APB 23(codification effort notwithstanding, old habits die hard) provides an exception to the general rule that a US multinational company must provide US taxes on the foreign earnings of its controlled non-US affiliates.
More specifically, APB 23 is the accounting rule that allows a U.S. multinational to assert that its investment (outside basis) in a foreign subsidiary is permanent and those foreign earnings will be indefinitely reinvested so there is no current or deferred incremental US tax liability.
In order to fully appreciate what’s at stake, you might want to take a quick look at the effective tax rate (ETR) calculation of any number of US SEC registrants; particularly those that derive significant portions of their earnings from the development and exploitation of intellectual property. The “mobility” of this type of income, coupled with the global trend toward lower corporate income tax rates, creates a real opportunity for many US multinational companies to minimize their global ETR if they can successfully assert the APB 23 exception. Put somewhat differently, a successful APB 23 representation essentially creates an opportunity for many US multinational companies to calculate a financial statement tax rate that closely mimics their non-US competitors filing in jurisdictions operating under a territorial corporate tax regime.
So far, so good. Let’s all sign up for one of those fancy APB 23 assertions. “Not so fast” might respond the ever vigilant financial statement auditor. As noted above, APB 23 is the exception to the general rule that US tax must be provided on global earnings. Like most exceptions to the norm, a successful APB 23 assertion comes at a price. In this case, the “price” comes in the form of limited access to offshore cash together with evidence demonstrating that the underlying earnings are not needed at home in the US and can be deployed successfully abroad.
In recent years, evidence supporting an APB assertion has come under increasing scrutiny by auditors and financial statement regulators alike. Many SEC comment letters address failures to support the assertion with robust evidence. Moreover, anecdotal reports suggest the PCAOB is increasing its focus in the area.
So how can you enjoy the ETR benefits associated with an APB 23 assertion while presenting evidence that will satisfy the host of critics? First, recall the assertion must be supported by evidence demonstrating both an ability to meet domestic cash needs with US earnings (i.e., no need to repatriate) as well as a plan to use foreign earnings outside the US. Mapping global cash sources and uses is a good starting point. The analysis should consider cap ex plans on a global basis, jurisdiction-by-jurisdiction. The analysis should also consider debt service needs and the ability to service local debt with local earnings. Don’t forget to consider more stringent debt covenants in the tighter credit environment. Finally, appreciate that this type of evidence will implicate a variety of corporate functions beyond tax management. It’s very likely that the treasurer, corporate development officer and CFO all have meaningful input.
At the end of the day, the assertion must support the Company’s view that the foreign earnings are permanently reinvested and be consistent with corporate goals and actions. Communication between the tax function, operations, finance and accounting is needed early and often to ensure the APB 23 assertion evidence aligns with the Company’s broader intent.
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