Domestic tax update. Scott Mackay Joan Schumaker. 1 May 2018

Transcription

1 Domestic tax update Scott Mackay Joan Schumaker 1 May 2018

2 Disclaimer EY refers to the global organization, and may refer to one or more, of the 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 U.S. This presentation is 2018 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of U.S. 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 those of the speakers and do not necessarily represent the views of Ernst & Young LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Page 2

3 Today s Agenda 2017 Tax Return planning opportunities Federal tax issues related to 2017 Tax Act Foreign Derived Intangible Income (FDII) Deduction Base Erosion Anti-Abuse Tax (BEAT) Inventory Planning Capitalization Changes to Bonus Depreciation Tax accounting considerations related to 2017 Tax Act FASB standards update Tax-related restatements and material weaknesses historical summary Other developments Page 3

4 2017 Tax Return planning opportunities Page 4

5 Top Domestic Opportunities for 2017 Tax Returns Section 199 Sale of business assets Transition tax implications Software-as-a-Service Final 199 analysis Capitalization and Cost Recovery Repair study Fixed asset analysis Cost segregation study Bonus depreciation study Inventory and UNICAP Trade discounts and allowances identify additional 199 deductions related to taxable asset sale of a business identify additional 199 deductions related to increased taxable income from Section 965 inclusions identify additional 199 deductions from SaaS, online software gross receipts assist with final analysis of 199 deduction including identifying new/overlooked revenue streams analyze costs capitalized as improvements to tangible property and reclassify as tax repair expenses review capitalized assets to assess shorter tax recovery periods and/or accelerated depreciation methods analyze new construction projects to properly assign (segregate) costs into tax recovery periods identify bonus eligible tangible property analyze vendor allowances and determine whether amounts received are a purchase price reduction of inventory acquired Retail Inventory Method (RIM) Auto 3115 for 263A - Inventory Auto 3115 for 263A - Self-constructed assets Inventory write-downs Charitable contributions of inventory assess whether a retailer could benefit from RIM assess any current exposure areas related to 263A costs required to be capitalized to inventory and identify any opportunities available assess any current exposure areas related to 263A costs required to be capitalized to self constructed assets and identify any opportunities available identify goods and determine writedowns for FIFO LCM and subnormal goods assess whether an enhanced charitable deduction of inventory is available under 170(e)(3) LIFO submethods review current LIFO methods and analyze PPI/CPI and compute proper LIFO adjustments Meals & Entertainment Meals & Entertainment final analysis of costs under pre-tax reform provisions R&D 280C election for NOL taxpayers assess implications of NOL carryback/carryforward for 174 expenses and 280C election 59(e) election assess whether 59(e) election could benefit NOL taxpayers or a taxpayer that expects to incur significant, future foreign R&D expenses Developed software deduction R&D Directive Orphan Drug Credit (ODC) Revenue and Expense Recognition Advance payments Employee bonus accrual IBNR Prepaid Insurance assess software development costs and immediately deduct qualifying costs determine whether the recent IRS Directive would provide additional benefits rather than the traditional 41 credit assess enhanced ODC for 2017 qualified clinical testing expenses before ODC is limited in 2018 under TCJA defer revenue recognition of advance payments via automatic method change under Rev. Proc for broad listing of qualified advance payments assess any opportunities or exposures related to employee bonuses (or other similar deferred compensation) accelerate the expense recognition of self-insured employee medical expense that are incurred but not reported (IBNR) accelerate the expense recognition for certain payment liabilities (e.g., insurance, maintenance, governmental permits) State taxes accelerate the expense recognition of state taxes paid Ratable service contracts accelerate ratable service contract expenses under Rev. Proc Cooperative advertising accelerate expenses related to cooperative advertising with a third-party Rebates and allowances accelerate expenses related to rebates and allowances paid to third-parties Transaction Cost Analysis General TCA market opportunities Review ongoing transaction cost analysis opportunities Transaction costs analysis lookback study analyze transaction costs to determine whether non-success based fees could be deducted 2017 Asset Acquisitions identify specific costs related to bonus eligible property acquired in an asset acquisition Push-down analysis for 2017 Private Equity (PE) analyze costs incurred for a portfolio entity and push down costs rather than capitalizing as start-up expenses under 195 transactions

