Sales and Use Tax Reserve Strategies Best Practices for Setting Reserves Under Government and Audit Scrutiny

THURSDAY, MARCH 13, 2014, 1:00-2:50 pm Eastern

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Sales and Use Tax Reserve Strategies Seminar

Vytenis Kirvelaitis, Grant Thornton

vito.kirvelaitis@us.gt.com

March 13, 2014

Myron Vansickel, Experis

myron.vansickel@experis.com

William Ault, Crowe Horwath

william.ault@crowehorwath.com

Today’s Program

Review of Material Terms of ASC 450

[William Ault]

Sales and Use Tax Issue Identification Process

[Vytenis Kirvelaitis]

Loss Contingencies and ASC 450 Examples

[Myron Vansickel]

Slide 7 – Slide 18

Slide 19 – Slide 29

Slide 30 – Slide 44

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

REVIEW OF MATERIAL TERMS OF ASC 450

William Ault, Crowe Horwath

Loss Contingencies: Material Terms

I. Recognition

- Probable, reasonably probable and remote

- Estimable

- What is a liability and what is a loss contingency?

II. Measurement rules and an estimated range of loss

III. Disclosure rules: Probable and reasonably possible

contingencies

IV. Recent end to FASB’s project on loss contingency disclosure

requirements

8

Recognition Of A Loss Contingency

An estimated loss from a loss contingency shall be accrued by a

charge to income if both of the following conditions are met:

a. Information available prior to issuance of the financial

statements indicates that it is probable that an asset had been

impaired or a liability had been incurred at the date of the

financial statements. It is implicit in this condition that it must be

probable that one or more future events will occur confirming the

fact of the loss.

b. The amount of loss can be reasonably estimated.

9

Probable, Reasonably Possible Or Remote?

Probable: The future event or events are likely to occur.

Reasonably possible: The chance of the future event or events

occurring is more than remote but less than likely.

Remote: The chance of the future event or events occurring is

slight.

10

Can The Amount Of The Loss Be Reasonably Estimated?

The requirement that the loss be reasonably estimable is intended

to prevent accrual in the financial statements of amounts so

uncertain as to impair the integrity of those statements.

Disclosure is preferable to accrual when a reasonable estimate of

loss cannot be made.

Does it relate to the current period or a prior period?

11

Loss Contingency Vs. Liability

A loss contingency is defined as an existing condition, situation or

set of circumstances involving uncertainty as to possible loss to an

enterprise that will ultimately be resolved when one or more

future events occur or fail to occur.

Amounts owed are not contingencies even though the accrued

amounts may have been estimated. There is nothing uncertain

about the fact that those obligations have been incurred.

12

Measurement Of A Loss Contingency

When both of the recognition criteria are met, and the reasonably

estimable loss is a range, accrual is required of:

- The amount that appears to be a better estimate than any other

estimate within the range, or

- The minimum amount in the range, if no amount within the

range is a better estimate than any other amount.

13

Slide Intentionally Left Blank

Disclosure When A Loss Contingency Is Not Recognized

Disclosure of the contingency shall be made when there is at least

a reasonable possibility that a loss or an additional loss may have

been incurred.

The disclosure shall indicate the nature of the contingency and

shall give an estimate of the possible loss or range of loss, or

state that such an estimate cannot be made.

15

Disclosure When A Loss Contingency Is Not Recognized (Cont.)

Disclosure is not required of a loss contingency involving an

unasserted claim or assessment, when there has been no

manifestation by a potential claimant of an awareness of a

possible claim or assessment, unless:

- It is considered probable that a claim will be asserted, and

- There is a reasonable possibility that the outcome will be

unfavorable.

Information may become available indicating that an asset was

impaired or a liability was incurred after the date of the financial

statements, or that there is at least a reasonable possibility that

an asset was impaired or a liability was incurred after that date.

16

The FASB’s Loss Contingency Disclosure Project Ends

Decision reached at the July 9, 2012 board meeting:

The staff summarized its outreach with regulators and provided a

short review of the feedback received on the two previous

exposure drafts. The staff posed the question to the board as to

whether the project should remain on the agenda, and if so what

the next steps are. The board voted 5-2 to remove the project

from the agenda, with no further action.

17

Scope Of FASB July 2012 Invitation To Comment

The invitation to comment applies only to notes to financial

statements. It does not address parts of a financial report outside

of financial statements, such as management’s discussion and

analysis (MD&A).

The invitation to comment applies to financial statements of

public and non-public entities.

18

SALES – USE TAX ISSUE IDENTIFICATION PROCESS

Vytenis Kirvelaitis, Grant Thornton LLP

Review Tax Audits

I. Audit History and Active Audits should be your initial starting point.

II. This is also where your external – financial auditors often ask questions.

III. Most recent audit cycles are key.

IV. Focus on the issues identified, not just the dollar amounts.

V. Consider the effects on the following:

multiple jurisdictions;

lines of business;

legal entities;

discontinued operations;

recent acquisitions.

*** Remember: The Power of an "Iceberg" and the "Titanic".

20

Consider Tax Controversies, Recent Developments

- Review recent tax litigation, hearings, and court cases.

- Examine recent private letter ruling requests.

- Consider "Hot Topics" from seminars and conferences.

- Review sponsored-proposed legislation or initiatives from:

1.) Your industry or trade groups;

2.) Taxpayer groups.

