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Tax toolkit: Separate company financial statements · 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 tuning in to our Toolkit series where we're taking a deep dive each month into a single topic, recapping the basics, but also focusing in on frequently asked questions and judgmental areas.
• 0:24
  SPEAKER_02: May is all about income taxes.
• 0:27
  SPEAKER_02: For many preparers, separate company financial statements are surprisingly challenging tasks to create.
• 0:34
  SPEAKER_02: And those challenges are nowhere more evident than in the tax provision.
• 0:38
  SPEAKER_03: You really can't start too early if you need to be doing this.
• 0:41
  SPEAKER_01: You don't want to underestimate the complexities that can arise when preparing separate company financial statements.
• 0:47
  SPEAKER_01: It's very important for the tax and accounting folks to make sure they communicate early and often with each other.
• 0:54
  SPEAKER_02: Jen Spang's with me once again today, and she's joined by Matt McCann, PWC National Office Partner.
• 1:00
  SPEAKER_02: Matt and Jen are going to take us through some of the big items to look out for as you prepare the tax provision within your separate company disclosures.
• 1:09
  SPEAKER_02: There's a lot to cover.
• 1:11
  SPEAKER_02: So let's get started.
• 1:14
  SPEAKER_02: Jen, Matt, thanks so much for joining me today to talk about a topic that's definitely one I spent a lot of time on when I was still back in the practice as an audit partner.
• 1:25
  SPEAKER_02: And so interested in learning all the hints and tricks related to separate company financial statements.
• 1:31
  SPEAKER_02: So thanks for joining me today.
• 1:33
  SPEAKER_02: Happy to be here.
• 1:34
  SPEAKER_01: Happy to be here.
• 1:35
  SPEAKER_02: All right.
• 1:36
  SPEAKER_02: So, Matt, let's just to kind of level set and start things off.
• 1:40
  SPEAKER_02: Obviously, companies are preparing separate financial statements for a lot of reasons, including spin-offs, sale of the sub.
• 1:46
  SPEAKER_02: I know mine were all because they had like debt financing requirements that they had to do or filing with the regulatory body.
• 1:54
  SPEAKER_02: So what like big picture if we step back and look at ASC 740, what does that say about how you account for income taxes in these separate financial statements?
• 2:04
  SPEAKER_01: Yeah, Heather, to start out, I would I would point out that ASC 740 doesn't provide a lot of detailed guidance in this in this area, but it does require that the consolidated amount of current and deferred tax expense for a group that files a consolidated tax return, it does does require that the expense get allocated among the group members when those members issue separate financial statements.
• 2:31
  SPEAKER_02: And then I know this is where some of the I'll call it trickiness can come in, that there sometimes can be members of a group that are tax transparent, like a single member LLC or a partnership.
• 2:42
  SPEAKER_02: How do they fit in from this allocation?
• 2:46
  SPEAKER_01: Yeah, historically there had been some questions around whether or not the allocation of the tax provision was required for a single member LLC.
• 2:55
  SPEAKER_01: So as a as a refresher, the U.S.
• 2:57
  SPEAKER_01: federal tax law provides an election for single member LLCs to be taxed either as associations, which is similar to a corporation, or as disregarded entities, which means that for U.S.
• 3:10
  SPEAKER_01: federal purposes, the single member LLCs are accounted for as divisions of the member and therefore don't file separate tax returns.
• 3:19
  SPEAKER_01: So there is there is an ASU that came out several years ago.
• 3:24
  SPEAKER_01: ASU 2019-12 specifies that an entity that's not subject to tax and is disregarded by the taxing authority, such as single member LLCs, and they're they're not required to allocate income taxes within its separate financial statements, but those entities may elect to do so.
• 3:43
  SPEAKER_01: So that that election can be made on an entity-by-entity basis and it it should be disclosed.
• 3:49
  SPEAKER_01: So this is considered an accounting policy that should be applied consistently from period to period.
• 3:55
  SPEAKER_02: So Matt, before we go on, let me ask a question because I just want to clarify here.
• 3:59
  SPEAKER_02: So you said it can be made on an entity-by-entity basis.
• 4:02
  SPEAKER_02: So just to be clear, if I have a few of these, some I could decide to allocate tax to, and others I don't have to.
• 4:10
  SPEAKER_01: That's exactly right.
• 4:11
  SPEAKER_02: Okay.
• 4:12
  SPEAKER_02: Just wanted to be sure because a lot of times, you know, when we have more than one, we say they all have to be the same.
• 4:16
  SPEAKER_02: So I just wanted to make that point.
• 4:17
  SPEAKER_01: Assuming you have multiple single member LLCs, right?
• 4:20
  SPEAKER_01: But that's that's different than say if you have a partnership that you also asked about, where earnings flow up to multiple owners and the partnership's not taxable.
• 4:30
  SPEAKER_01: So generally you're not going to allocate a provision to a partnership that prepares separate financial statements.
• 4:37
  SPEAKER_02: Okay, so then that's helpful.
• 4:39
  SPEAKER_02: And I may come back with a few questions on that.
• 4:41
  SPEAKER_02: But Jen, in the meantime, now that we are talking about the members that do prepare the separate company financial statements, what's the basis for how you allocate the consolidated provision?
• 4:54
  SPEAKER_03: Yeah, so as Matt mentioned, there isn't a significant significant amount of guidance in this area.
• 5:00
  SPEAKER_03: And in fact, the standard doesn't actually provide for a single allocation method, but it does provide that your method needs to be consistent with the broad principles of ASC 740.
• 5:12
  SPEAKER_03: It needs to be systematic and rational and consistent with the broad principles.
