Uncertainty Reigns Over Taxes

Controllers are wary about accounting guidance for uncertain tax positions that was supposed to lessen confusion and varied practices.
Helen ShawNovember 7, 2006

This summer, the Financial Accounting Standards Board issued what it hoped would be clear guidelines for recognizing and measuring uncertainty in income taxes. Instead, a new survey says, the guidance has finance executives feeling, well, uncertain.

Companies, of course, have always been in the awkward position of having to report their tax liability in their public financial statements. But an unlucky run-in with the Internal Revenue Service can change that figure, and some companies have more aggressive — or otherwise “uncertain” — tax positions than others. FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” was prompted by the board’s concern that companies were gauging the financial risk of IRS challenges differently, making their financial statements harder to compare. Issued in July 2006, the interpretation aimed to provide consistent accounting for uncertain income tax positions. Fin 48 is effective for fiscal years beginning after December 15, 2006.

But a survey conducted last month indicates there is still some ambiguity among finance departments about what must be disclosed, says Stephen Rose, a research consultant at the Controllers’ Leadership Roundtable at the Corporate Executive Board, a peer-networking membership organization, which questioned 43 corporate controllers and heads of taxation about the effects of Fin 48.

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“It’s kind of like penguins on an ice shelf,” said Rose, “No one wants to get in the water first and everyone wants to see what will happen,” he said. “They want to disclose as little as necessary while within the guidelines,” explained Rose.

Finance execs expect Fin 48 to result in various consequences to uncertain tax position estimates or reserves. Of the respondents, 30 percent expect the percentage change to be greater than 10 percent; 35 percent expect it will be less than 10 percent; 29 percent anticipate it will be between 0 and 10 percent; and 6 percent expect it to be between -10 percent and zero percent.

There could be various effects of Fin 48 on companies’ net income. Most respondents, 43 percent, predict that their company’s net income will be somewhat more volatile; 35 percent expect about the same volatility; 16 percent were unable to assess the impact on net income; 3 percent expect net income to be much more volatile; and 3 percent expect less volatility.

Companies also are planning different ways to report uncertain tax positions, the survey revealed. “There is a lot of uncertainty and the whole point of the guidance was to make things easier,” commented Rose.

For instance, companies are required to disclose information on uncertain tax positions for which it is “reasonably possible” that the amount of unrecognized tax benefits will change significantly within one year. But survey respondents interpreted that requirement differently. Most (70 percent) said they would consider “reasonably possible” to mean a 20 percent probability. Just under a quarter (22 percent) said it meant a probability of over 30 percent; and a small number (8 percent) said anything more than a 10 percent chance would be considered reasonably possible. Additionally, companies differ on which specific events would lead them to conclude that it is reasonably possible that a tax position could change.

Furthermore, while companies are seeking outside advice on uncertain tax positions, few are receiving the explicit guidance they need. A majority — 57 percent of respondents — reported that their external audit firm has not provided help on how to develop a compliance strategy to deal with Fin 48. Only 3 percent reported receiving explicit guidance, 19 percent reported receiving rough guidance, and 22 percent have received vague guidance. “Companies are telling us the [external auditors] don’t seem to want to stick their neck out on this one,” says Rose.

Yet another reason for hesitancy is the increased disclosure that will be required. (See’s “FASB Hoists Red Flags Higher for Taxman” .) Approximately 68 percent of respondents expect that FIN 48 will increase audits and/or requests for supporting documentation by the Internal Revenue Service and state taxing authorities.