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Page 1: Global tax accounting services newsletter - PwC · 2017-01-27 · Global tax accounting services newsletter Introduction In this issue Accounting and reporting updates Recent and

Click to launch

Global tax accounting services newsletter

Focusing on tax

accounting issues

affecting businesses

today

April – June 2015

Page 2: Global tax accounting services newsletter - PwC · 2017-01-27 · Global tax accounting services newsletter Introduction In this issue Accounting and reporting updates Recent and

Global tax accounting services newsletter

Introduction In this issue Accounting and reporting updates

Recent and upcoming major tax law changes

Tax accounting refresher Contacts and primary authors

Home Subscription

Introduction

Andrew Wiggins Global and UK Tax Accounting Services Leader +44 (0) 121 232 2065 [email protected]

The Global tax accounting services newsletter is a quarterly publication from PwC’s Global Tax Accounting Services (TAS) Group. In the newsletter we highlight issues that may be of interest to tax executives, finance directors, and financial controllers.

In this issue, we provide an update on the activity of the Financial Accounting Standards Board (FASB), the uncertain tax position project of the International Financial Reporting Standards (IFRS) Interpretation Committee, and the status of the exposure draft on recognition of deferred tax assets for unrealised losses released by the International Accounting Standards Board (IASB) in 2014. We also update you on the status of the new revenue standard and developments with country-by-country reporting.

In addition, we draw your attention to some significant tax law and tax rate changes that occurred around the globe during the quarter ended June 2015.

Finally, in the tax accounting refresher section we highlight certain aspects of accounting for income taxes associated with foreign branch operations—traditionally a complicated area of tax accounting.

This newsletter, tax accounting guides, and other tax accounting publications are also available online and on our new TAS to Go app, which you can download anywhere in the world via App Stores. To register for our quarterly TAS webcasts and access replays, please click here.

If you would like to discuss any of the items in this newsletter, tax accounting issues affecting businesses today, or general tax accounting matters, please contact your local PwC team or the relevant Tax Accounting Services network member listed at the end of this document.

You should not rely on the information contained within this newsletter without seeking professional advice. For a thorough summary of developments, please consult with your local PwC team.

Download PwC’s TAS to Go app

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Introduction In this issue Accounting and reporting updates

Recent and upcoming major tax law changes

Tax accounting refresher Contacts and primary authors

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In this issue

Accounting and reporting updates

The FASB activity update

The IFRS Interpretations Committee (IFRS IC) activity update

Status of the new revenue standard

Country-by-country (CbC) reporting developments

Recent and upcoming major tax law changes

Notable tax rate changes

Other important tax law changes

Tax accounting refresher

Accounting for income taxes associated with foreign branch operations

Contacts and primary authors

Global and regional tax accounting leaders

Tax accounting leaders in major countries

Primary authors

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Accounting and reporting updates

This section offers insight into the most recent developments in accounting standards, financial reporting, and related matters, along with the tax accounting implications.

The FASB activity update

Overview

On 8 June 2015, the FASB issued an exposure draft on tax accounting for stock compensation (see the Q1 of 2015 newsletter for the background) that includes the following revisions to the current guidance:

Recognition of all excess tax benefits

(‘windfalls’) and deficiencies (‘shortfalls’)

within income tax expense and elimination

of the requirement that cash taxes payable

be reduced in order to record a windfall

tax benefit.

Elimination of the requirement to display the gross amount of windfalls as an operating outflow and financing inflow in the statement of cash flows.

The proposed amendments to the accounting for

excess tax benefits and tax deficiencies would be

applied prospectively, while the proposed

amendments related to the classification on the

statement of cash flows would be applied

retrospectively for all prior periods presented.

The exposure draft did not specify an effective date. The FASB decided to wait until comments

are received on the proposal before determining a timeline.

The comment period for the exposure draft will end on 14 August 2015. Stakeholders are encouraged to provide comments on the above proposals.

Takeaway

The steps recently taken by the FASB and the

ongoing efforts of the FASB staff are intended to

reduce the complexity of accounting for income

taxes. Organisations should be proactively

evaluating the implications of the changes being

proposed in these tax accounting areas.

Consideration should be given to responding to the exposure draft by the end of the comment period.

There are also likely to be further developments as the FASB works through the tax accounting topics on its agenda.

Reshaping the tax function of the future

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Accounting and reporting updates

The IFRS IC update

Exposure draft on recognition of deferred

tax assets (DTAs) for unrealised losses

As we previously reported in the Q3 2014

newsletter, in August 2014, the IASB published

for comment the Exposure Draft on Recognition of

DTAs for Unrealised Losses (Proposed

amendments to International Accounting Standard

12 Income Taxes (IAS 12)). The comment period on

the Exposure Draft ended on 18 December 2014.

At its meeting in March 2015, the IFRS IC was

presented with a summary and an analysis of the

68 comment letters received on the Exposure

Draft, and decided to propose that the IASB should

proceed with the proposed amendments, subject to

some changes to the proposed wording.

