Field of Study: Taxes Transfer pricing is an accounting and tax practice used to determine the cost of goods or services rendered within businesses and between departments, subsidiaries or holding companies that operate under common control or ownership. But there is a risk that lies beneath transfer pricing, and that risk is tax manipulation. It is often a way to shift tax liabilities to a lower-tax jurisdiction or even another country, as transfer pricing can extend to both domestic and global markets. Marina Gentile, lead of the Global Transfer Pricing Strategies practice, and Chaya Siegfried, international tax partner, at Withum discuss how transfer pricing goes hand in hand with an effective global tax structure and how proper planning is key.

Field of Study: Taxes As the world is slowly coming out of the pandemic, companies are reevaluating their day-to-day operations, levels of performance within various departments, affiliates and subsidiaries, as well as customer and supplier relationships. Many companies have gone out of business, leaving customers to look for alternatives in their supply chain, while others have reorganized, transitioned to a virtual platform and switched from supply chains overseas to domestic or local manufacturers. As a result, their existing transfer pricing policy may no longer reflect the new corporate structure and intercompany cash flows. Chaya Siegfried, international tax partner and Marina Gentile, lead of Global Transfer Pricing Strategies practice at Withum, continue our segment by discussing the impact of the current environment on global tax and transfer pricing.

Field of Study: Accounting In July 2002, Congress established the Public Company Accounting Oversight Board, known as PCAOB, to oversee audits of public companies and SEC-registered brokers and dealers, in an effort to protect investors and the public interest. Over the years, there have been several cases of significant financial reporting fraud, significant internal control deficiencies, and other audit failures, resulting in the loss of investor confidence, yet the number of defective audits that resulted in enforcement actions by the PCAOB has been very small. Is the profession failing? Is accountability lost? Dan Goelzer, one of the founding members of the PCAOB, gives some insights on these questions.

Field of Study: Taxes The Whistleblower program, currently known as Internal Revenue Code (IRC) section 7623(a), allows the Secretary of the Treasury to pay such amounts as he or she deems necessary “for detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same.” In December of 2006, the Tax Relief and Health Care Act of 2006 made fundamental changes to the IRS awards program; one of the areas we hear about from time to time is recoveries for whistleblowers. Barbara Weltman, president of Big Ideas for Small Business explains the two avenues for recovery for whistleblowers and discusses an interesting case involving the Large Business and International (LBI) division of the IRS.

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1. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part I

2. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part II

3. Will the PCAOB Tighten the Leash?

4. Whistleblower Program, Updates on Final Regulations & Moon Tax!

CPA REPORT SUBSCRIBER GUIDE

AUGUST 2021 Summary Page i [p. 1]

CPE Requirements iii [pp. 3–5]

Segment One 1–1 [pp. 7–35]

Segment Two 2–1 [pp. 37–65]

Segment Three 3–1 [pp. 67–93]

Segment Four 4–1 [pp. 95–126]

Sememt Five 5–1 [pp. 127–157]

Evaluation Form A–1 [pp. 159–160]

Index B–1 [pp. 161–164]

Group Live Attendance Form C–1 [p.165]

68]

CPA Report is a product of www.kaplanfinancial.com

Note: CPA Report now includes one Government/Not-for-Profit segment.

Information regarding COVID-19 changes rapidly; further updates will be in upcoming segments.

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Field of Study: Accounting – Governmental The GASB has issued a number of new Exposure Drafts in 2021. They cover topics such as changes to the methods of accounting for account-ing principles, changes in accounting estimates and error corrections. They also deal with accounting for compensated absences and an important name change from Comprehensive Annual Financial Report to the Annual Comprehensive Financial Report. Marks Paneth Partner Warren Ruppel, CPA, explains the proposed changes as well the implication of the proposed rules on government accountants and auditors.

5. Accounting Changes and Error Corrections: New Guidance

Summary Page (continued)

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e CPE Requirements and Group Live

1. Select discussion leaders who have the appropriate education and/or experience both to teach the segment subject and conduct the subsequent group discussion.

2. Have each discussion leader review the video segment and the written materials in the Subscriber Guide prior to the presentation of the segment.

3. Make sure that each discussion leader certifies the attendance at his/her discussion group by signing and dating the Group Live Attendance Form.

4. (Individuals) View the video segment (30 to 35 minutes).

5. (Individuals) Discuss the segment materials as they relate to his/her own work and/or organization (20 to 25 minutes).

6. (Individuals) Evaluate the instructor using the criteria listed on the Evaluation Form.

7. Check with your State Board of Accountancy for specific details, including group live sponsorship registration requirements.

Group Live Format

When taking a CPA Report segment on a group live basis, individuals earn CPE credits when they (or their organization) do the following:

CPE RequirementsWhen properly administered, the CPA Report educational program meets the requirements for group live and self-study participation as defined in the Statement for Standards in CPE Reporting.

Please note:

l You cannot earn additional credits by taking the same course in group live format and online self-study format.

l CPE requirements vary from state to state. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. CPAs should contact their state board regarding specific CPE requirements.

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e The following information will help you plan and implement the CPA Report program within your firm:

How to Implement the CPA Report

1. Each quarter, you may receive by email a CPA Report Summary Page in advance of the video segment notifying you of the upcoming Continuing Professional Education topics that will be covered.

2. The CPAR DVD is expected to arrive the month following the end of the quarter. If you do not have a standard day and time each quarter designated as CPE day, issue a memo with the date of your upcoming seminar. (If attendance is not required, please provide plenty of advance notice for optimum participation).

3. Select the topic(s) you wish to cover in your session when the CPAR Summary Page or the actual program arrives.

4. It is best for an organization to have its CPE classes on a regular and consistent basis, so it is easy for the staff to remember when scheduling clients.

5. You may wish to provide each group live attendee a “Certificate of Completion” noting the hours earned and the topic areas.

6. Always check with your State Board of Accountancy for specific details, including group live sponsorship registration requirements.

If you need more information or have any questions, please contact Customer Service at CPESupport@kaplan.com or 914-517-1177.

Note: CPE requirements vary from state to state. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. CPAs should contact their state board regarding specific CPE requirements.

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Please note: This issue of CPA Report Online Self-Study is scheduled to go live online on August 31, 2021.

If you need more information or have any questions, please contact Customer Service at CPESupport@kaplan.com or 914-517-1177.

Online Self-Study

Kaplan Financial Education is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.nasbaregistry.org.

Self-Study Format

Participants can gain self-study credit by enrolling in the CPA Report Online Self-Study library of courses. All components of the program will be hosted online, including the video, interactive review questions, required reading, and final exam.

In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

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1. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part ILearning Objectives:

Segment Overview:

Recommended Accreditation:

Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date: October 13, 2022

Work experience in tax planning or tax compliance, or an introductory course in taxation.

None

1 hour group live 2 hours self-study online

Update

“Five New Directives on Transfer Pricing Examinations” “Transfer pricing and the pandemic recession: What to do about it” “How the IRS Expects Taxpayers to Deal with Transfer Pricing”

See page 1–11.

See page 1–20.

30 minutes

Transfer pricing is an accounting and tax practice used to determine the cost of goods or services rendered within businesses and between departments, subsidiaries or holding companies that operate under common control or ownership. But there is a risk that lies beneath transfer pricing, and that risk is tax manipulation. It is often a way to shift tax liabilities to a lower-tax jurisdiction or even another country, as transfer pricing can extend to both domestic and global markets. Marina Gentile, lead of the Global Transfer Pricing Strategies practice, and Chaya Siegfried, international tax partner, at Withum discuss how transfer pricing goes hand in hand with an effective global tax structure and how proper planning is key.

Upon successful completion of this segment, you should be able to: l Define transfer pricing and recognize the four types of

intercompany transfers, l Identify compliance factors with respect to transfer pricing

and planning opportunities to minimize risk, l Understand the transfer pricing documentation requirements

and the tax implications of their absence, and l Understand the impact of the pandemic in both transfer

pricing and international tax structures.

Field of Study: Taxes

A. Transfer Pricing & Risk of Tax Manipulation

i. Shifting tax liabilities to a lower-tax l Jurisdiction or country

B. What Is Transfer Pricing

i. Internal or Intercompany pricing between l Affiliated companies l Subsidiaries l Brother/sister joint ventures l Branches

ii. Economic control over ownership percentage

C. Four Types of Intercompany Transfers

i. Product

ii. Service

iii. Royalties

iv. Intercompany financing

D. Tax Manipulation Perception

i. Every multinational has the right to l Minimize their global effective

tax rate

ii. Transfer pricing is legal l When done correctly

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I. Ins and Outs of Transfer Pricing

A. OECD’s Focus

i. Fighting against international tax evasion

ii. Building a consensus on international tax principles to l Avoid, minimize or mitigate

v Unilateral responses to multilateral problems

B. Transfer Pricing Guidelines

i. OECD guidelines l Followed by many countries

ii. IRC section 482 l Followed by the U.S.

iii. Legislation varies by country

C. How to Determine Transfer Pricing

i. Identify the transaction l Ensure it exists

ii. Analyze and establish if arm’s-length

D. Arm’s-Length Transaction

i. Has to tie to the marketplace

E. Transfer Pricing Is Both

i. Industry agnostic

ii. Country agnostic

II. Transfer Pricing Guidelines on a Global Scale

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A. Compliance Factors

i. Before having a conversation on transfer pricing, understand your client’s l Business and operations l Goals and objectives

ii. Perform a benchmarking analysis

B. Planning Opportunities To:

i. Minimize transfer pricing risk and uncertainty l For global companies

ii. Set up a global strategy l Arm’s-length results in all

markets

iii. Manage cash flow

iv. Protect your assets

C. Why Consider Both?

i. If the activities, risks and analysis do not support putting the income in a certain country l Global tax planning is useless

D. Planting Seeds

i. Ideal for startups to l Get the right tax structure

v Grow with it l Understand

v Full transfer pricing documentation study is not needed

v Their accounting

E. Evaluating Your Transfer Pricing Model

i. Ensure it is done correctly

ii. Review it annually l Avoid penalties l Transfer prices are at arm’s

length

III. Value & Opportunity in Transfer Pricing

A. Transfer Pricing Documentation

i. Needs to be available on the day the return is due

ii. Required to be contemporaneous

iii. 30 days won’t be enough to prepare

iv. Can’t backdate

v. Documentation tells the story of your business l Gives power to the taxpayer

B. Absence of Adequate Documentation

i. 20% to 40% penalty l On top of the adjustment

ii. Exposes the business to l The IRS l Other tax authorities

C. Losses & Transfer Pricing

i. For a loss-generating company l Transfer pricing STILL applies l Income allocation is incorrect

ii. Limited risk distributor l Low-profit threshold

v Fixed at all times

IV. Importance of Transfer Pricing Documentation

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V. OECD Guidance and COVID-19 ImpactA. Guidance’s Four Priorities

i. Comparability analysis,

ii. Losses and the allocation of COVID-19 specific costs

iii. Government assistance programs

iv. Advance pricing agreements

B. Transfer Pricing & COVID-19

i. Profitability is down

ii. Risk-taking entity may diffuse costs l To global operations

v Limited risk companies take the hit

C. Multinational Enterprises & COVID-19

i. Potential increase in corporate and other tax rates l Over the next couple of years

ii. Employees remained in foreign countries for longer than intended l Tax implications for both

v Employer & employee

“… many of them are talking about raising corporate tax rates and… that is definitely something that multinational enterprises are going to be feeling over the next couple of years.”

— Chaya Siegfried

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Discussion Questions

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1. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part I

l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Marina Gentile and Chaya Siegfried discuss how transfer pricing goes hand in hand with an effective global tax structure and how proper planning is key.”

l Show Segment 1. The transcript of this video starts on page 1–20 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 1–7 to 1-8. Additional objective questions are on pages 1–9 and 1–10.

l After the discussion, complete the evaluation form on page A–1.

1. What is transfer pricing and what are the four main types of intercompany transfers that fall under the transfer pricing regulations? What types of intercompany transfers does your organization or clients have that require transfer pricing?

2. How can transfer pricing be a “value add” and what planning opportunities are available to avoid penalties? What value has your organization or clients uncovered as part of transfer pricing planning and analysis?

3. Why is it never too early for organizations to start considering transfer pricing and international tax structures?

4. What are the rules regarding providing transfer pricing documentation and what are the implications of the absence of adequate documentation?

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

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5. Why should loss-generating companies be concerned about transfer pricing? What was the experience of your organization or clients with their initial setup of transfer pricing and international tax structure?

6. What were the priority issues that were the focus of OECD’s guidance on transfer pricing based on the impact of the pandemic and its implications? How has your organizational or clients’ experience with transfer pricing been impacted by the pandemic?

7. What has been the impact of the current environment on international tax structures?

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s1. What is transfer pricing and what are

the four main types of intercompany transfers that fall under the transfer pricing regulations? What types of intercompany transfers does your organization or clients have that require transfer pricing? l Transfer pricing:

v Involves internal pricing when affiliated companies around the world interact with each other

l Types of intercompany transfers: v Product transfer from

manufacturer to distributor v Service provided by one entity to

another v Royalties for use of intellectual

property v Intercompany financing provided

by one affiliate to another l Participant response based on

personal/organizational experience

2. How can transfer pricing be a “value add” and what planning opportunities are available to avoid penalties? What value has your organization or clients uncovered as part of transfer pricing planning and analysis? l Value-added

v Risk of transfer pricing is lowered by conducting benchmarking analysis

v Considers the functions of each country, the risks, and the assets employed

v Sets global strategy to prioritize arms-length results in all markets

v Can set up a global treasury function for cash flow management incorporating transfer pricing

v Protects IP assets with clear lines between IP developer and service provider

l Participant response based on personal/organizational experience

3. Why is it never too early for organizations to start considering transfer pricing and international tax structures? l Companies can become global

almost as soon as they incorporate l Increasing transparency throughout

the world l Newer organizations have not built

their development team and will have flexibility

l Transfer pricing is an annual event and there are penalties for not doing it with transfer prices at arms-length

l Related party transactions must be reported

l Contemporaneous documentation for transfer pricing commonly requested/required

l Documentation acts as an insurance policy against IRS penalties

4. What are the rules regarding providing transfer pricing documentation and what are the implications of the absence of adequate documentation? l Documentation is required to be

contemporaneous to the year in question

l Documents cannot be backdated l IRS issues 30-day letter requiring

documentation be provided within 30 days

l IRS can impose a 20% or 40% penalty on top of tax adjustments if documentation cannot be presented

Suggested Answers to Discussion Questions1. Global Tax & Transfer Pricing Strategies: What Lies

Beneath – Part I

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be concerned about transfer pricing? What was the experience of your organization or clients with their initial setup of transfer pricing and international tax structure? l Concerns:

v Allocation of income could be incorrect with some affiliated companies being profitable

v Companies in a startup phase may want a specific entity to be a limited risk distributor

v Small profit thresholds for limited risk distributors should be fixed at all times to maintain valuable history

l Participant response based on personal/organizational experience

6. What were the priority issues that were the focus of OECD’s guidance on transfer pricing based on the impact of the pandemic and its implications? How has your organizational or clients’ experience with transfer pricing been impacted by the pandemic? l Priority issues in the guidance:

v Comparability analysis v Losses and the allocation of

COVID-19 specific costs v Government assistance programs v Advance pricing agreements

l Participant response based on personal/organizational experience

7. What has been the impact of the current environment on international tax structures? l Accounting for Equity Awards

v Every government is looking to increase their revenues due to the economic impact of COVID and the cost of various bailouts

v Company employees have ended up in countries where they did not intend to remain for longer periods than originally planned, which has income tax implications for both employees and employers

v Focus on reporting or approach to taxation of a digital economy

Suggested Answers to Discussion Questions (continued)

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1. Which of the following is the most tangible type of intercompany transfer subject to transfer pricing?

a) intercompany financing

b) royalties

c) product transfer

d) management services

2. Approximately how many countries today have adopted transfer pricing regulations?

a) 9

b) 25

c) 50-60

d) over 150

3. Which of the following is correct regarding determining transfer pricing?

a) rates have to be tied in some way to the marketplace

b) it is based on negotiation between affiliated entities

c) rates are provided by IRS guidelines

d) transfer pricing is neither industry agnostic nor country agnostic

4. Which of the following is an example of a "value add" from transfer pricing and international tax planning?

a) always results in the lowest effective global tax rate

b) protects intellectual property assets

c) reduces reporting requirements for related party transactions

d) audit documentation can be backdated as needed

5. How much time does the IRS generally give to an entity to provide its documentation for transfer pricing before imposing penalties?

a) 1 year

b) 6 months

c) 90 days

d) 30 days

6. Which of the following is correct about the strategy for limited risk distributors in regards to international tax structure and transfer pricing?

a) an entity should be a limited risk distributor only if it operates in a low-tax jurisdiction

b) limited risk distributors should have a low-profit threshold

c) its profit threshold depends on whether the overall group is making or losing money

d) the strategy first needs to be considered when the enterprise becomes profitable

7. How often does Marina Gentile suggest that global companies conduct concurrent and contemporaneous transfer pricing?

a) annually

b) every 3-6 months

c) every 2 years

d) once at the beginning of conducting business in a new locale

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment; a few may be based on the reading that starts on page 1–11.

Objective Questions

1. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part I

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8. Which of the following is correct regarding the IRS interim instructions on information document requests (IDRs) for LB&I examinations of transfer pricing?

a) mandatory transfer pricing IDRs are required for examinations where the taxpayer filed Form 5471 or 5472

b) IDRs will no longer be issued by Transfer Pricing Practice (TPP) or Cross-Border Activities (CBA) employees, but rather by Field Examiners

c) these procedural changes are attempting to manage the current high volumes of open transfer pricing cases

d) the specific guidance provided on what constitutes relevance and how to identify the initial indication of compliance risk significantly simplifies the audit process

9. Which of the following is a consideration for transfer-pricing analysis based on comparable third-party benchmarking?

a) survivor bias decreases the profitability range of companies in the comparable set

b) the impact of the pandemic is similar across companies in the same industry

c) comparable companies should be used regardless of their profit profile if they share functional and risk similarities with the tested entity

d) information from comparable businesses is generally not available until after the fiscal year is ended

10. Which of the following refers to the transfer pricing requirement to establish an arm’s length range of prices or returns against which to test controlled transactions?

a) best method rule

b) transactional net margin method

c) mandatory IDR

d) advance pricing agreement

Objective Questions (continued)

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By: Marina Gentile, iMBA, Lead, Global Transfer Pricing Source: https://www.withum.com/resources/five-new-directives-transfer-pricing-examinations/

Five New Directives on Transfer Pricing Examinations

The IRS Large Business and International (LB&I) division released five directives on transfer pricing that impact the way it approaches examinations. This communication has been highly anticipated by Withum transfer pricing professionals who heard Douglas O’Donnell, Commissioner LB&I, speak about IRS enforcement challenges, the drain on resources, and the expectation of announcements updating the IRS approach to transfer pricing examinations.

In a series of memorandums addressed to employees, Commissioner O’Donnell provides instruction and guidance for IRS examiners that cover the following transfer pricing examinations topics:

l Mandatory Information Document Request (IDR) for all LB&I Examinations are Eliminated

l Examiners are Reminded to Assess IRC §6662(e) Penalties where Relevant

l Approval is Required for Examiners/APA Officials before Rejecting Taxpayer’s “Best Method” Selection

l Policy for Reasonably Anticipated Benefits in Certain Cost Sharing Arrangements in Development

l Opening Cases Involving Stock-Based Compensation in Cost Sharing Arrangements are Restricted

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Self-Study Option

Reading (Optional for Group Study)

FIVE NEW DIRECTIVES ON TRANSFER PRICING EXAMINATIONS

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l In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Update

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More Transfer Pricing Insights

While we introduce all five, the first three apply to a wider audience and will be the focus of this article.

1) Interim Instruction on Issuance of Mandatory Transfer Pricing IDR

The mandatory transfer pricing IDR, in effect since January 2003, is no longer required for all examinations where the taxpayer filed Form 5471 or 5472, or is engaged in cross-border transactions. At least on an interim basis. Effective January 12, 2018, only the following cases require a mandatory IDR:

l Examinations arising under approved LB&I campaigns, where there is specific guidance for the mandatory transfer pricing IDR provided within the campaign; and,

l Examinations with an initial indication of transfer pricing compliance risk where Transfer Pricing Practice (TPP) and/or Cross-Border Activities (CBA) Practice Area employees are assigned to the case.

This procedural change attempts to manage the current high volumes of open transfer pricing cases, narrowing in on those cases that are most relevant in terms of magnitude, type, and complexity of the cross-border transaction. It appears that transfer pricing IDRs will no longer be issued by Field Examiners, but by TPP or CBA employees instead. On its surface, this appears to be a positive development for taxpayers since there is no automatic, routine request for transfer pricing documentation with every examination.

However, without specific definition around what constitutes relevance in terms of magnitude/ type/complexity of cross-border transactions, or guidance on how to identify the “initial indication of compliance risk,” it could complicate the audit process. Any LB&I-categorized Multinational Enterprise (MNE) would appear to fall under one of the two cases listed above, which would trigger a mandatory IDR in any event.

Also, while Field Examiners may no longer be required to routinely request, and check off receipt of, transfer pricing documentation, they must now possess the skills to make a determination about whether or not there is a perceived need to do so, or an “initial indication of compliance risk.” Field Examiners are not transfer pricing specialists, so they may be more apt to call in additional resources (such as TPP or CBA employees) earlier into their cases, where they would historically not have a reason for doing so. This could ultimately lead to a transfer pricing IDR in any event for taxpayers, except possibly with far more targeted and specific questions requiring that taxpayers explain the details of their transfer pricing policies, rather than just whether or not they have documentation.