• 5:17
  SPEAKER_03: And so one thing the standard does do is it mentions some things that would not be systematic, rational, and consistent with the broad principles.
• 5:26
  SPEAKER_03: So it says that if you allocated only current taxes when there actually are temporary differences at that subsidiary level, so you you basically allocated current but not deferred, that would not be consistent.
• 5:41
  SPEAKER_03: If you allocated deferred taxes on something that was pretty different than a normal asset and liability approach, so think about like a balance sheet approach, which is what 740 is, that would not be consistent with the broad principles.
• 5:56
  SPEAKER_03: And a big one is if you allocated nothing to a sub that, let's say was taxable just because the consolidated group, so the consolidated return, had no tax liability.
• 6:10
  SPEAKER_03: So basically the consolidation was zero, so you just ignored and didn't allocate anything to the sub that is also not consistent with the broad principle.
• 6:19
  SPEAKER_03: So they provide a bit about what it is not, but no specific method on what it is.
• 6:26
  SPEAKER_02: All right.
• 6:27
  SPEAKER_02: So then if there is no specific method and we know what we cannot do, people still have to do something.
• 6:32
  SPEAKER_02: So what are the approaches that companies take?
• 6:35
  SPEAKER_03: Yeah, so the common, the most common by far is called separate company.
• 6:40
  SPEAKER_03: Um so this is something where you look at that separate entity as if it were actually filing its own return and filing that with the government.
• 6:52
  SPEAKER_03: So you're going to calculate its current and deferred taxes as if it was a standalone entity.
• 6:57
  SPEAKER_03: So, you know, think about that example I just gave where you have a sub that's taxable and the group is not, um, this would you'd end up showing a tax liability at that subsidiary level, despite the fact that the consolidated group is zero.
• 7:13
  SPEAKER_03: So, you know, as a result, separate company, what we'll often often say is the sum of the parts don't necessarily equal the whole for you know that exact reason.
• 7:23
  SPEAKER_02: Okay, so then can you give an example?
• 7:26
  SPEAKER_03: Yeah, so that one I just gave is a little bit of one.
• 7:29
  SPEAKER_03: Um, one that comes up where people uh get focused is a valuation allowance.
• 7:35
  SPEAKER_03: So you could be in a situation where the subsidiary has a loss for which it on its own cannot recognize a benefit.
• 7:44
  SPEAKER_03: And so let's say on a pure separate company, you would have a valuation allowance on that deferred tax asset.
• 7:50
  SPEAKER_03: But if you look in consolidation, maybe that sub has lost money, but the rest of the group has made money.
• 7:57
  SPEAKER_03: So in fact, there might not even be any deferred tax assets, um, much less a valuation allowance.
• 8:02
  SPEAKER_03: So that's an example of where the sum of the parts wouldn't equal the whole because you've got this asset with a VA, but meanwhile, you know, you don't even have an asset somewhere else.
• 8:11
  unknown: Yeah.
• 8:12
  SPEAKER_03: In consolidation, I should say.
• 8:13
  SPEAKER_02: That's like that, you know, the books of the world don't need to balance, but I think this gets a little frustrating sometimes when you you have to make these exceptions.
• 8:22
  SPEAKER_02: But it it also makes sense from a standalone company basis.
• 8:25
  SPEAKER_03: Yeah, and and it can get a lot more complicated, just like uh if I think about it from like a US lens, it can get a lot more complicated when you have some of these tax provisions that look um not even on like a separate entity basis, but sort of how they look at the tax is just based on the blend.
• 8:46
  SPEAKER_03: So frankly, you can come up with foreign tax credits, or we've talked in the past about guilty, the global intangible low tax income.
• 8:53
  SPEAKER_03: Um, beat is another one that's a base erosion tax.
• 8:56
  SPEAKER_03: So all of those do almost like um, almost call it like a super aggregation.
• 9:02
  SPEAKER_03: So, like on a separate company basis, you might not have guilty or you might not have beat, but in consolidation, the group has it.
• 9:10
  SPEAKER_03: So you get into these questions about well, if you contributed to that, like should you allocate something there, even if on a pure separate company you don't get there?
• 9:21
  SPEAKER_03: So there are clearly some judgments that need to be made when you look at some of the different provisions that are out there from a tax perspective as well.
• 9:29
  SPEAKER_03: So definitely it can get complicated.
• 9:32
  SPEAKER_02: And when we think about some of those judgments, is this, you know, you have to have a reasonable basis, be consistent from period to period?
• 9:39
  SPEAKER_02: Is there more to it?
• 9:40
  SPEAKER_02: And I know, I mean, we're not going to get into all those specifics, but big pictures, you're thinking that through, are those sort of the general concepts that you would be thinking about?
• 9:49
  SPEAKER_03: Yeah, I mean, like on the ones that I just talked about, I would definitely expect that a company would figure out how they were going to treat those kind of blended items and then be consistent across them and across entities, unlike what we just talked through as a result of that ASU that lets you make a special election for every single single member of LLC.
• 10:09
  SPEAKER_03: That is a bit unique compared to what we're used to.
• 10:12
  SPEAKER_03: But I I would expect a company was was pretty consistent.
• 10:15
  SPEAKER_03: And particularly if you mentioned like regulatory and the like.
• 10:19
  SPEAKER_03: Like if you're doing financial statements year after year, no more than you'd expect somebody to be changing a policy every year.
• 10:25
  SPEAKER_03: Would you expect these methodologies to be changing every year?
• 10:28
  SPEAKER_02: That's super helpful.
• 10:29
  SPEAKER_02: And then, Jen, the other thing I think is interesting here is that I know in our guide we actually say that this method, separate company method, the SEC actually views as preferable.
