Spotting & Disclosing Uncertain Tax Positions

Tax is an inevitable part of doing business and between regulatory requirements changing or new circumstances, uncertain tax positions (UTPs) are inevitable too. From talking about the impact of ASC 740-10 on UTPs to looking at example scenarios and strategies for handling it, this blog will equip you with some ideas on how you can move forward.

At A Glance: What Is An Uncertain Tax Position?

UTPs are tax positions taken by a company that aren’t fully supported by tax laws or are in conflict with the interpretation of the law by tax authorities. Because of this, they could be challenged by authorities like the IRS.

They often arise because of changes in laws, differences in interpretations, or incomplete/incorrect information. UTPs also occur if a company takes a more aggressive stance on tax deductions or credits.

For more technical details and documentation, visit the IRS’ UTPs resource center.

Why Do They Matter?

If you’re challenged on your tax positions, your organization could incur additional taxes, penalties, and interest. This in turn can financially burden your company. As Centri’s Tax Advisory Practice Leader points out: 

How Does ASC 740 Affect UTPs?

The recognition, measurement, and disclosure of uncertain tax positions are influenced by ASC 740, which promotes a more conservative approach to calculating UTPs. (Fin 48 is no longer applicable to current accounting practices.)

Here are some of the big-picture ways ASC 740-10 affects UTPs at a glance.

Recognition:

The “More Likely Than Not” Standard

Companies can recognize the tax benefit of a UTP if it’s ‘more likely than not to be sustained by tax authorities. This is a bit stricter than prior regulation.

Quantitative and Qualitative Analysis

A thorough analysis of the UTP’s chance of success is now required. This process should incorporate historical precedents, tax authority practices, legal interpretations, and industry data.

Measurement: 

Estimated Range

Instead of being measured by a single-point estimate, ASC 740 outlines that UTPs should be measured based on a range of possible outcomes. This reduces optimistic outcomes that are misleading and accurately shows the uncertainty around the tax position.

Calculation of Tax Consequences

The potential tax impact for all possible outcomes within the position needs to be calculated so that they’re a part of considerations.

Disclosure:

UTPs With Material Impact

Companies must now disclose UTPs that could translate to a material impact on their financial statements and reporting. This disclosure should encompass the position itself, its potential financial IMPACT, and the chances of its success.

Quantitative and Qualitative Information:

Taking the analysis work done above,  it’s now required that you share both details like potential tax liability and legal arguments in the disclosure to provide comprehensive representation.

Uncertain Tax Positions Examples

Here are some fictional demonstrations based on real-world business scenarios that can lead to UTPs.

Transfer Pricing

The Situation: 

A large multinational business in the technology industry charges subsidiaries overseas a higher price for its goods, which reduces taxable income in its home country. This pricing method follows what is standard in the industry, but tax authorities are questioning its appropriateness.

UTP: 

The “arm’s-length” principle is a common concept when looking at international tax law. It ensures that business between related parties is conducted the same as if they were independent. With that in mind, the company’s UTP should analyze the relationship between subsidiaries from that angle to avoid bias as best as possible.

R&D Tax Deductions

The Situation:

A pharmaceutical company in the life sciences industry is claiming tax deductions for their R&D work on a new product, although the success of that new drug isn’t certain nor is its classification as research or experimentation.

UTP: 

If the significant deductions the company is claiming will meet the criteria that would make them qualify as R&D expenses since the outcome of the project and classification of it is uncertain.

Accounting Method Changes

The Situation:

As a result of a merger or acquisition, one company’s recognized income and tax liability are being impacted as they transition from one accounting method to another. Their new method means that the company’s timing of recognizing an item of income, gain, loss, or deduction is shifting, all of which impact tax.

UTP:
The tax team will need to determine if this new accounting method is in alignment with relevant accounting standards and possible challenges tax authorities could raise.

Effective Strategies For Managing Uncertain Tax Positions

Identify Them Early

It’s a lot easier to be proactive than reactive. Make sure your business builds a robust internal framework that can help you identify UTPs early on. 

When you uncover any, make sure to do a thorough review to consider its:

• Nature/significance to your company.
• Potential financial impact with a thorough cost-benefit analysis.
• Likelihood of success.

Also encourage your tax team to stay up to date by reviewing the latest tax laws, court rulings, and accounting standards. All play an important role in uncovering UTPs.

Facilitate Transparent Communication

Set your company up for success with detailed internal controls that help you create accurate and comprehensive documentation of the activities that are relevant to UTPs. From supporting documents to justifications and records of communication both internally or with tax authorities — record everything. Doing all this can help you manage risk.

If you know you’re taking an aggressive tax position that leads to a UTP, also proactively keep open communication with tax authorities and engage them in discussions. You should also make sure relevant stakeholders (like investors or auditors) are aware of the possible tax uncertainty and risks that come with your positions. All your communications should follow the guidelines mandated by ASC 740.

Advocate Support When You Need It

Whether you’re struggling to hire and retain accounting professionals (like many companies right now) or facing new technical territory you’re unfamiliar with, don’t let a lack of resources lead to mishandling a UTP. 

Instead, collaborate with tax experts who understand the complexities and are also up to date with the current legalities and regulations. Doing so may end up saving your company from taking an unnecessary financial gamble.

Where Can You Go From Here? 

UTPs can have a significant impact on your business both financially and beyond. By managing them proactively and seeking professional guidance when you’re unsure, you can ultimately minimize your risks and maximize tax savings for your company. 

Managing UTPs is an ongoing effort, so it’s important to regularly review and update your tax positions, especially as tax laws or regulations change. However, the effort to do this and devote resources toward it will set your business up for long-term success.