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Monitoring the Impact of Tax Reform on GAAP

by Nick Gibbons

As Congress and the Trump administration push for major tax reform, Republican lawmakers are weighing sweeping proposals to overhaul the tax code. The impact on financial reporting could be significant, so large companies are encouraging the Financial Accounting Standards Board (FASB) to monitor how the proposed changes may affect U.S. Generally Accepted Accounting Principles (GAAP).

Companies are worried that they won’t have time to digest the changes. Erik Bradbury, professional accounting fellow at Financial Executives International (FEI), a trade group that represents some of the largest U.S. companies, said that the proposals aren’t just about a change in the corporate rate, but instead make much larger changes in the tax system. If the potential impacts of fundamental change aren’t considered in advance, businesses could be behind the eight ball when the change comes.

Consumption Tax Proposal
One example of possible tax reform comes from House Ways and Means Committee Chairman Kevin Brady (R-Texas). He has released a tax reform blueprint that calls for a consumption tax that’s a hybrid of an income tax and the value-added tax (VAT). The latter is particularly common among European Union members.

The blueprint allows immediate expensing rather than deprecation for acquired assets, and bars deductions for net interest expense. It also includes a border adjustment tax, which would essentially exempt goods and services that are exported from being taxed. However, imports would still be taxed.

Financial Reporting Implications
Under GAAP, income taxes typically are accounted for under Topic 740, Income Taxes. However, gross receipts taxes and equity taxes have been excluded from that guidance. Consumption taxes, such as a VAT, also are usually accounted for as operating taxes outside the scope of the income tax guidance.

Given the possibility of tax reform that would be a hybrid between an income tax and a VAT, and the increasing prevalence of such taxes outside the U.S., FEI has asked the FASB to assess the effect of the tax reform on financial reporting. The group would like the FASB to consider changing the existing reporting requirements to instead classify these alternative taxes as an operating expense or an income tax.

Of course, the challenge with trying to assess the effect of tax reform on GAAP is that no one knows where the reforms will end up. If the proposed blueprint doesn’t become law, questions about how to account for a tax that is a mix between an income tax and a VAT may be moot.

Some practitioners predict that tax reforms will consist of lowering corporate tax rates and a one-time tax on multinational corporations’ undistributed foreign earnings. These changes would have different financial reporting implications.

Stay Tuned
In response to the comments from FEI, the FASB said that they are paying attention to the issue and will continue to monitor legislation that could affect GAAP, including stakeholder perspectives on its potential impact, before determining whether it’s appropriate to take action. 

July 26, 2017

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