Executive summary:
As a windy March concludes, it would be nice to believe the proverb that March comes “in like a lion, out like a lamb” also applies to the economy. Companies continue to face various economic headwinds at the end of the first quarter coupled with the continued pressures of inflation. Domestically, large corporations are also facing the new Corporate Alternative Minimum Tax enacted as part of the Inflation Reduction Act, while globally, countries are taking steps to enact the global minimum tax under the Pillar Two framework that will apply much more broadly. The following update provides insight on federal, state and international tax laws and updates from the Financial Accounting Standards Board that may impact companies and their income tax provisions in 2023.
ASC 740: Q1 2023 Provision Considerations
Impacts of the Inflation Reduction Act of 2022
Beginning on Jan. 1, 2023, two provisions of the Inflation Reduction Act of 2022 became effective for corporate taxpayers: the Corporate Alternative Minimum Tax (CAMT) and the 1% tax on stock buybacks. The CAMT imposes a 15% tax on the adjusted financial statement income of certain large corporations with average financial statement income in excess of $1 billion and U.S. corporations with foreign parents that have over $1 billion in financial statement income, that have at least $100 million in financial statement income. In drafting the Inflation Reduction Act and the CAMT, Congress directed the IRS and Treasury to provide rules regarding many areas of interpretation and application of the calculation of CAMT. To date, the IRS has provided limited guidance regarding the calculation and companies continue to have significant questions about the calculation. While the first return filings reflecting CAMT liabilities are still far off, companies subject to the CAMT may be wrestling with the many questions regarding the calculation of CAMT for their first-quarter provisions. Due to the indefinite credit generated by payment of CAMT, the impact of current year CAMT liabilities is not expected to have a significant impact on effective tax rates for most companies. Read more about the CAMT in the following article: The new corporate minimum tax: overview and highlights. Under ASC 740, a company that expects to be subject to the CAMT should measure its deferred taxes using its regular tax rate and consider the realization of any CAMT credit carryforward deferred tax asset similar to any other deferred tax asset.
The stock of domestic corporations traded on an established securities market and the stock of certain foreign corporations are subject to a 1% tax when the corporation repurchases the stock from their shareholders on or after Jan. 1, 2023. The 1% tax is not deductible for federal income tax purposes. For additional information on the 1% stock buyback tax, visit the following article: New tax on publicly traded corporations that repurchase their stock. The excise tax on stock buybacks is not an income tax and should not be accounted for as part of a Company’s income tax provision.
Expiration of favorable treatment for meals at restaurants
As part of the Consolidated Appropriations Act, 2021, companies were allowed to temporarily deduct 100% of the cost of food or beverages provided by a restaurant for the 2021 and 2022 calendar years. Beginning on Jan. 1, 2023, the cost of food and beverages at restaurants is once again subject to the 50% limitation under section 274(n)(1). Companies will need to ensure first quarter provisions reflect the appropriate limitations on meal expenditures.
Preparing for the evolving global tax landscape
The Organisation for Economic Co-operation and Development’s (OECD) Pillar Two initiative aims to impose a global minimum corporate tax of 15% of adjusted net income on large international businesses regardless of the location of the business’ headquarters or jurisdictions in which the business operates (Companies with total sales in excess of €750 million). The framework provides model tax legislation for participating countries to enact to achieve the objectives under Pillar Two. In essence, the model rules will top up the tax burden on a jurisdiction-by-jurisdiction basis to ensure that each jurisdiction is at a 15% tax rate.
Recently, the Financial Accounting Standards Board (FASB) has received inquiries from tax practitioners about the applicability of deferred tax accounting under ASC 740 to the global minimum tax. At this time, FASB staff believe the Pillar Two global minimum tax should be viewed as similar to the alterative minimum tax (AMT) as discussed in Topic 740 Income Taxes. Topic 740 states that for an alternative minimum tax, deferred taxes would not be recognized or adjusted for the future effects of the minimum tax.
Additionally, for those preparing income tax provisions under international standards, the International Accounting Standards Board (IASB) has recently published an exposure draft regarding the global minimum tax. The IASB has proposed a temporary exception to the accounting for deferred taxes arising from the implementation of the Pillar Two rules and specific disclosure requirements.
As of March 31, 2023, very few countries have enacted legislation to adopt the objectives set forth in the Pillar Two framework. However, during 2023 there is expected to be significant legislative changes across the approximately 140 countries that have collectively agreed to the Pillar Two framework. Ultimately, companies will need to evaluate the laws that are enacted for impacts on their income tax provision and reflect those impacts in the period in which the legislation is enacted.
Updates from the Financial Accounting Standards Board (FASB)
The FASB issued two accounting standards updates (ASU) during the first three months of the year, including ASU 2023-01: Leases (Topic 842) addressing common control arrangements and ASU 2023-02: Investments – Equity Method and Joint Ventures (Topic 323) that addresses accounting for investments in tax credit structures.
ASU 2023-02 expands the availability of the proportional amortization method for accounting in investments in tax credit structures. Historically, the proportional amortization method was limited in scope and could only be used to account for investments in low-income-housing tax credit structures. Under the new guidance, companies will be able to elect the proportional amortization method for investments in other tax credit programs if certain criteria are met. Adoption of ASU 2023-02 is required for public business entities for fiscal years beginning after Dec. 15, 2023, and for all other entities adoption is required for fiscal years beginning after Dec. 15, 2024. Companies may elect to adopt the guidance prior to the required dates.
