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There are certain situations in which deferred taxes are not provided. Some basis differences are not temporary differences because their reversals are not expected to result in taxable or deductible amounts. In addition, ASC 740-10-25-3 provides a number of specific exceptions to the underlying balance sheet approach to accounting for deferred taxes.

ASC 740-10-25-3

The only exceptions in applying those basic requirements are:
  1. Certain exceptions to the requirements for recognition of deferred taxes whereby a deferred tax liability is not recognized for the following types of temporary differences unless it becomes apparent that those temporary differences will reverse in the foreseeable future:
    1. An excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture that is essentially permanent in duration. See paragraphs 740-30-25-18 through 25-19 for the specific requirements related to this exception.
    2. Undistributed earnings of a domestic subsidiary or a domestic corporate joint venture that is essentially permanent in duration that arose in fiscal years beginning on or before December 15, 1992. A last-in, first-out (LIFO) pattern determines whether reversals pertain to differences that arose in fiscal years beginning on or before December 15, 1992. See paragraphs 740-30-25-18 through 25-19 for the specific requirements related to this exception.
    3. Bad debt reserves for tax purposes of U.S. savings and loan associations (and other qualified thrift lenders) that arose in tax years beginning before December 31, 1987. See paragraphs 942-740-25-1 through 25-3 for the specific requirements related to this exception.
    4. Policyholders' surplus of stock life insurance entities that arose in fiscal years beginning on or before December 15, 1992. See paragraph 944-740-25-2 for the specific requirements related to this exception.
  2. Recognition of temporary differences related to deposits in statutory reserve funds by U.S. steamship entities (see paragraph 995-740-25-2)
  3. The pattern of recognition of after-tax income for leveraged leases or the allocation of the purchase price in a purchase business combination to acquired leveraged leases as required by Subtopic 842-50
  4. A prohibition on recognition of a deferred tax liability related to goodwill (or the portion thereof) for which amortization is not deductible for tax purposes (see paragraph 805-740-25-3)
  5. A prohibition on recognition of a deferred tax asset for the difference between the tax basis of inventory in the buyer's tax jurisdiction and the carrying value as reported in the consolidated financial statements as a result of an intra-entity transfer of inventory from one tax-paying component to another tax-paying component of the same consolidated group. Income taxes paid on intra-entity profits on inventory remaining within the consolidated group are accounted for under the requirements of Subtopic 810-10.
  6. A prohibition on recognition of a deferred tax liability or asset for differences related to assets and liabilities that, under Subtopic 830-10, are remeasured from the local currency into the functional currency using historical exchange rates and that result from changes in exchange rates or indexing for tax purposes. See Subtopic 830-740 for guidance on foreign currency related income taxes matters.

2.4.1 “Outside basis” differences

ASC 740-10-25-3(a) provides that a deferred tax liability should not be recognized for certain specified temporary differences unless it becomes apparent that they will reverse in the foreseeable future. The most notable of these relates to an excess book-over-tax “outside basis” difference of an investment in a foreign subsidiary or a foreign corporate joint venture that is essentially permanent in duration. The accounting for income taxes related to outside basis differences is discussed in TX 11.

2.4.2 Nondeductible goodwill

The tax treatment (deductible vs. nondeductible) of goodwill will vary depending on the tax laws of the jurisdiction where the goodwill is recorded. In the United States, for example, acquired goodwill is amortizable for US federal tax purposes over 15 years (goodwill that is “created” by a taxpayer is generally nondeductible). See TX 10 for further discussion of nondeductible goodwill.
ASC 805-740-25-3 prohibits the recognition of a deferred tax liability for the reported amount of goodwill (or portion thereof) that is not deductible for tax purposes. Because goodwill is the residual in the purchase price allocation under ASC 805, establishing a deferred tax liability for the basis difference in goodwill would result in an increase in the amount of goodwill. This in turn would require an increase in the deferred tax liability, which would further increase goodwill. The FASB concluded that the resulting grossing up of goodwill and the deferred tax liability would not add to the relevance of financial reporting.
The above exception does not apply if there is an excess of tax-deductible goodwill over book goodwill at the acquisition date (i.e., a deductible temporary difference exists). In that case, a deferred tax asset should be recognized in accordance with ASC 805-740-25-8 through ASC 805-740-25-9.

2.4.3 Foreign currency remeasurement and indexation of tax basis

ASC 740-10-25-3(f) prohibits the recognition of deferred taxes for temporary differences related to assets and liabilities that, under ASC 830-10, Foreign Currency Matters, are remeasured from the local currency to the functional currency using historical exchange rates and that result from either: (1) changes in exchange rates or (2) indexing of the tax basis in the foreign jurisdiction. It is important to note that this circumstance only arises when the local currency is not the functional currency of a reporting entity. See TX 13 for a discussion of the accounting for foreign exchange movements with respect to ASC 740.

