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Managing the Indirect Tax Balance Sheet
Sinead Hughes PwC
Chicago [email protected]
Colleen Freeburg General Motors
Detroit [email protected]
Bruce Goudy Bruce Goudy Professional
Corporation
Toronto [email protected]
2017 IPT’s Value Added Tax Symposium
OVERVIEW
• Indirect Tax Liabilities
– Loss Contingencies
– Recognition & Disclosure
– Gain Contingencies
• Indirect Taxes Management
– Dashboards
– Basic Diagnostics
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2017 IPT’s Value Added Tax Symposium
What is ASC 450 (FAS 5)?
Requires a corporation to record a liability in anticipation of a judgment against it or a settlement when certain conditions are met
Requires corporations to disclose the existence of a specific contingency in their financial statements
Previously in Statement of Financial Accounting Standards (SFAS) No. 5
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2017 IPT’s Value Added Tax Symposium
What is a Contingency?
An existing condition, situation or set of circumstances involving uncertainty regarding
potential loss or impairment of an asset or
gain
that will ultimately be resolved when one or more future events occur or fail to occur.
e.g., awaiting a court decision regarding an indirect tax appeal
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2017 IPT’s Value Added Tax Symposium
Loss Contingency vs Estimated Accrual
Obligation to pay an amount is certain
Not dependent on the occurrence of a future event to confirm the liability
No plans to dispute the obligation
e.g., the amount of tax short-paid as a result of a clerical error
on a prior importation
Uncertainty about the amount of an estimated accrual does not make it a loss contingency
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2017 IPT’s Value Added Tax Symposium
Likelihoods of Loss
Three likelihood categories that a loss or impairment of asset has occurred at the date of financial statements (which will be resolved once a future event occurs)
PROBABLE
Loss is likely to be confirmed by future event
Higher threshold than IFRS “more likely than not” (more than a 50%)
REASONABLY POSSIBLE
Risk of loss or impairment is between Probable and Remote
REMOTE
Risk of loss is slight
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2017 IPT’s Value Added Tax Symposium
Recognition and Disclosure
Accrual for a loss contingency is required if both conditions met:
Probable
It is probable that a liability has been incurred or that an asset has been impaired at the date of the financial statements
Reasonably estimated
The amount of indirect tax contingent loss can almost always be reasonably estimated
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2017 IPT’s Value Added Tax Symposium
Assessing Likelihood
Qualitative and quantitative factors to consider:
1. Nature of the lawsuit, claim or assessment,
2. Progress of the case (including developments after the date of the financial statements but before those statements are issued),
3. Opinions or views of internal tax counsel and other advisers,
4. Experience of the entity in similar cases within that jurisdiction,
5. Experience of other companies in similar cases, and
6. Any decision by management as to how the entity intends to respond to the lawsuit, claim or assessment (for example, whether the Corporation plans to defend vigorously or seek settlement).
7. Detection risk?
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2017 IPT’s Value Added Tax Symposium
ASC 450 Decision Tree
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Start
Probable?
Reasonably Estimable?
Reasonably Possible?
No Accrual
---
No Disclosure
Disclosure Required
Accrual Required
YES
YES
YES
NO
NO
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2017 IPT’s Value Added Tax Symposium
Releasing Tax Reserves
Reserves should be released when the liability or
contingency has been cleared
Payment of liability
Audit finalized
Statute closed
New relevant information
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2017 IPT’s Value Added Tax Symposium
Example 1 Recognition & Disclosure
Company A is a defendant in an indirect tax lawsuit and concludes that an adverse
judgment would be approximately $1 million. However, you estimate that the chance of
losing is 40%. In such case, the accrual should be:
A. $400,000
B. $0
C. $1 million
D. None of the above
Suggested Answer: B) $0
The estimated probability of an adverse outcome is only 40%, so likelihood of loss is not
Probable (it is Reasonably Possible) and no accrual is required (although consideration
should be given as to whether disclosure is required). However, if settlement negotiations
are anticipated and settlement becomes Probable, Company A should accrue an amount
for the settlement
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s
policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 2 Recognition & Disclosure
Company A is a defendant in an indirect tax lawsuit. You conclude that an adverse
judgment would be approximately $1 million. You also conclude the likelihood of loss is
80%.
In such case, the accrual should be:
A. $800,000
B. $0
C. $1 million
D. None of the above
Suggested Answer: C) $1 million
Whether a risk ultimately falls into the Probable range is dependent upon the
circumstances of the case. There must be a substantial basis to believe Company A will
lose the case to conclude that likelihood of loss is Probable.