The FASB also issued a proposed ASU that is the result of a long-standing agenda item regarding additional income tax disclosures. The proposed ASU aims to improve the transparency and consistency of income tax disclosures by expanding the required disclosures around the rate reconciliation and income tax paid. The proposed ASU is the result of several years of deliberation by the FASB and multiple rounds of feedback from stakeholders, including financial statement preparers and readers of financial statements. The FASB is accepting comments on the proposed ASU through May 30, 2023 and will consider these comments in finalizing the ASU. Read more about the proposed disclosures in the following tax alert: ASC 740: FASB proposes new income tax disclosures.
State tax
There were several significant state tax law changes in the first quarter of 2023, including changes to tax rates, apportionment methodologies and updates to conformity with the Internal Revenue Code. Read more about state and local tax considerations in our companion alert: State tax law changes for the first quarter 2023.
International tax
Australia
In 2018, the Australian Taxation Office published guidance on when foreign incorporated companies would be treated as Australian tax residents. Transitional arrangements were put in place to allow companies time to change their governance arrangements to adhere to the new guidance. These transitional arrangements, which were due to expire on Dec. 31, 2022, will be extended again, to June 30, 2023.
Croatia
In December 2022, the United States and Croatia and signed the first ever income tax treaty. The treaty must still be ratified by each country before coming into force. Read more about the treaty in the tax alert: United States and Croatia sign first ever income tax treaty.
France
The contribution on the value added of companies (CVAE) has been abolished under Article 55 of the 2023 Finance Act and will be phased out over a two-year period. The objective of this new local tax reform is to support economic activity and industrial recovery. Considered as one of the main production taxes, the CVAE, is a local tax based on the taxable value added, the tax rate of which is determined according to a progressive scale based on the turnover of the company or the group to which it belongs. The CVAE is a self-assessed tax. It must be paid by any taxpayer that exercises a business activity as of Jan. 1 of the tax year.
The Finance Act for 2023 provides for the gradual elimination of the CVAE tax over the next two years with the CVAE rate being reduced by half in 2023 and eliminated in 2024.
Hong Kong
On Jan. 1, 2023, the Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance 2022, which amended the provisions in relation to the Foreign Source Income Exemption (FSIE) regime under the Inland Revenue Ordinance (Cap. 112), came into operation. Under the new FSIE regime, certain foreign-sourced income accrued to a member of a multinational enterprise group (MNE entity) carrying on a trade, profession or business in Hong Kong is to be regarded as arising in or derived from Hong Kong and chargeable to profits tax if the recipient entity fails to meet the economic substance, participation or nexus requirements (as applicable).
Netherlands
Effective Jan. 1, 2023, the lower bracket of the corporate income tax rate of 15% is increased to 19%. Also, the upper threshold for the 19% tax bracket has been reduced from EUR 395,000 to EUR 200,000. Beginning Jan. 1, 2023, the enacted tax brackets are as follows:
- EUR 0 – EUR 200,000 – 19%
- In excess of EUR 200,000 – 25.8%
On Dec. 12, 2022, the European Union Council announced that EU Member States had reached an agreement to implement the minimum tax component (Pillar Two) of OECD’s global international tax reform initiative. The Directive must be implemented in national law of the EU Member States by Dec. 31, 2023. The income inclusion rule and the qualified domestic minimum top-up taxes in general will apply in respect of fiscal years beginning from Dec. 31, 2023. The undertaxed payments rule in general will apply in respect of fiscal years beginning from Dec. 31, 2024. The Netherlands has already published a consultation bill with plans to submit an amended bill to the House of Representatives and the Senate during 2023 with an intention that the law will enter into force on Dec. 31, 2023 (effective from Jan. 1, 2024).
United Kingdom
The Chancellor of the Exchequer delivered his Spring Budget on March 15, 2023, with the associated Finance Bill published the following week on March 23, 2023. The key points to note in regard to proposed changes to corporate income taxes are as follows.
- Despite speculation that a further rate change might be announced, the previously enacted increase to the main rate of corporation tax from 19% to 25% for companies with profits of £250,000 (divided by the number of worldwide associated companies) or more with effect from April 1, 2023 was confirmed.
- The implementation of the income inclusion rule aspect of the OECD Pillar Two global minimum tax rules will go ahead in the UK as planned for accounting periods beginning on or after Dec. 31, 2023. At the same time, a UK domestic top-up tax, which also applies to wholly domestic businesses, will be introduced to ensure that in-scope multinational enterprises that have an effective tax rate on their UK operations below 15% pay a top-up tax in the UK rather than elsewhere.
- ‘Full expensing’ is introduced in respect of qualifying capital expenditure by companies on most new plant and machinery for the three years beginning April 1, 2023. This will provide 100% tax relief in the year of acquisition for such expenditure and replaces the 130% super-deduction for similar capital expenditure which ceases on March 31, 2023.
- There were numerous developments in relation to enhanced research and development (R&D) tax relief, most notably the introduction from April 1, 2023 of a higher 14.5% rate of refundable credit for loss-making companies that qualify as small and medium-sized enterprises (SMEs) and are ‘R&D intensive’, which mitigates the impact of the previously announced reduction in the refundable credit rate from 14.5% to 10% for SMEs generally. Significant new compliance requirements were also confirmed, including a pre-notification requirement for new claimants and a requirement for all claims submitted after Aug. 1, 2023 to be accompanied by an additional information form submitted via an online portal.
- The enhanced tax reliefs available to producers and developers of films, television programs and video games will be reformed to coincide with the introduction of the multinational and domestic top-up taxes. An expenditure credit model will be introduced to ensure that these reliefs continue to be effective in incentivizing qualifying activities, and as part of this process certain technical changes will be made, including the withdrawal of relief for video game development expenditure incurred in the European Economic Area.
- New designated investment zones are to be introduced, which will entitle investors to access a range of tax incentives, including enhanced rates of relief for capital expenditure in those designated zones, for up to five years.
A summary of the measures announced in the Spring Budget, with further more detailed analysis from RSM UK.