2.4.4 Tax effects of intra-entity inventory transactions

Ordinarily, there are tax effects when an asset is sold or transferred between affiliated companies that are consolidated for financial statement purposes but file separate tax returns. In consolidation, however, the seller’s pretax profit will be deferred for financial statement purposes, and the inventory will be carried at its cost to the seller until it is sold to an unrelated third party or written down. Under ASC 740-10-25-3(e) and ASC 810-10-45-8, no immediate tax impact should be recognized in the consolidated financial statements as a result of intra-entity transfers of inventory. ASC 740-10-25-3(e) (often simply referred to as “3(e)”) prohibits the recognition of a deferred tax asset for basis differences relating to intra-entity transfers of inventory. This treatment of intra-entity transfers is an exception to the asset and liability approach prescribed by ASC 740. Similarly, ASC 810-10-45-8 precludes a reporting entity from reflecting a tax benefit or expense from an intra-entity transfer between entities that file separate tax returns until the asset has been sold to a third party or written down.
This exception applies to intra-entity transfers of inventory between affiliated entities domiciled in different jurisdictions (e.g., a US corporation and a non-US corporation) as well as affiliated entities domiciled in the same jurisdiction but that file separate income tax returns (e.g., two affiliated US corporations that are not included in the same US corporate income tax return and hence are considered separate tax-paying components of the reporting entity).
Taxes paid (if any) by the seller, as well as any other tax consequences (e.g., as a result of temporary difference reversals), are deferred in consolidation. A question may arise as to the amount of tax paid by the seller on the intra-entity profit. We believe that, generally, the profit should be the last item to enter into the seller’s computation of taxes payable in the period of the sale, and the deferred tax should be calculated as the differential in taxes payable with and without the intra-entity profit.
After the consummation of the transaction, there generally will be no temporary difference in either the seller’s or the buyer’s separate financial statements. The seller’s separate financial statements generally will reflect the profit on the sale and a tax payable on that profit. The buyer’s separate financial statements will reflect the inventory at the intra-entity transfer price, which will be the buyer’s tax basis.

2.4.4.1 Deferred charge differentiated from deferred tax asset

Taxes paid on intra-entity transfers of inventory that are deferred for financial reporting purposes (deferred charges) are different from deferred tax assets recognized under ASC 740-10-30-5. Deferred tax assets are subject to revaluation for tax rate changes and are subject to realizability considerations using the model prescribed in ASC 740. However, deferred charges are not subject to the realizability model prescribed in ASC 740 and are not affected by tax rate changes. This is because the deferred charge represents the tax effect of a past event. The amount will not be changed by future events other than the sale or write-down of the related inventory. The only realization test applied would be part of an overall realization test for the related inventory. Thus, the carrying amounts of the inventory and the deferred charge, in total, should not exceed the anticipated after-tax proceeds on sale. In addition, since the deferred charge is associated with inventory, it would generally be classified as a current asset.
Question TX 2-1 addresses whether the tax effects of an intercompany toll manufacturing fee should be deferred on the basis that it is an intercompany transfer of inventory.
Question TX 2-1
Should the tax effects of an intercompany toll manufacturing fee be deferred on the basis that it is an intercompany transfer of inventory?
PwC response
Toll manufacturing arrangements occur when one reporting entity (the principal) purchases and holds title to raw materials or semi-finished goods throughout the manufacturing process. The principal, however, engages another reporting entity (the toll manufacturer) to perform aspects of the manufacturing process.
The toll manufacturer receives a fee for the manufacturing services performed under the tolling arrangement. In general, tolling arrangements do not compensate the toll manufacturer for holding inventory because the principal retains title to the inventory. Thus, the principal generally capitalizes the tolling fees paid as value is added to inventory for tax purposes, and eliminates any intercompany income or expense associated with the tolling arrangement.
We believe there are two acceptable views:
View A: A toll manufacturing arrangement is not an intra-entity transfer of inventory. The tolling fee under a toll manufacturing arrangement does not relate to the transfer of inventory since the principal maintains title throughout the tolling process. In other words, there is no transfer of inventory under ASC 740-10-25-3(e) and ASC 810-10-45-8. The tolling fee is instead a payment for services performed. Under this view, both parties (the principal and the toll manufacturer) would recognize the tax effects of the intercompany service fee and would not apply the exception in ASC 740-10-25-3(e).
View B: A toll manufacturing arrangement is an intra-entity transfer of inventory. We believe tolling arrangements could be interpreted to fall within the scope of the 3(e) exception because (1) the tolling arrangement resulted in a difference between tax and financial reporting basis from an intra-entity transaction, and (2) there is an income tax paid on intra-entity profits on assets remaining in the group. The wording of the exception under ASC 740-10-25-3(e) specifically prohibits recognition of a deferred tax asset on an intra-entity transfer of inventory. While inventory itself is not legally transferred under a tolling arrangement, there is an intercompany profit in the production of inventory that is eliminated in consolidation. Under this view, the tax effects on the inventory remaining within the consolidated group would be deferred until the inventory is sold to an unrelated third party.

