managing the indirect tax balance sheet · managing the indirect tax balance sheet sinead hughes...

Managing the Indirect Tax Balance Sheet

Sinead Hughes PwC

Chicago [email protected]

Colleen Freeburg General Motors

Detroit [email protected]

Bruce Goudy Bruce Goudy Professional

Corporation

Toronto [email protected]

2017 IPT’s Value Added Tax Symposium

OVERVIEW

• Indirect Tax Liabilities

– Loss Contingencies

– Recognition & Disclosure

– Gain Contingencies

• Indirect Taxes Management

– Dashboards

– Basic Diagnostics

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ASC 450 CONTINGENCIES

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What is ASC 450 (FAS 5)?

Requires a corporation to record a liability in anticipation of a judgment against it or a settlement when certain conditions are met

Requires corporations to disclose the existence of a specific contingency in their financial statements

Previously in Statement of Financial Accounting Standards (SFAS) No. 5

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What is a Contingency?

An existing condition, situation or set of circumstances involving uncertainty regarding

potential loss or impairment of an asset or

gain

that will ultimately be resolved when one or more future events occur or fail to occur.

e.g., awaiting a court decision regarding an indirect tax appeal

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Loss Contingency vs Estimated Accrual

Obligation to pay an amount is certain

Not dependent on the occurrence of a future event to confirm the liability

No plans to dispute the obligation

e.g., the amount of tax short-paid as a result of a clerical error

on a prior importation

Uncertainty about the amount of an estimated accrual does not make it a loss contingency

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Likelihoods of Loss

Three likelihood categories that a loss or impairment of asset has occurred at the date of financial statements (which will be resolved once a future event occurs)

PROBABLE

Loss is likely to be confirmed by future event

Higher threshold than IFRS “more likely than not” (more than a 50%)

REASONABLY POSSIBLE

Risk of loss or impairment is between Probable and Remote

REMOTE

Risk of loss is slight

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Recognition and Disclosure

Accrual for a loss contingency is required if both conditions met:

Probable

It is probable that a liability has been incurred or that an asset has been impaired at the date of the financial statements

Reasonably estimated

The amount of indirect tax contingent loss can almost always be reasonably estimated

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Assessing Likelihood

Qualitative and quantitative factors to consider:

1. Nature of the lawsuit, claim or assessment,

2. Progress of the case (including developments after the date of the financial statements but before those statements are issued),

3. Opinions or views of internal tax counsel and other advisers,

4. Experience of the entity in similar cases within that jurisdiction,

5. Experience of other companies in similar cases, and

6. Any decision by management as to how the entity intends to respond to the lawsuit, claim or assessment (for example, whether the Corporation plans to defend vigorously or seek settlement).

7. Detection risk?

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ASC 450 Decision Tree

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Start

Probable?

Reasonably Estimable?

Reasonably Possible?

No Accrual

---

No Disclosure

Disclosure Required

Accrual Required

YES

YES

YES

NO

NO

NO


Releasing Tax Reserves

Reserves should be released when the liability or

contingency has been cleared

Payment of liability

Audit finalized

Statute closed

New relevant information

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Example 1 Recognition & Disclosure

Company A is a defendant in an indirect tax lawsuit and concludes that an adverse

judgment would be approximately $1 million. However, you estimate that the chance of

losing is 40%. In such case, the accrual should be:

A. $400,000

B. $0

C. $1 million

D. None of the above

Suggested Answer: B) $0

The estimated probability of an adverse outcome is only 40%, so likelihood of loss is not

Probable (it is Reasonably Possible) and no accrual is required (although consideration

should be given as to whether disclosure is required). However, if settlement negotiations

are anticipated and settlement becomes Probable, Company A should accrue an amount

for the settlement

**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s

policy with regard to FAS 5 disclosures, etc.

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Company A is a defendant in an indirect tax lawsuit. You conclude that an adverse

judgment would be approximately $1 million. You also conclude the likelihood of loss is

80%.

In such case, the accrual should be:

A. $800,000

B. $0

C. $1 million

D. None of the above

Suggested Answer: C) $1 million

Whether a risk ultimately falls into the Probable range is dependent upon the

circumstances of the case. There must be a substantial basis to believe Company A will

lose the case to conclude that likelihood of loss is Probable.



