22nd Annual Health SciencesTax ConferenceAccounting for income taxes: hot topics anddevelopmentsDecember 3, 2012
Disclaimer►   Any US tax advice contained herein was not intended or written to be    used, and cannot be used, for the pu...
DisclaimerErnst & Young refers to the global organization of member firms of Ernst & Young GlobalLimited, each of which is...
Presenters►   Tricia Brosnan                                            ►        Joan Schumaker    Vice President of Globa...
Topics►   Recent developments:    ►    US, state and local    ►    Extenders    ►    Tax reform►   Current issues in resta...
Recent developments
Recent developments► State      and local:   ►     California     —       November 6, 2012 ballot initiative (Proposition ...
Recent developments► US:    ►    Internal Revenue Service Notice 2012-73: announces intent to issue a         delay in the...
Recent developments► US      (cont.):    ►    Key business tax provisions that expire December 31, 2012 include:          ...
Expired and expiring tax lawsTax accounting►   Computation of estimated annual effective tax rate    (EAETR) for interim r...
Tax reform proposals►   Reduction in US corporate tax rate    ►  A lower US corporate tax rate has been proposed in every ...
Current issues in restatements
Restatements            Restatement                                            Restatement          statistics — 2011     ...
Restatements     Top 3 topics — 2011            No.         %          Top 3 topics — 2010   No.   %   Income taxes       ...
Related income tax accounting topics►   Application of tax technical rules: tax basis and carryback    periods►   Realizab...
Application of tax technical rules: tax basisand carryback periods►   Incorrect identification or calculation of tax basis...
Realizability of DTAs►   Inappropriate evaluation of realizability of DTAs, resulting    in inappropriate valuation allowa...
Accounting for outside basis differences►   Inappropriate application of exceptions to deferred tax    liability recogniti...
Intercompany transactions►   Paying close attention to intercompany transactions    ►     Change in tax basis in buying ju...
Other quality occurrences►   Changing uncertain tax position (UTP) recognition without    change in facts and circumstance...
UTP changes in judgment►   Change in judgment as to recognition or measurement    ►     To be based on new information vs ...
SEC areas of focus
SEC regulatory focus►   Foreign earnings►   Realizability of DTAs►   UTPs►   Indirect taxes — contingenciesPage 23    Acco...
Foreign earnings►   Indefinite reinvestment    ►     Not an all or nothing assertion    ►     Positive assertion requires ...
Realizability of DTAs►   SEC comments    ►     How evidence was weighted:          ►   Specific positive and negative evid...
UTPs►   SEC comments:    ►     Compliance with disclosure requirements    ►     Proposed adjustments    ►     Changes and ...
Indirect taxes — contingencies►   SEC comments    ►     Continued focus on compliance with disclosure requirements        ...
PCAOB inspections
PCAOB — inspections — income taxes►   PCAOB observation for auditors consistent with income    tax restatement causes:    ...
Income taxesMaterial weaknesses►   Material weakness defined:    ►     “A material weakness is a deficiency, or a combinat...
Income taxesMaterial weaknesses — nature                                     9%                                           ...
Income taxesMaterial weaknesses — causes                         Lack of review          Error during preparation         ...
Income taxes — internal control keyconsiderations►   Understanding the process and identification of risk/control points: ...
Financial accounting update
Financial accountingIFRS update► SEC     update on IFRS status in US:    ► SEC   staff issued its final IFRS Work Plan Rep...
Financial accountingFASB and IASB joint projects update►   FASB and IASB (the Boards) goal — improved, high-quality, conve...
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Accounting for income taxes: hot topics and developments

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This panel will discuss the income tax accounting implications of legislative and regulatory developments, their impact on your company’s effective tax rate and actions companies are taking.

