Tax Executives Workshop May 2014 - Building a better ... controversy in this area spurred IRS to...

Domestic tax update

Tax Executives Workshop

May 2014

IRS Circular 230 disclosure

Any US tax advice contained herein was not intended or

written to be used, and cannot be used, for the purpose

of avoiding penalties that may be imposed under the

Internal Revenue Code or applicable state or local tax

law provisions.

These slides are for educational purposes only and

are not intended, and should not be relied upon, as

accounting advice.

Tax Executives Workshop - 4-6 May 2014

Disclaimer

► Ernst & Young refers to the global organization of member firms of

Ernst & Young Global Limited, each of which is a separate legal entity.

Ernst & Young LLP is a client-serving member firm of Ernst & Young

Global Limited operating in the US.

► This presentation is © 2013 Ernst & Young LLP. All rights reserved. No part of

this document may be reproduced, transmitted or otherwise distributed in any

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Any reproduction, transmission or distribution of this form or any of the

material herein is prohibited and is in violation of US and international law.

Ernst & Young LLP expressly disclaims any liability in connection with use

of this presentation or its contents by any third party.

► Views expressed in this presentation are not necessarily those of

Ernst & Young LLP.


Presenters

Joan Schumaker

Tax Partner

Ernst & Young LLP

New York, NY

[email protected]

Brandon Carlton

Tax Principal

Ernst & Young LLP

Washington, DC

[email protected]


Agenda

► Final tangible property regulations

► Recent accounting methods trends and guidance

► Financial accounting developments

► Income tax accounting challenges

► Tax legislation and regulatory guidance update


Final tangible property regulations


Timeline – the time to implement is now!

Tax department available to work on implementation

Tax department busy – tax provision, tax returns, holidays and vacation

2014 2015

J F M A M J J A S O N D J F M A M J J A S

Implementation deadline for 2014

15 September 2015 extended due

date for 2014 tax return

Release of transition

guidance for Temp

and Final Tangible

Property Regulations

(Rev. Proc. 2014-16)

Typical timeframe for

calendar year taxpayers

Implementation deadline for 2013

15 September 2014 extended due

date for 2013 tax return

Release of transition guidance for

Re-Proposed Tangible Property

Regulations for depreciation and

dispositions (Rev. Proc. 2014-17) .

2012 amended

return deadline for

certain provisions of

the Final Regs

Must apply final rules for the 2014 tax year. Note that for

2012 and 2013 tax years:

► May continue to use current methods

► May implement temporary rules (section by section)

► May early-adopt final rules (section by section)

Expected release

of Final

Depreciation and

Disposition

Regulations

Expected release of transition

guidance for Final Depreciation

and Disposition Regulations


► The regulations affect all taxpayers with tangible property and require compliance via Form 3115 or annual elections

► Generally effective for tax years beginning on or after 1 January 2014 (optional early adoption for 2012 and/or 2013 years)

Materials and supplies

(M&S) Acquisitions Improvements GAA and dispositions

§ 1.162-3 (Final) §§ 1.263(a)-1 and -2 (Final) § 1.263(a)-3 (Final) §§ 1.168(i)-1, -8 (Prop.)

► Definition of M&S

► Categories of M&S and

timing of deduction

► Incidental (when acquired)

► Non-incidental (when

consumed)

► Rotable and temporary

spare parts (when

disposed of)

► Limited annual election to

capitalize M&S (not all M&S

can be capitalized)

► Interaction with de minimis

safe harbor

► De minimis safe harbor -

annual election to follow

book expense policy

► Generally $5,000 per

invoice or item for

Taxpayers with written

book policies and AFS.

► Capitalize costs that

facilitate acquisitions

► 11 inherently facilitative

costs

► Certain acquisition costs

deductible

► Employee compensation

and overhead (can elect to

capitalize though)

► Certain real property

investigatory costs

(whether and which test)

► Unit of Property (“UOP”)

definition – functionally

interdependent property

except for:

► Buildings

► Plant property

► Leased property

► Network assets

► Improvement defined

► Betterment

► Restoration

► New or different use

► Safe harbor to deduct

routine maintenance

► Annual election to follow

book by capitalizing repairs

► General Asset Accounts

(GAA)

► Establish GAAs with

assets of similar

depreciation methods

► Can provide flexibility to

recognize (or not)

dispositions of assets

► Dispositions (not in GAA)

