On December 14th, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) No. 2023-09, "Income Taxes (Topic 740): Improvements to Income Tax Disclosures", which seeks to enhance income tax disclosures in financial statements. While several revisions were made to the originally proposed ASU based on feedback provided from A&M and other stakeholders, the final provisions in the ASU were largely as expected.
As discussed in our previous publications on this topic , the ASU provides greater transparency into entities' global operations and provides users with crucial information that help investors:
- Understand an entity's exposure to potential changes in jurisdictional tax legislation and the ensuing risks and opportunities;
- Assess income tax information that affects cash flow forecasts and capital allocation decisions; and
- Identify potential opportunities to increase future cash flows.
"The new standard responds to calls from investors for more
transparent, decision-useful information about a company's
income taxes," stated FASB Chair Richard R. Jones. "It
requires enhanced disclosures primarily related to existing rate
reconciliation and income taxes paid information to help investors
better assess how a company's operations and related tax risks
and tax planning and operational opportunities affect the
company's tax rate and prospects for future cash
flows."
Newly Required Disclosures
Rate Reconciliation
Public entities
The ASU substantially expands public company rate reconciliation reporting. Under the update, public business entities will be required to disclose the following categories, within a tabular format, using both percentages and reporting currency amounts within their effective tax rate disclosure:
- State and local income tax, net of federal (national) income tax effect
- Foreign tax effects
- Enactment of new tax laws
- Effect of cross-border tax laws
- Tax credits
- Valuation allowances
- Nontaxable or nondeductible items
- Changes in unrecognized tax benefits
Furthermore, any reconciling items discussed below would be required to be separately broken out to the extent the impact is greater or equal to 5% of the amount computed by multiplying income (or loss) by the applicable statutory federal income tax rate. For entities parented in the U.S., this amount is effectively any item with an effect of 1.05% (21% US federal rate x 5%) or greater:
- If the reconciling item relates to the effect of cross-border tax laws, tax credits, and nontaxable or nondeductible items categories, it must be disaggregated by nature.
- If the reconciling item relates to the foreign tax effects category, it must be disaggregated by jurisdiction (country) and by nature. Notably, unrecognized tax benefits do not need to be disaggregated by jurisdiction.
- If the reconciling item does not fall within any of the categories listed in listed above, it must be disaggregated by nature.
Reconciling items generally need to be presented on a gross basis, unless otherwise specified in ASU. One notable example of an item that is excluded from the gross basis presentation are certain cross-border tax law effects (such as global intangible low taxed income) and their related foreign tax credit, which are permitted to be presented on a net basis.
Finally, public business entities will be subject to certain qualitative disclosures in addition to the quantitative disclosures noted above. These include:
- A description of the states and local jurisdictions that contribute to the majority of the effect (greater than 50 percent) of the state and local income tax category.
- An explanation of the nature, effect, and significant year-over-year changes on reconciling items if not otherwise evident.
Private entities
Private entities are required to disaggregate rate effects similar to public business entities, however they are permitted to do so in a qualitative manner, rather than quantitatively. This will result in more qualitative disclosure being required than in the past, as certain items will need to be disclosed based on specific jurisdiction.
Income Taxes Paid
The ASU aligns both public and private entity guidance and requires that income taxes paid on the statement of cash flows be disaggregated between federal, state, and foreign taxes paid (net of refunds received). Within the disaggregated line items, further disaggregation will be required to be made based on individual jurisdiction if the tax paid is 5% or more of the total balance of each category.
Next Steps
Overall, the FASB's ASU will require an increase in income tax disclosures, adding additional information to what must be reported. Though this may be burdensome to the companies impacted, for many entities it will primarily necessitate a one-time effort at adoption. We anticipate most companies will already have access to the additional information that needs to be included in their disclosures. Adjusting to the new requirements will therefore be an exercise in setting up the necessary frameworks to compile and report this additional data within companies' financial statements. Once established, these tools and frameworks will continue to support disclosures going forward, minimizing additional strain introduced by the new rules after the initial year.
The FASB guidance will be required to be applied by companies on a prospective basis, with retrospective application now being optional. The final guidance is effective for annual reporting periods after December 15, 2024, for public companies. The ASU amendments will take effect for all other entities after December 15, 2025. This will provide Companies with sufficient time to start planning and putting frameworks into place, although the FASB will permit early adoption.
What A&M Tax Says:
Now that the ASU has been finalized, companies should begin assessing their reporting processes to ensure that there are proper systems in place to gather the required new information in preparation for the first reporting year in which it is applicable. It is also prudent to prepare draft disclosures to ensure that the information contains the requisite integrity. Additional resources should be planned to implement this ASU, particularly in the year of adoption. Decisions will also need to be made over whether to early adopt or provide for retroactive application of the rules, although we generally expect most companies will not elect to do so. While private companies have more runway for adoption, if they are acquired in a strategic acquisition by a public company, the information needs will be accelerated.
Providing greater transparency in tax disclosures is undoubtedly a positive step, as it allows stakeholders to gain a more comprehensive understanding of a company's tax position, sources of cash flows, and a greater comprehension of what jurisdictions the reporting company is operating in. It also sheds light on the trends associated with tax data over time. This can be particularly valuable in assessing potential risks and long-term sustainability. However, Company management may also need to be prepared for additional stakeholder inquiries based on the dissemination of more robust tax data, particularly around jurisdictional and cash tax information.
Originally published December 21, 2023.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
