Now that “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (the official name of the 2017 tax reform act – fitting for a “simplification” of the tax code!) has passed, issuers are faced with reviewing the impact of the tax reform act on its balance sheet, specifically deferred tax assets and deferred tax liabilities.
For those of us who have ignored those lines on the balance sheet, here is a quick primer: US GAAP and the US tax code have different requirements as to when to recognize income and expenses. These timing differences result in either deferred tax assets or deferred tax liabilities. In other words, if the US tax code requires recognition of income this year, but GAAP does not recognize the income yet, an issuer will need to pay the tax on the income now (the government doesn’t like to wait for its money). That’s an asset from a GAAP perspective – the issuer essentially “prepaid” income taxes that weren’t yet due as far as GAAP is concerned. From a GAAP perspective, that deferred tax asset will be used to offset GAAP tax expense in future years. The opposite is true with respect to deferred tax liabilities.
When the corporate tax rate changes (in this case, from a maximum of 35% to a maximum of 21%) the deferred tax assets aren’t as valuable anymore because the issuer won’t be subject to as much tax as it originally thought. Therefore, the tax asset needs to be written down to some lower value. That write down hits the bottom line and will have a significant adverse impact on the issuer’s quarterly results. Again, for those issuers “lucky” enough to have had significant deferred tax liabilities, those issuers will have significant gains in the quarter caused by, in essence (by lowering the tax rate), the US government partially forgiving the payment of those accrued tax obligations.
Issuers over the past week have begun to provide guidance as to what they expect the effect of the tax cut to be for their deferred tax assets and deferred tax liabilities. However, there is no black and white rule requiring disclosure in this case. While Item 2.06 (Material Impairments) of Form 8-K may initially have been of some concern for those issuers who need to write off tax assets, Corp Fin put those concerns to rest when issuing a new CD&I last week (Question 110.02). Consequently, it comes down to anti-fraud concerns as to when and what to disclose.