An uncertain tax position (UTP) is a tax position taken on a company’s tax return that does not meet the more-likely-than-not standard, meaning there is a 50% or less chance the position will be sustained if challenged by the relevant taxing authority.
A company must carefully assess its UTPs for financial reporting purposes.
Example UTP for an Investment Entity
Investment Fund Ltd., a hedge fund formed as a limited company (Ltd) in the Cayman Islands, invests in various high-yield junk bonds in Argentina. During the 2022 fiscal year, the hedge fund invested $15,000,000 into Argentina bonds and received interest income of $1,425,000. The hedge fund is taking the tax position that the interest income is exempt from income taxes in Argentina, so it has not filed an income tax return in Argentina, nor has it made any tax payments to the Argentina tax authorities.
When the hedge fund prepares its financial statements in accordance with U.S. Generally Accepted Accounting Principles (GAAP), it must analyze this tax position and determine whether a UTP accrual is required under Accounting Standards Codification (ASC) 740.
The hedge fund consults with tax advisors and determines that it is more-likely-than-not that the Argentina tax authorities would NOT agree with the tax position. In other words, if the Argentina tax authorities audit the hedge fund, there is less than a 50% chance they would agree the interest income is exempt from taxes. Therefore, the Argentina tax authorities would assess a tax liability and expect payment of income taxes from the hedge fund. The tax advisors estimate the potential tax exposure is 12% of the net interest income on those Argentina bonds.
Because of this UTP, the hedge fund records an accrual of $171,000 of income tax expense (12% times $1,425,000) on the income statement and a corresponding uncertain tax liability on the balance sheet. The hedge fund does not make a tax payment to the Argentina tax authorities; it simply records the accrual on its U.S. GAAP financial statements to account for the UTP.