• 10:39
  SPEAKER_03: That's right.
• 10:40
  SPEAKER_03: So for them, separate company is preferable.
• 10:44
  SPEAKER_03: You know, I think there are some other methods, and maybe Matt can hit on some of those, but there are some other methods that we use that are just modifications of separate company.
• 10:53
  SPEAKER_03: But the SEC had provided guidance that separate company was the preferred method in connection like with car belts and things like that.
• 11:02
  SPEAKER_03: So to the extent you are filing with the SEC, if you're not going to do separate company, you have to do some special disclosures and the like around like proformas and things like that.
• 11:13
  SPEAKER_01: Yeah, we've we've seen uh since since there are multiple acceptable methods, you know, not just the separate return.
• 11:19
  SPEAKER_01: We have we have seen the SEC require companies to provide a historical pro forma income statement reflecting the provision calculated on a separate return basis.
• 11:30
  SPEAKER_02: Oh, so even if they didn't follow it, they actually still had to tie back to that, basically.
• 11:36
  SPEAKER_01: That's right.
• 11:36
  SPEAKER_01: The SEC still still required it in certain cases.
• 11:40
  SPEAKER_02: Yeah, I have to say from like almost like a logic point of view, notwithstanding the fact it doesn't all balance, it is at least have like an element of I don't want to say simplicity, but like I said, logic to it that okay, I'm doing this entity by itself, what would it look like from a tax point of view?
• 11:58
  SPEAKER_02: That at least gives you some pretty good guardrails to follow.
• 12:02
  SPEAKER_03: I think that's fair.
• 12:03
  SPEAKER_03: And and it is the point, you you gotta ask yourself why are you providing those financial statements?
• 12:07
  SPEAKER_03: You're you're providing it to explain the provision for that entity, regardless of the fact that it's a part of a bigger group.
• 12:13
  SPEAKER_02: Right, right.
• 12:14
  SPEAKER_02: So then, Matt, I know um Jen just mentioned that there's sometimes modifications that you can do to the separate return method that's are commonly used.
• 12:24
  SPEAKER_02: So can you share any of those?
• 12:27
  SPEAKER_01: Yeah, sure, Heather.
• 12:28
  SPEAKER_01: So uh so one acceptable modification of the separate return method, it's commonly referred to as the benefits for loss approach.
• 12:36
  SPEAKER_01: So I'll I'll hit a couple points related to that.
• 12:39
  SPEAKER_01: But it's it's key to remember we're still talking about the separate return method of allocation.
• 12:44
  SPEAKER_01: So the only thing that the benefit for loss approach does, it modifies the separate return method, but only for purposes of evaluating realizability.
• 12:53
  SPEAKER_01: So essentially for consideration of whether evaluation allowance is needed or not on the on the separate company's deferred tax assets.
• 13:02
  SPEAKER_01: So this approach modifies the separate return method so that current or deferred tax assets, I would include net operating losses or NOLs, that they're they're going to be characterized as realized or realizable by the subsidiary when those tax assets are realized or realizable by the consolidated group.
• 13:21
  SPEAKER_01: And that's even if the sub would not otherwise have realized the attributes on a on a standalone basis.
• 13:28
  SPEAKER_01: If we go back to that example that Jen just gave you of the subsidiary having losses and generating an NOL carry forward.
• 13:35
  SPEAKER_01: So if the company's utilizing the benefits for loss method, even though the subsidiary is in a loss position, may not be able to use that NOL.
• 13:44
  SPEAKER_01: If the parent is able to use the NOL, then the subsidiary would go ahead and recognize the benefit in its separate financial statements.
• 13:51
  SPEAKER_02: So, Matt, to be clear here though, it is the subsidiary's NOL that you're talking about.
• 13:56
  SPEAKER_02: It's not like the parent is saying, oh, I've got some NOLs from another subsidiary, I'm gonna quote, let this sub use.
• 14:03
  SPEAKER_02: It's in the case of this subsidiary has an NOL, the parent can utilize it.
• 14:08
  SPEAKER_02: We take that into account when preparing the tax provision for this entity.
• 14:12
  SPEAKER_01: But that's right.
• 14:13
  SPEAKER_01: If a company's policy is the benefits for loss method, then you're looking at the whether the consolidated entity can use that sub's NOL to determine whether the subsidiary needs to book evaluation allowance or not.
• 14:26
  SPEAKER_02: All right.
• 14:27
  SPEAKER_02: And then are you saying that you also then would not reflect the deferred tax asset related to that NOL?
• 14:34
  SPEAKER_01: So gaps not very clear on this point.
• 14:37
  SPEAKER_01: So I would say it depends on your on your policy, since there may be more than one acceptable approach to derecognizing tax attributes.
• 14:46
  SPEAKER_01: So you gotta couple different different options from a policy standpoint.
• 14:50
  SPEAKER_01: You could derecognize either when it's used by the parent or when it's settled with the parent, or when the attributes are used or would have been used by the subsidiary on a standalone basis.
• 15:02
  SPEAKER_01: But I do want to make it clear that these derecognition approaches, that's only applicable to attributes like NOLs, not other temporary differences.
• 15:11
  SPEAKER_01: So when you're looking at derecognition of other deferred tax assets and liabilities, you'd follow the basic principles of ASC 740.
• 15:20
  SPEAKER_02: So, Matt, to go to the last one, when you said when the attributes are used by the sub on a standalone basis, so you're saying if I have the sub that's like operating losses year after year after year after year, they could actually even expire before that sub on its own could use them.
• 15:36
  SPEAKER_02: Uh so that but they would just sit there until either they were used or till that point in time.
