Until enactment of the new legislation, most tax credits (both production tax credits, or PTCs, and investment tax credits, or ITCs) have been both nonrefundable and nontransferable. The IRA introduces a transferability election through which a company can sell certain tax credits to third parties. The IRA and CHIPS also include a direct pay election under which the credit is considered a direct payment of tax and is refundable.
- Nonrefundable, nontransferable credits
The benefits of nonrefundable, nontransferable tax credits are realizable only if the company has taxable income sufficient to offset the credit amount.
IFRS Accounting Standards do not specifically address the accounting for ITCs and PTCs. As a result, companies need to choose an accounting approach, to be applied consistently, that best reflects the economic substance of the credit. This determination requires judgment in light of all relevant facts and circumstances.
We believe that generally it is appropriate to account for nonrefundable, nontransferable credits by applying the income tax guidance, IAS 12. This is because the substance of a nonrefundable, nontransferable credit is like a tax allowance (e.g. its benefits are determined or limited on the basis of the company’s income tax liability). Under IAS 12, ITCs and PTCs are recognized in profit or loss as a deduction from current tax expense to the extent the entity is entitled to claim the credit in the current reporting period. Any unused ITC is recognized as a deferred tax asset with corresponding income if it meets the recognition criteria.
Under US GAAP, we believe nonrefundable, nontransferable tax credits are also in the scope of the income tax guidance, ASC 740. Non-refundable base PTCs are recognized in the year they arise, which is typically the period in which the related production occurs. For non-refundable base ITCs, companies have an accounting policy choice – they can either (1) apply the flow-through method by recognizing the ITC benefit in the period it arises along with the related deferred tax asset or liability, or (2) apply the deferral method whereby the initial credit is deferred and recognized over the productive life of the qualifying property. There are further complexities to consider for increased and bonus credits.
Both the IRA and CHIPS introduce a direct pay mechanism for certain credits and certain taxpayers. The direct pay election allows a taxpayer to treat the credit as a direct payment of tax, and receive a cash payment if it does not incur any income tax liability.
Under IFRS Accounting Standards, it appears that the IRA’s refundable credits meet the definition of a government grant and should be accounted for under IAS 203. A company does not recognize a government grant until it has reasonable assurance (which we understand the SEC staff equates to ‘probable’ under US GAAP) that (1) it will comply with the relevant conditions and (2) the grant will be received. It recognizes the benefits of the credits in pre-tax income over the periods in which it recognizes the related costs. IAS 20 also has several presentation elections.
Under US GAAP, we also believe these tax credits are like government grants. However, US GAAP currently provides no specific guidance on government grants and many companies have an existing policy to analogize to IAS 20. Other acceptable approaches include analogizing to Subtopic 958-605 (not-for-profit contributions) or Subtopic 450-30 (gain contingencies).
For more information about grant accounting, read KPMG article, Government grants: IFRS compared to US GAAP.
The IRA allows companies to transfer certain credits (or portions of credits) to another unrelated taxpayer in exchange for cash. Each credit can only be transferred once, and the acquiring taxpayer can use the credit to offset its income taxes.
We believe the IRA’s refundable, transferable credits should be accounted for like other refundable credits under both IFRS Accounting Standards and US GAAP (see above for refundable credits).
Accounting for nonrefundable, transferable credits requires more judgment. As mentioned above for nonrefundable, nontransferable credits, IFRS Accounting Standards do not specifically address the accounting for ITCs and PTCs. If a company concludes that the economic substance of these credits is similar to a tax allowance, we believe it is appropriate to account for them by applying IAS 12. If a company concludes that the economic substance of these credits is similar to a government grant, we believe it is appropriate to account for them by applying IAS 20.
In determining the economic substance of these credits for purposes of developing an accounting policy, we believe a company may consider, among other factors, whether it generally expects to realize the benefits of the credits through reducing its taxable income or by transferring the credits to a third party.
Once the accounting policy is developed, a company should apply it consistently from period to period to all nonrefundable, transferable credits, regardless of how the benefits of the credits are actually realized at subsequent reporting dates – i.e. whether they reduce taxable income or are transferred to a third party. Like IFRS Accounting Standards, US GAAP does not specifically address how the transferability feature affects the accounting for these credits. While there may be more than one acceptable approach, we believe it is most appropriate to apply ASC 740 under US GAAP. Differences may arise in practice with IFRS Accounting Standards.
For more guidance about accounting for IRA and CHIPS, read KPMG publication, US tax legislation: IRA and CHIPS - US GAAP and IFRS Accounting Standards.