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Accounting for Income Taxes – International Aspects

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					Accounting for Income Taxes –
    International Aspects
         April 12, 2006
Common Questions Before We Begin…
2
    Continuing Professional Education (CPE):                      CPE certificates
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    minutes.
    Copy of Presentation: A copy of the presentation is available now by
    clicking File>Print>Document or File>Save>Document. Also, a copy will be
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    Your Questions: You are invited to submit questions to the presenters
    at any time during the event. Questions and answers will be anonymous to all
    but the presenters. Use the Q&A box on the lower right hand side of your
    screen to pose questions.
    Follow Up: If you have further questions about the above, please email
    Jack Frame at
                               jframe@bdo.com.


                                         2
Co-Sponsor:
Vincci Lo, Secretary & Head of Membership of TEI Asia
  3
                        Welcome to TEI Asia Chapter
              Who We Are: Part of the leading association of tax professionals in the
              world

              Mission: Provide a forum for tax executives to discuss current tax and
              management issues

              Membership: 5,400 members in 53 chapters in the U.S., Canada,
              Europe and Asia
              Why Join: Access to the best, most cost-effective tax training and
              camaraderie of fellow tax professionals
              How to Join:
                                   Vincci Lo at: VLo@lexmark.com


                                        3
 Presenter:
 J. Scott Hendon, CPA, MST
                                                                      Professional Profile
   4                          Experience
                              Scott Hendon has more than 20 years of experience providing tax consulting services to a wide
                              range of energy, high tech, manufacturing, distribution, and retail clients. He is a partner with BDO
                              Seidman’s National Tax Office and International Tax Outbound Consulting Group. Scott also is the
                              US representative on the BDO International Tax Steering Committee. Scott is actively involved in
                              assisting US companies with their offshore operations by developing structures and planning ideas
                              to reduce the worldwide effective tax rate through the use of holding companies, intangible
                              companies, hybrid entities and instruments, and financing companies.

                              Areas of Specialization
                               International Taxation
Scott Hendon                   Income Tax Accounting Services
International Tax Partner
                          Education
BDO Seidman, LLP
700 N Pearl Street         M.S., Taxation, Texas Tech University
Dallas, TX 75201           B.B.A., Economics, Hamline University
Tel: (214)665-0750
Fax: (214)953-0722        Professional Affiliations
shendon@bdo.com            AICPA
                           Dallas International Bar Association
                           International Tax Association of Dallas
                           Leadership Dallas
                           International Business Advisory 4Council, Greater Dallas Chamber
 Presenter:
 Catherine Fox-Simpson, CPA, MST
                                                               Professional Profile
   5                    Experience
                        Catherine is a regional leader for BDO’s Income Tax Accounting Services practice and brings more
                        than nine years of tax planning and consulting experience to our discussion. She has had
                        extensive experience preparing and reviewing federal and state corporate, partnership, and
                        individual income tax returns. In addition, Catherine has significant experience preparing and
                        reviewing deferred tax calculations, planning for the income tax effects of business mergers and
                        acquisitions, and reviewing organizational structures to determine tax minimization strategies. She
                        also consults with clients on various issues related to restructurings, net operating losses, and
                        mergers and acquisitions – including transaction cost analysis and accounting and tax transition
                        issues. Catherine is a member of the BDO Corporate Consulting Group, a member of the BDO
                        FAS 109 Resource Team, and a frequent speaker on the topic of Tax Provisions.
                        Areas of Specialization
Catherine Fox-Simpson   Income Tax Accounting Services
Tax Sr. Manager
BDO Seidman, LLP        Education
700 N Pearl Street       M.S. in Taxation, University of Central Florida
                         B.S. in Accounting, University of Central Florida
Dallas, TX 75201
Tel: (214)665-0768
                        Professional Affiliations
Fax: (214)953-0722       American Institute of Certified Public Accountants
cfox@bdo.com             Texas Society of Certified Public Accountants
                         Dallas Chapter, Texas Society of Certified Public Accountants
                         Florida Institute of CPAs
                         IRS’ Dallas Appeals Practitioners Liaison Committee

                                                         5
Course Objectives
6
    Upon successful completion of this course, participants
    will be able to:
    • Understand deferred taxes on inside basis differences in
      foreign subsidiaries.
    • Understand deferred taxes on outside basis differences in
      foreign subsidiaries and the ABP 23 exception.
    • Understand the implications when the exception does and does
      not apply
    • Understand the common tax reporting requirements related to
      outside basis differences.
    • Calculating U.S. Earnings and Profits and Subpart F
    • Understand US purchase accounting concepts.
    • Understand general accounting of intercompany transactions.


