FIN 48: Quantifying the Unknowable

Entering its second year, FIN 48 still remains a thorn in the side of corporate tax departments.

April 24, 2008
Sponsored by Vertex Inc.
by Bob Reynolds, International Tax Review

During the last few weeks, many large US corporations have been reporting their end of year results. In the footnotes, the impact of FIN 48 is beginning to show. Take the investment bank Lehman Brothers as a typical example. "On December 1, 2007, we adopted FIN 48. The aggregate impact to opening retained earnings from the adoption of this standard was a decrease of approximately $178 million," said CEO Richard Fuld.

Paul Stebbins, CEO of the World Fuel Services Corporation, reporting the last quarter of 2007's figures, said: "The company's effective tax rate for the fourth quarter was 27.4 percent, as compared to 17.5 percent for the fourth quarter of 2006. The higher effective tax rate resulted from additional provision related to FIN 48 as well as a shift in the mix of the results of operations derived from our subsidiaries in tax jurisdictions with higher tax rates, principally the United States."

James Rutledge of the environmental protection company Clean Harbors, said the adoption of FIN 48 had a significant effect on the company's performance. "Our effective tax rate for the year 2007 was 39 percent compared to only 12 percent in 2006. The increase year-over-year in our effective tax rate is mostly due to our recognizing the full impact of U.S. federal taxes this year and the effect of our implementing the FIN 48 accounting standard this year as well."

In a series of surveys among U.S. finance and tax directors during the last year, the reporting requirements under FIN 48 are seen as among the most challenging aspects of their work. It ranks alongside transfer pricing as presenting the most consistently complex and demanding aspect of the work of tax departments. The greatest difficulty has been putting a value on a potential liability which in the end may not be a liability.

Companies have been required to invest heavily in extra in-house and external support. New IT and accounting systems have been implemented at the cost of millions of dollars.

Inconsistent Picture

But the picture is not a consistent one. While many businesses have faced multiple problems in implementing the accounting standard, others have emerged frustrated and challenged but essentially unscathed. In its first year, a transitional regime was implemented giving companies time to devise processes which would be the basis of their FIN 48 systems in future years.

The second year has imposed a far more rigorous standard. And after the experience of the 2006 returns, companies have not been allowed to alter the way they compute returns and present their figures. Advisers argue that all parties are still learning about how the standard works and that process will continue for several years.

FIN 48 is an accounting standard designed to give clarity to uncertain tax positions (UTPs). In practice, this means finding a way to quantify what is unknowable. Typically, the potential tax exposure to a business may come from a dispute with a tax authority. The company may think it has a watertight case but the revenue agency may take a different view.

Uncertain Tax Positions

In June 2006, the US accounting standards setter the Financial Accounting Standards Board (FASB) published its interpretation FIN 48. Its aim was to provide greater clarity and transparency on uncertain tax positions (UTPs). It stemmed from its statement 109 — Accounting for Income Taxes.

It established criteria for recognition, de-recognition and measurement and improved tax risk disclosures of UTPs. In its first year transitional arrangements eased its path and, although corporations were concerned about how to manage the process to adopting FIN 48, none could anticipate its full impact.  

The standard is at its most acute in transfer pricing issues where the potential tax exposure can only be guessed at. One leading transfer pricing lawyer in the UK said: "This is an area where two well intentioned people can take diametrically opposed positions and both be right. This is why a potential exposure can be unknowable."  

In a survey conducted in December by Deloitte, 3400 tax executives in US companies commented on the most difficult aspects of FIN 48. The largest group — almost 50 percent — said it added no value to their financial reporting and 30 percent said that its implementation had been more difficult than they had anticipated.

To read more of Bob Reynolds' article, please view the full article at: http://vertexinc.com/AICPA .

Published with permission of International Tax Review. This article was previously published in the April 2008 edition of International Tax Review.