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Michigan Business Tax Financial Reporting

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Michigan Business Tax Financial Reporting Powered By Docstoc
					                                                                                                          October 2007



  Subject:                                                  State and Local
  Michigan Business Tax
  and Deferred Tax
                                                            Tax Alert
  Implications

The Tax Practice at BDO Seidman, LLP is                    Summary
among the largest tax advisory practices in                Effective January 1, 2008, the Michigan Single Business Tax will be
the United States. With 35 offices and more                replaced by the new Michigan Business Tax. The financial reporting
than 300 independent alliance firm locations               requirements of this new tax might catch taxpayers off guard if
in the United States, BDO Seidman has the
                                                           attention is not given to the possible deferred tax implications of the
bench strength and coverage to serve you.
                                                           imposition of this new tax. Additionally, in order to take full
For more information, please contact:                      advantage of the financial statement relief just enacted by the
                                                           Michigan Legislature, taxpayers should start analyzing the impact of
Richard Spengler, Partner                                  this new tax now.
BDO Seidman, LLP
99 Monroe Avenue NW Suite 800                              Background
Grand Rapids, MI 49503                                     On July 12, 2007, the new Michigan Business Tax (“MBT”) was
(616) 776-3687                                             signed into law, effective for business activity after December 31,
rspengler@bdo.com                                          2007 (see BDO Seidman Alert dated July 2007: New Michigan
                                                           Business Tax Signed into Law at
Andrea Collins, Senior Manager                             http://www.bdo.com/about/publications/tax/alerts/TaxAlert-
BDO Seidman, LLP
                                                           MIBusTax.pdf). There are two components of the new MBT: the
99 Monroe NW Suite 800
Grand Rapids, MI 49503
                                                           business income tax (“BIT”) and the modified gross receipts tax
(616) 774-7000                                             (“MGRT”). For FAS 109 purposes, it is BDO Seidman’s position that
acollins@bdo.com                                           both the BIT and MGRT are income taxes. With the imposition of any
                                                           new tax that is considered an income tax for FAS 109 purposes,
To ensure compliance with Treasury Department              deferred taxes must be calculated for the cumulative difference
regulations, we wish to inform you that any tax advice     between book and tax basis for all assets that are considered in the
that may be contained in this communication
(including any attachments) is not intended or written     calculation of the new tax. Additionally, the impact of the cumulative
to be used, and cannot be used, for the purpose of (i)     effect must be booked at the end of the financial reporting period
avoiding tax-related penalties under the Internal          including the enactment date of the tax, July 12, 2007. However,
Revenue Code or applicable state or local tax law
provisions or (ii) promoting, marketing or                 recently, an amendment to the MBT was passed that allows for relief
recommending to another party any tax-related              from possible detrimental impacts on the financial statement of any
matters addressed herein.                                  net deferred tax liability due to the imposition of the new tax.
Material discussed in this tax alert is meant to provide
general information and should not be acted on             Income Tax Deferreds
without professional advice tailored to your firm's        While some taxpayers have treated the MSBT (the tax to be replaced
individual needs.
                                                           by the new MBT) as an income tax for financial statement purposes,
                                                           most have treated it as an above-the-line, non-income tax. For
                                                           taxpayers that previously considered the MSBT an income tax, the
                                                           calculation of the deferred taxes associated with the enactment of the
                                                           BIT component of the new MBT will entail increasing the rate used
from 1.9% to 4.95%, and adjusting for any apportionment changes, as appropriate. However, for most
taxpayers, a completely new deferred tax amount will have to be calculated.

In general, any book-tax difference in the basis of assets results in a deferred tax asset or liability. If an asset
has a higher book basis, there will be higher taxes due in the future since the tax deductions have been larger
in the past. This results in a deferred tax liability being booked for financial statement purposes to reflect the
higher tax that will be paid in the future. If an asset has a higher tax basis, there will be lower taxes due in
the future since tax deductions have been lower in the past as compared to the book deductions taken. This
results in a deferred tax asset being booked for financial statement purposes to reflect the lower tax that will
be paid in the future.

