Matters Column

Tax footnote of financial statements reveal important information

March 4, 2016
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The last week of February, a news report said Pfizer reportedly would save $35 billion in taxes by virtue of its announced plans to merge with Allergan.

Such large numbers attract the attention of many. Whether the report is accurate depends on the underlying data or information on which it was based. The data or information often comes from disclosures in publicly filed financial information.

The use of such information in the past 18 months or so has created a lot of discussion. This is in part the result of the hype surrounding merger inversion transactions as well as the current political campaign. The tax topic often raises eyebrows since all different types of taxes affect our daily lives. Others, such as myself, are more connected with the topic given what we do in our day-to-day professional careers.

Public as well as private companies currently are finalizing their year-end results. Financial statements have or will soon be issued.

I miss the days when one actually received hard-copy annual reports of their public company investments. I recall waiting to see what theme the company would focus on in their annual report. Granted, we can access annual reports electronically, though in many cases it is a copy of the Securities and Exchange Commission Form 10-K filing.

The annual report or 10-K does include a significant amount of information. I have always gravitated to the management discussion and analysis section of the 10-K and also the tax footnote. Compared to financial statements and their footnotes of years ago, the tax footnote of today has a fair share of information for investors.

For many, in and out of government, the tax footnote has given the ammunition to make certain claims regarding corporate taxes. This can include the amount of corporate income taxes a particular company pays or doesn’t pay. The same financial statements are often the same source of information used in reports of the offshore earnings and offshore cash accumulated by public companies.

Given the recent media attention to inversions and reports of companies with low tax rates, I often find myself reading the tax footnote pages with a keen interest. The tax footnote can run for a number of pages and probably puts some readers to sleep. Included in the tax footnote is information on the current tax liability as well as deferred tax liabilities. The deferred taxes may result from temporary differences. These include differences on items such as accelerated depreciation taken for tax purposes but not necessarily for book purposes.

In future years, when the tax depreciation is less than the amount of book depreciation, the deferred tax liability will come due. The use of such differences may reduce a company’s cash tax payments in a given period.

The tax footnote also provides a schedule of any deferred assets and liabilities. These are tax attributes that may be favorable or unfavorable to the company’s tax position in future tax periods. Reading the disclosures further, there are comments regarding the amount of remaining tax loss carry forward and the status of any tax examinations in process.

The effective tax rate reconciliation is another area to which I turn my attention. This reconciliation provides the major items that impact the tax rate up or down from the statutory tax rate. For most U.S.-based companies, the starting point is the federal corporate income tax rate of 35 percent. Any significant reconciling items that impact the tax rate are then shown to arrive at the net effective tax rate that is reflected in the financial statements. 

Common reconciling items include the impact of foreign taxes on income attributable to non-U.S. activities. Other reconciling items may include research credits, the impact of state taxes and stock compensation.

The information in future tax footnotes may be impacted by the Base Erosion and Profit Shifting initiatives. The action plans from the BEPS initiative are intended to reduce some of the tax planning that may have been done in the past.

BEPS already has impacted international taxes and tax planning. The days of using a Double Irish structure in intellectual property planning may be limited. Ireland announced plans more than a year ago to phase out such structures that were often used by U.S. technology and pharmaceutical companies.

The U.K. has implemented its diverted profits tax to capture earnings it considers to have been earned in the U.K. but diverted outside the U.K. by certain aggressive tax-planning strategies. The U.S. recently announced a new Model Tax Treaty to serve as the platform for future tax treaty negotiations. The Model Treaty has many changes that will reduce the ability to utilize certain tax advantaged corporate structures.

The European Union has taken actions to limit the use of local country tax rulings from certain jurisdictions in international tax planning. Luxembourg, Netherlands and Ireland have been the targets of some of the E.U. investigations of Illegal State Aid. These and other actions, combined with possible U.S. tax reform, may have some dramatic impact on the numbers we all read in tax footnotes of financials statements of multinational companies.

Disclosures in public financial statements of public companies can reveal more information than a press release or marketing materials — and not just the tax footnote. Taking the time to read this information may shed some light on the company’s business as well as enhance the overall financial education of the readers. The financial analysts at investment banks look at this information for their understanding of the companies they follow. Investors and other interested parties should do the same.

Bill Roth is a tax partner with the local office of BDO USA LLP. The views expressed above are those of the author and not necessarily of BDO. The comments are general in nature and not to be considered specific tax or accounting advice and cannot be relied upon for the purpose of avoiding penalties. Readers are urged to consult with their professional advisers before acting on any items discussed herein.

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