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Income tax accounting refresh: Spinoffs · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC.
• 0:06
  SPEAKER_02: Welcome to PWC's Accounting Podcast.
• 0:09
  SPEAKER_02: I'm Heather Horn.
• 0:11
  SPEAKER_02: Thanks for joining me for our final episode in our May Tuesday series, in which our All-Star Podcast guest, Jennifer Spang, took over the podcast, picking the topics of the month, and joining me on all the episodes.
• 0:27
  SPEAKER_01: I would just say once a company decides it'll spin off a business, the timeline can vary from a couple of months to a couple of years.
• 0:36
  SPEAKER_01: And for the parent, you know, I think the key wrap-up point is just don't underestimate the level of effort involved.
• 0:42
  SPEAKER_03: Unlike a transaction where you're selling the business to another entity that already has their infrastructure and all that goes with it, SpinCo needs to be ready on day one to stand up the right resources to be able to just hit the ground running and continue.
• 0:57
  SPEAKER_02: That was Jen and Matt McCann, a partner in PwC's national office.
• 1:02
  SPEAKER_02: With much spin activity coming their way, Jen and Matt discussed practical challenges in income tax accounting in a spin-off transaction.
• 1:11
  SPEAKER_02: From preparing historical carve-out financial statements to allocating the total company tax provision to tax issues and post-spin filings, they take us through what we need to know.
• 1:22
  SPEAKER_02: So let's dive in.
• 1:29
  SPEAKER_02: So Matt, Jen, thanks so much for joining me today for the final episode in our month of income taxes.
• 1:35
  SPEAKER_02: So, Jen, thanks for all your thoughts.
• 1:37
  SPEAKER_02: And Matt, of course, welcome to the podcast.
• 1:39
  SPEAKER_02: So today's topic is a great one.
• 1:42
  SPEAKER_02: It's actually talking about spin-off transactions.
• 1:45
  SPEAKER_02: But Jen, I know when you were going through and picking each of these topics, you had a specific reason.
• 1:51
  SPEAKER_02: You picked each of them.
• 1:53
  SPEAKER_02: And so why in particular are we focusing on spin-offs now?
• 1:56
  SPEAKER_02: Like why are they important?
• 1:58
  SPEAKER_03: I'd say transactions can obviously take a lot of different forms.
• 2:01
  SPEAKER_03: And as we watch companies align or realign, depending on where they are in their life, their different businesses, spin-offs are just one of those kinds of transactions.
• 2:12
  SPEAKER_03: And over the last um few years, we've continued to see a fair bit of activity with spin-offs.
• 2:17
  SPEAKER_03: Obviously, I guess last year, I think it was, we did a uh podcast on separate company tax accounting.
• 2:24
  SPEAKER_03: So what do you do in that?
• 2:25
  SPEAKER_03: And so this, you know, in in that way, some of this will be a reminder.
• 2:30
  SPEAKER_03: But what we wanted to do was really talk about um separate company reporting, tax provision work, but in the context of the broader picture of a spin-off and all that comes with the preparation on that, part of which ends up being reflected in what you need to do both as a spin-e and a spin-over in your financial statement.
• 2:48
  SPEAKER_03: So I just think it it's a it's a very um timely topic.
• 2:52
  SPEAKER_02: I agree with that.
• 2:53
  SPEAKER_02: And I know you kind of alluded to this that when, you know, if I'm the company and I'm trying to figure out my optimal exit strategy, a lot of different things I can think about, including tax, obviously, though, regulatory, other reporting requirements, and lots of things.
• 3:08
  SPEAKER_02: And I know we also always say not to let the accounting drive, you know, the structure.
• 3:15
  SPEAKER_02: However, I know also tax, you actually have real dollar implications.
• 3:18
  SPEAKER_02: So it's it's a little more than just you know a an accounting convention here.
• 3:23
  SPEAKER_02: With all of that background then, Matt, I was hoping you could start us off today by really level setting on just what we mean when we say spin-off, and then we can kind of get more into the detail.
• 3:35
  SPEAKER_01: Sure.
• 3:36
  SPEAKER_01: I'd say typically we see sales transactions where a business is carved out and sold to a buyer as the more common way of divesting a business.
• 3:45
  SPEAKER_01: From the seller's perspective, the sale of a business might be strategic, it might be to provide needed cash and often has less SEC filing requirements than other options.
• 3:57
  SPEAKER_01: A spin-off typically refers to the prorrata distribution of a subsidiary stock to the parents' shareholders.
• 4:05
  SPEAKER_01: So the effect of a spin is to dividend off or carve out a piece of the company to its existing shareholders who will own shares in two different companies after the after the spin co becomes a standalone company with its own equity structure.
• 4:20
  SPEAKER_01: So unlike a sale or an IPO, a spin-off doesn't raise capital for the parent or the spin co.
• 4:26
  SPEAKER_01: But of course, there's all kinds of ways that transactions can be structured.
