Ninth Annual Domestic Tax Conference. 8 May 2014 Chicago

Transcription

1 Ninth Annual Domestic Tax Conference 8 May 2014 Chicago

2 Accounting for income taxes: hot topics and developments

3 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.

4 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 located in the US. This presentation is 2014 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 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.

5 Today s presenters Angela Evans Brian Foley Kathy Ford Joan Schumaker

6 Agenda Developments Legislative and other developments Accounting standard updates SEC areas of focus PCAOB focus on internal controls New COSO internal control framework Tax provision challenges Tax restatements and practice issues Reduce risk in tax accounting calculations Internal control over financial reporting Design considerations Best practice responses

7 Developments

8 Legislative and other developments Changes in tax laws and rates Legislative developments continue to occur in 2014 and include: Austria disallow deductions for interest and royalty payments made to affiliated companies abolish tax goodwill amortization for acquisitions after 28 February 2014 Chile exclude foreign group members that are resident in countries outside the EU from Austrian tax groups limit domestic group s ability to offset its income with losses of foreign group members to 75% of the domestic group income, starting in 2015 increased the current FTC limits to be used in Chile (both in the presence and absence of a tax treaty) expanded the foreign taxes that can be credited (beyond a foreign two tier structure) expanded the possible carryover of FTC (effective 1 January 2014) Iceland enacted new transfer pricing rules (effective 1 January 2014)

9 Legislative and other developments Changes in tax laws and rates Korea eliminated deductibility of reserves used as future R&D decreased the R&D investment tax credit for medium and large companies (effective 1 January 2014) Panama repealed on a retroactive basis the worldwide income tax system enacted at the end of 2013 and reinstated its territorial income tax system (effective 31 December 2013) U.S. Reminder Extenders such as CFC look-through rule, Subpart F active financing exception and research credit expired 31 December 2013 Deferred taxes should also be measured consistent with enacted tax law

10 Legislative and other developments Changes in tax laws and rates New York State (NYS) key components of the proposal include: Repeal of existing bank franchise tax and its merger into a substantially modified general corporation franchise tax Reduction in general franchise tax rate from 7.1% to 6.5% (beginning on or after 1 January 2016); Increase in Metropolitan Transportation Business Tax Surcharge rate 0% tax rate on the business income base for qualified NYS manufacturers (beginning on or after 1 January 2014) Adoption of an economic presence nexus standard Change in computation of NYS s NOLs from a pre-apportioned NOL to a post-apportioned NOL, and provision of an NOL conversion subtraction Adoption of a single receipts factor for all NYS taxpayers Change in sourcing of sales to NYS to provide for customer sourcing Elimination of the current subsidiary capital and related franchise tax provisions; and phase out of the capital base tax through 2020 Effective tax years beg. on or after 1/1/15, with exceptions noted

11 Other developments Brazil provisional measures Transitory Tax Regime (TTR) was introduced in 2007 to achieve tax neutrality in the GAAP conversion to IFRS, which began in 2008 Required continued application beyond 2007 of pre-ifrs Brazilian GAAP for tax purposes 17 September TTR Regulations NI 1, 397/2013 issued and provides specific guidance Requires Old Brazilian GAAP to determine interest on net equity deductions, taxable dividends, equity adjustments and other tax attributes Assess possible exposure Provisional Measure (PM) 627/2013 published 12 November 2013 terminates TTR effective 1 January 2015, with early adoption allowed 1 January 2014 PM was issued by the President and is valid Approval deadline extended to 21 April 2014 by Congress or its cancelled Aligns Brazilian GAAP to IFRS for tax purposes Impacts many areas including goodwill and investment in affiliates Transition to IFRS for tax purposes may affect book and tax bases and tax accounts

12 Things we have our eye on Federal President Obama s fiscal year 2015 budget tax proposals the Obama Administration proposed several tax law changes affecting businesses, including: Limiting the deductibility of certain interest expenses for US companies that are part of a worldwide consolidated group Subjecting certain income from related-party contract manufacturing arrangements to tax Increasing the research credit and making it a permanent part of the tax code, rather than a provision that expires every one to two years Repealing the last-in/first-out and the lower-of-cost-or-market inventory accounting methods Eliminating the tax deduction that US companies currently receive for expenses related to moving operations overseas

13 Things we have our eye on Federal Chairman Camp s Tax Reform Act of 2014, includes: Tax rate lowered to 25% (five-year phase-in) AMT (alternative minimum tax) repealed AMT credits refundable Major changes to corporate tax expenditures Limit deduction of an NOL carryforward or carryback to 90% of taxable income. Repeal certain special NOL carryback rules 20-year amortization for deductible goodwill and certain other intangible assets Modified alternative simplified credit (ASC) permanently extended equal to 15% of qualified research expenses for the year that exceed 50% of average of qualified expenses for preceding three years Establishes a new foreign dividend exemption system: 95% deduction for dividends from certain foreign subsidiaries Transition: deemed inclusion of deferred foreign earnings at 8.75% for earnings in cash, cash equivalents and short term assets 3.5% for other earnings

14 Things we have our eye on International The OECD s (Organization for Economic Co-operation and Development) Action Plan on Addressing Base Erosion and Profit Shifting (BEPS) aimed at government concern about the potential for multinational corporations (MNC) to reduce their tax liabilities through shifting of income to no or low tax jurisdictions pending actions include: Changes to the OECD Transfer Pricing Guidelines Changes to the OECD Model Treaty Changes to the OECD Model Treaty Commentary Recommendations regarding the design of domestic rules Country by Country Reporting Model

15 Financial reporting considerations Tangible property final regulations Considerations for 2014 reporting 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 deferred tax liability for any section 481(a) adjustment is to be included in estimated taxes Note: Refer to ASC through -61 for guidance on income tax accounting consequences of a method change

16 Accounting standard developments

17 Accounting standard updates Presentation of unrecognized tax benefits (ASU ) ASU , 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.