The staff will present the IFRS IC’s

recommendations at a future IASB meeting.

Uncertain tax positions

As mentioned in the Q4 of 2014 newsletter, the

IFRS IC decided to proceed with developing

guidance in the form of an interpretation for the

measurement of uncertain tax positions (UTPs).

It was expected that the IFRS IC would issue the

draft interpretation for comment at the time when

this newsletter was going to production.

We will update you on the developments in relation

to this project in our next newsletter.

Takeaway

The ongoing efforts of the IFRS IC and its staff may

lead to significant near-term improvements.

Organisations should continue to monitor further

developments as the IFRS IC works through

these projects.

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Accounting and reporting updates

Status of the new revenue standard

Overview

In April 2015, the FASB and IASB decided to

propose a one-year delay in the effective date of the

new revenue accounting standard to 1

January 2018.

Early application of the standard continues to be

permitted under IFRS. Companies reporting under

US Generally Accepted Accounting Principles (US

GAAP) would also be allowed to early adopt the

guidance as of the original effective date, i.e., 1

January 2017, if the deferral proposal is approved.

What’s next?

The FASB and IASB discussed several

implementation issues related to the new revenue

standard at joint board meetings in February and

March 2015. The boards were aligned on the need

to address stakeholder feedback on licenses,

performance obligations, and certain practical

expedients upon transition, but did not agree on

the approach.

The IASB is expected to recommend more limited

clarifications while the FASB changes will be more

extensive. The FASB has also decided to propose

changes in other areas, for example, guidance on

collectability and non-cash consideration, and new,

optional ‘practical expedients,’ such as allowing

companies to account for shipping as a cost, rather

than a revenue earning deliverable, and to exclude

all sales taxes from revenue, rather than evaluating

each tax on a jurisdiction-by-jurisdiction basis.

The joint discussions are expected to continue in

the coming months.

The IASB plans to put forth a single package of

proposed amendments later this year, which

should be open for comment for a period of at least

30 days. In contrast, the clarifications proposed by

the FASB will be released for public comment as

multiple exposure drafts.

Takeaway

Although companies will likely have an extra year

to prepare, the implementation effort should not be

underestimated. The earlier implementation issues

are identified, the more likely companies can

identify potential ways to address them. In our

experience, many issues don’t become evident until

companies begin applying the new guidance to

their specific transactions. The implementation

challenges also extend well beyond accounting and

income taxes, as the new guidance will impact

processes, systems, and internal controls.

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Accounting and reporting updates

CbC reporting developments

Overview

On 8 June 2015, the Organisation for Economic

Cooperation and Development (OECD) released a

package of measures for the

implementation of a new CbC reporting

plan developed under the OECD/G20 Base

Erosion and Profit Shifting (BEPS) project.

The new implementation package consists of model

legislation requiring the ultimate parent entity of a

multinational group to file the CbC report in its

jurisdiction of residence, including backup filing

requirements when that jurisdiction does not

require filing.

The package also contains three Model Competent

Authority Agreements to facilitate the

administrative exchange of CbC reports among tax

authorities from different jurisdictions. The model

agreements are based on the Multilateral

Convention on Administrative Assistance in Tax

Matters, bilateral tax conventions and Tax

Information Exchange Agreements (TIEAs).

In detail

Composition of the MNE group

The model legislation in the new implementation package provides that the multinational (MNE) group from which the CbC report would be required is “a collection of enterprises related through ownership or control such that it is either required to prepare consolidated financial statements for financial reporting purposes under applicable accounting principles or would be so required if equity interests in any of the enterprises were traded on a public securities exchange.” Thus, the model legislation makes it clear that purely private MNEs would be required to file a CbC report.

Exclusion of small MNE groups

The model legislation also confirms that small

MNE groups should be exempt from CbC reporting

requirements if the group has less than 750 million

Euro (or the equivalent of 750 million Euro in

another currency as of January 2015) in

consolidated revenue during the fiscal year

immediately preceding the fiscal year for which

reporting would be required.

Which entity would have to file?

Under the model legislation each jurisdiction

would require a CbC report from the ‘Ultimate

Parent’ of an MNE group if that ultimate parent is

tax resident in that jurisdiction. In addition, each

jurisdiction would require a CbC report from any

‘Constituent Entity’ of an MNE group that is tax

resident in that jurisdiction if (1) the ultimate

parent of the group is not obligated to file a CbC

report in its jurisdiction of tax residence; (2) the

ultimate parent’s jurisdiction of tax residence has

an exchange of information relationship (through

treaty, tax information exchange agreement, or the

Multilateral Convention on Administrative

Assistance in Tax Matters) with the constituent

entity’s jurisdiction of tax residence but does not

have a competent authority agreement in place to

effect CbC information exchange with that

jurisdiction; or (3) there has been a ‘systemic

failure’ by the ultimate parent’s jurisdiction to carry

out CbC information exchange. In these

circumstances, the model legislation also provides

that if there is more than one constituent entity

that is tax resident in a particular jurisdiction, the

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MNE group can designate one of those entities to

file the CbC report with that jurisdiction.