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s
policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 3 Differing Expert Opinions
Company A is planning to hire an attorney to handle its VAT case. Company A has obtained
the following opinions from these attorneys:
- Attorney 1 – 10-20% chance of success
- Attorney 2 – 50-60% chance of success
- Attorney 3 – 70-80% chance of success
Company A should:
A. Book a reserve
B. Disclose the fact that there is a potential liability
C. Hire Attorney 3 and not reserve
Suggested Answer: B) Company A should disclose the fact that there is a potential
liability
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s
policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 4 Audit Risk
Company A is a financial services company established in the UK. Further to seeking a formal opinion from a
professional services firm, and based on known industry practice, Company A has taken the position that its new
financial services product should qualify as a VAT exempt service, based on its interpretation of UK VAT legislation and
as such should not be subject to VAT.
HMRC has recently published guidance notes which clarifies its view that, based on the interpretation of UK VAT
legislation, it is of the view that the specific financial services products being sold by Company A do not meet the
conditions for VAT exemption as per the relevant section in the UK VAT legislation. Company A has not been audited in
the last 4 years. If audited, an assessment and negative outcome is probable (although the company is currently unable
to estimate the potential amount of any assessment).
Company A should:
A. Not book a reserve or disclose
B. Book a reserve
C. Disclose the fact that there is a potential liability
Suggested Answer: C) Company A should disclose the fact that there is a potential liability
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s
policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 5 Recognition & Disclosure
HMRC conducts an audit of Company A and raises a VAT assessment of USD 5m in
respect of underpaid VAT. HMRC is of the view that Company incorrectly applied a
reduced rate of VAT on the sale of its products in the UK.
Company A is of the view that its products qualify under the reduced rate of VAT.
Company A intends to appeal the assessment to HMRC. Company A concludes that it
has a 60% chance of success in its appeal.
Should company A be required to:
A. Disclose its position in a note to the financial statements
B. Accrue for the potential underpaid VAT
C. Not disclose the issue as a contingent liability in the financial statements
Suggested Answer: A) Company A should likely be required to disclose the issue as
a contingent liability in the financial statements
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s
policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 6 Settlement Offers
Company A is litigating a USD 5m assessment issued by HMRC. Company A has not booked a reserve or disclosed this liability. To obtain closure Company A has proposed a USD 1m settlement. HMRC has countered with a USD 3m offer. Both offers have been rejected.
Company A should:
A. Book a USD 1m tax reserve
B. Not book a reserve but disclose the offers
C. Not book a reserve or disclose
Suggested Answer: A) Company A should book a USD 1m reserve
in its accounts
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s
policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 7 Customer Indemnifications
Company A is protesting an audit assessment. Counsel has opined that it is probable that
Company A will lose its appeal. Company A has a tax indemnification provision in its
customer contracts that it plans to invoke.
Company A should:
A. Book a tax reserve
B. Not book a reserve but disclose the facts
C. Not book a reserve or disclose
Suggested Answer: C) Company A should not be required to book a reserve or
disclose the facts assuming:
A. It is probable that collection will occur
B. The amount of the liability is not considered material, otherwise disclosure
(but not accrual) appropriate
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s
policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 8 Calculating Accrual Amount
Company A is protesting an audit assessment. Counsel has opined that it is probable
that Company A will lose its appeal. Company A has estimated a VAT liability of USD
1m, interest of USD 300k and a penalty ranging from USD 50k – USD 100k (to be
negotiated with the tax authorities although probable penalty will be imposed).
What amount should Company A disclose as a contingent liability?
A. USD 1m
B. USD 1.35m
C. USD1.4m
Suggested Answer: B) Accrued interest should be included in the reserve
and penalties should also be included if probable they will arise. Where the
estimate falls within a range it is permissible to disclose the lower amount.
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s
policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Gain Contingency Recognition
• Recognize as revenue only upon settlement of
underlying event
– virtual certainty (e.g., funds received)
• Disclosure re nature of gain is allowable
• No misleading statements re likelihood of success
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2017 IPT’s Value Added Tax Symposium
Example 1 Gain Contingency
Company A is engaged in both VAT taxable and exempt supplies of services. Company A has not, up to now, deducted any VAT on its expenses as it did not have the data required to calculate a VAT recovery apportionment. Company A sourced the relevant data to calculate its VAT recovery rate in previous years. It submits a VAT reclaim to the local tax authority for USD 1m, based on apportionment guidelines issued by the local tax authority
Should Company A disclose a contingent gain in its financial statements?
Suggested Answer: Yes, as Company A is legally entitled to a VAT refund which is
prepared based on guidelines issues by the local tax authority
Is Company A entitled to record a tax asset at the time the claim is submitted?
Suggested Answer: No, Company A should not record a tax asset until it receives
confirmation from the local tax authority that the VAT amount will be refunded
• **Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 2 Asset Recognition
Company A has filed a foreign VAT reclaim with the UK tax authorities for USD 1m. As at year end, the claim is still being processed and Company A has not received any correspondence from the UK tax authorities.
