It’s been in the press a lot lately. U.S. companies are “cheating” the U.S. taxpayers by not paying their “fair share” of income taxes. How? By utilizing the indefinite reversal criteria within ASC 740, otherwise known as the “APB 23 exception.” See, when foreign subsidiaries of U.S. companies make money, they do pay income taxes – in their country of domicile. Of course, this may be at 0% if they are located in tax havens such as the Bahamas, Bermuda, or the Cayman Islands. This post explores the requirements of the often-maligned APB 23 exception and provides a word of warning for companies currently utilizing it.
How much money is being “stashed” overseas?
Piles! The amount of indefinitely reinvested foreign earnings approximated $2.4 trillion at the end of 2015, according to a study by Audit Analytics. This figure has risen steadily since 2008 when the amount held overseas was a mere $1.1 trillion.
Which companies hold the most money overseas?
Audit Analytics provided a list of the top 10 companies ranked by their total indefinitely reinvested foreign earnings. They are (in order):
- Microsoft Corp. ($108.3 billion)
- General Electric Co. ($104.0 billion)
- Apple Inc. ($91.5 billion)
- Pfizer Inc. ($80 billion)
- International Business Machines Corp. ($68.1 billion)
- Merck & Co., Inc. ($59.2 billion)
- Alphabet Inc. ($58.3 billion)
- Johnson & Johnson ($58 billion)
- Cisco Systems, Inc. ($58 billion)
- Exxon Mobile Corp. ($51 billion)
How do these companies avoid paying taxes?
Companies do pay taxes on foreign earnings, but they pay them when and where they are earned. However, if the company meets the indefinite reversal criteria within ASC 740, they do not owe U.S. taxes on the foreign earnings until they are repatriated or the company no longer meets the criteria.
What are the requirements of the APB 23 exception?
According to ASC 740-30-25-3, it is presumed that all undistributed earnings of a subsidiary will be transferred to the parent entity. Therefore, unless the indefinite reversal criteria are met, companies would need to record a temporary difference on these undistributed earnings as follows:
Dr. Deferred tax expense XXX
Cr. Deferred tax liability XXX
However, according to ASC 740-30-25-17, the presumption that all undistributed earnings will be transferred to the parent entity may be overcome, and no income taxes shall be accrued if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely or that the earnings will be remitted in a tax-free liquidation.
A parent entity shall have evidence of specific plans for reinvestment of undistributed earnings of a subsidiary demonstrating that remittance of the earnings will be postponed indefinitely. These criteria required to overcome the presumption are sometimes referred to as the indefinite reversal criteria.
It is important to note that the parent entity must have EVIDENCE of SPECIFIC PLANS for reinvesting the undistributed earnings of a subsidiary, which demonstrates that remittance of the earnings will be postponed indefinitely.
This means that being “undecided” is not good enough! Companies much have specific plans that are proven by evidence. Experience of the entities and definite future programs of operations and remittances are examples of the types of evidence required to substantiate the parent entity’s representation of indefinite postponement of remittances from a subsidiary.
Do companies need to worry about continuing to meet these criteria?
Yes. Nothing is forever. ASC 740-30-25-15 states that if circumstances change and it becomes apparent that some or all of the undistributed earnings of a subsidiary will be remitted in the foreseeable future but income taxes have not been recognized by the parent entity, it shall accrue as an expense of the current period income taxes attributable to the remittance.
As economic conditions change, entities may reevaluate their global cash needs and revise their plans for repatriating or reinvesting undistributed foreign earnings. This reevaluation may or may not raise issues about the entity’s prior assertions regarding the indefinite reinvestment of earnings in foreign subsidiaries. Changes caused by unforeseen circumstances do not raise questions about the original application of the exception. Entities should consider the following:
- Facts and circumstances that caused the change in condition
- Likelihood of these facts and circumstances recurring
- Entity’s expected actions if those facts and circumstances were to recur
- Entity’s specific plans to continue reinvestment
Be sure to have evidence supporting your assertion!
The indefinite reversal criteria are a privilege, not a right. Companies need to substantiate their assertion regarding permanent reinvestment with evidence, and external auditors are required to substantiate the evidence. Be careful before making public statements regarding your intention to reinvest or repatriate undistributed foreign earnings as doing so may have a negative financial impact. Be sure to consult our external auditors if your plans for the undistributed earnings have changed.
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Disclaimer
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.
Comments (4)
tim:
Feb 09, 2017 at 06:02 PM
This article is misleading and gives the appearance that GAAP rules are the determinant of paying tax. APB 23 does not dictate when a us parent has a federal tax liability. The tax code (sections 301 et. al) determine when a us parent has a federal tax liability. Don't confuse an accounting mechanism with a trigger for cash taxes.
Mike Walworth:
Feb 23, 2017 at 12:03 PM
Fair point! Being ex-auditors sometimes we get a little carried away with U.S. GAAP, which certainly doesn't dictate the actual tax liability for companies (that's the job of the Internal Revenue Code). We weren't trying to be misleading, but rather alert people to the nuances of the indefinite reversal criteria within Topic 740 (old APB 23). Thanks for reading!
Mike Walworth, Founder and CEO of GAAP Dynamics
Joe Accountant:
Feb 07, 2018 at 10:54 AM
I think that's why it is a DEFERRED tax liability, if any. If that DEFERRED tax liability is significant and the parent entity intends to sell the stock in the near term, then investors will want to know what that tax liability will be.
Mike Walworth, CPA:
Feb 07, 2018 at 11:37 AM
Thanks for reading and commenting!
If the criteria for the APB 23 exception is met, then no DEFERRED tax liability would be set up. However, once a company was unable to positively assert that overseas earnings were no longer reinvested indefinitely, the company would immediately have to set up a deferred tax liability.
IMPORTANT UPDATE: Many of the U.S.-based companies previously utilizing the APB 23 exception are now having to recognize deferred tax liabilities as a result of the new tax law enacted in the U.S. in 2017. That is part of the reason you're seeing companies report earnings "hits" as a result of the tax law. First, it's setting up deferred tax liabilities on overseas earnings. Second, a "hit" needs to be recorded for remeasuring deferred tax assets at a different (lower) rate.
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