• 15:41
  SPEAKER_02: It could be some period.
• 15:42
  SPEAKER_02: Is that right?
• 15:43
  SPEAKER_01: Yeah, that's right.
• 15:44
  SPEAKER_03: So important in like, you know, until it expires.
• 15:48
  SPEAKER_03: So like if it expired, let's say it was a 20-year carry cord, when you when you got to year 20, even though it might have been used in the consolidated group, you know, 15, 20 years ago, when you got to year 20, you'd now derecognize it.
• 16:04
  SPEAKER_03: Um now keep in mind though, if you're doing that on a pure separate company, I don't think that's gonna be as common when it comes to an NOL.
• 16:12
  SPEAKER_03: I think usually companies are gonna derecognize an NOL once it actually gets used by the parent.
• 16:19
  SPEAKER_03: But it truly could.
• 16:20
  SPEAKER_03: But if we go back just for a second, just because I think it's worth just seeing this distinction, if you're on a pure separate company method without benefits for loss, then like that's the only way you'll do it.
• 16:34
  SPEAKER_03: So you factually might not have an NOL, but you absolutely could be showing in a consolidated group, but you absolutely could be showing on a separate company financial statement a deferred tax asset for an NOL that's already been consumed by the group and that it stays there with a valuation allowance on it until it expires.
• 16:55
  SPEAKER_03: Or keep in mind in the US, it's indefinite carry forward now.
• 16:59
  SPEAKER_03: So forever, right?
• 17:01
  SPEAKER_03: So you've got to think about disclosure at that point, but uh you know, it you've got a footnote and all that goes with it.
• 17:07
  SPEAKER_03: But I just I think it's a great point.
• 17:09
  SPEAKER_03: Yeah.
• 17:10
  SPEAKER_03: Yeah, I just I'm a big one on um the benefits for loss is just a modification, like stressing exactly what Matt said.
• 17:19
  SPEAKER_03: It's just a modification with regard to this VA assessment.
• 17:23
  SPEAKER_03: But like these questions of how the deferred roll out and all that are, I think are just so important when you're looking at separate company.
• 17:30
  SPEAKER_02: And I think this example points out why there could be some benefits of the this method, because you don't wind up with almost like these um ghost, you know, uh NOLs that don't really exist, but they're still sitting there on the on the balance sheet is so don't really exist from the point of view of the consolidated group.
• 17:48
  SPEAKER_02: But actually, that leads really to a question I've been wanting to ask all along here, which is then how does tax sharing fit into this?
• 17:55
  SPEAKER_02: Because you did mention settlement, and I kept thinking if I'm that sub, I just gave my NOL to my parent.
• 18:01
  SPEAKER_02: I want the parent to be paying for me.
• 18:03
  SPEAKER_02: So, Matt, how do um like tax sharing agreements or other tax settlement agreements fit into this?
• 18:09
  SPEAKER_01: Yeah, most of the time, settlement between the parent and sub, that is gonna be covered by uh by a tax sharing agreement.
• 18:16
  SPEAKER_01: So that's a legal agreement between the parent of an affiliated group and various subsidiary members of that affiliated group, and the agreement's gonna govern the intercompany settlement of tax obligations among a whole host of other of other things as well.
• 18:31
  SPEAKER_02: And so then if we go back to that benefits for loss conversation, then you would look to this tax sharing agreement to determine how your NOLs are actually settling.
• 18:40
  SPEAKER_01: Yeah, that's right.
• 18:40
  SPEAKER_01: And uh and a lot of the a lot of the time the tax sharing agreement that's gonna mirror the method of allocation under ASC 740.
• 18:48
  SPEAKER_01: But that's not always the case.
• 18:49
  SPEAKER_01: So it's important to remember what we talked about earlier that the the tax provision must reflect an acceptable allocation under 740, regardless of what what might be dictated by the by the TSA.
• 19:02
  SPEAKER_02: So to that point, then if for some reason we had a tax sharing agreement that was something that wouldn't be acceptable under 740, I would have to apply 740, not look to the tax sharing agreement.
• 19:16
  SPEAKER_01: That's exactly right.
• 19:18
  SPEAKER_02: All right, interesting.
• 19:19
  SPEAKER_02: So then if how would we count for differences then between a method of allocation under 740 and the amounts paid or received in a tax sharing agreement?
• 19:30
  SPEAKER_01: Yeah, so if there is a difference, as you as you might expect, that's gonna that's gonna wind up running through equity.
• 19:35
  SPEAKER_01: It's gonna either be treated as a dividend or a capital contribution.
• 19:39
  SPEAKER_01: So let me let me give you an example.
• 19:41
  SPEAKER_01: Let's let's assume that we've got a company that's using the separate return method modified for benefits for loss.
• 19:47
  SPEAKER_01: Let's also assume that the company reflects settlement of taxes with the parent in its separate company balance sheet, meaning that when the parent company pays the subsidiary for its NOL, the deferred tax asset is reduced.
• 20:00
  SPEAKER_01: However, for this, for purposes of this example, let's let's assume that the subsidiary's separate company NOL is$100.
• 20:08
  SPEAKER_01: But according to the tax sharing agreement, the parent's only gonna pay for 50% of that.
• 20:14
  SPEAKER_01: So in this case, while the the benefit of the NOL and the subsidiary's financial statements will be the$100, the settlement of the balance sheet, it's gonna be$50 cash from the parent, and the other$50 will be reflected in equity as a distribution to the parent.
• 20:30
  SPEAKER_02: So then something that struck me there, Matt, is that if I'm the subsidiary, I might be somewhat, if not more so, offended that I'm only getting 50% of this NOL that I generated.