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Accounting for income taxes: hot topics and developments

  1. 1. 22nd Annual Health SciencesTax ConferenceAccounting for income taxes: hot topics anddevelopmentsDecember 3, 2012
  2. 2. Disclaimer► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.► These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.Page 2 Accounting for income taxes: hot topics and developments
  3. 3. DisclaimerErnst & Young refers to the global organization of member firms of Ernst & Young GlobalLimited, each of which is a separate legal entity. Ernst & Young LLP is a client-servingmember firm of Ernst & Young Global Limited operating in the US. For more informationabout our organization, please visit www.ey.com.This presentation is © 2012 Ernst & Young LLP. All rights reserved. No part of thisdocument may be reproduced, transmitted or otherwise distributed in any form or by anymeans, electronic or mechanical, including by photocopying, facsimile transmission,recording, rekeying, or using any information storage and retrieval system, without writtenpermission from Ernst & Young LLP. Any reproduction, transmission or distribution of thisform or any of the material herein is prohibited and is in violation of US and internationallaw. Ernst & Young LLP expressly disclaims any liability in connection with use of thispresentation or its contents by any third party.Views expressed in this presentation are not necessarily those of Ernst & Young LLP.Page 3 Accounting for income taxes: hot topics and developments
  4. 4. Presenters► Tricia Brosnan ► Joan Schumaker Vice President of Global Tax Ernst & Young LLP Operations New York, NY Pfizer Inc. +1 212 773 8569 joan.schumaker@ey.com► Jay Fischbein Tax Director for Janssen ► Mitchell Stauffer Pharmaceuticals Ernst & Young LLP Johnson & Johnson Chicago, IL 60606 +1 312 879 5720 mitch.stauffer@ey.comPage 4 Accounting for income taxes: hot topics and developments
  5. 5. Topics► Recent developments: ► US, state and local ► Extenders ► Tax reform► Current issues in restatements► U.S. Securities and Exchange Commission (SEC) areas of focus► Public Company Accounting Oversight Board (PCAOB) inspections► Financial accounting update: ► International Financial Reporting Standards (IFRS) ► Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) joint projectsPage 5 Accounting for income taxes: hot topics and developments
  6. 6. Recent developments
  7. 7. Recent developments► State and local: ► California — November 6, 2012 ballot initiative (Proposition 39) making single sales factor mandatory as of January 1, 2013 ► Washington, DC — September 14, 2012 — combined reporting regulations became final — October 2, 2012 — mayor approved legislation amending reporting provisions for 90 days; final legislation can take months or a year — If enactment of combined reporting results in an increase in combined group’s net deferred tax liability, a “FAS 109” deduction is provided ► Massachusetts — Effective July 1, 2012, law postponed for one additional year “FAS 109” deduction which was scheduled to begin in 2013 — The deduction, enacted in 2008 in combined reporting legislation, was originally to be claimed over seven years beginning in 2012 ► New Jersey — Voluntary disclosure initiative for companies with nexus from the use of intangible assets in NJ — Disclosure through January 15, 2013 for periods beginning after December 31, 2003 ► New York State — August 23, 2012: Department of Taxation and Finance issued proposed amendments to combined reporting regulationPage 7 Accounting for income taxes: hot topics and developments
  8. 8. Recent developments► US: ► Internal Revenue Service Notice 2012-73: announces intent to issue a delay in the effective date to January 1, 2014 of the tangible property temporary regulations ► Key business tax provisions that expired on December 31, 2011 include: ► Exceptions under subpart F for active financing income ► “Look-through” treatment of payments between related controlled foreign corporations ► The research tax credit ► 100% bonus depreciation of qualified property ► Increased expensing to US$500,000/US$2 million and an expanded Section 179 property definition ► The work opportunity tax credit ► The new markets tax credit ► 15-year straight-line cost recovery for certain business improvements ► The wind energy production tax credit ► Incentives for biodiesel and renewable diesel ► The cellulosic biofuel producer tax creditPage 8 Accounting for income taxes: hot topics and developments
  9. 9. Recent developments► US (cont.): ► Key business tax provisions that expire December 31, 2012 include: ► Extension of 50% additional first-year depreciation for property placed in service after December 31, 2011 ► Election to accelerate alternative minimum tax (AMT) credits in lieu of additional first-year depreciation ► Increased Section 179 dollar limitations for expensing to US$125,000/US$500,000 ► Repeal of collapsible corporation rules ► Tax-exempt bonds for educational facilitiesPage 9 Accounting for income taxes: hot topics and developments
  10. 10. Expired and expiring tax lawsTax accounting► Computation of estimated annual effective tax rate (EAETR) for interim reporting purposes should include the effects of enacted tax law or rates. ► Tax benefits of expired provisions should not be included in the computation of the interim or annual tax provision until tax law is reinstated. ► Be prepared to recognize the effects of reinstatement, if any, by December 31, 2012. ► Review extender provisions that expire at December 31, 2012 for exclusion from 2013 forecast estimated annual effective tax rate.Page 10 Accounting for income taxes: hot topics and developments