For the new BIT component of the MBT, the book-tax differences in the basis of assets will typically be the
same as the differences that taxpayers are already booking for federal and other state income tax purposes.
While there are possible differences between federal and state income tax basis (e.g. state de-coupling from
bonus depreciation), the majority of temporary Schedule Ms will also be ones for which deferreds will need
to be calculated for the BIT portion of the MBT. Depending on how a taxpayer currently calculates its state
deferred taxes, the same methodology could be followed in accounting for the BIT component of the MBT.
Another way to determine the deferred taxes associated with the implementation of the new BIT is to take
the items on the balance sheet at the end of the fiscal reporting period and calculate the difference in book
and tax basis. The total difference will then be multiplied by the estimated apportionment percentage under
the new MBT (note that MBT apportionment is calculated on a combined basis for unitary business groups,
is 100% sales factor, and there are new sourcing rules for sales other than tangible personal property) and
then the BIT rate of 4.95%. This methodology will likely be the preferred method due to a new deduction
that has recently been enacted and will be available in future years (see discussion below).

Modified Gross Receipts Tax Deferreds
For the MGRT component of the new MBT, the associated deferred taxes will also need to be calculated by
identifying the difference between the book and tax basis of each asset on the books at the end of the fiscal
reporting period. There are two main differences in calculating the deferred taxes for the MGRT, as
compared to the BIT, besides the rate used: (1) the tax basis in the assets; and (2) the assets for which the
book-tax difference should be calculated.

Even though the book basis of an asset will be the same for BIT and MGRT purposes, the tax basis between
the two taxes will be different. The tax basis for the MGRT will be zero for all assets on the books as of any
period prior to January 1, 2008. This is because of how the MGRT base is calculated. The MGRT base takes
a “person’s” entire gross receipts, with some exclusions, and then allows a deduction for “purchases from
other firms.” Purchases from other firms includes inventory, fixed assets, materials and supplies, and any
other tangible or intangible property that is subject to amortization, depreciation, or other capital cost
recovery method for federal income tax purposes. Even though the MBT does not go into effect until
January 1, 2008, the qualified assets on the books prior to then would have been allowed as a deduction as a
“purchase from other firms” when acquired. Since a tax deduction theoretically would have been allowed in
the past and will not be allowed in any future period, there is no MGRT basis for these assets. This effect is
caused by the fact that the deduction for “purchases from other firms” is allowed immediately in contrast to
the method of accounting that most taxpayers are on for book and tax purposes, the accrual basis. Since the
MGRT basis for each of these assets is zero, there cannot be a deferred tax asset associated with the MGRT,
only a deferred tax liability.

Since the acquisition of only certain assets (ones that fit the definition of “purchases from other firms”) can
be deducted from the MGRT base, only these assets should be reviewed to determine the book-tax basis
difference. As mentioned above, inventory, fixed assets, materials and supplies, and any other tangible or

                                                                                           (continues on next page)
intangible property that is subject to amortization, depreciation, or other capital cost recovery method for
federal income tax purposes are ones that will generate deferred tax liabilities. However, items such as cash,
accounts receivable, and land are some of the assets that are never deductible under the MGRT and thus
constitute permanent book/tax differences instead of impacting the deferred tax accounts. This is because
even if they were acquired after the MBT was in effect, there would be no deduction allowed for them from
the MGRT base.

Once the book-MGRT basis differences are determined, the deferred tax liability would be calculated by
multiplying the total difference by the estimated apportionment percentage under the new MBT and then by
the MGRT rate of 0.8%.

This initial booking of the deferred tax impact of the new MBT can be viewed as a one-time “catch-up”
financial statement entry. Once the cumulative impact has been booked, the amount of deferred taxes will be
adjusted in each future fiscal reporting period to reflect the book-tax differences. On the BIT component,
deferred tax assets and liabilities will be adjusted in similar ways to federal and/or other state income taxes.
For the MGRT component of the MBT, because an immediate deduction is allowed for each “purchase from
other firms,” there will continue to be no MGRT basis in those assets. If the assets are purchased in a given
fiscal reporting period, but have not been fully expensed for book purposes by the end of that fiscal
reporting period, a deferred tax liability will be recorded.

