Editor: Kevin D. Anderson, CPA, J.D.
Congress has sometimes retroactively enacted or extended tax provisions, such as the retroactive reinstatement to Jan. 1, 2012, and modification of the research tax credit (R&D credit) in Sec. 41 by the American Taxpayer Relief Act of 2012 (ATRA), P.L. 112-240, on Jan. 2, 2013. The R&D credit had expired on Dec. 31, 2011. The late reinstatement of the credit has a key effect on the U.S. GAAP treatment of the R&D credit on businesses’ 2012 financial statements.
Although an in-depth discussion on the constitutionality of retroactive legislation is beyond the scope of this item, ATRA’s enactment brings the issue of retroactive tax legislation to the forefront.
Basic Principles of the R&D Credit
Sec. 41 provides a “credit for increasing research activities.” A general business tax credit for companies that conduct research in the United States to develop or improve their products, manufacturing processes, and software, the R&D credit was originally introduced by the Economic Recovery Tax Act of 1981, P.L. 97-34. Since the credit’s original expiration on Dec. 31, 1985, it has been extended 15 times, usually after it had expired (Congressional Research Service, Research Tax Credit: Current Law, Legislation in the 113th Congress, and Policy Issues (Feb. 1, 2013)).
The R&D credit is designed to spur growth through innovation by enabling taxpayers with research-related expenditures to receive a credit against their regular income tax liability for a portion of qualified expenses. Eligible expenses include taxable wages (Sec. 41(b)(2)(D)), the cost of supplies (Sec. 41(b)(2)(C)), payments to certain contractors (Sec. 41(b)(1)(B)), basic research payments (Sec. 41(e)(2)), and energy research payments (Sec. 41(a)(3)).
The R&D credit allows for two calculation methods, the regular credit and the alternative simplified credit (ASC). The regular credit is 20% of the taxpayer’s qualified research expenditures (QREs) that exceed a calculated “base amount.” The ASC generally equals 14% of the QREs that exceed 50% of the average of the QREs for the three prior tax years. Under the regular credit method, the base amount cannot be less than 50% of the taxpayer’s current-year QREs.
A thorough explanation of the various types of calculations, definitions, and requirements for claiming the R&D credit is beyond the scope of this item. However, a brief example using the credit can shine light on financial reporting issues of retroactive tax law changes.
Example: Assume that a calendar-year taxpayer calculates its 2012 credit using the ASC method. If its average QREs over the previous three tax years are $50,000 and its current-year QREs are $60,000, its base amount is 50% of the prior three years’ average, or $25,000, and its credit—14% of the increment in QREs over the base amount—would be $4,900.
Here is the rub, though: Even though the taxpayer is allowed to report the benefit of the credit on its 2012 tax return, it cannot take the benefit on its financial statement for any period ending before 2013. Because the credit expired in 2011 and was made effective for tax year 2012 through retroactive legislation enacted in 2013, calendar-year taxpayers may not recognize the benefit of the R&D credit for purposes of their 2012 financial statement.
Retroactive Legislation and Financial Statement Reporting Interpretations
A reason that treatment for financial statement positions may differ from tax return positions is that financial statement reporting is governed by the Financial Accounting Standards Board (FASB), while tax return positions are governed by the Code. The FASB rules that are pertinent to determining the financial statement treatment of benefits conferred to taxpayers through retroactive tax legislation is in FASB Accounting Standards Codification (ASC) Paragraphs 740-10-25-47 and -48, which address the treatment of changes in tax laws and rates. These paragraphs state that the effect of a change in tax laws or rates, including a retroactive change in an enacted tax rate, is determined and recognized at the date of enactment. Furthermore, ASC Paragraph 740-10-25-48 states that “the tax effect of a retroactive change in enacted tax rates on current and deferred tax assets and liabilities shall be determined at the date of enactment using temporary differences and currently taxable income existing as of the date of enactment.”
Therefore, despite the fact that ATRA retroactively reinstated the R&D credit, allowing a credit for 2012 QREs to be claimed on a company’s calendar-year-end 2012 tax return, because the provision for R&D credits was allowed to expire, it did not exist, under the GAAP rules, for purposes of financial statement reporting during 2012. Even though the financial statements are issued after the effective date of the change in the tax law, current taxes and deferred tax assets and liabilities should be measured using the enacted tax law and rates as of the balance sheet date. It would, however, be prudent to disclose any significant anticipated financial effect of ATRA in the footnotes to the 2012 financial statements, as the benefit of the change in tax law will be reflected in calendar-year 2013 results.
For financial reporting by non-calendar-year-end taxpayers, the effect of changes in tax laws on current and deferred tax assets and liabilities should be recognized in income from continuing operations in the interim period that includes the enactment date of the changes. The effect of changes in tax laws or rates on current and deferred tax assets and liabilities at the enactment date should not be allocated to subsequent interim periods by adjusting the estimated annual effective tax rate. Further, even though the changes ATRA made to the R&D credit are retroactive, the change in the tax law should not be reflected in the estimated annual effective tax rate used in preparing interim financial information for periods ending before Jan. 2, 2013.
Kevin Anderson is a partner, National Tax Services, with BDO USA LLP, in Bethesda, Md.
For additional information about these items, contact Mr. Anderson at 301-634-0222 or firstname.lastname@example.org.
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