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and whether interest and penalties are taken into account in determining the size of a UTP.  Even with the added guidance, issues remain. Accordingly, TEI has developed for the IRS’s consideration a series of additional questions and proposed responses that will simplify UTP reporting and minimize duplicative reporting.

TEI’s specific recommendations focus on the following areas:

A.                General Filing Requirements for Schedule UTP;

B.                 Reporting of Uncertain Tax Positions the Taxpayer Expects to Litigate;

C.                 Positions that Increase Tax Attributes;

D.                “Disclosure Only” Positions;

E.                 Interest; and

F.                  Transfer Pricing Related Positions.

In addition, the comments note several instances where the instructions to Schedule UTP misapprehend (or depart from) the manner in which reserves are established for financial reporting purposes. To reduce taxpayer burdens and minimize inconsistent reporting, TEI recommends that the reporting of positions on the Schedule UTP follow as closely as possible the recording and reporting of tax reserves for financial reporting purposes. Specifically, TEI recommends that the Schedule UTP instructions and other guidance adopt a standard that an uncertain tax position should be reported when that item is both first reserved and relevant (or could be relevant) to the computation of tax on the return.

Tax Executives Institute

Tax Executives Institute is the preeminent association of business tax executives worldwide.  Our nearly 7,000 members represent 3,000 of the leading corporations in the United States, Canada, Europe, and Asia.  TEI represents a cross-section of the business community, and is dedicated to developing and effectively implementing sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works – one that is administrable and with which taxpayers can comply in a cost-efficient manner.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises, including the application of financial accounting standards to analyze and determine UTPs for which reserves are recorded and reported in their companies’ financial statements. We believe that the diversity and professional training of our members enable us to bring a balanced and practical perspective to the issues raised by Schedule UTP and the related instructions.

Background

On September 24, 2010, the IRS released, together with Announcement 2010-75, the final version of Schedule UTP and instructions for 2010 tax years.[2] The Announcement summarized the changes to the draft schedule released April 19, 2010, and made other related administrative announcements.

Schedule UTP requires the reporting of each U.S. federal income tax position on a return for which two conditions are satisfied:

• The corporation has taken the position on an applicable return for the current or a prior tax year, and

• The corporation (or a related party) has recorded a reserve in an audited financial statement with respect to that position, or did not record a reserve because the corporation expects to litigate the position.[3]

A corporation is not required to disclose a position taken in a year prior to January 1, 2010, even if a reserve is recorded in financial statements in 2010 or a subsequent year.[4]

The instructions explain that a “tax position taken on a return” is a tax position that would result in an adjustment to a line item on a return if the position is not sustained.[5] In determining reportable tax positions for Schedule UTP, taxpayers are required to use the unit of account employed for financial statement purposes[6] and to follow the reserve decisions made for recording the reserve for financial statement purposes.[7] If a corporation determines that no reserve is required because the position is either immaterial or “sufficiently certain,” then the position is not required to be disclosed on Schedule UTP.[8]

In the course of reviewing their tax provisions for the first quarter of 2011 or preparing their initial Schedule UTP, TEI members have identified a number of questions and issues that would benefit from additional guidance.  Because we believe the IRS should update the Schedule UTP FAQ quickly as additional issues and questions are identified (as it has with the Schedule M-3 FAQ webpage), we recommend the following suggested questions and responses for the FAQ.  As a general rule, TEI recommends that the guidance for Schedule UTP adopt a standard that an uncertain tax position should be reported on Schedule UTP when that item is both first reserved and relevant or could be relevant to the computation of tax on the return.

A. General Filing Requirements for Schedule UTP

Question 1:  Is an amended Schedule UTP required to be filed with amended tax returns?

