New FIN 48 Compliance Challenges

It’s crunch time for calendar-year corporate tax departments to finish their disclosures about uncertain tax positions and win auditor approval of them—and for many companies, the experience is the proverbial tightrope walk.

To comply with Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes, public companies have already faced the disclosures required in quarterly filings since the start of 2007. Now those businesses with a Dec. 31 close are scrambling to complete their first annual filing under the unpopular accounting pronouncement. It will not be easy.

Schuckman

“Companies had the challenge you’d normally expect when you have to adopt a new accounting standard,” says Dean Schuckman, head of the PricewaterhouseCoopers Tax Accounting and Controls Network. “However, there are some particular complexities associated with it due to the blending of accounting rules and income tax laws. Now the challenge is ongoing compliance with FIN 48.”

Tax and accounting experts say the annual filing requires more detail and more disclosure and is sure to be more closely scrutinized by numerous regulatory agencies. The Securities and Exchange Commission ostensibly wants more transparency so investors can see where companies may have uncertainties about the tax positions they claim in their financial statements. At the same time, however, countless taxing authorities—especially the Internal Revenue Service—have an interest in learning how FIN 48 disclosures may expose weaknesses in corporate tax returns that should be reviewed more closely.

And not to be left out, the Public Company Accounting Oversight Board will weigh in with its views on whether auditors did the appropriate amount of work to document a strong audit conclusion.

With all of those regulators watching closely, experts say one of the greatest challenges now is the forward-looking disclosure required in Paragraph 21D of FIN 48. That clause requires companies to predict changes that could occur in uncertain tax positions in the next 12 months. Specifically, companies must identify unrecognized tax benefits that might reasonably change in the coming 12 months, describe the nature of the uncertainty, and discuss what might cause a change to occur in the next 12 months. Finally, the disclosure must include a dollar estimate of the change that could occur.

“What disclosures are required under that particular disclosure requirement? That’s been the toughest challenge,” Schuckman says. “On the one hand, there’s the idea of transparency to the investing public. On the other hand, [the Financial Accounting Standards Board] was careful in coming out with FIN 48 to not necessarily require disclosure of specific tax issues. There’s a balance as you need to provide disclosure around what may reasonably happen in the next 12 months.”

Joan Rood of the law firm Buchanan Ingersoll & Rooney and a former trial attorney for the IRS says some SEC comment letters suggest the SEC staff is taking an interest in early disclosures around this part of FIN 48. “They seem to be dissatisfied with the disclosures under that paragraph,” she says. “Companies are saying, ‘Sorry, we’ll do better next time.’”

Rood

In a comment letter to Kimberly-Clark Corp., for example, the SEC staff noted that the company disclosed uncertainty around transfer pricing and various other federal tax positions that were being discussed in IRS appeals. “Tell us how you have met each of the disclosure requirements of paragraph 21D of FIN 48 for each significant uncertain tax position,” the staff wrote in the letter.

In its response, the company drew up a table for how each sentence in its original disclosure related to a Paragraph 21D disclosure requirement in FIN 48.

The Path to FIN 48 Consensus

Rood says the SEC recognizes it will take several years for companies and regulators to come to a mutual understanding of what is expected. “The SEC realizes it’s going to take a couple of cycles for companies to really implement these disclosures rules the way the SEC deems they should be implemented,” she says. “The SEC is commenting and people are responding. It will work out in time.”

“You have to say what the range of possible change could be, and if you say you expect it to change, you’re signaling to the IRS what your settlement range is. That’s a difficult thing for companies.”

— Joan Rood,

Counsel,

Buchanan Ingersoll & Rooney

She acknowledges that Paragraph 21D disclosure is tough for companies because it raises a huge red flag to tax authorities. “The main thing that might cause a change is an examination that could be complete in the next 12 months,” she says. “You have to say what the range of possible change could be, and if you say you expect it to change, you’re signaling to the IRS what your settlement range is. That’s a difficult thing for companies.”

Schuckman says another year-end headache that many companies are just beginning to face is the tabular disclosures required in FIN 48, providing a reconciliation of changes in the aggregate amount of unrecognized benefits from the beginning to the end of the year. It would include tax positions with uncertain tax benefits that get reduced because of settlements with tax authorities or are resolved by the statute of limitations expiring. It also would include changes in unrecognized tax benefits for prior-year tax positions or positions arising in the current year.

“This is a whole new disclosure required for the first time for calendar-year companies,” he says. “We’re strongly suggesting companies take a really close look at that disclosure and begin to map it out, because there may be some things in there that they may not have otherwise thought of. It’s important to get a handle on it quickly.”

Hanson

Jay Hanson of the auditing firm McGladrey & Pullen says the audit process adds another layer of uncertainty. The PCAOB is watching audit firms closely via its inspection process and wants to see fully documented conclusions for their audits, he says. “Someone who wasn’t associated with a particular engagement should be able to look at your work papers and understand what you did and reach the same conclusion,” he explains. “That for us is probably the biggest challenge, getting everything written down. There’s institutional knowledge that’s often not written down.”

PARAGRAPH 21D

Below is an excerpt of the disclosures required under FIN 48's Paragraph 21D.

D. For positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date:

The nature of the uncertainty;

The nature of the event that could occur in the next 12 months that would cause the change;

An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made.

Source

FASB (June 2006).

Giacoletti

Tim Giacoletti, a principal at the consulting firm Rehmann Group, says companies and auditors have tussled over how much documentation satisfies disclosure requirements but doesn’t share too much with taxing authorities. “A lot of companies think the amount of work that has been put into it is probably more than the benefit the financial community has gotten out of it,” he says. “Companies are pushing back on how much work to put into the documentation to provide to accounting firms. There still isn’t much guidance out there.”

David Neuenhaus, a partner at the tax law firm Neuenhaus Helverson, says companies also are still struggling with how to define a unit of account for FIN 48 purposes. “There are lots of ways to separate cost units for tax purposes,” he says. “Sometimes if you measure on a broad basis, you can be more certain. Sometimes if you measure on an individual basis, you might be less certain.”

Neuenhaus

Take research and development costs, for example. “Do you look at R&D per project, per unit, per country, per company?” Neuenhaus asks. “How do you analyze different issues? Are they on a transaction-by-transaction basis, or some sort of related basis? There’s a fair amount of internal effort on determining the appropriate unit of account, but no exact answer.”