Accounting Standards Update (ASU) 2023-09, Improvements to Income Tax Disclosures (ASU 2023-09) creates additional disclosure requirements to address stakeholder requests for more information regarding income tax considerations in an entity’s worldwide operations. The ASU will be most impactful to entities operating in multiple tax jurisdictions.
Key Highlights for Finance Functions:
- Public business entities will be required to disclose tabular reconciliation using percentages and amounts, broken out into specific categories (discussed further below) with certain reconciling items exceeding 5% of expected tax further disaggregated by nature and/or jurisdiction.
- Non-public business entities will be required to qualitatively disclose the nature and effect of significant reconciling items by specific categories and individual jurisdictions.
- Public business entities AND non-public business entities will be required to disclose income taxes paid (net of refunds received), disaggregated by federal (national), state/local and foreign. Disclose the income taxes paid (net of refunds received) to an individual jurisdiction when 5% or more of the total income taxes paid (net of refunds received).
Effective Date:
- Public business entities are required to adopt in annual periods beginning after December 15, 2024, with early adoption permitted.
- Non-public business entities are required to adopt in annual periods beginning after December 15, 2025, with early adoption permitted.
Other Changes:
Prior to the adoption of ASU 2023-09, Public Business Entities (PBEs) were required to disclose reconciling items in amounts or percentages. Upon adoption of ASU 23-09, PBEs are required to amounts and percentages. Additionally, the ASU requires incremental disaggregation requirements.
The ASU replaces “public entity” with “public business entity” within the income tax disclosure requirements.
The ASU removes the requirement for all entities related to disclose:
- Nature and estimate of the range of the reasonably possible change in the unrecognized tax benefits balance expected within the next 12 months, and
- The cumulative amount of each type of temporary difference when a deferred tax liability is not recognized because of the exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures
Companies will need to consider the Impact on internal control over financial reporting that the adoption of this ASU will have, particularly over the completeness and accuracy of the disaggregated information required in the rate reconciliation and cash taxes paid.
Tabular Reconciliation for PBEs:
The ASU requires PBE’s to provide a tabular reconciliation between the amount of expected income tax expense (benefit) determined by multiplying pretax income (loss) from continuing operations by the statutory tax rate (% rate) and the reported amount of income tax expense (benefit) divided by pretax income (loss) from continuing operations to derive the effective tax rate (% rate).
Statutory Tax Rate:
If the PBE “is not domiciled in the United States, the federal (national) income tax rate in that entity’s jurisdiction (country) of domicile shall normally be used in the rate reconciliation.” The ASU provides for the use of judgement in determining the appropriate statutory rate to utilize in the rate reconciliation and specific examples of when it may be appropriate to use the statutory income tax rate of a jurisdiction other than the jurisdiction in which the entity is domiciled. PBEs that use an income tax rate in the rate reconciliation that is other than the U.S. income tax rate must disclose the rate used and the basis for using it.
Reconciling Items for PBEs:
The ASU also adds ASC 740-10-50-12A, which requires entities to annually disaggregate the income tax rate reconciliation between the following eight categories by both percentages and reporting currency amounts:
1. State and Local income tax, net of federal (national) income tax effect
2. Foreign tax effects
3. Effect of changes in tax laws or rates enacted in the current period
4. Effect of cross-border tax laws
5. Tax Credits
6. Changes in valuation allowances
7. Nontaxable or nondeductible items
8. Changes in unrecognized tax benefits
If a reconciling item does not fall within any of the eight prescribed categories but meets the conditions for disaggregation relative to the 5 percent threshold, it must be “disaggregated by nature.” Similarly, an item that does not fall within any of the eight prescribed categories but does not meet the 5 percent threshold would be aggregated with any additional such reconciling items in an “other adjustments” category.
For SEC registrants that are required to provide comparative financial statements, if a reconciling item meets the 5 percent threshold for one, but not all, of the years presented within the rate reconciliation, it would generally be expected that the reconciling item be disclosed separately for all years presented.
Each of the eight rate reconciliation categories is further discussed below.
State and Local Income Taxes, Net of Federal:
This category reflects income taxes imposed at the state and local income tax level within the jurisdiction (country) of domicile, except for certain reconciling items related to changes in state and local UTBs that are included in the changes in UTBs category. Additionally, ASC 740-10-50-12B states that PBEs must supplementally “provide a qualitative description of the states and local jurisdictions that make up the majority (greater than 50 percent) of the effect of the state and local income tax category.” As such, a PBE discloses, in descending order from largest to smallest, the state or local jurisdiction(s) until the aggregated effect is greater than 50 percent.
Foreign Tax Effects:
This category includes reconciling items attributable to the impact of income taxes imposed by jurisdictions outside the country of domicile, except for certain reconciling items related to changes in foreign UTBs included in the changes in UTBs category. Further disaggregation of reconciling items within the foreign tax effects category is required by jurisdiction and by nature on the basis of the 5 percent threshold discussed above.
In addition, ASC 740-10-50-12A states “[w]ithin any foreign jurisdiction (regardless of whether it meets the 5 percent threshold), the reconciling item shall be separately disclosed by nature if [it] meets the 5 percent threshold.” This may happen when a particular foreign jurisdiction has a reconciling item or items that individually trigger the 5 percent threshold but are offset by other reconciling items that have an opposite impact on the rate reconciliation (i.e., the net impact of a foreign jurisdiction is below the 5 percent threshold in the aggregate).
