When to Recognize Income Taxes on Intra-Entity Transfers

On October 25, the FASB published an update to U.S. GAAP that requires businesses to recognize the immediate income tax consequences of intracompany asset transfers. The update doesn’t apply to transfers of inventory, an idea the FASB dropped after negative feedback from businesses. Here are the details.

Immediate tax recognition

Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740) — Intra-Entity Transfers of Assets Other Than Inventory, will require businesses to recognize the immediate income tax consequences of intracompany asset transfers. These types of transactions often involve a subsidiary of a company transferring intellectual property to another subsidiary.

The update officially eliminates an exception in Topic 740, Accounting for Income Taxes, which prohibits the recognition of the tax consequences for intracompany asset transfers until the asset has been sold to an outside party. The update applies to all asset transfers other than inventory.

Exception for inventory

Excluding inventory from the update is a major change from the FASB’s original proposal. Proposed Accounting Standards Update ASU No. 2015-200, Income Taxes (Topic 740): Intra-Entity Asset Transfers, was released in January 2015. It received an immediate backlash from business owners and their advisors.

In general, the volume of intracompany transfers of inventory is significantly greater than the volume of other asset transfers. If inventory were included in the updated guidance, businesses argued, it would be costly to make operating systems changes, estimate the annual effective tax rate for interim reporting purposes, and implement new processes and internal controls over financial reporting.

Businesses also contend that, because inventory typically turns quickly, deferring the recognition of the tax consequences from intracompany transfers doesn’t significantly affect the quality of information reported to investors and analysts. But, if companies were forced to recognize the tax consequences of intracompany transfers of inventory, it could lead to false volatility in reported earnings.

Financial Executives International’s Committees on Corporate Reporting and Taxation wrote to the FASB just five days after the proposal was released that it “fails to achieve the objectives of the simplification initiative and produces a financial statement result that has the potential to confuse financial statement users and undermine the credibility of financial reporting.”

In light of the harsh feedback, the FASB in October 2015 decided to do more research before proceeding. In June 2016, the board agreed to exempt transfers of inventory from the update because inventory transfers caused the most angst for companies.

Implementation schedule

Public companies will apply the update for fiscal years that start after December 15, 2017, and for quarterly reports in those years. Privately held businesses will apply them in annual reports for years that start after December 15, 2018, and interim period reports for years that start after December 15, 2019.

Companies will implement the accounting changes using what the FASB calls a modified retrospective basis, which means that the prior periods in a financial report don’t have to be adjusted to reflect the new requirements. Companies should adjust their retained earnings to show the effect of the new accounting on prior periods. The FASB believes this will let investors analyze the asset transfers’ effect on financial performance.

© 2016