Of the five instructions issued together, this is the only one that does not explicitly state that the directive only applies to examinations of LB&I taxpayers (i.e., assets equal to or greater than $10m). It will be interesting to see if this new procedure also makes its way beyond LB&I to middle market companies with global operations.

2) Instructions for Examiners on Transfer Pricing Examinations – Appropriate Application of IRC §6662(e) Penalties

Regulations require the IRS to apply penalties when the taxpayer fails to create, or to timely provide, IRC §6662(e) transfer pricing documentation contemporaneous to their tax return filings, or when the documentation provided is unreasonable or inadequate. Penalty rules are meant to hold taxpayers accountable for the reasonableness of their tax return positions and to motivate taxpayers (and their advisors) to adequately document these positions.

This new instruction reminds LB&I employees that penalty analysis should always be a part of the transfer pricing analysis, and that failure to apply penalties has adverse consequences. In particular, it provides less incentive for taxpayer compliance and adequate and timely preparation of documentation. Inadequate

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or incomplete transfer pricing documentation makes it difficult, resource intensive, and time-consuming for the examination team to assess a taxpayer’s reporting position, ultimately increasing taxpayer burden as well.

Appropriate application of penalties when documentation is inadequate maintains accountability and encourages reasonable and well-documented return positions that are assessed more efficiently, saving resources for both the IRS and taxpayers. As penalties become an increased focus, taxpayers have the incentive to have transfer pricing documentation each year, contemporaneous with their tax return filings, as a form of insurance against them.

3) Instructions for LB&I on Transfer Pricing Selection and Scope of Analysis – Best Method Selection

This new directive attempts to streamline LB&I review of the Taxpayer’s transfer pricing and best method selection, with resulting analysis, by imposing an approval process if the Examiner recommends a method other than the taxpayer’s selected best method. The Treaties and Transfer Pricing Operations (TTPO) Transfer Pricing Review Panel must now approve changing the taxpayer’s selection of a Treas. Reg. §1.482 method as the best method before the Examiner moves forward with its own analysis applying a different best method. This applies to both contemporaneous documentation examinations, as well as the Advance Pricing Agreement (APA) process.

There is a long chain of approval process, including an explanation to the review panel of why the taxpayer’s method is unreliable, whether it can be adjusted to make it more reliable, and what method is more reliable, and why. This extensive approval process is not meant to impede IRS examinations, rather it is designed to support the best use of limited LB&I transfer pricing resources.

This is very good news for taxpayers in that IRS Examiner’s cannot just ignore their transfer pricing analysis (and best method selection) in favor of a different

one, without presenting a specific and valid reason for doing so that has been reviewed and approved by a committee.

4) Instructions for Examiners on Transfer Pricing Issue Selection – Reasonably Anticipated Benefits in CSA

This directive expects examination teams to temporarily stop developing adjustments to existing Cost Sharing Arrangements (CSAs) where new Intellectual Property needs to be integrated as a platform contribution transaction (PCT). There is inconsistency in how Examiners are interpreting the §1.482-7 regulations on CSAs, so the IRS is developing a consistent, Service-wide position on the appropriate incorporation of subsequent PCTs into the Reasonably Anticipated Benefits (RAB) share of existing CSAs.

5) Instructions for Examiners on Transfer Pricing Issue Selection – CSA Stock-Based Compensation

This directive mandates that IRS officials stop opening cases related to stock-based compensation included in CSA intangible development costs until the Ninth Circuit issues an opinion on the Altera case currently on appeal. Commissioner O’Donnell recently commented that the IRS has received the not-so-subtle messages from the courts and continues to struggle, losing the majority of its transfer pricing legal cases, so this is a way to reconsider opening cases that it historically does not win, at least until there is more guidance on final court rulings.

To navigate these new LB&I directives, implications of new tax reform on transfer pricing examinations, new CbC reporting requirements, or all the other transfer pricing hot topics relevant to your global business, contact Marina Gentile, Lead, Global Transfer Pricing at Withum.

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TRANSFER PRICING AND THE PANDEMIC RECESSION: WHAT TO DO ABOUT IT

Source: EBSCO This article is for educational use only. Please do not use, distribute or share outside this course.

The COVID-19 pandemic has been globally devastating from both a personal and an economic standpoint. As of Jan. 5, more than 84 million people had been infected with the coronavirus, and more than 1.8 million people had died from the disease. Many multinational enterprises (MNEs) have suffered due to workforce issues, disrupted supply chains, and depressed demand caused by the pandemic. A lucky few industries, including digital services, biotech, and processed foods manufacturers, have achieved favorable outcomes based on specific higher demand. Nearly all businesses, even those that have fared better, are struggling to adapt to the post-pandemic business environment.

At the individual MNE level, the pandemic and the governmental interventions have forced sweeping changes in the allocation of functions, risks, and assets (tangibles and intangibles) among controlled parties and even produced material changes in the behavior of uncontrolled parties. Some of these changes were deliberate and intentional to address the impact of the pandemic (e.g., changes in functions and risks) while other allocations were simply the result of changes in demand and the resulting impact on profits (decreases or increases). In reaction to all of these material changes, MNEs will likely need to reevaluate their pre-pandemic transfer-pricing approach based on an updated application of the arm's-length principle and be prepared to defend changes in the transfer-pricing approach and results.

The pandemic and the pandemic recession

The pandemic has had a significant impact on the lives of people everywhere and on global business operations. Companies'

global supply chains have been disrupted by plant closures, employee absences, and transportation issues. Contractual obligations of all types have been strained, violated, and renegotiated. Lowered sales and profitability have reduced the inherent value of intangibles and undermined risk allocations between parties to transactions. It should be noted that these pandemic-induced problems occur between both controlled and uncontrolled parties, as most businesses continue to adapt to the post-pandemic business environment.

Due to these fundamental changes to functions, risks, and assets, transfer prices need to be reevaluated and possibly altered to align again with supply chains and to recognize changes in value contributed by location. Entire transfer-pricing systems may need to be redesigned, given new sources of value creation and a cessation of some of the prior points of demand and supply.

The arm's-length principle in a post-pandemic environment

The arm's-length principle is the globally agreed standard that prevents the manipulation of transfer pricing among controlled parties. The arm's-length principle dictates that the controlled entities earn the same results on controlled transactions as would have been realized if uncontrolled entities had engaged in the same transactions. Thus, the arm's-length principle essentially sets up an equation whereby the transactions between the controlled parties, including the functions, risks, assets, and results are compared to the functions, risks, assets, and results of the transactions between uncontrolled parties (comparable companies). The pandemic and recession due to it have imposed dramatic changes on both sides of that equation. On the controlled transactions side, the functions, risks, and assets may be fundamentally changed by

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the pandemic and recession; on the comparables side, the transactions may also have been altered in ways (similar or dissimilar) that are not specifically reported in the available financial statements.

These changes have exacerbated some of the practical imperfections of the application of the arm's-length principle, which often relate to implicit assumptions about information on comparable transactions. The lack of sufficiently detailed information on comparable transactions often leads to the adoption of profit-based methods, most prominently the comparable-profits method (CPM) or transactional-net-margin method (TNMM). The severe disruption faced by both controlled and uncontrolled companies during the pandemic and pandemic recession has made the comparables screening process more challenging than before, leaving open the question on how to best apply the arm's-length principle.

The Organisation for Economic Co-operation and Development Transfer Pricing Guidelines and the U.S. Treasury regulations under Sec. 482 subscribe to the arm's-length principle and provide voluminous guidance on the application of arm's-length concepts. However, neither the guidelines nor the regulations specifically address how intercompany transactions might change in the face of a global health or economic emergency. The guidelines and the regulations are similarly silent regarding when the impact of a crisis would require or allow a taxpayer to depart from its anticipated lookback analysis as a result of a departure from its prior transfer-pricing policy.

The guidelines and Sec. 482 regulations both rely upon certain assumptions in the performance of transfer-pricing analysis. The "going concern" assumption posits that the tested party is a continuing operation and, therefore, the appropriate comparable third-party benchmarks would need to generate a long-run steady positive result. For this reason, it is common when searching for comparables to screen out companies with more than one year of operating losses during the prior three

years, regardless of functional and risk similarities with the tested party.

This common practice creates a host of issues when companies are in the midst of an economic downturn and experiencing lower profits or losses. Additionally, there is a "survivor bias," which artificially inflates the profitability range of companies in the comparable set since companies that do not survive the downturn do not show up in the set — often they shut down or are acquired by other companies. Finally, there is an implicit assumption that financial results for companies in the comparable set appropriately reflect the segmented financials related to the controlled transactions. The differential impact of the pandemic across companies in the same industry, and sometimes within divisions of the same company, make this a formidable challenge. Consider, for example, a manufacturer of medical products that include products used in elective medical procedures and consumables used more broadly in hospitals and other practices. An evaluation of the overall results may be misleading, since the consumables segment would have fared much better than the elective procedures segment.

With respect to current or forward-looking transfer-pricing revisions/adjustments, an additional obstacle is that information from the comparable businesses is generally not available until after the fiscal year has ended (e.g., comparable data for a calendar-year-end taxpayer only begins to be available the following spring); thus, taxpayers do not have real-time data and information on the comparable companies' returns.

All the above conditions make management of transfer pricing more challenging than ever, both from a business planning and compliance perspective.

Rules regarding changed circumstances

If the planned margins and markups for controlled transactions no longer resemble arm's-length results, transfer- pricing changes should be considered. If

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intercompany contracts are no longer indicative of arm's-length negotiations, the intercompany contracts should be revised.

The contract "force majeure" clauses shed some light on contract validity, and some specific insight on transfer pricing can be obtained from the "critical assumption" language in advance pricing agreements (APAs). Force majeure clauses are commercial contractual provisions that excuse nonperformance by a party due to an "act of God" or extraordinary event that prevented that party from performing in accord with the contract.

The "critical assumption" clause of an APA serves the same purpose in the context of a taxpayer negotiating an APA. A taxpayer requesting an APA must propose critical assumptions — facts outside the control of the taxpayer or the IRS, the continued existence of which are material to the outcome of the transfer-pricing methodology. One general-purpose critical assumption included in all APAs requires that the business activities, functions, risks, assets, and financial and tax accounting methods of the taxpayer remain materially the same. A mere change in business results will not be considered a material change.

Reevaluation of transfer pricing

Economists broadly characterize economic shocks as either endogenous or exogenous. Endogenous shocks arise within the economic system. For example, the Great Recession of 2008 was caused by internal developments that culminated in the eventual economic shock. Events like COVID-19 or SARS are different in that they do not originate from the economy or even from human society.

One could argue that endogenous shocks can be predicted and risk-managed. For this reason, tax authorities might be less receptive to transfer-pricing changes/adjustments that leave entities in those jurisdictions with reduced profits or losses. On the other hand, exogenous shocks, such as COVID-19, are almost impossible to predict, both from a timing

perspective and magnitude of impact. The following are some aspects to consider:

l Companies could not fully control decisions of how to run the business due to government-mandated shutdowns of operations;

l Supply chain disruptions were outside of companies' control;

l Government assistance was different for companies and locations; and

l Ensuing demand shocks affected businesses differently depending on types of goods/services offered, customer base, and location of customers.

Tax authorities should consider these factors in evaluating whether transfer-pricing changes/deviations from prior periods were reasonable and whether they violated the arm's-length principle. Although the burden of proof is on the taxpayer to show that it followed the arm's-length principle, tax authorities should consider the extraordinary circumstances and limited information in evaluating a company's transfer-pricing determinations.

Company defense of revised transfer pricing

MNEs should set transfer prices as close to arm's length as possible, given limited real-time information. In some cases, the market gives off clear signals regarding what controlled taxpayers can do to align with the market. In other cases, the market is silent, and the taxpayers must decide what action to take.

Controlled taxpayers can adopt arm's-length behavior, even if detailed, current information on comparables is not available. The answer is either readily apparent, or the controlled taxpayer can model out an answer, given an informed understanding of its own demand and cost situation in the current market. More broadly, taxpayers may need to rely more heavily on economic analysis that is less dependent on comparables information but

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instead on economic theory to determine the allocation of profits or losses among affiliates.

The IRS and the OECD have each received questions about how MNEs should think about their transfer-pricing policies in 2020, given the reality of unexpected losses. The IRS responded in an April 14, 2020, frequently asked questions document that companies should stick with their existing transfer-pricing methods and comparable sets in a downturn and find other means to explain their results.

The effect of the pandemic recession on the tested party and the comparable firms must be carefully explained in 2020 documentation. Defending the MNE's behavior and results to a tax authority will be much easier if attempts were made during this recessionary period to conduct related-party business as if at arm's length and actions are explained with supporting evidence. The tax authorities should be willing to accept these explanations, provided the taxpayer has prepared sufficient analysis. Governments can be expected to discourage aggressive taxpayer attempts to use the confusion generated by the pandemic recession to shift income to low-tax jurisdictions. Even if tax authorities agree with a reallocation of risk during the crisis, they might insist on a new post-recession transfer- pricing approach. For example, tax authorities could argue

that the entities branded as limited-risk distributors that bore losses during the pandemic recession should earn higher returns following the recession.

Documenting changes The pandemic recession is not only considerably more devastating than recent recessions, it has also had a uniquely disruptive impact on functions, risks, assets, and allocation of profits among affiliates of MNEs.

Companies are currently faced with a decision whether to continue legacy transfer-pricing approaches that rely on pre-pandemic assumptions or to alter their transfer-pricing approach and document transfer prices to align with the post-pandemic realities.

As the pandemic is likely to linger well into 2021 and the recession even longer, companies should reevaluate their transfer pricing and make revisions as needed. Tax authorities will likely scrutinize changes; therefore, companies should maintain appropriate documentation and support to convince tax authorities that outcomes were the result of the pandemic rather than aggressive transfer pricing.

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By: Marina Gentile, iMBA, Lead, Global Transfer Pricing Source: https://www.withum.com/resources/irs-expects-taxpayers-deal-transfer-pricing/

How the IRS Expects Taxpayers to Deal with Transfer Pricing

A transfer price is the price charged for intercompany transactions among related entities. The principles of I.R.C. Section 482 require that intercompany transactions be priced at arm’s length. Although ostensibly a simple concept, the arm’s length standard has spawned thousands of pages of regulations, rulings, and opinions. In its most basic form, the arm’s length standard requires taxpayers to ask the question: “Would an independent company agree to this same pricing we use with our affiliated company?”

Transfer pricing continues to be a hot issue, especially for multi-national companies operating across one or multiple country borders. While this international scenario is the main focus, it’s important to note that the IRS has been increasingly applying Section 482 guidelines in benchmarking the pricing between purely domestic entities where there are tax implications to their interactions. Transfer pricing affects a multitude of intercompany transactions, including transfer of tangible property (products), transfer of intangibles (both technology and marketing related), loans (interest), and provision of services. Here is some guidance on how the US expects taxpayers to deal with their transfer pricing.

The Best Method Rule The Best Method Rule in the Section 482 regulations states that the method used to analyze the pricing of a controlled transaction must be the method that, given the facts and circumstances, provides the most reliable measure of an arm’s length result. The application of the best method rule establishes an arm’s length range of prices or financial returns against which to

test the controlled transactions. If the tested party financial results fall within the middle fifty percent of that range, known as the interquartile range, then the controlled transaction is considered – in theory – to be arm’s length. In practice, however, there is a well-established precedent for the IRS to favor the median point in this interquartile range, as any adjustments they make are typical to this point.

Tangible Property The transfer of tangible property is the type of intercompany transaction that is both common and relatively easier to understand (than the transfer of intangible property, for example), since it involves the transfer of an actual product. A distributer’s intercompany purchase of a tangible product from its affiliated manufacturer is also more obvious to test in many ways. The range of options for that arm’s length pricing is effectively within the narrow range somewhere between the cost to create the product and the price that the marketplace will bear to purchase the product. The arm’s length amount charged in intercompany transactions involving tangible property should be tested under one of the following methods provided and explained in Section 482: the comparable uncontrolled price method, the resale price method, the cost plus method, the profit split method, the comparable profits method, or an unspecified method.

Intangible Property Intangible property refers to both technology-related and marketing-related proprietary assets that the taxpayer develops and owns exclusively. The transfer pricing regulations broadly define intangible property as including:

l patents, inventions, formulae, processes, designs, patterns, or know-how;

l copyrights and literary, musical, or artistic compositions;

l trademarks, trade names, or brand names;

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HOW THE IRS EXPECTS TAXPAYERS TO DEAL WITH TRANSFER PRICING

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l franchises, licenses, or contracts;

l methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data; and,

l other similar items.

The “other similar items” makes room for a broad range, so we can essentially consider intangibles as something unique and proprietary that the individual taxpayer develops (whether intentional or not), and benefits from, to drive the superior performance and success of its business beyond a typical routine return. Intercompany transfers of unique intangibles initially caught the attention and scrutiny of the IRS during the 1980s, and ultimately led to the establishment US transfer pricing regulations. In determining the arm’s length price for the transfer of an intangible, there is a choice of four methods: the comparable uncontrolled transaction method, the profit split methods, the comparable profits method, or an unspecified method.

For the full article, please visit https://www.withum.com/resources/irs-expects-taxpayers-deal-transfer-pricing/

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SURRAN: Transfer pricing is an accounting and tax practice used to determine the cost of goods or services rendered within businesses and between departments, subsidiaries or holding companies that operate under common control or ownership. But there is a risk that lies beneath transfer pricing, and that risk is tax manipulation.

It is often a way to shift tax liabilities to a lower-tax jurisdiction or even country, as transfer pricing can extend to both domestic and global markets.

Internal Revenue Code section 482 authorizes the IRS to adjust the income, deductions, credits, or allowances of commonly controlled taxpayers to prevent tax evasion. Section 482 provides that, "prices charged by one affiliate to another, in an intercompany transaction involving the transfer of goods, services, or intangibles, yield results that are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances."

The IRS provides extensive FAQs on transfer pricing, which cover separately

l Documentation

l Best method review panel

l Country-by-country reporting

This can be found on the IRS site at https://www.irs.gov/ under international businesses.

FOSTER: Transfer pricing is often viewed as a vehicle for tax manipulation and this is one of the reasons it is always considered a hot topic. Transfer pricing goes hand in hand with an effective global tax structure and proper planning is key. Marina Gentile, lead of the Global Transfer Pricing Strategies practice, and Chaya Siegfried, international tax partner, at Withum, join us this month to discuss those very topics. Marina starts our conversation by defining transfer pricing and the main types of intercompany transfers.

GENTILE: Transfer pricing is essentially when affiliated companies operating around the world interact with one another. So it's the internal pricing, the intercompany pricing of these affiliated companies.

These could be parent's subsidiary, brother sister joint venture, a branch... it's any kind of affiliation. It's more about economic control rather than ownership percentage, right? So we're not talking about just a 51% ownership.

There are four main types of intercompany transfers that fall under the transfer pricing regulations and this is for the US and all over the world.

The most tangible would be a product transfer, right? You can visually see it transferring from the manufacturer in one country to the distributor in another. The second would be a service, so if one entity is providing management services or R&D services or something related

Video Transcript

1. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part I

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t to the other entity, that's the second one. The third one is related to royalties. So if you, say, have a developer of intellectual property and whether that's a technology or the brand name, whatever secret source of your business, the other affiliates that are benefiting from it should be paying a royalty back to the developer. Then the fourth of course is intercompany financing. So loans, lines of credit, any kind of financing that happens in the affiliates.

FOSTER: Companies, especially those that have many subsidiaries, may often use transfer pricing as a way to manipulate tax. So how does that occur? Marina explains.

GENTILE: There's a negative connotation about transfer pricing that's out there because the perception is that it's tax manipulation. The reality is every multinational has the right to minimize their global effective tax rate. That is completely legal and what everyone should be doing.

Then of course there is tax manipulation at the other end of that. What makes it legal is when the transfer pricing is correct, when the company has the arm's-length pricing, it's advised on what the market rates should be and they're operating in those ways, because essentially, they're just operating as third parties would operate, which is what the tax authorities are looking for.

So transfer pricing provides the substance, the business reason, the economic reason for the transaction. And so that is not purely tax-driven where you're then on that manipulation side.

SURRAN: The Organization for Economic Co-operation and Development (OECD) is an international organization that works primarily with governments and policy makers.

Amongst other areas of focus, OECD continuously works on the fight against international tax evasion and tries to build a consensus on international taxation principles in the hopes of avoiding, minimizing or mitigating "unilateral responses to multilateral problems."

In 2017, the organization issued transfer pricing guidelines for multinational enterprises in an effort to include revisions and compilation of previous reports issued by the OECD committee on fiscal affairs. In response to the pandemic, the organization issued in December 2020, guidance on the transfer pricing implications of COVID-19.

Marina Gentile discusses worldwide transfer pricing legislation as well as the OECD guidelines and initiatives around transfer pricing.

GENTILE: When I started in this field over 20 years ago, there were nine countries that had transfer pricing regulations. Today, there's well over 150. So now everyone is on the bandwagon because they need to protect their tax base. So the country that does have the legislation, those taxpayers are sort of catering to that country. But then if the other country doesn't have it, there's a disparity there.