                                 6
7




Deferred Taxes on Inside Basis Differences

       (This will be a review from the March 22 session.)




                                7
Calculating the Foreign Income Tax
Provision
8


    ●   Calculate the Total Income Tax Expense or Benefit for
        each tax jurisdiction in which the multinational group is
        subject to tax for the year. This is calculated by taking the
        sum of:


            –      Deferred Tax Expense or Benefit (i.e., the change
                during the year in an enterprise’s deferred tax liabilities
                and assets), and

            –      Income Taxes currently payable or refundable.



                                        8
Deferred Taxes on Inside Basis Differences
9   FAS 109 principles for calculating foreign deferred taxes apply to inside basis
    differences.
    An inside basis difference is:
     • A temporary difference between the local country tax and U.S. GAAP bases of
        assets and liabilities.
    Deferred Tax Asset (“DTA”) and Deferred Tax Liability (“DTA”) is calculated by
    taking the inside basis differences times the relevant foreign tax rate.
    Evaluate DTAs for Valuation Allowance
     • The gross DTA is evaluated to determine whether that asset should be reduced
        by a Valuation Allowance.
     • The Valuation Allowance is based on the total gross DTA – not on the net DTA
        (i.e., net of DTL).
    Recognize deferred tax expense or benefit
     • The change in the sum of the DTA, Valuation Allowance, and DTL during the
       year generally is recognized as Deferred Tax Expense or Benefit.
    Classify the DTA and DTL as Current and Noncurrent.

                                             9
Current Tax Expense
10


     ●   Compute current income/expense

         •     Determine the current liability or asset and current tax expense
             or benefit that are recognized for the estimated amount of income
             taxes payable or refundable based on the tax returns and
             enacted tax rate for the current year.

         •    This amount should also consider tax return positions that must
             be “reserved” for under GAAP rules.




                                        10
Inside Basis Example
11
     US GAAP basis of foreign subsidiaries net assets
                                 100
     Local country tax basis       80
         Inside basis difference   20
Foreign DTL at 26%                 5.2




                            11
Inside Basis Difference: NOL (Year 1)
12
          Low-Tax Jurisdiction
                            U.S.           CFC*       Total
Book Income/(Loss)        200        (100)         100


Current US Tax (35%)      70           0            70
Def. For. Benefit (16%)    0          (16)         (16)
       Total               70         (16)          54


ETR 54/100 = 54%


* Assumes NOL carryforward is available in foreign jurisdiction.




                                             12
Inside Basis Difference: NOL (Year 2)
13
              Low-Tax Jurisdiction – Year 2
                         U.S.          CFC           Total
Book Income/(Loss)        200            100           300


Current US tax (35%)       70              0            70
Def. Foreign Exp (16%)      0             16            16
      Total                70            16            86


ETR = 86/300 = 28.67%


Note – Assumes CFC’s income is not subject to current tax.




                                               13
Inside Basis Differences: NOL
14              High Tax Jurisdiction
                          US          CFC              Total
Book income/loss             200           (100)               100


Current US tax (35%)           70             0                 70
Def. Foreign tax (40%)         0            (40)               (40)
     Total                   70            (40)                30


ETR = 30/100 = 30%


* Assumes NOL carryforward is available in the foreign jurisdiction.




                                                  14
Inside Basis Difference: NOLs
15                                 High Tax Jurisdiction
                         US         CFC            Total
Book income/(loss)        200          100                 300


Current US tax (35%)          70          0                 70
Def. foreign tax (40%)         0        40                  40
      Total                   70        40                 110


ETR = 110/300 = 36.67%




                                              15
Tax Rate Change and Tax Holidays
16
     Tax Rate
     • Change in Tax rate (par. 27)
        • DTA and DTL should be adjusted for the effect of a change in
          tax laws or rates.
        • The effect of the tax rate change should be included in income
          from continuing operations for the period that includes the
          enactment date.
     • Tax Holiday
        • No DTA recognized for the expected future reduction in taxes
          payable during a tax holiday.
        • Disclose
            •   Aggregate dollar per share effect of holiday.
            •   Brief description and date the holiday will terminate.