• 20:41
  SPEAKER_02: And so why, what are some of the incentives that companies use as they're thinking through how to set up these tax sharing agreements?
• 20:50
  SPEAKER_03: Well, Heather, maybe I'll jump in here.
• 20:52
  SPEAKER_03: I think um, I think one thing I'd say is probably not about incentives to setting it up.
• 20:57
  SPEAKER_03: So, as a starting point, there may be written tax sharing agreements, um, or there may not be.
• 21:04
  SPEAKER_03: Um, there may still be settlement of these accounts, even if there isn't a written tax sharing agreement.
• 21:10
  SPEAKER_03: So I think you could see everything in between those extremes of you know, no sharing agreement and no allocation or payments to a tax sharing agreement that's very specific.
• 21:23
  SPEAKER_03: But like when you see percentages or maybe more um complicated or I don't know, elaborate sort of allocation, it might actually just be that 50% that they're not as direct saying they're only going to do 50%.
• 21:38
  SPEAKER_03: There might be some pro rata within the consolidated group.
• 21:41
  SPEAKER_03: So maybe this sub had NOLs, but maybe somebody, another sub did too.
• 21:48
  SPEAKER_03: And then maybe had three other subs that were profitable and the parent was profitable.
• 21:53
  SPEAKER_03: So the law actually, under like let's say US tax law, you actually, if those ever left the group, They'd leave with their pro rata version or amount, I shouldn't say version amount of their NOL or attributes.
• 22:08
  SPEAKER_03: So, like the tax sharing might just be in that context.
• 22:11
  SPEAKER_03: So it may not say 50%.
• 22:14
  SPEAKER_03: It just might be you're only getting 50% because your NOL got combined with everybody else's, and there was a pro rata use across.
• 22:21
  SPEAKER_03: So I think it's not so much about an incentive.
• 22:24
  SPEAKER_03: Um, I do think there are some industries that use their tax sharing agreements for flows of cash, though.
• 22:30
  SPEAKER_03: I do think there are certain industries where it's just a cash flow mechanism.
• 22:34
  SPEAKER_03: So in those cases, their tax sharing agreement may be modeling some sort of um business decision around that.
• 22:42
  SPEAKER_03: So, you know, I it's not to say that there's never uh an incentive or a reason, but I just think it could it could vary.
• 22:49
  SPEAKER_02: No, I think that's super helpful.
• 22:50
  SPEAKER_02: And actually, the reason I asked the question is again, if I put my auditor hat on, sometimes if you're auditing this and you really don't understand the substance of why it's set up the way it is, then it's hard to get your head around the what Matt was talking about, how it's settled, how you reverse things off the balance sheet.
• 23:06
  SPEAKER_02: And so I do think just again, if I'm the non-tax accountant or the non-tax auditor, I think having some understanding at least of the substance is helpful, especially as you're thinking about these separate company financial statements.
• 23:21
  SPEAKER_03: Well, and I would just add to that, Heather, that I mean, Matt has already said it, but maybe I'll just um repeat it because I think it's so important.
• 23:30
  SPEAKER_03: You know, regardless of what the tax sharing agreement says, your provision has to represent gap.
• 23:36
  SPEAKER_03: So, like I can't stress that enough.
• 23:38
  SPEAKER_03: I mean, the time Matt and I have had discussions around that disconnect.
• 23:42
  SPEAKER_03: Um, the other thing I just can't help but stress is that when you're thinking about the balance sheet, which is really where tax sharing comes in.
• 23:51
  SPEAKER_03: Tax sharing really comes into how am I going to settle up my balance sheet, my payable, my receivable, what have you, um cannot stress enough that you cannot de-recognize the subs deferred taxes, even when you might have an industry where it's very common for the parent to settle like all deferred.
• 24:13
  SPEAKER_03: So think about like a simple bad debt deferred tax asset or something.
• 24:16
  SPEAKER_03: The sharing agreement might say, I'm gonna settle all deferred, but you do not settle deferreds where the underlying temporary difference still exists at that sublevel.
• 24:29
  SPEAKER_03: So, in other words, where you still have a book basis, let's say I just set it in the receivable, you have to continue to account for those deferreds.
• 24:38
  SPEAKER_03: You're only de-recognizing when you're thinking about things like Matt said, like you're payable, like I owe the parent or a receivable, the parent owes me, or you know, let's say a deferred tax asset for some kind of an attribute that has actually already been consumed or will be consumed by the consolidated group.
• 24:56
  SPEAKER_02: I think that's great, Jen.
• 24:58
  SPEAKER_02: And I think it is definitely really helpful because I again, it's a non-tax accountant, I think it can get confusing very fast.
• 25:04
  SPEAKER_02: Well, why is one thing one way?
• 25:06
  SPEAKER_02: Why is something else another way?
• 25:07
  SPEAKER_02: But you the way you broke it down is like, well, there are actually very clear rules, notwithstanding the fact that there's no rules for stuff for company returns or minimal.
• 25:15
  SPEAKER_02: This, there it is pretty clear, you know, what you can do and can't do.
• 25:19
  SPEAKER_02: So I think that's helpful.
• 25:20
  SPEAKER_02: But Jen, let me ask another, I'll call it more complicated question, and this is back to a topic we talked about earlier, which is how do you think about uncertain tax positions in a separate company return?
• 25:30
  SPEAKER_02: I mean, a separate company provision.
• 25:33
  SPEAKER_03: Yeah, so it's a great one because um what you'll hear me say is no hindsight.
• 25:40
  SPEAKER_03: So when you're allocating, so what we've said, right, is a separate company literally looks at that separate as if it was a separate legal entity filing a tax return with a taxing authority.
