Despite strong criticism from various interested parties, Schedule UTP has been finalized. The schedule is intended to require certain large corporate taxpayers to disclose information concerning reserves for uncertain tax positions to the IRS starting in 2010. This article examines historic events leading to the IRS’s decision to require filing of Schedule UTP, explains the finalized filing requirements, and provides practical tips using examples of common situations for Japanese companies operating in the United States.
In 1998, the IRS Restructuring and Reform Act became law in response to criticisms from the public that some IRS agents had acted too aggressively and violated taxpayers’ rights in certain situations. The Act required the IRS to overhaul and restructure its entire organization and imposed certain significant restrictions on examinations and collection activities by the IRS.
Shortly after the Act became law, the IRS’s audit coverage dropped sharply. As the audit coverage went down, some taxpayers became more aggressive. This resulted in the rise of tax shelters and other aggressive tax savings strategies. Apparently, many large corporations adopted them. By the mid-2000’s, however, the IRS had successfully shut down many aggressive strategies by introducing various new enforcement measures, improving the audit coverage, and winning relevant court cases. Many corporate taxpayers who used the aggressive strategies had to pay a significant amount of back taxes with interest and penalties. Such assessments hit those companies’ bottom line in many cases as a surprise.
A concern was raised from a financial reporting perspective because it appeared that exposures from tax positions that may later be denied had not always been reflected adequately on corporations’ financial statements. While there was a requirement to provide reserves for uncertain tax positions based on Statement of Financial Accounting Standards No. 5, practice varied as there was no specific guidance on the issue.
Due to increasing significance of the issue, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 (FIN 48), which is now known as ASC 740. In general terms, FIN 48 requires a company to set up a reserve for an uncertain tax position as if the company has not sustained its position unless the company can establish that it is "more likely than not" (i.e., more than 50 percent chance) to eventually be sustained. US public companies were required to adopt FIN 48 in 2007. Others reporting on US Generally Accepted Accounting Principles (US GAAP) were required to adopt FIN 48 in 2009.
On January 26, 2010, IRS Commissioner Douglas H. Shulman, speaking at a New York State Bar Association Taxation Section meeting, announced that the IRS was considering implementing a requirement on corporate taxpayers to report uncertain tax positions pursuant to FIN 48 on their tax returns in order for the IRS to utilize their resources more efficiently. The IRS on the same day issued an advance copy of Announcement 2010-9 with more details about the proposed requirement and requested public comments.
On March 5, 2010, the IRS released Announcement 2010-17 which stated that the requirement to report uncertain tax positions pursuant to FIN 48 would commence with the returns for taxable year 2010.
On April 19, 2010, the IRS released Announcement 2010-30, announcing the release of draft Schedule UTP, "Uncertain Tax Positions Statement", and related draft instructions. The draft schedule required disclosure of the “maximum tax adjustment,” an estimate of the maximum amount of potential federal income tax liability that would result from denial of the uncertain tax position. Also, the draft instructions required disclosure of uncertain tax positions for which no reserve was provided because of the IRS’s administrative practice not to pursue adjustments on the issue or because the taxpayer expected to litigate the issue.
In response to these announcements, numerous public comments criticizing the Schedule UTP filing requirement were sent to the IRS by various interested parties including the American Institute of CPAs, American Bar Association, Tax Executive Institute, states CPA societies, state bar associations, various industry organizations, accounting firms, law firms, and small business owners.
On September 7, 2010, proposed regulations (REG-119046-10) were issued authorizing the IRS to require corporations to file Schedule UTP.
On September 24, 2010, IRS Commissioner Shulman made a speech at the American Bar Association conference in Toronto announcing that the IRS was releasing the following documents on that day:
- Announcement 2010-75 containing the final Schedule UTP and related instructions
- Announcement 2010-76 clarifying and modifying the IRS policy of restraint
- New field direction from the Deputy IRS Commissioner providing initial guidance regarding the examination of Schedule UTP and related matters
In response to the numerous public comments against the draft Schedule UTP, Announcement 2010-75 stated that the final Schedule UTP and its instructions relaxed the reporting requirements mainly in the following aspects:
- The filing requirement of Schedule UTP is phased in based on the taxpayer’s total assets.