6 Federal tax issues related to 2017 Tax Act Page 6

7 Revisions to Section 451 in Tax Cuts and Jobs Act Previous law (prior to Tax Cuts and Jobs Act) Accrual basis taxpayers include an amount in income when all events have occurred that fix the right to receive the income and the amount is determinable with reasonable accuracy (unless an exception applies) Cash basis taxpayers include an amount in income when it is actually or constructively received Newly enacted Section 451 Generally requires accrual basis taxpayers to recognize income at the earlier of when recognized for tax purposes under Section 451 (the all events test ) or when taken into account in applicable financial statements (effectively requiring tax recognition at the earlier of earned, due, received or recognized for financial statement purposes) Codifies the all events test and specifies the test should be applied to items of gross income Applicable to special rules for bonds and other debt instruments in part V of subchapter P, including the original issue discount rules; however, does not apply to any item of gross income in connection with a mortgage servicing contract Other special methods of accounting for reporting gross income (such as the installment method under Section 453 or the long-term contract method under Section 460) not impacted For contracts with multiple performance obligations, the amount allocated to each performance obligation for financial statement purposes shall be followed for tax Codifies and modifies the deferral method of accounting for advance payments currently in Rev. Proc (one-year deferral for certain advance payments) Effective for tax years beginning after December 31, 2017, and implemented as a change in method of accounting Retains rules for cash basis taxpayers to include an amount in income when it is actually or constructively received Page 7 Tax revenue recognition series I Highlights and implications of tax reform and ASC 606 implementation

8 Item of income tax statutory rules Section 61 Gross income defined Defines gross income; generally includes income realized in any form, whether in money, property or services Section 451 Taxable year of inclusion Provides the general rules as to the timing of when an item of Section 61 gross income is to be included in income Section 446 Methods of accounting Requires taxable income to be computed under a consistent tax method of accounting Committee Reports for the Tax Cuts and Jobs Act [o]nce it is determined that an item of gross income is clearly realized for Federal income tax purposes, [S]ection 451 and the regulations thereunder provide the general rules as to the timing of when such item is to be included in gross income. The provision does not revise the rules associated with when an item is realized for Federal income tax purposes and, accordingly, does not require the recognition of income in situations where the Federal income tax realization event has not yet occurred. Page 8 Tax revenue recognition series I Highlights and implications of tax reform and ASC 606 implementation

9 Advance payments Tax reform revisions and comparison Deferral rule Section 451(c) Rev. Proc Provides one year of tax deferral for: Provides one year of tax deferral for: Qualifying advance payments Qualifying advance payments Recognized in an AFS in a subsequent taxable year Recognized in an AFS in a subsequent taxable year Qualifying items Exclusions Applies to advance payments for: Goods, Services, or Such other items as may be identified by the Secretary List of exclusions, including rent and insurance premiums. Other Election time and manner to be provided Allocation of transaction price provision? Did you know? Applies to advance payments for: Services Sale of goods not accounted for under Treas. Reg (b)(1)(ii) Use (including by license or lease) of intellectual property Occupancy/use of property ancillary to provision of services Sale, lease, or license of computer software Guaranty/warranty contracts ancillary to any of the above Tangible or intangible subscriptions other than for which an election under Section 455 is in effect Memberships in an organization other than for which an election under Section 456 is in effect Any combination of the above Same list of exclusions as Section 451(c) Automatic method change (Change #84) Treas. Reg. Section was effectively repealed by the enactment of Section 451(c) Page 9 Tax revenue recognition series I Highlights and implications of tax reform and ASC 606 implementation