• 25:52
  SPEAKER_03: But when you do separate companies, you don't revisit every decision that's been made with record with regard to an uncertain tax position.
• 26:02
  SPEAKER_03: Because at the end of the day, you're allocating a total provision.
• 26:05
  SPEAKER_03: Um, that's not there wouldn't be new information or anything that would cause you to recognize an uncertain tax position differently just because you're showing it on a separate company basis.
• 26:15
  SPEAKER_03: So that's one where um you have to be careful and and ensure that you are you know looking at it through the lens of management's original decisions under both recognition and measurement.
• 26:26
  SPEAKER_02: All right.
• 26:27
  SPEAKER_02: And then how about something like an assertion for the indefinite reinvestment or APB23?
• 26:33
  SPEAKER_03: So I'll say this one I struggle a little bit more with.
• 26:36
  SPEAKER_03: I'll say still no hindsight, and generally speaking, you should be looking at through the lens that management originally made that decision.
• 26:44
  SPEAKER_03: Again, you're allocating a total provision, and there were decisions made about assertions or not assertions, being able to assert or not assert when you know the consolidated financial statements were completed.
• 26:57
  SPEAKER_03: I do say, and so I'd say that that's I think what the general guidance we would say.
• 27:02
  SPEAKER_03: I do think it can get a little trickier in more complicated fact patterns.
• 27:06
  SPEAKER_03: So sometimes judgment might be necessary because you could look at a separate company depending on why the financial statements are being done.
• 27:15
  SPEAKER_03: You could be doing something where the sub on its own has, let's say, foreign subsidiaries and would never have been able to assert.
• 27:23
  SPEAKER_03: So in that case, the consolidated parent is making an assertion, which is probably perfectly appropriate and they have the basis for doing it.
• 27:31
  SPEAKER_03: But you do want to just stop and evaluate whether there's anything that at a minimum should be disclosed, even if you do, just as I said, you've maintained the assertion because you're allocating the consolidated provision, you still might want to put some incremental disclosure or something in.
• 27:46
  SPEAKER_03: So that one, similar to UTP's, clearly is a starting point, but I that one can have some gray zone and maybe a bit more judgment.
• 27:54
  SPEAKER_02: Okay, that's very helpful.
• 27:55
  SPEAKER_02: So let me ask another, I'll call it complication.
• 27:58
  SPEAKER_02: And this is going back to what we said at the beginning is that one of the cases you may need to prepare or utilize separate uh financial statements would be for carve out financial statements.
• 28:09
  SPEAKER_02: And so, Matt, going back to you with this one, what are some of the considerations specific to thinking about a carve out?
• 28:16
  SPEAKER_01: Yeah, carve out uh situation can get uh pretty complicated pretty quick, especially because sometimes the carve-out financial statements may need to be prepared for a division or other part of a business that's not necessarily a separate legal entity, it's just part of a a larger consolidated financial reporting group.
• 28:37
  SPEAKER_01: And it gets even more challenging when the separate financial statements haven't been when no separate financial statements have been prepared in the in the past.
• 28:44
  SPEAKER_01: You're you're putting them together for the for the first time.
• 28:48
  SPEAKER_02: So then what are some of the things, because as we said, it's already complicated enough if you're just you know dealing with separate the separate provision for a subsidiary that's existed.
• 28:58
  SPEAKER_02: So now that we're dealing with, let's say, a division or something else, what are some of the things that we should be thinking about from the the tax perspective?
• 29:06
  SPEAKER_01: Yeah, let me let me hit on uh a couple of points.
• 29:09
  SPEAKER_01: I guess the first one to point out is just remember that the allocation methodology doesn't change, meaning that it has to still be systematic, rational, and consistent with the broad principles of ASC 740, everything Jen was talking about earlier.
• 29:23
  SPEAKER_01: The separate return method, that's still the preferred method for preparing carve-out financial statements, and is similar to what we what we were chatting about earlier.
• 29:32
  SPEAKER_01: It's important to understand kind of the overall purpose and intended use of the of the carve-out financial statements.
• 29:39
  SPEAKER_01: You know, they might be driven by a spin-off or a broader MA transaction.
• 29:45
  SPEAKER_01: Maybe they're needed for regulatory or financing requirements.
• 29:48
  SPEAKER_01: So whatever the whatever the context is, whatever would be most helpful to the users of the financial statements, yeah, that should influence the most appropriate method to use.
• 29:58
  SPEAKER_01: But it's also it's also very important for tax provision preparers to work closely with the rest of the accounting team to fully understand the pre-tax accounts as well as the impact of any adjustments to the historical consolidated accounts in order to reflect the appropriate income tax effects.
• 30:17
  SPEAKER_02: Well, and I think I'll put a pitch in for the tax people because if the accounting people wait and say, we're done, here you go, tax team, and by the way, have to issue these like tomorrow.
• 30:27
  SPEAKER_02: That's that's not exactly a way to work together.
• 30:29
  SPEAKER_01: So that could be a problem, right?
• 30:31
  SPEAKER_02: Yes.
• 30:31
  SPEAKER_02: So definitely I think it goes both ways that the tax team needs to understand what the accountants are doing, but the accountants need to bring the tax team in early into the process.
• 30:41
  SPEAKER_02: Anything else, Matt, that we should think about here?
• 30:44
  SPEAKER_01: Yeah, I mean, along the lines of what we've been talking about, you know, the tax accounting is going to follow the book accounting.
• 30:50
  SPEAKER_01: So the tax provision is gonna be affected by the methodologies that are used for the the revenue or the cost allocations, and that's it's likely gonna differ from what the consolidated entity is using because you you really have to, in a carve out, you've got to reflect all the costs of doing business on a standalone basis.
