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Income tax accounting refresh: equity method investments · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC.
• 0:06
  SPEAKER_03: Welcome to PWC's Accounting Podcast.
• 0:09
  SPEAKER_03: I'm Heather Horn.
• 0:12
  SPEAKER_03: Thanks for joining me as we continue our Tuesday series in which one of our All-Star podcast guests takes over the podcast, picks the topics for the month, and joins me on all the episodes.
• 0:25
  SPEAKER_03: For the month of May, our takeover guest is Jennifer Spang, the income tax accounting leader in PWC's national office.
• 0:33
  SPEAKER_03: This month, she takes over the podcast to share the latest insights on income tax accounting.
• 0:39
  SPEAKER_02: Equity method accounting is challenging, so you really have to make sure you understand all sides and you're talking about it on a cross-functional basis.
• 0:47
  SPEAKER_01: One thing I always encourage people to do is track the book basis, which sounds simple, but in a lot of cases it gets complicated quickly.
• 0:57
  SPEAKER_03: That was Jen and Cassie Bauman, a managing director in PWC's national office.
• 1:03
  SPEAKER_03: In this episode, they discuss tax considerations for equity method investments, including complications like the income tax accounting judgments needed, when there are additional acquisitions or changes in ownership of equity method investments, as well as bread and butter tax accounting for these types of investments.
• 1:23
  SPEAKER_03: They've got a lot to cover, so let's get started.
• 1:30
  SPEAKER_03: So, Jen, Cassie, welcome to our podcast.
• 1:34
  SPEAKER_03: Nice to have you back, Jen, and nice to see you, Cassie.
• 1:38
  SPEAKER_03: And for today's topic, we are going to be talking about the tax accounting for equity method investments.
• 1:45
  SPEAKER_03: And uh before we actually get into the income tax accounting, I thought it would be helpful just to give people a quick, very high-level refresher about equity method accounting in general.
• 1:56
  SPEAKER_03: So, Cassie, can you uh start with that, please?
• 1:59
  SPEAKER_01: Just a quick refresher.
• 2:00
  SPEAKER_01: An investor generally would apply the equity method of accounting when the investor doesn't control but has the ability to exercise significant influence over the operating or financial policies of the investee.
• 2:15
  SPEAKER_01: So if you translate that to voting percentage, the voting percentage that's presumed to provide an investor with the required level of influence necessary to apply the equity method of accounting varies depending on the nature of the investee.
• 2:30
  SPEAKER_01: And by nature, I mean is the investee a corporation or is it a partnership?
• 2:35
  SPEAKER_01: So thinking about corporations, generally ownership of 20% or more is considered to provide the ability to exercise significant influence.
• 2:46
  SPEAKER_01: And just as a like little sidebar, conveniently under the US federal tax code, ownership in excess of 80% is generally what allows you to elect to consolidate an entity on your tax return.
• 2:59
  SPEAKER_01: So thinking about that, if you're at like the 20% or more realm, I think equity is often often from gap perspective, 20 to 50%.
• 3:09
  SPEAKER_01: If you're at equity method for book purposes, for gap purposes, you'll also be on the tax side, treating it like an investment for tax purposes.
• 3:18
  SPEAKER_01: And so it's a convenient correlation between those two.
• 3:22
  SPEAKER_01: So getting back to the gap side, there's really no bright line ownership level test to determine control.
• 3:28
  SPEAKER_01: And in some cases, significant ownership percentages could still be accounted for under the equity method of accounting.
• 3:34
  SPEAKER_01: And just a common example here is you might have a partnership interest where, say, you might own 90% of that, but you're not the general partner.
• 3:44
  SPEAKER_01: So you don't make the decisions or control the operating or financial policies.
• 3:49
  SPEAKER_01: So in that case, you may still be accounting for that investment in that partnership using the equity method.
• 3:55
  SPEAKER_03: All right.
• 3:55
  SPEAKER_03: And definitely that was a very brief description of equity method accounting.
• 4:00
  SPEAKER_03: So we will include in the show notes.
• 4:02
  SPEAKER_03: I think we have a few other episodes on this topic if people are actually focused on that part of it.
• 4:07
  SPEAKER_03: But with at least that background, so people have a general sense.
• 4:10
  SPEAKER_03: Let's talk generally about tax accounting.
• 4:13
  SPEAKER_03: So, Cassie, can you continue?