Answer 1: An amended Schedule UTP need not be filed with an amended return unless a tax position is being taken on the amended return that differs from the original return and the position would have been required to be disclosed on a Schedule UTP filed with the original return (if a reserve that is recorded for that position in the audited financial statements had been recorded in the audited financial statements at the time the original return was filed).[9] Thus, a Schedule UTP is not required to be filed with a claim for refund as a result of an NOL or credit carryback if the tax position that affects the amount of the NOL or credit is already disclosed in the return for the year in which the item originates.

Explanation: TEI’s suggested Q&A will clarify that there is no requirement to update the Schedule UTP for changes in the reserve position as a result of amending a return for items unrelated to the uncertain tax position items. Changes in reserve positions should be reported in the Schedule UTP for the tax year in which the position was reserved in the audited financial statement. In the case of amended returns that result from carryback items that include an uncertain tax position, the position would be disclosed in the year the carryback originated (i.e., the “source year”); an additional disclosure in the year to which the item is carried would be duplicative.

B. Reporting of Uncertain Tax Positions the Taxpayer Expects to Litigate

Question 2: If a taxpayer has a tax position for which no reserve is recorded because the position is immaterial (or sufficiently certain) but the taxpayer would litigate if the position were challenged and not sustained at an administrative level, must the taxpayer report the position on Schedule UTP? Should the taxpayer disclose a reserve established as a result of an issue raised on examination?

Discussion. FAQ #1 released on March 23, 2011, provides helpful clarification for this (and other issues) by stating that “the schedule seeks the reporting of tax positions consistent with the reserve decisions made by the corporation for audited financial statement purposes under applicable accounting standards.” FAQ #1, however, only partially addresses the differences between the explanations of the litigation exception set forth in the instructions to Schedule UTP and in Announcement 2010-75. Specifically, the instructions state that the litigation exception applies where (a) the taxpayer determines there is a less than 50- percent probability of settling an issue, (b) the taxpayer intends to litigate the position, and (c) the taxpayer believes that it will more likely than not prevail.[10] The Announcement states “a tax position that a corporation would litigate, if challenged, but that is clear and unambiguous or is immaterial is . . . not required to be reported on Schedule UTP.”[11] Although both formulations of the rule are helpful (and FAQ #1 is also helpful), they are not entirely consistent and there are many fact patterns that fall between the guideposts.

• Is the expectation-to-litigate exception inapplicable unless the taxpayer has documented an express plan or intention to litigate the position that forms the basis for its accounting for the position as an uncertain tax position? If so, we recommend incorporating an example in the FAQ to eliminate confusion about when the expectation-to-litigate standard is satisfied.
• Does a change in a taxpayer’s intent to litigate after a position is taken on a return trigger a disclosure requirement where no reserve is initially recorded (e.g., because the taxpayer considered the position highly certain) and subsequently no reserve is recorded once litigation is intended (e.g., because a subsequent court decision makes the taxpayer’s original position less than highly certain and an agent asserts a proposed adjustment)? TEI recommends that the IRS clarify through an example how and when a change in a taxpayer’s “expectation to litigate” posture affects the Schedule UTP disclosure requirement.
• The IRS should clarify that there is no requirement to disclose a reserve created as a result of a proposed adjustment on examination. Since the IRS is already aware of the issue, disclosure on Schedule UTP would be superfluous.

Recommendation: The FAQ should include an example illustrating when the litigation exception applies to a material position the taxpayer believes is highly certain and for which no reserve is recorded.  For example, assume a taxpayer claims a tax deduction for $50 million in wages paid to employees.  For financial statement purposes, the taxpayer initially believes the position is highly certain that the deduction will be allowed.  A subsequent court decision makes the taxpayer’s position less than highly certain, but the taxpayer determines that it expects to litigate that position if challenged and thus records no reserve. On examination, the IRS asserts that the wages should be capitalized in part. When, if ever, should the position be disclosed on Schedule UTP?  TEI recommends clarifying that no Schedule UTP disclosure is required, either before or after the issue is raised by the agent.  In the former case, the subsequent court decision does not lead to a change in the taxpayer’s position or the reserve (even though the reason for the “no-reserve” position may have changed); in the latter case, the IRS is aware of issues identified during examinations.

