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Tax Accounting

Tax Accounting

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Tax Accounting

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  1. Tax Accounting Insurance Tax Conference November 4, 2010 Maria Jones, Miller & Chevalier Frank Svoboda, Torchmark Corporation Ryan Gibbons, Zurich North America Susan Leonard, Moderator PricewaterhouseCoopers LLP 1

  2. Tax Accounting • Agenda: • UTP • SSAP10R • Financial Reporting & Income Taxes • US GAAP & IFRS Convergence • Accounting for Insurance Contracts • Deferred Tax Assets Related to Debt Securities 2

  3. Schedule UTP

  4. Final Schedule UTP • Released September 24, 2010 • Required for 2010 tax return • Taxpayers must report on Schedule UTP if: • Tax position taken on its U.S. federal income tax return for the current year or a prior year, and • Company or a related party has recorded a reserve for that tax position for U.S. federal income tax in audited financial statements, or did not record a reserve because the company expects to litigate the position • Tax positions taken before the 2010 tax year will not be reported

  5. Final Schedule UTP • Final Schedule UTP and Instructions • Announcement 2010-75, Reporting of Uncertain Tax Positions • Announcement 2010-76, Requests for Documents Provided to Independent Auditors, Policy of Restraint, and Uncertain Tax Positions • IRS Directive for All Large Business and International Division Personnel from Steven T. Miller, Deputy Commissioner for Services and Enforcement, to All LB&I Personnel, regarding the Reporting of Uncertain Tax Positions (the “Directive”)

  6. Final Schedule UTP • Significant changes from draft schedule • Phase-in for small companies • No disclosure for general administrative practice items • Clarified expect to litigate UTPs • Maximum tax adjustment (MTA) estimate eliminated • Ranking of reserve items and identification of 10% items • Issue description not to include rationale

  7. Final Schedule UTP • Phase-in for small companies • For 2010, private or public companies with total assets of $100 million or more that issue or are included in audited financial statements and that file a Form 1120, 1120-F, Form 1120-L, or Form 1120-PC must file Schedule UTP. • Companies with total assets of $50 million or more will need to file beginning in 2012. • Companies with total assets of $10 million or more will need to file beginning in 2014.

  8. Final Schedule UTP • Eliminated disclosure for general administrative practice items • Items for which a reserve would have been recorded but for a determination that the IRS has a practice of not challenging these items during an examination. • Draft Schedule UTP required disclosure

  9. Final Schedule UTP • Clarifies requirement for disclosure of UTPs that taxpayers expect to litigate. • Report tax positions for which company did not record a reserve because it expects to litigate the position. • Instructions clarify that items to be reported are those for which the company has determined that the probability of settling with the IRS is less than 50%, and under applicable accounting standards, no reserve was recorded because the company intends to litigate the tax position and has determined that it is more likely than not to prevail on the merits in litigation.

  10. Final Schedule UTP • Maximum tax adjustment (MTA) estimate eliminated • New requirements • Ranking of reserve items • Items for which no reserve has been booked due to expectation that the issue will be litigated can be assigned any rank, regardless of amount at issue • Indicate if item constitutes more than 10% of the total reserves for all items disclosed on the Schedule UTP • Indicate transfer pricing positions with a “T” and all other positions with a “G”

  11. Final Schedule UTP • Tax position description not to include rationale • Concise description of relevant facts and information to apprise the IRS of the identity of the position and the nature of the issue. • Not required to include the rationale for the UTP and the nature of the uncertainty in the description • Should not include an assessment of the hazards or an analysis of the support for or against the position. • These instructions are consistent with the disclosures that taxpayers make for penalty-protection purposes on Form 8275.

  12. Final Schedule UTP: Related Administrative Issues • Expanded Policy of Restraint in Announcement 2010-76 • IRS expanding its policy of restraint to include “particular documents that relate to uncertain tax positions and the workpapers that document the completion of Schedule UTP.” • If taxpayer provides a document that is otherwise protected under the attorney-client privilege, section 7525, or the work-product doctrine to an independent auditor as part of an audit of the taxpayer’s financial statements, the IRS will not assert during an examination that the taxpayer waived the applicable protection by providing the document to the auditor.