• 4:14
  SPEAKER_01: Yeah, so you're thinking here about your investment in the equity method entity from a book perspective and the investment from a tax perspective.
• 4:24
  SPEAKER_01: So you're thinking book tax basis difference here.
• 4:27
  SPEAKER_01: You're talking about an outside basis difference, which is something we've talked about in a previous podcast.
• 4:32
  SPEAKER_01: So that's the investment in the stock of that entity.
• 4:36
  SPEAKER_01: So for tax purposes, the investment is generally recorded at cost basis.
• 4:41
  SPEAKER_01: For book purposes, you start at book at cost basis, but then any of the investor shares of the investees' earnings are recorded for book purposes through application of the equity method.
• 4:56
  SPEAKER_01: So this typically results in a temporary difference between the book and tax basis of these investments.
• 5:02
  SPEAKER_01: And deferred taxes should be provided on those basis differences, including any unremitted earnings.
• 5:10
  SPEAKER_01: So a book over tax basis in the investment, so your book basis is higher than your tax basis, would generally result in a deferred tax liability.
• 5:19
  SPEAKER_01: And a tax over a book basis would generally result in a deferred tax asset.
• 5:26
  SPEAKER_01: Now, one question that often comes up is there's some guidance in ASC 740 related to subsidiaries that says if I have a deferred tax asset related to an investment in a subsidiary, I would generally not record that unless it will reverse in the foreseeable future.
• 5:44
  SPEAKER_01: So something that comes up often with equity method accounting is well, my equity method investment is in a tax over book position.
• 5:52
  SPEAKER_01: I have a DTA.
• 5:54
  SPEAKER_01: Do I apply that guidance about foreseeable future that exists for subsidiaries?
• 5:58
  SPEAKER_01: And generally the answer is no.
• 6:00
  SPEAKER_01: So you're generally recording the DTA here.
• 6:04
  SPEAKER_01: So thinking about those DTLs and DTAs that you have recorded, one thing you have to think about is how will that reverse?
• 6:13
  SPEAKER_01: So how will that DTL or DTA be realized?
• 6:19
  SPEAKER_01: Are you expecting dividends from the investee, or are you expecting that that DTA or DTL wouldn't reverse until you sell or liquidate that investment?
• 6:28
  SPEAKER_01: And this includes, you know, any DTA or DTL that relates to, generally DTL that relates to those unremitted earnings.
• 6:37
  SPEAKER_01: So you have to be thinking about the assumed pattern and type of future taxable income or loss that would be expected upon recovery.
• 6:45
  SPEAKER_01: So if payments of dividends are unlikely, the investor may have to assume that they're going to recover that basis difference through sale.
• 6:54
  SPEAKER_01: So some things you need to think about here are whether that gain or loss, so DTA or DTL, on disposal would be capital or ordinary in nature.
• 7:05
  SPEAKER_01: That distinction could impact your realizability assessment if you had, say, a DTA related to your equity method investment.
• 7:14
  SPEAKER_01: If it's capital, you may not have a source of income to realize that and may need a valuation allowance on it, for example.
• 7:21
  SPEAKER_01: And then in many cases, if you had a DTL, you would have to think about whether you measure that or DTA, you'd measure it at the capital gains rate, if there is a capital gains rate in the country that you're that you exist in.
• 7:37
  SPEAKER_01: And you'd have to think about that even if you don't have any current intention of actually disposing of that equity method investment.
• 7:45
  SPEAKER_01: So that's a few things that you have to think about if the payment of dividends is unlikely.
• 7:51
  SPEAKER_01: If the equity investee has paid dividends in excess of current year earnings in the past, and that practice is expected to continue in the future, it may be appropriate to assume that the basis difference will reverse just through normal dividend distributions.
• 8:06
  SPEAKER_01: Now, one nuance here is if the investor is in a jurisdiction where dividends are not taxable due to something called a dividends received deduction, or those dividends are in effect a return of capital that wouldn't be subject to tax when they're made, then you it may not be appropriate to actually record a deferred tax liability in those situations.
• 8:30
  SPEAKER_03: All right.
• 8:30
  SPEAKER_03: So you're saying then, Cassie, in those cases, you can't you really need to sort of map out how you're expected to like realize or recover that DTA DTL, and then that will drive the accounting.
• 8:42
  SPEAKER_01: That's right.
• 8:43
  SPEAKER_03: Okay.