18 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 Footnote disclosure Prior to adoption of ASU Following adoption of ASU Deferred tax assets Accrued environmental costs $100 $100 Net operating loss carryforwards Less: valuation allowance Total deferred tax assets (matches balance sheet) $145 $95 Does not change disclosure of unrecognized tax benefits, which are required to be presented gross

19 Accounting standard updates Affordable housing projects (ASU ) Accounting Standards Update (ASU) , 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 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

20 Regulatory developments

21 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

22 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

23 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

24 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

25 Tax provision challenges

26 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

27 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?

28 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?

29 Intraperiod allocation 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

30 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?

31 Realizability of DTAs Same framework Establishing a valuation allowance for the first time Determining whether a valuation allowance continues to be necessary Have all four sources of taxable income been considered?

32 Realizability of DTAs 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?

33 Realizability of DTAs 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

34 Realizability of DTAs Company A could sell a non-core asset The book basis of the asset is $100 The tax basis of the asset is $10 The fair value of the asset is $300 The company has a net operating loss of $200 that is expected to expire in 2 years The enacted tax rate for the company is 30% Assume the company was previously break even and has no taxable temporary differences Is the sale of a non-core asset a qualified tax planning strategy?

35 Realizability of DTAs Conclusion: Yes and no A decision to sell an appreciated non-core asset may represent a tax planning strategy to the extent it results in the reversal of a temporary difference in an earlier period In the example, the existing $90 taxable temporary difference may reverse in an earlier period In some cases what appear to be tax planning strategies also represent forecasts of future income Excess of fair value over book basis is a projection of future taxable income Pretax gain on sale would be subject to the same limitations as any other projections of future income In the example, the $200 excess is a projection Projection of future taxable income is not a tax planning strategy

36 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

37 Internal control over financial reporting (ICFR)

38 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

39 COSO Framework Principles of effective internal control Control environment 1. Demonstrates commitment to integrity and ethical values 2. Exercises oversight responsibility 3. Establishes structure, authority and responsibility 4. Demonstrates commitment to competence 5. Enforces accountability Risk assessment Control activities Information and communication Monitoring activities 6. Specifies suitable objectives 7. Identifies and analyzes risk 8. Assesses fraud risk 9. Identifies and analyzes significant change 10. Selects and develops control activities 11. Selects and develops general controls over technology 12. Deploys through policies and procedures 13. Uses relevant information 14. Communicates internally 15. Communicates externally 16. Conducts ongoing and/or separate evaluations 17. Evaluates and communicates deficiencies

40 Tax ICFR Precision and evidence of management review Thinking about precision determine and document: Nature of review procedures? Are the procedures capable of identifying errors? Would the control identify errors or fraud that could be material to the financial statements? Do the procedures address the relevant risks? Does control identify errors? Nature of the errors? Examples? If not, why? Nature of the questions; follow-up; outcome? Is there contradictory evidence indicating the control is not suitably designed? Is evidence sufficient to support the assessment? Page 40

41 Tax ICFR Design example Poor example Appropriate personnel review the return to provision true-up calculation. Better example On an annual basis, in the period in which the federal income tax return is filed (when),the Chief Accounting Officer (who) reviews the return to provision calculation ensuring all positions taken on the income tax return were appropriately considered in the prior year income tax provision (what, why). All return to provision items $250k or greater (net of tax) are evaluated for the effect on the current year or prior year income tax provision (what). Considerations are documented within the return to provision workpaper file and supported with supplemental evidence, if necessary (how).

42 Tax ICFR Best practice responses Address any increased auditor requirements Review control design Who, when, what and how of the controls Control owner has appropriate authority and competency Management review controls precision, sensitivity evaluation, level of operation, controls ability to generate questions, and identify errors Data Precision of the control is the sensitivity to which it functions (i.e., is the control sensitive enough to prevent or detect errors or fraud that could result in material misstatement in the financial statements) Qualitative and quantitative thresholds for reviewer for follow up Completeness and accuracy Integrity of underlying reports Workpapers with appropriate evidential support to document both the design and operating effectiveness of review controls

43 Tax ICFR Best practice responses Evaluate effectiveness of internal controls design and operation based on current business and procedures Walk-through procedures and assess if process narrative or flowchart is up to date Will a flowchart be required? Document performance of review controls signature is not sufficient Document the precision of review controls frequency, nature and extent of issues identified Retain evidence of issues identified and resolution of those issues Document review thresholds and procedures that support manual controls (e.g., quantitative and qualitative) Understand and document effectiveness of controls related to source data and inputs to tax provision calculations Perform assessment of control execution and testing

44 Thank you! Page 44

45 Ninth Annual Domestic Tax Conference 8 May 2014 Chicago