- Examine new Department of Revenue regulations, rules,

informational bulletins, notices and publications.

- Don't forget about the Streamlined Sales Tax (SST)!!!

21

Slide Intentionally Left Blank

Check out your "Tool Kit" or "Tool Box"

Tax Systems:

- Review strengths and weaknesses of current software.

- Ensure updates are timely implemented (ex. tax rates).

- Understand the tax mapping.

Reference Materials and Training:

- Review tax manuals, matrices and guideline documents.

- Evaluate "live" and web-based training.

- Consider success of "help desk" and "tax support".

Documentation:

- Explore customer sales tax exemption tracking and updating.

- Consider treatment of certificates in various jurisdictions.

23

Examine Sales/Use Tax Returns

- Step back and take an objective look at your current sales/use tax

returns and preparation process:

1.) Do we file on time with no late or processing notices?

2.) Is there a tax return calendar?

3.) Is there a current flowchart of the tax preparation process?

4.) Is the information process automated or manual?

5.) What are the "hiccups", manual workarounds?

6.) Are there sufficient "Checks" of the underlying information?

- Do not rely on your own observations. Ask the preparer(s) and others

in your organization.

*** WHAT ABOUT ACCOUNT RECONCILIATIONS !!! *** 24

Sales Tax Exemption Certificate Management

- Customer sales tax exemption certificates continue to receive significant scrutiny

from tax auditors and corporate tax departments.

- Jurisdictions vary as to the "life" of an exemption certificate with some making it

very clear (ex. Florida – 1 year) while others are silent.

- Common issues include the following:

1.) Incomplete certificates (ex. no date)

2.) "Un-timely" receipt of certificates

3.) "Stale" certificates

4.) Name or legal entity changes

5.) Missing or inaccurate descriptions for products purchased

6.) Certificate application to various jurisdictions

*** Various tools from Avalara, Vertex, etc. can help with all of this. ***

25

Web-Based Sales

- If your company has internet sales, make sure you explore the

potential sales/use tax issues.

- Common issues include the following:

1.) Traditional "Nexus Footprint"

2.) "Amazon" legislation

2.) Collection of proper customer exemption information

3.) Drop Shipments Rules

4.) Tax treatment of freight, postage, shipping &

handling charges

5.) Potential "Disclosure Provisions"

26

Taxation of "Software" and Services

The sales/use treatment of "software" and services are probably amongst the most complicated areas of state and local taxation due to the impact of technology and the lack of guidance by the Departments of Revenue.

I. This can impact your purchases and sales requiring a thorough analysis.

II. Jurisdictions are struggling to understand the technology and the evolving nature of services while applying tax concepts designed for sales of tangible personal property.

III. "Digital equivalents" under SSTP illustrate the transition of traditional sales/use taxation.

***Companies do not properly "source" transfers or sales of "software".***

27

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Final Reminder

• Don't forget the "Local" in state and local

• Very aggressive and expanding Departments of Revenue.

• Also quite creative with new taxes and approaches to

technology.

• Not afraid to litigate

• Traditionally active in the states of Alabama, Louisiana, and

Colorado.

• City of Chicago, Cook County (Illinois), and City and County of

Los Angeles are other well known locals.

29

LOSS CONTINGENCIES AND ASC 450 EXAMPLES

Myron Vansickel, Experis

ASC 450 Examples

I. Unrecorded Liability

II. Contingency Reserve

31

Unrecorded Liability

Client X has changed outside auditing firms and the new firm has question the

client regarding their sales and use tax policies and procedures.

Client installs various WiFi systems within colleges and universities, hotels and

some commercial businesses.

32

Unrecorded Liability

Client has been in business for 10+ years and is now looking back at what they

may owe and have to pay for their past sells to customers.

The Client has decided not to go back to their customers now to collect tax as it

has been several years for may of these sales

33

Unrecorded Liability

The Client has estimated the amount of tax that is owed by its customers for each

taxing jurisdiction that the client conducted work that taxes these types of

system installs.

34

Unrecorded Liability

Is this an unrecorded liability where you have to provide a reserve sales tax

reserve or is this a

contingency reserve where you are in dispute with some taxing authority as to

what may be owed once the tax issues are resolved?

35

ASC 450

I. Contingency Reserves

Go back to the definition of what is a contingency reserve.

36

ASC 450

Review what a contingency liability is and then review the next client details.

37

ASC 450

Client Y purchased a business that has a website that is basically a “virtual event

center”. Buyer and seller are trying to establish an escrow amount regarding

whether this software on the web is a SaaS, i.e., a service or is it a transfer and

use of software subject to tax.

38

ASC 450

New Jersey: The New Jersey Division of Taxation did provided a private letter

ruling that SaaS is not subject to tax.

Here the taxpayer had a monthly subscription fee for customers to use a web

application that was hosted by the Taxpayer’s computer systems.

39

ASC 450

Any reserve required here?

40

ASC 450

Client Y now needs to know how Massachusetts will decide whether their SaaS will

be deemed to be a service or taxable software?

41

ASC 450

The MA private letter ruling was opposite of the NJ ruling.

MA theory was that the “virtual event center” transferred taxable software to the

subscriber to customize its detail that it wanted to present in the virtual event

program, thus giving the subscriber use of the canned software.

42

ASC 450

Should the buyer and seller establish an escrow based on the MA private letter

ruling?

Because it is in escrow, how would you record it on the buyers financial

statements?

43