• 4:30
  SPEAKER_02: So why would why do we see companies doing a spin transaction instead of just selling part of their business?
• 4:38
  SPEAKER_02: Trevor Burrus, Jr.
• 4:38
  SPEAKER_01: Public companies typically use spin-offs to enable the separate businesses to more readily pursue the individual long-term, any individual long-term strategic goals they have with the view that some of its businesses are ultimately worth more as standalone companies than as part of a part of a consolidated group.
• 4:58
  SPEAKER_01: So companies often use use spin-offs as a tax-free way to unlock value for shareholders.
• 5:05
  SPEAKER_01: So after the spin, as I mentioned, the shareholders own shares in in two entities, and the the overall value held by the shareholders typically doesn't change, at least not not immediately.
• 5:17
  SPEAKER_01: And although uh a spin-off is not a sale of securities, Spinco's newly issued shares are typically registered with the with the SEC.
• 5:27
  SPEAKER_01: And that's gonna be accomplished by filing a Form 10 registration statement that generally includes historical standout, standalone carve-out financial statements for the Spinco, and it's gonna also require other historical and pro-forma financial information.
• 5:44
  SPEAKER_02: All right.
• 5:44
  SPEAKER_02: So, Matt, you just mentioned that you have to include financial statements, and those would be those carve out financial statements of this newly formed entity.
• 5:54
  SPEAKER_02: But again, before we get into the tax issues, can you just remind us what we mean when we're talking about carve-off financial statements in the context of a spinoff?
• 6:03
  SPEAKER_01: Sure.
• 6:04
  SPEAKER_01: And the there really is no legal or accounting definition of carve-out financial statements.
• 6:10
  SPEAKER_01: Carve outs just refer to the separate financial results and financial position of a portion of a larger reporting entity.
• 6:17
  SPEAKER_01: And that can take the form of an entire subsidiary, an operating unit, a product line, or a brand.
• 6:24
  SPEAKER_01: And financial statements, the financial statements that are presented, they may or may not even be of a legal entity, and that can lead to complexities in the basis of presentation of the of the carve-out financial statements.
• 6:37
  SPEAKER_01: For this podcast, we'll be referring to to carve outs just in the context of a spin, but I would I would point out that that's a that's a broad, broad term that could apply to a whole host of transactions that could have have different reporting requirements.
• 6:52
  SPEAKER_01: In a spin-off transaction, probably the area requiring the longest lead time is the preparation of the historical carve-out financial statements for the spin code.
• 7:02
  SPEAKER_01: So this is an area that coordination and input from key areas across the business is going to be required throughout the throughout the process.
• 7:10
  SPEAKER_01: The need for data and numerous judgments by management can be uh can be challenging, especially when limited authoritative guidance exists.
• 7:20
  SPEAKER_01: There really isn't much at all in in U.S.
• 7:23
  SPEAKER_01: GAAP on on preparing carve outs.
• 7:25
  SPEAKER_01: There's some SEC guidance that addresses specific elements of carve outs, but that's even that's still fairly high-level guidance.
• 7:34
  SPEAKER_01: But there are there are very well understood practices with regard to preparation of the of the carve-out financials.
• 7:41
  SPEAKER_01: So you really just want to want to ensure you have the right experts engaged to advise throughout the throughout the process.
• 7:48
  SPEAKER_02: All right, so definitely a lot to think about with carve out financial statements.
• 7:52
  SPEAKER_02: And I know we have an entire guide devoted to them.
• 7:55
  SPEAKER_02: So if if our listeners are preparing them, they should look at that more broadly.
• 8:00
  SPEAKER_02: But Jen, let's go back to the income tax provision specifically, because I can only imagine the complexity of started trying to sort out the taxes that will go with this carved-out entity.
• 8:13
  SPEAKER_02: Um, so I know we've previously mentioned in this mini-series a podcast we did last year on separate company financial statements.
• 8:22
  SPEAKER_02: So I'm sure that's going to come into play.
• 8:25
  SPEAKER_02: But can you give us just a refresher on some of what we talked about there?
• 8:29
  SPEAKER_03: I guess level setting.
• 8:30
  SPEAKER_03: So the income tax accounting standard requires that you allocate a consolidated provision among the group members when those group members are filing separate returns.
• 8:41
  SPEAKER_03: Now, the standard doesn't provide a single method that is necessary or required.
• 8:48
  SPEAKER_03: The standard requires that any method be systematic, rational, and consistent with the broad principles of ASC 740.
• 8:57
  SPEAKER_03: Um so there's there's really, I would say, two methods that we see most commonly, and I should back up.
• 9:04
  SPEAKER_03: Well, the standard, just as a reminder, doesn't tell us how you have to do it.
• 9:08
  SPEAKER_03: It does give you examples that would be inappropriate.
• 9:10
  SPEAKER_03: So anybody who's going down this path should take a look at the standard with that.
• 9:14
  SPEAKER_03: But um the two most common methods we see, and I would really argue they're just one, um, just one of them has a tweak, is the separate return method.
