SEC Staff Provides Disclosure and Accounting Guidance in Response to Recent Tax Reform Legislation

On December 22, 2017, President Trump signed into law tax legislation commonly referred to as the Tax Cuts and Jobs Act (the Tax Bill). The Tax Bill made significant changes to corporate taxation, including, among other things, lowering the highest corporate tax rate from 35% to 21% for tax years beginning on or after January 1, 2018.

Before the President signed the Tax Bill into law, numerous companies and industry groups asked the Securities and Exchange Commission (SEC) to issue guidance interpreting Accounting Standards Codification Topic 740 (ASC Topic 740), which requires companies to reflect the impact of tax law changes in the quarter in which the law is enacted. Given the significant concerns among filers, on December 22, 2017, the SEC Office of the Chief Accountant and the Division of Corporation Finance (Staff) issued guidance designed to clarify and reconcile certain diverse viewpoints regarding the information required to comply with ASC Topic 740, and the disclosure requirements under Item 2.06 of Form 8-K. 

Staff Accounting Bulletin No. 118

The SEC Staff issued Staff Accounting Bulletin No. 118 (SAB 118) to clarify certain aspects of ASC Topic 740, which does not address situations in which companies are not able to adequately assess the impact of new tax legislation. Specifically, SAB 118 provides a three-step process for applying ASC Topic 740: 

1. First, a company must reflect in its financial statements the income tax effects of the Tax Bill on items for which the company can make a complete assessment under ASC Topic 740. These items are not provisional items.
2. Next, during a company’s “measurement period,” a company must report provisional amounts of the income tax effects of the Tax Bill for items for which the company’s assessment under ASC Topic 740 is incomplete, but for which it can make a reasonable estimate. A company may adjust provisional amounts as it obtains additional information in subsequent reporting periods. Any such provisional amounts or adjustments included in a company’s financial statements during the “measurement period” should be included in income from continuing operations as an adjustment to tax expense or benefit in the reporting period in which the amounts are determined.
3. Finally, for items for which a company cannot make a reasonable estimate, a company is not required to report provisional amounts, and it would continue to apply ASC Topic 740 based on the tax law existing immediately before December 22, 2017. A company is required to report provisional amounts for these items in the first reporting period in which the company is able to make a reasonable estimate of the income tax effects of the Tax Bill. 

SAB 118 specifies that a company’s “measurement period” lasts from December 22, 2017 (the Tax Bill’s enactment date) until the date on which the company, acting in good faith, has obtained, prepared and analyzed the information it needs to complete the accounting requirements under ASC Topic 740. In no event can the “measurement period” extend beyond December 22, 2018. 

SAB 118 also provides that a company should disclose the following information regarding the financial statement reporting impacts of the Tax Bill for items for which an assessment under ASC Topic 740 is incomplete: 

1. Qualitative disclosures of the income tax effects of the Tax Bill for which the accounting is incomplete;
2. Disclosures of items reported as provisional amounts;
3. Disclosures of existing current or deferred tax amounts for which the income tax effects of the Tax Bill have not been completed;
4. The reason why the initial accounting is incomplete;
5. The additional information that is needed to be obtained, prepared or analyzed in order to complete the accounting requirements under ASC Topic 740;
6. The nature and amount of any measurement period adjustments recognized during the reporting period;
7. The effect of measurement period adjustments on the effective tax rate; and
8. When the accounting for the income tax effects of the Tax Bill has been completed.

SAB 118 only applies to the income tax effect of the Tax Bill, and the guidance provides that a company may not report provisional amounts or adjustments to provisional amounts for tax changes that are unrelated to the Tax Bill. 

CD&I 110.02

In addition to SAB 118, the SEC Staff issued Compliance and Disclosure Interpretations 110.02 (CD&I 110.02), which provides that the re-measurement of deferred tax assets (DTAs) due to the reduced maximum tax rate, or other provisions of the Tax Bill, does not trigger a filing obligation under Item 2.06 of Form 8-K. According to the guidance, a re-measurement of DTAs due to the Tax Bill is not an impairment under ASC Topic 740. However, if during its “measurement period,” a company determines that an impairment has occurred due to the Tax Bill, the company may rely on the instructions to Item 2.06 of Form 8-K, and disclose the impairment or provisional amount regarding a possible impairment in the company’s next periodic report. 

Observations

While SAB 118 and CD&I 110.02 provide companies with much-needed guidance for applying ASC Topic 740 in the context of the recently enacted sweeping tax reform legislation, the guidance is silent on various important accounting issues. For example, the guidance does not discuss how to address ASC Topic 740 in the context of filing new registration statements, or on making offerings under effective registration statements. The SEC Staff also did not specify the extent to which the guidance applies to voluntary disclosures under Regulation FD, such as earnings releases. Eversheds Sutherland attorneys are available to assist you in interpreting these and other questions related to accounting changes triggered by the Tax Bill.

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