Domestic Tax Update. Scott Mackay Joan Schumaker. 3 May 2016

Transcription

1 Domestic Tax Update Scott Mackay Joan Schumaker 3 May 2016

2 Circular 230 disclaimer 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. 2

3 Presenters Joan Schumaker Tax Partner Ernst & Young LLP New York, NY Scott T. Mackay Tax Partner Ernst & Young LLP Washington, DC 3

4 Agenda Federal tax Recent legislative and other developments Accounting for income taxes FASB project status Accounting standard updates PCAOB focus areas SEC focus areas Restatement trends and common causes of tax restatements 4

5 Federal Tax Developments 5

6 Treasury / IRS Projects Released IIR guidance under 263(a) for Retail Refresh & Remodel Costs Rev. Proc Proposed Regulations under 199 regarding Software Revenue procedure under 461 on economic performance for liabilities created under ratable service contracts Rev. Proc Informal guidance 6

7 Treasury / IRS Projects Underway IIR guidance under 263(a) for Gas Transmission & Distribution Companies Negative additional 263A costs IIR guidance under 167 and 168 for determining whether certain assets used by a wireline telecommunication service provider are primarily used for providing one-way or two-way communication services. Regulations under 460 regarding home construction contracts and rules for certain changes in method of accounting for long-term contracts. Guidance regarding the treatment of deferred revenue in taxable asset sales and acquisitions. Regulations under 472 regarding dollar-value last-in, first-out (LIFO) inventories, including rules for combining pools as a result of a change in method of accounting, certain corporate acquisitions, and certain nonrecognition transactions Other? 7

8 Challenges implementing the Retail IIR Safe Harbor Calculation Total fixed asset additions (per AFS) (subtract listed exclusions) = Qualifying remodel-refresh costs 75% deducted 25% capitalized Capital expenditure portion (CEP) Recovered over 15 or 39 years Included in a group GAA Depreciate out unless entire store location is disposed of 8

9 Challenges implementing the Retail IIR Justifying 15-year QLIP property vs. 39-year nonresidential real property Identifying and reversing prior partial dispositions Many taxpayers are unaware that they have partial dispositions for tax purposes because they are recorded as full dispositions for book purposes Rev. Proc requires taxpayers to revoke prior partial dispositions for qualified buildings If taxpayers do not revoke prior partial dispositions, the safe harbor is applied on a cutoff basis and there is no Section 481(a) adjustment for buildings for which dispositions were taken, but not restored Creating appropriate general asset accounts to track and depreciate capital expenditure portion 9

10 Challenges implementing the Retail IIR Excluded remodel-refresh costs Safe Harbor Calculation Total fixed asset additions (per AFS) (subtract listed exclusions) = Qualifying remodelrefresh costs 75% deducted 25% capitalized Listed Exclusions 1. Section 1245 property 2. Intangibles, including software 3. Land and land improvements 4. Initial acquisition/production/lease of a building 5. Initial build-out for a new lessee 6. Activities to rebrand a building within two tax years of initial acquisition, production, or lease 7. Ameliorate pre-existing material condition/defect 8. Material additions to a building 9. Restoration related to a casualty event 10. Adapt >20% of building to new or different use 11. Store closed for more than 21 consecutive days 12. Taxpayer claimed 179, 179D, or 190 deduction 10

11 Challenges implementing the Retail IIR Excluded remodel-refresh costs Taxpayers have misunderstood and misapplied exclusions rules, such as: Unnecessarily excluding all remodel activities occurring within 2 years of initial acquisition Taxpayers misapply the 2-year restriction of the rebranding exclusion (exclusion 6) to all activities, substantially reducing their benefit Using broad or irrelevant search terms to disqualify costs Excluding all items containing expansion in order to exclude material expansions (exclusion 8) Excluding all items that are restorations, when this exclusion only applies to restorations as a result of a casualty loss (exclusion 9) 11