• 8:43
  SPEAKER_03: So you can't just you have to look into the future, basically.
• 8:47
  SPEAKER_03: All right, that's helpful.
• 8:48
  SPEAKER_03: So then, Jen, let me bring you into the conversation.
• 8:51
  SPEAKER_03: And I know that many times a company will have an equity method investment and then they keep adding to it.
• 8:58
  SPEAKER_03: And in some cases, then the investee could actually become a subsidiary, or you could have the opposite situation where you have a subsidiary and then you sell part of it, and now you have an equity method investment.
• 9:09
  SPEAKER_03: So, how does that sort of those types of changes, how do they impact your tax accounting?
• 9:16
  SPEAKER_02: Yeah, let's start with going from an investee to a subsidiary.
• 9:19
  SPEAKER_02: And I think it probably makes sense to just level set on two big picture thoughts.
• 9:24
  SPEAKER_02: So when you go from an investee to a subsidiary, the acquirer's original interest or their historical interest will be re-measured at fair value.
• 9:33
  SPEAKER_02: And that's going to come up in some of the other things that we'll talk about.
• 9:36
  SPEAKER_02: So that holding gain, if you will, will be recorded through the PL.
• 9:42
  SPEAKER_02: In addition, an important factor can be that because you were an investee for all the reasons Cassie just talked about, you may well already have prior to buying that interest, you may already have an existing deferred tax asset or liability on that investee.
• 9:59
  SPEAKER_02: So now when you buy this incremental interest, while you've had a remeasurement for book purposes, for tax purposes, nothing has happened.
• 10:08
  SPEAKER_02: You haven't had any increase in your basis.
• 10:10
  SPEAKER_02: So now new temporary differences might be coming into play.
• 10:14
  SPEAKER_02: And I point that out because it's new temporary differences, but um you have to remember you already have some recorded when you're starting to think about what you do next.
• 10:22
  SPEAKER_02: So if I start there, and again, we stick with investee to subsidiary.
• 10:28
  SPEAKER_02: Um the key thing here is that as an investee, um, for again, all the reasons Cassie mentioned, you didn't really have um control, let's say, of the reversal of that basis difference.
• 10:40
  SPEAKER_02: But once you move to a subsidiary, there are some exceptions in US GAAP that may now apply.
• 10:46
  SPEAKER_02: And we've actually talked about these on other webcasts or other podcasts, but actually probably both.
• 10:51
  SPEAKER_02: Um so think about a foreign subsidiary where um you are now a subsidiary and you have the intent and ability to assert indefinite reinvestment.
• 11:04
  SPEAKER_02: So now all the thing, all of a sudden, the um the assertion what we refer to as APB 23 very frequently may apply.
• 11:12
  SPEAKER_02: So to the extent that you had previously recorded a deferred tax liability on your interest and you now have the intent and ability to assert indefinite reinvestment, you'll derecognize that pre-prior deferred tax liability.
• 11:24
  SPEAKER_02: Similar but different guidance for a domestic subsidiary, um, while different language, essentially there in a domestic subsidiary, it's the ability to recover an investment in a tax-free manner.
• 11:36
  SPEAKER_02: So again, if you had a deferred tax liability recorded that you now, as a subsidiary, have the ability to recover that basis tax-free, you'd have to derecognize that deferred tax liability.
• 11:49
  SPEAKER_02: And then for both foreign and domestic, to the extent that you had recorded previously a deferred tax asset as a subsidiary, whether again domestic or foreign, there is a specific gap that basically says you can only record a deferred tax asset on an outside basis difference if it will be realized in the foreseeable future.
• 12:12
  SPEAKER_02: And foreseeable future is generally about a year.
• 12:15
  SPEAKER_02: Um, so it needs to be some transaction that would actually recognize the benefit.
• 12:20
  SPEAKER_02: So if you now have moved into that subsidiary territory and you cannot say that you you, in fact, will be able to reverse the difference in the foreseeable future, then you need to derecognize that deferred tax asset.
• 12:34
  SPEAKER_02: So, you know, all of those exceptions come into play.
• 12:38
  SPEAKER_02: Any of the accounting that's triggered by that, any recognition or I should say derecognition in this example of the deferred tax liabilities or deferred tax asset, those will go through continuing ops.
• 12:49
  SPEAKER_02: Now, I gave the the longer one to start with.
• 12:52
  SPEAKER_02: If you're instead going from a subsidiary to an investee, chances are if you've been applying any of those exceptions I just talked about, as an investee, you're not going to be able to apply them anymore.