  11. 11. Tax reform proposals► Reduction in US corporate tax rate ► A lower US corporate tax rate has been proposed in every tax budget or reform plan submitted. ► If enacted, possibility the rate reduction is phased in ► Consider 2013–2014 income deferral or deduction acceleration decisions: ► Real after-tax cash benefit if a lower tax rate is enacted and deductions are accelerated into a 35% tax year or income is deferred into a lower rate year ► Increase in taxable temporary differences may result in a discrete financial statement benefit upon enactment (assuming a lower rate is enacted ► Effective tax rate impact recognized in the period of enactment of legislation that lowers corporate tax rate.► Broadening of tax base► Territorial regime► Base erosion provisions► Model effective tax rate under legislative proposalsPage 11 Accounting for income taxes: hot topics and developments
  12. 12. Current issues in restatements
  13. 13. Restatements Restatement Restatement statistics — 2011 No. % statistics — 2010 No. % Big R — audit opinion 39 1.0% Big R — audit opinion 42 1.1% revised revised Little r — audit opinion 24 0.6% Little r — audit opinion 23 0.6% not revised not revisedPage 13 Accounting for income taxes: hot topics and developments
  14. 14. Restatements Top 3 topics — 2011 No. % Top 3 topics — 2010 No. % Income taxes 18 20% Revenue recognition 21 17% Revenue recognition 9 10% Income taxes 15 12% Statement of cash flows 5 6% Derivatives 9 7%Page 14 Accounting for income taxes: hot topics and developments
  15. 15. Related income tax accounting topics► Application of tax technical rules: tax basis and carryback periods► Realizability of deferred tax assets (DTAs)► Accounting for outside basis differences► Intercompany transactions► OtherPage 15 Accounting for income taxes: hot topics and developments
  16. 16. Application of tax technical rules: tax basisand carryback periods► Incorrect identification or calculation of tax basis and carryback periods ► Requires technical understanding of tax law: ► Often for multiple taxing jurisdictions ► May be simple or complex► Detailed record of tax basisPage 16 Accounting for income taxes: hot topics and developments
  17. 17. Realizability of DTAs► Inappropriate evaluation of realizability of DTAs, resulting in inappropriate valuation allowance conclusion: ► Projections of taxable income does not equal tax planning strategy ► Substitution of a tax benefit does not equal realization ► Evaluating DTAs on a net basis and using naked credits as a source of taxable income does not equal realizationPage 17 Accounting for income taxes: hot topics and developments
  18. 18. Accounting for outside basis differences► Inappropriate application of exceptions to deferred tax liability recognition for outside basis differences ► Not providing taxes for basis difference related to investments in: ► Partnerships ► Equity method investments ► No longer qualifying for exception with changes in investment ownership ► Corporate joint venturesPage 18 Accounting for income taxes: hot topics and developments
  19. 19. Intercompany transactions► Paying close attention to intercompany transactions ► Change in tax basis in buying jurisdiction must be eliminated. ► Prepaid tax is deferred until the asset leaves the consolidated group.Page 19 Accounting for income taxes: hot topics and developments
  20. 20. Other quality occurrences► Changing uncertain tax position (UTP) recognition without change in facts and circumstances► Inappropriate current vs noncurrent presentation for deferred taxes and UTPsPage 20 Accounting for income taxes: hot topics and developments
  21. 21. UTP changes in judgment► Change in judgment as to recognition or measurement ► To be based on new information vs simply changing an interpretation or evaluation of previous information ► Expected to be supported by triggering events with new information► Change in judgment that results in subsequent recognition, de-recognition or changes in measurement of a tax position that was taken in a prior annual period (including any interest and penalties) ► Discrete event recognized in earnings in the period (interim or annual) in which the change occurs► Change in judgment related to a tax position taken in prior interim periods of the current year ► Include in EAETRPage 21 Accounting for income taxes: hot topics and developments
  22. 22. SEC areas of focus
  23. 23. SEC regulatory focus► Foreign earnings► Realizability of DTAs► UTPs► Indirect taxes — contingenciesPage 23 Accounting for income taxes: hot topics and developments
  24. 24. Foreign earnings► Indefinite reinvestment ► Not an all or nothing assertion ► Positive assertion requires specific documentation and evidence of plans each reporting period► Consider financial reporting implications of tax planning► SEC comments ► Disaggregation in rate reconciliation ► Rate differences vs permanent differences ► Liquidity discussion and consistency with accountingPage 24 Accounting for income taxes: hot topics and developments