10 Foreign Derived Intangible Income Page 10

11 Foreign Derived Intangible Income The Foreign Derived Intangible Income (FDII) deduction is available to domestic C corporations that derive income from the export of property (tangible and intangible) and services The deduction is not restricted to dispositions or licenses of intangible property and eligibility is not necessarily dependent on IP location The deduction is equal to a specified percentage of FDII Benefit: (1) provides permanent benefit; (2) lowers effective tax rate; (3) increases earnings per share and cash flow Page 11

12 What qualifies? Deduction eligible income Deduction eligible income Taxable income (DEI) NON-DEI Starting point: deduction eligible income concept Gross income determined without regard to: Subpart F income Global intangible low-taxed income (GILTI) inclusion Financial services income Dividends received from 10%-owned controlled foreign corporations (CFCs) Domestic oil and gas extraction income, and Foreign branch income Less deductions (including taxes) properly allocable to such gross income Page 12 Federal tax reform unpacked

13 What qualifies? Qualifying foreign sales income Deduction eligible income (DEI) NON-DEI Taxable income Qualifying foreign sales income Nonqualifying sales income Taxpayer then determines the portion of deduction eligible income that is derived from qualifying foreign sales of: Property Services Page 13 Federal tax reform unpacked

14 Qualifying foreign sales income Sales of property Property sold by the taxpayer To any person who is not a US person, and Which is for a foreign use Sold includes sale, lease, license, exchange, or other disposition Foreign use means any use, consumption, or disposition which is not within the US Property includes tangible and intangible property Sales of services Services provided by the taxpayer To any person not located within the US, or With respect to property not located within the US Domestic intermediary and related-party transaction considerations Page 14

15 Examples Sales of property US-based online retailer sells and ships products to customers with shipping and billing addresses inside and outside the US US Company Customers inside the US Qualifying? Customers outside the US Qualifying? Page 15

16 Examples Services vs. services with respect to property Qualifying? US transportation company ships product originating in US to destination outside US Qualifying? US airline provides flights originating in US to destination outside US US Company US Company Delivery from inside to outside US Property destination outside US Flight from inside to outside US Flight destination outside US Customer located inside US Customer located outside US Page 16

17 Computing FDII Deduction eligible income (DEI) (10% x qualified business asset investment (QBAI)) x Foreign-derived deduction eligible income (FDDEI) Deduction eligible income (DEI) Consider taxable income limitation Page 17

18 FDII deduction variables Deduction eligible income (DEI) (10% x qualified business asset investment (QBAI)) x Foreign-derived deduction eligible income (FDDEI) Deduction eligible income (DEI) Increase deduction eligible income (DEI) Decrease qualified business asset investment (QBAI) Increase foreign-derived deduction eligible income (FDDEI) Page 18

19 FDII deduction tax planning considerations Taxpayers must consider each component s impact on the taxpayer s overall tax liability, including the following: Planning around one variable in FDII equation could adversely affect another variable in FDII equation (e.g., planning to decrease QBAI could decrease DEI) Interaction with GILTI deduction when taxable income limited (i.e., increasing FDII reduces a more valuable GILTI deduction if taxable income limited) International considerations Interplay with international tax provisions (BEAT, foreign tax credits, GILTI, etc.) FDII must be considered in connection with any international planning strategies (e.g., restructuring, transfer pricing) Modeling is essential Page 19

20 FDII scoping considerations Are you a domestic C corporation that is not a regulated investment company (RIC) or real estate investment trust (REIT)? Are you in a taxable income position? Do you have foreign sales, leases, licenses, etc. of property (tangible/intangible) or services? Is your deduction eligible income greater than 10% of its QBAI (consider using net book asset value for estimate)? Do you have a GILTI inclusion under Section 951A? Are you subject to BEAT? BEAT can reduce FDII benefit by approximately half. Page 20