                                         16
Polling Question 1
17
     Does your Company have a Tax Holiday and are
     you making financial statement disclosures?
     A. Yes
     B. No
     C. Do not know




                         17
Financial Statement Presentation
18


     FAS 109 Disclosure Requirements

     • Description of temporary differences that comprise ending balance
       sheet amounts, including NOLs (and expiration dates)
     • Components of income tax expense between current and deferred.
     • Reconciliation of total income tax expense to the statutory U.S. tax
       rate (“effective rate reconciliation”).
     • Total deferred tax assets and liabilities recorded in the balance sheet.
     • Total valuation allowance, the net change to the valuation allowance
       and the reasons for the change.
     • Liabilities avoided due to APB 23.
     • Disclosure of tax holidays (no asset).




                                       18
FAS 109 Practical Problems
19
     Foreign reporting packages and tax accounts recorded by the
     CFC.
      • Local-country tax basis balance sheet
      • Application of FAS 109 to tiered structures
      • Reporting packages tie to final numbers for the period
     Check-the box entities
      • Impact on the US current and deferred tax provision (no APB23)
      • Application of DCL rules
     Foreign acquisitions.
      • Stock versus asset purchases
      • U.S. GAAP purchase accounting
     U.S. anti-deferral regimes (Subpart F).
     U.S. “Topside” adjustments.




                                       19
FAS 109 Practical Problems (cont.)
20


     Statutory books
     • Differences between local country statutory reporting and U.S.
       GAAP reporting
     Deferred tax assets and the use of tax planning strategies
     to record tax benefits
     Coordination of international tax planning strategy with
     impact on effective tax rate / financial statements.
     Increased scrutiny of the worldwide tax provision.




                                    20
21


Deferred Taxes on Outside Basis Differences
and APB 23




                     21
APB 23 - Where does it fit in?
22


     U.S. Parent (“USP”) computes deferred taxes
     on book/tax basis differences of internal assets
     and liabilities
     CFC computes deferred taxes in much the
     same manner as USP (U.S. GAAP book v.
     relevant tax basis)
     USP must also compute deferred taxes on
     outside basis in CFC shares
     • This is where APB 23 can operate


                           22
What is the APB 23 exception?
23
     Paragraph 31 of FAS 109 provides as follows:
     A deferred tax liability is not recognized for the
     outside basis differences unless it becomes
     apparent that those differences will reverse in
     the foreseeable future.
     Applies solely to basis difference in the shares
     of stock of CFC, that is, the ‘outside basis’
     difference, not to the internal assets/liabilities
     of the CFC. The internal basis differences of
     the CFC must always be accrued (if material).
                            23
Deferred Taxes on Outside Basis
Differences
24
     In general, FAS 109 and APB 23 require that
     deferred US tax be provided on outside basis
     differences
     An outside basis difference is:
     • A temporary difference between the US parent's
       book and tax basis in its investment in a foreign
       subsidiary
     Outside basis differences generally reverse
     upon the payment of dividend or the sale of
     stock

                              24
US Tax Principles - Offshore Earnings
25
     Foreign Branch or Partnership
     • Foreign earnings are immediately taxed in the US
     • Foreign taxes are creditable (subject to limitations)
     • USP may elect entity classification for certain forms
        • “Check the Box” election




                                     25
US Tax Principles - Offshore Earnings
26
     Foreign Corporation
     • Foreign earnings taxed when repatriated
        • Actual Dividend
        • Deemed Dividend
           •   US Anti-Deferral Rules
                • “Subpart F
                • Section 956




                                        26
Items That Affect “Outside” Basis
27


                                   Book   Tax
     Initial Formation              X      X
     Undistributed Earnings         X
     Cumulative Translation         X
     Adjustments
     Subpart F Inclusions                 X
     Stock Options                        X
     Book Losses                   (X)
     Distributions                 (X)    (X)

                              27
APB 23 Exception vs. Election
28

     Not an election
     Exception applies if the specific facts and
     circumstances warrant
     Based on a company’s ability and intent to
     control the reversal of a taxable temporary
     difference (i.e. the outside basis difference
     in the stock of CFC due to unrepatriated
     earnings)


                             28
                                                     63
APB 23 – Possible Positive
    Evidence
29