Effect of Changes in Tax Laws or Rates Enacted in the Current Period:
This category includes the cumulative tax effects of a change in enacted tax law or rates in the jurisdiction (country) of domicile on current or deferred tax assets and liabilities as of the enactment date.
Effect of Cross-Border Tax Laws:
This category “reflects the effect of incremental income taxes imposed by the jurisdiction (country) of domicile on income earned in foreign jurisdictions.” When the jurisdiction (country) of domicile taxes cross-border income but also provides a tax credit on the same income during the same reporting period, the tax effect of both may be presented on a net basis within this category.
For a U.S.-domiciled PBE, this category includes the incremental tax impacts of the global intangible low-taxed income (i.e., GILTI), base erosion and anti-abuse tax (i.e., BEAT), and foreign-derived intangible income (i.e., FDII) rules.
Tax Credits:
This category includes the impacts of federal income tax credits earned in the jurisdiction (country) of domicile that are not reflected as part of the effect of cross-border tax laws.
Changes in Valuation Allowances:
This category includes the initial recognition and subsequent changes to the federal (national) valuation allowance in the jurisdiction (country) of domicile that occur during the current year.
Nontaxable or Nondeductible Items:
This category consists of items that are either nontaxable or nondeductible for federal (national) tax purposes in the jurisdiction (country) of domicile.
Changes in UTBs:
This category includes reconciling items resulting from changes in judgment related to tax positions taken in prior annual reporting periods (e.g. subsequent recognition, derecognition, and change in measurement). When an unrecognized tax benefit is recorded in the current annual reporting period for a tax position taken or expected to be taken in the same reporting period, the unrecognized tax benefit and its related tax position may be presented on a net basis in the category where the tax position is presented. Alternatively, the entity may present such UTB in the changes in UTBs category. Reconciling items presented within this category may be disclosed on an aggregated basis for all jurisdictions.
In paragraph BC29, the FASB acknowledged that entities may need to apply judgment when assessing (1) “how to categorize certain income tax effects that do not clearly fall into a single category” or that have “characteristics of multiple categories” and (2) “the nature of reconciling items for further disaggregation. . . . For example, an entity may decide to include the tax effects of share-based payment awards (such as nondeductible expenses, shortfalls, and windfalls) in [this] category” even though windfalls might not be viewed as belonging to this category. In such a case, the entity should consider whether, in accordance with ASC 740-10-50-12C, it must describe the types of tax effects related to share-based payments that it has included in this category.
Entities Other Than PBEs:
Entities other than PBEs are required to qualitatively disclose the nature and effect of the specific categories of reconciling items listed in ASC 740-10-50-12A(a) as well as individual jurisdictions that result in a significant difference between the statutory tax rate and the effective tax rate. A numerical reconciliation is not required.
Income Taxes Paid:
Income taxes paid must be disaggregated by foreign, domestic, and state taxes, with further disaggregation by jurisdiction on the basis of a quantitative threshold of 5 percent “of total income taxes paid (net of refunds received).”
The FASB specifically addresses whether comparative disclosures are required for income taxes paid by jurisdiction in paragraph BC74 of the ASU, which states that the Board “considered but decided not to require disclosure of comparative information by jurisdiction for all years presented. The Board noted that requiring comparative information for income taxes paid could result in operability challenges and may be contrary to the guidance on materiality in Topic 105 (such as when a jurisdiction meets the quantitative threshold and is material in the current period but was not presented in previous periods because the amount of income taxes paid was not material).”
Accordingly, one acceptable presentation of an entity’s disclosure for income taxes paid under the ASU is illustrated below. It is assumed in this illustration that the entity is U.S.-domiciled.
ASU 2023-09 does not specify whether such disclosures of income taxes paid should be included on the face of an entity’s statement of cash flows or within the notes to the financial statements.
Example A (Public Business Entity)
The ASU provides the following example that illustrates the specific categories and the reconciling items disclosed by a public business entity in its tabular rate reconciliation in accordance with paragraphs 740-10-50-12A through 50-12B. The entity is domiciled in the United States and presents comparative financial statements. For the disclosure of foreign tax effects in accordance with paragraph 740-10-50-12A(b)(2), it is assumed that the 5 percent threshold, computed by multiplying the income (or loss) from continuing operations before income taxes by the applicable statutory federal (national) income tax rate of the United States, is met:
- For Ireland, both at the jurisdiction level and for certain individual reconciling items of the same nature within Ireland
- For the United Kingdom, for certain individual reconciling items of the same nature within the United Kingdom, but not at the jurisdiction level
- For Switzerland and Mexico, at the jurisdiction level, but not for any individual reconciling items of the same nature within each jurisdiction.
Example B (not a Public Business Entity)
The following illustrates significant reconciling items disclosed by an entity other than a public business entity in accordance with paragraph 740-10-50-13. 740-10-55-233 The difference between Entity W’s effective tax rate and its statutory tax rate is primarily attributed to tax credits, state taxes, and foreign taxes. More specifically, the foreign tax effects of Entity W’s operations in Ireland had a decreasing effect on its effective tax rate, while the foreign tax effects of Entity W’s operations in France had an increasing effect on its effective tax rate. Entity W received federal research and development tax credits, which decreased its effective tax rate, while state taxes in California increased its effective tax rate.