The model legislation makes it clear that the OECD

members believe that the CbC report can be

collected ‘locally’ if the jurisdiction in which the

ultimate parent is headquartered is not engaged in

collecting and exchanging the reports. The

introduction to the implementation package states

that the model legislation “takes into account

neither the constitutional law and legal system, nor

the structure and wording of the tax legislation of

any particular jurisdiction.” Furthermore,

“[j]urisdictions will be able to adapt this model

legislation to their own legal systems, where

changes to current legislation are required.” It will

be interesting to see if jurisdictions in which

constituent entities are tax resident will find the

collection of global information of the entire

MNE to be within their constitutional and

legal framework.

The model legislation also contains a provision that

would allow MNEs to avoid the filing of CbC

reports locally in situations in which reporting and

exchange is not carried out in the ultimate parent’s

jurisdiction. In these cases MNEs could instead

designate another group entity as a ‘surrogate

parent’ to file CbC reports.

The model legislation provides for an apparently

administratively burdensome system of

‘notifications.’ Under this system, each constituent

entity of the MNE will notify its jurisdiction of tax

residence whether it will act as the ultimate parent

entity or surrogate parent entity. If not, it will need

to notify the jurisdiction which entity in the group

will act as the ultimate parent or surrogate parent

or, where the CbC report will be filed locally. If

there is more than one constituent entity in the

local jurisdiction, it will need to be determined and

reported which entity will be designated as the

filing entity. These notices are to be delivered to the

tax administrations in each jurisdiction in which

the MNE has constituent entities by the end of each

fiscal year for which the CbC report would be made.

Receiving and processing these notices will also

place a further administrative burden on tax

administrations, but presumably they are

considered necessary for the tax administrations to

know where the CbC report for each MNE group

will be filed each year and from which country they

will be exchanged.

Intended use and confidentiality

The implementation package makes it clear that

the OECD members have reached at least initial

consensus on the use and confidentiality of the CbC

reports.

The model legislation provides that the tax

administration collecting the CbC report “shall use

the CbC report for purposes of assessing high-level

transfer pricing risks and other base erosion and

profit shifting related risks in [Country], including

assessing risk of non-compliance by members of

the MNE group with applicable transfer pricing

rules, and where appropriate for economic and

statistical analysis.” The legislation further

provides that “[t]ransfer pricing adjustments by the

[Country Tax Administration] will not be based on

the CbC report.”

The model legislation also provides that “[t]he

[Country Tax Administration] shall preserve the

confidentiality of the information contained in the

CbC report at least to the same extent that would

apply if such information were provided to it under

the provisions of the Multilateral Convention on

Mutual Administrative Assistance in Tax Matters.”

Whether and how countries can actually implement

and police these use and confidentiality restrictions

remains to be seen.

Importantly, the model competent authority

agreements reflect these same restrictions on use

and confidentiality, as the special risk assessment-

only use restriction in the model legislation would

not otherwise apply to a jurisdiction receiving a

CbC report through a treaty-based exchange. The

competent authority agreements, however, further

provide that “Jurisdictions are not prevented from

using the CbC report data as a basis for making

further enquiries into the MNE group’s transfer

pricing arrangements or into other tax matters in

the course of a tax audit and, as a result, may make

appropriate adjustments to the taxable income of a

Constituent Entity.” Presumably, this caveat was

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not considered necessary in the model legislation

because it can be assumed that a jurisdiction

actually collecting the CbC reports directly will

consider itself free to use the information in this

way. Of course, this caveat reflecting the intended

use of the CbC reports to make “further enquiries

into the MNE group’s transfer pricing

arrangements or into other tax matters in the

course of a tax audit” presents one of the main

concerns that MNE groups will have once the CbC

reports are filed and exchanged.

Annexed to the model competent authority

agreements is a Confidentiality and Data

Safeguards Questionnaire which presents a series

of questions to be answered by tax administrations

in working out competent authority agreements to

automatically exchange information electronically.

This type of questionnaire was initially developed

in connection with efforts to implement US Foreign

Account Tax Compliance Act (FATCA)

requirements and the so-called Common Reporting

Standard. Presumably, the questionnaire was

included in the CbC reporting implementation

package to convey to both governments and private

sector stakeholders that governments seeking to

participate in CbC report exchange intend to

take seriously their obligations to keep the

reports confidential.

Penalties

The model legislation contains a note that the

legislation “does not include provisions regarding

penalties to be imposed in the event a Reporting

Entity fails to comply with the reporting

requirements for the CbC report.” The note further

states that “[i]t is assumed that jurisdictions would

wish to extend their existing transfer pricing

documentation penalty regime to the requirements

to file the CbC report.” Thus, the application of

penalties for failure to file CbC reports will be

determined by each jurisdiction, and consequently,

the penalties for failure to report could vary widely.