     Existing contracts or firm sales backlog that will
     produce sufficient cash flow to alleviate need
     for retained earnings of CFC
     Capital expenditure or other specific plans for
     reinvestment of cash at CFC level
     Lack of Subpart F generating activities that
     might cause deemed distribution of income



                           29
APB 23 – Possible Negative
    Evidence
30
     Do Accumulated Earnings or Net Worth type
     taxes in foreign jurisdiction provide a motivation
     to distribute?
     Is conversion to commissionaire or similar
     planning likely to reduce need for funds at
     subsidiary?
     Is a check-the-box election planned to create a
     deemed distribution?
     Current debt service requirements for USP

                            30
APB 23 - Documentation
31


     APB 23 contains a presumption that all
     earnings will be distributed to the ultimate
     corporate shareholder unless “clear plans”
     exist that demonstrate reinvestment
      • Support should be documented (auditors,
        shareholders, SEC)
      • Compliance With Sarbanes – Oxley Section
        404 requirements


                         31
Documentary Evidence
32
     Required Information for support:
      • Detailed legal ownership chart for material CFCs;
      • E&P and Tax Pool estimates for material CFCs’
      • Understanding of where, and to what extent,
        company is currently applying APB 23;
     Additional Useful Information
      • U.S. GAAP separate company balance sheet for
        each first-tier CFC; and
      • Estimate of U.S. tax basis in shares of 1st-tier CFCs


                               32
APB 23 Disclosure
33   The following information shall be disclosed whenever
     a deferred tax liability is not recognized…
      • A description of the types of temporary differences
        for which a deferred tax liability has not been
        recognized and the types of events that would
        cause those temporary differences to become
        taxable
      • The cumulative amount of each type of temporary
        difference
      • The amount of unrecognized deferred tax liability for
        temporary differences related to investments in
        foreign subsidiaries or a statement that
        determination is not practicable
                               33
Analyzing ABP 23: Example 1
34                                                  $300 million APB 23 amount.
                                                    USP does not plan to repatriate CFC1
     Bank                                           earnings to the US unless it is tax
                                                    efficient to do so.
                                                    USP has US debt.
     Loan
                                                    USP has the wherewithal to fund the
                   USP                              debt from US profits.
                                                    USP intends to use CFC1’s excess
                                                    cash for future international
                                                    expansion.
                  CFC1                              CFC1 has $300 million of unremitted
                                                    earnings and profits. The intent is to
            Analysis                                permanently reinvest such earnings.
              This is a viable multifaceted plan.
              Key factors to viability: USP has wherewithal to handle US debt
              without accessing CFC1’s cash and has the ability to use such cash in
              an international expansion. 34
Analyzing ABP 23: Example 2
35
                                                  $300 million APB 23 amount.
                                                  USP does not plan to repatriate CFC1
     Bank                                         earnings to the US unless it is tax
                                                  efficient to do so.
                                                  USP has US debt that is due within 2
     Loan
                                                  to 3 years.
                    USP
                                                  Current results indicate USP will
                                                  require cash from CFC1 to repay bank
                                                  debt.
                                                  USP has no plans for future
                  CFC1                            international expansion.
                                                  CFC1 has $300 million of unremitted
            Analysis                              book earnings.
              Plan to reinvest CFC earnings indefinitely is questionable.
              USP must intend to refinance existing debt and also demonstrate the
              ability to refinance existing debt .
                                           35
APB 23 – Mechanics if exception does
not apply
36


     Deferred tax liabilities (DTL) set up for:
      • Foreign tax: Withholding taxes that the CFC
        will incur upon the repatriation (§901)
      • US federal taxes (not netted by FTC), include
        §78 Gross-up in calc
      • US state taxes (varies by state)
     Deferred tax assets (DTA) set up for:
      • Foreign Tax Credits (§901, §902)
     Valuation Allowance analysis for DTAs


                               36
                                                        68
APB 23 – Mechanics if exception
does not apply (cont’d)
37
     Valuation Allowance considerations
     • The DTAs created by the FTC should
       not be automatically netted with the
       DTLs created by the residual taxes
     • A FTC limitation calculation needs to be
       done
        • Projections of Foreign Source
          Income and Deductions


                           37
                                                  69
Items for Tax Package Being Sent to U.S.
38
     Deferred Tax Assets and Liabilities for Inside Basis
     Difference
     Earnings and Profits for Outside basis differences and to
     calculated residual tax
     Taxes paid and support for taxes that should be sent to
     U.S. for documentation
     Withholding Tax rates
     Roll forward of tax payables and receivables
     Possible local level revenue agency audits and items that
     may give rise to a contingent tax liability.