► Optional annual election to

recognize partial

dispositions (e.g., building

structural components)

► Reasonable valuation

method to determine

disposition gain or loss

► Coordination of

dispositions with IRS

examination of repairs

Overview and framework


TPR Procedures and Implementation

► Rev. Proc. 2014-16 (Final TPR Regulations)

► M&S, acquisition costs, and improvements/repairs

► Rev. Proc. 2014-17 (Proposed TPR Regulations)

► Depreciation and dispositions

► Expect similar rules for final depreciation and dispositions regulations

► Interaction with section 263A (UNICAP)

► Self-constructed asset compliance not a pre-requisite to implement TPR,

but IRS is increasing focus on section 263A

► Self-constructed asset changes now automatic

► Other implementation considerations


Recent accounting method trends and guidance


Section 263A and 471 – Sales Based Royalties and Vendor Allowances

► Final regulations released in January 2014

► Sales based royalties capitalized to COGS

► Option to elect out and allocate between ending inventory and

COGS

► Vendor chargebacks are allocable to COGS

► Regulations reserved on other sales based vendor allowances


Section 263A – Self-Constructed Assets and OREO property (Rev. Proc. 2014-16)

► Self-constructed asset UNICAP changes now automatic

► Scope limitations waived if filed with a TPR change

► Allocable indirect costs should be capitalized to property “produced”

► “Produce” includes construct, build, install, manufacture, develop,

improve, create, raise, or grow.

► Includes property produced on behalf of a taxpayer by 3rd party contractor

► Other Real Estate Owned (“OREO”) Property section 263A

changes now automatic

► Real property acquired through foreclosure or similar transaction

► GLAM 2013-001 may eliminate capitalization requirement


Section 199 – Benefits and Burdens of Ownership

► In a contract manufacturing arrangement, only the taxpayer that

has the benefits and burdens of ownership can claim the

section 199 deduction

► Significant controversy in this area spurred IRS to issue

multiple LB&I directives to its agents

► Initial LB&I directives didn’t reduce controversy

► Third directive (LB&I-04-1013-008) issued on October 19, 2013 provided

a simplified approach – Taxpayers in a contract manufacturing

arrangement can agree on who may claim the section 199 deduction.


Favorable changes

► Depreciation

► Software-development costs

► Deferral of advance payments

► Prepaid expenses

► Incurred but not recorded/

workers’ comp.

► Inventory (method of identifying

and valuing)

► TPR (early adopters)

Exposure items

► Unicap (§263A)

► Bonus/vacation accrual and

other deferred comp.

► Revenue recognition

► Expense recognition

► Improperly obtained method

changes

► Improperly implemented

method changes

Top accounting method changes

Accounting and Regulatory Developments


Financial reporting considerations Tangible Property Regulations – 2014 considerations

► All provisions are effective in 2014

► Consider impact on current and deferred taxes

for the year

► Can affect valuation allowance judgments and

estimated annual effective tax rate

► Consider when the reversal of the DTL related to

the section 481(a) adjustment is to be included

in estimated taxes


Accounting standard updates Presentation of unrecognized tax benefits (ASU 2013-11)

► ASU 2013-11, Presentation of an Unrecognized Tax Benefit

(UTB) When a Net Operating Loss (NOL) Carryforward, a

Similar Tax Loss, or a Tax Credit Carryforward Exists

► Effective for fiscal years, and interim periods within those

years, beginning after 15 December 2013 for public entities

and fiscal years beginning after 15 December 2014 for

nonpublic entities

► Determine whether a deferred tax asset (DTA) is available for

offset based on the DTAs that exist at the reporting date and

assume tax position is disallowed at the reporting date

► Present liability associated with UTBs as a reduction to related DTA

for NOL, similar tax loss or tax credit carryforward if such

settlement is required or expected

► Present UTB as a liability; not combined with DTA if net settlement

is not required or expected

► Applied prospectively. Retrospective application is permitted.


