Back in April, we reported on the Financial Accounting Standards Board’s (FASB) proposed Accounting Standards Update (ASU), “Income Taxes (Topic 740): Improvements to Income Tax Disclosures.” Initially released in March, it aimed to increase the transparency and usefulness of income tax disclosures.
The comment period recently concluded and, after deliberating on the feedback received, the FASB Board released affirmations with only minor alterations to its previous proposal. The final ASU is expected to be issued in the fourth quarter of 2023.
The earlier proposed ASU expanded disclosure requirements in the following areas:
There were multiple clarifications made by the board that will aid practitioners in preparing these disclosures with less ambiguity:
Effective Tax Rate
The most significant change to the proposed ASU relates to the presentation of unrecognized tax benefits. The proposed ASU required that changes in unrecognized tax benefits must be disaggregated by jurisdiction. This level of detail surrounding companies’ tax exposures was highly unpopular in the comment phase, including commentary provided to FASB by A&M. Feedback received frequently highlighted that disaggregation could expose companies to commercial risk. Accordingly, the FASB determined that these amounts could be aggregated under a single line item in the tabular reconciliation.
Another point of clarification provided was that all items within the effective tax rate must be presented on a gross basis unless otherwise specified in the final guidance. 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.
To better harmonize disclosure requirements with those of the SEC, the FASB will incorporate guidance resembling that found in SEC Regulation S-X Rule 4-08(h)(2), pertaining to General Notes on Financial Statements—Income Tax Expense. This guidance permits foreign entities to employ a statutory income tax rate different from their home country’s rate and mandates the disclosure of the rate chosen and the rationale behind its selection when it deviates from the U.S. federal corporate income tax rate.
Finally, the Board opted against introducing an independent proposed disclosure that would necessitate a qualitative explanation, during interim reporting, of any reconciling items leading to substantial shifts in the estimated annual effective tax rate compared to the effective tax rate in the preceding annual reporting period.
Income Taxes Payable
Under the guidance, companies will be required to provide a breakout of amounts paid for taxes between federal, state, and foreign taxing jurisdictions, rather than a lump sum amount. However, companies will only be required to disclose this information on an annual basis rather than on an interim basis as originally required in the initial proposed update.
The Board’s decisions largely leave private entities with less onerous reporting requirements than public business entities.
Effective Tax Rate
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 approved guidance reaffirms FASB’s decision to align the private company disclosure requirement with that of public business entities. Rather than reporting income taxes paid as a single line item on the statement of cash flows, private companies will now need to disaggregate this information 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.
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, and interim periods within fiscal years beginning after December 15, 2025, for public companies. The ASU amendments will take effect for all other entities after December 15, 2025, with interim periods after December 15, 2026. This will provide Companies with sufficient time to start planning and putting frameworks into place, although the FASB will permit early adoption.
It is evident that the standard setters considered the concerns and questions raised by stakeholders, including A&M, during the proposal stage as the approved guidance offers some tangible improvement from the proposed version. Moreover, the requirements now appear to be more operable, providing clearer guidelines and reducing ambiguity for both preparers and users of financial statements.
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.
Companies should assess their reporting processes to ensure that there are proper systems in place to gather this information in preparation for the final ASU’s adoption.
Please contact our experts if you have any questions on how these disclosure changes might impact your financial reporting process.