MAY 2007 EDITION
FIN 48 Revisited: Fog Clearing on Controversial Tax Disclosures
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For months, issuers have stalled on the application of the Financial Accounting Services Board's Financial Interpretation Number 48 (FIN 48). Confounded by the complexity of FIN 48's evaluations, these issuers have sought reprieve by requesting additional guidance and delays on implementation, to little effect. These long awaited filings applying FIN 48 are beginning to trickle in -- providing relevant examples of the formal application of FIN 48's challenging standards with the addition of the FASB's recent proposed FIN 48 guidance. This new round of FIN 48 disclosures identified by SEC Currents highlight the application of FIN 48 in a number of different circumstances and provides necessary guidance for issuers that continue to retreat from FIN 48's rigorous requirements.
The practical dynamics of FIN 48 require an issuer to consider the relative reliability of tax positions held or to be held in the future. According to FIN 48's provisions, tax positions must be assessed on a more-likely-than-not standard of being sustained in the face of regulatory scrutiny or possible litigation. If a particular tax position held by a company does not meet this estimated 50-percent threshold its benefits can not be recognized within the issuer's financial statements. The challenging aspect of this provision relates to the necessity for every issuer to separately analyze and consider each tax benefit under FIN 48's proscriptions. The breadth of FIN 48's application underscores the significant time and resources issuers must commit to properly adhere to the standards.
As previously reported by SEC Currents, issuers have been hesitant to apply and disclose FIN 48's impact in filings following the application date of December 15, 2006. The majority of previous FIN 48 disclosures nominally addressed the accounting standard with only cursory speculation on the resulting tax impact as clearly shown in the December 10-K filing of bank holding company Coast Financial Holdings, Inc.
In July, 2006, the FASB released FASB Interpretation No. 48, "Accounting for Uncertainty in Income
Taxes, and interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the accounting and
reporting for income taxes where interpretation of the tax law may be uncertain. FIN 48 prescribes a
comprehensive model for the financial statement recognition, measurement, presentation and disclosure
of income tax uncertainties with respect to positions taken or expected to be taken in income tax
returns. The Company adopted FIN 48 on January 1, 2007. The cumulative effect, if any, of applying FIN
48 will be recorded as an adjustment to the beginning balance of retained earnings. The adoption of FIN
48 did not have any impact on the Company's results of operations and financial condition.
(Source: COAST FINANCIAL HOLDINGS INC 10-K filed 03/24/2006 and 10-K filed 03/15/2007 : Full Comparison )
Despite the persistence of issuers' complaints over the confusing accounting terminology, the FASB has proposed only limited guidance intended to clarify such concerns. Because the ultimate settlement standard referred to within FIN 48's explanation proved a difficult sticking point for issuers' determinations, the FASB issued interpretative guidance to assist issuers in determining if a tax position was effectively settled.
According to FIN 48's original language, the more-likely-than-not threshold for recognition is measured as having a greater than 50-percent chance of being realized upon ultimate settlement with a taxing authority. The use of terminology such as ultimate settlement helped to cloud the requirements of FIN 48 and provided yet another item for measurement and calculation. The FASB's proposed Staff Position No. Fin 48-a (FSP Fin 48-a), assuages issuers concerns by clarifying the ultimate standard language used in FIN 48's original language. Accordingly, the FASB's staff position deletes the ultimate portion of the phrase and further defines the settlement requirement as occurring when:(1) the taxing authority has completed his examination including all administrative reviews and appeals;(2) the enterprise does not intend to appeal or
litigate and portion of the tax position; and(3) the enterprise thinks its highly unlikely that the tax authority would subsequently examine or reexamine any aspect of the tax position.
While the FASB's proposed guidance is currently the balloting process that immediately precedes formal adoption by the accounting board, it appears likely that the changes will be instituted largely as proposed. This conclusion will help to clarify some of the confusion that has surrounded FIN 48's application.