Accounting standard updates Presentation of unrecognized tax benefits – example

• In Country Z, disallowed tax positions must be settled

with available NOL carryforwards

• Assume Company A has, tax effected, a $75 NOL and $50 in

unrecognized tax benefits for which a liability is recorded

• Does not change disclosure of unrecognized tax benefits, which

are required to be presented gross

Footnote disclosure Prior to adoption of

ASU 2013-11 Following adoption of

ASU 2013-11

Deferred tax assets

Accrued environmental costs $100 $100

Net operating loss carryforwards 75 25

Less: valuation allowance 30 30

Total deferred tax assets

(matches balance sheet)

$145 $95

► Accounting Standards Update (ASU) 2014-01, Accounting for

Investments in Qualified Affordable Housing Projects, issued

January 2014

► If conditions met, allows investors to elect the proportional

amortization method to account for investments in low income

housing tax credits (LIHTC)

► Replaces effective yield method

► Investor amortizes to income tax expense the cost of investment

in proportion to the tax credits and other tax benefits it receives

► Effective for interim and annual periods beginning after 15

December 2014. Early adoption permitted. New disclosures.

► Retrospective application. Option to continue effective yield

method for existing investments as of the date of adoption.

► FASB considering project to expand to other tax credit

investments

Accounting standard updates Affordable housing projects (ASU 2014-01)


PCAOB focus area Internal control over financial reporting (ICFR)

► Income taxes has been selected as a focus area by the

PCAOB, and we continue to see an increase in the focus on

income taxes

► PCAOB has found deficiencies in auditors’ reviews of internal

controls related to income taxes

► Failed to understand the likely sources of potential misstatement

(i.e., identify What Could Go Wrong (“WCGW”))

► Failed to obtain an understanding of the review procedures

performed

► Scope of review activities

► Level of precision at which the review is performed

► Source and reliability of information used to perform the control

► Failed to sufficiently test the operating effectiveness of review

controls

► Testing limited to management inquiries and observation of sign offs

► Failed to test controls separately outside of substantive testing


SEC focus areas Effective tax rate reconciliation

► Clearly label items in income tax rate reconciliation

► For material rate reconciling items associated with

foreign jurisdictions, disclose the specific

jurisdictions that materially affect the effective tax

rate, their tax rates, and information about the

effects of such foreign jurisdictions (e.g., magnitude

and mix) on the effective tax rate

► May question whether large “provision to return” or

“true-up” adjustments reflect prior year errors rather

than changes in estimates

► Registrants should determine that rate reconciliation

information is consistent with other disclosures in

MD&A or footnotes


SEC focus areas Valuation allowances ► Challenge boiler plate disclosure in footnotes and in

MD&A related to realizability of deferred tax assets

► Disclosures about realizability of deferred tax assets

should address:

► Four sources of taxable income

► Prominence of each source and material uncertainties

► Assumptions or limitations associated with each source

► Foreign tax credits and NOL carryforwards,

including period over which expected to be

realized or otherwise expire

► Positive and negative evidence considered and

relative weight of each supporting conclusion

about the need for valuation allowance


SEC focus areas Indefinite reinvestment

► Disclose pursuant to ASC 740 the cumulative amount of

temporary differences related to investments in foreign

subsidiaries and foreign corporate joint ventures that are

indefinitely reinvested

► Disclose the amount of unrecognized DTL or if

applicable, a statement that determination of the amount

is not practicable.

► Disclose the types of events or circumstances that would

cause the unrecognized DTLs to become taxable (i.e.,

the events that would cause repatriation of foreign

earnings)

► Challenge registrants when their indefinite reinvestment

assertions appear inconsistent with the parent’s liquidity

needs or disclosures elsewhere in the filings


Updated COSO internal control framework

► In May 2013, Committee of Sponsoring Organizations

(COSO) released the Internal Control – Integrated

Framework: 2013 (2013 framework) to provide an

updated framework for designing and evaluating

internal controls

► Original 1992 framework is valid through 15 December

2014, after which it is superseded by the 2013 framework

► SEC staff have not mandated a specific transition date

► The longer companies use the 1992 framework, the more

likely they may be questioned by the SEC staff

► Disclose framework used

► Implementing the 2013 framework is opportunity for tax

departments to obtain budget to close gaps while

company-wide changes may be occurring


Income Tax Accounting Challenges


Tax provision challenges Restatements

► General causes:

► Application of tax technical rules

► Tax basis

► Intraperiod tax allocation

► Interim periods

► Accounting for outside-basis differences

► Realizability of deferred tax assets (DTAs)

► DTLs as source of income

► Tax planning strategies

Income tax

errors are a

leading cause

of

restatements


Appropriate application of tax basis

► Essential starting point: maintaining a detailed and

accurate record of the tax basis of all assets and

liabilities, including those without a book basis

► A fluctuation analysis of tax basis supporting the deferred

tax balances may not provide sufficient audit evidence

► Common pitfall: Not properly identifying a tax basis or

attribute or not appropriately recording and tracking

the tax basis or attribute in subsequent periods

► Requires technical understanding of tax law

► Often for multiple taxing jurisdictions

► May be simple or complex

How is the tax basis evaluated?