So what happened was the OECD, which is effectively a global think tank. It provides this guidance, it researches, it sort of brings these countries together, so a good part of the world follows OECD guidelines for transfer pricing. The U.S. - we're special, as we always are. So it's a little bit different, the regulations are Section 482 of our internal code.

So it's something that as transfer pricing practitioners we need to navigate and manage, right? So the wording might be different, the name of the method might be different, but mathematically we can find common ground. So I often operate on that US OECD level where I'm

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t making sure that I can cover my global client.

Then of course as I said around the world, countries have their own legislation.

Most countries do have that two real things in common, that arm's-length standard, that expectation that affiliated companies would operate as if they were total strangers, just meeting each other. So if you need a service in one market and you don't have your subsidiary there, you would have to pay someone, a third party that would expect a profit element to it. So that's the key there. And every country really operates on that dynamic.

FOSTER: Marina gives us her insights as to how transfer pricing can be accurately determined and if it affects certain industries or even countries more than others.

GENTILE: How to determine transfer pricing, that's the magic that's around it. So identifying the transaction and that it exists is a big part of it, but then how do we approach it and how do we analyze it? And oftentimes there's just a misconception there about what that arm's-length pricing means and how to get it.

So for example, I would have a client that says, "Well, we negotiated with our affiliate. We sat down and we negotiated and we came up with this pricing." And what the IRS or other tax authority would say about that is, "That is not arm's-length pricing. You have two controlled entities that sit down and negotiate a price, there's room for collusion there, right? There's room for tax manipulation."

So that would not be considered arm's-length. You have to tie it to the marketplace, so that's where your transfer pricing advisors come into play. This is not an easy thing for a company to do on its own, it's cost-prohibitive, right? I mean, I spend whatever on databases every year, right, to be able to service my clients and typical companies would not do that. It would not make sense for them to do that.

So we use our resources or third-party available public data, the same resources that the IRS would use or other tax authorities and we pull the comparables, we benchmark it. We say, "Okay, if you have an R&D service provider in India, what does that look like? What does the profitability of that entity look like based on the metrics, based on the marketplace?" And then we can guide our clients accordingly.

Transfer pricing is both industry agnostic and country agnostic. So that's what makes it very interesting for me because at the end of the day even though I've been doing this for many years, the issue that comes to me, the client that comes to me, the different iterations of countries, types of transfer pricing, industries, I mean, I work with pre-revenue tech startups, I work with farmers, I work with concert event providers the whole financial services, manufacturing, distribution and everyone. It's a hot topic; it's just getting hotter by the minute and so we need to operate in that arena where we're looking at it fully across industries.

FOSTER: Marina addresses how transfer pricing can be a "value-add" as well as various planning opportunities available other than annual compliance to avoid penalties.

GENTILE: Lots of value add in transfer pricing, okay? There's a lot of different motivations for our clients and what they in particular need. And that's why it's important to have the overall conversation.

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t I don't just jump in and talk to the transfer pricing, I speak to them about their business and their operations and what their goals are, where are they? What are their objectives? What are they trying to achieve?

So we can partner together using transfer pricing as a tool. One is the sort of compliance factor around it and making sure that we're lowering the risk of transfer pricing and that's by doing the benchmarking analysis.

If you think of it, it's like a global profit or loss and how do we divide it between the different countries, based on the functions of each country, the risks, the assets employed, and that's how we approach it.

Transfer pricing risk is one of, if not the biggest risk for global companies in terms of the tax department and what they're dealing with. There's a lot of uncertainty there.

So if we can set a strategy, a global strategy that gets sorted to the arm's-length results in all the markets, there's a lot of peace and certainty to that. And then companies have other objectives like tax minimization and wanting to lower the effective global tax rates. So sometimes we're able to come in and say, "Okay, well, let's take a look at this."

This is where Chaya and I end up working together on this. She as an international tax specialist, me on the global transfer pricing side, and we can come up with a strategy that works for that objective.

Another one will be cash flow management, right? Sometimes you have for example, with investment banks or other companies where there's sort of unpredictability on which entity around the world will... What their deals are going to look like for that year, right? You have this volatility. You effectively set up a global treasury function if you're able to think of cash flow management as the objective and how things work and we can use the transfer pricing for that.

Then finally it protects your assets. As a global company, you want to know where your intellectual property is, where it sits, where it's developed, where it's paid for, where it will be litigated if there's an issue around that, right? You want to protect those valuable assets. So clear lines in transfer pricing between the IP owner developer versus the service provider.

So you could have a whole contract shop in Ukraine or India or wherever doing transfer pricing, but the IP itself could be owned somewhere else. And I don't want to get too into the details, you need the substance to support that strategy, but it's available.

FOSTER: Like everything else, transfer pricing has its own challenges but also opportunities for companies, yet there are also important considerations with respect to a global tax structure. Chaya Siegfried, international tax partner at Withum, starts by giving us her views from an international tax planning perspective.

SIEGFRIED: From an international tax planning perspective, when we go and sit with a client or a company and discuss their global structure, it's very easy to say, "Okay, let's just put all our profit in Ireland because they have such a low tax rate." But that would be completely ignoring the fact that there is an arm's-length standard in place, both on the US side and the Irish tax side. So that's why it's important to consider and to keep in mind both your global tax structure, but also what's the impact of transfer pricing because if the activities that you're doing, the risks and the analysis does not support putting all of that income in that country, then your global tax planning is useless.

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t So it's important when you're doing the structuring that you keep in mind both, the structure but also the impact of transfer pricing. Because at the end of the day, transfer pricing is there and it needs to be addressed and that arm's-length standard is important.

FOSTER: Marine Gentile continues with the impact on transfer pricing.

GENTILE: I'm presented at Withum with such a variety of clients. I have some big, giant multinationals and I also have some pre-revenue tech startups that we work with, and I love to work with those companies. The truth is they're just starting out, they don't know anything about taxes, transfer pricing or any of the like, they're just trying to get their product out of the lab into the marketplace, right, and commercialize it.

It's very rewarding to be able to speak to them and sort of plant the seed around, "Let's get the structure right from the beginning so that it grows with you as a business." I spend a lot of time doing that and just sort of considering at that point it's not like they need a full transfer pricing documentation study.

This is now consulting, I'll spend a few hours running some numbers for them, "Let's get this into your accounting." So there are ranges of what can happen at that startup stage of course, Yeah, so it's just good to help them navigate because they will get themselves sort of into trouble without realizing they're getting themselves into trouble.

We were saying earlier, in the press there's this negative connotation that companies are manipulating taxes and transfers of business et cetera. But really there's just a giant category of companies and people that just don't even know that these rules and regulations exist. So it's my job to help them so they can focus on growing the business and I can focus on keeping them where they need to be from that standpoint.

FOSTER: Marina shares with us her advice to clients. Is there such a thing as "too early to start"?

GENTILE: You cannot think about transfer pricing too early, it's just not even possible. If somebody comes to me pre going global, which by the way, what does that even mean in today's world? We're global at the minute of incorporation, right? Whether it's online sales or... It's a very different world.

So these factors come into play for everybody really. No one's hiding anymore, it's a very transparent world. So the sooner we think about it, the more we can put a strategy in place that's bespoke to that company, right? Because let's say they haven't built their development team yet and they have the flexibility. Well, okay. Well, what's the best place to put boots on the ground in terms of development that'll work for you guys?

Having said that, I work with so many mature companies that just never quite got their transfer pricing right. Either they never had a study done or thought of it, or it's old, right? I mean, transfer pricing is actually; it's an annual event. There are penalties around not doing it, at the time of your tax return filing you're meant to have the transfer prices at arm's-length.

So you're signing the return, your advisor is signing the return that all the international forms are right, that all the transfer pricing is correct. You don't know that that's true unless you've run the numbers and done the study and shown that that's arm's-length pricing.

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t Here in the US we hold onto the document until it comes up in audit. So two years down the road you get audited, asked for your... It's a very common question by the revenue agent, "Can you present your contemporaneous documentation for transfer pricing?" And you're meant to then pull it from your files and present it, but it should have been prepared two years or whenever before, right, at the time of the filing for that year. So that's a critical distinction. It is honestly a beautiful insurance policy. It protects against penalties because the IRS can also impose penalties on top of that situation. And a lot of our foreign countries actually have to file and submit the transfer pricing. So there are different nuances.

SIEGFRIED: I think anytime we file a return that has a Form 5471 or Form 5472, the 8858, 8865, those are also all of them are asking to report related party transactions. We see time and time again without fail under audit, when those forms are included in tax returns, the very first thing that the auditor will ask for would be the transfer pricing. It's very easy, they'll go straight for those related party transactions, they're all listed there. It's a roadmap for them and they're going to ask for it immediately. So it's not even if I and up with an auditor that will ask it, it's pretty much automatic.

FOSTER: And that brings up another great point, the importance of contemporaneous documentation, upon receipt of an IRS 30-day letter.

SIEGFRIED: They issue a 30-day letter. So this documentation and like Marina says, you're supposed to have it on the day that your return is due and it's required to be contemporaneous. if you get a 30-day letter saying forward your transfer pricing, in 30 days you will not have enough time to create contemporaneous documentation, it's just not a big enough window. So it's not as though you can push them off and say, "Oh, we'll give it to you in a couple months from now." They want it within 30 days.

FOSTER: Marina discusses the implications of the absence of adequate documentation on transfer pricing and penalties the IRS can impose.

GENTILE: There's the ability and the IRS has the right to impose a 20% or a 40% penalty on top of that adjustment if you cannot present your documentation, okay, that was contemporaneous to the year in question.

Whether or not it happens, we're dealing with revenue agents, we're dealing with people, I've found some very reasonable ones where they give me the opportunity to run the analysis and present them a document in the moment, right? I find others that are just like, "Nope, you didn't have this two years ago, it's not contemporaneous."

So Chaya mentioned you don't have the time to within 30 days prepare the document. But the other part of that is you can't backdate that document. As a taxpayer, you don't want to be in that position where you're dependent or you want to present the story of your business. That's what the report does; it allows the company to say, "This is my business, this is how it works. It's unrelated to tax manipulation as you can see, nothing to see here, please move on."

That gives the power to the taxpayer. If they present nothing, not only are they exposed to those penalties, but they're exposed to whatever analysis the IRS or other tax authority is going to do on their business. And you don't want to be in a position where you're responding to that as opposed to the government needing to respond to you.

FOSTER: So what happens if you are a loss-generating company? Do you still have to worry about transfer pricing?

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t SIEGFRIED: One other point which I think is important to note and is the pet peeve of Marina and I and we see it very often is there's this perception I'll say out there in the market that if you are a loss-generating company, you don't have to worry about transfer pricing because there's no income. That's not actually the case.

Firstly, we've come across fact patterns where maybe the U.S. company showed a loss, but the non U.S.-related companies, those were all profitable. That could just be because the allocation of income was incorrect and there should be some income in the U.S.

In addition, even if you're in a startup phase and you're not generating income, the history of... If you have, let's say for instance in the group a limited risk distributor, you want a specific entity to be a limited risk distributor.

Typically you want that because that entity is in a high-tax jurisdiction and limited risk distributors have a low-profit threshold. But that little profit threshold has to be fixed at all times, whether the overall group is making money or losing money, it's that idea of low risk but set income.

If you don't have that set up when the enterprise is in that startup phase where maybe they're not profitable yet, then you lose that valuable history and your story's, always about the storytelling, your story of saying, "Well, this entity in a high-tax jurisdiction is a limited risk distributor." The storyline doesn't play out if at the time when the overall company was losing money that entity lost money too. Because if it's limited risk, that means that it should have a fixed amount of profits, small, but fixed. So the perception that, "Oh, we're a loss making, we don't really need to worry about transfer pricing," that's not correct. Again, we see that all too often.

SURRAN: The pandemic gave rise to unique economic conditions and caught not only individuals off guard, but also businesses as well as governments. Everyone was in a state of disarray and panic set in for a short period last year at this time, trying to figure out all aspects of life.

Earlier we mentioned the OECD's guidance on transfer pricing in lieu of the pandemic and its implications. In addition to the transfer pricing guidelines (TPG) for multinational enterprises, there was a need to address transfer pricing rules for the financial years impacted by COVID-19, not only from the taxpayers' standpoint but also from the tax authorities'.

This guidance focuses on four priority issues:

1. Comparability analysis,

2. Losses and the allocation of COVID-19 specific costs,

3. Government assistance programs, and

4. Advance pricing agreements.

FOSTER: Marina Gentile talks about some of the compliance factors companies faced in 2020 with respect to transfer pricing, short-term and long-term considerations and the impact of the pandemic.

GENTILE: I would encourage every company that has global operations to have concurrent and contemporaneous transfer pricing annually, okay, at the time of the tax return filing. In FY 19, sorry, FY 2020, it's more critical than ever, let's put it that way. Because you know what happened.

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t The COVID-19 disruptions, a global pandemic, a lot of companies suffered. A lot did not, by the way. There's opportunity and challenges depending on luck and how you're situated in the marketplace or industry or whatever.

But it's certainly stressful, because a lot of times these companies if they have been on transfer pricing strategies and they have this overall policy, they operate a certain way and a lot of it is around targeted operating margins for the low risk, low function operations. Like the distributor we were talking about earlier or the service provider. Suddenly, the business shifts, it's impacted and so profitability is down or whatever's happening like the entire business possibly is down. So then what happens?

The risk-taking entity, the entrepreneurial risk-taker might try to diffuse these costs around the global operation. So suddenly, you have limited risk limited function companies that are then going to take a hit related to COVID-19 when the strategy and the structure before then had been, "No, we're going to limit their function and risk and we're going to thus limit the profitability in those markets."

FOSTER: Chaya Siegfried discusses the impact of the current environment in international tax.

SIEGFRIED: Firstly, with the economic impact of COVID and the various bailouts from governments across the world, every single government is now looking to increase their revenues. Many of them are talking about raising corporate tax rates and other tax rates. So that is definitely something that multinational enterprises are going to be feeling over the next couple of years.

From a personnel perspective, we've also found that companies' employees have landed up in countries where they didn't intend to remain for much longer periods than was originally planned because they got stuck in the country due to the travel restrictions under COVID.

That also could potentially have income tax implications where you may have thought that you had an employee going to vacation in Spain for a week and the next thing they're working from home in Spain for a few months, does that now give the employer permanent establishment in Spain, what are the income tax implications to the individual? So there are a lot of issues around that. The IRS has issued some guidance on that so these are other issues that we're dealing with.

Then not related to COVID at all, actually this is something that has been in the making for a while but is actually COVID delayed it to some degree, but we're nearing some sort of conclusion is the OECD's reporting or approach to taxation of a digital economy. This is something that they've been working on and the think tank has been looking for different approaches on how to tax the digital economy differently than a non-digital economy. And it looks like we're very close; probably in the first quarter of 2021 we'll get the final agreement for all the parties involved. Or we won't, or it'll just fall off the face of earth and everyone's going to go off on their own and do their own thing.

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Segment Two

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two 2. Global Tax & Transfer Pricing Strategies:

What Lies Beneath – Part II

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Learning Objectives:

Segment Overview:

Field of Study:

Recommended Accreditation:Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Taxes

Work experience in tax planning or tax compliance, or an introductory course in taxation.

None

1 hour group live 2 hours self-study online

Update

“Transfer Pricing Implications from U.S. Tax Reform”

“A Primer on Transfer Pricing”

“Transfer Pricing at the State and Local Tax Level”

See page 2–11.

See page 2–19.

31 minutes

As the world is slowly coming out of the pandemic, companies are reevaluating their day-to-day operations, levels of performance within various departments, affiliates and subsidiaries, as well as customer and supplier relationships. Many companies have gone out of business, leaving customers to look for alternatives in their supply chain, while others have reorganized, transitioned to a virtual platform and switched from supply chains overseas to domestic or local manufacturers. As a result, their existing transfer pricing policy may no longer reflect the new corporate structure and intercompany cash flows. Chaya Siegfried, international tax partner and Marina Gentile, lead of Global Transfer Pricing Strategies practice at Withum, continue our segment by discussing the impact of the current environment on global tax and transfer pricing.

Upon successful completion of this segment, you should be able to: l Recognize how changes in transfer pricing strategies can

affect a business, l Identify the differences in tax between domestic and

multinational companies, l Understand the concept of double taxation and possible ways

to avoid it, and l Determine who can qualify for a deduction under IRC

section 250.

Expiration Date: October 13, 2022

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A. Companies Are Re-evaluating

i. Day-to-day operations

ii. Levels of performance within various l Departments l Affiliates l Subsidiaries

iii. Customer & supplier relationships

B. Transfer Pricing & Restructuring

i. Transfer pricing policy may no longer reflect l New corporate structure l Intercompany cash flows

C. Marina Gentile’s Recommendation & Views

i. Do not change your transfer pricing strategy

l Because of the pandemic

ii. Stay steady, consistent, quantifiable l To avoid paying income

adjustments l Document the impact on your

company

iii. Compare financials to peers

iv. The pandemic was not created for tax manipulation l Adjust for real changes

I. Revisiting Transfer Pricing Decisions

Outline

A. Digital Economy Taxation Questions

i. Who has the right to tax

ii. How much profit should be allocated

B. Domestic vs Multinational Tax

i. Domestic companies l Taxed on 100% of revenues by

one country

ii. Multinational enterprises l Which country gets to tax? l How much can they be taxed?

C. Outdated Tax Principles

i. Based on physical presence

ii. Measured by l Employees l Inventory l Physical activities

iii. Level of substances determines income allocation

D. Double Taxation on $100M Global Income

i. 20% of the revenue comes from France

ii. $20M allocated to France

iii. France tax on $20M

iv. U.S. tax on $100M

v. Company is taxed on $120M l Paying taxes on more income than

earned

II. Tax Challenges with Digital and Global Economy

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A. Considerations Between Countries on Taxation

i. Collaboration & coordination

ii. Establish procedures to be followed upon disagreements l Be able to resolve conflicts

“There needs to be some collaboration and coordination between the different countries and how they tax.”

— Chaya Siegfried

B. Mutually Agreed Upon Procedures

i. Process and framework on resolving issues, inconsistencies and their application l Transfer pricing

ii. Process is l Time consuming l Costly l Requires a lot of resources

C. Alleviate the Pain By

i. Establishing a process for two countries to be talking to each other

IV. Agreements between Countries

A. Fixing the Problem

i. Use of tax credits

ii. Treaties between countries

B. Unilateral Measures

i. May result in double taxation

C. Foreign Tax Credits

i. Limited to taxes paid on foreign source income

D. Digital Services Tax

i. May not be considered in the U.S. as income tax l Depending on how it’s

calculated

III. Addressing Tax Challenges

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A. OECD’s Pillars

i. Pillar I l Market-based taxing

ii. Pillar II l Global minimum tax on income

regardless of where it is earned

B. New Roadmap on Digital Economy Tax

i. Throw out old transfer pricing rules

ii. Introduce a new way of allocating profit l Rewriting transfer pricing rules

C. OECD’s Role

i. Think tank

ii. Can’t enforce measures

D. Transfer Pricing – Historically vs Now

i. Historically l Based on substance l Valuation of activities in

different markets v Contribution to global

business

ii. Now l Technology driven digital

companies l Not driven by people or physical

presence

V. New Approaches to Global Taxation

A. Section 250 Deduction

i. Applicable if you are profitable in the U.S.

ii. Can’t claim the deduction with NOLs l Effective tax rates may increase

B. Areas to Remember

i. Tax rate increase from different tax authorities

ii. Unintentional presence of employees

iii. Be prepared to handle losses l Avoid high-level estimates l Use a model

C. Chaya Siegfried’s Final Thoughts

i. Plan ahead

ii. Ensure your transfer pricing is l In place l Done properly l Documented

iii. Create a global structure and revisit it

D. Marina Gentile’s Final Thoughts

i. Transfer pricing is important regardless of company size

ii. Ensure it’s arm’s-length

iii. Annual transfer pricing documentation is l Recent l Correct l Valuable tool for planning

iv. Use it for cash flow management, tax minimization & asset protection

v. Create your own model and strategy

“…make sure that we look okay in every market and make sure that every entity is compensated based on their value, their contribution to the overall global business.”

— Marina Gentile

VI.Things to Remember Looking Forward

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1. What are some challenges global businesses are encountering in the current environment and what strategy changes are they considering? What types of restructuring might your organization or clients need to consider in this environment?

2. What should companies consider in regards to changing transfer pricing policy strategy due to the pandemic according to Marina Gentile?

3. How is international taxation different for digital economies compared to traditional economies?

4. What is double taxation in international tax and what are the ways it has been dealt with historically?

5. How would the tax on the digital economy affect the old transfer pricing rules?

6. What are some factors to consider with respect to COVID-19 and global taxation? How is your organizational or client tax structure possibly impacted by the pandemic and are any changes necessary as a result?

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2. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part II

l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Chaya Siegfried and Marina Gentile continue our segment by discussing the impact of the current environment on global tax and transfer pricing.”

l Show Segment 2. The transcript of this video starts on page 2–19 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 2–7 and 2–8. Additional objective questions are on pages 2–9 and 2–10.

l After the discussion, complete the evaluation form on page A–1.

Discussion Questions

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

Group Live Option

For additional information concerning CPE requirements, see page vi of this guide.

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7. What is the purpose of FDII and GILTI and what is their impact on a corporation’s transfer pricing? How has your organization or clients been impacted by taxation requirements of FDII and GILTI?