Time for filing and effective date

Consistent with the OECD guidance issued on 6

February 2015, the model legislation provides that

the CbC report should be filed “no later than 12

months after the last day of the Reporting Fiscal

Year of the MNE group.” Also, the model legislation

provides that the effective date of legislation would

be for reporting fiscal years of MNE groups

beginning on or after 1 January 2016. The 1

January 2016 effective date, however, is presented

in brackets, presumably to acknowledge that some

countries will deviate from that date.

Takeaway

For many OECD countries there may be a need to

implement CbC reporting through changes to

domestic law before it can fully come into effect.

However, it is clear that there is a strong

commitment from countries to implement CbC

reporting effective 1 January 2016, as

recommended by the OECD.

Given the lead time generally required to prepare

internal systems and processes for CbC reporting

and the level of funding and change that may be

required, it is critical that taxpayers begin to assess

now whether their current information and

accounting systems will allow them to comply with

the above CbC reporting requirements, as well

as any subsequent information requests from

tax authorities.

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Recent and upcoming major tax law changes

This section focuses on major changes in the tax law that may be of interest to multinational companies and can be helpful in their tax accounting considerations. It is intended to increase readers’ awareness of the main global tax law changes during the quarter, but does not offer a comprehensive list of tax law changes that should be considered for financial statements.

Notable enacted tax rate changes

Country Prior rate New rate

India (CIT) 30% 25%1

1 The corporate tax rate in India was reduced from 30% to 25% over four years starting with the 2016–2017 financial year. This change

was enacted on 14 May 2015.

Around the world:

When to account for

tax law changes

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Recent and upcoming major tax law changes Other important tax law changes

Click each circle to review

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Recent and upcoming major tax law changes

Australia

During the second quarter of 2015, the third and

final element of the Investment Manager

Regime became law. Broadly, the new rules

exempt foreign funds (including eligible US

onshore and offshore funds) from Australian tax on

Australian-source gains. The rules apply to

assessments for the 2015-2016 tax year and

subsequent years. Entities have the option to apply

the amendments to earlier tax years beginning 1

July 2011, through 30 June 2015.

During the second quarter of 2015, the Australian

Treasurer delivered the Federal Budget, that

included the following key proposals:

With effect from 1 January 2016, the general

anti-avoidance rules would be expanded to

capture certain arrangements that have a

primary purpose of avoiding a taxable

presence in Australia. This measure would

apply to both new and existing schemes. The

exposure draft legislation for this measure has

been released.

Increased penalties would be introduced for

income years commencing on or after 1 July

2015, for companies that enter into tax

avoidance or profit shifting schemes.

The OECD’s new transfer pricing

documentation standards, including CbC

reporting, would be implemented from 1

January 2016.

In addition, the Australian government released

the exposure draft legislation detailing

amendments to the consolidation regime

previously announced in the 2013–2014 and 2014–

2015 Federal Budgets. The proposed new rules are

aimed at restoring integrity to the consolidation

regime. Most significantly, the rules would remove

perceived ‘double benefits’ or ‘double detriments’

when an Australian target or subsidiary joins a tax

consolidated group. The exposure draft was open

for comments until 19 May 2015.

Canada

During the second quarter of 2015, the Canadian

Federal Minister of Finance presented the 2015

budget that included the following key proposals:

A 50% declining-balance rate would be

introduced for machinery and equipment

acquired between 2015 and 2026 primarily for

use in Canada for the manufacturing and

processing of goods for sale or lease.

The section 55 anti-avoidance rule (which may

tax certain inter-company dividends as capital

gains) would apply to dividends received after

20 April 2015, in situations where one of the

purposes for the dividend is to effect a

significant reduction in the fair market value of

any share or a significant increase in the total

cost of properties of the dividend recipient.

The dividend rental arrangement rules would

be modified for dividends that are paid or

become payable after October 2015. The

modifications deny the inter-corporate

dividend deduction on dividends received from

a Canadian share where there is a synthetic

equity arrangement. A synthetic equity

arrangement would be considered to exist

when the taxpayer (or a person that does not

deal at arm’s length with the taxpayer) enters

into one or more agreements that have the

effect of providing to a counterparty all or

substantially all of the risk of loss and

opportunity for gain or profit.

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Denmark

During the second quarter of 2015, a general anti-

avoidance rule was enacted in Denmark. The rule

will apply to any foreign transactions with a Danish

entity. In essence, the protection normally available

to transactions under Danish tax treaties and EU

Directives will no longer be available unless

multinational companies meet certain substance

and commercial reasons tests. Notably, certain

EU countries may be viewed as tax havens for

Danish purposes.

European Union (EU)

During the second quarter of 2015, the European

Commission presented Tax Transparency

Package 2.0 to fundamentally reform corporate

taxation in the EU, which sets out a series of

initiatives to tackle tax avoidance, secure

sustainable revenues and strengthen the Single

Market for business. Key aspects of the plan

include a proposal for a Common Consolidated

Corporate Tax Base, a framework to ensure

effective taxation where profits are generated and

increased tax transparency.

