In December 2023 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. The ASU made changes to the required tax disclosures a reporting entity provides in its financial statements with the goal to enhance transparency by providing more detailed tax disclosures to investors.
Specifically, the ASU focuses on income tax paid and the rate reconciliation, and applies a materiality threshold to identifying amounts requiring separate disclosure. The specified materiality threshold is intended for separate disclosure of specific line items and does not apply to the overall disclosure requirements. While the new rules affect many types of entities, we will explore the impact on funds registered with the Investment Company Act of 1940, particularly open-end funds, closed-end funds and exchange traded funds (ETFs).
Any fund with income tax payments is subject to the modified rules. However, the ASU is likely to be most impactful to the following funds:
Additionally, funds may need to consider individual items, such as state income tax payments or refunds, withholding taxes, and foreign current and deferred taxes.
According to the FASB, investors, lenders, creditors, and other allocators of capital indicated that existing income tax disclosures require improvements to allow for better understanding of how an entity’s operations and tax risk impact its tax rate and expected cash flows.
To achieve these goals, the ASU requires disaggregation of various tax items by jurisdiction and by nature (tax item type). The materiality threshold for separate disclosure is based on SEC Regulation S-X 210.4-08(h)(2) used by public entities of five percent. The tax paid disclosures require a five percent threshold to be applied on any tax payment or refund that is five percent or greater than the total tax paid (net of refunds). If any individual tax payment or refund is greater than the threshold, then a disaggregated disclosure is required. For the tax rate reconciliation, if the absolute value of a “significant reconciling item” is equal to or greater than five percent of the amount calculated by multiplying pretax income or loss by the applicable statutory rate, then the reconciling item should be disclosed separately. The Regulation S-X five percent threshold has traditionally been used to assess ASC 740 disclosures and is not new to entities that are already subject to these requirements.
There are a few key disclosure changes to understand: income tax paid, tax rate reconciliation, and additional disclosures related to domestic and foreign income as well as domestic and foreign income tax expense or benefit.
On an annual basis, funds need to disclose the amount of income taxes paid (net of refunds) separately by jurisdiction (federal, state and foreign). Further disaggregation of income taxes paid (net of refunds) is required by individual jurisdiction if the amount in an individual jurisdiction is equal to or greater than five percent of the total income taxes paid (net of refunds). The five percent threshold is applied to the absolute value of a net payment or net refund in each jurisdiction as compared to the absolute value of the total income taxes paid (net of refunds).
International funds frequently pay foreign taxes that are likely subject to these new disclosure requirements.
Domestic corporate blockers and funds not qualifying to be RICs (or having failed their RIC status) are generally subject to more extensive tax payment disclosures and accruals as compared to RICs simply because most RICs usually do not have tax payments and accruals. The modified rules are likely to require corporate blockers and funds not taxed as RICs to disclose more detail.
Example:
Assume a fund pays income tax as follows:
| Jurisdiction | Income | Tax Rate | Total Tax Paid | After Tax Income |
| Country 1 | $1,000 | 30% | ($300) | $700 |
| Country 2 | $600 | 30% | ($180) | $420 |
| Country 3 | $100 | 15% | ($15) | $85 |
| $1,700 | ($495) | $1,205 |
The first step is to determine if the total tax paid of $495 is material. If the tax is material, the Regulation S-X five percent threshold is used to determine what jurisdictions require separate disclosure. Therefore, any income tax paid above $24.75 requires separate disclosure ($495 total tax times five percent = $24.75).
Sample Income Taxes Paid Disclosure:
The fund paid $495 of income tax to foreign jurisdictions. Income tax paid to the following jurisdictions is five percent or more of the total tax paid:
| Country 1 | $300 |
| Country 2 | $180 |
Note: Country 3 is below the amount requiring separate disclosure and, therefore, does not require inclusion.
The FASB’s view is that the tax rate reconciliation is among the most useful tax disclosures. The ASU is now standardizing the presentation of the tax rate reconciliation table for all public entities. The following eight categories are required in a rate reconciliation table, using both percentages and dollar amounts. Additionally, any reconciling item that is equal to or greater than the five percent threshold (income or loss times the corporate income tax rate) should be disclosed separately from these categories if it is different by nature or jurisdiction (country):
Funds are required to provide an explanation, if not otherwise evident, of the nature, effect and underlying causes of the individual reconciling items disclosed. Additionally, for the state and local category, funds should include a qualitative description of the state and local jurisdictions that make up the majority (greater than 50 percent) of the category.
The modified disclosure rules are likely to have an impact on how domestic corporate blockers and funds that do not qualify to be RICs present their tax rate reconciliation tables. The old rules had a general requirement for providing a reconciliation but there was no explicit rule for separately identifying items. The FASB indicated that the standardization would provide consistency and comparability to investors.
Additional disclosure is necessary for:
While RIC specific impact is unclear, this requirement may have to be considered for its potential impact on funds with international exposure.
Fortunately, some previously required disclosures were deemed no longer necessary. Funds no longer need to disclose the following items:
For public entities, the guidance is effective for fiscal years beginning after December 15, 2024. The ASU should be applied on a prospective basis; however, early adoption is allowed for financial statements not yet issued.
ASU 2023-09 will affect many funds. Work with your tax adviser to consider these changes and their impact, and to evaluate if you have the right processes in place to be able to obtain the detailed information required.
Contact Andreana Shengelya or a member of your service team to discuss this topic further.
In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.