  13. Final Schedule UTP: Related Administrative Issues • Expanded Policy of Restraint in Announcement 2010-76 • This policy will not apply to documents for which the taxpayer has waived the applicable protection by some other means and to requests for tax accrual workpapers where “unusual circumstances exist or the taxpayer has claimed the benefits of a listed transaction.” • The expanded policy of restraint will also allow taxpayers to redact some information from tax reconciliation workpapers relating to the preparation of Schedule UTP. • The IRS’s policy of restraint does not in any way affect the discoverability of documents in litigation or other contexts.

  14. Final Schedule UTP: Related Administrative Issues • Duplicative Reporting • Announcement 2010-75 provides that for positions other than reportable transactions, a complete and accurate disclosure of a tax position on Schedule UTP will be treated as if the corporation filed a Form 8275 or 8275-R • IRS studying whether Schedule UTP could suffice for reportable-transaction-disclosure purposes. • IRS is forming a working group to study and revise Schedule M-3 to reduce the extent to which Schedule M-3 and Schedule UTP require duplicate reporting.

  15. Final Schedule UTP: Related Administrative Issues • CAP Taxpayers • Must file Schedule UTP • Protective Form 1120F filers  • Must file Schedule UTP

  16. Final Schedule UTP: How will this change the IRS Exam? • IRS Processing of Schedule UTP • Directive states that the IRS will establish a “centralized process” in LB&I • Centralized process is intended to enable LB&I to select issues and returns for audit, and identify gaps in guidance • LB&I agents will receive training on Schedule UTP over the next year  

  17. Final Schedule UTP: How will this change the IRS Exam? • IRS recognizes this as a “Game Changer” • Part of drive towards greater taxpayer transparency • Schedule UTP is intended to advance to earlier in the process discussions between the IRS and taxpayers on important issues • Concern that Exam will feel compelled to issue NOPAs with a proposed adjustment for each item listed on Schedule UTP

  18. Final Schedule UTP: How will this change the IRS Exam? • Exam cannot settle issues based on the hazards of litigation • Must propose adjustment, or give it up completely • Hard to give up when the taxpayer has acknowledged risk • Exam likely to feel compelled to “write it up”

  19. Final Schedule UTP: How will this change the IRS Exam? • Expect to see a push to expand LMSB programs • Compliance Assurance Process (CAP) • Pre-Filing Agreements (PFA) • National Office Guidance • Fast Track Appeals • May see new initiatives to push Appeals settlement authority down to the Exam level • Similar to Accelerated Issues Resolution • Settlement Guidelines / Global Offers

  20. Final Schedule UTP: How will this change the IRS Exam? • Exam will need to be instructed as to what to do with the new information • How much discretion will they have to not raise issues listed on the schedule? • To what extent will they examine issues not on the schedule? • Will the instructions and training materials be made public?

  21. Final Schedule UTP: Best Practices • Companies required to file Schedule UTP should examine procedures for handling issues that will be listed on the schedule • Prepare for the likely examination of the issue • Identify and organize documents • Identify key individuals with knowledge • Develop legal position/prepare position paper if appropriate

  22. Update on Statutory Accounting for Deferred Taxes

  23. Where Have We Been? • SSAP10R adopted in 2009 • Applicable only to 2009 and 2010 annual statements • Expanded ability to admit DTAs if meet certain minimum RBC thresholds (i.e., for financially stable companies) • Generally required companies to: • First determine “net realizable” gross capital and ordinary DTAs (after a valuation allowance), • Admit the portion that will be realizable within 3 years • Limit the admitted DTA relying on future taxable income to 15% of capital and surplus • Provide expanded disclosures and reporting of “incremental” DTA