• 9:24
  SPEAKER_03: And so, simply put, you are preparing the financial statements, imagining that that entity that you're looking at is a separate filing on its own from a tax return perspective.
• 9:36
  SPEAKER_03: So that's one method.
• 9:38
  SPEAKER_03: The second method is still separate company.
• 9:41
  SPEAKER_03: It's just we call it modified on benefits for loss.
• 9:45
  SPEAKER_03: You do the exact same thing as separate company.
• 9:48
  SPEAKER_03: You calculate, you measure, you you deal with all of your income tax accounting the same as you would in a pure separate company.
• 9:56
  SPEAKER_03: The only difference here is when you go to this step of assessing realizability of deferred tax assets, you consider the consolidated group.
• 10:05
  SPEAKER_03: So when you think about this in the context of a spin, um, unless you have a detailed provision that was magically kept for Spin Co., think about everything Matt just said, you're talking about carving up the business, you might have assets, you might have companies, you might have both.
• 10:22
  SPEAKER_03: Um, you know, ultimately when you spin, it's all in a legal entity that you're spinning out, right?
• 10:27
  SPEAKER_03: But today, as you begin to do these historical financial statements that Matt just talked about, you you you may not have all those structures, but you're reporting it for both pre-tax and tax, but you're reporting it on what you're what it is you're gonna spin out, what you're gonna carve out.
• 10:44
  SPEAKER_03: And so, in that, um, if you haven't had detailed spin co um, you know, a magic provision of spin co already calculated, you're actually gonna have to go back and figure that out.
• 10:56
  SPEAKER_03: And that's gonna require that coordination because your tax provision is based upon what's in pre-tax.
• 11:01
  SPEAKER_03: So coordination in that.
• 11:03
  SPEAKER_03: And then when that inclusion goes into that form 10, it's based upon the financial statement accounts that are included in the carve out entity.
• 11:14
  SPEAKER_03: And so, well, you must have a legal entity by the time you get there.
• 11:16
  SPEAKER_03: But again, before you get there, you're putting pieces together.
• 11:20
  SPEAKER_03: So sometimes it's easy because it's all in a subsidiary, but sometimes it's not.
• 11:24
  SPEAKER_03: Now, the SEC, while there's no specific gap that tells you that you must use a specific method, the SEC has said that the separate company is their preferred method.
• 11:35
  SPEAKER_03: So certainly in a spin, you know, where you're going to be filing registration statements, we'd expect generally a company would be using the separate return.
• 11:44
  SPEAKER_03: But to the extent, for example, you do something else, you should just be disclosing that and doing your pro forma from separate return to that something else.
• 11:53
  SPEAKER_03: So honestly, when you do benefits for loss, it's already disclosed because it has to do with your realizability.
• 11:58
  SPEAKER_03: So you are truly doing separate company when you're when you're using that method.
• 12:02
  SPEAKER_03: Um, so I think you know, those are probably the biggest points.
• 12:07
  SPEAKER_03: Just it's important to know, again, there is no special rule for separate company when you're dealing with a spin.
• 12:13
  SPEAKER_03: It's really just application of that allocation method for these group of assets and liabilities that are going to be spun out.
• 12:20
  SPEAKER_02: So, Jen, let me ask you a question about this preferability because you said that the SEC preference is for this or it's preferable to use a separate return method.
• 12:29
  SPEAKER_02: And you also said if you are using the benefits for loss method, you're thinking of realizability in the context of a consolidated group.
• 12:39
  SPEAKER_02: So if you are just talking about entity you are about to spin off, then thinking about realizability in the context of the consolidated group actually doesn't even really make sense because you are not going to be part of that group to realize the assets and liabilities.
• 12:55
  SPEAKER_02: Is that fair or not?
• 12:57
  SPEAKER_03: Well, no, it's a very fair thought.
• 12:59
  SPEAKER_03: And we will talk about this, but it can depend because if I just continue in that line of thinking, on a separate company basis, you might say that there's a deferred tax asset for like an NOL or something like that.
• 13:14
  SPEAKER_03: But in fact, you the consolidated group might have already used that NOL, right?
• 13:21
  SPEAKER_03: So I think it's a fair question, but you'll find that those are the kinds of complexities that you need to think through.
• 13:28
  SPEAKER_03: So we will talk a little bit about that as well.
• 13:30
  SPEAKER_02: All right.
• 13:30
  SPEAKER_02: So I just tried to shortcut our entire podcast, and apparently I should not have.
• 13:34
  SPEAKER_02: So maybe that's a good lead-in to our next question, because then, Matt, I'll draw you back into it.
• 13:39
  SPEAKER_02: It's that as you are thinking about the carve out financial statements, what are some of the things that you're thinking about in the preparation or in thinking about those income taxes?
• 13:49
  SPEAKER_01: Yeah, there's there's a few things to think about.
• 13:51
  SPEAKER_01: In a lot of cases, the carve-out financial statements might be prepared long after the balance sheet date, but you shouldn't use any any hindsight.