Intraperiod allocation

► Be mindful of the complexity of the intraperiod

allocation rules

► Common pitfalls:

► Failure to apply the exception (losses from continuing operations

and income from other sources)

► Failure to consider interaction of exception with the interim

reporting rules

► Inappropriate “backwards tracing”

► Failure to follow 2 step process when income from discontinued

operations is recognized in an interim period and losses from

continuing operations are expected for the year

Are there losses from continuing operations and income from another

source?

Does the financial reporting reflect the exception to the intraperiod

allocation rules?


Intraperiod allocation (cont.)

► Exceptions to the general rule apply in all situations

where there is:

► A loss from continuing operations and

► Cumulative income from all other sources

► Exception also applies to interim periods when company

anticipates an ordinary loss from continuing operations

for the year

► Applicable even to periods of a full valuation allowance

► Does not change overall annual tax provision (benefit)

► However, may change tax provision (benefit) between

interim periods

The result of this computation (as well as the need to do the

computation) is often counterintuitive


Accounting for outside basis differences

► Outside basis differences may not be recognized if certain

exceptions are applicable

► Section 14.1 of Income taxes FRD, General: summary of

application of exceptions and common entity types

► Common pitfalls:

► Not providing taxes for outside basis difference related to

investments in partnerships or equity method investments

► No longer qualifying for exception with changes in investment

ownership

Are the exceptions to outside basis differences appropriately

applied?


Realizability of DTAs

► Same framework

► Establishing a valuation allowance for the first time

► Determining whether a valuation allowance continues to

be necessary

► Have all 4 sources of taxable income been

considered?


Realizability of DTAs (cont.)

► Future reversals of existing taxable temporary

differences

► Evaluate DTAs on a gross basis

► Consider the timing of reversal of existing taxable

temporary differences

► Common pitfall: DTAs evaluated on a net basis

► Common pitfall: Naked credits are used as a source of

taxable income

Will the deferred tax liabilities result in taxable income in the

appropriate period?

Are there deferred tax liabilities associated with book balances that do

not have a known period when they may affect the income statement?


Realizability of DTAs (cont.)

► What is a tax planning strategy?

► A strategy that is prudent and feasible

► A strategy that a company ordinarily might not take, but

would take to prevent an operating loss or tax credit

carryforward from expiring unused

► A strategy that would result in the realization of deferred

tax assets

► Common pitfalls

► Substituting or refreshing one DTA with another without

evaluating the “new” DTA for realizability

► Considering a projection of future taxable income a tax

planning strategy


Tax provision challenges Best practice responses – reduce risk in calculations ► Improve calculations and detailed supporting workbooks/tools for:

► Tax basis balance sheets to validate deferred taxes

► Automate unrecognized tax benefit calculations for interest and

cumulative translation adjustments, and roll-forwards including

interaction with other tax attributes and valuation allowance

determinations

► Automate tracking of tax attributes and reconcile to tax returns

► Indefinite reinvestment assertion documentation and determine

outside basis differences and compare to E&P calculations

► Share-based payments – prove DTA balances, APIC pool, Section

162(m) adjustment, and tracking of payments to foreign employees

► Fixed asset deferred tax proof with reconciliation of sub-ledgers to

general ledgers and tax systems

► Consider third party to test and improve tax provision Excel

spreadsheets for enhanced efficiency, accuracy and controls

► Improve forecast data for legal entity calculations and engage finance

for items outside tax’s direct control


Tax legislation and regulatory guidance update


Tax legislation and regulatory guidance update ► Legislative

► Camp proposal (LIFO, advertising, R&D, depreciation)

► IRS/Treasury guidance projects

► Current projects

► Anticipated timing

► Other hot topics


Tax Executives Workshop May 2014 - Building a better ... controversy in this area spurred IRS to...

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