Accounting regulators have been generally responsive to issuers' requests for a clarification but have remained steadfast in requiring that FIN 48 disclosures be made without delay in issuers' next chronological filing. As such, issuers appear to be scrambling to make the proper calculations and disclose the resulting impact within their securities filings.
Specialty pharmaceutical company CollaGenex Pharmaceuticals, Inc. includes an expansive disclosure outlining FIN 48's impact in the company's recently released Form 10-K filing. This disclosure includes the typical boiler plate language explaining FIN 48's provisions and proper application. Like most other filers mentioning FIN 48, CollaGenex notes that any differences in financial statement prior to the adoption of the rule will be accounted for in the company financials as a cumulative-effect to the beginning balance of retained earnings.
However, CollaGenex's FIN 48 filing is easily distinguished from the typical disclosures of most issuers, as the company's filing elaborates significantly on the practical application of the rule and its threshold requirements. According to the filing, CollaGenex's policy prior to the adoption of FIN 48 was to recognize an uncertain tax benefit or detriment only if it was probable that the position would be sustained upon review. FIN 48's more-likely-than-not threshold lowers the bar for recognition as CollaGenex notes in their disclosure. The company explains that this variation in the threshold for recognition of tax positions dictates that the company reverse certain accrued expenses upon implementation of FIN 48.
The company further explains that their application of FIN 48 involves a transaction involving a foreign subsidiary. According to CollaGenex's filing, the subsidiary's sale of certain assets in the United Kingdom caused the company to account for potential U.K. income tax liability. However, as a result of adopting FIN 48's more-likely-than-not standard for recognition, the company reversed the tax impact. Accordingly, the filing notes that the company later received notice form the U.K. government that no additional taxes were due in relation to this transaction. This disclosure provides a tangible example of accounting changes that occur upon application of FIN 48.
In June 2006, the Financial Accounting Standards Board, or the FASB, issued Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes--An Interpretation of FASB Statement No. 109," or FIN 48.
FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial
statements and prescribes a threshold of more-likely-than-not for recognition of tax benefits of
uncertain tax positions taken or expected to be taken in a tax return. FIN 48 also provides related
guidance on measurement, derecognition, classification, interest and penalties, and disclosure.
Differences between the amounts recognized in the financial statements prior to the adoption of FIN 48
and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment
recorded to the beginning balance of retained earnings.
As required, we will adopt FIN 48 on January 1, 2007. Prior to the adoption of FIN 48, our policy was to
recognize tax benefits of uncertain tax positions only if it was probable that the position would be
sustained. Accordingly, we anticipate that certain accrued expenses for uncertain tax positions will be
reversed upon adoption of FIN 48 due to the lower recognition threshold. Based on our analysis, we
estimate that accrued expenses will decrease in the amount of $945,000 and retained earnings will
increase by the same amount as of January 1, 2007 as a result of the adoption in FIN 48.
Sale of U.K. and European Dental Assets
On November 3, 2004, CollaGenex International Ltd ("CIL"), a wholly-owned U.K. subsidiary of the
Company, sold its U.K. and European dental assets to Alliance for net proceeds of $2,980. This
agreement provided for the sale by CIL to Alliance of certain trademark rights, U.K. and European
governmental marketing authorizations, distribution agreements and other intangible assets relating to
the sale or potential sale of Periostat in the U.K., Europe, Israel, South Africa, New Zealand and
Australia. The agreement also granted Alliance an option to acquire a license to register and market
Periostat-MR(TM), a once-daily, modified release form of Periostat, for adult periodontitis in the same
territories. The Company has retained all rights to Periostat-MR for all other clinical indications. The
Company also entered into a Supply Agreement with Alliance pursuant to which the Company will supply
Periostat in bulk tablet form to Alliance at a negotiated transfer price.
As part of this sale in 2004, the Company recorded a liability of $945 within accrued expenses for
anticipated U.K. income taxes due on this sale. As described in note 2, the Company adopted FIN 48 on
January 1, 2007. As a result of the adoption, this liability was reversed on January 1, 2007 as the
threshold for this tax uncertainty was above more-likely-than not. On January 19, 2007, the Company
received a notice from the U.K. taxing authorities saying that no changes were needed to the Company's
tax return which means that no additional taxes were due related to this transaction.
