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Some companies are counting tens of millions, or even billions, of dollars of IOUs from the taxman as assets on their balance sheets, even though the taxman says it doesn’t “O” them anything.
The result is some potentially nasty surprises lurking in financial footnotes, and these IOUs could start cropping up more often as cash-strapped governments around the world ratchet up scrutiny of multinationals and new global minimum tax rules come into effect.
It is more important than ever for shareholders to examine how companies account for controversial tax positions.
Take Coca-Cola, which has a big one of these IOUs on its balance sheet, totalling $6bn. This is what the company had to pay the US Internal Revenue Service last year after repeated tax court rulings that it improperly tried to shift profits to low-tax jurisdictions like Ireland. Instead of counting the payment as a hit to profit, the company just added it as an IOU into the line item “other noncurrent assets” on its balance sheet.
Such accounting is possible as long as there are lines of appeal open to a company, and as long as it has lawyers that will certify it is “more likely than not” that the company will win in the end and get the money back.
The company’s auditor must also sign off that the legal opinion seems reasonable. Coke says the IRS unfairly switched methodologies for counting overseas profits and the matter is now with an appeals court in Atlanta.
Of course, lawyers can be wrong. The clothing group VF Corp, which owns The North Face and Vans brands, paid the IRS $876mn in 2022 after losing a long-running tax court tussle over the accounting for its acquisition of shoe brand Timberland, but added the money back as an IOU on its balance sheet, on the basis it was likely to get it back after an appeal.
Less than a year later, a US appeals court sided with the IRS and the one-sided IOU turned out to be worthless. It was written off in the 2024 accounts, dinging VF’s net income.
Tax disputes can take years to resolve, and there can be twists and turns. Uber disclosed last week that the UK’s tax authority, His Majesty’s Revenue & Customs, had stopped demanding quarterly top-up payments in their tussle over whether the ridesharing app needs to pay VAT on the full cost of the fare, or just on Uber’s cut.
Uber had been reluctantly paying the difference since 2022 while fighting the matter in court, and adding tens of millions of pounds a month to its one-sided IOU, which now totals £1.4bn.
HMRC recently lost a tax tribunal case against Uber’s rival Bolt on the same issue, so the odds of that Uber getting paid back have gone up — and hence the taxman is no longer insisting on being paid the top-up for now — but HMRC is seeking leave to appeal, so the matter is not closed.
Complicating matters for shareholders, these one-sided IOUs can be described in different ways by different companies and can be hard to find in the footnotes. Companies may also go into more or less detail on the legal arguments on which they rely to make the “more likely than not” judgment that justifies counting the disputed payment as an asset.
“The question is, do companies correctly estimate the probabilities?,” says accounting researcher Olga Usvyatsky. “If they don’t, then investors are in for a big surprise, in some cases a multibillion-dollar surprise.”
Shareholders should note that this accounting doesn’t just flatter the balance sheet. It flatters the income statement, too, and therefore the all-important earnings per share metric on which stock markets hang.
That is because the money that companies say they have overpaid would come back to them with interest, if they really do prevail in court. Coke’s giant payment to the IRS generates notional interest of more than $10mn a month, and that money does go through the profit and loss statement. In the first quarter, it accounted for $53mn of the company’s $3.3bn in net income.
Auditors have a role to play in making sure that all these details are clearly signposted in companies’ accounts. One option to improve disclosure is for a fuller discussion in the “critical audit matters” section of an audit report, part of a company’s annual report. These are currently typically boilerplate statements on how the accounting for uncertain tax positions required extra work.
If they were to set out some of the legal arguments that were taken into account, they could provide the extra illumination that shareholders need in the increasingly contentious world of global tax.