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1. What are some challenges global businesses are encountering in the current environment and what strategy changes are they considering? What types of restructuring might your organization or clients need to consider in this environment? l Challenges and strategy changes:

v Figuring out where cash is and how to get it to entities that need it more

v Movement of excess cash can be very difficult in some markets

v Companies are reconsidering their supply chains

v Businesses are looking at diversification instead of relying only on one market

l Participant response based on personal/organizational experience

2. What should companies consider in regards to changing transfer pricing policy strategy due to the pandemic according to Marina Gentile? l The pandemic, while difficult, is a

blip we will get past l Companies need to show they have

maintained consistent transfer pricing policy throughout

l Companies should not be paying income adjustments voluntarily

l Companies should consider quantifying how they were financially impacted

l Nobody created a global pandemic to take advantage of tax rates

l If the business is exactly the same but for the disruption, it can be explained in the transfer pricing

3. How is international taxation different for digital economies compared to traditional economies? l Another tenet is who can be taxed in

a jurisdiction l Historical international tax rules and

regulations were written in a time where business was conducted physically without internet or ecommerce

l Current rules and regulations heavily focused on physical substance and do not translate well to digital commerce

l Roadmap needs to be developed to how world tax authorities in different jurisdictions should be taxing services or businesses operating digitally

4. What is double taxation in international tax and what are the ways it has been dealt with historically? l Double taxation is when companies

are paying taxes on more income than they earned

l Double taxation could involve different rates and different tax authorities

l One way it has been fixed historically from a purely domestic perspective is with foreign tax credits

l Another way it has been dealt with historically is through treaties between countries

l Unilateral measures enacted by individual countries do not provide benefits and cause double taxation

5. How would the tax on the digital economy affect the old transfer pricing rules? l The roadmap to taxing the digital

economy throws out the old transfer pricing rules and introduces a new way of allocating profit

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l Not all companies will be impacted l Countries involved in plans being

developed by the OECD will have to pass legislation so that their tax laws look similar

l Technology-driven digital companies are not driven by people or physical presence which is the basis of historical transfer pricing

l Transfer pricing is essentially a business valuation of these segments of the global business so a different approach is needed around that

6. What are some factors to consider with respect to COVID-19 and global taxation? How is your organizational or client tax structure possibly impacted by the pandemic and are any changes necessary as a result? l Factors to consider:

v Different tax authorities are going to be raising tax rates

v Employees may be in places that are not the original intention

v While always planning for profit, companies should also keep in mind what happens in the event there are losses

v Certain deductions are only available if a company is profitable in the U.S.

v Companies should model the impact of losses on existing tax structure and consider whether adjustments to how functions are set up is needed

v Companies should also look at adjusting transfer pricing to make sure the impact of losses won’t increase the effective tax rate over a couple of years

l Participant response based on personal/organizational experience

7. What is the purpose of FDII and GILTI and what is their impact on a corporation’s transfer pricing? How has your organization or clients been impacted by taxation requirements of FDII and GILTI? l Purpose and impact on transfer

pricing: v These provisions are an attempt

to prevent the shifting of profits to foreign tax havens

v Foreign Derived Intangible Income (FDII) encourages companies to develop and keep IP in the US

v FDII creates an export incentive and rewards IP holding within the U.S. by establishing a reduced rate on related income

v Global Intangible Low-Taxed Income (GILTI) subjects foreign income derived from IP in low tax jurisdictions to current U.S. taxation

v FDII and GILTI have an indirect impact on transfer pricing as transfer pricing considerations do not go away with increased U.S. ownership of IP although countries of focus may be changed

v Every major market in the world has transfer pricing regulations and there will still be intercompany transfers among global affiliates

l Participant response based on personal/organizational experience

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sSuggested Answers to Discussion Questions (continued)

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1. Which of the following is a challenge some entities have that Marina Gentile identified as particularly difficult in certain markets requiring government involvement?

a) supply chains

b) virtual platform development

c) cash repatriation

d) business diversification

2. What did Marina Gentile note as it relates to changing transfer pricing policy strategy due to the pandemic?

a) companies should reduce profitability at their low-risk entity

b) entities should plan on paying income adjustments voluntarily based on changes in income allocation

c) all companies must change their strategies as a result of changes in the way their products get to market

d) nobody created a global pandemic to take advantage of tax rates

3. How has the problem of double taxation been dealt with historically?

a) treaties

b) unilateral measures

c) changing definitions of foreign source income

d) prevention of foreign ownership of domestic entities

4. According to Chaya Siegfried, what is holding up the process of implementing a global minimum tax on income regardless of where it is earned?

a) United Nations oversight

b) COVID-19

c) disagreement over whether it should only apply to digital companies

d) disputes over how to determine if a company has physical substance

5. How will taxing the digital economy affect the old transfer pricing rules according to Chaya Siegfried?

a) it will have very little impact across the board

b) transfer pricing will continue to be based on substance

c) it eliminates the old transfer pricing rules for every company and industry

d) for companies to be impacted by these rules, it pretty much rewrites the transfer pricing book

6. Which of the following entities is prohibited from a GILTI deduction under Section 250 of the IRC?

a) entities with indirect interests in controlled foreign corporations

b) trusts

c) entities with a net operating loss in the U.S.

d) U.S. individual shareholders of controlled foreign corporations

7. How often should transfer pricing and compliance be considered according to Chaya Siegfried?

a) several times per year

b) annually

c) every 2-3 years

d) every 5 years

8. Which of the following types of payments are excluded for the purposes of determining BEAT?

a) COGS

b) services (subject to certain exclusions such as those that are G&A in nature)

c) royalties

d) interest

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the reading for self-study that starts on page 2–11.

Objective Questions2. Global Tax & Transfer Pricing Strategies: What Lies

Beneath – Part II

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9. Which of the following is correct about the arm's length charge for services charged by a member of a controlled group under transfer pricing regulations?

a) the regulations require the use of the comparable uncontrolled services price method for controlled party services

b) the charge can be based on a markup above both direct and indirect costs

c) taxpayers are prohibited from passing on costs to a related party with no markup for any type of expenses

d) charges may not include an allocation of overhead among different entities who benefit from those services

10. Which of the following refers to a prospective agreement between the taxpayer and IRS about transfer pricing methodology and an arm's length range of results?

a) advance pricing agreement

b) simplified cost method

c) BEMTA

d) transfer pricing IDR

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

TRANSFER PRICING IMPLICATIONS FROM U.S. TAX REFORM

By Marina Gentile, iMBA, Lead, Global Transfer Pricing Source: https://www.withum.com/resources/transfer-pricing-implications-tax-reform/

The Tax Cuts and Jobs Act, signed into law on December 22, 2017, has caused a radical change in the U.S. tax system, impacting both domestic and international organizations, as well as some individuals. Since that date, the tax implications for corporations continue to be extensively analyzed, digested and modelled to assess the impact to individual client structures.

There are transfer pricing implications that align with some of the international tax changes for businesses, in particular related to new global structuring that may take place in order to take advantage of lower U.S. tax rates and incentives to develop and keep intellectual property in the U.S. There is, however, no immediate transfer pricing consideration that will impact 2017 corporate tax return filings, like the deemed

repatriation requirement for offshore liquid assets of U.S. corporations.

An amalgam of diverse considerations for corporations ensures that the transfer pricing implications will not be the same for everyone, and must be considered and modelled on a one-on-one basis with clients. Simultaneous consideration must be given to business objectives, supply chain factors, compliance requirements, global tax efficiencies, expansion planning and other factors that drive cash needs for the global business. With the individualized and longer-term transfer pricing impact still to be seen, there are some initial transfer pricing takeaways that can be gleaned from the Tax Cuts and Jobs Act.

FDII and GILTI: An Indirect Impact on Transfer Pricing

Foreign Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI), among other provisions, in short, attempt to prevent the shifting of profits to

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l In order to ensure adherence to

NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Update

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foreign tax havens. FDII encourages companies to develop and keep intellectual property (IP) in the U.S., rather than migrating abroad, in an effort to maintain the higher, non-routine income derived from said IP within the U.S. FDII also effectively creates an export incentive and rewards IP holding within the U.S by establishing a reduced rate on income associated with certain exports (sales/leases of property, royalties, and services to non-U.S. parties). In a similar vein, GILTI penalizes companies by subjecting foreign income derived from IP in low tax jurisdictions to current U.S. taxation. This introduces an anti-deferral mechanism to the tax law. FDII and GILTI work in tandem so that the IP of U.S. companies (and the income associated with that IP) remains in the U.S., or is migrated back, if held overseas.

FDII and GILTI have more of an indirect impact on a corporation’s transfer pricing. Transfer pricing considerations do not go away with increased U.S. ownership of IP, though the countries of focus may be altered. Transfer pricing is not just a U.S. consideration: every major market of the world has transfer pricing regulations or guidelines, and there will still be intercompany transfers among global affiliates to test against the arm’s length standard. While IP ownership may increase in the U.S., companies still have incentives to support this IP with offshore technology development service centers in markets with low labor costs. Thus, specific tested intercompany transactions may be altered, in addition to the markets of those tested intercompany transactions, but the level of intercompany transactions – and overall need for transfer pricing analyses – will not necessarily change.

More on FDII and GILTI

BEAT: A More Direct Impact on Transfer Pricing

Compared to FDII and GILTI, Base Erosion Anti-Abuse Tax (BEAT) arguably has a more direct transfer pricing impact, in that it involves related parties. BEAT requires applicable taxpayers to pay tax equal to base erosion minimum tax amount (BEMTA).

BEAT targets payments from (to) U.S. companies to (from) related foreign parties. BEAT will generally only apply to those companies with significant related-party payments to foreign affiliates, however, the introduction and application of BEAT makes such significant related-party payments more expensive. A list of included and excluded payments per BEAT are as follows:

l Included – payments for services (subject to certain exclusions), royalties, and interest.

l Excluded – payments for Cost Of Goods Sold (COGS), payments for services tested under the Services Cost Method (SCM) (i.e., services that are more general and administrative in nature and do not contribute significantly to the fundamental success or failure of the business), and qualified derivative payments (subject to specific conditions).

An interesting and unclear feature of BEAT is the exclusion of COGS payments from base erosion payments. Many questions still remain as to what is an acceptable embedded COGS service. It can be argued that the COGS payment exclusion even incentivizes certain services to be recorded as COGS that would have not otherwise been classified as such. Additional, or more precise, reporting for intercompany transactions are anticipated. For example, the importance of method selection (e.g. asking, “Is the service SCM or not?”) as well as identification of a transaction as a service or royalty, versus embedded as part of COGS, will be subject to extra scrutiny.

As well, there are significant increases in penalties – from $10,000 to $25,000 – for failure to disclose intercompany transactions by filing Form 5472 at the time of a corporations tax return filing. This form is filed for each foreign or domestic related party with which a corporation has a reportable intercompany transaction during the tax year.

More on BEAT

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Limitations on Income Shifting Through IP Transfers

The definition of an intangible asset of Section 936(h)(3)(b) has been amended to include any goodwill, going concern value, workforce in place, and any other item in which the value or potential value is not attributable to tangible property. This codification of intangible asset prevents the inappropriate justification of transfers of value without compensation on those transfers. Moreover, Section 482 was also amended to clarify the authority of the Secretary and the Internal Revenue Service. The amended text states that IP transfers may be valued on either (i) an aggregate basis (if this is the most reliable means of valuation) or (ii) a realistic alternative basis (which observes potential profits or prices if the IP were to be transferred to an uncontrolled party).

Including goodwill, going concern value, and workforce in place as IP may make the comparable uncontrolled transaction (CUT) method less reliable as a selected transfer pricing method. The reason for this is because the complexity of a given company’s IP has been magnified as a result of the increased number of IP sources. As a consequence, it is now more likely that the nature of one company’s IP is less comparable to the nature of a tested company’s IP, and thus the CUT will not be selected as the Best Method.

The Tax Cuts and Jobs Act has certainly affected transfer pricing, and some of the immediate influences have been discussed. FDII, GILTI and BEAT interrelate with one another and it is challenging—perhaps implausible—to declare a singular impact of the new law given the variegated organizational structures and businesses of U.S. multinational enterprises. The various aspects must be modeled together and for each individual company. Just as one aspect of the Tax Cuts and Jobs Act can have a positive impact, another can have a negative one. Thus, the overall bearing of the Tax Cuts and Jobs Act is best assessed by viewing the facts and circumstances of a

given organization and modeling the ultimate impact based on each client’s unique facts, circumstances and business objectives.

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By Marina Gentile, iMBA, Lead, Global Transfer Pricing Source: https://www.withum.com/resources/primer-transfer-pricing/

A transfer price is the price charged for intercompany transactions. The principles of I.R.C. Section 482 require that intercompany transactions be priced at arm’s length. Although ostensibly a simple concept, the arm’s length standard has spawned thousands of pages of regulations, rulings and opinions. In its most basic form, the arm’s length standard requires taxpayers to ask the question: Would an independent company agree to this same pricing that occurs with an affiliated company?

Transfer pricing continues to be a hot issue for multi-national companies, as well as domestic entities with transactions between related parties, including for-profit and not-for-profit entities. Transfer pricing affects a multitude of intercompany transactions, including but not limited to: transfer of tangible property (products), transfer of intangibles (covered in further details later), loans (interest), and provision of services.

The remainder of this article will review how the U.S. transfer pricing regulations affect the intercompany transactions between for-profit (“FP”) and not-for-profit (“NFP”) related entities.

The Best Method Rule The best method rule in the Section 482 regulations states that the method used to analyze the pricing of a controlled transaction must be the method that, given the facts and circumstances, provides the most reliable measure of an arm’s length result. The application of the best method rule establishes an arm’s length range of prices or financial returns against which to test the controlled transactions. If the tested party financial results fall within the middle fifty percent of that range, known as the

interquartile range, then the controlled transaction is considered to be arm’s length.

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In determining the most reliable measure of an arm’s length result, FPs and NFPs should consider the degree of comparability between controlled and uncontrolled transactions by analyzing the functions, contractual terms, risks, economic conditions, and the nature of goods and services supplied. In the event that this analysis requires numerous or sizable adjustments to meet comparability, the comparable price may be deemed not be reliable.

Tangible Property The transfer of tangible property is the type of intercompany transaction traditionally contemplated when reviewing transfer pricing. The arm’s length amount charged in intercompany transactions involving tangible property should be tested under one of the following methods: the comparable uncontrolled price method, the resale price method, the cost plus method, the profit split method, and the comparable profits method.

Intangible Property Intangible property refers to both technology-related and marketing-related proprietary assets of the taxpayer. The transfer pricing regulations broadly define intangible property as including:

l patents, inventions, formulae, processes, designs, patterns, or know-how;

l copyrights and literary, musical, or artistic compositions;

l trademarks, trade names, or brand names;

l franchises, licenses, or contracts;

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A PRIMER ON TRANSFER PRICING

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l methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data; and

l other similar items.

FP’s use of NFP’s unique software (or vice versa), for example, regardless of whether the software is patented, constitutes a method, program, or system and is the transfer of an intangible. Intercompany transfers of unique intangibles initially caught the attention and scrutiny of the I.R.S. during the 1980s, and ultimately led to the establishment U.S. transfer pricing regulations. In determining the arm’s length price for the transfer of an intangible, FP (and/or NFP) has a choice of three methods: the comparable uncontrolled transaction method, the profit split methods, and the comparable profits method.

Intercompany Financing Although many I.R.S. rules deal with the proper amount of, and deductibility of, interest charged between related parties, the transfer pricing regulations have their own twist that applies after the taxpayer has applied the other sections. The transfer pricing loan regulations generally apply to bona fide indebtedness beginning on the date after the indebtedness occurs, with several exceptions. The exceptions include:

l two months of relief from an arm’s length interest charge for transactions in the ordinary course of business;

l three months of relief from an arm’s length interest charge for a debtor outside the U.S.;

l an unspecified method of relief for the regular trade practice of the creditor’s industry; and,

l relief for property purchased for resale in a foreign country.

There are three main issues to consider when evaluating intercompany financing:

1. Does the financing arrangement represent bona fide indebtedness, or is

it, in substance, a contribution to capital by the Lender to the Borrower?

2. Does the interest on the related party debt meet the “Situs” rule for loans obtained by Borrower at the situs of the Lender?

3. Does the interest rate on the related party debt meet the arm’s length standard under the rule set forth in Treas. Reg. 1.482-2(a)(2)?

The arm’s length rate of interest imputed must be between 100 to 130 percent of the Applicable Federal Rate. For loan terms of six months and less than three years, taxpayers should apply the Federal short-term rate. Terms between three and nine years require the Federal mid-term rate and terms over nine years require the Federal long-term rate.

Services A member of a controlled group must receive an arm’s length charge for performing marketing, managerial, administrative, technical or other services for the benefit of another member of the group.

The charge for the performance of services is generally the total cost incurred regarding the services, plus an arm’s length markup. These costs are both direct and indirect costs. Direct costs constitute the compensation paid and travel expenses of employees performing the services, material supplies consumed, telecommunications expenses, and similar items pertaining specifically to that service. Indirect costs constitute an allocation of a broad range of overhead/general & administrative type of expenses amongst different entities who benefit from those services.

To be considered a controlled service, a benefit must be provided as defined under the Benefits Test in the regulations. Essentially, the Benefits Test asks the question: Does this service benefit the company in a way that it would need to pay an independent entity to perform this same service, if its affiliate no longer provided it?

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The regulations specify six transfer pricing methods for controlled party services. They are:

l the simplified cost method

l the comparable uncontrolled services price method

l the gross services margin method

l the cost of services plus method

l the comparable profits method

l the profit split method

The simplified cost method that, in part, replaces the cost-only safe harbor and gives the taxpayer the option to pass these costs along to their related party with no markup, provided they are included in the IRS “white list” (i.e., typically basic general and administrative type expenses).

Penalties If the I.R.S. determines that 1) an intercompany transfer price was less than 50 percent or more than 200 percent of arm’s length price or 2) the transfer pricing adjustment increases taxable income by $5 million or more, a penalty equal to twenty percent of the additional tax may be assessed. The penalty increases to forty percent if 1) the intercompany transfer price was less than 25 percent or more than 400 percent of an arm’s length price or 2) the transfer pricing adjustment is $20 million or more.

Additionally, a 20% penalty is doubled to 40% if proper transfer pricing documentation is not contemporaneously maintained. Transfer pricing documentation not only protects the taxpayer from an increased penalty, but often persuades the I.R.S. that a transfer pricing adjustment is not necessary.

Many multinational companies have employed advanced pricing agreements to establish stability and avoidance of penalties. In the advanced pricing agreement (“A.P.A.”) process, the taxpayer and the I.R.S. prospectively agree to the taxpayer’s

facts, transfer pricing methodology and an arm’s length range of results. The A.P.A. will include a set of critical assumptions that, if followed, will not result in an examination of transfer pricing in the future. The burden is on the taxpayer, however, to present an annual status report to the I.R.S. reflecting the fact that there have been no substantial changes in its business since the signing of the A.P.A., and that they indeed complied with the agreed-upon operating results in that year. Although A.P.A.s have traditionally been the purview of large companies, the I.R.S. recently issued streamlined procedures to make the process more cost efficient for smaller companies.

Conclusion The simplest scenarios for expanding a business with multiple entities may bring transfer pricing problems to a Tax Director. Although the transfer of tangible property is the most obvious, transfers of intangible property, loans in the form of extended payment terms, and the provision of services may also cause problems. Fortunately, several planning tools, such as documentation and A.P.A.s, can prevent unexpected surprises while avoiding adjustments and penalties.

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By Marina Gentile iMBA, Lead, Global Transfer Pricing https://www.withum.com/resources/transfer-pricing-at-the-state-and-local-tax-level/

Transfer Pricing, with a Dash of SALT

Transfer pricing discussions have been thus far highly focused in the global arena.

This scrutiny and litigation continues to be a trending topic, increasing in transparency and crackdown by tax authorities on a global level. The past few weeks we have seen an uptick in discussions pertaining to coordinated enforcement on the purely domestic front in the United States. State-level auditors are going on record with organized efforts to identify and audit the intercompany transactions of corporations operating within their states to ensure arm’s length – or market-rate – pricing with affiliated firms.

The perception is that corporations are dealing in tax rate arbitrage on the state level, not just the international one, seeking to minimize taxes paid in high taxed states by allocating more income to low taxed states via transfer pricing manipulation. State tax authorities are seeking to protect tax base erosion, or more accurately, increase sources of tax revenue via income adjustments around intercompany pricing. The general state of the world economy today is prompting outside the box thinking on new areas of revenue-generation, and government agencies are not immune to this trend.

This trend for transfer pricing scrutiny applies to the separate reporting states, and generally not applicable to states with mandatory group filing (e.g. combined reporting states). While many states have moved to a combined reporting structure, where one tax return is filed for the parent and affiliates regardless of location, there

are number of states that employ separate reporting regimes; meaning separate tax returns are required for each affiliate that has nexus.

Thus far, this has been more of a vague concept on the state level, with broad and ambiguous authority prescribed to state tax auditors to make transfer pricing income adjustments. State provisions tend to garner considerable attention on intercompany transactions pertaining to management fees, debt (i.e. interest expense), and intellectual property (i.e. royalties). Outside of this realm, it is often considered to be abstruse in how states regulate against profit shifting, as states sometimes find themselves with limited tools in addressing. The states often hold the ability to assert discretionary authority to adjust businesses profits. Further, states may combat these so called “abuses” by asserting nexus with the out-of-state related entity and/or force combination through audits.