• 14:00
  SPEAKER_01: You're not preparing the historical financial statements based on information you know today.
• 14:05
  SPEAKER_01: You have to think about what information would have been available at the prior reporting dates.
• 14:11
  SPEAKER_01: And it's important to keep in mind whatever goes in the carve-out financial statements, that needs to be consistent with management's historical assertions inherent in the financial statements that the carve out is being derived from.
• 14:23
  SPEAKER_01: But that doesn't necessarily mean the assets and liabilities recorded by SpinCo are just a portion of the consolidated assets and liabilities.
• 14:31
  SPEAKER_01: And Jen just gave a perfect example of that when you're talking about deferred tax assets for for attributes.
• 14:38
  SPEAKER_01: So if you're doing a separate company provision calculated on a separate return basis, as Jen just talked about, then yeah, that's that's a great example.
• 14:47
  SPEAKER_01: You might have attributes like NOLs or other credits that are appropriately refre reflected on the carve out financials, but it's not something that the spin code can actually take with them because they've actually been used by the by the consolidated group.
• 15:02
  SPEAKER_01: So this is an area where transparent disclosures are going to be gonna be very important.
• 15:07
  SPEAKER_01: And any any adjustment from carve-out to actuals would would generally be re generally be reported as an adjustment in the pro forma pro forma information in the Form 10.
• 15:20
  SPEAKER_02: All right.
• 15:20
  SPEAKER_02: So then one of the things Matt just mentioned was about assertions and being consistent.
• 15:26
  SPEAKER_02: And so, Jen, how do you sort of think about that?
• 15:29
  SPEAKER_03: Well, so as we've said, a tax provision, this separate company provision you're doing, if you will, it's just a carve out of a total company provision.
• 15:39
  SPEAKER_03: And so assertions should not change just because of the carve out, and importantly, also not because of the timing of the preparation of the historical financial statements.
• 15:50
  SPEAKER_03: So a few examples.
• 15:51
  SPEAKER_03: So think about a valuation allowance and imagine that we are doing a carve out in 2023, and the business that we're carving out had a valuation allowance in 2021.
• 16:04
  SPEAKER_03: Um let's imagine that in the consolidated financial statements in 2023, there's a release of that valuation allowance.
• 16:12
  SPEAKER_03: Now, 2023, we have that information.
• 16:14
  SPEAKER_03: It's all available evidence, right, from a VA.
• 16:17
  SPEAKER_03: So sometimes companies might say, Well, I should push that VA release almost back to 2021, and that would be inappropriate.
• 16:24
  SPEAKER_03: Um, you're recording the financial statements based upon the original financial statements that were completed.
• 16:30
  SPEAKER_03: So you're not creating a new fiction, if you will.
• 16:32
  SPEAKER_03: So that's an example.
• 16:34
  SPEAKER_03: UTPs is an area that um will come up here, and again, you're allocating a total provision.
• 16:40
  SPEAKER_03: So UTPs shouldn't be looked at through the lens of, let's say, a different company or different facts, you know, they than what existed in the historical financial statements and how those were looked at.
• 16:52
  SPEAKER_03: Of course, when you're looking at the spin code, the UTP should be based upon spin COs driven UTPs and activity rather than some other method, I guess if you would say that.
• 17:03
  SPEAKER_03: The allocation to spin code, though, like when we're thinking about UTPs, could be different when it actually gets spun versus um what's the separate return method might have driven.
• 17:15
  SPEAKER_03: So again, there's gonna be um things that could be different in the historical financial statements versus when this transaction actually goes goes live.
• 17:24
  SPEAKER_03: At the same time, they I think one of the things that again, UTPs being such a big area of discussion in frankly any transaction, but spins are no exception.
• 17:34
  SPEAKER_03: Both the spinner and the spin-ee are going to need to have an agreement on how those UTPs will be handled as it goes forward.
• 17:42
  SPEAKER_03: And so that's typically done going back to the reporting through a written tax sharing agreement or in dem and maybe some indemnification agreements.
• 17:51
  SPEAKER_03: Um the tax sharing agreement is actually going to get disclosed in that Form 10 that Matt mentioned.
• 17:57
  SPEAKER_03: Um, and in fact, the agreement will actually be included in that as an exhibit.
• 18:02
  SPEAKER_03: So, and that's all prior to effectiveness of the spin.
• 18:06
  SPEAKER_03: Um the agreement, as you'd expect, it covers who's covering which taxes, how audit settlements will be handled, how audit disagreements, disagreements will be resolved, and things like that.
• 18:18
  SPEAKER_03: So there's a lot, I think, in that UTP space as well.
• 18:21
  SPEAKER_02: So and I think, Jen, to the point you just made, then I keep going back to your example of the fact that this um SUN company had this NOL the parent already used.
• 18:31
  SPEAKER_02: And I guess when I asked the question, I was thinking it more, thinking of it more from the perspective that, oh, it's beneficial for this entity to be part of the consolidated group because maybe it will realize it's deferred tax assets or otherwise.