France

During the second quarter of 2015, the French

Ministry of Finance released new measures

aimed at increasing transparency and promoting

trust between the French tax authorities (FTA) and

taxpayers. This action is a part of the French

government’s focus on tax evasion and tax fraud on

a national and international scale. The following

four new measures have been announced:

Improving predictability of reassessments by

publishing a list of aggressive tax structures

considered to be illegal by the FTA.

Adopting ten ‘commitments’ to encourage

transparent and constructive dialogue with

taxpayers during tax audits. For example, the

FTA commits to indicating, whenever possible,

the main objectives of an audit at inception to

help a taxpayer anticipate the documents that

will be requested, meeting deadlines in

providing conclusions of the audit to the

taxpayer with timely responses to their

comments, and maintaining confidentiality and

tax secrecy as required under the law.

Creating a national committee of experts

composed of judges, academics, and business

tax directors to provide expertise to the FTA in

the analysis of complex cases.

Creating a Research & Development (R&D) tax

credit advisory board to provide consultation

services to taxpayers during tax audits where

the FTA challenges qualifying expenses.

India

During the second quarter of 2015, previously

announced 2015 Budget proposals were

enacted in India. These included the following:

For current financial year 2015–2016, the tax

surcharge was increased by 2%.

The implementation of the general anti-

avoidance rules was deferred for two years in

order to implement them as part of a

comprehensive regime that addresses the

OECD’s BEPS project.

Tax residency rules were amended to introduce

the ‘place of effective management’ concept.

This concept is essentially defined as the place

where key management and commercial

decisions that are necessary for the conduct of

the business are, in substance, made.

Italy

During the second quarter of 2015, the Italian

government released draft legislation which

covers a large number of international tax issues

including the following:

Roll-back provisions would be introduced for

all Advance Pricing Agreements (APA) and the

potential APA scope would cover exit and entry

values of assets and liabilities in the event

of outbound and inbound transfers of

tax residence.

Costs incurred in transactions with entities

resident in tax heavens, under the so-called

‘Black List’ rules, which are currently non-

deductible unless certain specific exemption

conditions are met, would be deductible up to

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their ‘arm’s length’ value provided the

underlying transactions have actually

taken place.

The attribution of profits to an Italian

permanent establishment of a foreign entity

would follow the principles set out by the

OECD. An optional regime would also be

introduced allowing Italian companies with

foreign branches to exempt such income from

Italian tax.

The draft decree is currently under review in the

Italian Parliament, and is therefore still potentially

subject to modification.

During the quarter, the Italian tax authorities also

issued guidelines addressing the anti-

avoidance rules that apply to the notional

interest deduction (NID) regime. NID is a

notional deduction with respect to ‘new equity,’

which includes retained earnings and certain cash

capital contributions over a particular equity basis

as of 2010.

Malaysia

During the second quarter of 2015, the Malaysian

Ministry of International Trade and Industry

issued guidelines on incentives for multinational

corporations seeking to establish or expand their

presence in Asian countries through a Malaysian

Principal Hub. The incentives are structured in

three tiers based on various criteria including

minimum annual sales, employment, annual

business spending and other qualifying activities.

Through the Principal Hub incentive, Malaysia

hopes to position itself as playing a key role in the

integrated global supply chain of multinationals.

New Zealand (NZ)

During the second quarter of 2015, the NZ Finance

Minister delivered the 2015 Budget that included

a proposal for a new ‘bright line’ test to ensure that

taxpayers selling NZ residential property (with

some exceptions) within two years of purchase will

pay tax on the profits. Additional administrative

requirements would also be introduced for non-

resident investors buying and selling NZ residential

property, including requirements to have a NZ

bank account and Inland Revenue Department

(IRD) number and disclosure of their tax

identification number from the home country.

In addition, the IRD released an Officials’ Issues

Paper proposing several changes to the non-

resident withholding tax (NRWT) rules in

relation to interest earned by non-residents from

related party debt. The Issues Paper is part of the

IRD’s work on BEPS and is a feature of the

government’s tax policy work program announced

by the Minister of Revenue earlier this year.

Broadly the proposals include the following:

The type of instruments that can give rise

to interest income subject to NRWT would

be broadened.

The rules for determining the amount and

timing of interest income subject to NRWT

would be better aligned with the financial

arrangement rules.

Switzerland

During the second quarter of 2015, the Swiss

Federal Council released the updated draft bill of

the Swiss Corporate Tax Reform III (CTR

III) for further parliamentary discussion. The key

elements of CTR III include the following:

CTR III abolishes cantonal holding, domiciliary

and mixed company status, and principal and

Swiss finance branch rules at the federal level.

The changes respond to the European Union’s

and OECD’s criticism concerning these

regimes.

CTR III introduces a cantonal patent box for

patents and similar rights that takes into

account the nexus approach recently developed

by the OECD. Under this provision, the cantons

may grant a maximum relief on patent box

profit of 90%.