• 31:10
  SPEAKER_01: So, for example, you know, the carve-out financial statements should reflect an allocation of corporate overhead expenses and the related tax effect.
• 31:19
  SPEAKER_01: Along those same lines, any intercompany transactions that are obviously are gonna be eliminated at the consolidated level.
• 31:26
  SPEAKER_01: They would not be eliminated in the carve-out financial statements.
• 31:29
  SPEAKER_01: You know, those are those are gonna be reflected usually as a related party item along with along with the related tax effect.
• 31:37
  SPEAKER_01: And then the last the last point I'll make when preparing carve-out financial statements, they should consider the effect of changes in the tax payable balance on the statement of cash flows and account for differences between the actual cash flow and the and the tax allocation.
• 31:53
  SPEAKER_01: The timing of when a carve out entity monetizes tax attributes, you know, that that may also change, resulting in adjustments to previously reported cash flows.
• 32:03
  SPEAKER_01: So there's there's a lot of uh lot of different pieces, a lot of complexities that can that can arise when you're when you're putting together the the carve-out financials.
• 32:11
  SPEAKER_02: Yes, definitely a lot.
• 32:12
  SPEAKER_02: Jen, how about from your perspective, anything to add to that?
• 32:16
  SPEAKER_03: I actually would maybe offer out three comments and just because one thing Matt just said triggers a thought for me.
• 32:22
  SPEAKER_03: You know, you mentioned before those ghost NOLs, and um, never is there a time more than in carve outs that you can see that.
• 32:29
  SPEAKER_03: I I this question is probably the most common, so maybe just worth just mentioning.
• 32:33
  SPEAKER_03: And, you know, you clearly could have consolidated group financial statements, or let's say a consolidated US return that has no NOLs, but on a separate company basis, you do.
• 32:44
  SPEAKER_03: And people will sometimes get very concerned with showing that deferred tax asset in the financial statements that they're going, let's say they're doing it for a sale, and they're like, but that NOL isn't gonna go with.
• 32:56
  SPEAKER_03: And that is true, and it doesn't change exactly like Matt just said, it doesn't change that you have to do it under US GAAP.
• 33:04
  SPEAKER_03: But what I tell people in those cases is just do disclosure.
• 33:08
  SPEAKER_03: It's it's standard.
• 33:09
  SPEAKER_03: So just make sure your disclosure is transparent that those NOLs are based upon the methodology consistent with US GAAP.
• 33:16
  SPEAKER_03: Um, but in fact, they won't be going with the buyer.
• 33:19
  SPEAKER_03: So just something Matt just said just triggered those.
• 33:22
  SPEAKER_03: So I threw that out.
• 33:23
  SPEAKER_02: So I think that is an important, really important point because yeah, I think that gives like a level of discomfort.
• 33:29
  SPEAKER_02: Like, wait a minute, this isn't a quote's real asset, but I I think what you described makes a lot of sense.
• 33:35
  SPEAKER_03: Yeah.
• 33:35
  SPEAKER_03: But so then I would just raise two other points.
• 33:38
  SPEAKER_03: Um, I I we never can talk about valuation allowances enough, it would appear.
• 33:44
  SPEAKER_03: Um, but one of them goes back to, in fact, both of my points would go back to hindsight and no hindsight.
• 33:49
  SPEAKER_03: So just a reminder, particularly in carve outs, you do not go back um with your perfect knowledge today and reflect it to history.
• 33:58
  SPEAKER_03: So let's just take an example.
• 34:00
  SPEAKER_03: Let's imagine that you had losses in 2019 and recorded a valuation allowance.
• 34:06
  SPEAKER_03: And maybe you had even had a forecast at the time that looked good, but it wasn't objectively verifiable.
• 34:13
  SPEAKER_03: And the company ended up putting a valuation allowance on that deferred tax asset.
• 34:17
  SPEAKER_03: But now let's say you're in 2021 and the valuation allowance has now been released, and now you're gonna go back and do a carve out for 2019.
• 34:28
  SPEAKER_03: Your initial reaction might be to say, well, look, I know I had a forecast back then that showed I was gonna be profitable, and I know I released the valuation allowance in 2021.
• 34:37
  SPEAKER_03: So maybe I should never put it up in the separate company.
• 34:41
  SPEAKER_03: And so that's a no-fly zone.
• 34:43
  SPEAKER_03: Um, so no hindsight when you are doing the financial statements on a separate company basis.
• 34:49
  SPEAKER_03: You do it based upon the information that was available at that point in time and the waiting at that point in time.
• 34:55
  SPEAKER_03: So that's just another no hindsight.
• 34:58
  SPEAKER_03: And then I just I think my other point would just be going back to like UTPs and outside basis assertion, same thing there as we talked about earlier.
• 35:06
  SPEAKER_03: So no different in a carve out than it is for any other reason that you're preparing separate company financial statements for.
• 35:12
  SPEAKER_02: So it's actually a really good reminder though, Jen, of why contemporaneous documentation is so important.
• 35:18
  SPEAKER_02: Because if you had good documentation back at the time, it's so easy to do this if you're not exactly sure why you know something was, you can't remember when something happened, it makes it a lot more difficult.
• 35:29
  SPEAKER_02: So just a good reminder to have good controls uh in the first place.
• 35:33
  SPEAKER_02: So, Matt, Jen, definitely a very interesting lot to think about for something that on the surface doesn't seem like it'd be that hard, but you get into it definitely a lot.
• 35:42
  SPEAKER_02: So, as you, I know you both talk to a lot of um clients, you talk to a lot of engagement teams.