21 Base Erosion Anti-Abuse Tax Inventory Planning Page 21

22 Base Erosion Anti-Abuse Tax Inventory Planning Section 59A imposes on each applicable taxpayer for any taxable year a tax equal to the base erosion minimum tax. Applies to base erosion payments paid or accrued in taxable years beginning after 31 December 2017 Applicable taxpayer: Corporation (other than a RIC, REIT, or S corporation); Average annual gross receipts of at least $500 million for the three-year period ending with the preceding taxable year; and That has a base erosion percentage of 3% or higher (2% for banks and securities dealers) for that taxable year Modified taxable income : Determined without regard to any deduction allowed for the taxable year with respect to any base erosion payment; or the base erosion percentage of any net operating loss (NOL) allowed under section 172 Page 22

23 Base Erosion Anti-Abuse Tax Inventory Planning Taxpayers may reduce the impact of the BEAT by ensuring all amounts paid to foreign related parties allocable to inventory transactions are capitalized Generally, costs related to the production or resale of inventory are capitalizable under section 263A. Base erosion payments that might be capitalized to inventory include: Licensing, franchise and royalty costs associated with property produced or acquired for resale; and Shared services, including procurement, supply chain, accounting, and IT Cost of goods sold (COGS) generally excludes marketing, selling, advertising, distribution, or section 174 expenses Potential to avoid BEAT in year of payment to the extent bonus depreciation does not result in the full expense of the self-constructed asset (SCA) during the year Costs capitalized to SCA are generally recovered as the asset is depreciated Potential to avoid BEAT in year of payment to the extent bonus depreciation does not result in the full expense of the SCA during the year Otherwise deductible period costs may be capitalized if a portion of the cost is properly allocable to property produced may not result in a material distortion of income Page 23

24 Changes to bonus depreciation Page 24

25 Changes to Bonus Depreciation 100% bonus depreciation for qualifying property acquired and placed in service after 9/27/17 and before 1/1/23 generally (extra placed in service year for LPPP and certain aircraft) Phase down through 2026: 80% for qualified property placed in service before 1/1/24 60% for qualified property placed in service before 1/1/25 40% for qualified property placed in service before 1/1/26 20% for qualified property placed in service before 1/1/27 Property acquired before 9/27/17 and placed in service after such date is subject to prior law rules (50% bonus in 2017 generally, 40% bonus in 2018 generally, 30% in 2019 generally Acquisition date primarily dictated by written binding contract rules and may required detailed analysis. Determination of acquisition date for self-constructed assets is unclear (particularly those constructed on behalf of the taxpayer by a 3 rd party pursuant to a written binding contract), IRS guidance on this issue is forthcoming Page 25

26 Changes to Bonus Depreciation Qualifying property generally New law vs. old law Differences Addition of qualified film or television production property and qualified live theatrical production property Removal of QIP (effective for property placed in service after 12/31/2017). Accordingly QIP acquired after 9/27/17 and placed in service on or before 12/31/2017 is eligible for 100% bonus. QIP, QLIP, QRP and QRIP considerations in light of Congressional oversight Page 26

27 Changes to Bonus Depreciation Certain used property now bonus eligible (new original use property historically bonus eligible and continues to be bonus eligible) Additional requirements for used property under new law Property not used by the taxpayer at any time prior to acquisition Property not acquired from a related party Property not acquired in a carryover basis transaction Basis of property acquired not determined by reference to property held/formerly held by taxpayer Note that certain deemed asset acquisitions of used property may not qualify for bonus under such rules. For example, Certain Section 338 transactions involving related parties (e.g., 338(h)(10) elections) Certain Rev. Rul and Rev. Rul transactions Certain partnership step-ups arising from Section 754 elections Page 27

28 Changes to Bonus Depreciation Other considerations What does not qualify for bonus depreciation Required ADS property Assets held by trades/businesses with floor plan financing (2018 tax year and forward) Assets held by rate regulated utilities Elections under bonus depreciation Election out of bonus depreciation performed on a taxpayer-bytaxpayer basis and class-of-property by class-of-property basis Election to utilize 50%, instead of 100% bonus only applicable for first tax year ending after 9/27/2017 and applies to all bonus eligible property placed in service by the taxpayer in that tax year Page 28