The reform proposes a cantonal super-

deduction for research and development costs.

The reform proposes to adapt the current

cantonal capital tax. The cantons may relieve

the capital tax on equity to the extent it

relates to patents and similar rights as well

as participations.

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Map view

The extent of cantonal rate reductions will be at

the cantons’ discretion.

USA

During the second quarter of 2015, the IRS and US

Treasury issued final regulations under

Section 7874 (TD 9720) for determining when

an expanded affiliated group will be considered to

have substantial business activities in a foreign

country. Broadly, the final regulations retain the

25% bright-line rule provided in the 2012

temporary regulations. They apply to acquisitions

completed on or after 3 June 2015, and are

effective as of 4 June 2015.

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Tax accounting refresher

In this section we highlight certain aspects of accounting for income taxes associated with foreign branch operations—traditionally a complicated area of tax accounting.

Accounting for income taxes associated with foreign branch operations

Foreign branch operations generally represent

operations of an entity conducted in a country that

is different from the country in which the entity is

incorporated. For US entities, a branch can also

take the form of a wholly owned foreign

corporation that has elected for tax purposes to be

treated as a disregarded entity of its immediate

parent corporation.

Taxation of foreign branches may vary between

various jurisdictions, which in turn may impact

accounting for income taxes associated with such

operations. While specifics of tax accounting for

branches may need to be worked out for each

jurisdiction, in our discussion below we will focus

on the key aspects of the income tax standards IAS

12 (IFRS) and ASC 740 (US GAAP) relating to

branch operations.

Inside basis differences

Branch operations are often subject to tax in two

jurisdictions: the foreign country in which the

branch operates and the entity’s home country.

Accordingly, the entity should typically have two

sets of temporary differences relating to the

branch’s underlying assets and liabilities (generally

referred to as ‘inside basis’ differences) that give

rise to deferred tax assets and liabilities. Such

differences arise in (1) the foreign jurisdiction in

which the branch operates and (2) the entity’s

home jurisdiction.

Under both IFRS and US GAAP, the temporary

differences in the foreign jurisdiction will be based

on the differences between the book basis and the

related foreign country tax basis of each asset and

liability. The temporary differences in the home

country jurisdiction will be based on differences

between the book basis and the home country tax

basis in each asset and liability.

Some countries, like the UK, provide a tax

exemption in the entity’s home country for certain

branch profits. Consequently, no credit is available

in the home country for foreign taxes paid by the

branch. To the extent that the branch tax

exemption applies, only temporary differences

arising in the foreign jurisdiction would need to

be considered.

IFRS and US GAAP: similarities and

differences

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Outside basis differences

Under IFRS, a temporary difference might also

arise between the total carrying amount of the

reporting entity’s net assets in the branch and the

tax base of the reporting entity’s investment in the

branch. This temporary difference is sometimes

referred to as ‘outside basis’ difference.

Situations where outside basis differences in

relation to branches could arise are quite rare.

Nevertheless, the IAS 12 specifically addresses

them as it was written broadly and with flexibility

in mind. Outside basis differences may arise, for

example, due to undistributed profits (e.g., if

branch profits are taxed on distribution) or changes

in foreign exchange rates.

Where the book value of the entity’s net assets in

the branch is greater than their tax base (e.g., due

to retained profits) an entity needs to recognise a

deferred tax liability (DTL), except to the extent

that both of the following conditions are satisfied:

1) the entity is able to control the timing of the

reversal of the temporary difference; and

2) it is probable that the temporary difference will

not reverse in the foreseeable future.

As an entity controls the ultimate distribution of

the profits of a branch, it is able to control the

timing of the reversal of temporary differences

associated with that investment. Therefore, if the

entity has determined that those profits will not be

distributed in the foreseeable future it does not

recognise a DTL.

Where the tax base of the entity’s net assets in the

branch is greater than the book value (e.g., due to

accumulated losses or write-downs), the entity

shall recognise a DTA, but only to the extent that it

is probable that:

1) the temporary difference will reverse in the

foreseeable future; and

2) taxable profit will be available against which

the temporary difference can be utilised.

Under US tax rules, income in the branch is

directly taxable to the owner. As a result, there

generally should be no timing differences

associated with the investment in the branch itself

under US GAAP. However, timing differences may

arise in relation to foreign currency movements.

These are discussed later in this section.

Foreign taxes

The entity should record deferred taxes in its home

country for the tax effects of foreign DTA and DTL

because each would be expected to constitute a

temporary difference in the home country deferred

tax computation. More specifically, when a

deferred foreign tax liability is settled, it increases

foreign taxes paid, which in turn decreases the

home country taxes paid as a result of additional

foreign tax credits or deductions for the additional

foreign taxes paid. Equally, when a deferred foreign

tax asset in the foreign jurisdiction is recovered, it

reduces foreign taxes paid, which increases the

home country taxes as a result of lower foreign tax

credits or deductions for foreign taxes paid.