• 13:03
  SPEAKER_02: So now you might be talking about going the opposite direction where you actually need to record those deferred taxes on that incremental basis difference that I mentioned at the outset.
• 13:13
  SPEAKER_03: All right.
• 13:13
  SPEAKER_03: So just to tie together what you said with what Cassie just said is Cassie made a point of saying for an equity method investee, you do not have to apply this bar of that it will reverse in the foreseeable future, but you do apply that bar for subsidiaries.
• 13:30
  SPEAKER_03: And so when you are moving back and forth between them, you have to make sure you focus on that difference.
• 13:36
  SPEAKER_03: That's exactly right.
• 13:37
  SPEAKER_03: All right.
• 13:37
  SPEAKER_03: Thank you.
• 13:38
  SPEAKER_03: When you were talking, I said, I think Cassie just talked about this.
• 13:40
  SPEAKER_03: So glad to put those pieces together.
• 13:42
  SPEAKER_03: And then Cassie, any other nuances we should be focused on here?
• 13:46
  SPEAKER_01: Yeah.
• 13:47
  SPEAKER_01: So just piggybacking off of what Jen was talking about, imagine a situation where you had invested in a partnership to begin with, and then you bought some more and you bought some more, and then eventually you own 100% of the partnership.
• 14:02
  SPEAKER_01: So thinking about the couple ways that that can happen, the first may be you, as just a single entity, may have bought 100% of the partnership directly.
• 14:14
  SPEAKER_01: And in that case, the partnership under tax law can't be a partnership anymore because it's only got one owner.
• 14:19
  SPEAKER_01: And so in that situation, you would basically derecognize the um outside basis difference you had been recording, and now you're consolidating that partnership.
• 14:32
  SPEAKER_01: And so you don't have to worry about this outside basis concept anymore.
• 14:36
  SPEAKER_01: But what often happens is that companies will acquire, say a parent company will acquire 100% of a partnership, but it won't do it directly.
• 14:45
  SPEAKER_01: So it might own 20%, and then one of its subsidiaries might own 50%, and then, you know, but in in total, in the structure, 100% is owned.
• 14:55
  SPEAKER_01: Well, the re the reality is companies do that for a reason.
• 14:59
  SPEAKER_01: Um and you have to respect the form of the partnership when you're doing that.
• 15:04
  SPEAKER_01: And so um a lot of times this is where companies stumble because they think, oh, I own 100% of it.
• 15:10
  SPEAKER_01: So I'll just de-recognize all these outside basis DTLs and DTAs, and that guidance doesn't apply to me anymore.
• 15:16
  SPEAKER_01: But if you own, if you have a couple different entities in your structure that own a piece of a partnership to get to the 100%, then you have to basically, from the view of each of those partners, say, okay, this subsidiary owns 50% of that partnership.
• 15:30
  SPEAKER_01: I need to record the outside basis difference that they own using the 50%.
• 15:36
  SPEAKER_01: Um, and and then the pieces just get added up in consolidation.
• 15:39
  SPEAKER_01: But this is an area that I think a lot of people try to apply a common sense approach to it, whereas the gap is very form-driven in this situation.
• 15:49
  SPEAKER_03: So basically you're saying from an income tax accounting perspective, you actually recognize the fact that it is held in separate entities, even if they're in one consolidated group.
• 15:58
  SPEAKER_03: Simpli again, simplistically.
• 16:00
  SPEAKER_03: Yep, that's right.
• 16:01
  SPEAKER_03: All right, that's helpful.
• 16:02
  SPEAKER_02: And I guess just staying with that, you know, when we're talking about complexities and going back to what I just talked about with moving from an investee to a subsidiary and how that might change your deferred taxes.
• 16:14
  SPEAKER_02: You know, there are also complexities when you think about that through a partnership lens.
• 16:18
  SPEAKER_02: Everything I talked about is clearly applicable to a subsidiary.
• 16:22
  SPEAKER_02: There's a question in a partnership as to how you now look at that.
• 16:26
  SPEAKER_02: If, for example, Cassie has laid out you could have all of these tiers, if you will, you could have different ownership percentages in different pieces of the structure where you could still have, still have a partnership from a you know a legal perspective in tax.
• 16:41
  SPEAKER_02: And so now the question becomes how do I figure out how much do I record, if you will, on my outside basis in the partnership?