12 Section 199 Overview Section 199 is an incentive provision relating to certain domestic manufacturing and production activities. Deduction is 9% of lesser of Qualified Production Activities Income (QPAI) or taxable income. Qualifying activity $ Applicable property QPAI = from less cost of goods sold (COGS) & expense Lease, license, sale Construction, architecture, engineering Qualifying production property (QPP), qualified films, utilities Real property 12

13 Section 199 controversy Contract manufacturing Only one taxpayer can qualify for the same activity performed on the same property. Benefits and burdens test determines party considered to have manufactured the property. What is manufactured, produced, grown, or extracted (MPGE)? To qualify for the Section 199 deduction for QPP, the taxpayer must manufacture the property in whole or significant part in the United States. Are taxpayer s activities substantial in nature? Are taxpayer s activities packaging, repackaging, labeling, or minor assembly? 13

14 Section 199 controversy Online software Regulations disallow domestic production gross receipts (DPGR) from services. Gross receipts derived from providing access to online software are DPGR only if the taxpayer meets one of two exceptions. General Legal Advice Memorandum Taxpayer did not have income attributable to DPGR from customers downloading its computer software application (App) free of charge. 14

15 Proposed Section 199 regulations and outlook Significant issues addressed by proposed regulations (August 2015) Temporary provisions W-2 wages (statutory change) Construction rules Item rule MPGE Oil related QPAI (statutory change) Section 460 and COGS Qualified film (statutory change) Contract manufacturing Guidance outlook Section 199 final regulations Section 199 online software proposed regulations Litigation outlook Benefits and burdens cases docketed No online software cases Examination activity 15

16 Research credit Overview Section 41 is an incentive provision for certain domestic R&D activities Legislative changes Credit has been made permanent Certain small taxpayers credit allowed against AMT Certain start-up taxpayers credit can offset payroll tax liability Qualified research expenses Qualified research Exclusio ns Wages Supplies Contract research expenses (65%) Expenses under Section 174 Technological in nature New/improved business component Process of experimentation Research outside US Internal use software, except as provided by regulation Funded research After commercial production Marketing 16

17 Research credit controversy Section 174 Final regulations published 21 July 2014 Exam s application of the more generous rules Internal use software (IUS) Proposed regulations published 20 January 2015 Breadth of dual function software Exam s application of the high threshold of innovation standard Supplies used in research Union Carbide case disallowed unsegregated supplies used in process research Prototype costs as supply costs Funded research Fairchild Indus., Inc. vs. US, Geosyntec Consultants, Inc. vs. US, Dynetics, Inc. vs. US 17

18 Research credit proposed and final regulations and outlook Internal use software History Proposed regulations for IUS IUS = general and administrative Non-IUS = sold or third-party interaction Dual function software High threshold of innovation test Taxpayers can apply proposed regulations to tax years ended on or after 20 January 2015 Alternative simplified credit (ASC) election Final regulations to elect ASC on an amended return Group credit allocation Proposed and temporary group credit allocation Requires taxpayers to allocate group credit on basis of qualified research expenditures (QRE) of each controlled group member Effective for tax years beginning on or after 3 April 2015 Guidance outlook Final IUS regulations Final group credit allocation regulations Final intragroup gross receipts regulations Proposed supplies regulations 18

19 Hottest Method Changes Favorable Changes Exposure Items Depreciation Tangible Property Regulations Deferral of Revenue / Advance Payments Bonus/vacation accrual and other deferred comp. Expense recognition Unicap ( 263A) Inventory / Unicap ( 263A) Bad Debts Incurred but not recorded / workers comp. Software-development costs Prepaid expenses Revenue recognition Improperly obtained / implemented method changes 19

20 Accounting for income taxes 20

21 FASB project status 21

22 FASB income taxes simplification project Intercompany scope exception Proposal would eliminate exception that requires deferral of the income tax effects of intercompany sales/transfers of assets Would recognize income tax expense in the period of the sale/transfer Would recognize deferred tax effects of the difference between the tax basis of the asset in the buyer s jurisdiction and its book basis after elimination of the intercompany profit For public business entities, FASB expects proposed amendments effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, FASB expects proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption permitted, but not before the effective date for public business entities Modified retrospective transition approach In October 2015, FASB asked its staff to research the costs and benefits of deferring the income tax effects only for intercompany inventory transactions 22