In considering the amount of deferred taxes to be

recorded in the home country as they relate to

foreign DTA and DTL, an entity must consider how

those foreign deferred taxes, when paid, will

interact with the tax computations in the home

country tax return. For example, in the US, a

taxpayer makes an annual election to deduct

foreign taxes paid or to take them as a credit

against its US tax liability. In making this decision

a taxpayer will need to consider a number of

factors, including the interaction of the income and

taxes of the foreign branch with the income and

taxes of the entity’s other branches and

foreign corporations.

If the taxpayer expects to take a credit for the

foreign taxes to be paid, it should record (before

considering any related credit limitations) a home

country DTA (DTL) for each related foreign DTL

(DTA) at a rate of 100% for the amount of the

foreign deferred taxes that are expected to be

creditable (see example below).

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If the foreign taxes that will be paid as the deferred

taxes reverse are not expected to be fully creditable

(e.g., in situations where the foreign tax rate

exceeds the home country tax rate), unique

considerations can arise. As a result, it may be

appropriate to record home country deferred taxes

on foreign country deferred taxes at a rate of less

than 100% of the foreign deferred tax asset or

liability, or under US GAAP it may be appropriate

to record such deferred taxes at a rate of 100% with

a valuation allowance for the portion of any net

foreign deferred taxes that, when paid, result in

credits that are expected to expire unutilised.

If the entity expects to deduct (rather than take a

credit for) foreign taxes paid, it should establish in

the home country jurisdiction deferred taxes on the

foreign DTA and DTL at the home country enacted

rate that is expected to apply in the period during

which the foreign deferred taxes reverse.

If there is no net DTA in the foreign jurisdiction

(e.g., due to a full valuation allowance under US

GAAP), a corresponding DTL in the home country

jurisdiction would generally be inappropriate.

Example

Background/facts

Company P has a branch in Country X where

the statutory tax rate is 25%.

In the current year, the branch is profitable.

For tax purposes in both Country X and

Company P’s home country, the branch has

excess tax over book depreciation of $5,000

and accruals deductible when paid of $3,000.

Both of these items represent

temporary differences.

In Company P’s home country, the branch is

taxed at 40%.

Taxes paid to Country X will be claimed as a foreign

tax credit.

Question

What are the amounts of deferred income taxes to

be recorded in the consolidated financial

statements?

Analysis/conclusion

Because the branch is taxed in both Country X and

Company P’s home country, the taxable and

deductible temporary differences in each

jurisdiction must be computed. A DTA for the

home country’s tax effects of the foreign DTL

associated with the depreciable property, as well as

a DTL for the home country’s tax effects of the

foreign DTA associated with the reserves, would be

included in the deferred tax balance. The effect of

these foreign deferred taxes on the foreign taxes

paid will, in turn, affect the home country tax

liability as a result of the impact on future credits

or deductions for foreign taxes paid.

This concept is illustrated below:

Country X

Accruals

deductible

when paid

$750 $3,000 x 25%

Depreciation $(1,250) ($5,000) x 25%

Branch DTL,

Net

$(500)

Home country

Accruals

deductible

when paid

$1,200 $3,000 x 40%

Depreciation $(2,000) ($5,000) x 40%

DTA on branch

DTL, Net

$500 $500 x 100%;

presumes 100%

foreign tax credit

Home country

DTL, Net

$(300)

Total DTA

/(DTL)

$(800)

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Foreign currency translation

Another area that must be considered is accounting

for foreign currency movements in relation to

foreign branches, including foreign currency

movements on branches’ temporary differences.

Under IFRS, a DTA (subject to the recognition test)

or a DTL should be recognised on foreign currency

movements on temporary differences related to a

foreign branch. The resulting deferred tax is

credited or charged to profit or loss.

Under US GAAP the effects of translating the

financial account balances from the branch’s

functional currency to the parent’s reporting

currency, including foreign currency movements on

temporary differences related to a foreign branch,

should be recorded in the cumulative translation

adjustments (CTA) account. In circumstances when

the temporary differences associated with the

translation adjustments of the foreign branch will

not be taxed in the home country until there is a

remittance of cash, for example, in the United

States, a question arises as to whether or not an

entity can apply an indefinite reversal assertion to

the CTA of the branch.

We believe the answer depends upon which of two

acceptable views the entity applies in its

interpretation of the accounting literature. View 1 is

that an indefinite reversal assertion is not available

for a branch and View 2 allows for the application

of an indefinite reversal assertion (when facts and

circumstances permit). The views are summarised

as follows:

View 1 — An exception to comprehensive

recognition of deferred taxes only applies to outside

basis taxable temporary differences related to

investments in foreign subsidiaries and certain

foreign corporate joint ventures. Because branch

income is directly taxable to the owner or parent,

there is technically no outside basis difference

in the branch and therefore the exception is

not applicable.

