Income Tax Disclosures: Targeted Improvements in the Works

The income tax disclosures project is back on the active agenda of the Financial Accounting Standards Board (FASB). The decision was made after hearing feedback from stakeholders that the existing disclosure rules aren’t sufficiently useful for decision-making. The objective of the revived project is to focus on targeted improvements, steering clear of aspects of the topic that could be controversial.

History lesson 

The income tax disclosure project started in 2014. Initially, the project’s objective was to broadly improve the effectiveness of footnote disclosures. Accounting Standards Codification Topic 740, Income Taxes, was used to test whether the FASB’s disclosure framework was an efficient tool in improving disclosure rules.

Notably, proposed Accounting Standards Update (ASU) No. 2016-270, Income Taxes (Topic 740): Disclosure Framework — Changes to the Disclosure Requirements for Income Taxes, was met with significant negative feedback. It attempted to address investor and analyst concerns that the current disclosure rules for income taxes leave investors to resort to guesswork on the potentially significant liabilities for some companies. Investors and analysts are especially interested in the potential global tax implications. So, the proposal would have required businesses to:

  • Separate foreign and domestic taxes,
  • Describe enacted changes in tax law,
  • Explain circumstances that cause a change in the assertion about the indefinite reinvestment of undistributed foreign earnings, and
  • Disclose the aggregate of the cash, cash equivalents and marketable securities held by foreign subsidiaries.

Publicly traded businesses would have had to provide extra information, including the total amount of unrecognized tax benefits that offsets the tax credits that are carried over from one reporting period to the next. They also would have had to disclose the line items in the financial statement in which the unrecognized tax benefits are presented and the related amounts of the benefits.

The FASB went back to the drawing board in 2019. Proposed Accounting Standards Update (ASU) No. 2019-500, Income Taxes (Topic 740) Disclosure Framework — Changes to the Disclosure Requirements for Income Taxes, wasn’t issued to address a specific accounting problem that needed to be solved. “It was really about validating whether we got it right with respect to the disclosure framework,” said FASB member Susan Cosper. This proposal was never finalized, however.

Shortcomings of the current guidance

A typical footnote disclosure of a public company provides the following information:

  • A breakdown of pretax income by domestic versus foreign,
  • A breakdown of the total income tax expense between current and deferred by three major jurisdictions: 1) federal, 2) state, and 3) foreign,
  • “Significant” components of income tax expense,
  • The components of deferred income taxes,
  • The gross uncertain tax benefits (also known as income tax reserves),
  • A reconciliation of the reporting entity’s statutory rate to its accounting effective tax rate, and
  • Valuation allowance narratives.

Unfortunately, these disclosures leave out a number of key details related to corporate taxable income and income taxes actually “paid or payable.” For example, the disclosures don’t provide a reconciliation of pretax income and taxable income for the three major jurisdictions. And they don’t provide a reconciliation of the accounting effective tax rate for the consolidated reporting entity to its cash effective tax rates in all material jurisdictions.

Additionally, the current guidance focuses on the disclosures of total income tax expense (current expense plus deferred expense). In some cases, a company may report high deferred income tax expense and a normal effective tax rate while its current income tax expense, and ultimately income tax payable, is low — or even zero.

Revised focus

The FASB’s revived income tax disclosure project aims to improve disclosures on 1) income taxes paid, and 2) the effectiveness of the rate reconciliation table. “It would be very helpful to have more information about the estimates that entities are making; I think today the tool to provide that information is the reconciliation table,” said FASB member Marsha Hunt.

FASB members rejected exploring further disaggregation of income tax information on a country-by-country basis and other items that could be controversial. In general, the FASB wanted this project to be achievable, pointing to some of the complexity that could result in trying to bite off too many other issues.

The big picture

Meanwhile, the Organisation for Economic Co-operation and Development (OECD) is working on global income tax reform, including establishing a global minimum corporate tax rate and income reallocation for the top global companies. Although the FASB’s tax disclosure is narrow in scope, it aligns with the OECD’s objectives by striving to provide enhanced transparency in reporting the actual amounts and locations of taxable profits and cash income tax payments.