tax executives workshop may 2014 - building a better ... controversy in this area spurred irs to...
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Domestic tax update
Tax Executives Workshop
May 2014
Page 2
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
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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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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.
Tax Executives Workshop - 4-6 May 2014
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Presenters
Joan Schumaker
Tax Partner
Ernst & Young LLP
New York, NY
Brandon Carlton
Tax Principal
Ernst & Young LLP
Washington, DC
Tax Executives Workshop - 4-6 May 2014
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Agenda
► Final tangible property regulations
► Recent accounting methods trends and guidance
► Financial accounting developments
► Income tax accounting challenges
► Tax legislation and regulatory guidance update
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Final tangible property regulations
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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► 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
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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
Tax Executives Workshop - 4-6 May 2014
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Recent accounting method trends and guidance
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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
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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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.
Tax Executives Workshop - 4-6 May 2014
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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
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Accounting and Regulatory Developments
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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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.
Tax Executives Workshop - 4-6 May 2014
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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
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► 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)
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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Income Tax Accounting Challenges
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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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?
Tax Executives Workshop - 4-6 May 2014
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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?
Tax Executives Workshop - 4-6 May 2014
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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
Tax Executives Workshop - 4-6 May 2014
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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?
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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?
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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?
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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
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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
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Tax legislation and regulatory guidance update
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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 - 4-6 May 2014