C. Positions that Increase Tax Attributes

Question 3: When is Schedule UTP reporting required for an uncertain tax position that increases an NOL or a tax attribute that is utilized later?

Answer 3: The position should be disclosed in the year the position is taken on the return (if reserved) or in a subsequent year if a reserve is recorded subsequently.  Consistent with the analysis under ASC 740, the reserve should be based on the position itself and not the tax attribute in which it is embedded.

Explanation:  We believe that the result in Example 9 in the Schedule UTP instructions should be limited to the rare situations where a reserve is not recorded in the year of the deduction (i.e., 2010 in the facts of Example 9) but is recorded in the year the NOL is used (i.e., 2011).  In the more typical case, a reserve is recorded in the year in which the deduction position is taken and not in the year in which the NOL is used.  If both an original return position and the use of the NOL with the uncertain tax position embedded in it are considered to be “taking a position on a return” (because each position affects a line item on a return), taxpayers would be subject to multiple, cascading UTP disclosure requirements. For example, a UTP related to a deduction taken on a return not only changes the amount of a net operating loss carryforward but can also change the amount of a credit carryforward used in a later year as well as other tax positions that are indirectly affected by the amount of the NOL, such as the foreign tax credit limitation or the section 199 deduction.  In each case, a line item on the return would be affected that could require additional UTP disclosures.

Question 4: In 2012, a taxpayer acquires another company (Target) with an NOL carryforward of $100 that arose in 2011, a pre-acquisition year. The taxpayer identifies an uncertain tax position of $20 that arose in 2011 and is embedded in the 2011 NOL, and in its accounting for the acquisition in 2012, records a reserve of $20.  The taxpayer does not use any part of the acquired NOL in 2012 or 2013 but uses part in 2014 and part in 2015.  When should the UTP with respect to the acquired NOL be disclosed?

Answer 4: The UTP should be disclosed in 2012 when the reserve is recorded.

Explanation: Schedule UTP reporting is required for positions when the item is or could be relevant to a calculation of tax.  If a reserve exists in the period that the item is used or becomes relevant to the tax calculation, then the item would be reported on the Schedule UTP for the year in which the tax liability is affected.[12]

In this example, if the taxpayer established a reserve for the acquired NOL in its audited financial statements and disclosed the NOL as an available carryforward in its return, then the item should be disclosed in its Schedule UTP for the year the NOL is available for use (i.e., 2012).  Although the NOL is not used on the 2012 return, it is available for use and therefore could be relevant to the calculation of the tax.  The item need not be disclosed in future periods because it has been disclosed once.

D. “Disclosure Only” Positions

Question 5:  Where a reserve exists with respect to an item reported on a tax return but the item is not relevant to the computation of tax liability, is Schedule UTP reporting required? For example, would a UTP related to the calculation of earnings and profits or foreign taxes disclosed on a Form 5471 be required to be disclosed in any year where there is no actual or deemed dividend income inclusion?

Answer 5: Schedule UTP reporting is only required for positions when the item is relevant to the calculation of tax liability.  Reporting of a UTP is not required for items that are only disclosed and reported on the return.  If a reserve exists in the period that the item is used or becomes relevant to the tax calculation, then the item would be reported on the Schedule UTP for the year in which the tax liability is affected.[13]

In the example above, assume the taxpayer established a reserve in its audited financial statements for an item included in earnings and profits or its foreign tax credit pool because it is not indefinitely reinvesting such earnings outside the United States.  Assume further that the uncertainty relates to whether the foreign tax is creditable. In that situation, although a reserve is established, the item is not and would not become relevant to the calculation of the tax for a tax year until a dividend is actually paid (or deemed paid under Subpart F).  As a result, disclosure on Schedule UTP is not required until the year in which the UTP becomes relevant to the calculation of tax (i.e., in the year a dividend is paid or deemed paid).