23 FASB income taxes disclosure project Initial deliberations foreign earnings FASB tentatively decided to require additional disclosures as follows: Pre-tax income (loss) disaggregated between domestic and foreign earnings Income tax expense (benefit) disaggregated between domestic and foreign Income taxes paid disaggregated between domestic and foreign Foreign income taxes paid to any country that are significant relative to total income taxes paid The amount of and explanation for a change in assertion about the temporary difference for the cumulative amount of investments associated with undistributed earnings that are (1) asserted to be essentially permanent in duration, or (2) no longer asserted to be essentially permanent in duration Foreign earnings that are indefinitely reinvested for any country that represents at least 10% of the entity s total foreign earnings that are indefinitely reinvested 23

24 FASB income taxes disclosure project Initial deliberations uncertain tax positions FASB tentatively decided to add requirements that public entities disclose as part of the tabular rollforward of unrecognized tax benefits the following: Settlements disaggregated between those that are cash and noncash (e.g., an existing net operating loss carryforward used to settle with the taxing authority) A breakdown of the total amount of unrecognized tax benefits by the balance sheet line item in which the amounts are presented FASB also tentatively decided to eliminate for all entities the requirement to disclose certain information when it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date 24

25 FASB income taxes disclosure project Initial deliberations other disclosures The FASB also made tentative decisions for other income tax disclosures that would require entities to disclose: Information about an enacted change in tax law if it is probable that the change will affect the entity in a future period 25

26 FASB income taxes disclosure project Initial deliberations other disclosures FASB also made tentative decisions for other income tax disclosures that would require public entities to disclose: Income tax rate reconciliations Individual reconciling items of more than 5% of amount of pre-tax income times applicable federal statutory income tax rate A qualitative description of items that have caused a significant change in the rate An explanation of the nature and amounts of valuation allowances recorded and released during the reporting period The amounts and expiration dates of tax carryforwards recorded on the tax return (not tax effected) and in the financial statements (tax effected) and the total amount of unrecognized tax benefits that offsets carryforwards. 26

27 FASB income taxes disclosure project Initial deliberations transition and next steps FASB tentatively decided to require prospective transition for all income tax disclosures FASB asked its staff to perform outreach on the operability of requiring companies to disclose cash and cash equivalents, marketable securities and loans underlying undistributed earnings that are indefinitely reinvested After the outreach is complete, FASB plans to issue an exposure draft on the proposal 27

28 FASB government assistance disclosure project proposal FASB proposal would require for-profit entities to make certain disclosures about assistance they receive from legally enforceable agreements with governments: The nature of the assistance, including a general description of the significant categories and the form in which the assistance has been received The accounting policy used to account for the government assistance The line items on the balance sheet and income statement that are affected by government assistance and the amounts The amounts of government assistance received that are not directly recorded in the financial statements (e.g., loan guarantees, loans with below-market rates, tax abatements) unless impracticable to do so 28

29 FASB government assistance disclosure project proposal The disclosure requirements would apply to certain arrangements accounted for under the income tax guidance in addition to grants, loan guarantees and other types of government assistance. The guidance would be applied prospectively to all agreements existing at the effective date and those entered into after the effective date. Entities would be permitted to apply the guidance retrospectively. FASB is currently redeliberating the proposal based upon feedback received during the comment period. 29

30 Accounting standard updates 30

31 Revenue recognition ASU Revenue recognition accounting standard issued on 28 May 2014 Supersedes virtually all industry and interpretive guidance Requires more estimates and judgments than current guidance The FASB has issued a one-year deferral of the original effective date of ASU Standard will be effective for public entities for annual periods beginning after 15 December 2017 (2018 for calendar-year companies) Nonpublic entities will still have the option of an additional year (effective for annual periods beginning after 15 December 2018) Early adoption will be allowed for both public and nonpublic entities using original effective dates (2017 for calendar-year companies) The deferral was issued in ASU on 13 August 2015 The IASB voted for a one-year deferral as well 31

