SEC Guides Funds on Applying FIN 48 to NAV Calculations

In a letter to three prominent fund families, SEC Chief Accountant Conrad Hewitt advised that accounting for tax positions should be performed in accordance with FIN 48 for all of a mutual fund’s net asset value (NAV) calculations. The letter was sent to Fidelity Investments, the Oppenheimer Funds, and Massachusetts Financial Services Company. Richard F. Sennett , Chief Accountant of the Division of Investment Management, also signed the letter. The SEC officials specifically noted that the guidance is limited to assessing tax positions reflected in NAV calculations subject to the Investment Company Act and should not be applied by analogy in other cases.

Noting that financial statements prepared in accordance with GAAP are prohibited from using FASB Statement No. 5 on accounting for contingencies for assessing tax positions, the chief accountant rejected the funds’ suggestion that they should not record a tax liability in NAV if no reduction is required by an analysis performed under FAS 5. The SEC officials believe that the accounting for tax positions should be performed in accordance with FIN 48 for all NAV calculations To do otherwise, they reasoned, could result in application of two different standards, a practice that not only would be confusing to investors but, more importantly, leave significant uncertainty as to the value of a fund share.

FIN 48 was written to clarify the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109 on accounting for income taxes. It requires a fund to determine whether a tax position, based on its technical merits, meets the more-likely-than-not recognition threshold that the position will be sustained upon examination. This determination is based on the individual facts and circumstances of that position evaluated in light of all available evidence.

Although FIN 48 was written to provide guidance on financial reporting, it does not address how tax positions should be accounted for in the calculation of NAV for purposes other than financial reporting, such as for shareholder transactions. FIN 48 challenges funds because they calculate NAVs much more frequently than they prepare financial statements, recognized the SEC, which is somewhat unique to the fund industry. For example, open-end funds generally calculate NAVs daily in order to effect transactions in their shares.