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Example 3 Differing Expert Opinions

Company A is planning to hire an attorney to handle its VAT case. Company A has obtained

the following opinions from these attorneys:

- Attorney 1 – 10-20% chance of success



Company A should:

A. Book a reserve

B. Disclose the fact that there is a potential liability

C. Hire Attorney 3 and not reserve

Suggested Answer: B) Company A should disclose the fact that there is a potential

liability



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Example 4 Audit Risk

Company A is a financial services company established in the UK. Further to seeking a formal opinion from a

professional services firm, and based on known industry practice, Company A has taken the position that its new

financial services product should qualify as a VAT exempt service, based on its interpretation of UK VAT legislation and

as such should not be subject to VAT.

HMRC has recently published guidance notes which clarifies its view that, based on the interpretation of UK VAT

legislation, it is of the view that the specific financial services products being sold by Company A do not meet the

conditions for VAT exemption as per the relevant section in the UK VAT legislation. Company A has not been audited in

the last 4 years. If audited, an assessment and negative outcome is probable (although the company is currently unable

to estimate the potential amount of any assessment).

Company A should:

A. Not book a reserve or disclose

B. Book a reserve

C. Disclose the fact that there is a potential liability

Suggested Answer: C) Company A should disclose the fact that there is a potential liability



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HMRC conducts an audit of Company A and raises a VAT assessment of USD 5m in

respect of underpaid VAT. HMRC is of the view that Company incorrectly applied a

reduced rate of VAT on the sale of its products in the UK.

Company A is of the view that its products qualify under the reduced rate of VAT.

Company A intends to appeal the assessment to HMRC. Company A concludes that it

has a 60% chance of success in its appeal.

Should company A be required to:

A. Disclose its position in a note to the financial statements

B. Accrue for the potential underpaid VAT

C. Not disclose the issue as a contingent liability in the financial statements

Suggested Answer: A) Company A should likely be required to disclose the issue as

a contingent liability in the financial statements



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Example 6 Settlement Offers

Company A is litigating a USD 5m assessment issued by HMRC. Company A has not booked a reserve or disclosed this liability. To obtain closure Company A has proposed a USD 1m settlement. HMRC has countered with a USD 3m offer. Both offers have been rejected.

Company A should:

A. Book a USD 1m tax reserve

B. Not book a reserve but disclose the offers

C. Not book a reserve or disclose

Suggested Answer: A) Company A should book a USD 1m reserve

in its accounts



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Example 7 Customer Indemnifications

Company A is protesting an audit assessment. Counsel has opined that it is probable that

Company A will lose its appeal. Company A has a tax indemnification provision in its

customer contracts that it plans to invoke.

Company A should:

A. Book a tax reserve

B. Not book a reserve but disclose the facts

C. Not book a reserve or disclose

Suggested Answer: C) Company A should not be required to book a reserve or

disclose the facts assuming:

A. It is probable that collection will occur

B. The amount of the liability is not considered material, otherwise disclosure

(but not accrual) appropriate



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Example 8 Calculating Accrual Amount

Company A is protesting an audit assessment. Counsel has opined that it is probable

that Company A will lose its appeal. Company A has estimated a VAT liability of USD

1m, interest of USD 300k and a penalty ranging from USD 50k – USD 100k (to be

negotiated with the tax authorities although probable penalty will be imposed).

What amount should Company A disclose as a contingent liability?

A. USD 1m

B. USD 1.35m

C. USD1.4m

Suggested Answer: B) Accrued interest should be included in the reserve

and penalties should also be included if probable they will arise. Where the

estimate falls within a range it is permissible to disclose the lower amount.



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Gain Contingency Recognition

• Recognize as revenue only upon settlement of

underlying event

– virtual certainty (e.g., funds received)

• Disclosure re nature of gain is allowable

• No misleading statements re likelihood of success

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Example 1 Gain Contingency

Company A is engaged in both VAT taxable and exempt supplies of services. Company A has not, up to now, deducted any VAT on its expenses as it did not have the data required to calculate a VAT recovery apportionment. Company A sourced the relevant data to calculate its VAT recovery rate in previous years. It submits a VAT reclaim to the local tax authority for USD 1m, based on apportionment guidelines issued by the local tax authority

Should Company A disclose a contingent gain in its financial statements?

Suggested Answer: Yes, as Company A is legally entitled to a VAT refund which is

prepared based on guidelines issues by the local tax authority

Is Company A entitled to record a tax asset at the time the claim is submitted?

Suggested Answer: No, Company A should not record a tax asset until it receives

confirmation from the local tax authority that the VAT amount will be refunded

• **Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s policy with regard to FAS 5 disclosures, etc.

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Example 2 Asset Recognition

Company A has filed a foreign VAT reclaim with the UK tax authorities for USD 1m. As at year end, the claim is still being processed and Company A has not received any correspondence from the UK tax authorities.