- The requirement to report the maximum tax adjustment is eliminated and replaced by ranking and identification of “major tax positions.”
- The requirement to disclose positions for which no reserve was established due to an administrative practice of the IRS is eliminated.
A Corporation is required to file Schedule UTP if the corporation:
- Issues audited financial statements or is included in audited financial statements of a related party;
- Files a Form 11201, Form 1120-F2, Form 1120-L3, or Form 1120-PC4;
- Satisfies the total asset threshold (discussed below); and
- Has one or more tax positions that must be reported on Schedule UTP.
For this purpose, audited financial statements are financial statements on which an independent auditor has expressed an opinion under the US GAAP, International Financial Reporting Standards (IFRS), or other country-specific accounting standards.
"Example 1": X is a US corporation wholly owned by a Japanese company Y, whose stock is publicly held in Japan. X’s financial statements prepared under US GAAP are not audited by an independent auditor on a stand-alone basis. However, X’s financial statements are included in Y’s worldwide consolidated financial statements which are audited by an independent audit firm in Japan. X files Form 1120, satisfies the total asset threshold, and has several tax positions that need to be reported on Schedule UTP. X must file Schedule UTP.
A Taxpayer is required to file Schedule UTP only if it satisfies the total asset threshold which is phased in as follows:
For taxable years 2010 and 2011: $100 million or more
For taxable years 2012 and 2013: $50 million or more
For taxable years 2014 and thereafter: $10 million or more
An affiliated group of corporations filing a consolidated return needs to file a Schedule UTP for the affiliated group. The above total asset threshold is applied on an affiliated group basis.
Generally, Schedule UTP requires the reporting of each tax position taken by a corporation on its US federal income tax return if:
- The corporation has taken a tax position on its US federal income tax return for the current year or for a prior year; and
- Either the corporation or a related party has recorded a reserve with respect to the tax position in audited financial statements.
The following should be noted with respect to the general rule described above:
- Only US federal income tax positions needs to be reported. No reporting is necessary for foreign, state, or local tax even if a reserve is recorded. However, a corporation is required to report a tax position that arises out of the uncertainty of a foreign tax position if a reserve for US federal income tax was recorded to reflect such uncertainty (e.g., foreign tax credits).
- While the initial recording of a reserve triggers reporting of a tax position taken on a return, subsequent increase or decrease in the amount of the reserve needs not be reported.
- As an exception to the above general rule, a corporation must report a tax position taken on its return for which no reserve was recorded because the corporation intends to litigate the tax position and has determined that it is more likely than not to prevail in the litigation even though the probability of settling with the IRS is expected to be 50 percent or less.
- A corporation is not required to report a tax position taken in a tax year beginning before January 1, 2010, even if a reserve is recorded with respect to that tax position in audited financial statements issued in 2010 or later.
"Example 2": Corporation Z, a calendar year taxpayer, recorded a reserve on its balance sheet as of December 31, 2010 for a potential transfer pricing adjustment with respect to royalties paid to its Japanese parent company during 2009. Z is not required to report the tax position on the royalty paid to the parent company in 2009 on Schedule UTP because it is a tax position taken in a tax year beginning before January 1, 2010.
Schedule UTP has three parts. Specific items to be reported in each part are as follows:
Part I is used to report tax positions taken by the corporation on its current year tax return, including:
- Sequential number for each tax position reported.
- The primary Internal Revenue Code (“IRC”) sections (up to three) relating to the tax position.
- Indication of whether the tax position creates a temporary or permanent difference.
- The employee identification number (“EIN”) of a pass-through entity if the tax position taken by the corporation relates to a tax position of the pass-through entity.
- Identification of the “major tax position” – whether the reserve for the tax position exceeds 10 percent of the aggregate amount of the reserves for all of the tax positions reported on the schedule (both Parts I and II).
- Ranking of all the tax positions reported on the schedule (both Parts I and II) based on their respective reserve size. The letter T identifies transfer pricing positions and the letter G identifies all other tax positions.