• 16:49
  SPEAKER_02: And that could be dependent upon something we call as to whether you have a look-through policy.
• 16:55
  SPEAKER_02: So it brings in yet another complexity.
• 16:58
  SPEAKER_03: And okay, that's another term.
• 17:01
  SPEAKER_03: So what is a look-through policy?
• 17:03
  SPEAKER_02: Yeah, so look-through policies, uh, you know, in its simplistic sense, what I'd say is you're looking into a partnership and you're looking at what is driving that outside basis difference.
• 17:14
  SPEAKER_02: Now, note what we've already said.
• 17:16
  SPEAKER_02: In a partnership, you're recording an outside basis.
• 17:20
  SPEAKER_02: There's just a single layer of tax.
• 17:22
  SPEAKER_02: Um, so it the partnership itself is generally not a taxable entity.
• 17:26
  SPEAKER_02: But you might have a partnership that has, for example, non-deductible non-deductible goodwill in it, or maybe the partnership itself has subsidiaries that it's asserting outside basis difference, like an APB23 assertion.
• 17:39
  SPEAKER_02: So a look through policy basically says I'm gonna look at the outside basis in the partnership just as I'm expected to do a single outside basis, but I am going to look through the partnership to see if there is a an exception under US GAAP that the partnership is applying.
• 17:58
  SPEAKER_02: And I'm gonna reflect that when I think about my outside basis.
• 18:01
  SPEAKER_02: So, what does that mean?
• 18:02
  SPEAKER_02: If I look into the partnership and I see non-deductible goodwill, then what I'd say is the portion of my outside basis difference that's driven by that non-deductible goodwill, just like I would not have recorded deferred taxes on that, I won't record deferred taxes here on the outside basis to the extent it's driven by that.
• 18:21
  SPEAKER_02: Now, this look through policy, you know, it's a policy choice, you need to consistently apply it.
• 18:26
  SPEAKER_02: So it's not like you do it for non-deductible goodwill, but if another exception applies, you ignore those.
• 18:31
  SPEAKER_02: You need to do it consistently for all of it.
• 18:33
  SPEAKER_02: So as Cassie just said, and when you were asking about these other nuances, it's just yet another layer that you need to think about when you have these partnerships in the middle of these, these interests.
• 18:43
  SPEAKER_03: So I'm sure there's more to this, but before we go on, let me ask a follow-up.
• 18:46
  SPEAKER_03: So do well, maybe two follow-ups.
• 18:49
  SPEAKER_03: One is do we typically see companies adopting this look through policy or why or wait, why not would you want to have that policy?
• 18:58
  SPEAKER_02: I would say there's probab it's probably a complete mixture.
• 19:01
  SPEAKER_02: It's it's diverse.
• 19:03
  SPEAKER_02: And why?
• 19:04
  SPEAKER_02: It comes to a lot of things.
• 19:05
  SPEAKER_02: So, you know, one, you might not have even realized that you had adopted a policy that, you know, there's probably a lot of areas and gaps where that happens.
• 19:13
  SPEAKER_02: Right.
• 19:13
  SPEAKER_02: Yes.
• 19:13
  SPEAKER_02: You find yourself in that spot.
• 19:15
  SPEAKER_02: You know, other reasons are the reality is when you're looking through the partnership, um, some might argue that is more complex, right?
• 19:24
  SPEAKER_02: So you need to now be tracking because you have already got to track your outside basis.
• 19:28
  SPEAKER_02: So you need to know your total temporary difference.
• 19:31
  SPEAKER_02: But now you've got to also track what's going on inside to make sure that you're you're dealing with the right amounts, right?
• 19:37
  SPEAKER_02: If you're making the election.
• 19:38
  SPEAKER_02: So in some cases you might say it's more simplistic to just stick with the single outside basis and move on.
• 19:44
  SPEAKER_02: But on the other hand, um, and particularly when you have, I would say, particularly when you have non-deductible goodwill or you have um an APB 23 certion where the partnership has a foreign subsidiary, you know, the reality is you could be booking deferred, if you don't look through, you could be booking deferred tax liabilities that will sit there for, you know, a very, very long time.
• 20:04
  SPEAKER_02: When you compare that to your corporate peer, you know, you wouldn't have recorded those.
• 20:08
  SPEAKER_02: So some just look at that and say it makes more sense to not reflect that deferred tax liability and say that I have this, you know, almost imminent liability when in fact I I don't.
