An Overview of ASU 2023-09 Improvements to Income Tax Disclosures

Background

On December 14, 2023, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) regarding income tax disclosures found in Topic 740 of the codification.  The update, known as ASU 2023-09, was created in response to investors’ requests for improvements to “enhance the transparency and decision usefulness” of income tax disclosures. Specifically, investors wanted improved disclosures for the following three reasons:

1. To better understand an entity’s exposure to potential changes in jurisdictional tax legislation and the ensuing risks and opportunities.
2. To better assess income tax information that affects cash flow forecasts and capital allocation decisions.
3. To better identify potential opportunities to increase future cash flows.

The changes are primarily designed to benefit investors, aiding them in making informed capital allocation decisions.

ASU 2023-09 applies to all entities that are subject to Topic 740, Income taxes. For public business entities (PBEs), the new requirements will be effective for fiscal periods beginning after December 15, 2024. For other entities, the requirements will be effective for fiscal periods beginning after December 15, 2025. Early adoption is permitted, but unlikely.

The update includes two main provisions: rate reconciliation, and other disclosures. They will each be discussed in this article.

Rate Reconciliation Requirements

One of the largest changes ASU 2023-09 implemented was more specific requirements surrounding the income tax rate reconciliation. The requirements give eight specific categories that must be disclosed in addition to anything that meets the 5% threshold required in Regulation S-X. 

Some overall requirements to be considered in a rate reconciliation are:

• The rate reconciliation must use both percentages and currency amounts
• Numerical reconciliation is only required for public business entities. Qualitative disclosures are required for all other entities, although the qualitative disclosures differ for non-public business entities
• ASC 740-10-50-12C “A public business entity shall provide an explanation, if not otherwise evident, of individual reconciling items… such as the nature, effect, and underlying causes of the reconciling items and the judgment used in categorizing the reconciling items”
• The first line in the reconciliation is “computed by multiplying the income (or loss) from continuing operations before income taxes by the applicable statutory federal (national) income tax rate of the jurisdiction (country) of domicile.” “Public business entities using a rate other than the US federal corporate income tax rate must disclose the rate and the basis for using the rate” (ASC 740-10-50-12)
• Reconciliations should be disclosed each annual reporting period (ASC 740-10-50-12)

The table below outlines the eight mandatory categories to be included in the rate reconciliation, along with the specific considerations required for each category:

❶ A qualitative description of the state and local jurisdictions that make up >50% of the effect of the state and local income tax category must be given

❷ Anything that does not fall under the 8 categories but does meet the 5% quantitative threshold should be disaggregated by nature

❸ Companies may choose to report these net of their related tax credits, any remaining tax credits would be reported gross under tax credits

❹ Companies may choose to report these net of the underlying positions taken in the current year

❺ "A reporting entity that is domiciled in the United States is required to separately disclose any reconciling item whose tax effect is greater than 1.05 percent (21% × 5%) of income from continuing operations". This applies to any category with a “yes” in the disaggregation of 5% quantitative threshold column above in addition to the other category

In addition, the ASU incorporates an example of a rate reconciliation to illustrate the different specific categories that are required. 

Example 39

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In a comment letter to Wave Sync Corp., the SEC questions the rationale behind valuing stock that was issued in a November 2021 transaction at a significantly different amount from the cash received in a July 2021 third-party stock sale. The letter points out Wave Sync Corp.’s absence of substantive operations before November 2021 and the lack of observable factors supporting the notable increase in stock value during that period. Specifically, the SEC states, “we note that the Registrant had no substantive operations prior to the November 2021 transaction and that there were no observable factors that could reasonably support your conclusion that the stock value increased from $.50/share to $4/share during that period.” Additionally, the SEC references the commencement of negotiations in April 2021 and emphasizes the need to adhere to ASC 820-10-05-1c, which requires maximizing the use of relevant observable inputs for fair value estimation. They request a revision to fully comply with ASC guidance.

The response from Wave Sync Corp. asserts that since new management took over and the company began generating revenue in 2021, the value of the company and its common stock has increased from less than $1 per share to over $1 per share. In this response, Wave Sync Corp. backed up this assertion with an estimation that management conducted using level 3 inputs.

Level 3 Measurement

Wave Sync Cor. outlined its transition into the digital mining industry and shared that its five-year projection would include total profits of $81.5 million ($16.3 million per year on average). It also shared its earnings per share (EPS) prediction over the five-year period of $2.58 ($0.52 each year). Using this information and the given market price-to-equity ratio (P/E ratio) of 1.6, Wave Sync Corp. calculated its projected share price as $0.83 per share before its stock reverse split. Following the 1-for-5 reverse split, it calculated a share price of $4.14 per share.