View 2 — In deliberating ASC 740, the FASB

indicated that the underlying rationale for the

exception to recognising deferred taxes related to

investments in foreign subsidiaries is based on the

inherent complexity and hypothetical nature of the

calculation. However, application of the exception

depends on an entity’s ability and intent to control

the timing of the events that cause temporary

differences to reverse and result in taxable amounts

in future years. In particular, the exception focuses

on the expectation of owner or parent taxation in

the home jurisdiction. If taxation of the CTA occurs

only upon a remittance of cash from the branch,

the timing of taxation can be controlled by the

owner or parent. On that basis, an indefinite

reversal assertion could be applied to the CTA of a

foreign branch (even though the assertion could

not apply to the periodic earnings of the branch

since they pass through to the parent). This is not

an ‘analogous’ temporary difference which would

be prohibited; rather, it is in the scope of the

exception. That is because such amount relates to a

foreign operation and carries with it the same

measurement complexities as any other foreign

outside basis difference.

The view taken is an accounting policy that should

be applied consistently. Accordingly, if View 1 is

adopted, it would be applied to all of the company’s

foreign branches. If View 2 is adopted, indefinite

reversal could be asserted for any branch for which

the criteria are supportable by specific plans

relating to the unremitted branch earnings. As a

result, under View 2, an indefinite reversal

assertion could be made and supported for one

branch while not being made for another.

For a company applying View 2, other points to

note are as follows:

The fact that earnings have already been taxed

can make the assertion difficult when there is a

possibility of repatriation from

foreign operations.

When an overall translation loss exists in the

CTA, it is necessary to demonstrate that the

temporary difference will reverse in the

foreseeable future before recognising a DTA.

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In the event that an indefinite reversal

assertion changes, the deferred taxes

attributable to current year CTA movement are

recorded to other comprehensive income.

However, because the beginning-of-year CTA

balance did not arise during the year, but

rather in prior years, the tax effects associated

with those prior-year cumulative balances

should be recorded to continuing operations.

The US Internal Revenue Service (IRS) has

indicated that final regulations applying to foreign

currency translation could be issued by the end of

the calendar year. These regulations may impact

US GAAP accounting for foreign currency

movements in relation to branches as

discussed above.

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Contacts

For more information on the topics discussed in this newsletter or for other tax accounting questions, including how to obtain copies of the PwC publications referenced, contact your local PwC engagement team or your Tax Accounting Services network member listed here.

Global and regional tax accounting leaders

Global and United Kingdom

Andrew Wiggins

Global and UK Tax Accounting

Services Leader

+44 (0) 121 232 2065

[email protected]

EMEA

Kenneth Shives

EMEA Tax Accounting

Services Leader

+32 (2) 710 4812

[email protected]

Asia Pacific

Terry Tam

Asia Pacific Tax Accounting

Services Leader

+86 (21) 2323 1555

[email protected]

Latin America

Marjorie Dhunjishah

Latin America Tax Accounting

Services Leader

+1 (703) 918 3608

[email protected]

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Contacts

Tax accounting leaders in major countries

Country Name Telephone Email

Australia Ronen Vexler +61 (2) 8266 0320 [email protected]

Belgium Koen De Grave +32 (3) 259 3184 [email protected]

Brazil Manuel Marinho +55 (11) 3674 3404 [email protected]

Canada Spence McDonnell

Nicole Inglis

+1 (416) 869 2328

+1 (604) 806 7781

[email protected]

[email protected]

China Terry Tam +86 (21) 2323 1555 [email protected]

Finland Kaj Wasenius +358 (20) 787 7302 [email protected]

France Marine Gril-Gadonneix +33 (1) 56 57 43 16 [email protected]

Germany Heiko Schäfer +49 (69) 9585 6227 [email protected]

Hungary David Williams +36 (1) 461 9354 [email protected]

India Pallavi Singhal +91 (80) 4079 6032 [email protected]

Italy Marco Meulepas +39 (02) 9160 5501 [email protected]

Japan Masanori Kato +81 (3) 5251 2536 [email protected]

Mexico Fausto Cantu +52 (81) 8152 2052 [email protected]

Netherlands Jurriaan Weerman +31 (0) 887 925 086 [email protected]

Poland Jan Waclawek +48 (22) 746 4898 [email protected]

Romania Mariana Barbu +40 (21) 225 3714 [email protected]

Singapore Paul Cornelius +65 6236 3718 [email protected]

South Africa Loren Benjamin +27 (11) 797 5426 [email protected]

Spain Alberto Vila +34 (915) 685 782 [email protected]

United Kingdom Andrew Wiggins +44 (0) 121 232 2065 [email protected]

United States David Wiseman +1 (617) 530 7274 [email protected]

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Primary authors

Andrew Wiggins

Global and UK Tax Accounting

Services Leader

+44 (0) 121 232 2065

[email protected]

Katya Umanskaya

Global and US Tax Accounting

Services Director

+1 (312) 298 3013

[email protected]

Steven Schaefer

National Professional Services

Group Partner

+1 (973) 236 7064

[email protected]

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