Explanation: The instructions to Schedule UTP suggest that a position is taken on a return whenever there would be an adjustment to any line item on the return if the underlying UTP is not sustained.[14] There are myriad lines on a tax return that require data for information purposes only and do not affect the computation of tax liability. TEI recommends clarifying the instructions to state that the line item on the return with the underlying UTP would also have to be relevant to the calculation of tax liability for the year in which the amount is reported.

Question 6: Does the use of a previously unused tax attribute on the return for which a reserve has been recorded create a recurring Schedule UTP disclosure requirement?  For example, in 2011 a taxpayer incurs a net operating loss of $100, which includes an uncertain tax position of $30, and records a reserve for the $30 UTP in its audited financial statements. Taxpayer reports the UTP in its 2011 return schedule, but does not use the NOL until 2014.

Answer 6: No. Consistent with the Schedule UTP instructions (page 1, “Reporting current year and prior year tax positions”), if a position with respect to a tax attribute is disclosed on an original return for the year in which the reserve for the UTP is recorded,  it does not need to be reported in subsequent tax years.

Explanation: Once a position has been reported on Schedule UTP it should not be necessary (and would be potentially misleading) to report it in a subsequent year even where the position affects a line item on a subsequent year’s return.

E. Interest

Question 7: Does the accrual of interest in 2010 (or later) as part of the tax reserve for a pre-2010 position require reporting of the pre-2010 position on Schedule UTP?  How should this be reported?^[15]

Answer 7: Interest accrued on a tax reserve for a position taken prior to 2010 should not be reported on Schedule UTP.

Explanation: The transition rule on page one in the Schedule UTP instructions does not require reporting of positions taken in pre-2010 tax years. Hence, it would be inconsistent to require the disclosure of a pre-2010 position merely because interest on such position is recorded in 2010 or a subsequent year.  TEI’s recommended response is consistent with FAQ #3 and #4 released on March 23, 2011, and we commend the IRS for the clarifications provided in those responses.

F. Transfer Pricing Related Questions

Question 8: Assume that all of a taxpayer’s recorded reserves for uncertain tax positions are for transfer-pricing issues in foreign jurisdictions. The only transfer-pricing UTP items associated with the U.S. tax return are for so-called “competent authority adjustments.” Is the company required to disclose any positions on Schedule UTP for transfer-pricing issues?

Answer 8: For purposes of the Schedule UTP disclosure requirements, a U.S. federal income tax adjustment, asset, or benefit that results from a non-U.S. tax reserve is not considered a “reserve.”  As a result, the item should not be disclosed on Schedule UTP.

Explanation: TEI’s recommendation is consistent with the instructions to Schedule UTP, which requires reporting only for increases in U.S. federal income tax liabilities.

Question 9: Is a UTP arising from or related to a cost-sharing agreement classified as a “transfer pricing UTP” for purposes of Schedule UTP?

Answer 9: Yes. If any part of a position is uncertain because of the effect of the application of any of the regulations under section 482, including Treas. Reg. § 1.482-7, the position should be considered a transfer-pricing item.

Explanation:  The simple rule in Answer 9 will minimize confusion about whether UTPs are related to transfer-pricing issues.

Conclusion

Tax Executives Institute appreciates the opportunity to present its recommendations for additional guidance for uncertain tax positions.  If you have any questions, please do not hesitate to contact Eli Dicker or Jeffery P. Rasmussen of the Institute’s legal staff at 202.638.5601 or edicker@tei.org or jrasmussen@tei.org.

Respectfully submitted,

TAX EXECUTIVES INSTITUTE, INC.

Paul O’Connor
International President

cc:        The Honorable William J. Wilkins, Chief Counsel
Heather C. Maloy, Commissioner, Large Business & International Division