In many cases there has been very limited case law for auditors and taxpayer’s to seek guidance. In three more recent state tax cases involving transfer pricing adjustments, the courts all sided with the taxpayer. The courts agreed the state tax agencies misused their discretionary authorities to reallocate the taxpayer’s income. The state could not present defensible support for income adjustments related to transfer pricing.

However, just this month there is more explicit discussion of Treas. Reg. §1.482 of the Internal Revenue Code (“Treas. Reg. §1.482”) applying to the state taxation. Under Treas. Reg. §1.482, transfer prices within a controlled group must meet the arm’s-length standard and, thus, be consistent with the results that would have been realized if uncontrolled taxpayers had engaged in similar transactions under similar circumstances. In short, affiliated companies must operate as if independent, total strangers, using market-rate pricing. Note that a negotiation between two affiliated

TRANSFER PRICING AT THE STATE AND LOCAL TAX LEVEL

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firms does not result in market-rate pricing. Rather, the pricing must be benchmarked to comparable firms or transactions in the marketplace via an economic analysis based on Treas. Reg. §1.482 methodologies.

Several states, mostly in the Southeast, are taking a more united, proactive, and aggressive approach to educating themselves on scrutinizing taxpayer’s transfer pricing. They meet regularly and are advised by transfer pricing consultants, training state audit teams on how to target taxpayers, assess transfer pricing, and build an economically-sound argument that pricing is not market-rate and an income adjustment may be warranted. Multistate businesses with separate state tax filings should consult with their transfer pricing and state tax advisors for guidance on how to assess and mitigate audit risk.

Two states are a bit further along, with Indiana and North Carolina offering options for businesses operating in those states to address and negotiate transfer pricing. North Carolina has launched a voluntary disclosure program, focused on resolving transfer pricing in back years. Businesses operating in North Carolina can voluntarily step forward to disclose and adjust any prior years transfer pricing, paying the additional taxes without penalty. There is a very brief window for taking advantage of this program, with disclosure deadlines in September and October, so corporations should consult their transfer pricing and state tax advisors to assist in engaging in these interactions and negotiations with state tax authorities.

Indiana has adopted a state-level Advance Pricing Agreement (“APA”) program where taxpayers can voluntarily opt to work with the government to prospectively negotiate transfer pricing. Resolution in an APA setting allows taxpayers a high degree of certainty that their transfer pricing will not be disputed and there will be no need for costly and time-consuming future litigation. Best candidates for pursuing an APA are companies with higher levels of intercompany transfers, or with a contentious audit history with the state. The commitment is heavy, so the APA approach is not for the casual Indiana taxpayer.

The COVID-19 crisis amplifies this, where states will be looking for revenue and this is an area that could see increased scrutiny as well as allocation of wages due to tele-commuting. While the connection between state tax and transfer pricing is relatively new in the press, there has been a behind-the-scenes movement for a few years. Withum, and presumably other advisors, have been working with their clients to address purely domestic intercompany pricing.

It’s critical to reach out to your advisors today so you understand your company’s position and tax exposure in this area. Withum can assist you in mitigating this risk. Applying arm’s length – or market-rate – pricing to transactions between affiliated entities has many advantages. Here are 4 ways that Withum can help put your organization in a position of strength:

l Understanding and minimizing state tax risk exposure related to intercompany transactions.

l Calculating arm’s length pricing for intercompany transfers ensures affiliates all operating at market-rate. Four key focus areas: tangible products, services, licensing/royalty arrangements, and financing (such as loans and lines of credit).

l Valuing and compensating each affiliated entity for its relative contribution to the success of the business, ensures that no one entity is over- or under-paying taxes in any given state.

l Performing a cost allocation analysis of taxpayer’s accounts ensures revenue and expenses are allocated to the correct entities based on contribution of each entity to the business.

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tVideo Transcript

SURRAN: As the world is slowly coming out of the pandemic, companies are reevaluating their day-to-day operations, levels of performance within various departments, affiliates and subsidiaries, as well as customer and supplier relationships.

Many companies have gone out of business, leaving customers to look for alternatives in their supply chain, while others have reorganized, transitioned to a virtual platform and switched from supply chains overseas to domestic or local manufacturers.

As a result, their existing transfer pricing policy may no longer reflect the new corporate structure and intercompany cash flows.

Even though the roll-out of vaccines may indicate the end of the virus, and gives hope for a brighter future in 2021, it does not alleviate the challenges introduced by the pandemic. Many economists and analysts feel that the financial crisis of 2020 and the results of the outbreak will linger for years to come.

But no one can predict what "years to come" means, how long this will last and what the final impact will be. One thing is certain, not all companies are equal. They won't bounce back at the same rate. Changes in an existing transfer pricing policy structure may be a consideration but they need to be evaluated to see if they are truly necessary, as some operational changes may not be permanent.

For instance, if a company switched to localized sourcing from overseas, that shift may be a temporary solution, as China is bouncing back from the pandemic. If existing transfer pricing policy may no longer be appropriate, reassess. But, reassess wisely!

FOSTER: Many enterprises are restructuring as a way to handle the challenges they are facing in the current environment, and transfer pricing is one area they should also be thinking about. Marina Gentile, lead of Global Transfer Pricing Strategies practice and Chaya Siegfried, international tax partner, at Withum, continue our segment on transfer pricing and global tax. Marina starts by sharing with us her experiences as of this point.

GENTILE: From a business standpoint, right, while a lot had challenges in economics, it's also a time to reassess, in good times, everything is great and everyone is operating smoothly. When something hits, suddenly you have CEOs and CFOs trying to figure out where the cash is, how to get it to the entity that's bleeding the most and needs it more.

Then they find out it's stuck in markets where maybe they didn't think through what's the strategy? Like, "Why do we have so much cash in..." I won't name names, but there are markets out there that historically it's very difficult to get any excess cash out of. It takes time, it takes government involvement. It helps them to rethink like, "Hey, this is not super efficient. This is a weakness in our business and we should take a look at this. "

I've got clients that are reconsidering their supply chains because they just feel like maybe Asia-Pac's just a little too far away and maybe Mexico looks viable or our middle fly over states in the U.S. or Canada or something a little bit closer to home. I'm seeing that quite a bit, I didn't

2. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part II

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t know if that was going to be a short-term blip or people are taking that seriously, but it seems to be a factor. And also diversifying, maybe not relying only on one market.

FOSTER: Panic never helped anyone, and according to Marina, changing your transfer pricing policy strategy due to the pandemic may hurt you more in the long run. Here is why.

GENTILE: I just want to caution people not to panic and change their strategies. To me, that's the message here. Do not change your transfer pricing policy strategy based on this one event because it's a blip, it's hard no doubt, but we will get past it and you want to show that you have maintained your consistent transfer pricing policy throughout. Because then it brings up questions on the other end, "Okay. Well, wait a minute. So now when profitability is low, you're going to give a hit to this low-risk entity, but what happens when your profitability is high? Are we going to get more profit than in this country?"

You don't want to be there. So steady, consistent, quantifiable. I also don't believe anyone should be paying income adjustments voluntarily based on this. I would look at the company. By the way, I called all of my clients in March and said, "Hey, this is how I want you to think of this year, I want you to think of how you're impacted and I want you to try to quantify it. So write it down.

I would then look at the financials and when I compare them to the comparables in the marketplace, I would then say, "Okay, if not for this, you would have been here. So here's the actual financial." And then if we back out like that's happened for many years before then you have this consistent operating whatever, we would be in that same place. So check we're all set.

Because at the end of the day, listen, nobody created a global pandemic to take advantage of tax rates. This is just an event that happened that we all have to deal with. And I think that point gets missed, because I think the tax authorities are taking a super strong position on this, rightly so. Every situation is different, every dynamic is different.

I can support my client because this is not something created for tax manipulation that only they are dealing with, the entire world is dealing with this right now. So that's why I say don't panic because I think people tend to think, "Oh, I really have to change something." And now yes, a lot of companies have changed their operations, they've had to pivot, they've changed the way their product gets to market.

Those are real changes, those are changes we need to talk about those because that will impact transfer pricing. And we should adjust for those.

But if your business is exactly the same but for the disruption, then don't panic and we'll sort it out and explain it in the transfer pricing and that's why you need that more than ever. Because a couple of years down the road when you get audited, hopefully everyone's saying, "Wait a minute, what pandemic? Why were we disrupted?"

SURRAN: Taxation of the digital economy addresses the fundamental questions related to global taxation: Who has the right to tax? How much profit should be allocated?

International consensus is necessary in creating a mechanism for resolving controversies and avoiding double taxation. Several countries passed unilateral measures but can they be a reason or a cause of double

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taxation? And the question still remains if these changes in taxation should apply to only large digital economies, the Amazons, Googles and Netflixes of the world, or across the board to all companies.

Chaya discusses how taxation is different in digital economies and some of the important considerations.

SIEGFRIED: So the two underlying tenets of international tax is who does a country have the right to tax? Who can I tax if you're dealing with them? Obviously, if you're dealing with a company that operates just domestically in one country, then the tax authorities and the government of that country get to tax that company on 100% of its revenue.

Now, if you have companies that are operating from a multinational perspective, now the question is, well, who gets to tax them? And how much can each of those taxing authorities tax those companies?

So historically, the international tax rules and regulations, the policies that we've been working with, both Marina and I, are in place for probably close to 100 years. They were written in a time where business was really done physically. There was no internet; there was no e-commerce. Those rules are very heavily focused on substance, wherever a company has physical substance meaning wherever they have employees, where they have maybe in some cases inventory, things of that nature.

Wherever there are physical activities going on, that's where taxation tied in and that was where you were able to tax a person. Then depending on that level of substance, that's how much income would be allocated to that particular jurisdiction.

So if you think about e-commerce and digital commerce, those principles completely don't translate well. The example I like to use is a company like Netflix. Netflix is a U.S.-based business and streaming content into countries all over the world.

Let's take France for instance. Netflix may not have any physical presence in France, but they can easily have $40, $50 million of revenue from clients or customers in France that are streaming their content. Now the question becomes, well, there's so much economic value coming out of France directed at Netflix, which is a U.S. - based company. Shouldn't France have the opportunity to tax Netflix? Under what rules or policies should France have the ability to tax Netflix? And how much of that income should France be able to tax? Is it the full $40 million let's say or how do we work that out?

These are all questions that the OECD has been working on trying to develop an approach, a roadmap to how world tax authorities in different jurisdictions should be taxing digital-type services or businesses that operate in a digital world.

FOSTER: Double taxation is always a concern when it comes to international tax. Chaya gives us her views and discusses ways it can be avoided.

SIEGFRIED: So let me explain first what double taxation is. So let's take our example with Netflix, okay? Let's say that Netflix globally has $100 million of income. I completely pulled those numbers out of a hat, those are not the numbers but just for our example to illustrate. Then we're saying that 20 million or 20% of their revenue comes from France. So maybe 20 million we'll allocate to France.

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t So France says, "Look, I want to tax 20 million of that income."

And then Netflix comes back to the U.S. and the U.S. says, "No, this is all U.S. income so we're going to tax 100 million of your income." So now a company that made only 100 million is paying tax on 120 million of income.

That's double taxation, that's where you have a fact pattern where companies are paying taxes on more income than they've actually earned and maybe different rates or what have you to different authorities but that's not from a global business perspective, from a global tax authority perspective, that is not good policy. Nobody wants that to happen, everyone wants that business enterprise to be taxed appropriately, not too much, not too little, but the right amount appropriately for the level of income that they have.

In terms of how you would fix that with taxation, so historically that's been done from a purely domestic perspective with the foreign tax credit.

So in our example, if we pay taxes on the 20 million in France, then when it comes to the U.S., we should get a credit for those taxes paid to France that would reduce our U.S. source income. I'm sorry, that would reduce our U.S. tax.

The other way that we have historically dealt with this double taxation concern is through treaties. So when you have two countries that agree on certain terms to only tax certain types of activities or certain levels, that's another way where you would avoid double taxation on your multinational enterprises.

FOSTER: Chaya gives us her insights on the unilateral measures that some countries have already passed and whether there is any benefit to them.

SIEGFRIED: Unilateral measures, I don't see any benefit. Those are pretty detrimental because when you have unilateral measures, that's when you will have double taxation.

So there are a couple of countries, I don't remember all of them off the top of my head, but I think Saudi Arabia was one of them, France was threatening where they implemented these digital services taxes or DSTs, and these were done unilaterally.

And the issue with that is firstly, you're going to land up having double tax because if France says, "Okay, our tax base is 20 million." And the U.S. says, "Our tax base is 100 million." So now you have 120 million of income being taxed.

Even with a foreign tax credit, if the U.S. says, "No, all of Netflix's income is U.S.-sourced," you may have potential foreign tax credits but it's going to be limited because your foreign tax credit is limited to taxes that you pay on your foreign source income.

That means no foreign source income, no foreign tax credit. You're going to have double taxation. Treaties have addressed this, the issue of sourcing so that everyone's on the same page consistently, but the treaties don't address sourcing for digital type transactions. Again, it's something that wasn't contemplated when the OECD model treaties were drafted.

FOSTER: So how would the digital services tax be considered from a U.S. perspective?

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t SIEGFRIED: Even in a context where you would have a foreign tax credit and the sourcing would work out, the digital services tax may not be considered, from a U.S. perspective, they may not consider it an income tax depending on how it's calculated. And again, you only get to take a foreign tax credit on income taxes. So the problem with unilateral measures is you're going to end up having double taxation.

There needs to be some collaboration and coordination between the different countries and how they tax. The other issue is if there is a disagreement between how the U.S. wants to tax something and how France wants to tax something, what are the procedures to work that out?

There needs to be a mechanism for the U.S. to communicate with France, the U.S. tax authorities to communicate with the French tax authorities to work out these different issues.

Most treaties, I think probably all treaties actually, include mutually agreed upon procedures which is that the process and the framework for how the U.S. would work with that other country to resolve any issues inconsistencies and how they're applying – very often it's transfer pricing.

So one country is saying, "No, the transfer pricing should be set that the profit is in our country." And the other country is saying, France is saying, "No, it should be in our country." So we need to have the U.S. and France work this out so that the taxpayer is not left holding back. Reality is those mutually agreed upon procedures, that process takes forever. Marina, I'm not sure, how you ever dealt with those in your practice?

GENTILE: Yes, very much so a lot of competent authority type of negotiations and discussions, whether with advanced pricing agreements around transfer pricing or just on its own with a particular audit situation, it takes a lot of time and a lot of funds, a lot of resources sometimes to get it accomplished. You don't want to go there, let's put it that way unless it's critical.

SIEGFRIED: You don't want to go there, agreed Marina, but we certainly need the process in place for the two countries to be talking to each other.

GENTILE: Yeah, absolutely. I mean, the taxpayer can't be burdened by this. They have no way to resolve this without that competent authority, government to government, negotiation.

FOSTER: Chaya discussed whether digital economies and the changes in taxation apply only to them or other companies overall.

SIEGFRIED: Therein lies the entire project that the OECD is working on. So pillar one and pillar two have been drafted and are pretty close to finalization. Global minimum tax on income regardless of where it is earned.

Just to quickly run through, pillar one relates to a market-based taxing. So wherever your market is, that's how you'll be taxed. Which again, digresses from the concept of substance.

Then pillar two is a global minimum tax where a company would have to pay a global minimum tax on its income regardless of where it's earned. Even if it's in the Caymans, there should still be a minimum tax that's assessed on the earnings of that company.

So what's actually holding up the process from getting to finalization is a disagreement between the world tax authorities whereby France, China,

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t even I think at this point I think most countries are saying, "This should only apply to digital companies."

The U.S. on the reverse is saying, "Well, that pretty much targets all U.S. companies because the large digital companies, the large technology companies are all U.S.-parented multinationals." So they felt that it was unfair targeting of U.S. companies and they would like to see these new tax rules or these new concepts of how companies are taxed apply to any market facing companies. So think French fashion brands, German automobiles, any big brand that's market-facing, customer-facing actually, that's where they want it to apply.

Obviously on the reverse, you have countries like France and Germany pushing back because they don't want it to apply to their companies. It's not yet determined who that will apply to in terms of market. In terms of size of company, typically these rules will only be applied at the... I want to say a couple of 100 million in revenue. So think 5-600 million in revenue initially. But I do think that there will be a time, I can't predict how many years out it will be, that these rules would really apply. It'll filter down and they'll apply to companies of all sizes, not just those huge, huge multinationals.

FOSTER: But how would the tax on the digital economy affect the old transfer pricing rules and how would profit be allocated?

SIEGFRIED: I think it's actually the other way around, right? So the new roadmap to how we're going to tax the digital economy is pretty much going to throw out all of the old transfer pricing rules and introduce a new way of allocating profit.

It almost rewrites the transfer pricing for these companies, for the companies that are impacted. I'm not saying it throws it out for every company, but for the companies that are going to be impacted by these rules, it pretty much rewrites the transfer pricing book.

I do want to say that OECD is a think tank, they don't actually have the ability to enforce any of these measures. This is just a plan, it's going to be a model plan and then the hope is that each of the countries that were involved with the plan go back home and pass the legislation so that their tax authorities or their tax laws look similar or exactly like this plan.

GENTILE: Historically transfer pricing has been based on substance, like boots on the ground, physical presence, people. It's been really important as you value the different activities happening in different markets and how that contributes to the global business, and now this concept tips it a little bit, Because technology-driven digital companies, this type of economy is not really driven by people or physical presence at the location.

The Netflix example is great, I love that example. People are streaming it everywhere without physical presence in those markets. So it's just a very interesting concept, it's a very different concept and we need to sort of figure out and agree on how to value that.

Transfer pricing is essentially a business valuation of these segments of the global business. And so now we're going to have to take a bit of a different approach around that. So always keeping us on our toes. Always something new to think about. It's great. I mean, that's why I think as professionals in this field, I think that's why we can be active and thriving and happy in our careers because there's a lot of change and things to keep up with.

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t SURRAN: In July 2020, the IRS issued final regulations on determining the amount of the deduction for foreign derived intangible income and global intangible low taxed income (GILTI) under Section 250.

Section 250 was added to the Internal Revenue Code ("Code") by the Tax Cuts and Jobs Act (TCJA) enacted in 2017.

The final regulations (TD 9901) have a significant impact on individuals and certain trusts that hold direct and indirect interests in controlled foreign corporations (CFCs) and make elections under IRC section 962, which allows individuals and certain trusts that are U.S. shareholders of CFCs to be taxed on GILTI and subpart-F income (passive and certain easily "shift-able" income) as if they were domestic corporations.

However, that deduction is only applicable if you are profitable in the U.S. If you're showing a net operating loss in the U.S., you don't get that deduction, which may increase your effective tax rates. This is why global tax planning is crucial, especially in the current environment.

FOSTER: Chaya Siegfried gives us some factors to consider with respect to COVID-19 and global tax.

SIEGFRIED: I would say keep in mind or think about how those issues that I mentioned earlier, like our very first question that we discussed how the different tax authorities are going to be raising the rates as well as the issues with employees maybe being in places that was not the original intention. So definitely keep that in mind and consider how that's going to impact your overall tax picture.

I think the other thing is for a lot of our planning conversations that we had had or the structures that we put in, we always plan for profit, but also keep in mind what happens in the event that there are losses.

So to give you an example, something like GILTI, there's a section 250 deduction, but that deduction is only available if you're profitable in the U.S. If you're showing a net operating loss in the U.S., you don't get that 250 deduction and that may over a couple of years increase your effective tax rates.

There are things that you need to think about. I always tell people post TCJA, which seems like a lifetime ago but it's only three years now, we can't just high-level estimate things, we need to model.

So we need to go back in and model and see what the impact of losses are on our structure and consider whether or not there are any adjustments either to how we set up our functions or what have you. Or if we can adjust our transfer pricing to make sure that the impact of the losses is not going to increase our effective tax rate over a couple of years.

FOSTER: Chaya Siegfried and Marina Gentile conclude our segment on global tax and transfer pricing and leave us with their final thoughts.

SIEGFRIED: For companies that are catching up on taxation of the digital economy or they've been keeping up with it all along throughout, it's actually quite a drama. There's some human drama there, tax is not all black and white boring dead stuff, there are also letters between the U.S. Treasury and the rest of the world. So there's been some drama there.

Definitely it's something if you haven't been tracking you should follow because even if you're not in that 500 million revenue range, eventually

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t it's going to filter down, may filter down in different forms. It may filter down just parts of it but over time, I can't tell you again how many years it will take, but there will be a point in time where these rules are going to impact your business. So it's better to plan ahead and plan for it.

The other thing I would say, and this is something that came out of the other measures or the other targets of the OECD BEPS project, transfer pricing. It's very hot. And it has been, it continues to be, it's a big emphasis on not just the U.S. but from a worldwide perspective, every tax authority, this is very big for them.

Again, you need to make sure that your transfer pricing is in place, it's done properly and you have everything organized and just pay attention to what's going on out there.

And Marina and I always say that it's very dynamic, our profession is dynamic because things are always changing. So you can't just create a global tax structure and then not think about it. File it, set it up and then move on with business.

Everything needs to be done with thought and things need to be revisited from time to time as things change. It's not a static, it's a moving part, a lot of moving parts. Things are always changing. So you need to make sure that you're constantly checking in and making sure that your structure is still working the way it should be, your transfer pricing is still in place and any of these new rules around taxation of the digital economy they're not going to hit you by surprise.

GENTILE: I hope I'm getting the message across about transfer pricing and it's important to any global company regardless of the size, right?

Or life cycle, time in their life cycles. So I really want to just cement home that this is an annual compliance obligation. There is some confusion in the world around that and I think sometimes people think well, every three years, every five years, something.