(Source: COLLAGENEX PHARMACEUTICALS INC 10-K filed 03/16/2006 and 10-K filed 03/16/2007 : Full Comparison )
Environmental services provider Clean Harbors, Inc. expands the company's disclosure to describe impending changes after implementing the new FIN 48 guidance in a recent Form 10-K filing. According to the company's annual filing, Clean Harbors expects an approximately $40 million increase to the company's reserves for tax positions to account for potential uncertainty. This value also includes relative interest and penalties assessed with respect to the tax position. The company applies this tax result under both the standards of SFAS 5 "Accounting for Contingencies" and FIN 48 which employ different standards of recognition. Because SFAS 5 requires a probability threshold while FIN 48 uses a more-likely-than-not standard, Clean Harbors reports that FIN 48's provisions will apply where SFAS 5 does not. This comparison of the two measures provides some insight into the challenging and often time contrasting nature of evolving accounting standards.
In June 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in
Income Taxes--an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in the financial statements by prescribing a recognition threshold
and measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. FIN 48 also provides guidance on accounting for de-
recognition, classification, interest and penalties, accounting in interim periods, disclosure and
transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.
Upon adoption, management estimates, that a cumulative effect adjustment to retained earnings of
approximately $40 million will be necessary to increase reserves for uncertain tax positions, including
appropriate interest and penalties. The outcomes of such uncertain tax positions are not considered
probable and, as prescribed by SFAS 5 "Accounting for Contingencies", the contingencies were not
accrued. However, under the more likely than not criteria of FIN 48, an adjustment to accrue the full
amount of the uncertainties is required. The Company believes its tax positions on these matters could
result in a more favorable outcome. This estimate is subject to revision as management completes its
(Source: CLEAN HARBORS INC 10-K filed 03/16/2006 and 10-K filed 03/17/2007 : Full Comparison )
The calculation of uncertain tax positions continues to challenge issuers as clearly shown in the Form 10-K filing of EastWest Bancorp, Inc. EastWest applies the standards of FIN 48 to estimate a resulting reduction in retained earnings of between $6.5million and $7.5 million as a result of uncertain tax positions. EastWest's filing elaborates on the company's tax uncertainties, identifying several of the company's legal challenges to income tax liabilities in California. The company predicts that these tax challenges precipitate the company's estimated reduction in retained earnings pursuant to FIN 48. Accordingly, EastWest weighs the company's potential failure in asserting these tax positions using the standards of FIN 48's more-likely-than-not assessment and concludes that a reduction in reported earnings is necessary.
Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48") which supplements SFAS
No. 109, Accounting for Income Taxes, by defining the confidence level that a tax position must meet in
order to be recognized in the financial statements. The Interpretation requires that the tax effects of a
position be recognized only if it is "more-likely-than-not" to be sustained based solely on its technical
merits as of the reporting date. The more-likely-than-not threshold represents a positive assertion by
management that a company is entitled to economic benefits of a tax position. If a tax position is not
considered more-likely-than-not to be sustained based solely on its technical merits, no benefits of the
position are to be recognized. Moreover, the more-likely-than-not threshold must continue to be met in
each reporting period to support continued recognition of a benefit. At adoption, companies must adjust
their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained
as of the adoption date. Any necessary adjustment would be recorded directly to retained earnings in the
period of adoption and reported as a change in accounting principle. FIN 48 is effective for fiscal years
beginning after December 15, 2006. Management has evaluated the Company's uncertain tax positions in
accordance with the provisions of FIN 48. During the first quarter of 2007, the adoption of this standard
is expected to result in a reduction of retained earnings by approximately $6.5 million to $7.5 million.
This adjustment will be recorded on a net of tax basis.