• 18:45
  SPEAKER_02: But I guess in either case, whether the parent was going to help them realize something or the parent already used up its beneficial attributes, that is all going to be specified then in this tax sharing agreement.
• 18:59
  SPEAKER_02: So that will be clear as people are reading.
• 19:02
  SPEAKER_02: I'm just trying to think through like very tactically how some of this actually works.
• 19:06
  SPEAKER_02: Does it get down to that level of information?
• 19:09
  SPEAKER_03: So the tax sharing agreement will address um, it'll address a lot of things operationally and otherwise, right?
• 19:16
  SPEAKER_03: But a deferred tax asset is just the financial reporting of, let's say, a book and tax basis or at the difference, or it's uh it's the deferred tax asset is a reflection of attributes.
• 19:29
  SPEAKER_03: Okay.
• 19:30
  SPEAKER_03: So generally when when I was mentioning the NOL, I'm talking about attributes.
• 19:33
  SPEAKER_03: So, you know, if you're filing a consolidated return, if you come to a place where you break that up, there are specific rules on how you allocate and break up those attributes.
• 19:44
  SPEAKER_03: So for example, if you were not a separate legal entity, then those attributes, we might be reflecting them because let's say that SpinCo has a loss.
• 19:56
  SPEAKER_03: And that loss would under normal tax create a carry-forward.
• 20:01
  SPEAKER_03: If where we're bringing together accounts, not necessarily entities in all cases, when you get into that, that NOL carry forward that was created didn't really exist.
• 20:12
  SPEAKER_03: That was just in my this example, like a division of a bigger corporation.
• 20:16
  SPEAKER_03: So when the when the actual separation comes to happen, there's nothing to send with them.
• 20:21
  SPEAKER_03: They weren't a separate legal entity.
• 20:23
  SPEAKER_03: Now, a different fact pattern, assume they are a separate legal entity.
• 20:27
  SPEAKER_03: And again, this isn't unique to spins, but assume that they were a separate legal entity, but they're filing as part of a consolidated group, then how much of the, let's say, carry forwards that remain and will go with them will depend upon how these separate return rules work.
• 20:45
  SPEAKER_03: That's all specific guidance in the tax law.
• 20:48
  SPEAKER_03: So if I circle fully back to your question, there's like a fiction, if you will, because you need to follow, as I said earlier, that pre-tax income or loss.
• 20:58
  SPEAKER_03: That is the beginning of your tax provision.
• 21:00
  SPEAKER_03: You're calculating and reflecting a tax provision on those pre-tax operations.
• 21:06
  SPEAKER_03: But when you actually come to the spin, the law is gonna tell you how on attributes, it's gonna tell you how you share and break those out.
• 21:13
  SPEAKER_03: So the tax sharing agreement, I want to come back to that.
• 21:17
  SPEAKER_03: Um, that might talk about some things, but that actually won't be the driver.
• 21:21
  SPEAKER_03: It could be that it could drive that the law is gonna divide it up a certain way, but there could be something in the sharing agreement that says you're gonna pay me or I'm gonna pay you.
• 21:30
  SPEAKER_03: So the sharing agreement could deal with that, but the law will tell you how you break up the all right.
• 21:35
  SPEAKER_02: Let me ask another question here.
• 21:37
  SPEAKER_02: So this is going back to something we've talked about in the past in other situations.
• 21:42
  SPEAKER_02: And I want to think about how that applies here and specifically about outside base, outside outside basis differences and whether or not your indefinite reinvestment assertion needs to be the same.
• 21:55
  SPEAKER_02: Um, the spin code has to have the same assertion that the consolidated group did.
• 22:00
  SPEAKER_03: Yeah, that's another big question that that we see.
• 22:02
  SPEAKER_03: And it goes back to the last question that we were talking about earlier, just around um assertions and how you think about those and not using hindsight and the like.
• 22:11
  SPEAKER_03: So at times when you look at a carve out situation, management might look at that and say, that carve out wouldn't be able to support an assertion that we've supported in the consolidation.
• 22:21
  SPEAKER_03: So shouldn't we change that?
• 22:23
  SPEAKER_03: Generally, it's not appropriate again to go back and revisit those assertions because you're allocating a provision.
• 22:30
  SPEAKER_03: You're allocating a total provision that was based upon certain assertions and assumptions, and you're just allocating that.
• 22:36
  SPEAKER_03: Now, in the event there is a spin-off, we do think you have to think about and evaluate whether that spin-off impacts the parent's ability to make their assertion.
• 22:49
  SPEAKER_03: And so you might look at that as at the time of the consideration, you know, that maybe the announcement, is there at this point something that says, I can no longer assert that I have the intent and ability to hold this subsidiary, that I intend to indefinitely reinvest it.
• 23:08
  SPEAKER_03: If the parent were to conclude that prior to the date of the spin, or actually at either point.