When should company A book an asset of USD 1m in its financial statements:

A. At the time the claim is filed

B. At the time notification of approval of the claim is received from the tax authorities

C. At the time the funds are received into Company A’s bank account

Suggested Answer: C)

**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s policy with regard to FAS 5 disclosures, etc.

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Example 3 Asset Impairment

Company A has recorded ICMS credits as an asset on its balance sheet based on an ICMS incentive granted by a certain State in Brazil. However the incentive is not in accordance with Federal tax legislation. More recently, the Brazilian president rejected a plea to regularize such tax incentives. The Federal government is due to release a statement regarding their formal position on the ICMS incentive. Company A has received a legal opinion from a Brazilian law firm which states that it is probable that the ICMS credits will be rejected.

Should Company A be required to impair its tax asset?

Suggested Answer: Company A should impair once it can reasonably estimate the FV of the revised credits

**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s policy with regard to FAS 5 disclosures, etc.

23


Netting Assets & Liabilities

• Optional for US GAAP even if all conditions are met –

company accounting policy required

• Assets and liabilities cannot be netted unless business

has ability and intent to offset those amounts against

each other upon settlement

• Examples where netting not appropriate

– Separate VAT registrations

– ITC not available until VAT paid to suppliers

– Discrete refund claims (8th & 13th directives)

– Amounts in dispute with tax authorities

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Indirect Tax Incentives

Incentives administered through indirect taxes

e.g., reduced rates, interest free or low interest loans, deferred

submission of tax collected for building a manufacturing facility

Have all conditions of the grant been considered when accounting for it ?

(i.e., recognize benefit, any liability for claw-back provisions)

Reasonable assurance that all conditions will be met is sufficient for recognition

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Indirect Tax Indemnities

Contingent liability of Company A to compensate another party if taxes become payable by the other party

Contingent liability of another party to compensate Company A if taxes become payable by Company B

Generally applicable to purchase or disposition of assets/business

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Roles and Responsibilities

Depends upon the Company roles & responsibilities

Tax Accounting may be split between the Accounting and Tax Teams

Responsibilities extend to import duties, property taxes, etc. that may not be responsibility of tax staff

Global, regional & central roles

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Establishing Reserves

Identify what is important to the company (accuracy, budgeting, timing)

Identify risk areas

Systems limitations, frequency of law changes, changes in

supply chains/business operations

Business acquisitions

Mitigate risk areas

VDA’s, ruling requests, remediation of known issues

Document positions

28


INDIRECT TAX

DASHBOARDS &

DIAGNOSTICS

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Indirect Tax Dashboards

– Present big picture

– Highlight key risks / opportunities

– Limit distractions

– Ability to expand / drill down to details

– Leverage relevance to other users

• Global vs regional, tax types, etc.

– Easily refreshed month over month in a timely

manner

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Key Elements To Consider

• User’s needs for

– Balances

– Cash Flows

– Costs

– Throughput

– Tax Types

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Indirect Tax Assets

Key Asset Categories

Refunds Submitted, Pending Refund

Accrued Refunds, Not Yet Submitted

Net unused input credit carryforwards

Prepayments

Deposits

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Indirect Tax Asset Dashboard

• Age and Forecast – Current/ Noncurrent

• Tax Type

• Refunds filed pending refund / not yet filed

• Prepayments

• Deposits

• Contingent gains

• Forecast receipt / offset date

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Indirect Tax Assets Dashboard

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Example – Ageing Overview

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Ageing of Indirect Tax Assets

• Periods should be relevant

– 0-90, 90-180, >180

• Factor to assessing risk of non-collection & potential

impairment of asset

• Direct effect on cash flow burden

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2017 IPT’s Value Added Tax Symposium 37


Indirect Tax Liability Dashboard

• Need ability to capture information globally re

– Tax payable

• charged to others

• self-assessed / owing by business

– Input credits

– Adjustments (P&L) & Transfers (B/S)

– Payments

– Contingent Losses

– Payment due date / forecast

38


Basic Indirect Tax Diagnostics

• Reasonability / Trends

• Payment = prior month liability

• Debit entries using “tax collected” accounts

• Credit entries using “input credit” and “payment”

accounts/codes

• Debit balances in liability accounts

• Credit balances in asset accounts

• Netting

• Reconciliations

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Example – Liability Balances

40


QUESTIONS?

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managing the indirect tax balance sheet · managing the indirect tax balance sheet sinead hughes...

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