• 20:17
  SPEAKER_02: So I there's no one answer and there's no there's no one reason.
• 20:21
  SPEAKER_02: I think it truly is a policy election that you see companies making for their own um, their own drivers, if you will, depending upon how they look at this through their lens.
• 20:32
  SPEAKER_02: And again, you know, you might have done it through a prior acquisition or something like that.
• 20:36
  SPEAKER_01: I was just gonna say, and sometimes when I get the question that you asked, Heather, um, I will say to companies, well, what's your plans for that partnership if you haven't picked one already, if you haven't picked a policy?
• 20:48
  SPEAKER_01: Because if you have right now multiple partners within your structure that own that, but within like a year or two, you're planning on collapsing it and just making it a direct ownership and getting rid of the partnership, then the reality is like if you apply look through in that situation, you'll have less changes to your deferred taxes to worry about when you actually collapse the partnership than you would if you, you know, don't apply look through today and start recording deferred on basis differences that you're gonna have to unwind when you collapse the partnership.
• 21:19
  SPEAKER_03: So very helpful perspective.
• 21:20
  SPEAKER_03: So one more quick question on that, which is you said, Jen, you can't pick and choose.
• 21:25
  SPEAKER_03: So, like if you did this because of non-deductible goodwill, you can't do something different with a a different type of item.
• 21:33
  SPEAKER_03: However, can you have different policies for different uh partnerships?
• 21:39
  SPEAKER_02: It's a great question.
• 21:40
  SPEAKER_02: I mean, I think in general, um, we would say no, and that similar to any other policies, it should be consistent across the company.
• 21:46
  SPEAKER_02: Uh, but that is a question that comes up.
• 21:48
  SPEAKER_02: And it can get particularly tricky if, you know, like maybe you had a partnership 10 years ago, but who knows what you were doing.
• 21:56
  SPEAKER_02: Right.
• 21:57
  SPEAKER_02: So so I think similar to other policy comments.
• 22:00
  SPEAKER_02: Um, you know, probably similar practical questions can come up when you're thinking about that.
• 22:05
  SPEAKER_03: All right, that's helpful.
• 22:06
  SPEAKER_03: So then let me ask another follow-up question.
• 22:07
  SPEAKER_03: So, what if a company did record inside basis differences instead, would that matter?
• 22:14
  SPEAKER_03: So, would the net inside basis DTA DTL be the same as the total outside basis DTA DTL?
• 22:21
  SPEAKER_03: And maybe before you answer, you should remind our listeners of the difference between inside basis and outside basis, at least at a high level.
• 22:28
  SPEAKER_01: Yeah, so inside basis differences, you're looking at like the assets and liabilities in the partnership in this in this example that we're talking about.
• 22:36
  SPEAKER_01: So it's, you know, accounts receivable and it's inventory and it's intangibles.
• 22:41
  SPEAKER_01: Like you would, you know, if you were recording a deferred tax asset or liability on each of those line items, those are inside basis differences.
• 22:48
  SPEAKER_01: Outside basis is the investment in the partner capital or the stock of a corporation.
• 22:54
  SPEAKER_01: So it's it's it's looking at the entity as a whole rather than the components that are within the entity you're investing in.
• 22:59
  SPEAKER_02: And maybe Cassie, I'll just just take that one step further.
• 23:03
  SPEAKER_02: If you think about it, in a corporation, there are two levels of tax.
• 23:08
  SPEAKER_02: There's tax inside the box.
• 23:09
  SPEAKER_02: So let's imagine you're looking at a subsidiary in France, right?
• 23:13
  SPEAKER_02: France is going to tax the operations of what's inside that corporation.
• 23:18
  SPEAKER_02: But there's a second layer of tax when it's owned by somebody else.
• 23:21
  SPEAKER_02: Let's imagine it's owned by the US.
• 23:23
  SPEAKER_02: So that outside basis part represents the second layer of tax that, in my example, you know, the US would have.
• 23:31
  SPEAKER_02: In a partnership, because a partnership is typically not taxable, you just have a single layer of tax.
• 23:38
  SPEAKER_02: So that is the outside basis.
• 23:39
  SPEAKER_02: So I don't know if that helps a little bit as well, kind of pulling those examples together.
• 23:44
  SPEAKER_01: Yeah.
• 23:44
  SPEAKER_01: So then getting back to your to your question, Heather, about does it matter?
