Financial Statement Impact of Trump’s Tax Reform

Accounting Standards Concept (“ASC”) 740-10-45-15 requires that the effect of a change in tax law or rates to be recognized in the period that includes the enactment date. President Trump’s tax reform proposals, which were outlined in his “The Biggest Individual and Business Tax Cut in American History” memorandum, suggest significant changes to tax legislatives. Some of them are expected to be signed into law before the end of 2017. The financial statement impact of these provision must be reflected in enterprises’ annual financial statement in the period they are enacted, irrespective of the effective date. In other words, if his proposals become law in 2017, the related tax impact must be reflected in the enterprises’ 2017 financial statement. For interim financial statement issuers, the financial statement impact of the tax law change needs to be reflected in the quarter these changes are enacted. In order to manage the financial statement reporting in a timely manner, enterprises need to stay up-to-date on their tax legislative development and implement plans to reflect such changes in their financial statements.

We will discuss some of Trump’s tax proposals and their potential financial statement impact, along with recommendations on action items enterprises should consider taking in advance:

Mandatory Repatriation
Under present law, the general rule on the U.S. tax on foreign earnings of foreign corporate subsidiaries is that the tax is deferred until it is distributed back to the U.S. shareholders. During Trump’s campaign, he introduced a special corporate tax repatriation holiday rate of 10% to bring the money stashed offshore back into the U.S. The blueprint contains a similar proposal which provides a mandatory repatriation tax at 8.75% for cash and 3.5% for non-cash assets. If enacted, multinational companies with foreign subsidiaries must account for deferred and current tax liabilities associated with unremitted foreign earnings.

The repatriation tax will be assessed on previously untaxed earnings and profits (“E&P”) of foreign subsidiaries. E&P is the measure of a corporation’s economic ability to pay dividends to its shareholders and is a basis to determine the U.S. federal income tax. Internal Revenue Code (“IRC”) §964 and the regulations thereunder provide the procedures for foreign corporations to calculate E&P, and the computation is based on a multi-step approach; including conversion of foreign subsidiaries’ books to U.S. GAAP, application of U.S. tax rules to re-determine the taxable income, and application of E&P adjustments provided under IRC section 312 with accompanying regulations. This exercise needs to be done year by year since inception, and may require substantial resources and hours. Additionally, enterprises must account for foreign withholding taxes and potential benefit associated with foreign tax credits.

Many enterprises have taken an indefinite reinvestment assertion under ASC 740, also known as the APB 23 exception, supporting a position not to provide tax provision for foreign subsidiaries’ earnings. Under this assertion, enterprises can forgo recording a deferred tax liability associated with the unremitted earnings of foreign subsidiaries as management has the intent and ability to indefinitely reinvest the profits or otherwise indefinitely postpone taxation in U.S. However, if the remittance becomes mandatory, enterprises must quantify and record deferred tax impact of remittance of foreign earnings, foreign withholding taxes and potential benefit associated with the ability to utilize foreign tax credits.

Tax Rate Reduction
President Trump proposed to introduce a single corporate federal tax rate of 15%. The proposed rate in the House Republican’s tax reform blueprint mirrors Trump’s rate reduction proposal and suggests a single corporate tax rate of 20%.

As stated above, ASC 740 requires that the tax effects of changes in tax laws or rates to be recognized in the period in which the law is enacted. Deferred tax liabilities and assets shall be adjusted for the effect of a change in tax rates when enacted. When deferred tax accounts are adjusted as required by ASC 740-10-35-4 for the effect of a change in tax rates, the effect shall be included in income from continuing operations for the period that includes the enactment date.

Unless the rate change applies retroactively, the enactment date differs from the effective date resulting in a delayed effective date or phase-in approach. This adds complexity as some of deferred tax assets and liabilities scheduled to reverse during the transition period would be measured at a rate different from the new rate. A detail analysis of timing of reversal of temporary differences must be considered in measuring deferred tax assets and liabilities.

Territorial Tax System
In his memorandum, President Trump calls for a need to fundamentally change the U.S. tax system to a territorial regime, in which only US-related profits are taxed. Under the current tax system, U.S. enterprises are subject to tax on worldwide income – earnings of foreign subsidiaries are subject to taxation when they are repatriated or deemed remitted back to U.S. However, under the territorial tax system, U.S.-based multinational corporations pay U.S. tax only on their domestic income. Based on the House Republican’s tax reform blueprint, the foreign earnings of U.S. businesses will be entitled to a 100-percent exemption for dividends from foreign subsidiaries.

At this point, there is not enough detail available to assess the potential financial statement impact. However, such change will dramatically reshape the current outbound international taxation, removing Subpart F regime and how enterprises are taxed on its foreign earnings. The reform will also get rid of many tax incentives, including domestic production activity deductions.

Recommendation: Enterprises should continually monitor development of tax legislatives, assess their implication to financial statement, and plan implementation steps ahead to manage the financial statement reporting in a timely manner.