As economic turmoil deepens in countries abroad, it may get even tougher for public companies to assert that their foreign earnings are permanently invested in overseas havens, safe from U.S. federal tax.
Securities and Exchange Commission staff members recently renewed their warning that they are scrutinizing claims by multinational companies about overseas earnings that are never brought back to the parent company's balance sheet.
During routine filing reviews, the staff is studying whether companies are complying with Accounting Standards Codification Topic 740, Accounting for Income Taxes, which requires companies to establish a deferred tax liability for foreign earnings that will eventually be subject to U.S. tax when repatriated, or brought onto the parent company's U.S. balance sheet. SEC staff discussed their latest concerns at a recent meeting of the Center for Audit Quality's SEC Regulations Committee.
According to U.S. tax rules, foreign earnings are taxed at the U.S. federal tax rate when repatriated, minus whatever tax was paid in the foreign jurisdiction where they were earned, says Bob Norton, chief income tax officer at consulting firm Vertex. “Our corporate tax rate is the second highest in the G20 behind Japan, so when a company repatriates earnings, they are taxed on the excess of the U.S. tax rate over the foreign country's rate,” says Norton. “That increases the effective tax rate, and it hurts earnings.”
Companies can avoid booking that deferred tax liability and paying an incremental tax if they can convince regulators that those earnings are permanently reinvested outside the United States and will never be brought back. “But you have to be able to support that assertion,” Norton says.
SEC staff member Angela Crane told the committee the staff is focused on disclosures when certain foreign operations “appear to have a disproportionate financial effect on consolidated operations,” according to a CAQ summary of the discussion. If companies really plan to keep their earnings offshore to avoid tax consequences, then the SEC staff wants more information, Crane said. When it spots such a situation, the SEC staff will ask the company to provide disaggregated financial information related to pre-tax income and effective tax rates to better understand the disproportion, she said.
If it's material, the SEC staff will ask a company to disclose the amount of cash and short-term investments held by foreign subsidiaries that are not available to fund domestic operations because they are permanently invested elsewhere. The SEC is also asking companies to explain to investors that it would have to accrue and pay taxes on those funds if they were repatriated, and that the company does not intend to repatriate the funds, if it's true, Crane said.
Questions began surfacing in 2009 as the economic crisis led to tight lending and liquidity problems in the United States, even while companies sat on cash overseas, says John Aksak, a managing director at tax consulting firm True Partners. If a company is cash-strapped at home, but sitting on cash abroad, the SEC wants to see it explained to investors. To pass muster with the SEC, companies need to be sure they are telling a consistent story through their balance sheet, their disclosures, their management discussion and analysis, and their tax footnotes, Aksak says. “Can the reader understand what's going on here?” he says. “Or does the company need to provide some additional information?”
“Using Greece as an example, would you really leave your cash over there if things turn out bad? If that's the case, you can't make an assertion that you're invested for the foreseeable future.”
—Peter Bible,
Partner-in-Charge,
EisnerAmper
More recently, regulators and auditors are beginning to wonder if companies are telling a believable story when they are heavily invested in countries where economic turmoil is creating huge uncertainties, says Peter Bible, partner-in-charge of the public company group at accounting firm EisnerAmper and a member of the Center for Audit Quality's SEC Regulations Committee. “If you're in a country like Greece, Italy, or Ireland, where you have a very low tax rate but also a very unstable government right now, what effect, if any, might that have on earnings or operations in that country?” he asks. “Given the overall economic concerns in that country, what might that do as you are enjoying a large earnings stream at a low tax rate over there?”
The SEC is primarily concerned with assuring companies have fully disclosed their plans, he says, but companies should be prepared for those assertions to be challenged by auditors and the SEC. “This could result in someone questioning whether you need to provide for that additional 10 percent,” he says, referring to the additional tax companies might have to pay if they repatriate funds from overseas. “Using Greece as an example, would you really leave your cash over there if things turn out bad? If that's the case, you can't make an assertion that you're invested for the foreseeable future. The story line has to hold together.”
FOREIGN EARNINGS DISCLOSURES
In the excerpt below from the CAQ's SEC Regulations Committee Meeting Summary provides information on “MD&A Disclosures About Foreign Operating Results and Income Taxes”:
Angela Crane [associate chief accountant at the SEC] noted the SEC staff continues to focus on registrants' disclosures when certain foreign operations appear to have a disproportionate financial effect on consolidated operations. In those instances, the SEC staff has requested that registrants provide disaggregated financial information related to pre-tax income and the effective tax rates from a particular country with a disproportionate effect.
Many companies do not provide US deferred taxes on undistributed earnings of foreign subsidiaries (under ASC 740, Accounting for Income Taxes) because those earnings are considered to be indefinitely reinvested. Ms. Crane stated the SEC staff has been asking registrants to consider the effect on consolidated liquidity when they intend to indefinitely reinvest foreign earnings. The SEC staff requests disclosure, if material, of the amount of cash and short-term investments held by foreign subsidiaries that are not available to fund domestic operations unless the funds are repatriated, a statement that the company would need to accrue and pay taxes if repatriated, and a statement that the company does not intend to repatriate the funds, if true.
Source: CAQ's SEC Regulations Committee Meeting Summary.
Brad Davidson, a partner with audit firm Crowe Horwath and another member of the SEC Regulations Committee, says he hasn't seen instances where auditors have challenged the permanent investment assertion based on political or economic turmoil in specific countries, but he sees it as plausible. “If that situation applied, it would be a great question for auditors to ask,” he says.
There are some key factors companies can consider to help decide if the assertion will hold up, says Rick Day, national director of accounting at McGladrey & Pullen. If a company has had a significant change or disruption in operations in a given country—such as customers experiencing difficulties or delivery problems—it might be a red flag, he says.
Still, it doesn't mean the SEC or anyone else will insist companies repatriate and pay taxes on overseas earnings, says George Clarke, an attorney with law firm Miller & Chevalier. “Globally, there are still plenty of places for U.S. companies to invest foreign earnings,” he says. “The large multinationals have robust, substantial overseas operations that use a lot of cash, so it's not at all surprising that companies would reinvest the profits they earn in those or other foreign subsidiaries.”
Clarke says some companies may be waiting for another repatriation holiday, like the one offered in 2004 when companies were given a window of time to bring cash back to the United States at a reduced tax rate, or they may be hoping for a change in U.S. tax policy altogether to reduce U.S. tax on foreign earnings.
No comments yet