Undistributed foreign earnings: disclosure requirements and considerations

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Practical tip 06/19/2012 by Assurance services
Undistributed foreign earnings: disclosure requirements and considerations

At a glance

Undistributed foreign earnings that are indefinitely reinvested outside the United States result in a significant unrecorded tax liability for many U.S.-based multinationals. The amount of undistributed foreign earnings has grown substantially in recent years. As a result, expectations for transparency have increased along with concerns about a lack of comparability or consistency in disclosures. This Practical tip focuses on the U.S. GAAP disclosure requirements and considerations relating to undistributed foreign earnings.

Undistributed foreign earnings that are indefinitely reinvested outside the United States result in a significant unrecorded tax liability for many U.S.-based multinationals. The amount of undistributed foreign earnings has grown substantially in recent years. As a result, expectations for transparency have increased along with concerns about a lack of comparability or consistency in disclosures.

This Practical tip focuses on the U.S. GAAP disclosure requirements and considerations relating to undistributed foreign earnings.

The following disclosures are required in a company’s annual financial statement footnotes:

  • The accumulated amount of undistributed foreign earnings of subsidiaries, and any other component of the outside basis difference, such as cumulative translation adjustments, for which a deferred tax liability has not been recorded because of an indefinite reversal assertion
  • The estimated unrecognized deferred tax liability related to such amounts if the determination of an estimate is practicable, or a statement that calculation of an estimate is not considered practicable
  • A description of the types of events that would cause such foreign earnings (and any other component of the outside basis difference) to become taxable in the parent's home country jurisdiction

Additional disclosures should be considered in interim financial statements when it is reasonably possible that a material adjustment related to indefinitely reinvested foreign earnings will occur within approximately one year, or when significant changes have occurred since the last annual filing.

Recent trends and concerns

Global economic conditions coupled with regulatory efforts to improve financial statement transparency have increased the focus in this area. The topic has also attracted attention from U.S. legislators, tax reform advocacy groups, investors, analysts, and the media. Some companies have recently begun to repatriate some of their accumulated foreign earnings in response to operational changes and liquidity needs. Others have remitted earnings to facilitate funding of U.S. acquisitions and stock buybacks.

The frequency of SEC comments on this topic continues to increase. The SEC’s comments emphasize the need to provide accurate, transparent, and plain-English disclosures of significant assertions and estimates, including those associated with undistributed foreign earnings. The SEC also assesses the interplay between a company’s MD&A disclosures of liquidity and capital resources and its indefinite reinvestment assertions related to foreign earnings.

Companies should consider the following:

Estimate of the tax cost to repatriate

As noted above, companies are required to estimate and disclose the unrecognized tax liability they would incur upon remittance of reinvested earnings, unless calculation of an estimate is not practicable. Some companies include a statement that determination of the tax liability is not practicable, while others are silent and do not provide an estimate. The SEC expects an affirmative statement in the financial statement footnotes to be provided if an estimate is not practicable and has further asked companies to explain and disclose in their footnotes why (i.e., the specific reasons) an estimate is not practicable.

In assessing whether an estimate is practicable, companies should consider whether any repatriation scenarios have been internally discussed or whether there has been experience with calculations relating to past remittances of foreign earnings. Some companies have consistently disclosed such estimates, and trends indicate that more companies are now disclosing an estimate despite historical disclosure that an estimate was not practicable.

It is important to maintain sufficient and clear documentation to support an assertion that it is not practicable to estimate the unrecognized tax liability. For example, considerations include the extent of uncertainty as to which remittance structure would be used (among several possibilities) should a decision be made to repatriate, the availability and the complexity of calculating foreign tax credits, and the implications of indirect taxes, including withholding taxes that could potentially be required depending on the repatriation structure.

Description of events that would trigger the unrecognized tax

The SEC has also asked companies to describe the types of events that would trigger a tax on foreign earnings. Typical events that could trigger a tax might include:

  • U.S. acquisitions or other investments, stock buybacks, and shareholder dividends to be funded by cash distributions or loans from foreign subsidiaries
  • Certain foreign corporate restructurings or reorganizations
  • A decision to exit a particular business or jurisdiction leading to a sale of stock to a third party
  • Anticipated tax law changes that are considered unfavorable and would result in higher taxes on repatriations that occur after the change in tax law goes into effect

Jurisdictions in which foreign earnings are being accumulated

Certain companies may have operations or treasury functions in jurisdictions with tax rates significantly lower than the U.S. tax rate. Disclosure of the specific countries in which such activity resides can provide useful information to assist financial statement users in understanding where income is being generated, where excess cash may be residing, and the tax cost or savings from the current structure. A more detailed explanation of a particular foreign company structure that accounts for the majority of a registrant's accumulated foreign earnings and the potential tax consequences of remittances might be relevant for some registrants.

Implications on liquidity and capital resources

Foreign cash and cash equivalents may constitute a large portion of a company's total cash and cash equivalents. The SEC has asked companies with significant unremitted foreign earnings to explain what portion of their foreign earnings is kept in cash and cash equivalents. The SEC believes information about cash and cash equivalents kept outside of the United States provides important insight into a company's available liquidity and capital resources. Companies should make clear whether these funds might be subject to a significant tax cost upon repatriation.

Evidence relied upon to substantiate an indefinite reinvestment assertion

A company that incurs a significant tax from repatriation of foreign earnings in the current year may have historically maintained an indefinite reinvestment assertion. In this situation, it is important to document in which period the company first knew of its intention to repatriate and the evidence relied on to substantiate the assertion. The explanation should be clear and specific as to reinvestment plans at the entity- and country-specific levels, including consideration of formal budgeting or forecasts and events that resulted in the remittance. The explanation should be in sufficient detail to support any continued indefinite reinvestment assertion with respect to either accumulated or future foreign earnings.

Questions

PwC clients that have questions about this Practical tip should contact their engagement partner. Engagement teams that have questions should contact a member of the income tax team in the National Professional Services Group (1-973-236-7806).

Authored by:

Edward Abahoonie
Partner
Phone: 1-973-236-4448
Email: edward.abahoonie@us.pwc.com

Yosef Barbut
Director
Phone: 1-973-236-7305
Email: yosef.barbut@us.pwc.com