• 23:48
  SPEAKER_01: So it does matter.
• 23:51
  SPEAKER_01: Um, and there are a number of different types of things that can cause transactions between the inside basis and the outside basis amounts in a partnership.
• 24:00
  SPEAKER_01: So that can range from contributions to and distributions from the partnership, um, how transactions related to acquiring or disposing partnership interests can be structured, as well as a number of other elections that an entity could make in the partnership that could impact the outside basis, but not the inside basis.
• 24:21
  SPEAKER_01: So while, you know, certain fact patterns, it's possible that the overall inside net inside basis differences and the outside basis difference might not vary significantly.
• 24:32
  SPEAKER_01: Oftentimes there are inside versus outside basis differences that continue to change over the life of that partnership.
• 24:40
  SPEAKER_01: Um so it's important to track the outside basis if that's what Gap is telling you you should do.
• 24:45
  SPEAKER_02: Importantly, under the tax law, there are there are a number of elections, particularly in connection with a partnership.
• 24:52
  SPEAKER_02: There are a number of elections that you can make where you may have received a step up in your interest in the partnership.
• 25:02
  SPEAKER_02: But that is just a step up in the outside basis.
• 25:06
  SPEAKER_02: So it doesn't translate, frankly, no different than when we think about a business combination where you're getting a step up for tax for sorry, book purposes, but if you're acquiring stock, you're not getting a step up for tax.
• 25:17
  SPEAKER_02: So it's similar here.
• 25:18
  SPEAKER_02: And so that that election that you can make if you have a step up in the outside basis, now if you're just trying to attract just your inside basis, you right out of the gate have missed a piece of your outside basis difference.
• 25:31
  SPEAKER_02: So you'll immediately disconnect.
• 25:33
  SPEAKER_02: So I just I I couldn't agree more with what Cassie just walked through.
• 25:36
  SPEAKER_02: It's it's very important.
• 25:38
  SPEAKER_03: All right.
• 25:38
  SPEAKER_03: This is definitely a good reminder, and I think very helpful context.
• 25:42
  SPEAKER_03: So, Jen, obviously there's a lot we've already talked about here, but any other common questions we get or other areas where you see people getting tripped up with this accounting?
• 25:53
  SPEAKER_02: Yeah, I think just worth mentioning maybe two.
• 25:56
  SPEAKER_02: One is uncertain tax positions, uncertain tax positions.
• 26:00
  SPEAKER_02: So just important to keep in mind that again, when you're thinking about this, let's say you have a partnership, you could have, you know, you have a corporate owner and they're assessing their UTPs on their business just naturally and regularly as part of their financial accounting.
• 26:16
  SPEAKER_02: But keep in mind there could be uncertain tax positions that have occurred in the partnership that are really flowing up to that corporate entity.
• 26:24
  SPEAKER_02: So you also have to be thinking about whether you have any UTPs in connection with that interest.
• 26:28
  SPEAKER_02: The other thing is interim.
• 26:30
  SPEAKER_02: And here um I just I think it's just worth noticing or noting that when you are recording your interim provision, um, you know, it's it's typically appropriate to record your investor's equity net of um net of tax, essentially.
• 26:47
  SPEAKER_02: It's just normal.
• 26:49
  SPEAKER_02: Um, but you could have investor level of taxes for all of the reasons we've just talked about here.
• 26:55
  SPEAKER_02: And so in that, um, we basically have seen any incremental tax like that, it could be appropriate to exclude that incremental tax from your normal or your overall ETR.
• 27:07
  SPEAKER_02: And then what you would do is just calculate a separate ETR for that that's based really on your equity investee.
• 27:13
  SPEAKER_02: It's just based on your operation that.
• 27:15
  SPEAKER_02: Um, but we are somewhere some diversity.
• 27:17
  SPEAKER_02: So just important to think about how you're treating those investor level taxes in your interim calculation.
• 27:24
  SPEAKER_03: All right, that's helpful.
• 27:26
  SPEAKER_03: Let me rewind though to the comment on uncertain tax positions.
• 27:29
  SPEAKER_03: So inherently, if this partnership is well, let's assume it's a case where you are not owning all the parts of this partnership through different entities, but there's actually third-party owners as well.
• 27:40
  SPEAKER_03: Do you typically see then that these owners would be sort of aligning their thoughts on uncertain tax positions?
