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October 04, 2023 | Tom Ballard

Did financial reporting rules adversely impact investments in innovation?

Mark Brumbelow, PYA's Managing Principal of Tax, shares his thoughts on changes to FIN 48.

Two new studies by researchers at North Carolina State University (NC State) find that regulations aimed at improving the transparency of corporate accounting practices may have had unintended consequences.

Specifically, as reported in this news release, the researchers found that corporate financial reporting requirements implemented in 2007 were associated with decreases in the amount of money companies spent on innovation, capital improvements, and mergers and acquisitions.

“Accounting transparency is important, particularly for publicly traded companies,” says Nathan Goldman, an Associate Professor of Accounting and corresponding author of the two papers on the work. “That being said, our findings suggest there can be unexpected knock-on effects of some transparency efforts, such as a decline in corporate innovation.”

The papers focused on something called the Financial Interpretation Number 48 (FIN 48) which was first issued 16 years ago by the Financial Accounting Standards Board.

Since NC State wrote that the “findings are particularly relevant given new rules passed on August 30 that require companies to provide enhanced tax disclosures beginning in 2025,” we asked Mark Brumbelow, PYA’s Managing Principal of Tax, for his thoughts.

“The IRS (Internal Revenue Service) has long held that the R&D credit was an area ripe for unjustified claims,” he said. “As a result, the IRS designated R&D tax credits as a Tier One issue – and that designation came down in 2007. Tier One issues are those that the IRS examines more closely to try to curtail abuse (both as a means to improve reporting compliance and to discourage taxpayers from taking marginal positions on the matter). I would argue that this Tier One designation might have done as much or more to curtail superfluous R&D credit claims than the reporting requirements under FIN 48.”

Noting that one of the original pushbacks to the FIN 48 guidance was that it was giving the IRS a roadmap for examination, Brumbelow said, “I do not think that has played out to the extent they expected. I do not think the IRS has the resources for such an exercise. I think it is more likely the additional scrutiny came because of the Tier One designation.”

In terms of the new disclosure rules, he said they require additional disclosures related to cash taxes paid to various jurisdictions, foreign and domestic as well as more granular details reconciling differences between statutory and effective tax rates – and tax credits could be a significant driver in that difference. Brumbelow added, “It is unclear whether these more detailed disclosures would result in any additional IRS scrutiny to the taxpayer. Further, these new rules are not expected to have a significant impact on the FIN 48 disclosures at the heart of the article.”

He concluded with this observation: “Whether it is because of the FIN 48 disclosure requirements discussed or the IRS classification of R&D Credits as a Tier One issue, this is an interesting article about some trends in the innovation space.”


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