United States

Income taxes: Intra-entity transfers of assets other than inventory

FINANCIAL REPORTING INSIGHTS  | 

Current generally accepted accounting principles (GAAP) preclude recognizing current or deferred income tax consequences on intra-entity asset transfers between consolidated entities until the asset has been sold to an outside party. This prohibition on recognizing tax consequences is required even if such entities file separate tax returns in different tax jurisdictions (e.g., a U.S. corporation and a non-U.S. corporation). This current prohibition is an exception to the general principle of comprehensive recognition of current and deferred income taxes.

The Financial Accounting Standards Board recently issued Accounting Standards Update (ASU) 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which eliminates the exception for an intra-entity transfer of an asset other than inventory. The ASU requires that an entity recognize the current and deferred income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Two common examples of assets that are included in the scope of the ASU are intellectual property and property, plant and equipment. The ASU does not change GAAP for an intra-entity transfer of inventory.
This amendment will have a significant impact on the tax effect of certain intercompany transactions. For example, assume the following facts:

  • A subsidiary in the United States sells an intangible asset (intellectual property) to a subsidiary in Bermuda for $50 million.
  • The book and tax basis of the intangible asset is zero.
  • The tax rate in Bermuda is zero.
  • The tax rate in the United States is 40%.  Accordingly, the U.S. subsidiary will have a current-year tax liability of $20 million.

Under current GAAP, the $20 million U.S. current tax would be recorded as a deferred charge and would be amortized to income over the life of the intangible asset. Since Bermuda has a zero tax rate, there would be no offsetting deferred tax asset (although current GAAP precludes the recognition of deferred tax assets/liabilities in intercompany transactions).

In contrast, under the amended guidance, the company would record the full $20 million of current tax expense in the year of the transaction. Since Bermuda has a zero tax rate, there is no offsetting deferred tax asset.

For public business entities, the ASU is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. For all other entities, the ASU is effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019.  Early adoption is permitted. The amendments should be applied on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption.