APB 23: Insight into Increased Scrutiny for Supporting Evidence
With the PCAOB and SEC’s recent interest in how U.S. multinational companies disclose their plans for reinvesting foreign subsidiary earnings, it is imperative that tax professionals be aware of the U.S. GAAP APB 23 (“APB 23”) documentation requirements. This newsletter describes the APB 23 assertion, why there has been increased regulatory scrutiny surrounding the assertion, and the steps U.S. multinational corporations should take to ensure they are providing sufficient disclosure on their financials.
What is the APB 23 Assertion?
APB 23 (codified as FASB “ASC 740-10-25-3”) allows an exception to the general rule that a U.S. multinational company must accrue U.S. taxes on foreign earnings of its controlled non-U.S. subsidiaries. This exception provides that a U.S. multinational company may declare its foreign earnings as indefinitely invested abroad so that, in effect, there will be no U.S. tax liability. In other words, it allows the company to assert that its foreign subsidiary investments will be permanently reinvested and that foreign earnings will not be repatriated to the U.S. As a result, the foreign earnings would not be subject to U.S. taxation via this assertion. If the APB 23 assertion is not made, then the U.S. company must record a deferred tax liability on its undistributed earnings, which technically should equal the outside basis difference between the book basis and the tax basis in the foreign subsidiary.
The APB 23 exception comes with a significant burden—the “sufficient evidence” requirement. An APB 23 assertion requires that a multinational company provide evidence that demonstrates an ability to meet its domestic cash needs with only U.S. earnings and its plan to reinvest foreign earnings outside the U.S. This documentation usually requires the assertion to be supported by the following: the company’s global business position; financing requirements; capital expenditure requirements; domestic cash flow; liquidity needs; budgets and forecasts; tax-planning strategies; and other similar supporting documents. It is worth noting that an entity’s past experience, by itself, is not enough to support its indefinite reinvestment assertion; instead, the entity must show sufficient intent and ability to reinvest undistributed foreign earnings.
The company must also disclose in the footnotes of its financial statements the amount of its undistributed foreign earnings and its reasonable estimate of the deferred tax liability, if such assertion was not made. However, the company can indicate that it is “not practicable” to determine the amount of the unrecognized deferred tax liability.
The Increased Scrutiny by the SEC
Analysts and regulators are now, more than ever, interested in the APB 23 assertion. The following rationales have been attributed to the recent increased scrutiny:
- a significant increase in the amount of undistributed earnings over the past few years;
- changes by companies to their prior indefinite reversal assertions;
- an increase in repatriation by certain companies due to liquidity and/or acquisitions; and
- a stricter lending environment.
Therefore, the SEC has been significantly increasing the amount of comment letters related to APB 23 documentation and the level of detail provided in such comment letters. The goal of the increased scrutiny, as stated by an associate chief accountant with the SEC’s Division of Corporate Finance, is to provide investors with more information regarding where companies are holding cash and what tax and liquidity implications those holdings may bring. The SEC also has a strong interest in how consistently and thoroughly companies describe their foreign earnings reinvestment plans, as well as the validity of their intent to reinvest. This increased scrutiny has resulted in many revised disclosures and requests for more detail in future filings as a result of recent SEC inquiries.
The SEC also wants to make sure that there is consistency within a company’s staff as to any assumptions related to forecasted results among treasury, tax, legal, and financial reporting. That is, the SEC is looking for a more thoughtful approach to disclosures where tax and financial reporting staff members provide more cautious documentation and work together closely on their plans for repatriation of foreign earnings. The SEC is also analyzing the Management Discussion and Analysis section of the financials for more fact-specific data on liquidity disclosures. Any business decisions or overall strategy that could contradict a company’s intent to reinvest foreign earnings indefinitely likely will be highly scrutinized.
Steps for U.S. Multinational Corporate Tax Departments to Ensure Compliance
In order to ensure companies are conforming to the increased scrutiny, it is advisable that there be open dialogue with external audit teams during the audit planning process regarding what type of detailed computations and documentation will be required to support the APB 23 Assertion. In particular, because the SEC is questioning the “not practicable” language provided for under FAS 109 (codified as FASB “ASC 740”) to estimate their undistributed foreign earnings, many auditors are increasing their expectations on supporting calculations of the legal justification, costs, or other difficulties on a jurisdictional basis to repatriate such earnings for disclosure purposes. This period of increased scrutiny is the proper time to ascertain whether companies are conducting a deeper analysis to provide sufficient evidence that their assertion can be sustained and survive regulatory scrutiny.
How True Partners Can Help
True Partners has a dedicated team of multinational tax professionals with the experience to assist corporate tax departments with the detailed computations and documentation required to support an APB 23 analysis. We understand the type of analysis required by the SEC and by the major accounting firms. As an independent tax consulting firm with no conflicting audit function, True Partners can prepare an unbiased analysis and help our clients create an internal process that can be used to create and support all future computations and documentation. For more information on how we can help you meet these new requirements, contact one of our experienced International Tax professionals.