"Example 3": Corporation Z recorded reserves on its balance sheet as of December 31, 2010 for the following tax positions taken on its 2010 federal income tax return:
Item #1: Potential adjustment to transfer pricing $5.0M
Item #2: Potential adjustment to R&D credits $2.0M
Item #3: Potential adjustment to entertainment expenses $0.1M
Items #1 and #2 should be marked as “major tax positions.” Ranking descriptions for Items #1, #2, and #3 should be “T1,” “G2,” and “G3,” respectively.
Part II is used to report the tax positions taken by the corporation on a prior year tax return. However, a corporation is not required to report a tax position if it is already reported on Schedule UTP submitted in a prior year. The positions are disclosed in the same manner as Part I. The only additional information required in Part II is the taxable year in which the tax position was taken.
Part II need not be completed for Schedule UTP for the 2010 tax year.
In Part III, a concise description of each tax position listed in Part I and Part II is required. The concise description must include a description of the relevant facts affecting the tax treatment of the position and information that reasonably can be expected to apprise the IRS of the identity of the tax position and the nature of the issue. In most cases, the description should not exceed a few sentences.
Currently, there is no specific penalty for failure to report tax positions on Schedule UTP. Imposition of such penalty would require a legislative action.
The IRS will treat a complete and accurate disclosure of a tax position on Schedule UTP as satisfying the disclosure requirements for accuracy-related penalty purposes with respect to non-economic substance transactions that are not reportable transactions5. Also, if there is a complete and accurate disclosure on Schedule UTP, a corporation does not need to file a Form 8275, "Disclosure Statement", or Form 8275-R, "Regulation Disclosure Statement", regarding the tax position in order to prevent accuracy-related penalties6.
To prevent interference with taxpayers’ financial reporting disclosures, the IRS has had a long-standing policy not to request certain tax accrual workpapers during examinations unless the case involves undisclosed tax shelters or certain unusual circumstances.7 It has generally been understood that disclosures under FIN48 are within the definition of “tax accrual workpapers” subject to the policy of restraint unless it is a part of publicly filed documents.
As the Schedule UTP reporting requirement was introduced, the IRS expanded and clarified its policy of restraint and to forgo seeking the following documents: 8
- Working drafts, revisions, or comments concerning the concise description of tax positions reported on Schedule UTP;
- The amount of any reserve related to a tax position reported on Schedule UTP; and
- Computations determining the ranking of tax positions to be reported on Schedule UTP or the designation of a tax position as a “major tax position.”
"Example 4": X is a US corporation wholly owned by a Japanese company Y, whose stock is publicly held in Japan. X’s financial statements prepared under US GAAP are audited by an independent auditor in the U.S. on a stand-alone basis but not publicly disclosed. X’s financial statements are included in Y’s worldwide consolidated financial statements which are prepared under the Japanese GAAP and disclosed to the public in accordance with the Financial Instruments and Exchange Act in Japan. While X booked reserves for uncertain tax positions and made footnote disclosures on its stand-alone financial statements, Y’s published consolidated financial statements did not contain any footnote disclosure about X’s reserves. When the IRS audits X’s income tax returns and requests a copy of X’s stand-alone audited financial statements, X should be allowed to redact the footnote showing the amounts of the reserves for uncertain tax positions.
The IRS intends generally to refrain from providing Schedule UTP information to other governments unless there is a reciprocal arrangement with the foreign government regarding uncertain-tax-position information, such as where the foreign government collects similar information for its own tax administration purposes and agrees to make the information available to the IRS in a similar manner. In situations where reciprocity does exist, the IRS would consider other factors in determining whether to disclose the information, including the relevance of the information to the foreign government.9
1. U.S. Corporation Income Tax Return.
2. U.S. Income Tax Return of a Foreign Corporation.
3. U.S. Life Insurance Company Income Tax Return.
4. U.S. Property and Casualty Insurance Company Income Tax Return.
5. See Announcement 2010-75: Coordination with Form 8275 and 8886
6. See Announcement 2010-75: Coordination with Form 8275 and 8886
7. See Internal Revenue Manual 18.104.22.168.
8. See Announcement 2010-76
9. See Announcement 2010-75:Exchange of information with foreign governments
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The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG LLP. All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity.