Web Exclusive: FIN 48: Managing Your Tax Risk Through Insurance
By GARY BLITZ, a managing director of Aon Financial Solutions, which specializes
in the use of insurance to address tax and transactional risks
The FIN 48 tax disclosure rules are now a reality for publicly traded American companies across all industries and soon will apply to private U.S. companies. Yet FIN 48 continues to fill chief financial officers and tax executives with angst as they work to comply with accounting guidance that may have enhanced subjectivity and inconsistency in its attempt to increase transparency and level the playing field.
FIN 48 insurance could help mitigate a company's risk, however, and help the CFO sleep at night.
Under the Financial Accounting Board's Interpretation No. 48, companies now must undertake an often subjective analysis of whether a position should be "recognized" for FIN 48 purposes or the flipside--whether a liability for an "unrecognized" position must be reserved and disclosed.
Unfortunately, while the new rules have enhanced transparency, they still require many judgment calls. The potential for ambiguity is significant. In addition, the incentives seem skewed: i.e., a public company has to balance its obligations to make truthful and full disclosure (subject to serious legal consequences under the securities laws and Sarbanes-Oxley) with the fear of providing a roadmap to the IRS and other tax authorities.
Companies have varying degrees of what can be thought of as FIN 48 risk. This is the risk that a company's FIN 48 reserving and disclosure practices--what the company has decided to recognize and not recognize for FIN 48 purposes--will line up with the company's actual results after the IRS and other tax authorities have conducted audits, challenged those determinations with which they disagree and litigated with the taxpayer if disputes cannot be settled.
While tax executives over time will become used to dealing with FIN 48, they certainly will continue to wrestle with their FIN 48 disclosures and seek means to mitigate the risk. This is where FIN 48 insurance can be "a new and powerful tool in the tax risk management arsenal," according to Harvey Pitt, former SEC chairman.
In his May 2009 Compliance Week column, Pitt also noted that insurance "goes further, however, by actually shifting the risk of adverse outcomes from the company to the insurer, and effectively capping the cost of such outcomes at the cost of the premiums, reducing cash flow volatility by providing a source of cash in the event of adverse tax consequences and reducing potential earnings volatility by reducing the likelihood of adverse outcomes."
A FIN 48 EXAMPLE
An illustration might help. Say a hypothetical company has seven material tax positions, which it estimates could give rise to a $100 million tax liability if all of the positions are successfully challenged by IRS and other relevant tax authorities.
Two of these positions, having a potential $20 million of liability, were acquired in an M&A transaction, and the company set up a FIN 48 reserve equal to $20 million. The remaining five positions relate to various joint ventures and financing transactions the company has entered into around the world. On each of these transactions, the company has received solid tax opinions and determined that it is not required to accrue a FIN 48 liability.
However, the company's recently hired CFO has a different risk tolerance than his predecessor. The new CFO is concerned that, on audit, one or two of the five positions might be successfully challenged and the company would have to recognize FIN 48 liability and take the attendant hit to earnings.
The new CFO in the above example might want to consider insurance to mitigate its FIN 48 risk.
TOO GOOD TO BE TRUE?
FIN 48 insurance takes on a markedly different structure than traditional transactional tax insurance. It is an annual policy. While traditional tax insurance is generally written for a three- or six-year statute of limitations period, FIN 48 insurance will be written for a shorter period of time, likely from one to three years.
Also, unlike traditional tax policies, a FIN 48 policy can cover multiple tax positions. In fact, the structure anticipates that, as each year goes on and a company updates its FIN 48 analysis, it will seek to decrease or increase the policy limit it maintains.
FIN 48 insurance is a user-friendly tool for tax executives not used to buying insurance products. FIN 48 insurance is straightforward in concept and has few exclusions. It identifies the specific tax positions that are insured. It is a customized policy that can be structured to achieve different goals of a company.
Most policies will cover recognized positions (i.e., no FIN 48 liability recognized) against the risk that the tax authorities challenge those positions. Claims under FIN 48 policies will be handled in a manner much as they are with traditional tax policies and similar liability policies. As such, the insured company is expected to keep the insurer informed. Insurers will have the right, among other things, to associate in any contest with a tax authority and will have the right to consent to any settlements. However, insurers should not get in the way or interfere with ongoing operations.
FIN 48 insurance, like its companion product tax insurance, will not fit every bill nor be available to cover every conceivable tax risk. There is a clear prohibition against underwriting reportable and listed transactions (also known as tax shelters).
Nonetheless, there is a wide spectrum of risks that can be underwritten. One only has to start with IRS Rev. Proc 2009-3 issued in January 2009 to realize the magnitude of the number of areas where the IRS will not provide a private letter ruling. Many of these topics, however, are capable of being underwritten by tax insurers.
FIN 48 and an ever-increasingly complicated tax landscape will continue to challenge tax and financial executives seeking to comply with the FIN 48 framework. As such, many such executives will look outside their corporations to manage this risk. While third-party expertise will play an important role, an ability to transfer the economic downside of an incorrect FIN 48 decision through insurance and protect a company's earnings will be a tool increasingly utilized by corporate America.
July 1, 2009
Copyright 2009© LRP Publications