2.4.4.2 Intra-entity intellectual property migration arrangements

Questions have arisen in practice around the tax accounting considerations for intra-entity intellectual property migration arrangements. Question TX 2-2 addresses different considerations when intellectual property is sold within the consolidated group for cash versus an installment note.
Question TX 2-2
When internally-generated intellectual property (IP) is sold to another member of the same consolidated group, are there any distinctions between a sale for cash versus a sale for an installment note?
PwC response
Yes. Depending on whether the sale is for cash or an installment note, the implications could be different. Consider an example in which a US parent transfers IP with a zero book basis to a foreign subsidiary.
For both the sale for cash and the sale for an installment note, the consolidated reporting entity would be required to recognize the deferred tax asset in the foreign subsidiary for the book/tax basis difference.
If the sale is for cash, the consolidated reporting entity would recognize tax expense on the sale of the IP. If the sale is for an installment note, there are two acceptable views when recording the tax effects to the US parent in relation to the future taxes that will be paid as the intra-entity installment note is collected.
Under the first view, no temporary difference remains in the consolidated balance sheet since the installment note payable and receivable are eliminated in consolidation. A deferred tax liability would not be recognized under this view.
Under the second view, a fixed and unavoidable obligation to pay taxes over the period of the installment note exists and, therefore, a deferred tax liability should remain in the consolidated balance sheet.
The approach a reporting entity selects is an accounting policy election that should be applied consistently.

Question TX 2-3 addresses accounting for transactions in which the total consideration received is partially dependent on future events.
Question TX 2-3
How should companies account for transactions in which the total consideration received is partially dependent on future events?
PwC response
A reporting entity may transfer an asset from one jurisdiction (that of the seller) to another jurisdiction (that of the buyer) for an amount based on the asset’s future productivity in the buyer’s jurisdiction. In this instance, the seller’s tax consequences are tied to revenues generated in the future and are therefore contingent.
One common contingent payment transaction is known for US tax purposes as a “367(d) transaction,” which occurs when a US corporation transfers IP to a foreign corporation in exchange for shares of stock of the foreign corporation. For US tax purposes, the transaction is deemed to be a sale of property in exchange for payments (considered to be annual royalties) that are contingent upon the future revenues generated from the IP. This deemed royalty is based upon a predetermined royalty rate and is included as taxable income in future periods.
In many jurisdictions, notwithstanding the deferred taxation of this transaction in the US, the IP will have an established tax basis at the time of transfer. Therefore, deferred taxes would need to be recorded in the buyer’s jurisdiction if the buyer’s tax basis is different than the consolidated book basis and will result in a future deductible amount.
For 367(d) transactions, the prevailing view is that since there is no book versus tax basis difference in the consolidated balance sheet, no deferred tax liability would be recorded. This view would result in recognition of only the foreign deferred tax basis difference that arises upon the transfer. No US tax expense would be recognized at the time of transfer; rather, the US current tax provision would reflect the effects of the deemed royalties in future periods as they are included in taxable income.
Based on discussion with the SEC staff, we understand that the staff would accept not recognizing a deferred tax liability in the US. A registrant that is considering recognizing a deferred tax liability (similar to that described under the installment sale scenario in Question TX 2-2) is encouraged to consult with the SEC staff prior to electing this approach.
We believe that a similar approach would apply to other intra-entity transfers in which there may be contingent elements, similar to 367(d) transactions.
Question TX 2-4
If a US company transfers acquired IP that has an associated deferred tax liability (dating back to the IP’s acquisition) to a reporting entity in another country through a 367(d) transaction, does the deferred tax liability remain with the transferor upon transfer?
PwC response
We believe that the US company transferring the acquired IP should retain the associated deferred tax liability. This is because even though the IP is no longer resident in the US, the tax consequences from recovering the IP will still occur in the US, only now in the form of future royalties. Companies should monitor for specific events (e.g., impairments, acquisitions) that may change the book value of the IP and therefore have an impact on the measurement of the associated deferred tax liability.
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