Relief for Deferred Tax Impact
On September 30, 2007, House Bill 5104 was passed and provides for relief for taxpayers that have a net
deferred tax liability impact to their financial statements as a result of the enactment of the MBT. The bill
allows an MBT taxpayer to claim a future deduction against its BIT base that is calculated using the
taxpayer’s current apportionment and tax rates and is set at a level that will create a tax benefit in the future
equal to the net deferred tax liability recorded related to enactment of both the BIT and MGRT. Because the
deduction will be allowed on future MBT returns, a taxpayer should record a deferred tax asset equivalent to
the net deferred tax liability required in the cumulative effect entry. The result is that there should be no
negative financial statement impact as a result of the enactment of the new MBT (i.e. no current year tax
provision detriment). Any future deferred tax entries will be the result of timing differences between book
and tax deductions, changes in the taxpayer’s apportionment percentage or MBT tax rates. The net deferred
tax relief provision is a one-time deduction/entry that is only intended to offset the negative effects on a
taxpayer’s deferred tax accounts as a result of the enactment of the MBT but will not affect annual changes
to the MBT deferreds that result from changes in the taxpayer’s facts.

As discussed above, if a person subject to the MBT has a book-tax difference at the end of the first fiscal
year including July 12, 2007 that results in a deferred tax liability, the person is allowed a future deduction
over a period of 15 tax years, beginning with the 2015 tax year. The deduction is equal to the following:

   •   4% of the book-tax difference, for tax years 2015 through 2019
   •   6% of the book-tax difference, for tax years 2020 through 2024
   •   10% of the book-tax difference, for tax years 2025 through 2029.

The deduction is limited to the amount necessary to offset the deferred tax liability related to adoption of the
MBT. The book-tax difference in assets is allowed to only be used once for the BIT and once for the
MGRT. The amount of the deduction is the gross amount of the book-tax difference, without any federal
income tax effect. If the adjustment is greater than the BIT base for a particular year, any excess deduction
is allowed as a carryforward to a future year as a deduction before apportionment. No limitation on the
carryforward period has been provided. Additionally, there appears to be no provision for taxpayers who are
only subject to the MGRT (i.e. a taxpayer that is immune from the BIT because of P.L. 86-272). If a
taxpayer is not subject to the BIT, there appears to be no relief provided for the financial statement impact
of the imposition of the MGRT.                                                       (continues on next page)
House Bill 5104 indicates that the Michigan Department of Treasury may require taxpayers to report the
amount of the deduction on a specific form to be developed. If there is such a requirement, the deduction
may be reported on the form due on or after the date the first quarterly return and estimated payment is due
for the MBT, which is due on the 15th day of the fourth month following the end of a taxpayer’s fiscal year.

How BDO Seidman Can Help
With the enactment of the new MBT, every MBT taxpayer will have new deferred taxes that are required to
be recorded. Booking the deferreds related to the BIT component of the MBT might be as simple as
adjusting the rate at which current deferred taxes associated with the Michigan Single Business Tax were
determined (i.e. from 1.9% to 4.95%). However, since most taxpayers did not consider the MSBT an
income tax in the past, all new deferreds will be required to be calculated and booked in the first fiscal
reporting period including July 12, 2007. While booking deferreds related to the BIT component might
seem fairly straightforward to many taxpayers, booking deferreds related to the MGRT can be much more
complex.

Additionally, with the passage of House Bill 5104, it becomes even more important to capture all of the
possible deferred tax liabilities associated with the implementation of the new MBT. Once the deduction
amount is reported to the Michigan Department of Treasury, it does not appear that any modification will be
allowed. BDO Seidman state tax professionals are available to assist taxpayers in identifying all of the
assets that would have related book-tax differences for both the BIT and MGRT components of the tax, and
calculating the associated deferred taxes and deduction amount to report to the Michigan Department of
Treasury.

				
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