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1.3 Defining a “tax based on income”
Publication date: 30 Jun 2023
us Income taxes guide
The ASC Master Glossary defines income taxes as “domestic and foreign federal (national), state, and local (including franchise) taxes based on income.” ASC 740 establishes standards of financial accounting and reporting for the tax consequences of “revenues, expenses, gains, or losses that are included in taxable income.” The ASC Master Glossary defines taxable income as “the excess of taxable revenues over tax deductible expenses and exemptions for the year as defined by the governmental taxing authority.” Thus, we believe that implicit in ASC 740 is the concept that taxes on income are determined after revenues and gains are reduced by expenses and losses. Therefore, as discussed in TX 1.3.1.1, taxes based solely on revenues (e.g., gross receipts tax) would not be subject to ASC 740. However, in general, practice has been that a “tax based on income” would apply to tax regimes in which revenues or receipts are reduced even by only one category of expense.
The principles of ASC 740 are applicable to “taxes based on income.” However, US GAAP does not clearly define the term “tax based on income” or specify characteristics that differentiate taxes based on income from taxes that are not. The legal definition of the tax (as an income tax or otherwise) is not determinative in an evaluation of whether a tax should be accounted for as a tax based on income. We believe that a tax based on income is predicated on a concept of income less allowable expenses incurred to generate and earn that income. However, the tax does not need to be on total pre-tax income to be an income tax. A tax on a subset of the income statement, such as a tax on net investment income (e.g., investment income less investment-related expenses), would also be a tax on income since it would employ the net income concept.
1.3.1 Application of ASC 740 to specific types of taxes
Based on the manner in which a tax is computed, it is not always clear whether a tax meets the definition of a “tax based on income.” In some cases, the tax may be based only partially on income. In other cases, the law’s overall complexity may make it difficult to determine whether the tax is based (either wholly or partially) on income.
1.3.1.1 Gross receipts and margin tax
A gross receipts tax is generally based on a jurisdiction’s definition of “taxable gross receipts.” In devising this tax, many jurisdictions do not take into consideration any expenses or costs incurred to generate such receipts, except for certain stated cash discounts, bad debts, and returns and allowances. Because the starting point of the computation of a gross receipts tax is not “net” of expenses, we believe that a gross receipts tax is not a tax based on income subject to ASC 740. Treatment of gross receipts taxes as an operating expense and not as an income tax is also consistent with the treatment afforded to premium taxes that states often levy on insurance companies.
In jurisdictions in which a tax is calculated on modified gross receipts, consideration should be given as to whether it is a tax based on income. We believe that a tax based on gross receipts reduced for certain costs (e.g., inventory, depreciable and amortizable assets, materials and supplies, wages) is a tax based on income subject to ASC 740. Margin taxes are also generally within the scope of ASC 740.
1.3.1.2 Tonnage tax
In the shipping industry, it is common for tonnage taxes to be assessed based on the weight of goods transported or a deemed weight figure based on the size of the entity’s vessels. Tonnage taxes are not generally within the scope of ASC 740. Even in cases in which an entity makes an election to pay a tonnage tax instead of an income tax, the tonnage tax is not based on income.
1.3.1.3 Digital services tax
A digital services tax is generally assessed on certain activities of a business where the generation of revenue may not correspond with its physical presence. The calculation of digital services tax varies by jurisdiction and requires careful assessment to determine whether the tax is based on income, and therefore includable within the scope of ASC 740, or whether in fact the tax is a tax on gross receipts or some other measure. Generally, if the digital services tax is based on specific revenue transactions or revenue streams, without any deduction of expenses incurred, it would not be within the scope of ASC 740.
1.3.2 Other ASC 740 matters related to taxes not based on income
There is a question as to whether reporting entities should account for (1) timing differences inherent in the computation of taxes that are not based on income and (2) tax credit carryforwards relating to taxes that are not based on income.
We believe that the effects of timing differences reflected in the computation of a tax not based on income should not be reflected in the financial statements because taxes not based on income are not within the scope of ASC 740. For example, in the case of a gross receipts tax, there may be differences between when gross receipts are included in GAAP income and when those amounts are included in the taxable base of gross receipts. Although these differences in the timing of recognition between GAAP and tax are analogous to temporary differences as defined in ASC 740, we do not believe that this analogy alone is sufficient to justify recording an asset or a liability.
Similarly, we do not believe deferred tax assets should be recorded for credits useable against taxes not based on income. Chapter 4 of the Conceptual Framework (FASB Concepts Statement No. 8) defines an asset as “a present right of an entity to an economic benefit.” In many cases, therefore, an asset should not be recorded for non-income tax credit carryforwards, because the benefit often depends upon a future event (e.g., the generation of future amounts that is subject to tax) and is therefore not a “present right” to an economic benefit. We believe, however, that if a tax benefit can be achieved without future transactions (e.g., if a credit carryforward can be used to offset a tax on outstanding equity), it might be possible to justify recognizing an asset, albeit outside of ASC 740. Entities should make sure they understand the nature of how the carryforward arose and whether incremental benefit will be provided.
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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