32 Revenue recognition standard Effective date Dates shown are for calendar year-end entities Mandatory adoption Effective date First presentation Public 1 January March Q Nonpublic 1 January December 2019 annual F/S Early adoption Public 1 January March Q 1 January March 2017 interim F/S 31 December 2017 annual F/S Nonpublic 31 March 2018 interim F/S 1 January December 2018 annual F/S 1 January March 2019 interim F/S 32

33 Revenue recognition standard Transition methods (1) Full retrospective Cumulative catch-up adjustment at 1/1/2016 Financial statements New GAAP New GAAP New GAAP Footnotes ASC 250 disclosures Modified retrospective Cumulative catch-up adjustment at 1/1/2018 Financial statements Legacy GAAP Legacy GAAP New GAAP Footnotes Legacy GAAP (1) This slide does not reflect early adoption 33

34 Revenue recognition standard Tax technical considerations Taxpayers will need to determine when and how any change in revenue recognition for financial reporting purposes is recognized for tax purposes. For taxpayers applying a deferral method for advance payments, the amounts deferred for tax purposes are determined by reference to the amounts deferred for financial statement purposes. Consider whether a change in revenue recognition for financial statement purposes is also a permissible method for tax purposes. In certain jurisdictions, local tax liability is based upon statutory financial statements. When local statutory financial statements are prepared under IFRS, the statutory financial statements may change with adoption of the standard Evaluate whether a foreign subsidiary s earnings and profits (E&P) or local tax change the amount by which a distribution is taxable as a dividend, the amount of Subpart F inclusion, or deemed paid foreign tax credits. Evaluate intercompany prices and transfer pricing policies where adoption changes revenue, profits or third-party comparables used in determining transfer pricing. Companies may need to review the methodology for compiling sales apportionment data. 34

35 Revenue recognition standard Income tax accounting considerations New temporary differences may arise or existing temporary differences may be computed differently Companies may need to revise their processes and data collection tools Valuation allowance considerations may change Change in deferred tax assets, temporary difference reversals or expected future taxable income may affect judgments regarding the realizability of deferred tax assets Multinational companies will need to consider the effects of changes in revenue recognition for financial reporting purposes at foreign subsidiaries Jurisdiction-by-jurisdiction analysis necessary to assess whether the change in revenue recognition for financial reporting results in temporary differences due to differences in timing and amount of revenue recognized for financial reporting and tax purposes Current and deferred tax consequences of the cumulative effect adjustment reported in the period of adoption Requires careful consideration of the income tax accounting effect of individual items included in the cumulative effect adjustment A change in an accounting method for tax purposes requires careful consideration of the period the change in method is considered for financial reporting purposes 35

36 Classification of deferred taxes ASU FASB issued ASU , Balance Sheet Classification of Deferred Taxes, that requires the classification of all deferred tax assets and liabilities as noncurrent No longer allocate valuation allowances between current and noncurrent No change to jurisdictional offsetting requirements For public business entities, standard effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, standard effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption permitted for all entities in any interim or annual period Entities may elect either a prospective or retrospective transition approach 36

37 Financial instruments: Classification and measurement ASU FASB issued ASU , Recognition and Measurement of Financial Assets and Financial Liabilities Measure many equity investments at fair value and recognize changes in fair value in net income unless the investments qualify for practicability exception Assess the realizability of a deferred tax asset (DTA) related to an available-for-sale (AFS) debt security in combination with other DTAs Use the same four sources of taxable income that are used for other DTAs Include the expected reversal of unrealized losses on AFS debt securities that an entity has both the intent and ability to hold until recovery as a component of its overall projection of future taxable income May not be able to rely on projections of future taxable income for purposes of evaluating realizability of DTAs if significant negative evidence exists (e.g., cumulative losses in recent years) 37

