For this first post, let’s start with the news — Late 2017, the US statutory rate went from 35% to 21% (a 40% drop). There are many other aspects of the tax reform that impact corporations, we may discuss these in future posts. For now, we will focus only on what happens when we change the tax rate in TRCS.
Other countries have changed their rates, or will do it in the future. And states and local jurisdictions rates are always changing because apportionment will vary every year. But this recent 14% cut is a lot more material for most US-based companies.
Many clients want to make sure they understand how the rate change calculates in their provision application and how it impacts their deferreds, effective tax rate and return to accrual. All the screenshots below are from TRCS, but it works the exact same way with HTP, the on-premise version of Oracle’s tax provisioning offering.
So, how do you do it? It is very simple: just open the Tax Rates form for 2017 and change the closing deferred rate to 21%. In this example, to make things easier to trace we ignore states, but in practice there would be state tax and apportionment rates, either state-by-state or blended or a combination of both. The prior year and current year rates remain at 35%.
The current provision applies the current year 35% rate. Here we assume a net income before tax of $1,000,000 and a miscellaneous accrual current year adjustment of $300,000.
Now let’s move on to the temporary differences schedule and assume for the same adjustment an opening balance of $100,000 and an other adjustment of $(50,000). Based on that, the total gross P&L activity is $250,000, and the closing balance $300,000.
Here is how it looks in TRCS. I filtered out the columns with no data for clarity.
Now the interesting part: deferred tax!
The opening balance, current year and other adjustments all are tax effected at the 35% rate. But the closing balance is tax effected at the new going forward rate: 21%.
$350,000 x 21% = $73,500
The difference between the 35% and the 21% rates goes to the rate change column:
$350,000 x (21% – 35%) = $(49,000.0)
But what if you want to see the details behind this rate change?
Just click on the + sign in the column header to drill down in your roll forward dimension to see the impact of the change between your closing and opening rates and closing and current year rate:
The table below details how each column is impacted by the rate change:
| in k$ | Opening | Current Year | Other |
|---|---|---|---|
| Gross | 100 | 300 | -50 |
| Rate | 35% | 35% | 35% |
| Tax Effected | 35 | 105 | -17.5 |
| Adjust to rate | 21% | 21% | 21% |
| Rate Change | 100 x (21% – 35%) = -14.0 | 300 x (21% – 35%) = -42.0 | -50 x (21% – 35%) = 7.0 |
The impact of rate change from the opening balance is $(14,000) and the impact from current year is $(42,000) + $7,000 = $(35 ,000)
Note that if the ending balance is 0, then the rate change calculates differently, I will get back to that at the end of this post.
As you can expect the rate change flows to the ETR. Again, you can zoom in to distinguish the impact of opening and current year.
And yes, a lower tax rate will increase the total tax expense the year the change is enacted (if you are in a net deferred tax asset position). That’s because when the rate is 40% lower, this deferred asset suddenly become 40% less valuable, which is offset by a large deferred tax expense. As an example Alphabet (Google’s parent company) posted a 138% effective tax rate in Q4 2017, part of which comes from changes in deferred tax. Although the impact of the one-time transition tax on accumulated foreign earnings probably has an even greater effect.
That will of course show in the Tax Account Rollforward:
How does the rate change impacts Return-to-Accruals?
Now that we looked at all the main reports for FY17, we can look at what happens when there is a return to accrual amount. So let’s complete our example from above by entering some data in the return columns. In the RTA schedule, the first three columns correspond to the provision period (P12), and the second three columns correspond to the return period (P13). The last column is the resulting difference, aka the true-up.
Here we will assume that the gross amount calculated at return time for our miscellaneous accrual temporary difference is $200,000, which is $100,000 less than what was estimated for the provision. The calculated tax effected true-up is $(35,000). As you can see the RTA is tax effected at the current year rate for the year FY17.
This $(35,000) will flow to FY18’s current provision.
The gross temporary differences for FY18 will show the $(100,000) gross true-up in the RTA column.
As you can see, in the tax effected deferred roll forward screenshot below, the FY18 current year tax rate of 21% gets applied to the RTA column. So in the deferred the true-up is $(21,000). Which is different from the rate used in the current provision where the true-up was using the old 35% rate.
It can get counter-intuitive when looking at FY18’s ETR. The schedule shows the current and the deferred RTA on the same screen. One is tax effected at 35% and the other at 21%. The net of the two is $(14,000), which corresponds to the 14% rate change on the $100,000 gross difference.
Side note: one HTP client wanted to separate out this rate change more clearly. So we built a custom logic to tax effect the deferred RTA at the prior year rate ($(35,000) in the example above) and we created a new column in the deferred rollforward containing the rate impact of the rate change on that RTA: $14,000. The net is still $(21,000). In that case the ETR was showing current and deferred RTA equal to $(35,000) and $35,000 and a rate change impact from RTA of $(14,000). The total RTA ETR was the same, but the presentation is slightly different.
What happens to your rate change when the ending balance is 0
There is one last thing that can be surprising when the ending balance for a temporary difference is zero. In that case the rate change calculates differently.
Let’s add a second temporary difference to our example from FY17, but this time the $100,000 opening temporary difference reverses out during the year such that the ending balance is 0.
In that case the opening is tax effected at the opening rate and the current year is tax effected at the current year rate, which in our case are both 35%.
The difference with the general case is that when the ending balance is 0, the rate change opening is applying the difference between the opening and the current year rates, which in our case are equal. And the system does not calculate a rate change impact due to the current year activity. So both rate change columns are null.
If we show the two methods side by side:
| Case ending is 0 | General case | |||
|---|---|---|---|---|
| Opening | Current Year | Opening | Current Year | |
| Gross | 100 | -100 | 100 | -100 |
| Rate | 35% | 35% | 35% | 35% |
| Tax | 35 | -35 | 35 | -35 |
| Adjust to rate | 35% (CY) | n/a | 21% (closing) | 21% |
| Rate Change | – | – | -14 | +14 |
It doesn’t change the total rate change, but it can make it a little bit more complicated to understand. Especially if you have a mix of some differences with a 0 ending balance and some with a non-0 ending balance and want to prove the calculation at an aggregate level.
I hope this helped you understand how tax rate changes work in TRCS and HTP. If you have any question, feel free to use the comment box below.
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