FASB Discussion of Uncertain Tax Positions

At its Feb. 16 board meeting, the Financial Accounting Standards Board (FASB or the "Board") retained its earlier consensus on accounting for uncertain tax positions, referred to Feb. 16 as the "Asset Approach," and voted to proceed toward a ballot draft for final vote by the board in anticipation of issuing an exposure draft for public comment. The proposal would be issued in the form of a draft Interpretation to FASB Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," (SFAS 109).

"Asset Approach" retained over "Impairment Approach"
In reaffirming the "Asset Approach," the board rejected an alternative method - the "Impairment Approach" - which had been suggested after the FASB met with the Internal Revenue Service (IRS). The Impairment Approach was rejected, in part, due to its reliance on "detection risk" as a key component (i.e., the risk that a transaction will be reviewed or "detected" by taxing authorities).

• Most board members did not believe detection risk should be considered in the financial accounting model, mainly because there are other hurdles Board members believe need to be met for the related tax asset to meet the test of being "probable" under Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies" ("SFAS 5").
• Some of the asset recognition thresholds discussed included whether the tax position was deemed to have "substantial authority," (i.e., if challenged, the taxing authority would not impose a penalty).

Dual Threshold for Recognition (Probable), Derecognition (More Likely than Not)
The FASB also endorsed a "dual threshold" approach to recognition of the tax asset - with "probable" being the standard for recognition, and "more likely than not" being the standard for derecognition. However, certain questions were raised as to:

• whether use of the term "probable" would be operational,
• how the term "probable" relates to measurement of "best estimate" (as decided at Nov. 17, 2004 board meeting), whether there should be a "bright line" test for "probable," e.g. based on estimated percent of tax asset after settlement (if challenged by taxing authority)

Classification as current vs. deferred (noncurrent) liability - based on timing
Following on the discussion of "probable," another issue arose, although not specifically identified in advance in the Board Handout, regarding whether the difference between the tax basis and "probable" basis should be classified as a current liability, or deferred (non-current) liability. As explained by the FASB staff, the classification issue arises after the tax return is filed/tax payment is made, due to a presumption that a company may have retained cash that should have been sent to the government. Some board members indicated they would strenuously object to requiring current classification, as they thought it would be misleading to record a current liability that would be released to income over a period of years after, e.g. IRS audits are settled.

The agreement reached by the board was that classification as current vs. deferred (noncurrent) would be based on the timing of expected cash payment (expected timing of cash payment under settlement if challenged).

Board rejects proposed tabular disclosure of estimates
The Board did not agree with FASB staff's view that enhanced disclosures are necessary, such as the staff's proposed tabular presentation of management's estimates underlying uncertain tax positions. Although some believed in providing more "sunshine" to this information, others believed it would needlessly require disclosure of sensitive information. Transition: Cumulative Effect of Change in Accounting Principle

The board agreed with the FASB staff's recommendation that accounting for the impact of adopting the proposed Interpretation should be treated as the cumulative effect of a change in accounting principle.

Interest and Penalties
The board agreed with the staff's approach to the accrual of interest and penalties.

Comment Period on Exposure Draft and Effective Date of Proposed Interpretation
Although not discussed at the Feb. 16 FASB meeting, the board previously agreed (at its Nov. 17, 2004 meeting) that an Exposure Draft of the proposed Interpretation on uncertain tax positions would be "May 13, 2005, or 60 days after issuance of the ED, whichever is later". Regarding the proposed effective date of the final Interpretation, the FASB also previously agreed on Nov. 17, 2004 that the effective date would be annual periods ending after Dec. 15, 2005. As such, the Interpretation would be effective for the year ending Dec. 31, 2005 for calendar year companies, and there would be SEC SAB 74 disclosure requirements earlier in the year. [NOTE: FASB staff indicated at the Nov. 17, 2004 meeting that most preparers would prefer effective date of Jan. 1, 2006 [i.e., annual periods BEGINNING after Dec. 15, 2005], even considering SAB 74 requirements, in today's Sarbanes-Oxley 404 environment. There is some concern about whether effective date of Dec. 15, 2005 (and SAB 74 related disclosures earlier in '05) would give enough time for expert opinions necessary on such estimated tax benefits. FASB board members said they will be interested to see what comment letters will say on this.]

Prepared Feb. 17, 2005 by Edith Orenstein (eorenstein@fei.org), Manager of Research, Financial Executives Research Foundation (FERF). This summary does not represent FEI opinion, unless specifically noted above.