                                38
39




Calculating Earnings and Profits and Subpart F




                       39
Earnings and Profits (E&P)
40
     E&P determines how much of a distribution is
     taxable as a dividend under US tax principles
     E&P calculation is required to determine the
     amount of tax that must be accrued by the USP
     • Current Provision if,
        • Actual Dividend
        • Deemed Dividend (US) Anti-Deferral Rules
     • Deferred Provision if APB 23 does not apply




                                 40
Earnings and Profits
Computation of Earnings and Profits
41


  Step #1 – Prepare Local GAAP financial statements (P&L
  and balance sheet)
  Step #2 – Make U.S. GAAP adjustments to arrive at U.S.
  GAAP P&L and balance sheet
  Step #3 – Make U.S. tax adjustments to arrive at U.S.
  taxable income basis P&L and tax basis balance sheet
  Step #4 – Make U.S. E&P adjustments for all material
  items
  Result: U.S. E&P



                           41
Earnings and Profits
Typical Earnings and Profits Adjustments Made
42



     Actual or accrued current taxes vs. book provision
     Deferred compensation
     Timing of Depreciation Deduction
     Hybrid interest
     Tax vs. book goodwill amortization
     Bad debt, contingency, litigation, and pension reserve account
     movements
     Severance reserves
     F/X gain or loss on non-functional currency asset and liability
     realization transactions and translation gain/loss that runs through
     P&L


                                      42
Earnings and Profits
Computation
43            of Earnings and Profits

  Maintained on a pools basis
  Pre-1987 on a year by year basis
  Post-1986 in pools based on separate FTC limitation baskets
  Increased for dividends received from other CFCs
  Look-through apply such that the increase in E&P in respect of the
  dividend follows the separate FTC limitation pools of E&P of the CFC
  which paid the dividend
  PTI retains its character as such in the recipient CFC
  Maintained in functional currency until distributed or deemed distributed
  Actual dividends – spot rate on date of dividend
  §956 deemed dividends – spot rate at year-end (sets $ basis in PTI asset)
  Subpart F – daily weighted-average rate (sets basis in PTI)

                                   43
Polling Question 2
44
     Does your Company compute a detailed Earnings
     and Profit and Tax Pool calculation for foreign
     subsidiaries?
     A. For all foreign subsidiaries
     B. Only for material foreign subsidiaries
     C. On none of the foreign subsidiaries




                               44
Earnings and Profits (E&P)
45
     E&P determines how much of a distribution is
     taxable as a dividend under US tax principles
     E&P calculation is required to determine the
     amount of tax that must be accrued by the USP
     • Current Provision if,
        • Actual Dividend
        • Deemed Dividend (US) Anti-Deferral Rules
     • Deferred Provision if APB 23 does not apply




                                 45
US Anti-Deferral Rules
46
     Normally, foreign corporation’s earnings not taxed
     to USP until repatriated
     Exceptions include:
     • Subpart F – Certain earnings deemed abusive
     • Section 956 – Certain investments in US property




                              46
Anti-Deferral Regimes – Subpart F
47   Subpart F provides that certain types of income of a CFC, even
     though undistributed, are includible in the income of its U.S.
     shareholders in the year the income is earned by the foreign
     corporation.
     A foreign corporation is a CFC for this purpose only if more than
     50% of the combined voting power or 50% of the value of all
     classes of stock is owned directly or constructively by U.S.
     shareholders having a 10 percent or greater stock interest.
     Only U.S. shareholders are taxed on the undistributed income. For
     this purpose, an U.S. shareholder is an U.S. person that actually or
     constructively owns 10% of the voting power of all classes of voting
     stock of the foreign corporation.
     The undistributed income taxed to the U.S. shareholders of a CFC
     is referred to as “subpart F income”.

                                    47
Section 956
48
     In addition to subpart F income being treated as if it were
     distributed and taxed to the U.S. shareholders of a CFC,
     earnings of a CFC invested in (a) U.S. property (with
     certain exceptions) pursuant to Section 956 are taxed to
     the U.S. shareholders.
     •   Loans to U.S.
     •   Investment in U.S. Manufacturing IP
     •   Receivables from U.S. outstanding more than industry average
     •   Exception for U.S. bank deposits of foreign subsidiary
     This provisions make the quarterly examination of a CFC’s
     balance sheet a necessity for the tax professional.