• 23:14
  SPEAKER_03: So either, you know, you could have it at different points in the spectrum, including right before the spin.
• 23:19
  SPEAKER_03: The key is if the parent changes its assertion around that, it's going to record a charge in continuing ops prior to the spin, I guess is the key.
• 23:28
  SPEAKER_03: And then the other thing is to the extent that the parent has changed the assertion, we'd expect that to be consistent in then the separate company financial statements, right?
• 23:37
  SPEAKER_03: Because it would be consistent with the allocation that was originally the allocation would be consistent with what was determined in the consolidated accounts.
• 23:43
  SPEAKER_03: But we wouldn't generally expect that when you're creating carve out financial statements, that you're going to have a change in that assertion.
• 23:51
  SPEAKER_03: I mean, maybe that's the takeaway.
• 23:53
  SPEAKER_03: In most things, there's judgment, there are things to think about, but generally you wouldn't be expecting to change that assertion.
• 24:00
  SPEAKER_02: All right.
• 24:01
  SPEAKER_02: That's helpful.
• 24:02
  SPEAKER_02: So then, Matt, let me go back to you, and I'm going to kind of pull in the question I was sort of driving at before, which is, you know, based on this conversation we're having, it the uh income tax provision that or the tax the tax attributes reserves that you're reflecting in these carve-out financial statements or these spin financial statements are actually different from what's really going to happen when this transaction occurs.
• 24:30
  SPEAKER_02: And so given that, it almost feels like that you're going to either need to have some very detailed disclosure or otherwise to make sure the people using these financial statements understand what they're really getting compared to what is reflected.
• 24:44
  SPEAKER_02: So, how do you think about that?
• 24:46
  SPEAKER_01: Yeah, that's right.
• 24:46
  SPEAKER_01: Disclosures are going to be very important here, as you as you pointed out.
• 24:50
  SPEAKER_01: So we we already talked about the fact that ASC 740 may require spin code to reflect certain things in their historical financial statements that's not necessarily reflective of what they're going to look like on a standalone basis.
• 25:04
  SPEAKER_01: So some of the types of items that need to be considered for disclosure, a couple examples would be any changes in policy elections or tax elections.
• 25:15
  SPEAKER_01: So, for example, the benefits for loss method that that Jen pointed out, and you mentioned, Heather, does that really make sense to use that for the historical financials?
• 25:23
  SPEAKER_01: Well, that may be the the policy that was elected for the historical financials, and it needs to be consistently applied.
• 25:30
  SPEAKER_01: But if you if you know that analysis or that election is not available as a standalone company, and that could potentially result in a different conclusion around a evaluation allowance, then that's definitely something that needs to be needs to be disclosed.
• 25:47
  SPEAKER_01: We're also just talking about the APB 23 assertion.
• 25:50
  SPEAKER_01: That might change in the future or that can't be supported post-spin, and that's that's certainly something that would be appropriate to disclose those expected changes and the estimated financial statement impact of of such a change.
• 26:04
  SPEAKER_01: And we've talked a few times now about the example of certain attributes that are recorded in the carve-out financial statements, but might have been used in the consolidated financial statements.
• 26:14
  SPEAKER_01: So that's that's a pretty obvious disclosure item.
• 26:17
  SPEAKER_01: You want to let the users of the financials know that those assets don't actually exist or the spin kill won't be won't be taking those with them post post-spin.
• 26:28
  SPEAKER_02: All right.
• 26:28
  SPEAKER_02: That's a very important point there.
• 26:30
  SPEAKER_02: So then I think now we're sort of leading up to now what happens when the spin occurs.
• 26:37
  SPEAKER_02: So maybe starting with like what are the reporting requirements, and then we'll obviously get into some of these tax questions.
• 26:44
  SPEAKER_01: Sure.
• 26:45
  SPEAKER_01: So so the spin-off, yeah, is obviously not the end of the SEC reporting process for the SpinCo.
• 26:50
  SPEAKER_01: It's it's really just the just the beginning.
• 26:53
  SPEAKER_01: So as soon as the registration statement is declared effective, that's that's the point that Spinco is going to have the same reporting requirements as as any standalone public company.
• 27:04
  SPEAKER_01: They'll have a range of continuing reporting obligations.
• 27:07
  SPEAKER_01: They'll have to start doing their Q's and Ks and any event-driven filings, filings throughout the year on Form 8K.
• 27:16
  SPEAKER_01: So you you want to be thinking ahead to what your future filing requirements are.
• 27:21
  SPEAKER_01: So for example, take your take the filing of the first Form 10 Q.
• 27:26
  SPEAKER_01: It's going to present your your actual quarter on an actual post-spend basis.
• 27:30
  SPEAKER_01: There's no more, no more allocations.
• 27:32
  SPEAKER_01: You're you're on your own at that point, so it's your results of operations, but the the historical information is still going to be on a carve-out basis.
• 27:40
  SPEAKER_01: And each of the quarters is not something that would have been required in the Form 10.
