IAS Foreign Currency Translation Part I

Temporary Differences Resulting From «Push-Down» Adjustments

Under FASB Statement 52, following a business combination accounted for as a purchase transaction, the amounts allocated at the date of acquisition to the assets acquired and liabilities assumed (including goodwill) should be translated as if the purchase adjustments were recorded directly on the books of the foreign subsidiary. This also would be the case for foreign investees accounted for by the equity method.

Purchase price adjustments, other than goodwill that is not tax deductible, allocated to the assets and liabilities of a foreign enterprise create temporary differences under Statement 109 because such allocations generally do not result in adjustments to the foreign tax bases of the assets and liabilities. These temporary differences result whether the foreign entity uses the U.S. dollar or the foreign currency as its functional currency.

The following example illustrates the application of these two requirements:

Example: Assume at December 31, 1991, a U.S. multinational company purchased a foreign subsidiary for a price $100,000 in excess of the foreign entity«s book value and tax basis. The exchange rate is FC2 = $1.00. At the date of acquisition, the fair value of the foreign subsidiary»s land and buildings exceeded their respective book values by $75,000. The excess of the purchase price over the fair value of the assets acquired ($25,000) was allocated to goodwill. For purposes of this example, assume a) the foreign currency is the functional currency, b) foreign earnings are permanently reinvested, c) amortization and depreciation charges are immaterial, and d) purchase adjustments are reflected for U.S. consolidation purposes only and are not recorded on the foreign entity's local statutory accounting records.

The $100,000 of purchase price adjustments are converted into FC amounts and allocated to the foreign subsidiary at the date of acquisition as follows:

Deferred taxes are provided on the FC150,000 temporary difference relating to land and buildings at the foreign entity's effective tax rate of 40% = FC60,000. This amount is charged to goodwill and then translated into dollars at the current exchange rate as follows:

Translated amounts at the end of 1992 when the foreign currency increases in value from FC2 = $1.00 to FC1.6 = $1.00 are as follows:

Deferred taxes of FC60,000 continue to be provided on the temporary difference relating to land and buildings.

APB Opinion 23 Exception for Foreign Operations

Under APB Opinion 23 (see Section 7 of this booklet), there is a presumption that all undistributed (foreign) earnings will be transferred to the parent company unless there is sufficient evidence that such earnings will be permanently reinvested or that earnings will be distributed in a tax-free liquidation. If sufficient evidence exists to support an APB Opinion 23 exception, deferred taxes are not provided for amounts owed and payable in the U.S. upon repatriation of foreign earnings. Deferred taxes are, however, provided on earnings that are not considered permanently reinvested. For example, even though a foreign entity's beginning retained earnings are permanently reinvested, deferred taxes are provided on the portion of current earnings that are expected to be repatriated.

Allocation of Deferred Taxes to Translation Adjustments

Subsidiaries and affiliates of a U.S. multinational company that use the foreign currency as the functional currency report translation adjustments in a separate component of shareholders« equity. If a foreign subsidiary»s earnings are permanently reinvested, deferred taxes do not have to be provided on the temporary differences. For the portion of foreign earnings that are not considered permanently reinvested, income taxes would be provided. In addition, income taxes relating to translation adjustments would be required to be allocated to the separate component of shareholders' equity. The calculation of this allocation is complex and will vary depending on the specific facts and circumstances. The approach illustrated in the following example allocates the U.S. foreign tax credit to earnings. Another approach, as illustrated in Appendix B paragraph 276 of Statement 109, allocates the U.S. foreign tax credit to both earnings and the translation component of equity.

The following examples illustrate the allocation of income taxes to the translation component of shareholders' equity when earnings are not permanently reinvested:

Example 1. Assume that a foreign subsidiary of a U.S. parent has net assets of FC13,000 and FC15,000 at December 31, 1991 and 1992, respectively. During 1992, the foreign currency devalues from FC1 = $1.00 to FC1 = $0.80. Also assume that deferred income taxes were not provided in 1991 and prior years because the foreign earnings were considered permanently reinvested. In 1992, a decision is made to remit all of the foreign entity«s earnings to the U.S. over the next several years. The parent company accrues a deferred tax liability for the additional taxes that will be payable and owed in the U.S. assuming all earnings have been repatriated. For this example the U.S. parent»s incremental tax rate net of foreign tax credits is assumed to be 10%. Deferred taxes also are provided on the translation component of equity. For this example the tax rate is assumed to be 34% because there are no offsetting credits in the foreign taxing jurisdiction relating to U.S. dollar translation adjustments. Deferred taxes at December 31, 1992 would be calculated as follows:

(1) FC10,000 X ($1.00-$.80)

(2) FC3,000 x ($1.00-$.80) + FC2,000 x ($.90-$.80)

For 1992, net deferred tax expense is $208. For financial reporting purposes, $480 of expense is allocated to the income statement and a $272 tax benefit is allocated to the translation component of equity.

Example 2. Assume the same circumstances in Example 1, except that the foreign currency increases in value from FC1 = $1.00 to FC1 = $1.20.

For 1992, net deferred tax expense is $792. For financial reporting purposes, $520 of expense is allocated to the income statement and $272 is allocated to the translation component of equity.

In each of the two examples, the original investment in common stock is considered as permanently reinvested under APB Opinion 23. Therefore, additional U.S. income taxes are not provided nor are income taxes allocated to the translation component of equity based on changes in exchange rates relating to the common stock.

An accrual for additional deferred income taxes along with an allocation to the translation component of equity is appropriate if the entire investment was not considered permanently reinvested. If this were the case in Example 1, instead of having a deferred tax liability of $208, there would be a net deferred tax asset of $472 [(34% of $2,000 = $680) – $208] which would require further evaluation regarding recoverability under Statement 109 (see Section 5 of this booklet). In Example 2, an additional deferred tax liability of $680 would be charged to the translation component of equity.

Transaction gains and losses pertaining to certain hedging activities and intercompany foreign currency transactions that are of a long-term investment nature are permitted to be reported in the translation component of equity. Under Statement 52, any income taxes related to those transaction gains and losses should also be allocated to the translation component of equity.