Professional Documents
Culture Documents
No. 2011-03
June 16, 2011
This policy election does not apply to foreign corporate joint ventures that are permanent in duration, foreign
branches, or domestic entities.
National Professional Services Group | CFOdirect Network www.cfodirect.pwc.com
Practical tip
When a company acquires a controlling interest in, or otherwise obtains control of, a
foreign equity investee, the DTL previously recorded for the equity in earnings of the
foreign investee is required2 to be "frozen" until: (1) dividends from the subsidiary
exceed the parents share of the subsidiarys earnings after the date on which the
equity investee became a subsidiary or (2) the parent disposes of its interest in the
subsidiary. This amount would be "frozen" even if the parent has an intent and ability
to indefinitely reinvest the foreign subsidiary's earnings and, therefore, does not plan
to provide for income taxes on future earnings.
If the company expects to make an indefinite reinvestment assertion with respect to
the foreign subsidiary, the additional taxable temporary difference arising from a
holding gain would require a company to either:
1. Record a DTL on the holding gain and "freeze" the DTL related to the entire
outside basis difference, or
2. Not record a DTL on the holding gain and only "freeze" the DTL that relates to
unremitted earnings of the investee as of the date control is obtained (i.e., the
preexisting DTL as of the date the equity interest is remeasured to fair value) 3.
The approach selected is an accounting policy election that should be consistently
applied to all acquisitions.
If the company does not expect to make an indefinite reinvestment assertion with
respect to the foreign subsidiary, the deferred tax effect of the entire outside basis
difference should be recorded. This is because it is implied that upon recovery of the
investment (e.g., through dividend distributions), the entire outside basis taxable
temporary difference will reverse in a manner that will have tax consequences.
On occasion, the expected manner of recovery prior to obtaining control does not
have tax consequences to the investor company, so no DTL is provided for the taxable
temporary difference in the foreign equity investee. Therefore, when the investor
company obtains control over the investee there is no DTL to "freeze." In such
circumstances, if the company expects to maintain an indefinite reinvestment
assertion after the foreign equity investee becomes a foreign subsidiary, no DTL
would be recorded.
A practical example
Scenario 1
Facts:
Company X is a US corporation which owns 40% of Company A (a foreign corporation)
and accounts for its investment using the equity method. Company X's applicable federal
and state tax rate is 40%, and it has recorded a DTL of $16 million for its 40% equity in
the undistributed earnings of Company A because any recovery method (e.g., dividends
or capital gain income from a disposition) would be taxable to Company X. The
Practical tip
measurement of the US DTL does not reflect any foreign tax credits or withholding taxes
since Company A is domiciled in a zero rate jurisdiction.
In the current period, Company X acquires the remaining 60% equity of Company A for
an amount significantly in excess of book value, resulting in a holding gain of $100
million. Company X expects to make an indefinite reinvestment assertion when
Company A becomes a foreign subsidiary.
Analysis:
Company X is required to "freeze" the $16 million DTL which relates to its equity in the
undistributed earnings of a foreign equity investee. Additionally, Company X can adopt
an accounting policy to either "freeze" the entire outside basis difference and thus record
an additional DTL of $40 million (40% of the additional $100 million taxable temporary
difference arising from the holding gain), or alternatively not record an additional DTL
and only "freeze" the preexisting $16 million DTL.
The recorded DTL would remain "frozen" until Company A either distributes the related
earnings or until Company X disposes of its interest in Company A.
Scenario 2
Facts:
Assume the same fact pattern as Scenario 1, except Company X does not expect to
maintain an indefinite reinvestment assertion after Company A becomes a foreign
subsidiary.
Analysis:
Company X would recognize an additional DTL of $40 million (40% of the additional
$100 million taxable temporary difference arising from the holding gain). The total DTL
recognized on the balance sheet for the entire outside basis difference in Company A
would be $56 million ($16 million preexisting DTL plus $40 million additional DTL).
Questions
PwC clients that have questions about this Practical tip should contact their engagement
partner. Engagement teams that have questions should contact a member of the Tax
team in the National Professional Services Group (1-973-236-7806).
Practical tip
Authored by:
Brett Cohen
Partner
Phone: 1-973-236-7201
Email: brett.cohen@us.pwc.com
Yosef Barbut
Director
Phone: 1-973-236-7305
Email: yosef.barbut@us.pwc.com
Trent Horsfall
Senior Manager
Phone: 1-973-236-5376
Email: trent.r.horsfall@us.pwc.com
Practical tips offer tips on applying financial reporting requirements and are prepared by the National Professional Services Group of PwC. This
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