FIN 48: I Can Get It for You Retail

Big inventories and far-flung locations can spell trouble for companies trying to gauge their uncertain tax positions.
Alan RappeportOctober 5, 2007

Complying with new rules always costs companies time and money. The latest one bugging the brains of finance executives is FIN 48, which dictates how firms must account for uncertain tax positions.

A new report by accounting firm BDO Seidman finds that complying with FIN 48 has been a “headache” and that big retailers have been feeling the worst of it. “It’s just like when 404 came out,” says Catherine Fox-Simpson, a partner at the firm, referring to the most controversial section of the Sarbanes-Oxley Act. “CFOs are very concerned about FIN 48. Sitting down and making an inventory of your tax positions has been a process for many companies.”

FIN 48 requires that corporations disclose how much they have kept in reserve to cover the possibility that the Internal Revenue Service or state tax officials might disallow such tax treatments as a company’s claim for credits and deductions, exclusions of certain revenue from taxable income, or the decision that a merger or other transaction can be deemed tax-free. Gauging uncertain tax positions can be especially problematic for retailers, which tend to carry big inventories and may deal in a variety of states with different tax rules. “Where the complications might arise is when you have to use your judgment to determine how much tax might be exposed,” Jerry Gronfein, CFO of Ben Bridge Jeweler, a 79-store retail chain owned by Berkshire Hathaway, tells “It’s always hard to measure your exposure.”

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According to BDO Seidman, 78 percent of the 140 retail CFOs polled say FIN 48, which went into effect in 2006, has made financial reporting harder for them. Accounting for “inventory capitalization and revenue” was the most troublesome for 49 percent of the CFOs polled, while 38 percent cite having problems with state, local, and Internet tax issues. The number of those annoyed is slightly higher for larger retailers.

“The state and local tax issues can be complex because the tax rules can vary greatly from state to state and from one local jurisdiction to another,” says David Brooks, a principal with Rachlin Cohen and Holtz, an auditing and accounting consultancy. “For instance, the determination of whether an entity has ‘nexus’ [a presence in the state], and is therefore required to file an income-tax return in a particular jurisdiction, is often based on regulations that are subject to interpretation.” Crossing state lines and dealing with evolving Internet tax laws further complicate matters.

These days companies must start by assuming their tax positions will be audited, and try, with the help of attorneys and accountants, to handicap the likelihood that their tax decisions would survive an audit. Previously, companies kept estimates relating to their tax reserves to themselves for fear of tipping off competitors or the IRS. Under FIN 48, they must fully disclose their tax reserves — a measure imposed to prevent companies from overstating their reserves and using that to manage their earnings.

Some, however, worry that the IRS might overreact to the new transparency. “Many CFOs are concerned that the taxing authorities will use these disclosures as a road map to identify potential audit targets,” says Brooks.

So far, however, there hasn’t been a noticeable rise in the number of audits as a result of FIN 48, according to Fox-Simpson, who nevertheless expects an increase. BDO Seidman had no information on the actual costs associated with FIN 48. But the task of determining past and present exposure along with an array of local laws has been undeniably taxing.