  24. Where Have We Been (Cont.) • Impact of adoption • Life industry - Approx. $10 billion incremental DTA • Net admitted DTA approx. 11% of C&S and 40% of Adjusted Gross DTA.¹ • P&C industry - $3.5 billion incremental DTA • Net admitted DTA approx. 5% of C&S and 52% of Adjusted Gross DTA. ¹

  25. Issues with Adoption • Implementation Issues • Reporting of Valuation Allowance • Reduction of Gross DTA (net of DTL) on p2, col 1, or • Inclusion as part of non-admitted asset in col 2 • Most have reduced the Gross DTA, but diversity in practice • Para. 6e indicates Gross DTAs should be reduced by a valuation allowance to determine “adjusted” gross DTAs • Footnote 1 further indicates that only “Adjusted” gross DTAs are subject to the admissibility test of Para 10. • Different interpretations of the meaning of “within the financial statements”, however • NAIC instructions support reduction of p2 col 1 Gross DTA

  26. Implementation Issues (cont.) • Surplus adjustment for incremental DTA • Diversity in practice as to how incremental DTA, and the related change in nonadmitted DTA, flows through surplus • Change in nonadmitted asset per page 2 and Exhibit of Nonadmitted Assets reflects effect of incremental DTA, but • Effect of incremental required to be separately reported as a write-in through surplus • Report change in nonadmitted asset through surplus equal to change from Exhibit of Nonadmitted Assets? • No cross-check error, but need additional write-in to offset increase in surplus required for write-in of incremental DTA • Allow cross-check error, in that surplus line item for change in nonadmitted asset doesn’t tie to Exhibit of Nonadmitted Assets (higher since offsetting the incremental DTA reported separately)

  27. Implementation Issues (cont.) • Requirement of SSAP10R paragraph 18(g) to report each component of the calculation, by tax character (i.e., 10a, 10b, 10c, 10ei, 10eii, 10eiii) • Question as to whether amounts reported for Para. 10(e) should be the “incremental” amount, or the total amount computed under such paragraph • Instructions would indicate the whole amount • Para. 10e operates independently of Para. 10a, b and c, and thus supports position total amount should be reported • Some companies reported incremental so that the total of the lines for Para. 10(e) agreed to the incremental amount reported, and the sum of all lines equaled the total admitted DTA

  28. Implementation Issues (cont.) • Other • Components of deferred tax asset – net of valuation allowance or gross? • Mechanics of reporting a non-admitted asset when company in overall DTL position • Capital DTA, with portion non-admitted • Ordinary DTL that exceeds admitted capital DTA • Proper reporting of Incremental DTA as a write in for “Special” surplus funds (pg. 3, line 34 of life blue book) • Separate company calculations vs. consolidated group • Use of tax-sharing agreement • Cumulative losses

  29. What’s Next • Extension of SSAP10R through 2011 Annual Statements • Provides for one more year to review and consider • data call results and 2010 annual statement data, • use of tax-planning strategies, • FIN48, • Academy of Actuaries report on RBC charges on DTA, • impact of tax-sharing agreements, and • impact of admitted DTAs during receivership. • DTA Subgroup to submit formal recommendation to SAPWG, likely after first of year, to be commented on and voted on in 2011 • Possible could be further extended, depending on results • Interested parties from across insurance industry will continue to work with NAIC to formulate a solution – something other than a return to the original SSAP10.