29 Tax accounting considerations related to 2017 Tax Act Page 29

30 Staff Accounting Bulletin (SAB) 118 Enactment date effects: determination is required whether Accounting is complete Accounting is incomplete but the company has a reasonable estimate Accounting is incomplete and the company does not have a reasonable estimate Codified into ASC 740 (ASU ) Adjustments to provisional amounts Include in tax expense/benefit during period GILTI policy election has not been made when: Disclosed that a policy election has not yet been made No material GILTI deferred tax amounts have been recorded Required disclosures must be updated every quarter during measurement period New processes and internal controls are necessary Page 30

31 SAB 118 disclosures In addition to ASC 740 disclosures Qualitative information about the income tax effects of the Act for which the accounting is incomplete The items reported as provisional amounts Existing current or deferred tax amounts for which the income tax effects of the Act have not been completed The reason the initial accounting is incomplete The additional information that needs to be obtained, prepared or analyzed to complete the accounting requirements under ASC 740 The nature and amount of any measurement period adjustments recognized during the reporting period Effect of measurement period adjustments on the effective tax rate When the accounting for the income tax effects of the Act has been completed Page 31

32 Global intangible low taxed income (GILTI) Tax accounting considerations and election In general, the income subject to tax under the GILTI provisions should be included in the US shareholder s taxable income in the current year and included in the US income tax provision. FASB staff guidance provides an accounting policy election to account for GILTI: View A Record the tax effects of GILTI in the period the tax liability is generated (i.e. period cost ) View B Provide for deferred tax assets and liabilities related to basis differences that exist and are expected to affect the amount of GILTI inclusion in future years upon reversal (i.e. deferred method ) FASB staff believes that Topic 740 is not clear as it relates to the accounting for GILTI, and an entity may apply either interpretation of Topic 740. An entity must disclose its accounting policy in accordance with paragraphs through The staff plans to monitor how entities that pay tax on GILTI are accounting for and disclosing its effects by reviewing annual or quarterly reports issued over the next few quarters. Following this review, the staff will provide an update to the Board so it can consider whether improvements may be needed for the accounting or disclosures for the tax on GILTI. Page 32

33 Conformity to IRC (corporate) As of 7 March 2018 Key Fixed Rolling Selective California conforms to IRC as of 1 January 2015 (except Subpart F rolling conformity BUT, it doesn t conform to Subpart F income) CA OR WA NV ID AZ UT MT WY CO NM ND SD NE KS OK MN IA MO AR WI IL No corporate income tax ME VT NH NY MA MI CT PA IN OH MD WV VA KY NC TN SC R I N J D E AK TX LA MS AL GA D C HI FL Texas conformity date is 1 January 2007 Page 33

34 FASB update Page 34

35 Selected FASB projects Project Improving the accounting for asset acquisitions and business combinations (Phase 3) Customer s accounting for implementation costs incurred in a cloud computing arrangement that is a service contract (EITF 17-A) Consolidation targeted improvements to related party guidance for variable interest entities Technical corrections and improvements Elimination of Subtopic Codification improvements (includes updates to ASC 740) Distinguishing liabilities from equity Status Initial deliberations Exposure draft comment period Exposure draft redeliberations Exposure draft redeliberations Exposure draft redeliberations Initial deliberations Disclosure framework Exposure draft redeliberations 1 1 The disclosure framework project is being executed across several topics, which are in various stages of completion, but most are generally in the exposure draft redeliberations phase. Page 35