When you are signing that tax return, when your advisor is signing that tax return, you are stating that your pricing is arm's-length pricing in those international forms.

So you need to know the answer to that and the way to have the answer to that is to have that annual transfer pricing documentation so that you have the most recent data available and you have your pricing correct. So that's critical. Then that report itself is your penalty protection in an audit situation as well where you can present it and you're not sort of subjected to the 20, 40% type of penalties arena.

Also, it's such a valuable tool for planning and for taking a very global high-level approach to your business and then drilling down to get the transfer pricing right in each market. And I believe that it creates a very efficient, let's say peaceful structure It addresses the concerns. Transfer pricing really is the highest sort of challenge or uncertainty for any tax department of a multinational. So let's address it, let's look at it and let's make sure that we look okay in every market and make sure that every entity is compensated based on their value, their contribution to the overall global business. I mean, that's key to get that done.

As we said, cash flow management, tax minimization, protecting assets, those are huge advantages to have. The transfer pricing tool is very useful and allows us to just help our clients meet their overall objectives regardless of where they're coming from. And I'm going to sort of play on something Chaya said about... She actually didn't say it on this, well, we've

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t presented a lot together and she often will say, "Don't look at your startup next door. Don't look at your buddy that you're golfing with and what they're doing for transfer pricing. It's very unique.

You need to model, you can't just eyeball it and come up with or take someone else's strategy."

To this day, we often get transfer pricing reports submitted, "Oh yeah, no, we had it done and this is our structure," and whatever. And you look at it and it's that 10 years ago, 13 years ago tax haven in zero tax jurisdiction countries with no substance at all right? Those types of structures, people are onto that, governments are onto that, right? And the advantages with the new tax law aren't as great as they were before. So this is a very fluid thing. You file your tax returns every year, right? You audit your financial statements every year. You need to address transfer pricing every year to make sure that you're in the right place.

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Segment Three

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3. Will the PCAOB Tighten the Leash?

Learning Objectives:

Segment Overview:

Field of Study:

Recommended Accreditation:

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date:

Accounting

October 13, 2022

Work experience in financial reporting or accounting, or an introductory course in accounting.

None

1 hour group live 2 hours self-study online

Update

See page 3–19.

33 minutes

In July 2002, Congress established the Public Company Accounting Oversight Board, known as PCAOB, to oversee audits of public companies and SEC-registered brokers and dealers, in an effort to protect investors and the public interest. Over the years, there have been several cases of significant financial reporting fraud, significant internal control deficiencies, and other audit failures, resulting in the loss of investor confidence, yet the number of defective audits that resulted in enforcement actions by the PCAOB has been very small. Is the profession failing? Is accountability lost? Dan Goelzer, one of the founding members of the PCAOB, gives some insights on these questions.

Upon successful completion of this segment, you should be able t l Understand the purpose of the PCAOB’s inspection reports, l Determine some of the potential drawbacks if audit

workpapers inspected by the PCAOB are publicly disclosed, l Recognize the correlation between audits of financial

statements and uncovering fraud, and l Identify the areas the PCAOB should consider to ensure

greater public trust.

Reading (Optional for Group Study):

“General Electric, a Bigger Fraud Than Enron” See page 3–11.

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A. PCAOB’s Primary Duties

i. Register public accounting firms

ii. Establish or adopt standards

iii. Inspect registered firms

iv. Investigate and discipline registered firms

l Including associated persons

B. Overcoming Differences in Professional Judgment

i. Making confidential parts of inspections public

ii. Establishing l International inspections

program l Internal control auditing

v Internal control over financial reporting

I. PCAOB Inspection Goals & Tools

A. PCAOB’s Inspection Report

i. Lack of sufficient evidence to support audit opinion l Financial statements l Effectiveness of internal controls

ii. Includes serious audit deficiencies

iii. Used as a teaching tool l Improve or change audit practice

B. High Percentage of Deficiencies

i. Does not equate with materially misstated financials l Small number of restatements

ii. Audit selection is risk based l Report doesn’t represent entire

practice l Looks at most difficult areas of

difficult audits v High probability of

deficiencies

iii. Related to internal control over financial reporting

C. Dan Goelzer’s Views on Public Disclosure

i. Won’t add pressure to perform better

ii. Deficiencies don’t represent a company

iii. Confidentiality provisions of SOX

iv. Due process will delay inspections

“If the company also had to get involved in that process, I think it would really bog down inspections…”

— Dan Goelzer

II. Identifying & Disclosing Deficiencies

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A. GE Allegations

i. Not substantiated

ii. No restatement of financial statements

iii. Education

B. Financial Reporting Fraud

i. Restatements are tracked

ii. Only 6% of public companies restated in 2019 l Quality is improving

iii. Reduced number of SEC enforcement actions

C. Uncovering Fraud in Audits

i. Properly executed audits may not uncover fraud

ii. Investors expect audits to uncover fraud

iii. Audits are based on risk of material misstatement

iv. Expectation gap

III. Substantiating Fraud

A. The PCAOB Should

i. Be more transparent l Policy goals & inspections l Setting objectives l Hearing from investors & critics

ii. Restart public meetings with advisory groups

iii. Congress should make proceedings public

iv. Improve inspection reports l Audit quality indicators l Shift from deficiencies to firm

quality control standards

v. Create an anti-fraud center

“… Congress should unshackle its enforcement program by making the proceedings public. I think that would help with public confidence.”

— Dan Goelzer

B. Engagement Selection Methods

i. Risk-based

ii. Random

C. Inspection Outlook in Coming Year

i. Impact of COVID on financial reporting & auditing

ii. Industries experiencing disruptions due to COVID

iii. Impairment determinations

iv. Going concern

v. Allowance for loan losses

vi. Critical audit matters

vii. Auditor response to cyber threats

D. If Audit Deficiencies Are Found

i. Audit firm needs to perform more audit work l Correct problems

ii. Restate if material misstatements found

IV. Recommendations Looking Forward

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3. Will the PCAOB Tighten the Leash?

l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Dan Goelzer gives some insights on why, in spite of several cases of significant financial reporting fraud and significant internal control deficiencies and other audit failures, the number of defective audits resulting in enforcement actions by the PCAOB has been very small.”

l Show Segment 3. The transcript of this video starts on page 3–19 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 3–6 to 3–8. Additional objective questions are on pages 3–9 and 3–10.

l After the discussion, complete the evaluation form on page A–1.

1. Congress established the Public Company Accounting Oversight Board (PCAOB) to oversee audits of public companies. What are the duties of the PCAOB? Do you agree with the organization’s mandate? Why or why not?

2. Since its inception, the PCAOB has faced a number of issues and challenges. What were some of the hurdles faced by the organization after its establishment? What are your thoughts as to whether and how the organization has overcome these hurdles?

3. The PCAOB’s Inspection Reports of public audit firms may create misleading perceptions about the work of the audit firm being reviewed. What are some of the negative conclusions that often get drawn from a PCAOB inspection? Do you or your organization come to similar conclusions?

4. Some people argue for disclosure of the names of the companies whose audit workpapers were examined. What are the arguments for and against such disclosure? Do you agree with principle of such disclosure? Why or why not?

Discussion Questions

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

Group Live Option

For additional information concerning CPE requirements, see page vi of this guide.

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s5. Since the passage of Sarbanes Oxley Act

in 2002, financial reporting has undergone some changes. How have companies altered their financial reporting practices? Do you agree with the speaker that it has improved? Why or why not?

6. There are certain actions the PCAOB can take to ensure greater trust by the public. What are some recommended actions? What actions would you like the PCAOB to consider undertaking?

7. The PCAOB does not disclose the specific process by which it selects audits firms for inspection. What are some of the drivers the PCAOB uses to select a firm for review? Do you agree with the current approach?

Discussion Questions (continued)

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1. Congress established the Public Company Accounting Oversight Board (PCAOB) to oversee audits of public companies. What are the duties of the PCAOB? Do you agree with the organization’s mandate? Why or why not? l PCAOB’s Primary Duties

v Register public accounting firms v Establish or adopt standards v Inspect registered firms v Investigate and discipline

registered firms and associated persons.

l Participant response based on personal/organizational experience

2. Since its inception, the PCAOB has faced a number of issues and challenges. What were some of the hurdles faced by the organization after its establishment? What are your thoughts as to whether and how the organization has overcome these hurdles? l Overcoming Differences in

Professional Judgment v Making confidential parts of

inspections public l Establishing:

v International inspections program k Initially a lot of resistance to

PCAOB inspections of U.S. companies in other countries where other regulators prevailed

k Overcome through negotiations and discussion with other regulators

k International inspections program is now an important part of the PCAOB

l Internal control auditing k Required as part of Sarbanes

Oxley

b Challenge to create a new audit standard in a short period of time

b AS2 and subsequently AS5 v Internal control over financial

reporting l Participant response based on

personal/organizational experience

3. The PCAOB’s Inspection Reports of public audit firms may create misleading perceptions about the work of the audit firm being reviewed. What are some of the negative conclusions that often get drawn from a PCAOB inspection? Do you or your organization come to similar conclusions? l PCAOB’s Inspection Report

v Contains instances where there is a lack of sufficient evidence to support an audit opinion k On the financial statements k Over the effectiveness of

internal controls. v Includes serious audit deficiencies

k Per Dan Goelzer, a high audit deficiency amount is not evidence of the failure of the accounting profession or its ineffectiveness b Audit deficiencies do not

equate with materially misstated financials j Small number of

restatements k Audit selection is risk-based

b Report doesn’t represent entire practice

b Looks at most difficult areas of difficult audits j High probability of

deficiencies k Many deficiencies relate to

internal controls over financial reporting

3. Will the PCAOB Tighten the Leash?

Suggested Answers to Discussion Questions

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sv Used as a teaching tool to Improve

or change audit practice l Participant response based on

personal/organizational experience

4. Some people argue for disclosure of the names of the companies whose audit workpapers were examined. What are the arguments for and against such disclosure? Do you agree with principle of such disclosure? Why or why not? l Arguments for requiring disclosure of

companies whose audit workpapers were examined: v Would add additional pressure on

financial managers and audit committees to improve controls and safeguards

l Arguments against requiring disclosure: v Won’t add pressure to perform

better v Deficiencies don’t represent a

company v Confidentiality provisions of SOX v Due process will delay inspections

l Participant response based on personal/organizational experience

5. Since the passage of Sarbanes Oxley Act in 2002, financial reporting has undergone some changes. How have companies altered their financial reporting practices? Do you agree with the speaker that it has improved? Why or why not? l Financial reporting fraud since

Sarbanes Oxley Act v Restatements are actively tracked v Only 6% of public companies

restated in 2019 v Thus, quality is improving v Reduced number of SEC

enforcement actions l Uncovering fraud in audits

v Properly executed audits may not uncover fraud

v Investors expect audits to uncover fraud

v Audits are based on risk of material misstatement

l Expectation gap l Participant response based on

personal/organizational experience

6. There are certain actions the PCAOB can take to ensure greater trust by the public. What are some recommended actions? What actions would you like the PCAOB to consider undertaking? l Per Mr. Goezler, the PCAOB should:

v Be more transparent k About policy goals &

inspections k When setting objectives k More open to hearing from

investors & critics v Restart public meetings with

advisory groups v Congress should make proceedings

public v Improve inspection reports

k Develop audit quality indicators or other measures of audit firm performance

k Shift from deficiencies to firm quality control standards

v Create an anti-fraud center l Participant response based on

personal/organizational experience

7. The PCAOB does not disclose the specific process by which it selects audits firms for inspection. What are some of the drivers the PCAOB uses to select a firm for review? Do you agree with the current approach? l Engagement selection methods

v Risk based selection methodology k Heightened risk of material

misstatement due to: b Challenging audit areas

Suggested Answers to Discussion Questions (continued)

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sb Risk characteristics of the

company b Accounting issues that make

the audit difficult k Review of only the most

challenging parts of the audit b Issues that require the

auditor to make difficult judgments or other kinds of challenges

v Random selection l Inspection Outlook in Coming Year

v Impact of COVID on financial reporting & auditing

v Industries experiencing disruptions due to COVID

v Impairment determinations v Going concern v Allowance determination on loan

losses v Critical audit matters v Auditor response to cyber threats

l Participant response based on personal/organizational experience

Suggested Answers to Discussion Questions (continued)

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1. Sarbanes Oxley envisions that the PCAOB would inspect:

a) auditors of all companies that are registered with the SEC

b) only auditors of all private companies

c) only auditors of U.S. based companies that are registered with the SEC

d) only auditors of U.S. based companies that are private

2. According to recent statistics the number of recent cases of significant financial fraud has been ____ and the number of defective audits ____.

a) low, high

b) high, high

c) high, low

d) low, low

3. PCAOB findings indicate that the percentage of inspections that lead to a restatement of the company's financial statements is ____ than the overall audit deficiency rate.

a) approximately the same as

b) higher

c) lower

d) the answer cannot be determined

4. According to Dan Goelzer, requiring public disclosure of the names of companies:

a) should be required because the deficiencies accurately represent the company being audited

b) should not be required as it would not lead to pressure to perform better

c) should not be required even though the sarbanes oxley act confidentiality provisions allow for it

d) should be required even if due process would delay the inspections

5. In the recent GE case, the allegations against the company:

a) required some changes to the company's disclosures

b) required a restatement of the financial statements

c) were ultimately substantiated

d) resulted in the arrest of the CEO

6. Since the passage of the Sarbanes Oxley Act:

a) there have been no restatements

b) there has been an increased number of sec enforcement actions

c) the number of restatements has increased

d) there has been a reduced number of sec enforcement actions

7. According to Dan Goelzer, the PCAOB should:

a) create an anti-fraud education center

b) not be allowed to attend meetings between the advisory groups to preserve the perception of its independence

c) be allowed to hold closed door meetings so that they can keep their inspection processes a secret

d) be more transparent with respect to its goals and objectives

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the reading for self-study that starts on page 3–11.

Objective Questions

3. Will the PCAOB Tighten the Leash?

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8. The PCAOB audit selection method:

a) is solely risk based

b) is solely random

c) can be either risk based or random

d) is unknown

9. According to the Markopolos report, GE's fraud related to:

a) failure to appropriately reserve for losses related to its long-term care insurance business

b) improper revenue recognition

c) overstatement of capital assets

d) improper capitalization of expenses

10. Per the Markopolos report, one of the indicators of fraud at GE was the company's:

a) high working capital

b) decreased revenues

c) increased depreciation expenses

d) low current ratio

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

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GENERAL ELECTRIC, A BIGGER FRAUD THAN ENRON

Source: https://fm.cnbc.com/applications/cnbc.com/resources/editorialfiles/2019/8/15/2019_08_15_GE_Whistleblower_Report.pdf Summary: GE’s $38 Billion in Accounting Fraud www.gefraud.com by Harry Markopolos, CFA®, CFE

Synopsis: This is my accounting fraud team’s ninth insurance fraud case in the past nine years and it’s the biggest, bigger than Enron and WorldCom combined. In fact, GE’s $38 Billion in accounting fraud amounts to over 40% of GE’s market capitalization, making it far more serious than either the Enron or WorldCom accounting frauds. Enron’s CEO, Jeff Skilling resigned on August 14, 2001, Enron was downgraded to junk status on November 28th and filed for bankruptcy protection on December 2nd. On March 11, 2002 WorldCom received document requests from the SEC related to its accounting and loans to officers; on April 30th CEO Bernie Ebbers resigns regarding his $400 million in personal loans from the company, then on June 25th CFO Scott Sullivan is fired

before WorldCom files Chapter 11 on July 21st. It’s been 17 years since WorldCom so we’re long overdue for something like GE. As you read our slide deck you’ll see that GE utilizes many of the same accounting tricks as Enron did, so much so that we’ve taken to calling this the “GEnron” case.

To prove GE’s fraud we went out and located the 8 largest Long-Term Care (LTC) insurance deals that GE is a counterparty to, accounting for approximately 95% or more of GE’s exposure. Either these 8 insurance companies filed false statutory financial statements with their regulators or GE’s financial statements are false. We’ll show you the losses from each reinsurance arrangement in both dollar losses and percentage losses and let you determine who is telling the truth.

We paid to use the National Association of Insurance Commissioners (NAIC) and AM Best Databases to access these 8 insurers’ statutory financial statements filed with the relevant state insurance commissions. What they revealed was GE was hiding massive loss ratios, the highest ever seen in the LTC insurance industry, along with

l In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Update

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exponentially increasing dollar losses being absorbed by GE. The GE Capital insurance unit with the largest losses is ERAC and that unit’s average policy-holders’ age is now 75. The losses in this unit led to GE’s unexpected late 2017/early 2018 $15 Billion reserve hit. Unfortunately, the fast approaching 5-year age group between 76-80 will see a 77% increase in LTC claims filed which will see GE’s losses increase several-fold. We expect to soon see loss ratios of 750% to 1,000% or more on some of GE’s reinsurance agreements. According to industry data, approximately 86% of GE’s LTC claims are ahead of them and the accompanying losses are growing at an exponential and un-survivable rate.

Of the $29 Billion in new LTC reserves that GE needs, $18.5 Billion requires cash immediately while the remaining $10.5 Billion is a non-cash GAAP charge which accounting rules require to be taken no later than 1QTR 2021. These impending losses will destroy GE’s balance sheet, debt ratios and likely also violate debt covenants. Unfortunately, GE has almost no cash, so they had to request special forbearance from the Kansas Insurance Department (KID) to be able to fund their January 2018 $15 Billion reserve increase over a 7-year time horizon, so the odds of them being able to fund $18.5 Billion in new cash reserves is doubtful. What’s even more doubtful is GE becoming cash flow positive in 2021 as management would have you believe.

GE’s cash situation is far worse than disclosed in their 2018 10-K, in fact once GE’s $9.1 Billion accounting fraud tied to its Baker-Hughes GE (BHGE) acquisition is accounted for, GE only had $495 Million in cash flow from operating activities in 2018 and it ended the year with MINUS $20 Billion in working capital. After we accounted for the $38 Billion in accounting fraud GE’s debt to equity ratio goes from the 3:1 ratio it reported at the end of the 2nd quarter 2019 to a woefully deficient 17:1. My team has spent the past 7 months analyzing GE’s accounting and we believe the $38 Billion in fraud we’ve come across is merely the tip of the iceberg.

To put it into perspective, $38 Billion in accounting fraud is over 40% of GE’s

market capitalization and we know we only found a portion of it. If you love analyzing accounting fraud as much as we do, we’re sure you’ll find our slide deck a gripping read. ii Awareness:

I first became aware of GE’s suspect accounting attending educational program luncheons at the CFA® Society of Boston in the late 90’s. Chief investment officers, portfolio managers, analysts, and directors of research would all comment on how they believed GE’s earnings numbers couldn’t be true because they always met or beat consensus earnings estimates every quarter, year after year, no matter what the economy was doing. The question around the lunch table was always, “as an investment manager charged with beating the S&P 500, how much GE stock should you put into your portfolios?” When GE had a 3% weight in the S&P 500, if you only had a 1% allocation to GE, your portfolio was effectively short GE by a 2% portfolio weight. Most agreed that the proper thing to do was to be neutral on GE and invest a 3% benchmark weight of your portfolio in GE shares so that it would neither hurt nor help your performance.

GE Is Hiding $29 Billion in Long-Term Care Losses:

There are three key risks to GE’s survival. First, a stiff recession after ten years of domestic economic growth, will see that the next chapter in GE’s history is Chapter 11. Second, in 2021 there isn’t going to be any positive cash flow, which is the fairy tale that GE’s new management team is pitching because an accounting rule change for insurance liabilities and significant under-reserving is going to cause GE to take $29 Billion in additional reserve hits for its Long-Term Care (LTC) liabilities. Third, assuming GE can avoid a recession and somehow borrow enough to fund its LTC liabilities, it will next face repaying its $107 Billion in debt and also covering its $27 Billion in pension liabilities. How is GE, a company that has almost no cash and which earned a total of only $14.9 Billion over the last seven years, going to out-earn over $160 Billion in liabilities with the operating

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business units it hasn’t already sold to stay afloat?

As you go through our presentation you’ll see that our “edge” was having two members of my team with extensive insurance fraud expertise. They own a forensic accounting and consulting firm in Baltimore that specializes in this field.

The GE LTC story is very similar to AIG’s Financial Products Corporation (AIGFP) and how that ill-fated unit destroyed AIG’s share price and resulted in a $189 Billion government bailout to keep AIG alive. For many years AIGFP sold credit default swaps, took the premiums as “earnings” and never set aside proper reserves until the 2007-2009 Global Financial Crises revealed that the underlying securities AIGFP was guaranteeing were anything but the solid credits AIG thought they were. AIG’s stock price enjoyed those “earnings” for many years until the risks became apparent too late for AIG to survive without government assistance.

GE’s LTC reinsurance units are part of GE Capital (GEC), and GEC was very happy to imprudently account for LTC insurance premiums as “earnings” in the 1980’s, 1990’s and 2000’s while policy-holders were still young and weren’t filing claims. GE continuously failed to fund adequate reserves to offset its LTC liabilities, allowing itself to book billions in “earnings” over a period of decades and pay dividends to the holding company and then to shareholders.

We include a 2018 LTC industry age chart in our presentation showing at what ages LTC claims are filed. Industry data shows that 86.2% of the GE-ERAC’s claims are ahead of them so, if less than 14% of these claims have already led to a $15 Billion reserve hit, simple math tells you what the other 86% will do to GE’s balance sheet. GE’s LTC losses will continue rising at an exponential rate until it either files for bankruptcy protection or finds some way to out-earn its LTC liabilities. You’ll note that GE’s 7 March 2019 Teach-In failed to show you any of the industry comparative data that we’ve included in our slide deck.