Finally, Wave Sync Corp. argued that its stock price of $0.50 may not effectively reflect the company’s value in an inactive market. Wave Sync Corp. defended its valuation, based on Level 3 unobservable inputs derived from market data at the time, as representing the company's worth accurately.

Based on its analysis and negotiation process, Wave Sync Corp. concludes that $4 per share is a reasonable price for the November 2021 purchase transaction, which was agreed upon unanimously by both parties involved.

Wave Sync Corp.'s response justifies the notable rise in the valuation of its stock from $0.50 per share to $4 per share, relying on Level 3 inputs for fair value measurement. Using fair value methodology ensures that financial measurements accurately depict the economic reality of a company, providing stakeholders with reliable information for decision-making. This approach is particularly crucial in volatile markets like cryptocurrencies, where precise valuation is essential for transparency and credibility.

Additional Disclosures 

Income tax expense and income taxes paid

Within the statement of cash flows, companies are required to disclose the amount of income taxes paid disaggregated by federal, state, and foreign. All jurisdictions to which income tax paid is greater than 5% of total income taxes paid must be disclosed (ASC 740-10-50-22 and 23). Income tax paid is calculated net of refunds received in this calculation. 

Income (or loss) from continuing operations before income tax expense must be disaggregated between domestic and foreign (ASC 740-10-50-10A). Additionally, income tax expense (or benefit) from continuing operations must be disaggregated by federal, state, and foreign shall be disclosed for each annual reporting period. Income taxes on foreign earnings that are imposed by the jurisdiction of domicile shall be included in the amount for the jurisdiction of domicile (ASC 740-10-50-10B). Both of these requirements are consistent with current SEC Regulation S-X requirements Rule 4-08(h).

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Removed Disclosures

Unrecognized Tax Benefits

In relation to unrecognized tax benefits, public business entities no longer must disclose “positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date”

Deferred Tax Liability

The ASU removes the requirement to report the “cumulative amount of each type of temporary difference” when a “deferred tax liability is not recognized due to exceptions to comprehensive recognition…related to subsidiaries and corporate joint ventures” (ASU 740-30-50-2). According to the basis for conclusion, paragraph 94, stakeholders indicated the reason for this change results from the Tax Cuts and Jobs Act, and “a change in assertion about the indefinite reinvestment of foreign earnings would not result in the recognition of a material deferred tax liability in many cases.”

Responses to the ASU

The proposed ASU was released in March 2023. During a period of a few months, entities and stakeholders had the opportunity to submit comment letters to the FASB, expressing their thoughts on the update. In total, 61 comment letters were submitted, with the majority coming from CPA firms and financial institutions.

The CPA firms, such as KPMG and RSM, responded very positively to the proposed updates, supporting all the FASB positions and affirming that the proposed amendments would be helpful for investors. On the other hand, some financial institutions, including Mastercard and American Express, as well as other companies and organizations in the industry, such as Greif Inc. and the National Association of Manufacturing, disagreed with many of the proposed amendments. These groups felt that the new requirements would increase the cost and complexity of the disclosure process without providing additional useful information to investors. Some even suggested that the new requirements undermine the materiality standard by mandating unnecessarily detailed disclosures.

Other groups, especially U.S. Congress, expressed significant concern regarding the disaggregation of jurisdictional tax information. They were concerned that such disclosures result in a competitive disadvantage for companies since other foreign competitors are not required to disclose such detailed tax information. Additionally, Congress was particularly concerned that the unrecognized tax benefits disclosures would expose U.S. companies to increased tax audits by foreign governments. 

In response to these concerns, the FASB spoke with investors to understand the practical use of these disclosures. Investors expressed that, for unrecognized tax benefits, an aggregated disclosure would adequately serve their analytical needs. As a result, the FASB decided to allow entities to aggregate disclosures related to unrecognized tax benefits across all jurisdictions. However, they maintained that the other disaggregated disclosures remain separate, as they are disclosed at a high enough level that the benefits of better information outweighed the potential costs. 

Another recurring concern raised in multiple comment letters pertained to interim reporting. In the original proposed ASU, companies were required to provide, on an interim basis, a description of reconciling items that lead to significant changes in the estimated annual effective tax rate compared to the effective tax rate of the prior annual period. However, companies questioned the necessity of adding this disclosure, since the estimated annual effective tax rate and the prior year’s effective tax rate lack comparability due to exclusions of discrete items. Consequently, the Board determined that an additional interim disclosure requirement was unnecessary and subsequently removed it from the final ASU. 

While the FASB addressed some concerns related to the disaggregation of jurisdictional tax information and interim reporting requirements, not all issues were fully resolved. Investors welcomed certain changes, but financial institutions and other entities expressed reservations. Ultimately, the ASU aims to strike a balance between transparency and practicality, providing insights for investors while minimizing unnecessary complexities for businesses. The journey toward improved income tax disclosures continues, with ongoing dialogue and adjustments.