Tesla Inc. managed to quadruple its net income in comparison to the previous quarter by drawing a staggering $5.9 billion from its tax valuation allowance. Despite what initially appears to be an impressive move, the fourth-quarter earnings report largely disappointed. The grand gesture was not cash infusing the bottom line, as the results reported to Wall Street late Wednesday evening would initially indicate.
Edward Maydew, an accounting professor at the University of North Carolina Kenan-Flagler Business School, explained that this move was a required and long-awaited accounting manoeuvre that mirrored those adopted by large, profitable companies like Amazon.com Inc. The decision to effectively empty the tax allowance reserve, which subsequently boosts earnings, was largely up to Tesla.
In an earnings call, Tesla executives informed analysts that the accounting move was not reflective of core earnings, but rather a one-time non-cash benefit “due to our recent history of sustained profitability.”
Under normal circumstances, companies amass tax benefits, like net operating losses, in lean years to counterbalance future tax bills. At the same time, they will create a tax valuation allowance – an accounting reserve that represents their best estimate of tax benefits that appear unattainable. By the end of 2022, Tesla held a valuation allowance worth $7.35 billion.
When companies show signs of profit, thus facing larger potential tax bills, it becomes clear they will utilise their tax benefits, leading to a reduction in the tax valuation buffer. Tesla moved into profit under official US GAAP in 2019 and saw its earnings rise significantly over the following few years.
Companies are then forced to reduce the reserve they have put aside to cover unrealised tax benefits when it’s “more likely than not” that they will use these benefits. Key factors in this assessment include loss history, tax benefits related to stock-based pay, and tax planning strategies.
Tesla hinted at this move in its year-end 2022 financial report. It has become clear that Tesla, and other companies like it, must maintain transparency with its investors about such manoeuvres. Jack Ciesielski, publisher of The Analyst’s Accounting Observer, commended Tesla on doing exactly that.
However, it must be noted that despite this increase in net income, the upfront tax benefits have enabled Tesla to illustrate steadily increasing net income over multiple quarters. If it weren’t for this tactic, its net income for the fourth quarter would have been $2 billion, rather than the reported $7.9 billion. While this is a slight increase from the previous quarter, it represents a 46% decrease compared to profits in the fourth quarter of 2022.
Such an accounting move is not exclusive to Tesla – Amazon.com Inc. used a similar strategy over two decades ago after years of being in the red. Maydew noted that, like Tesla, Amazon was highly transparent about their decision.