36 FASB standards effective dates Several standards were effective in Q1 18 for public companies: ASU , intra-entity transfers of assets other than inventory ASU , definition of a business ASU (codified in ASC 606), revenue from contracts with customers ASU , recognition & measurement of financial assets and financial liabilities Several other standards were able to be early adopted in Q1 18: ASU (codified in ASC 842), leases ASU , reclassification of tax reform effects stranded in AOCI ASU ASU ASC 606 ASU ASC 842 ASU Early adoption 1/1/2017* 1/1/2017 1/1/2017 1/1/2016** 1/1/2017 Any period Public company 1/1/2018 1/1/2018 1/1/2018 1/1/2018 1/1/2019 1/1/2019 Private company 1/1/2019 1/1/2019 1/1/2019 1/1/2019 1/1/2020 1/1/2019 * Early adoption only permitted in the first interim period if an entity issues interim financial statements. ** Applies to certain provisions only. For public companies that have not yet adopted the new standards, disclose the effect of adoption on future periods Page 36

37 ASU reclassification of certain tax effects from AOCI The effect of new tax laws on deferred taxes initially recorded in OCI is recorded as tax expense related to continuing operations Prohibition of backward tracing triggers stranded debits/credits in AOCI ASU gives the option to reclassify to retained earnings Stranded tax effects related to the change in federal tax rate Other stranded tax effects that relate to the Act Requires new disclosure of accounting policies on how a company releases the tax effects from AOCI Careful consideration on how ASU interacts with other accounting standards effective Effective dates of ASU for calendar year-ends Transition All entities Early adoption? Retrospectively or in the period of adoption 2019 Yes Page 37

38 Tax-related restatements and material weaknesses Page 38

39 Tax-related restatements and material weaknesses: summary of the numbers Year * Total restatements Big R restatements Notes on restatements Total restatements include both little r and big R or revision restatements. An EY study of 2016 restatements found that tax was the most frequently cited reason for restatements, accounting for 16% of the total. Some companies are uncovering errors as part of the review and revaluation of deferred taxes due to tax reform Year * Material weakness Notes on material weaknesses In recent years, the number of companies reporting material weaknesses has remained fairly steady, and tax continues to be one of the biggest drivers of material weaknesses. *Through 3/31/2018 Page 39

40 Restatements: common errors Deferred tax accounting errors are most frequently cited as the cause of restatements. Other causes include discrete tax adjustments that affect income tax expense (specifically including payroll, real estate, withholding tax calculation errors) and classification errors Specific errors identified include: Accounting for acquisitions/dispositions (specifically purchase accounting and goodwill impairment calculations) this is the most frequently cited error Treatment of federal and state NOLs and carry-forwards Capitalization/depreciation/amortization of tangible and intangible assets and inventory for accounting purposes Foreign taxes (foreign tax credits, currency translation adjustments) Stock-based compensation, improper calculation of APIC Valuation allowance adjustments Uncertain tax positions Errors relating to intercompany activities, transfer pricing (allocation of sales, sale of assets) Pension plan accounting (foreign and domestic) Page 40

41 Material weaknesses: causes Accounting errors People Process The primary causes Accounting errors People Processes and controls There is a trend away from citing people issues as being the predominant cause of material weaknesses in favour of citing specific accounting errors Specific accounting errors cited overlap with restatements and also include: Complex and non-routine or non-recurring transactions State and local taxes Incorrect calculations of deferred taxes by foreign subsidiaries People issues are generally described as the inability of management to properly review the income tax accounting and lack of personnel with sufficient technical knowledge and experience in tax accounting Process and control issues include: Lack of adequate policies and procedures to ensure the completeness, accuracy and preparation of the income tax provision Lack of documentation Financial close and work compressions Improper segregation of duties Page 41

42 Other developments Page 42

43 Other developments Partnership audit regime proposed regulations addressing the adjustment of tax attributes to reflect partnership adjustments under the centralized partnership audit regime introduced by the Bipartisan Budget Act of The proposed attribute regulations also address the allocation of an imputed underpayment. US Burden Reduction Reforms : delayed the effective dates of Sec. 385 & 987 regulations. Page 43

44 Q&A Page 44

45 Thank you! Page 45

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