38 Financial instruments: Classification and measurement ASU No longer separately evaluate the DTAs related to AFS debt securities Can not solely rely on intent and ability to hold debt securities with unrealized losses until recovery, which may not be until maturity, akin to a tax planning strategy For public business entities, standard effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2017 For nonpublic business entities, standard effective for annual periods beginning after 15 December 2018 and interim periods in annual periods beginning after 15 December 2019 Can early adopt as of effective date for public business entities Early adoption permitted for certain provisions (does not include income tax provision) Generally apply modified retrospective approach 38

39 Leases ASU The IASB issued IFRS 16 Leases in January The FASB issued ASU , Leases, in February Effective date 1 January 2019 for calendar-year public business entities with early adoption permitted Key changes to today s US GAAP guidance include: Lessees would recognize assets and liabilities for most leases. For lessors, the guidance would modify today s classification criteria and accounting for sales-type and direct financing leases. Leases would be classified using criteria similar to current US GAAP without the bright lines. Classification would determine how entities recognize lease-related revenue and expense, and would continue to affect what lessors record on the balance sheet. New presentation and disclosure requirements 39

40 Leases ASU Application of the new guidance results in changes to pre-tax book accounting: Lessees Likely recognize new lease-related assets and liabilities on the balance sheet and may change measurement of other lease-related assets and liabilities Lessors May see a change in the recognition and measurement of leaserelated assets and/or derecognition of underlying assets for certain leases Timing of recognition of lease income may change for some leases Special accounting for leveraged leases is eliminated These changes affect certain aspects of accounting for income taxes such as: Recognition and measurement of DTAs and deferred tax liabilities (DTLs) Assessment of the recoverability of DTAs (i.e., the need for and measurement of a valuation allowance) 40

41 Stock compensation ASU ASU , Improvements to Employee Share-Based Payment Accounting, issued in March 2016 Excess tax benefits and tax deficiencies recognized in the income statement (prospective transition) Account for excess tax benefits and tax deficiencies as discrete items in the interim period in which they occur Eliminates the requirement that excess tax benefits not be recognized until they are realized (modified retrospective transition with a cumulative catch-up adjustment to retained earnings) Excess tax benefits presented as an operating activity in the statement of cash flows (prospective or retrospective transition) For public business entities, effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption is permitted for all entities in any interim or annual period for which financial statements have not been issued 41

42 IFRS developments IAS 12 amendments recognition of DTAs for unrealized losses IAS 12 amended for years beginning on/after 1 January 2017, early adoption permitted Decreases below cost in the carrying amount of a fixed-rate debt instrument measured at fair value for which the tax base remains at cost give rise to a deductible temporary difference irrespective of whether the debt instrument s holder expects to recover the carrying amount of the debt instrument by sale or by use, e.g., continuing to hold it to maturity Determining temporary differences and estimating probable future taxable profit against which deductible temporary differences are assessed for utilization are two separate steps and the carrying amount of an asset is relevant only to determining temporary differences The carrying amount of an asset does not limit the estimation of probable future taxable profit Future taxable profit includes the probable inflow of taxable economic benefits that results from recovering an asset, and that may exceed the carrying amount of the asset Must consider whether tax law restricts the sources of taxable profits against which it may make deductions on the reversal of that deductible temporary difference, e.g., capital loss limitations 42

43 PCAOB focus areas 43

44 PCAOB 7 May 2015 audit committee dialogue Identified deficiencies related to: Auditing estimates (including tax-related estimates) auditing the estimate and related internal controls Identified emerging risk area: Auditing of management s indefinite reinvestment assertion and the related internal controls Questions to consider: How is understanding of critical assumptions and methods obtained? How is contrary evidence evaluated? What is the nature of evidence gathered regarding management s assertions? Are indefinite reinvestment assertions consistent with other disclosures (e.g., MD&A)? 44

45 AICPA national conference December 2015 PCAOB remarks related to tax PCAOB staff stated that inspections will likely focus on the following areas of emerging risks in 2016 that pertain to tax: Risks associated with mergers and acquisitions Income taxes, specifically matters related to a company s assertions related to undistributed cash held in overseas subsidiaries Cybersecurity risks 45