The Franchise Tax Board is currently in the process of reviewing and assessing our refund claims for
taxes and interest for tax years 2000 through 2002. Management is continuing to pursue these claims, to
monitor developments in the law in this area, and to monitor the status of tax claims with respect to
other registered investment companies.
Management has considered this claim as part of its evaluation of uncertain tax provision in accordance
with the provision of FIN 48. During the first quarter of 2007, the adoption of this standard is expected to
result in a reduction of retained earnings by approximately $6.5 million to $7.5 million
(Source: EAST WEST BANCORP INC 10-K filed 03/14/2006 and 10-K filed 03/01/2007 : Full Comparison )
Airline operator Republic Airways Holdings, Inc.'s Form 10-K filing provides a valuable example of FIN 48 example by both providing the standard boiler plate explanation of the tax provision and subsequently expanding its explanation to note the company's application of FIN 48. Following the standard boiler plate description of FIN 48 and its impending application date, Republic Airways discloses that the potential affect of the rules application will be reflected in the company's opening retained earnings. As such, Republic Airways notes that while the company is still in the process of assessing FIN 48's full impact, the company estimates an impact of between $2.0 and $2.5 million on consolidated financial statements upon adoption of the standard. This estimate appears to indicate a substantial miscalculation in Republic Airways' previous year estimates as the company discloses a previous assessment of $1.2 million for probable losses due to uncertain tax positions.
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes--an Interpretation of FASB Statement No. 109 (FIN 48),
which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that we
recognize in our financial statements, the impact of a tax position, if that position is more likely than not
of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are
effective beginning January 1, 2007. The cumulative effect of adopting FIN 48 will be recorded as a
change to opening retained earnings in the first quarter of 2007. We are in the process of completing our
assessment of the impact on our consolidated financial statements and estimate that the impact upon
adoption will range from $2.0 to $2.5 million. At December 31, 2006, we had $1.2 million recorded for
income tax contingencies for a probable loss for uncertain tax positions.
(Source: REPUBLIC AIRWAYS HOLDINGS INC 10-K filed 02/27/2006 and 10-K filed 03/15/2007 : Full Comparison )
National City Corporation recently filed Form 10-K applies FIN 48's standards to account for an approximately $24 million charge on retained earnings to increase reserves for uncertain tax positions. This disclosure represents one of the few filings which proactively addresses potential revision by management subsequent to initial calculations. National City also notably
expresses FIN 48's more-likely-than-not standard as a greater than fifty percent threshold a diversion from most issuers who express the threshold verbatim from FIN 48's language.
Accounting for Uncertainty in Income Taxes: In June 2006, the FASB issued Interpretation No. 48 (FIN
48), Accounting for Uncertainty in Income Taxes, an interpretation of SFAS 109, Accounting for Income
Taxes. FIN 48 prescribes a comprehensive model for how companies should recognize, measure,
present, and disclose in their financial statements uncertain tax positions taken or expected to be taken
on a tax return. Under FIN 48, tax positions shall initially be recognized in the financial statements when
it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax
positions shall initially and subsequently be measured as the largest amount of tax benefit that is
greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full
knowledge of the position and all relevant facts. FIN 48 also revises disclosure requirements to include
an annual tabular rollforward of unrecognized tax benefits. The provisions of this interpretation are
required to be adopted for fiscal periods beginning after December 15, 2006. The Corporation will be
required to apply the provisions of FIN 48 to all tax positions upon initial adoption with any cumulative
effect adjustment to be recognized as an adjustment to retained earnings. Upon adoption, management
estimates that a cumulative effect adjustment of approximately $24 million will be charged to retained
earnings to increase reserves for uncertain tax positions, which is subject to revision as management
completes its analysis.
Issuers are clearly expanding their FIN 48 disclosures, suggesting that substantive evaluation of the pronouncement is not entirely unmanageable. Still, confusion appears rampant as the vast majority of issuers continue to avoid formal application of the accounting standard. SEC Currents will continue to provide novel analysis of current FIN 48 filings to bridge the compliance gap and secure the proper evaluation of uncertain tax positions.
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