• 27:45
  SPEAKER_01: So that's going to present just its own unique set of challenges, especially from an income tax perspective, because you're going to need forecasts to prepare your estimated annual effective tax rate.
• 27:57
  SPEAKER_01: You've got to do it on a carve-out basis.
• 27:59
  SPEAKER_01: And that's not something you're going to have for each quarter unless you unless you plan ahead for it.
• 28:04
  SPEAKER_01: So the the key is really to understand what's required early so that you can plan ahead, ensure you have the right complement of resources to be able to handle the accounting, the tax, financial reporting, internal control requirements, just a whole host of considerations you got to be prepared for for operating as a as a standalone SEC reporting entity.
• 28:28
  SPEAKER_02: So I I know there's some specific tax issues we should talk about, but we talked about the fact that tax law, maybe the tax sharing agreement and otherwise, that's going to govern what tax assets and liabilities ultimately the spin company has.
• 28:45
  SPEAKER_02: So now pre-spin, I did my separate company and I reflected I don't want to call it fiction, but I reflected uh I prepared that based on these specific rules.
• 28:56
  SPEAKER_02: Now, one day after the spin, those balances are different.
• 29:04
  SPEAKER_02: So the real question here that I had is how does this get adjusted?
• 29:10
  SPEAKER_02: I talked to Jen and Matt about this offline after the recording, and here's what I learned.
• 29:16
  SPEAKER_02: Upon spinoff, the deferred tax assets for attributes that have already been utilized in consolidation will be reflected as a transfer to the former parent through an adjustment to equity on the standalone financial statements of SpinCo as part of closing out the parent investment account.
• 29:34
  SPEAKER_02: So, with that, if we go back to our NOL example, in SpinCo's first 10Q post, they'll have detailed disclosures about the transaction separation from the parent, including a detail of the actual assets, liabilities contributed by the parent.
• 29:51
  SPEAKER_02: Any differences between what was in the carve outs versus the actual opening Spinco balances will get shrewd up as part of closing out the parent investment account at the spin date.
• 30:02
  SPEAKER_02: The quote fictitious NOL would be treated effectively as if the sub distributed that asset to the parent, which, if you take a step back and think about it, actually is what happened.
• 30:18
  SPEAKER_02: So then, Matt, obviously given all the complexities here, your point on making sure you have a plan in place is very important.
• 30:25
  SPEAKER_02: But let's assume we have our plan.
• 30:27
  SPEAKER_02: So what are some of the tax issues that companies should be preparing for as they get ready for these post-spin filings?
• 30:35
  SPEAKER_01: One of the tax-related issues to be on top of relates to indemnifications, which Jen, you already mentioned, that's that's a pretty common, pretty, pretty common agreement you're going to see really in any in any divestiture transaction, and that can be an indemnication from or to the former parent.
• 30:54
  SPEAKER_01: We could probably do a whole podcast on indemnifications and accounting issues, but just at a real high level, when a when a wholly owned subsidiary that was previously included as a member of a consolidated federal income tax return is spun off from its parent, the sub may agree to indemnify the parent for any income taxes that the parent may be assessed related to the resolution of the sub's pre-spend uncertain tax positions.
• 31:21
  SPEAKER_01: So the general rule, if we're if we're talking about the parent's liabilities, is that even though the sub may be legally liable for the parent's taxes, and that's because the tack the taxing authority may consider all entities in the original consolidated filing as being jointly liable for the taxes of the entire pre-spin consolidated group.
• 31:44
  SPEAKER_01: But the convention under U.S.
• 31:45
  SPEAKER_01: GAAP is that each entity should recognize income taxes related to its own operations.
• 31:52
  SPEAKER_01: So the sub is not recording the parents' liabilities, but would record any UTPs related to its operations.
• 32:00
  SPEAKER_01: So we we hit on that already, and that that should already be reflected on the carve-out financial statements, and we would expect that accounting to continue post-spin while the sub is still considered a primary obligator until those positions are are ultimately settled.
• 32:17
  SPEAKER_01: So it could go the other way.
• 32:19
  SPEAKER_01: The parent may indemnify SpinCo for income tax exposures, even those related to SpinCo's prior operations.
• 32:28
  SPEAKER_01: So in this case, SpinCo still has to record the liability, but assuming that the indemnification fully covers the exposure, we think it would be reasonable for SpinCo to record an indemnification receivable at the same amount as the tax liability.
• 32:45
  SPEAKER_01: But the indemnified party, SpinCo in this case, they shouldn't offset the indemnification receivable against the tax liability because those amounts are receivable from and payable to two different parties, so they don't they don't qualify for for offset.
• 33:00
  SPEAKER_01: So even though they effectively do offset, they're still recorded gross.
• 33:04
  SPEAKER_01: So any any future adjustments to the UTP will be reflected in the tax line.
• 33:09
  SPEAKER_01: Any offsetting adjustment to the indemnification receivable, that'll be reflected in pre-tax income.