                                    48
49




Inter-Company Cross Border Transactions




                     49
Sale of Inventory/Property
50
     An inter-company sale of inventory or depreciable
     property can result in gain for tax purposes, but
     be deferred/eliminated for financial statement
     purposes.
     FAS 109, Par. 9(e) provides that ARB 51 is not
     amended; therefore, must be followed.
     ARB 51 delays the tax impact on the inter-
     company transaction until the property is sold
     outside of the financial reporting consolidated
     entity.

                            50
ARB 51 – Delay of Tax Impact
51
     Delay of tax impact is accomplished by:

     •   Establishment of DTA by seller for local country tax
         paid, which reverses when the asset is sold outside of
         the consolidated enterprise; or
     •   Adjustment of gain eliminated in consolidation, and
     •   No deferred tax is recorded on buyer’s books.




                               51
ARB 51 Example
52
     Foreign sub sells inventory to US Parent for $200.
     Inventory had basis of $100. The foreign tax rate
     is 25%.
     What are the required tax entries?




                           52
ARB 51 Example continued
53



Sales Price                     200
Basis in Inventory              100
     Gain on Sale               100
Tax Rate                         25
ARB 51 Required (DTA)/DTL       ( 25)
Net Impact on Financial Stmts     0


                        53
54




Business Combinations




                    54
SFAS 109: Business Combinations
55
     General Rule, Paragraph 30:
     •   Each identified asset and liability is assigned its respective fair value
         (Refer to SFAS 141)
     •   A deferred tax liability (DTL) or asset (DTA) is then established for
         the difference between book and tax bases resulting from the
         purchase price allocation and for any carryforwards
     •   DTA may include future benefits of NOLs and tax credit
         carryforwards
     •   The need for a valuation allowance must be assessed
     Exceptions where do not record DTA or DTL at purchase
     •   Goodwill not deductible for tax purposes
     •   Acquired Opinion 23 differences



                                        55
SFAS 141: Business Combinations
56

     Under the General Rule Paragraph 30: Each
     identified asset and liability is assigned its
     respective fair value
     If Purchase Price > FV Assets; Excess =
     Goodwill
     Provisions apply to basis differences in both
     taxable and non-taxable combinations



                           56
Polling Question 3
57
     My understanding of US GAAP purchase
     accounting principles is:


      A. Extensive knowledge
      B. Limited knowledge
      C. No knowledge




                         57
Goodwill
58

     Residual of purchase price allocation
     Two Types: Tax Deductible and Non-Deductible
     FAS 109 requirements differ whether goodwill can be
     deducted for tax purposes or not.
     Recognition of DTA or DTL prohibited if goodwill is not
     amortizable for tax purposes.
     • Non-Deductible Goodwill - No Temporary Difference
     • Deductible Goodwill -Temporary Difference




                                 58
Negative Goodwill
59

     Purchase price < FMV of assets
     FAS 141 requires negative goodwill to reduce on
     a pro-rata basis amounts assigned to acquired
     assets
     Excess recognized as an extraordinary gain (very
     rare)
     Allocation effects temporary difference and
     changes the deferred tax asset or liability

                            59
Identified Intangibles
60

 SFAS 141: Provides for the recognition of
 intangible assets, apart from goodwill, where the
 intangible asset meets one of two criteria
 Recorded separately if it arises from contractual or
 legal right (regardless of whether rights are
 separable or transferable)
     • Recorded separately if it is either separable or transferable
       (e.g., sold, rented, licensed, transferred or exchanged)




                                   60
Identified Intangibles
61

     Intangible assets not meeting the “separate
     recognition criteria” are classified as goodwill (e.g.,
     assembled workforce)
     Basis differences related to identified intangible
     assets are temporary differences for which
     DTA/DTL should be recognized
     Identified Intangibles = Temporary difference
     regardless of availability of a tax deduction


                              61
Identified Intangibles
62
     Illustrative list of identifiable intangibles acquired:
     • Market-related intangibles (trademarks, tradenames, internet domain
       names, non-compete agreements)
     • Customer-related intangibles (customer lists, customer relationships,
       order backlog)
     • Artistic-related intangibles (movies, books, music, newspapers,
       photos)
     • Contract-based intangibles (royalty agreements, supply contracts,
       employment agreements, broadcast rights)
     • Technology-based intangibles (software, patents, databases, trade
       secrets, formulas)