• 27:50
  SPEAKER_03: Or obviously they have to make an independent assessment.
• 27:53
  SPEAKER_03: And so you could wind up with a different point of view.
• 27:57
  SPEAKER_03: Just curious if there's interaction there typically, or it really depends.
• 28:01
  SPEAKER_02: I well, so I'd answer that maybe in a few ways.
• 28:03
  SPEAKER_02: One, it's probably hard to know.
• 28:05
  SPEAKER_02: Fair point.
• 28:06
  SPEAKER_02: Right.
• 28:06
  SPEAKER_02: In that fact pattern, they're independent parties.
• 28:09
  SPEAKER_02: So they're not likely talking about how they're handling their own businesses.
• 28:13
  SPEAKER_02: Now, that said, you you will have reporting from the partnership that will equally go to all partners.
• 28:21
  SPEAKER_02: And the reporting that will go up, a K1, it will it will reflect the operations of the partnership and it will reflect credits that might belong to the partners.
• 28:33
  SPEAKER_02: Um it could reflect a number of different things in sort of a section where it provides other information about the operations of the partnership.
• 28:40
  SPEAKER_02: So the information will flow up to the partners the same, um, just under a normal agreement, and then uh at normal reporting, and then you'll make your independent decision as to how you account for that.
• 28:53
  SPEAKER_03: That makes sense.
• 28:54
  SPEAKER_03: And your point that they're probably not talking to each other about this also makes sense.
• 28:58
  SPEAKER_03: I didn't really consider it that way.
• 29:00
  SPEAKER_03: It was more thinking, oh, it's this big issue with the partnership.
• 29:02
  SPEAKER_03: Right.
• 29:03
  SPEAKER_03: Of of course we're talking to each other, but you may or may not be.
• 29:06
  SPEAKER_03: Exactly, exactly.
• 29:08
  SPEAKER_03: So all right.
• 29:09
  SPEAKER_03: So then uh Jen Cassie, this is obviously very helpful.
• 29:14
  SPEAKER_03: And I know an area uh just from listening to you, that this can can get very tricky.
• 29:20
  SPEAKER_03: And I always like to ask a question at the end of any final advice that you would give to our listeners if they are dealing with or if they have equity method investees, and then obviously have to think about their taxes.
• 29:32
  SPEAKER_03: So maybe Cassie'd go to you first.
• 29:34
  SPEAKER_01: Yeah, sure.
• 29:35
  SPEAKER_01: So one thing I always encourage people to do is track the book basis, which sounds simple, um, but in a lot of cases it gets complicated quickly.
• 29:45
  SPEAKER_01: And the tax basis is often, when you're thinking about equity method investment, the that outside tax basis is usually easier to track than the book basis is, in particular, in situations like we were talking about, where in those situations where a company owns 100% of a partnership through multiple entities, they're just consolidating that partnership.
• 30:09
  SPEAKER_01: And so a lot of times they just stop tracking the book basis at the each individual entity level.
• 30:15
  SPEAKER_01: And that is where things get complicated because you can't do correct deferred tax accounting if you don't know what the book basis is at each level of the uh partnership.
• 30:24
  SPEAKER_03: So yes, although I think it's a great reminder, although it is also a little scary that you have to remind people that it's important to kind of do that basic blocking and tackling.
• 30:33
  SPEAKER_03: So how about Jen from your perspective?
• 30:36
  SPEAKER_02: I think I'd just double down on that, to be honest, because I think it is what we see and being a challenge.
• 30:41
  SPEAKER_02: And maybe I can add to that, you know, you're talking about how to account for an equity method investment.
• 30:47
  SPEAKER_02: So for any tax listeners, it's important to make sure you understand the book accounting and understand how that all comes together.
• 30:54
  SPEAKER_02: And as you mentioned, I think earlier, equity method accounting is challenging.
• 30:58
  SPEAKER_02: So, you know, maybe I would just add that you really have to make sure you understand all sides and you're talking about it on a cross-functional basis.
• 31:06
  SPEAKER_03: All right.
• 31:06
  SPEAKER_03: Well, definitely good reminders and great topics.
• 31:09
  SPEAKER_03: So thank you so much for uh joining me today.
• 31:12
  SPEAKER_03: Thanks for having us.
• 31:14
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• 31:16
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• 31:19
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• 31:36
  SPEAKER_03: From Thought Leadership at PwC, I'm Heather Horn.
• 31:40
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