• 33:16
  SPEAKER_01: So these these situations may require the spin co to have a line of communication with its former parent since SpinCo has to continue to account for certain UTPs that are that are being handled by its its former parent.
• 33:30
  SPEAKER_02: Well also sounds like uh you mentioned disclosure before, and this is another place where disclosure will be very important to explain these relationships.
• 33:39
  SPEAKER_02: All right.
• 33:40
  SPEAKER_02: So that's all from the perspective of the company that got spun off, but obviously now you have this parent that's left with almost like a hole, and it it's had a lot of changes as well.
• 33:50
  SPEAKER_02: So, Jen, how do I think about the parent company accounting or a former parent, I guess.
• 33:56
  SPEAKER_03: You know, and I think that idea of it has now has a hole is I think an important one.
• 34:01
  SPEAKER_03: So similar to you know, spin code getting ready for what comes next, the parent needs to do the same.
• 34:07
  SPEAKER_03: Um, so you know, there might be things like valuation allowances where um now maybe with the exit of the spin, there could be some impacts that you're thinking about, needing to think about.
• 34:18
  SPEAKER_03: Um, you know, generally speaking, if you've and and maybe I should say this is like a nanosecond before the spin, you know, if you determine that there are assets that you're spinning that need a VA, you're gonna need to reflect that um before the spin.
• 34:31
  SPEAKER_03: But then from a from an ongoing perspective, the parent may also need to think about, well, they will need to think about whether and how to look at their discontinued operations analysis.
• 34:43
  SPEAKER_03: And depending on the facts, um how significant it is, there might be pro forma financial statements reflecting the disposition that are necessary within four days of that spin.
• 34:54
  SPEAKER_03: So that's that can be obviously a pretty tight turnaround.
• 34:57
  SPEAKER_03: Now, when you think about the discontinued operations analysis, that's obviously through ASC 205.
• 35:03
  SPEAKER_03: But the key here is that you won't meet that discontinued ops treatment until you um the spin is consummated.
• 35:12
  SPEAKER_03: So now having just managed to carve out, having managed to create historical financial statements and do all that, now you need to go back again and take a look at discontinued operations.
• 35:23
  SPEAKER_03: Um the parent would need to retro, if if in fact they qualify for discontinued operations, the parent itself is gonna need to retrofec retrospectively present the um assets and liabilities of the entity being spun off.
• 35:38
  SPEAKER_03: And of course, that also includes tax provision, um, which would be subject to just basic intra-period rules, which have, you know, again, a whole other set of uh guidance with regard to that in 740.
• 35:50
  SPEAKER_02: Well, and I think to your point about just divestiture more broadly, there are so many issues to think about.
• 35:56
  SPEAKER_02: And we did do a prior podcast on that.
• 35:59
  SPEAKER_02: So we'll make sure to include a link to that in the show notes.
• 36:02
  SPEAKER_02: Um, but in general, obviously, this it in and of itself is a very complicated topic and definitely I think a lot for companies to think about.
• 36:13
  SPEAKER_02: And clearly you both have a lot more experience with this than you know a company that's maybe coming to this new or maybe hasn't done it frequently.
• 36:21
  SPEAKER_02: So just for wrap-up, I would like to ask the question if you have any final advice, and maybe Matt, I'll ask you first.
• 36:30
  SPEAKER_01: Sure.
• 36:31
  SPEAKER_01: Yeah, I would I would just say once a company decides it'll spin off a business, the the timeline can vary from a couple of months to a couple of years.
• 36:40
  SPEAKER_01: And for the parent, you know, I think the key wrap-up point is just don't don't underestimate the level of effort involved in preparing the carve-out financial statements and the amount of coordination that'll be involved, you know, literally across all business units of the of the company.
• 36:56
  SPEAKER_02: All right, that's helpful.
• 36:57
  SPEAKER_02: Jen, how about from your point of view?
• 36:59
  SPEAKER_03: I think if I take it from the Spinco level, unlike a transaction where you're selling the business to another entity that already has their infrastructure and all that goes with it, um, SpinCo needs to be ready on day one to stand up the right resources to be able to just hit the ground running and continue.
• 37:16
  SPEAKER_03: So, you know, you've spent a significant amount of time to get to that point.
• 37:20
  SPEAKER_03: Um, but being ready for that go date is I think going to be critical, including in the tax space as you begin to navigate all that we've talked about.
• 37:28
  SPEAKER_02: Yeah, I was just thinking that hiring a tax VP may be the first thing that you should be doing here, given all that's going to need to be uh, you know, thought of during this transaction.
• 37:38
  SPEAKER_02: But definitely a great topic, very interesting, and I definitely learned a lot today.
• 37:42
  SPEAKER_02: So thank you both so much for joining me.
• 37:45
  SPEAKER_01: Thanks for having us.
• 37:46
  SPEAKER_01: Thanks, Taylor.
• 37:47
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• 37:50
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• 38:10
  SPEAKER_02: From Thought Leadership at PWC, I am Heather Horn.
• 38:14
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