  30. What’s Next (cont.) • Imposition of new disclosure on use of tax-planning strategies • “The impact of tax-planning strategies on the determination of adjusted gross DTAs and the determination of net admitted DTAs, by percentage and by tax character” • Recommendation to NAIC that a narrative be provided with the percentages of the total, using a with/without computation, rather than a tabular presentation • Need to disclose impact on both Gross DTA and admitted DTA • Closely consider impact of tax planning strategies on use of capital DTAs, like impaired securities • If no carryback potential, tax planning strategies likely used to support no valuation allowance • Strategy to hold to recovery • Strategy to sell and trigger tax loss • Strategy to sell gain securities in portfolio • Very possible 100% of capital gross and admitted DTAs could be attributable to use of tax-planning strategies

  31. What’s Next (cont.) • FIN48 Discussion • Possible consideration of expansion of FIN48 rather than current SSAP5 model • Could be problematic if required to record FIN48 current liability and a deferred tax asset that might not be admissible • Future data calls • NAIC wants ability to capture footnote information, aggregate it and analyze the components • Poor response and data collection for 2009 • Hoping for better results in 2010 – important for industry to respond and provide consistent data • Format likely similar to illustration within instructions

  32. Financial Reporting & Income Taxes: PotpourriUS GAAP & IFRS Convergence, Accounting for Insurance Contracts, and Deferred Tax Assets Related to Debt Securities

  33. US GAAP & IFRS Convergence

  34. IFRS is Gaining Momentum Worldwide • More than 110 countries around the world require or permit IFRS in some form for companies listed domestically. • The European Union, Australia, New Zealand, and Israel currently require IFRS. • Several other key jurisdictions are in the process of requiring IFRS for public companies: Brazil and India in 2010, Canada and South Korea in 2011, Mexico and Argentina in 2012. • Japan is working on an IFRS convergence project and is scheduled to decide on mandatory use by 2012.

  35. Update on the SEC’s Consideration of Adoption of IFRS by US Companies • The SEC issued a proposed “Roadmap” to adoption of IFRS in the US in November 2008. 200 comment letters were received. • On February 24, 2010, the SEC published a statement reaffirming its support for a single set of high-quality global accounting standards and for the convergence of US GAAP and IFRS. • The SEC noted that timely completion of the convergence project would best position IFRS to serve as the single set of global accounting standards.

  36. The SEC’s Work Plan Will Lead to a Decision on IFRS by 2011 • The SEC’s statement announced a work plan to address several items requiring further analysis and the events that must occur by 2011 when the SEC expects to make a determination on whether to further incorporate IFRS into the US financial reporting system. • The work plan identifies six areas of concern: • Sufficient development and application of IFRS for the US domestic reporting system • Independence of the standard setting process • Investor understanding and education regarding IFRS • Examination of the US regulatory environment that would be impacted by a change in accounting standards • The effect of IFRS on both large and small US issuers • Human capital readiness • If the SEC decides to move forward with adopting IFRS, US companies would report under IFRS no earlier than 2015, with prior-year comparables required.

  37. Numerous Accounting Standards are Being Impacted by US GAAP and IFRS Convergence • IFRS has already significantly influenced US GAAP. The ongoing US GAAP and IFRS convergence project is resulting in numerous changes to accounting standards, regardless of the SEC’s decision on adopting IFRS. • In a 2009 Memorandum of Understanding the FASB and IASB committed to jointly developing standards that will converge and improve US GAAP and IFRS in the following several areas, with final standards issued by the end of 2011. There are other joint projects not covered in the MoU.

  38. The Impact of IFRS Convergence on the Tax Function • IFRS convergence would have significant impacts on many aspects of a company’s tax function. • Tax provision (ASC 740 (FAS 109) vs. IAS 12) • Changes in the determination of book income and tax expense will impact the effective tax rate • DTAs and DTLs will need to be recalculated using IFRS basis • Uncertain tax positions • Tax planning and compliance • Computation of book-tax differences • Cash taxes where financial accounting drives tax calculation (e.g. leases, advance payments) • State: state tax apportionment and net-worth calculations • Foreign: foreign tax credits, cash repatriation strategies, and transfer pricing

  39. The Impact of IFRS Convergence on the Tax Function (Continued) • Tax controversy • Financial accounting changes may prompt taxing authorities to take new positions on tax issues • Requirement to request consent to change tax accounting methods • Tax processes, controls, and people • Processes in all elements of the tax function will need to be redesigned • Adjust controls for changes in processes • Extensive training for personnel at all levels