                                     62
Purchase Price Accounting Example -
Stock Acquisition Without Tax Basis Step-Up
63

                                         Historical             Fair              SFAS 141
                                       Book/Tax Basis       Market Value        Balance Sheet

     Cash                                    1,000,000          1,000,000           1,000,000
     Accounts Receivable                    25,000,000         25,000,000          25,000,000
     License                                          0        10,000,000          10,000,000 *
     PP&E                                   50,000,000         75,000,000          75,000,000 *
     Goodwill                                         0        40,000,000          52,250,000


       Total                                76,000,000        151,000,000         163,250,000


     Deferred Tax Liability                           0                            12,250,000


     Equity                                 76,000,000                            151,000,000
                                                                                  163,250,000
     Deferred Tax Journal Entry

     Goodwill                            * $12,250,000

        Deferred Tax Liability                              $12,250,000

                • * (Book/Tax Difference = $10,000,000 for License; $25,000,000 for PP&E)
                • $35,000,000 step-up on all assets, excluding Goodwill, at 35% corporate tax rate = $12,250,000 DTL
                                                               63
Tax Deductible Goodwill
64

     If tax deductible goodwill, FAS 109 separates into two
     components:
     • First Component
         • Equals lesser of "book" goodwill or "tax" goodwill
         • Any difference between the book and tax basis in future years is
           temporary difference
     • Second Component - Remainder
         • If book goodwill - a tax benefit is never recognized (permanent
           difference)
         • If tax goodwill - recognize when realized
           on tax return
         • No deferred taxes recognized




                                        64
Purchase Price Accounting Example -
Asset Acquisition
65

                                      Historical            Fair             SFAS 141
                                    Book/Tax Basis      Market Value      Balance Sheet

     Cash                                 1,000,000         1,000,000         1,000,000
     Accounts Receivable                 25,000,000        25,000,000        25,000,000
     License                                       0       10,000,000        10,000,000 *
     PP&E                                50,000,000        75,000,000        75,000,000 *
     Goodwill                                      0       40,000,000        52,250,000


       Total                             76,000,000       151,000,000       163,250,000


     Deferred Tax Liability                        0                         12,250,000


     Equity                              76,000,000                         151,000,000
                                                                            163,250,000

     First Component of Goodwill = $40,000,000 (Temporary Difference as amortized for tax purposes)
     Second Component of Goodwill = $12,250,000 (Permanent Difference)




                                                          65
Tax Deductible Goodwill
66


     Accounting rules are complex!
     (FAS 109, Paragraph 262 - 269)
     • First, divide goodwill into two components:
        • Financial reporting goodwill equal to tax goodwill
            •   Generally will create a deferred tax liability in subsequent
                reporting periods when tax benefits are realized
        • Financial reporting goodwill in excess of tax goodwill
            •   Existing rules apply (e.g., “no change”)
            •   Goodwill impairment charge for financial reporting treated as a
                "permanent difference"



                                       66
Tax Deductible Goodwill
67
     Tax goodwill in excess of financial reporting goodwill
     • Immediate recognition of tax benefit prohibited
     • As the tax benefit of the deductible goodwill is realized on subsequent
       periods' tax returns, that benefit will be recognized for financial reporting
       purposes in the following manner:
         • First, reduce to zero any financial reporting goodwill related to the acquisition;
         • Second, reduce to zero any other non-current intangible assets related to the
           acquisition, and
         • Third, reduce income tax expense
     • Application is complex because of iterative nature of the adjustments (see
       SFAS 109, par. 263 for example)




                                               67
Goodwill Impairment
68
     Tax Deductible Goodwill - Changes in temporary
     difference should be reflected in deferred taxes
     Non-Deductible Goodwill - No tax benefit
     recorded. Treated as a permanent difference




                            68
Combination of Goodwill Types
69

     Purchased tax deductible and non-deductible
     goodwill
     Acquiror recognizes deferred taxes on deductible
     goodwill not non-deductible goodwill
     Subsequent impairment needs to be allocated to
     the two types of goodwill
     • Specific Identification
     • Systematic and Rational