When should company A book an asset of USD 1m in its financial statements:
A. At the time the claim is filed
B. At the time notification of approval of the claim is received from the tax authorities
C. At the time the funds are received into Company A’s bank account
Suggested Answer: C)
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Example 3 Asset Impairment
Company A has recorded ICMS credits as an asset on its balance sheet based on an ICMS incentive granted by a certain State in Brazil. However the incentive is not in accordance with Federal tax legislation. More recently, the Brazilian president rejected a plea to regularize such tax incentives. The Federal government is due to release a statement regarding their formal position on the ICMS incentive. Company A has received a legal opinion from a Brazilian law firm which states that it is probable that the ICMS credits will be rejected.
Should Company A be required to impair its tax asset?
Suggested Answer: Company A should impair once it can reasonably estimate the FV of the revised credits
**Note these are suggested answers and are dependent on the exact circumstances of the case and the organization’s policy with regard to FAS 5 disclosures, etc.
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2017 IPT’s Value Added Tax Symposium
Netting Assets & Liabilities
• Optional for US GAAP even if all conditions are met –
company accounting policy required
• Assets and liabilities cannot be netted unless business
has ability and intent to offset those amounts against
each other upon settlement
• Examples where netting not appropriate
– Separate VAT registrations
– ITC not available until VAT paid to suppliers
– Discrete refund claims (8th & 13th directives)
– Amounts in dispute with tax authorities
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2017 IPT’s Value Added Tax Symposium
Indirect Tax Incentives
Incentives administered through indirect taxes
e.g., reduced rates, interest free or low interest loans, deferred
submission of tax collected for building a manufacturing facility
Have all conditions of the grant been considered when accounting for it ?
(i.e., recognize benefit, any liability for claw-back provisions)
Reasonable assurance that all conditions will be met is sufficient for recognition
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2017 IPT’s Value Added Tax Symposium
Indirect Tax Indemnities
Contingent liability of Company A to compensate another party if taxes become payable by the other party
Contingent liability of another party to compensate Company A if taxes become payable by Company B
Generally applicable to purchase or disposition of assets/business
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2017 IPT’s Value Added Tax Symposium
Roles and Responsibilities
Depends upon the Company roles & responsibilities
Tax Accounting may be split between the Accounting and Tax Teams
Responsibilities extend to import duties, property taxes, etc. that may not be responsibility of tax staff
Global, regional & central roles
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2017 IPT’s Value Added Tax Symposium
Establishing Reserves
Identify what is important to the company (accuracy, budgeting, timing)
Identify risk areas
Systems limitations, frequency of law changes, changes in
supply chains/business operations
Business acquisitions
Mitigate risk areas
VDA’s, ruling requests, remediation of known issues
Document positions
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2017 IPT’s Value Added Tax Symposium
Indirect Tax Dashboards
– Present big picture
– Highlight key risks / opportunities
– Limit distractions
– Ability to expand / drill down to details
– Leverage relevance to other users
• Global vs regional, tax types, etc.
– Easily refreshed month over month in a timely
manner
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2017 IPT’s Value Added Tax Symposium
Key Elements To Consider
• User’s needs for
– Balances
– Cash Flows
– Costs
– Throughput
– Tax Types
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2017 IPT’s Value Added Tax Symposium
Indirect Tax Assets
Key Asset Categories
Refunds Submitted, Pending Refund
Accrued Refunds, Not Yet Submitted
Net unused input credit carryforwards
Prepayments
Deposits
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2017 IPT’s Value Added Tax Symposium
Indirect Tax Asset Dashboard
• Age and Forecast – Current/ Noncurrent
• Tax Type
• Refunds filed pending refund / not yet filed
• Prepayments
• Deposits
• Contingent gains
• Forecast receipt / offset date
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2017 IPT’s Value Added Tax Symposium
Ageing of Indirect Tax Assets
• Periods should be relevant
– 0-90, 90-180, >180
• Factor to assessing risk of non-collection & potential
impairment of asset
• Direct effect on cash flow burden
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2017 IPT’s Value Added Tax Symposium
Indirect Tax Liability Dashboard
• Need ability to capture information globally re
– Tax payable
• charged to others
• self-assessed / owing by business
– Input credits
– Adjustments (P&L) & Transfers (B/S)
– Payments
– Contingent Losses
– Payment due date / forecast
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2017 IPT’s Value Added Tax Symposium
Basic Indirect Tax Diagnostics
• Reasonability / Trends
• Payment = prior month liability
• Debit entries using “tax collected” accounts
• Credit entries using “input credit” and “payment”
accounts/codes
• Debit balances in liability accounts
• Credit balances in asset accounts
• Netting
• Reconciliations
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