Corporate tax reform and ASC 606
Implications of the new revenue recognition standard
Understand the tax opportunities companies should consider when analyzing their revenue recognition method.
July 19, 2017
A blog post by Wendy Friese, senior manager, Deloitte Tax LLP
Accounting departments are diligently working through the intricacies of the Financial Accounting Standards Board’s new revenue recognition standard, ASC 606 Revenue From Contracts with Customers, as they prepare for the application of the new standard. The standard is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2017, for public companies, and for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019, for nonpublic companies. The American Institute of Certified Public Accountants formed industry task forces to help develop accounting guidance for how to apply the new revenue recognition standard to specific issues identified in each industry. Certain companies are working with their IT Departments to develop new enterprise resource planning systems to capture the necessary data to analyze their revenue streams.
In other words, adopting ASC 606 is a substantial challenge for many organizations.
The tax law may also be transformed in the near future if the United States Congress overhauls the Internal Revenue Code with corporate tax reform. There is uncertainty around exactly what is the plan for tax reform, but the one thing that has been consistently reiterated is that the proposal will have some type of corporate tax rate reduction from the current rate of 35 percent. If companies plan ahead for tax reform, they may be able to permanently benefit from their cash savings by accelerating deductions into the higher tax rate year or deferring revenue into the lower tax rate year.
As a result of the extensive work companies are already undertaking, the new revenue recognition standard provides the perfect opportunity for companies to concurrently analyze their tax accounting methods for corporate tax reform planning. Companies can leverage their understanding of their revenue items gained from the ASC 606 implementation process to determine whether there may be a more advantageous tax accounting method to defer revenue recognition into the lower tax rate year.
Under general US federal income tax principles, an accrual-basis taxpayer reports income in the taxable year in which (1) the right to the revenue becomes fixed and (2) the amount of revenue can be determined with reasonable accuracy. The amount is considered fixed at the earliest of when payment is made, payment is due, or performance has occurred. The amount is determinable with reasonable accuracy when an approximate amount is reasonably ascertainable.
A few of the tax opportunities companies should consider when analyzing their revenue recognition method include:
- Variable considerations: Companies may have benchmarks, milestones, or performance bonus provisions in their contracts with customers that need to be satisfied before they have the right to receive payment for their goods or services. Companies may defer recognition of the variable or contingent revenue for US federal income tax purposes until the provisions within the contracts are met such that the amounts are fixed and determinable.
- Disputed income: Companies may have customers that dispute the amounts billed for various reasons such as clerical errors, incorrect quantity, or dissatisfaction with the quality of goods, and short the payment of the invoiced amounts in these circumstances. Companies may exclude the disputed amounts from taxable income in the tax year the sales transaction occurred since they do not have a fixed right to receive that portion of the income. The companies would recognize taxable income in the year they settled the dispute with their customers.
- Advance payments: Companies may receive payments in advance of when they perform the services or provide the goods to their customers. Companies may be able to defer to the following taxable year in which they receive the advance payment the portion of their revenue not recognized in their financial statements in the initial year of receipt under Revenue Procedure 2004-34. Alternatively, advance payments for goods may be deferred for two years under Treas. Reg. § 1.451-5.
If companies are not using these methods of accounting for US federal income tax purposes, but want to use them as part of their tax reform planning, they generally have to file a Form 3115, Application for Change in Accounting Method, under Revenue Procedures 2015-13 and 2017-30. The change in tax accounting method generally requires companies to calculate a cumulative catch-up adjustment that is equal to the difference between the use of the companies’ old and new methods of accounting for the item being changed as of the first day of the taxable year of the change (section 481(a) adjustment). The section 481(a) adjustment would be recognized as follows:
- Positive section 481(a) adjustment: It is an increase to taxable income and is recognized ratably over four taxable years (or two for taxpayers under examination by the Internal Revenue Service) beginning with the taxable year of change.
- Negative section 481(a) adjustment: It is a decrease in taxable income and the adjustment is recognized entirely in the taxable year of change.
Changes in method of accounting to defer recognizing revenue generally result in negative section 481(a) adjustments that decrease taxable income because companies would have over-recognized revenue under their old method. If companies change their method of accounting before the reduction of corporate tax rates becomes effective, they could potentially be achieving the dual benefit of decreasing their taxable income in the higher tax rate year as a result of section 481(a) adjustment and deferring their revenue recognition into the lower rate tax year. To bring synergy into the work stream, companies can leverage their work in ASC 606 to look for these corporate tax reform planning opportunities.
Note: The views expressed in this blog are those of the blogger and not official statements by Deloitte or any of its affiliates or member firms.