Update requires recognition of income tax consequences of intraentity transfers

The FASB on October 24, 2016, published Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740) — Intra-Entity Transfers of Assets Other Than Inventory, to require businesses to recognize the immediate income tax consequences of intracompany asset transfers, which often involve a subsidiary of a company transferring intellectual property to another subsidiary.

The proposal eliminates an exception in Topic 740, Accounting for Income Taxes, which prohibits the recognition of the tax consequences for intracompany asset transfers until the asset has been sold to an outside party.

The update applies to all asset transfers other than inventory, a change from the FASB’s original proposal, which was released in January 2015 as Proposed Accounting Standards Update ASU No. 2015-200, Income Taxes (Topic 740): Intra-Entity Asset Transfers.

Businesses bashed this plan because they said they believed intracompany transfers do not affect earnings and the proposed change would be counterintuitive — and costly. Others said the proposal would lead to false volatility in reported earnings.

Financial Executives International’s Committees on Corporate Reporting and Taxation wrote to the FASB five days after the plan’s release that the proposal “fails to achieve the objectives of the simplification initiative and produces a financial statement result that has the potential to confuse financial statement users and undermine the credibility of financial reporting.”

In light of the harsh feedback, the FASB in October 2015 said it needed to do more research before proceeding. In June, the board agreed to exempt transfers of inventory from the update because inventory transfers caused the most angst for companies.

Businesses said the volume of intracompany transfers of inventory is significantly greater than the volume of other asset transfers. It would be costly to make operating systems changes, estimate the annual effective tax rate for interim reporting purposes, and implement new processes and internal controls over financial reporting. Since inventory typically turns quickly, deferring the recognition of the tax consequences from intracompany transfers does not significantly affect the quality of information reported to investors and analysts, the FASB said.

Public companies will apply the update for fiscal years that start after December 15, 2017, and for quarterly reports in those years. Privately held businesses will apply them in yearly reports for years that start after December 15, 2018, and interim period reports for years that start after December 15, 2019.

Companies will implement the accounting changes via what the FASB calls a modified retrospective basis, which means that the prior periods in a financial report do not have to be adjusted to reflect the new requirements. Companies should adjust their retained earnings to show the effect of the new accounting on prior periods. The FASB believes this will let investors analyze the asset transfers’ effect on financial performance.

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