  40. Accounting for Insurance Contracts

  41. The FASB and IASB are Working on a Joint Project on Accounting for Insurance Contracts • While not included in the 2009 Memorandum of Understanding, the FASB and IASB are working on new guidance on accounting for insurance contracts. • The IASB issued an exposure draft on its standard (IFRS 4) on July 30, 2010. The comment period is open until November 30, 2010. A final standard is expected by June 30, 2011. • The FASB issued a discussion paper on its preliminary views on September 17, 2010, with a comment period open until December 15, 2010. • The FASB and IASB will jointly host roundtable discussions in December in Tokyo, London, and Norwalk, CT.

  42. Accounting for Insurance Contracts:Highlights of FASB and IASB Proposals • The FASB and IASB agree on many, but not all elements. Their proposals represent a fundamental change from current accounting rules. • Highlights of the proposals: • Single model for all types of insurance: P&C, life, health, reinsurance. • Requires unbundling of components not closely related to insurance coverage. • Contracts are measured using the estimated present value of cash flows, re-measured at each reporting period, and discounted at a risk-free rate of return. • The measurement model consists of “building blocks.” The FASB model has 3 building blocks and the IASB model has 4. • Estimated profit is deferred at contact inception and amortized over the life of the contact; estimated losses are recognized immediately. • Incremental contract acquisition costs are included in net cash flows, deferring and amortizing them over future periods. Other acquisition costs are expensed. • The IASB proposal requires a simplified measurement model for short-duration contracts. • Contract issuers would not recognize premiums as revenue but instead report underwriting margin and changes in cash flow estimates and experience variances. • Extensive information provided in footnote disclosures.

  43. Accounting for Insurance Contracts:Measurement Model • Building blocks used in measurement model: • #1: Expected future cash outflows less future cash inflows • Cash outflows: probability-weighted range of scenarios reflecting possible outcomes. • #2: Discounting using current rates to reflect the time value of money • Not based on assets actually held; based on assets that match the risk. • #3 (IASB model): Risk adjustment • Amount the insured would rationally pay to transfer risk. • #4 (IASB model): Residual margin • Removes profit at inception and releases over time, not remeasured. • #3 (FASB model): Composite margin • Combination of IASB’s risk adjustment and residual margin building blocks. • Simplified measurement model for short-duration contracts: • Applies to IASB model; no similar provision in FASB model. • Pre-claims obligation equals discounted premiums less acquisition costs, reduced over the coverage period

  44. Deferred Tax Assets Related to Debt Securities

  45. Deferred Tax Assets Related to Debt Securities – Background • Debt securities classified as available-for-sale (AFS) generate unrealized gains or losses when they are marked to market. • Alternate views exist on the evaluation of deferred tax assets on unrealized losses on AFS securities: • View A: DTAs on unrealized losses are evaluated separately from other DTAs and DTLs in determining whether a valuation allowance is required (discrete approach). • View B: All deferred tax items are evaluated in the aggregate for realizability based on taxable profits or other sources (comprehensive approach).

  46. Deferred Tax Assets Related to Debt Securities – Current Status • SEC • Either approach is acceptable. • Selection of either approach is an accounting policy that should be applied consistently. • FASB • Exposure Draft issued on May 26, 2010, “Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities” includes guidance that specifies that View B is correct. • Until final Accounting Standard Update is issued, entities should continue to follow their current accounting policy. • IASB • IFRS staff supports View B. • IFRS Interpretations Committee (IFRIC) will address the issue at its meeting scheduled for November 4th and 5th.

  47. Contact Info Maria Jones (202) 626-6057 mjones@milchev.com Frank Svoboda FSVOBODA@torchmarkcorp.com Ryan Gibbons (847) 605-7631 ryan.gibbons@zurichna.com Susan Leonard (213) 830-8248 susan.leonard@us.pwc.com

  48. This document is not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties that may be imposed on the taxpayer. October 29, 2014 48