46 AICPA national conference December 2015 SEC staff remarks on ICFR Commission s management guidance for ICFR is aligned with PCAOB AS No. 5 PCAOB s ICFR findings may reflect not only inadequate audit execution but also deficiencies in management s controls and management s assessments Discussed the level of evidence that management is required to retain to support the effectiveness of controls (including management review controls) 46

47 SEC focus areas 47

48 AICPA national conference December 2015 SEC staff remarks on income tax Focus on quality and clarity of management discussion and analysis (MD&A) disclosures, including those related to income tax rate reconciliations, valuation allowances and earnings that have not been repatriated Enhance disclosures in MD&A when: Income tax expense is material to financial statements both recorded expense and expense based on statutory tax rate There are material fluctuations or lack of fluctuations that were expected in the effective tax rate (ETR) There are risks and uncertainties Provide transparent disclosure in MD&A of significant foreign earnings, including earnings and tax rates within specific jurisdictions and jurisdictions effects on the ETR 48

49 AICPA national conference December 2015 SEC staff remarks on reinvestment of foreign earnings SEC staff has asked registrants to explain how they have overcome the presumption and to provide evidence of specific plans for reinvestment of foreign earnings (e.g., past experience, working capital forecasts, long-term liquidity plans, capital improvement programs, merger and acquisition plans, investment plans). SEC staff also requests similar evidence when registrants assert that they intend to indefinitely reinvest only a portion of undistributed foreign earnings or when undistributed foreign earnings are considered to be indefinitely reinvested, but there is a recent history of repatriation. Staff indicated that when there is a change in assertion, registrants should disclose the facts and circumstances that led to it during the reporting period. 49

50 AICPA national conference December 2015 SEC staff remarks on liquidity and reinvested foreign earnings Example SEC staff comment If significant to an understanding of your liquidity, in future filings please clarify the amount of cash and investments held outside of the US. Additionally, to the extent material, please describe any significant amounts that may not be available for general corporate use related to cash and investments held by foreign subsidiaries where you consider earnings to be indefinitely invested. Also, address the potential tax implications of repatriation. 50

51 SEC comment focus Comment area 2015 Ranking 2014 Ranking Management s discussion and analysis 2014 and 2015 % of total registrants that received comment letters % Fair value measurements % Revenue recognition % Non-GAAP financial measures % Signatures, exhibits and agreements % Income taxes % Segment reporting % Intangible assets and goodwill % Acquisitions and business combinations Executive compensation disclosures % % 51

52 Tax restatements and material weaknesses 52

53 Tax restatements increased past three years Common errors Classification errors 5% Stock-based compensation 8% Other 16% Acquisitions/ dispositions 16% Valuation allowance 11% Deferred tax accounting 44% Generally, three most common causes of restatements are: Deferred tax accounting Accounting for acquisitions/dispositions (specifically purchase accounting and goodwill impairment calculations) Valuation allowance adjustments During 2015, issues relating to stock-based compensation arose more frequently Improper classification of current and noncurrent deferred tax assets also commonly cited Other errors often cited: Errors relating to intercompany activities Treatment of federal and state carryforwards Foreign taxes (foreign tax credits, currency translation adjustments) Capitalization/depreciation/amortization of tangible and intangible assets purposes Pension plan accounting (foreign and domestic) 53

54 Material weaknesses Causes Primary causes fall in three general areas: Segregation of duties 6% Documentation 6% Improper treatment 40% People Processes and controls Accounting errors (valuation allowances, NOLs, pensions state taxes, leases, impairment mentioned in 2015) People issues are typically described as: People 31% Personnel with insufficient technical knowledge, experience, training in tax accounting Lack of investment, resources and focus in tax reporting Process and control issues include: Lack of adequate policies and procedures to ensure the completeness, accuracy, preparation and review of the income tax provision Lack of documentation Lack of timely reconciliation of tax accounts Review procedures 17% Inadequate monitoring of significant transactions and new reporting requirements Financial close and work compressions Improper segregation of duties 54

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