payment of tax) even if there are other options to monetize (e.g., the ability to transfer or sell the credit to a third party). Regardless of whether the election is made, these credits would generally not be within the scope of ASC 740. However, in certain rare situations, it may be appropriate to reflect the benefit of a refundable credit within ASC 740 if a significant disincentive for the taxpayer to elect the refund exists. This may be the case, for example, when a company will be taxed by a jurisdiction if they claim a refund for the credit but not taxed if they reflect the credit through the income tax return. In this case, it may be appropriate to reflect the credit in accordance with ASC 740 if the impact of the incremental tax would be significant and therefore the company intends to reflect the credit on the income tax return. All facts and circumstances should be considered in the evaluation.

On August 16, 2022, the Inflation Reduction Act (IRA) was signed into law. The IRA includes significant extensions, expansions, and enhancements of numerous energy-related tax credits and also creates new credits in multiple categories. The law provides an election to transfer (i.e., sell) certain credits to another taxpayer. The transfer may be for all or a portion of a credit, but any credit may only be transferred once. Whichever entity uses the credit – the originator of the credit or the transferee — only has the option to use the credit against their income tax liability. The cash received in exchange for credits transferred is not includable in taxable income of the transferor nor deductible to the transferee.

ASC 740 does not directly address how to account for nonrefundable transferable credits that may be used by a reporting entity as a reduction of income tax payable on its income tax return or that may be sold to another taxpayer. As it relates to the specific credit transferability provisions introduced by the IRA, we understand that the FASB staff believes it is most appropriate to account for such credits as part of the provision for income taxes under ASC 740, regardless of whether the reporting entity that receives the credit claims the credit on its tax return or if that entity sells the credit to another taxpayer. The FASB staff further believes that if a credit is sold, it is most appropriate for any difference between the notional amount of the credit originally received and the proceeds from sale to be recorded in the income tax provision. Because there is no directly applicable GAAP, the FASB staff acknowledges that other views may be acceptable, such as accounting for transferable credits similar to refundable or direct-pay credits by accounting for the entire credit outside of the tax line.

If a reporting entity accounts for transferable credits, including any difference between the proceeds and the notional value of the credits, as part of the income tax provision, a reporting entity also needs to determine whether to consider any expected sale of the credits as a source of realization in its valuation allowance assessment.