                             69
Taxable v. Non-Taxable Transactions
70
     Taxable purchase of stock - “Inside asset basis does not
     change”
     • In a domestic stock purchase the tax bases of assets inside the
       purchased corporation do not change
     • If a section 338 election is made, or if the assets of a business are
       acquired, the purchase price is allocated under sections 338 and 1060
     Taxable purchase of assets
     • Tax allocation may or may not be identical to the book purchase price
       allocation
     Tax-free reorganization
     • Carryover tax basis and accounting methods
     • GAAP - will do purchase accounting


                                     70
Polling Question 4
71
     In the last 24 months, my company has
     participated in an international acquisition?


     A. Yes
     B. No




                             71
 Valuation Allowances
72

     Valuation Allowance established at time of
     combinations
     Need based on the combined company’s past and
     expected future results of operations as of the
     acquisition date
     Assessment should consider tax law provisions
     that restrict future use of temporary differences




                            72
Subsequent Release of Valuation Allowance
73

     Tax benefits recognized subsequent to the
     acquisition are applied, in order:
     1. Reduce to zero any goodwill related to the
        acquisition;
     2. Reduce to zero other non-current intangible assets
        related to the acquisition;
     3. Reduce income tax expense




                             73
APB Opinion 23 in Business Combinations
74

     Acquiror makes its own determination as to the
     reinvestment strategy
     Purchaser’s assertions are made without regard to
     any prior assertions made by Target
     DTL resulting from repatriation assertion will be
     recognized in purchase price accounting




                             74
Open Discussion
75




                  75
 Who to call?.....
  76




Vincci Lo                          Scott Hendon                Catherine Fox-Simpson
Secretary & Head of Membership     International Tax Partner   Tax Sr. Manager
TEI Asia Chapter                   BDO Seidman, LLP            BDO Seidman, LLP
Lexmark                            700 N Pearl Street          700 N Pearl Street
21/F, West Wing, Hennessy Centre   Dallas, TX 75201            Dallas, TX 75201
500 Hennessy Road                  Tel: (214)665-0750          Tel: (214)665-0768
Causeway Bay                       Fax: (214)953-0722          Fax: (214)953-0722
Hong Kong,                         shendon@bdo.com             cfox@bdo.com
Tel: (852) 2501 8628
vlo@lexmark.com




                                                  76
Helpful Websites for U.S. Guidelines
77   Financial Accounting Standards Board (FASB)
      • FASB - http://www.fasb.org/
          • The Financial Accounting Standards Board Home Page
          • FASB on Income Tax Accounting – FAS 109

     Other helpful websites:
      • Internal Revenue Service - http://www.irs.gov/
          • Internal Revenue Service Home Page
      • AICPA - http://www.aicpa.org
          • The American Institute of Certified Public Accountants Home Page
      • Federal Reserve Board - http://www.federalreserve.gov/releases/
          • Statistics: Releases and Historical Data, such as interest and foreign exchange
            rates
      • International Accounting Standards Board - http://www.iasb.org
          • International Accounting Standards Board Home Page
      • SEC - http://www.sec.gov
          • The U.S. Securities and Exchange Commission Home Page




                                           77
Disclaimers
78   Material discussed in this presentation is meant to provide general
     information and should not be acted on without obtaining professional
     advice tailored to your firm’s or company’s individual needs.
     It is not intended that the material be considered advice on the
     application of accounting principles as described in Statement on
     Auditing Standards (SAS) No. 50 (as amended by SAS No. 97)
     To ensure compliance with Treasury Department regulations, we wish
     to inform you that any tax advice that may be contained in this
     communication is not intended or written to be used, and cannot be
     used, for the purpose of (i) avoiding tax-related penalties under the
     Internal Revenue Code or applicable state or local tax law provisions
     or (ii) promoting, marketing or recommending to another party any tax-
     related matters addressed herein.




                                     78
About BDO Seidman, LLP
79
 BDO Seidman, LLP is a national professional services firm providing
 assurance, tax, financial advisory and consulting services to private
 and publicly traded businesses. For more than 95 years, we have
 provided quality service and leadership through the active
 involvement of our most experienced and committed professionals.


 BDO Seidman serves clients through more than 30 offices and over
 250 independent alliance firm locations nationwide. As the U.S.
 member firm of BDO International, BDO Seidman, LLP belongs to a
 worldwide network of independent professional firms that combined
 offer over 23,000 partners and staff operating in 105 countries and
 over 600 offices.



                                   79

				
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