  25. 25. Realizability of DTAs► SEC comments ► How evidence was weighted: ► Specific positive and negative evidence weighed ► “Robust and non-boilerplate” disclosure that explains weighting and sources of income considered and objectivity of evidence ► Cumulative losses ► Difficult to support assertion that economic downturn is an aberration ► Timing and reason for changes in valuation allowance ► Consistency of assumptions ► Consistency of accounting with management’s discussion and analysisPage 25 Accounting for income taxes: hot topics and developments
  26. 26. UTPs► SEC comments: ► Compliance with disclosure requirements ► Proposed adjustments ► Changes and prior disclosurePage 26 Accounting for income taxes: hot topics and developments
  27. 27. Indirect taxes — contingencies► SEC comments ► Continued focus on compliance with disclosure requirements ► Disclose the range of reasonably possible losses in excess of amount accrued, if any, or that exposures cannot be estimated or are not material. ► SEC staff does not object to aggregation. ► SEC staff challenges unclear disclosures. ► Changes without prior disclosure ► SEC staff will challenge “surprise” disclosures and accruals. ► Use of non-standard termsPage 27 Accounting for income taxes: hot topics and developments
  28. 28. PCAOB inspections
  29. 29. PCAOB — inspections — income taxes► PCAOB observation for auditors consistent with income tax restatement causes: ► DTAs ► Valuation allowance ► Tax contingency reserves ► Existence, completeness and/or valuation of other income tax accountsPage 29 Accounting for income taxes: hot topics and developments
  30. 30. Income taxesMaterial weaknesses► Material weakness defined: ► “A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.” ► Reasonable possibility is defined as “reasonably possible” or “probable,” as used in Accounting Standards Codification (ASC) 450, Contingencies (450-20-25-1) (formerly FAS 5) ► Probable: The future event or events are likely to occur ► Reasonably possible: The chance of the future event or events occurring is more than remote, but less than likely► A material weakness in internal control over financial reporting may exist even when financial statements are not materially misstated.► Restatement (Big R) of previously issued financial statements to reflect the correction of a material misstatement is an indicator of a material weakness.Page 30 Accounting for income taxes: hot topics and developments
  31. 31. Income taxesMaterial weaknesses — nature 9% Nature of material weaknesses 24% Operation of control Both (design and operation) Design of control 67% Ernst & Young LLP analysis of public filings disclosing material weaknesses from 2010 – Q2 2012Page 31 Accounting for income taxes: hot topics and developments
  32. 32. Income taxesMaterial weaknesses — causes Lack of review Error during preparation Lack of expertise Lack of resources Oversight of third party Foreign entity oversight Error within data Multiple causesLack of internal communication may be identified 0% 5% 10% 15% 20% 25% 30% FrequencyErnst & Young LLP analysis of public filings disclosingmaterial weaknesses from Q1 2010 – Q2 2012Page 32 Accounting for income taxes: hot topics and developments
  33. 33. Income taxes — internal control keyconsiderations► Understanding the process and identification of risk/control points: ► Sources of information ► Third parties (reliance, review, data) ► Unique, non-routine, infrequent classes of transactions► Understanding controls: ► Who, when, what and how of the controls ► Control owner has appropriate authority and competence ► Management review/reconciliation controls — precision, sensitivity evaluation, level of operation, controls ability to generate questions and identifying errors► Data/communication: ► Completeness and accuracy ► Accuracy of underlying reports► DocumentationPage 33 Accounting for income taxes: hot topics and developments
  34. 34. Financial accounting update
  35. 35. Financial accountingIFRS update► SEC update on IFRS status in US: ► SEC staff issued its final IFRS Work Plan Report (the Report) in July 2012. ► The Report does not include a recommendation to the SEC on how and whether to incorporate IFRS into US financial reporting. ► SEC staff indicated that many issues identified would be partly mitigated by an endorsement approach that retains a role for the FASB. ► No decision is expected before 2013.Page 35 Accounting for income taxes: hot topics and developments
  36. 36. Financial accountingFASB and IASB joint projects update► FASB and IASB (the Boards) goal — improved, high-quality, converged accounting standards► FASB and IASB joint convergence projects: ► Leases — Exposure Draft expected by first half of 2013 ► Financial instruments — Exposure Draft on classification and measurement expected by the first half of 2013 ► Financial Instruments — Exposure Drafts on impairments expected by end of 2012 ► Consolidation — FASB Final Standard expected in first half of 2013 ► Revenue recognition — Final Standard expected in first half of 2013► The Boards have focused on financial instruments, revenue recognition, leases and insurance contracts. ► Certain lower-priority projects set aside for near term► The Boards are re-deliberating many projects, making tentative decisions. ► These decisions are subject to change as the re-deliberations progress► Effective dates and transition methods for several joint projects have not been finalized.Page 36 Accounting for income taxes: hot topics and developments

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