When you see the data we’re providing that compares GE’s LTC loss ratios to the rest of the industry’s, you’ll know why they’re hiding their true financial picture from you.

Insurance companies keep GAAP books if they’re public companies, but State Insurance Departments also require them to file Statutory Financial Statements using a completely different set of statutory accounting rules, which we’ll call SAP going forward. These are longer, more complex filings than the 10-K’s that analysts use and it takes special training to know what you’re looking for. But once you know how, it’s easy to model the differences between GAAP and SAP accounting. Simply accessing and analyzing the SAP filings from the Long-Term Care (LTC) insurers who were reinsuring with GE-ERAC showed us how much GE was losing each year. What we saw were exponentially growing losses that are going to bleed GE of additional cash such that GE is unlikely to become cash-flow positive in 2021 and beyond.

GE twice went out of its way to intimidate analysts on pages 5 and 12 of their 7 March 2019 insurance “Teach-In” where they blow smoke by saying, “we are dependent on accurate and timely reporting from over 200 ceding companies covered by more than 1,000 reinsurance treaties.” While these statements are true, they were also deceiving because GE was including the life insurance, long-term disability and structured settlements portions of their insurance business to confuse and intimidate analysts from looking into their LTC Statutory Filings. Our analysis of GE’s seven largest iii reinsurance deals accounts for approximately 95%, maybe a tad more, of GE’s total LTC reinsurance liabilities.

We also analyzed GE’s own reinsurance with failing reinsurer LifeCare. Only 8 of these 200 ceding companies matter for LTC purposes and they account for $29 Billion in losses that GE still hasn’t acknowledged or reserved for. If GE truly wanted to provide investors with transparency they could have easily have

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shown you these 8 reinsurance deals and the steadily growing losses for each, but they kept those hidden. Rest assured, our Whistleblower Report details each reinsurance deal in Appendix I where each deal’s P&L is presented year by year, from 2013 through 2018, so that you can see those exponentially rising losses that GE doesn’t want you to know about.

We paid to use the National Association of Insurance Commissioners (NAIC) and the AM Best databases, from which we obtained the SAP filings for the vast majority of LTC insurance carriers that GE is reinsuring. The three relevant forms, with all of the information needed to determine that GE is committing accounting fraud, are found in Forms 1 & 2 and Exhibit 6. We detail how we used each form, why, and provide the footnotes so that you can duplicate our work and see for yourself how GE is pulling the wool over investors’ eyes. The eight carriers mentioned in the previous paragraph reported all of the LTC premiums taken in, policy claims paid out each year, along with their loss ratios and how the losses were apportioned between themselves and GE. That was all it took to figure out GE’s scheme.

GE was able to hide its LTC liabilities for a long, long time because its actuaries are about as independent as KPMG, GE’s auditor for the past 110 years, and the ratings agencies. All are getting paid by GE, so of course they’ll never question GE’s LTC reserves. That GE had to add $15B to LTC reserves, in late 2017/early 2018, which shocked GE’s longsuffering investors, shows how independent, competent and credible their external actuaries and auditors are.

We calculated GE should have taken a reserve hit as early as 2012, and certainly no later than 2015, but they waited until new management came in and booked what little reserve they could afford in late 2017/early 2018, a $15 Billion commitment that they had to request a special exemption from the Kansas Insurance Department (KID) to spread over a 7-year period because, plainly put, GE isn’t liquid right now and likely

won’t survive long enough to make their last few years of reserve payments anyway.

GE no longer controls its destiny nor its cash flows, KID does, and that state’s insurance commission will determine how much forbearance it receives when it comes to:

1) adding reserves,

2) dividend increases and

3) share buybacks.

GE’s $15 Billion LTC reserve hit was a nasty market surprise and it’s about to get $29 Billion worse. Read our analysis and then look at the transcripts from GE’s 7 March 2019 “Insurance Teach-In” and ask yourself 3 questions: 1) who’s being transparent – them or us? 2) who’s showing you GE’s reinsurance losses by insurance carrier by year, by dollar amount – them or us? and 3) whose accounting do you trust more – theirs or ours?

When you benchmark GE to a responsible insurance carrier using going concern accounting such as Prudential (PRU), GE needs $18.5 Billion in additional reserves in order to be able to pay claims. We compare GE’s LTC policies to Prudential and Unum, two insurers with similar pre-mid-2000’s vintage LTC policies, but whose policies have much lower risk characteristics than GE’s. Prudential’s 2018 loss ratio on similar policies was 185% and they’re reserving $113,455 per policy while GE’s loss ratios are several times higher and they’re only reserving $79,000 per policy. Just to match Prudential’s level of reserves would require an immediate $9.5 Billion increase in reserves.

Unfortunately for GE, the LTC policies they’re reinsuring have much worse risk characteristics than PRU’s and even $113,455 in reserves per policy totaling $9.5 Billion, would not be nearly enough. Here are the comparisons between the two:

1. GE’s Premiums Per In-Force Life are only $1,133 vs. PRU’s $2,723.

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2. GE’s Average Attained Age is 75 vs. PRU’s 68.

3. GE’s % of Policies not paying premiums is 26% vs. PRU’s 2%.

4. GE provides Lifetime Benefits on 70% of its policies vs. PRU’s 24%.

5. GE has no ability to raise premiums because it is only a reinsurer while PRU can and is able to file its own requests for rate increases with state departments of insurance.

Risk Factor # 1, GE is taking in only 41.6% of the premium dollars per policy ($1,133/$2,723). The present value of GE’s $1,590 premium shortfall ($2,723-$1,133) per policy vs PRU adds another $3.6 Billion in additional required reserves. Risk Factors # 2 – # 5 add another $5.4 Billion in new required reserves. GE’s benefits being paid out are much iv higher since it’s on the hook for lifetime benefits on 70% of its policies and its insureds are 7 years older than PRU’s and far more likely to be filing claims in the very near term. Only 74% of GE’s policies are still paying premiums vs 98% of PRU’s. 7% of GE’s LTC policies aren’t paying premiums because those insureds have filed claims and are receiving policy benefits. What GE’s “Teach -In” didn’t explain is why the other 19% of their LTC policies aren’t paying premiums. There’s a lot of additional critical information that GE is withholding from public view which we’ve included in our report, so we encourage you to read it.

If the $18.5 Billion in additional required reserves weren’t bad enough, GE also has a $10.5 Billion difference between its $30.4 Billion in statutory reserves and it’s $19.9 Billion of GAAP reserves. This $10.5 Billion difference will lead to a $10.5 Billion non-cash charge to earnings between now and the new insurance accounting rule change which goes into effect in 1QTR 2021. This will result in a devastating $10.5 Billion hit to GE’s already thin shareholder’s equity cushion and put its credit rating and debt covenants at grave risk. Responsible insurance

carriers such as PRU and Unum have already taken these charges against earnings in 2018 because they’re using going concern accounting while GE is playing for time, praying for miracles and trying to avoid bankruptcy. To summarize, GE is hiding $29 Billion in additional LTC losses from investors and our Whistleblower Report will walk you through the details using figures provided by eight of GE’s LTC counter-parties. Either those eight companies are lying and reporting false data or GE is.

We will end our LTC section with two key questions for GE’s management regarding LTC: 1) make your reinsurance agreements public and 2) provide your LTC actuarial assumptions.

GE Is Hiding $9.1 Billion in Baker Hughes Losses:

GE originally structured its disastrous 2017 investment in Baker Hughes, which combined the two company’s Oil and Gas businesses into a new entity, Baker Hughes, a GE Company (BHGE). GE held a 62.5% interest in BHGE and BHGE controlled the business. GE accounted for its holdings in BHGE as a Non-Controlling Interest, which was entirely consistent with the substance of the transaction and the nature of GE’s investment in the newly formed entity.

In November 2018, that accounting treatment changed when GE announced its plans to exit its investment in BHGE, and sold 101.2 million BHGE shares via a secondary offering, which left it with a 50.4% ownership interest. GE booked a $2.2 Billion pre-tax loss from that sale. GE improperly continued to account for its shares in BHGE as a Non-Controlling Interest in 2018, despite the fact that the substance of GE’s BHGE’s holdings was now strictly an investment, a clear violation of FASB Accounting Standards Codification 810-10-25-38A “Recognition – Variable Interest Entities” and FASB SFAC No. 8, BC3.26’s “Substance over Form” Concept. However, if GE had treated it as an Investment, as accounting

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rules require, it would have incurred a $9.1 billion loss. Maintaining a 50.4% interest (non-controlling interest threshold) in BHGE is a sham transaction with no business purpose done solely so that GE can create the false impression that GE has a reason to keep $9.1 billion in losses off of its books in 2018. Why Didn’t GE Disclose Its Working Capital of Minus $20.3B and Its Current Ratio of .67?:

The same $52B of Baker Hughes assets and $22B of revenues are reported on both GE’s 2018 financial statements and BHGE’s where in reality, only one entity, BHGE actually controls these assets and cash flows. Backing out BHGE’s cash flow from operating activities (CFOA) reduces GE’s 2018 CFOA from $2.257B to a meager $495M.

GE’s 2018 year-ending working capital was minus $14.3B with BHGE and minus $20.3B without! Knowing this was critical information for investors, lenders, vendors, retirees, and regulators it was a willful omission on their part to not provide customary working capital reporting and disclosures in their 10-K. Do a word search on “working capital” and you will see GE spreads out its discussion of working capital over numerous pages of their 10-K and only discusses changes in working capital, but never gives you a true picture of how dire their financial position is. We provide you with our working capital schedules for GE both with and without BHGE on Slide 104.

We are saving GE’s worst for last, because this is the last chapter in our report, immediately ahead of Chapter 11. GE’s current ratio is a stunningly low .67 when you back out the Baker-Hughes numbers from GE’s year-end balance sheet. What’s impressive about GE’s accounting is they offer very little transparency in their financial statements, which meant we had to calculate GE’s current ratio for ourselves, which, of course, we did and you can see how we calculated it on Slide 105. A .67 current ratio is many things, but investment grade is not one of them. Do a word search for “current ratio” in GE’s 2018 10-K and ask yourself why it’s not there for GE’s industrial business? Our final three questions are for v KPMG, GE’s auditors

for the past 110 years dating back to 1909: 1) What did you know? 2) When did you know it? and 3) Where’s your “Going Concern Opinion?” How We Analyzed GE and Discovered the Fraud:

I won’t reveal every technique we used because every wannabe accounting fraudster out there is going to be reading this section closely looking at it as a “how not to get caught” primer. There’s no point in making them harder to catch than they already are.

It took several months of hard work using dozens of publicly available sources. We read 2002-2018’s Annual Reports and 10-K’s, while modeling lots of different performance metrics and accounting entries. Seeing GE change their numbers without earnings restatements was alarming enough. What was worse, GE would change its reporting formats every 2-4 years to prevent analysts from being able to make comparisons across time horizons! In other words, GE went out of its way to make it impossible to analyze the performance of their business units. Why would a company do that? We could only think of two reasons: 1) to conceal accounting fraud or 2) because they’re so incompetent they’re not capable of keeping proper books and records. I’m not sure which reason is worse because both are bad and each is a path to bankruptcy.

One technique used was what’s called Sherlock Holmes’ “dog that didn’t bark method” of looking at what didn’t appear on GE’s financial statement but should have. That “missing dog” was everything between top line revenue and profit margin, in other words all of the many expenses it takes to run a legitimate business. GE would post revenue numbers for its business units and then give you their profits with no expenses listed between the top and bottom lines.

Other companies competing with GE, or in the case of Safran, GE’s 50/50 joint-venture partner at jet engine manufacturer CFM, would report its expenses, R&D costs, tax credits, etc., while GE, for the same joint-venture would only report the top and bottom lines. What was most interesting here was that Safran acknowledged in their 2017 Registration Document (p. 50) that

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they were losing money on each LEAP engine produced and only hoped to cover their Cost of Goods Sold (COGS) by the end of the decade. So, if LEAP engines were over 51% of CFM’s jet engine sales in 2018, and they didn’t even cover the COGS on each engine sold, how did GE Aviation’s free cash flow go up so much in 2018? Two answers come to mind: 1) GE Aviation is using gain on sale accounting using some sort of mark-to-model basis and/or 2) GE is fabricating its numbers. Keep in mind that GE was caught doing both by the SEC in August 2009 and lightly punished, committing over $3.4 Billion in accounting fraud while GE’s long-suffering shareholders paid $50 Million in fines and management, KPMG, and the Audit Committee all got to keep their jobs. What lesson did GE’s management learn? If you guessed, accounting fraud leads to bigger bonuses and no one gets fired and no one goes to jail, well, that’s my guess too.

The analyst community fell for GE’s accounting tricks hook, line and sinker by always priding themselves in coming up with methods to allocate GE’s corporate overhead and expenses to the business units. The most common method analysts used was revenue-weighting corporate overhead and allocating those expenses in accordance to each business unit’s percentage of total revenue. I call that “chasing rabbits,” and when you do that, you’re playing into the accounting fraudsters’ hands. Anyone who’s hunted rabbits knows you can’t chase rabbits and expect to catch them, yet that’s what analysts are attempting when they’re allocating expenses and overhead to GE’s business units. Instead analysts should have been asking GE why it wasn’t allocating pension costs, corporate overhead and other expenses to its business units in an accurate and transparent manner.

One mantra I teach in my advanced forensic accounting seminars to Certified Fraud Examiners, Internal Auditors and Chartered Financial Analysts is, “Listen to what is said and then look at what they do. Where there’s a difference dig in, because that’s where the fraud is.” GE tells

investors it owns a portfolio of operating companies and that it will buy and sell companies in order to assure its continued growth. Now look at what they do, they don’t provide standalone financial statements listing each business units’ expenses such that investors or outsiders interested in buying GE’s businesses can properly value them. I believe this is a willful concealment to hide how poorly these units are really doing. It would be much easier to spin off units, sell units, and value units that kept stand-alone books and records, yet GE doesn’t do that.

On a revenue-weighted basis during the 7-year period from 2012-2018, GE’s industrial business units earned an average annual profit margin of 14.7%. But, GE on a consolidated basis only earned $14.93 Billion on $928.355 Billion of cumulative revenues over that same 7-year period for a 1.6% profit margin which is far below GE’s 5.5% weighted vi average cost of capital. Clearly something’s amiss in these numbers because they don’t pass the test of reasonableness. How can the industrial units be earning 14.7% while GE is only earning 1.6%? Sadly, the analyst community allowed GE to get away with not producing usable, transparent financial statements that might have prevented this fraud.

GE might have survived LTC if it had a competent CEO. Unfortunately, GE’s CEO was Jeff “Two-Jet” Immelt, an executive who excelled at overpaying for value-destroying purchases such as Alstom and Baker Hughes, just in time for cyclical downturns. Faced with stagnating to declining revenues, GE engaged in financial engineering, vaporizing $52.2 Billion in stock buybacks from 2012-2018, which was 3.5 times more than GE’s earnings of only $14.9 Billion over that same time period. GE also raised its dividend to unsustainably high levels, paying out $54 Billion, which was 3.6 times GE’s earnings, during that key seven-year period. That $106.2 Billion unwisely spent on financial engineering to keep the bonus train running could and should have been used to: 1) pay for losses to wind-down GE Capital; 2) fund GE’s new additional $29 Billion in required

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LTC reserves; and 3) eliminate GE’s $27 Billion pension shortfall. Sadly, that $106.2 Billion is gone forever and now GE is on the brink of insolvency. The majority of what’s left inside of GE Capital’s black box is very likely unsaleable unless GE is willing to pay billions to get someone to take these toxic liabilities off its hands.

Clues Missed by Investors and Analysts:

Unfortunately, most investors are not trained as Certified Fraud Examiners (CFE’s) and have no idea of what forensic accounting analysis entails. The biggest clue that this is an Enronesque accounting fraud were the $53.5 Billion in Negative Surprises in 2017 and 2018 which destroyed over $130 Billion in market capitalization. There were two dividend cuts totaling $8 Billion per year, $15 Billion added to LTC reserves, a $22 Billion goodwill writedown on Alstom, and an $8.5 Billion Long Term Service Agreement (LTSA) restatement of 2016 and 2017 earnings. When you see that many large dollar adjustments in such a short time frame that’s not house-cleaning, it’s a red flag that the prior years’ financial statements were false, internal controls are weak to non-existent, and there are a lot more cockroaches in the GE earnings’ kitchen that you haven’t seen yet. Our Whistleblower Report only details $38 Billion in accounting fraud, but we know we didn’t catch everything. Only GE’s accounting department knows where the rest of the skeletons are buried.

One other key clue was watching over ten years of media interviews of GE executives. What stands out, when asked what went wrong with all of these acquisitions, asset sales, negative earnings surprises, surprise write-downs and dividend cuts, senior leadership of this company repeats the same message, “we’re not here to discuss the past, we’re only going to discuss the future.” This is no surprise – from people who have something to hide.

Concluding Remarks:

All information contained within our Whistleblower Report was obtained from publicly available sources, most of which cost nothing to procure such as annual reports, Society of Actuary Reports, and news articles. The only paid data sources used were the National Association of Insurance Commissioners (NAIC) and the AM Best databases.

Each slide is extensively footnoted so that you can see what source document and page number each piece of information used comes from. This will allow you to duplicate our work and determine whether or not you agree with our forensic analysis. We have also provided a listing of all source documents used at the end of our presentation for your use. This is a Whistleblower Report not Investment Research. We are not making any investment recommendation nor are we offering investment advice.

I want to express my sympathy to the one million people who count on GE for either salaries, healthcare, or pensions. Make no mistake, GE’s current and past employees are the victims here as are GE’s lenders, vendors, and customers all of whom have to deal with the aftermath of an accounting fraud. The only winners are GE’s fat cat executives who enriched themselves with undeserved bonuses as they drove this once proud beacon of American business into the ground. I encourage you to hold them accountable.

Thank you very much for taking the time to read our Whistleblower Report, we hope you find it informative. Harry Markopolos, CFA®, CFE

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tSURRAN: In July 2002, Congress established the Public Company Accounting

Oversight Board, known as PCAOB, to oversee audits of public companies, and SEC-registered brokers and dealers, in an effort to protect investors and the public interest.

The PCAOB has four primary duties:

• Register public accounting firms that prepare audit reports for issuers, brokers and dealers;

• Establish or adopt auditing and related attestation, quality control, ethics, and independence standards;

• Inspect audits and quality control systems of registered firms; and

• Investigate and discipline registered public accounting firms and their associated persons for violations of specific laws, rules or professional standards.

Over the years, there have been several cases of significant financial reporting fraud, significant internal control deficiencies, and other audit failures, resulting in the loss of investor confidence, yet the number of defective audits that resulted in enforcement actions by the PCAOB has been very small. Is the profession failing? Is accountability lost?

MORIARTY: Dan Goelzer, was one of the founding members of the PCAOB and a retired partner of the law firm Baker McKenzie. He joins us this month and gives us some insights from his days on the board.

GOELZER: Initially I don't think the firms perhaps took the inspection program completely seriously. We've heard a lot that inspection findings reflected differences in professional judgment.

I think we're eventually able to overcome that, particularly by beginning to make the confidential parts of inspection reports public when we felt that firms weren't improving their quality control standards fast enough. But I think today the inspection programs really make a major difference in audit quality. We'll probably talk more about that as we go ahead.

The second thing I'd say is getting an international inspections program up and running. Sarbanes-Oxley envisions that the PCAOB would inspect auditors of all companies that are registered with the SEC. And obviously that includes many companies located outside the United States with audit firms based outside the United States. There was certainly a lot of resistance initially to the idea of the PCAOB sending its inspection staff into other countries where other regulators prevailed. And performing inspections of domestic firms through negotiations and discussion with other regulators were able to overcome that. And the international inspections program, I think today is a very important part of what the PCAOB does.

The third thing I'd cite was getting internal control auditing up and running. This is something that Sarbanes-Oxley required, really called for a whole new audit opinion, an opinion on the effectiveness of the company's internal control over financial reporting.

There were a lot of challenges in creating that audit particularly in a relatively short period of time over a couple of years. We promulgated the initial standard AS2 that went into effect. There were a lot of

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3. Will the PCAOB Tighten the Leash?

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t complaints from companies about the costs that were imposed on them and the amount of additional audit work that was performed. Congress became concerned, we were in the middle of a political firestorm. With some prodding from the SEC, we revised the auditing standard and created Auditing Standard No. 5. And I think that's worked quite well.

The PCAOB's inspections program focuses heavily now on internal control auditing. In fact, again, this we'll probably discuss later many of the deficiencies that have to do with the internal control audit. And I think the overall effect has been to really cause companies to strengthen their controls. I think that's made a major difference in the reliability of financial reporting.

MORIARTY: Speaking about critical audit deficiencies, Lynn Turner, former Chief Accountant of the SEC once said that "any other industry that had this level of failure would be out of business". Dan weighs in on this statement.

GOELZER: I certainly have heard Lynn say that. Maybe we ought to start out by talking about what those deficiency percentages mean. The PCAOB will describe in the public part of an inspection report, any situation it detects in its inspections where it feels that the audit firm didn't have sufficient appropriate evidence at the time that it issued its opinion to support the opinion, either over the financial statements with respect to the financial statements or with respect to the effectiveness of internal controls.

