Accounting For Uncertain Tax Positions

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January 19, 2006

Recently, the Financial Accounting Standards Board (FASB) began redeliberating the Exposure Draft of proposed Interpretation, Accounting for Uncertain Tax Positions – an Interpretation of FASB Statement No. 109, which was issued in July 2005. The proposed Interpretation would clarify Statement 109, Accounting for Income Taxes, to indicate the criterion an individual tax position would have to meet for the benefit of that position to be recognized in an enterprise’s financial statements. The proposed Interpretation has raised concerns among financial statement preparers because the probable threshold that would be required before a tax position could be recognized would negatively impact the financial statements of many companies. Following is a summary of the initial redeliberation, which took place on November 22, 2005.

FASB redeliberation

As a part of the FASB’s due process, comment letters were solicited on the proposed Interpretation. Because of the significant impact the proposed Interpretation would have on most taxable entities, it is not surprising that the FASB received over 100 comment letters. Financial statement preparers, accounting firms, and other interested parties that responded objected to various aspects of the proposed Interpretation.

The FASB began redeliberating the proposed Interpretation at its November 22, 2005 meeting. As part of the redeliberation process, the FASB will consider the comments it has received. To the extent that the FASB reaches different conclusions in its redeliberations, the final Interpretation will differ from the proposed Interpretation.

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Decisions to date

Change of initial recognition criteria to more likely than not ─ The most significant decision reached by the FASB at the November 22, 2005 meeting was to change the initial recognition criterion for uncertain tax positions from probable to more likely than not. The tax benefit recognition criterion would be met if the evidence indicates that it is more likely than not (a level of likelihood greater than 50 percent) that the tax position would be sustained, including resolution of related appeals or litigation. Under the proposed Interpretation issued in July 2005, an uncertain tax position would not be recognized unless it was probable of being sustained (a higher threshold than more likely than not). Probable was meant to have the same meaning that it has in Statement 5, Accounting for Contingencies.

As a result of this change, entities subject to the proposed Interpretation would apply the same threshold for both recognition and derecognition of a tax benefit. That is, the tax position would be derecognized when it is no longer more likely than not that it would be sustained.

Other decisions ─ The FASB also reaffirmed previous decisions that were reflected in the proposed Interpretation, including the following:

• to retain the proposed guidance that the unit of account for a tax position would be determined based on facts and circumstances. The final Interpretation would also require that the determination of facts and circumstances be based on how the enterprise supports and documents its tax return and how issues are addressed with taxing authorities.

• to retain the proposed two-step tax benefit recognition process. That process requires an enterprise to first determine whether it can recognize a tax position, and then in a second step to determine the measurement of the benefit. In applying the two-step method, the FASB decided to retain the proposed presumption that the tax position will be examined. Additionally, the FASB decided to retain the proposed requirement to use the best estimate, rather than an expected value, approach to measuring the amount of the benefit to recognize.

Effective date has not been redeliberated ─ The effective date in the proposed Interpretation is for fiscal years ending after December 15, 2005. Therefore, the proposed Interpretation would be effective at December 31, 2005 for a calendar-year company. The FASB has not yet formally reconsidered that date, but it is widely expected that the effective date will be delayed in the final Interpretation. Current plans are that a final Interpretation will be issued in the first quarter of 2006.

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