Video"Sunlight is said to be the best of disinfectants," Supreme Court Justice Louis Brandeis famously said. But that was in 1914, at least a quarter of a century before the invention of sunblock and a growing awareness that too much sunlight can, in fact, be harmful. When "sunlight" is trotted out now as a metaphor to describe the benefits of expanded financial disclosures, companies don't feel cleansed so much as overexposed.
Recently they have felt positively burned. FIN 48, a set of rules that govern how companies must account for uncertain tax positions, went into effect nine months ago. (It applies to fiscal years that start after December 15, 2006.) The rules require companies to include specific information regarding potential federal and state income-tax liabilities when they report their 2007 results. Before FIN 48, information on the size of reserves maintained to satisfy potential tax liabilities was not broken out separately, but safely tucked in with other potential liabilities.
Disclosing such reserves is a boon for analysts, of course, who can never get too much information about the companies they cover. But companies are far more concerned about what another entity may do with the information. "Now everybody in the world — including the Internal Revenue Service — can see what those exposure items are in total," says one vice president of taxation at an S&P 500 company who, like other corporate financial executives contacted for this article, demanded that his name be withheld. "If you're an IRS agent and you see that a company has X number of exposure items," he says, "that really stacks the deck. The IRS can see what amounts you have set up and changes you might have made, and will start asking questions. We used to have some privacy in these matters."
Subparty On?
A strong reaction, perhaps, but not a paranoid one. Indeed, the IRS appears almost eager to start examining the enhanced financial reports that will soon head its way. At a conference in New York last spring, IRS chief counsel Donald Korb said his agents are "not going to turn a blind eye" to the tax-reserve details disclosed under FIN 48. In fact, he used this phrase at least four times during his remarks, confirming corporate tax executives' fears that the IRS will use FIN 48 as a road map to find and challenge tax-reduction strategies.
"For example," says Marian Rosenberg, a tax analyst with Thomson Tax & Accounting, "if a taxpayer shows a contingent tax liability for Subpart F income [which pertains to income from controlled foreign corporations] on its FIN 48 financial disclosure but does not show this item in its tax return, the IRS has instructed its examiners to question that."
As if providing the IRS with a road map to current delicate tax matters weren't enough, the IRS has signaled an interest in departing from its long-standing policy of not reopening tax years that have been examined and closed if information contained in FIN 48 disclosures appears to warrant a reconsideration of past decisions.
"Certain companies may be significantly affected by this new standard," says Neri Bukspan, a managing director and chief accountant at Standard & Poor's. "Companies with highly structured, tax-motivated transactions and complex operational structures, as well as those companies that have taken aggressive positions in their tax filings," are most at risk.
Bukspan ticks off some potential problems, any of which might drag down stock prices or reduce corporate credit ratings: FIN 48 could adversely affect leverage ratios, increase pressure on financial covenants that in some instances may require reworking, diminish shareholders' equity, increase contingent liabilities, and cause greater volatility in year-to-year reported earnings. So far these "side effects" have had no material affect on S&P's ratings of companies, but it's still very early days.
"FIN 48 will create a little bit of 'lumpiness' in reported earnings because of the way the statement works," Bukspan says. "Sometimes the unrecognized tax positions are recognized only upon resolution, which could occur either when the statute of limitations expires or when an audit is completed."
This is because FIN 48 encompasses a number of areas where the ultimate tax liability appears uncertain. These include claiming credits and deductions, excluding certain revenues from taxable income, and treating a merger as a tax-free transaction. Gray areas such as these have tended to elude government auditors for two reasons. First, in any given year they might not conduct an audit. Second, even if an audit is conducted, the IRS or state examiners might not notice the questionable items.
That's changed now. "Companies may no longer factor in the probability of not being audited or that the item will not be discovered in an audit," says Bukspan. "What's more, companies must now accrue interest and penalties based on the applicable tax law for the potential underpayment of taxes related to the FIN 48 liability that's recognized. This is based on the difference between the position taken in the company's tax return and the amounts reported in its financial statements."
Reader Comments» Post a comment