• 35:47
  SPEAKER_02: What advice would you give for someone who's kind of dealing with this for the first time?
• 35:51
  SPEAKER_02: And Matt, I'll start with you.
• 35:54
  SPEAKER_01: Yeah, I would I would maybe just reiterate some of the points we were just we were just talking about and and uh re-emphasize, you know, that you don't you don't want to underestimate the complexities that can arise when preparing separate company financial statements.
• 36:08
  SPEAKER_01: It's very important for the the tax and accounting folks to make sure they communicate early and often with with each other and fully understand the pre-tax accounts, especially when preparing the carve out financial statements, so that collectively they can assess the appropriate income tax accounting considerations.
• 36:26
  SPEAKER_02: Yeah, I don't think you can give that advice enough.
• 36:28
  SPEAKER_02: And Jen, how about from your perspective?
• 36:30
  SPEAKER_03: Well, I maybe head on something that we didn't talk about, and that's just we've talked a lot about it, almost um inferring we're just talking about on an annual basis.
• 36:40
  SPEAKER_03: But the reality is, like when you're doing carve outs or and frankly, in a lot of these separate companies, you also are dealing with quarters.
• 36:48
  SPEAKER_03: And so in carve outs in particular, we see a lot of people stumble over the quarters because you didn't necessarily have a forecast for that subsidiary to, let's say, do an annual effective tax rate.
• 37:00
  SPEAKER_03: So we've talked about all of these things that are happening in the methodologies, but now imagine doing it on an interim basis and needing to come up with an eight and annual effective tax rate and all that goes with it.
• 37:10
  SPEAKER_03: So um, you know, there's judgment involved.
• 37:14
  SPEAKER_03: You really can't start too early if you need to be doing this.
• 37:17
  SPEAKER_03: And it's definitely good to bring tax in a little earlier in the process than on the tail end.
• 37:22
  SPEAKER_02: All right.
• 37:22
  SPEAKER_02: I think that might be the theme of this of this podcast.
• 37:25
  SPEAKER_02: So definitely great advice.
• 37:27
  SPEAKER_02: Thank you guys so much for all the insight.
• 37:29
  SPEAKER_02: But before I let you go, I do have our stump the gus.
• 37:33
  SPEAKER_02: These ones, I'm I'm not sure easier, but are at least not really focusing on pop culture.
• 37:41
  SPEAKER_02: These are just fun facts about the month of May.
• 37:45
  SPEAKER_02: So you can see how you do here.
• 37:49
  SPEAKER_02: So the first one is what spring flower officially represents the month of May.
• 37:56
  SPEAKER_02: And I'll give you sort of a hint because of the vintage that I smiled when I saw this because the day we're recording this is my grandmother's birthday.
• 38:05
  SPEAKER_02: She passed away some time ago.
• 38:06
  SPEAKER_02: And this was her favorite flower.
• 38:08
  SPEAKER_02: So if you want to get a sense of someone who's born in like 1914, this was her favorite flower that might give you a hint of what flower this would be.
• 38:17
  SPEAKER_03: Are there flowers that didn't exist in in in at that two now?
• 38:22
  SPEAKER_03: Okay, I might embarrass myself very badly because I'm gonna guess tulips, but maybe not.
• 38:28
  SPEAKER_01: Yeah, I I have no idea.
• 38:29
  SPEAKER_01: I'll go with uh daffodils.
• 38:32
  SPEAKER_02: Those are both good guesses, but Lily of the Valley.
• 38:35
  SPEAKER_02: Oh that's that's like sort of like a vintage type of flower, at least a little, not one that came top of mind.
• 38:44
  SPEAKER_02: Um all right, so then this one this depends on how you're how much you're into Cinco de Mayo.
• 38:49
  SPEAKER_02: So Cinco de Mayo celebrates the Mexican victory over which country in 1862?
• 38:56
  SPEAKER_01: 1862.
• 39:00
  SPEAKER_03: Oh, Matt, this is bad because we learned this from from Michelle, and I'm drawing a complete blade.
• 39:07
  SPEAKER_02: Well, remember the US was in the middle of its civil war at the time.
• 39:10
  SPEAKER_02: So definitely the US was preoccupied while this was going on.
• 39:15
  SPEAKER_02: So Britain?
• 39:18
  SPEAKER_02: I don't know.
• 39:19
  SPEAKER_01: France.
• 39:20
  SPEAKER_02: All right, Matt.
• 39:21
  SPEAKER_02: Score one for Matt.
• 39:23
  SPEAKER_02: Good guess.
• 39:24
  SPEAKER_02: Although I think I think if Jen had guessed, or if you had guessed Britain, then Jen would have guessed France.
• 39:31
  SPEAKER_02: So that's like a collective effort.
• 39:33
  SPEAKER_02: So good job, guys.
• 39:34
  SPEAKER_02: Hopefully, we've got a little laugh at the end of a very serious topic.
• 39:38
  SPEAKER_02: Um, but thanks so much for joining me today.
• 39:40
  SPEAKER_02: Thanks for having us.
• 39:41
  SPEAKER_01: You're welcome.
• 39:43
  SPEAKER_02: That's our show for today.
• 39:45
  SPEAKER_02: Join me this Thursday for more coverage of greenhouse gas emissions.
• 39:49
  SPEAKER_02: Last week we looked at scope one and scope two of the GHG protocol.
• 39:54
  SPEAKER_02: And this week we'll be focused in on scope three.
• 39:57
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• 40:00
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• 40:05
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• 40:14
  SPEAKER_02: From Thought Leadership at PWC, I'm Heather Horn.
• 40:18
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• 40:22
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