For the six global network firms, essentially the six largest accounting firms in 2019, and that's the last year for which they released inspection reports, 24% of inspected audits had deficiencies that were identified in part one of the PCAOB's inspection report.

For information, Deloitte had the lowest percentage of 10%. BDO had the highest percentage of 42%. For the six firms as a group, as I said, it averages out to 24%.

Those numbers, the aggregate percentages have been dropping somewhat over time. They were 27% the year before. So I would certainly agree that the number ought to be lower. I guess, ideally or theoretically it ought to be zero.

Certainly any deficiency that the PCAOB identifies and describes in part one of an inspection report is serious. But I think there are several reasons why that percentage isn't really evidence that the profession overall is failing or something that calls into question the effectiveness of the profession.

And first, just to go back to something I said already, it doesn't mean that the company's financial statements were materially misstated. I think when people hear discussion of audit failure rates, there may tend to be an assumption that, that means that the auditor missed the material misstatement in the company's financial statements. That's not what PCAOB inspection findings indicate. And again, we may talk about this later too, but in fact, the percentage of inspections that identify a material misstatement or that lead to a restatement of the company's financial reporting is much lower. It's probably somewhere around 3%. Again, any instance of that is, of course, serious and something that should be cause for concern and addressed, but it's a much lower rate than the overall inspection deficiency rate.

Second, the PCAOB largely looks at audits on a risk basis, although they're starting to bring in more random selection to their inspection

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t selections. So I guess the point is a PCAOB inspection report isn't looking at the entire practice or trying to present a picture of the overall audit practice, it's looking at what it believes to be the most difficult parts of the most difficult audits.

Naturally that's where you would expect to find the highest probability of deficiencies. I would assume if they selected engagements to inspect on a random basis so that they were doing a fair sample of the overall public company audit practice of a firm, the deficiency rates would be much lower.

I guess, I know the third thing I think people have to keep in mind is that the great majority of these deficiencies relate to the audit of internal control over financial reporting. I think something like 81% of all the deficiencies they cited in the 2019 reports had to do with ICFR reporting. And again, I don't want to suggest that that isn't serious or that it shouldn't be addressed and something firms and the public need to be concerned about. But again, I see it in terms of the impact on investors as a different level than material misstatements in the financial statement. So I think all those things maybe help to put that a little bit in perspective. I might add too.

I'm not sure that zero deficiencies is really a realistic goal. For one thing, well, I think the PCAOB would deny it. To some extent, I think they use the inspection process as a teaching tool for the firms.

There are areas where they're trying to improve or change audit practice. So the firms learn about those things through the inspection process and then they adjust their audit procedures. Also just thinking about what auditing is, business is very dynamic, business conditions are changing rapidly. It's a human effort with human beings making judgements about difficult issues. Things are going to occasionally go wrong. Again, that's not to condone them or suggest that there isn't room for improvement, but I just don't think it's fair to look at the overall deficiency percentages based on PCAOB inspection reports and see that the audit profession is failing.

MORIARTY: It is argued that the names of the companies whose audit workpapers were examined should be made public, which would add additional pressure on the financial managers and audit committees to improve their controls and safeguards. But why has such a level of transparency not been acted on?

GOELZER: I guess the argument is often phrased as that the PCAOB should disclose the names of the companies that were inspected when there's a deficiency in the audit. And so the audit is described in the inspection report. And I guess the first thing I'd say is I think the people that make that argument, I think maybe are operating on a premise that isn't correct.

I don't think that disclosure would really add pressure to financial managers or audit committees to do a better job, because remember what the inspection is looking at isn't the company's financial report, it's looking at how the audit was performed. Audit committees and financial managers and CFOs don't control the audit procedures.

Again, as I've already said, the vast majority of inspection findings don't suggest that there was a material error in the financial statements that wasn't detected or a material weakness in the company's controls.

So the deficiency doesn't really say anything about the company itself. With that background or I guess to answer your question more directly, when the board decided in the early days that the names of inspected

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t companies shouldn't be included in the inspection report, it was really approached more as a legal question than a policy question.

Our legal staff advised us of the confidentiality provisions, the Sarbanes-Oxley Act didn't permit us to disclose the names of the inspected companies.

As a lawyer, I always prefer it when clients follow their lawyer's advice. In our case, the board took the advice of it's counsel and didn't disclose that information. A lot has been written about this subsequently. I appreciate that, perhaps not all lawyers agree with that interpretation of the Sarbanes-Oxley Act, but again, we approached it more as a legal question than as a policy question. I will say that even from a policy standpoint, I don't think it's a simple question.

Something else we were concerned about was that if the company was named, it was likely to give the impression, that there's something wrong with the company or the company's reporting. And if the PCAOB is going to make public statements that could be interpreted that way, due process might require that the company get to participate in the inspection process and defend itself. And as it is now, there's back and forth between the PCAOB inspection staff and the audit firm. And the audit firm tries, if they wish, to explain why they don't feel there should be a deficiency found in their audit.

If the company also had to get involved in that process, I think it would really bog down inspections and make it harder for them to accomplish their underlying purpose, which is to improve the work of the audit firm. So I'm all in favor of transparency. I can see the argument better in those few cases where the PCAOB does identify something that leads to a restatement on the company's financial statements, but it's not as simple of an issue as it's sometimes made out to be. And I think probably the system we have now is the most workable one.

SURRAN: In 2019, Harry Markopolos, Bernie Madoff's whistleblower, released a report on General Electric ("GE") alleging $38 billion in accounting fraud that was even bigger than Enron and WorldCom combined. He argued that GE was hiding $29 billion in long-term care losses, and $9.1 billion in Baker Hughes losses, a GE Company where GE held 62.5% interest and controlled the business.

Since 2016, several large dollar adjustments were noted where, according to Mr. Markopolos, such adjustments in a "short time frame, is not housecleaning, it's a red flag that the prior years' financial statements were false, internal controls are weak to non-existent, and that there are a lot more cockroaches in the GE earnings' kitchen that you haven't seen yet."

At the end of 2020, GE agreed to pay a $200 million penalty to settle federal claims without admitting or denying the SEC's allegations, and the settlement order did not allege GE violated U.S accounting rules or anti-fraud laws.

MORIARTY: GE's outside auditors were issuing clean opinions for years and the PCAOB audits did not uncover the fraud, even though audits are risk-based. How did the PCAOB miss it and shouldn't there have been subsequent SEC enforcement actions against the company? Isn't this a sign that the profession is failing?

GOELZER: In that particular case, at least, I think it turns out that the charges weren't really substantiated. There were some disclosures problems at GE, but

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t they didn't relate to the financial statements and they didn't end up restating their financial statements.

More broadly, I guess it's an education point. But I think investors should have somewhat more confidence in financial reporting and how it's changed or improved since 2002, when the Sarbanes-Oxley Act was passed. I'm not sure there's a perfect measure of the incidence of financial reporting fraud, but I'd point out two things.

First, certainly restatements are tracked actively. Audit Analytics for one, does, I think an annual report of the number of restatements that companies that are filed with the SEC have filed and that's fallen sharply since the PCAOB came into existence. I think their latest report found that about 6% of public companies restated in 2019,which is the lowest percentage since they started tracking restatements in 2006.

Now, there may be other factors involved in why restatements are less frequent and restatements and financial frauds aren't the same thing, but still to me, it's a sign that the quality of financial reporting is improving.

Another sign is to look at the financial reporting cases that the SEC brings. They issue a report every year on their enforcement activity.

In 2019, again, the last year that we have, they brought 108 enforcement actions that they classified as issuer reporting or auditing and accounting cases.

In contrast in 2002, the year Sarbanes actually passed. They brought 199 such cases, almost twice as many. So I think there's reason to think that financial reporting is improving and the incidence of financial reporting fraud is decreasing, certainly not increasing.

We hear it often that it isn't the objective of an audit to uncover fraud. And I guess that's true in a sense, although I'm not sure I want to sign on 100% with that statement.

It's certainly true that a properly executed audit won't necessarily uncover every conceivable fraud that may have been committed, but in general, I think investors expect rightly that an audit is going to uncover fraud that produces a material misstatement in the financial statements.

Audits are supposed to be planned and executed taking into account what's the risk of material misstatement? How might a material misstatement occur? And how do we conduct our audit to look at those possibilities and make sure that they don't exist?

So I guess we often hear there's an expectation gap. And I think it's true that to some extent, the public expects more from auditors than they're really capable of producing, unless you conducted a forensic audit, which would be fantastically expensive. But in general, I think auditing should and does serve to detect or serve as a deterrent to fraud.

Now, whether the PCAOB inspection program should uncover financial reporting fraud is a separate question. As we've touched on a little they have at least in part a risk-based programs that they try to look at the most challenging audits and the most challenging parts of those audits.

But I guess at the end of the day, they don't have a way of predicting or detecting undisclosed frauds any more than other people in the market have a way of detecting undisclosed frauds. So it's certainly possible that they don't inspect cases that later turn out to be financial reporting frauds. I'm not aware of situations where they did perform an inspection, gave a clean opinion or did locate a deficiency and it was later found that the

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t company's financial statements involve significant fraud. Those cases may exist, but I don't think any one has ever been publicized.

MORIARTY: Dan Goelzer gives us his views on additional safeguards, inspection tools and techniques PCAOB needs to add to its toolbox to ensure greater trust by the public. And what more should they do to protect investors and the public interest?

GOELZER: I'd start out with something that's maybe a little different than what you're actually asking. I think the PCAOB needs to be a bit more transparent with the public about its policy goals, what it does and inspections, it's standard setting objectives, and maybe a little more open to hearing from investors and also from potential critics of the PCAOB.

Before 2018, the board had two advisory groups, the standing advisory group and the investor advisor group and it held public meetings with those several times a year.

They provided important feedback to the board. Those groups haven't met in the last couple of years.

And I think that's been a mistake on the PCAOB's part. I think the kinds of issues that we're talking about here should be discussed in public and the board should be a participant in those discussions and should be able to present its side of the case. And I think that would give investors more confidence and more understanding on what the PCAOB is doing. So I hope that's going to change. The board hasn't held as many public meetings in the last few years of the board itself, hasn't held as many public round tables as it has in the past. And I think there's more work to be done in that area to build up public confidence.

I guess the second thing I mentioned, I won't repeat it all, but I do think that Congress should unshackle its enforcement program by making the proceedings public. I think that would help with public confidence.

Third they've taken some steps to improve the inspection reports, but I think more can be done in that regard, also.

It's very difficult, I think for a reader of an inspection report to get a sense of how serious or how fundamental a particular audit deficiency described in the public part of a PCAOB inspection report is. And it wouldn't necessarily be easy.

I think maybe the PCAOB ought to try to see if it could come up with audit quality indicators or some other measures of how well or not so well a firm is performing other than just numbers of deficiencies in part one of an inspection report. I think that might help to put all of this in better perspective.

I think they have said, and I think it's a good idea, that they're somewhat shifting their emphasis from deficiencies in particular engagements to firm quality control standards. And how the firm anticipates audit challenges and deals with them, they've put out a Concept Release to modernize their quality control standards for auditing firms. And I think that's all very important.

Something else that was discussed several years ago, is whether the PCAOB should create a fraud or maybe it'd be better to call it an anti-fraud center that would go back and do a forensic analysis of major financial reporting and auditing failures to try to understand why they happened and what lessons can be drawn from them just to prevent such

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t things in the future. That was a recommendation of an advisory committee that the Treasury convened, I guess way back at the end of the Bush years, but the board talked about implementing it, but they've never actually implemented it. And I think that might be something worth considering again. So those are a couple of suggestions.

MORIARTY: Dan discusses the risk drivers for choosing workpapers, the risk of audit deficiencies projected, criteria used and if the process has changed over time.

GOELZER: Well, of course, they don't disclose the specifics of how they select engagements. So we can only talk about that at a general level.

I think in their most recent inspection outlook, they say they use both risk-based and random methods of selection. They try to look at audits where they think there's a heightened risk of material misstatement challenging audit areas, risk characteristics of the company or its accounting issues that will make the audit difficult. When they select an engagement to review, they try to look at what they consider to be the most challenging parts of the audits. So they don't look at the entire audit, but wherever they think there are likely to be issues that require the auditor to make difficult judgments or other kinds of challenges.

And maybe to make that just slightly more concrete, when I was there, obviously during the financial crisis, there was a heavy emphasis on looking at companies in the financial services industry. Within those audits, we certainly looked at fair value determinations for illiquid financial instruments and how those were audited in the internal control audits. I guess both, well, then and now they've looked at how management review controls are performed, particularly any control that depends on a human being making some sort of a judgment or comparing a budget to an actual or something as a control. So those are the kinds of things that they focus on.

Obviously, the priorities change over time. They just issued their inspection outlook for the coming year. There's a long laundry list of things they say they're going to look at and I won't try to repeat them all. But they certainly know that COVID may well have had an impact on financial reporting and on auditing.

They say they're going to look at industries that may be experiencing disruptions because of COVID. They say transportation, entertainment, hospitality, manufacturing and certain segments of retail. That's a pretty broad group of industries, but apparently that's where their focus will be.

Then they talk about things like impairment determinations, going concern, determinations allowance for loan losses and those sorts of issues that may be driven by COVID.

They say they're going to look at how auditors are making their determinations about what are critical audit matters. They talk about looking at how auditors responded to cyber threats, particularly in companies that have experienced cyber breaches. So those are just a few examples of how they think about risk areas and selecting engagements.

I will say it's interesting too that they're moving more apparently to random rather than risk-based selections. And it will be interesting to see how that drives inspection findings. Again, I would expect the percentage of deficiencies to fall if you're looking at more and more engagements on

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a random basis rather than a risk basis. But yeah, I guess we'll find out over the next couple of years. There are pros and cons.

People tend to think of the inspection report as an overall report card on the firm's audit process. If that's going to be the case, then you've really got to look at engagements on a random basis. On the other hand, if you want to improve audit quality, it seems you really have to focus more on the hard things rather than on the routine or the mundane aspects of auditing and that calls for a risk-based approach. So you need to strike a balance.

MORIARTY: Dan gives us his insights as to the percentage of audit workpapers the PCAOB investigated that resulted in financial statement restatements or rescinding their clean opinion.

GOELZER: It's interesting. They've started publishing numbers like that, but just in the last few years, so we don't have a long track record of them.

They don't distinguish between restatements of the financial statements and withdrawal or modification of the opinion on internal controls. They just lump those two things together. But at least in the most recent inspection reports, which were for the 2019 inspections, the percentage of engagements they inspected where they found something that led to a restatement or a modification of the ICFR opinion, was about 3.5%.

I have in front of me here the numbers for the six largest firms. For several of them over zero. For Deloitte, Grant, it was zero. The highest one was PwC which had 6.6%. But whenever it happens, it isn't good, but these aren't high percentages relative to the overall deficiencies that they identified in their inspection reports.

In this context, maybe it's worth noting too that whenever the board finds the deficiency, when there's a deficiency described in part one, the audit firm would have to go back and do more audit work to correct the problems.

So if performing that additional work uncovered a material misstatement, then that would come out as a restatement in the vast number of cases, the audit firm goes back and performs the work that the PCAOB feels it didn't perform properly, in the first instance, doesn't discover any problem in the controls or financial statements and then things go on. There's no change in the audit opinion or on the financial reporting. But I wouldn't want to leave the impression that unless there's a restatement, nothing happens as a result of a PCAOB inspection finding.

MORIARTY: Dan Goelzer concludes our segment and leaves us with his final thoughts.

GOELZER: The PCAOB has accomplished a lot in the, whatever it is, 18, 19 years now that it's been operating. I think it's made a difference in audit quality and in the reliability of financial reporting. That isn't to say that everything's perfect or there isn't room for improvement. There certainly is a lot of room for improvement, but I think investors, for example, looking at the record over the last 19 years can take some comfort in the fact that there are fewer restatements, apparently fewer SEC enforcement actions involving financial reporting matters.

In general, when it's surveyed investor confidence in financial reporting, audit and financial reporting is relatively high. I think a lot of that is just attributable to the basic fact that auditors of public companies know now that when they do their work, there's not an insignificant possibility that a PCAOB inspector is going to come in later on and look at how that work was done. And I think that imposes a discipline that was missing in the system before and has had positive effects on auditing.

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Segment Four

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4. Whistleblower Program, Updates on Final

Regulations & Moon Tax!

Segment Overview:

Field of Study:

Recommended Accreditation:Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date:

Taxes

October 13, 2022

Work experience in tax planning or tax compliance, or an introductory course in taxation.

None

1 hour group live 2 hours self-study online

Update

“Whistleblower Office”

“Advance Child Tax Credit Eligibility Assistant”

“Internal Revenue Service Data Book, 2020”

“Electronic Tax Administration Advisory Committee: Annual Report to Congress”

See page 4–13.

See page 4–23.

32 minutes

The Whistleblower program, currently known as Internal Revenue Code (IRC) section 7623(a), allows the Secretary of the Treasury to pay such amounts as he or she deems necessary “for detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same.” In December of 2006, the Tax Relief and Health Care Act of 2006 made fundamental changes to the IRS awards program; one of the areas we hear about from time to time is recoveries for whistleblowers. Barbara Weltman, president of Big Ideas for Small Business explains the two avenues for recovery for whistleblowers and discusses an interesting case involving the Large Business and International (LBI) division of the IRS.

Learning Objectives:

Upon successful completion of this segment, you should be able to:

l Understand key changes made by the IRS in its Whistleblower Awards Program,

l Identify changes based on final regulations on federal disasters and application of mandatory 60-day extension,

l Identify tools available for Child Tax Credit eligibility, and l Understand the purpose of the IRS annual data book and the

report issued by the Electronic Tax Administration Advisory Committee.

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A. Key Changes in the Law

i. IRC section 7623(b) l Awards are no longer

discretionary

ii. Compensation 15% to 30% of collected proceeds

iii. Added whistleblower appeal rights

iv. Creation of Whistleblower Office

B. Avenues for Recovery

i. IRC section 7623(a) l Discretionary by the IRS

v Not the Tax Court

ii. IRC section 7623(b) l Mandatory award

v Upon collection of taxes l Tax Court has jurisdiction

C. Taxpayer First Act (excerpt)

"No employer or any officer or employee contractor, subcontractor, agent of such employer may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in terms and conditions of employment, including through an act in the ordinary course of such employee's duties in reprisal for any lawful act done by the employee."

I. Whistleblower Protections Update

A. Startup Costs

i. Deduction capped at $5,000

ii. Excess amortized over 15 years

B. Active Trade or Business

i. When revenue is generated

C. FICA Tax Credit Section 45(b)

i. FICA tax paid by employer on tips l Exceeding tax on wages

“When it comes to owing unpaid employment taxes, the common law employers are still on the hook, even if PEOs fail to make deposits.”

— Barbara Weltman

II. Cost Deductions and Tax Breaks

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A. Final Regulations

i. Mandatory rule does not supplant IRS discretionary rule

ii. May extend certain deadlines up to 1 year

iii. Details time sensitive acts covered by the Mandatory Extension Rule

B. Mandatory 60-Day Extension Applies to:

i. Time sensitive actions

ii. Contributions, rollovers and distributions

iii. Individuals with l Principal residence in a disaster

area l Principal place of business in a

disaster area l Records maintained in a disaster

areas

iv. Visitors killed or injured by the disaster

v. Joint filers – only one spouse needs to qualify

III. Further Consolidated Appropriations Act 2020

A. Option to Use Shorter Recovery Period

i. Property placed in service before January 1, 2018

ii. No ADS used before TCJA

B. Eligible Taxpayers Can:

i. Make the change retroactively

l Filing an accounting method change

OR l Filing an amended return

ii. Partnerships can file an administrative adjustment request

IV. Recovery Period For Residential Rental Property

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Outline (continued)

A. If Subject to BBA Audit Regime

i. File amended return instead of administrative adjustment request l Before October 15, 2021

ii. Applicable ONLY to initial partnership returns l Before June 17, 2021

B. Physical Presence Extension Relief

i. Extended through June 30, 2022

ii. Applicable if physical presence is required

iii. Use of l Electronic notarization l Plan representative

iv. Executed via l Live audio video technology l Witnessed by plan representative

C. Available IRS Tools

i. Child tax credit eligibility assistant

ii. Advanced child tax credit 2021 information page l Includes link to non-filer sign-up

tool

iii. Child tax credit update portal l View eligibility and payments l Unenroll from advance payments

V. Other IRS Relief and Extensions

A. Fiscal Year 2020 – The IRS:

i. Processed over 240 million tax returns and forms

ii. Collected close to $3.5 trillion in federal taxes

iii. Issued over $736 billion in refunds l Including $268.3 billion in EIPs

B. American Space Commerce Act

i. Extend a 100% bonus depreciation l From December 31, 2023 to

January 1, 2033 l Recovery period less than 20

years

VI. IRS in Review and Looking Forward

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l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Barbara Weltman explains the two avenues for recovery for whistleblowers and discusses an interesting case involving the Large Business and International (LBI) division of the IRS.”

l Show Segment 4. The transcript of this video starts on page 4–23 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 4–7 to 4–10. Additional objective questions are on pages 4–11 and 4–12.

l After the discussion, complete the evaluation form on page A–1.

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4. Whistleblower Program, Updates on Final Regulations & Moon Tax!

1. The Internal Revenue Code (IRC) allows the Secretary of the Treasury to pay out awards to whistleblowers. What are the main provisions of the IRC regarding whistleblower payments? Have you or your organization had any experience with this provision?

2. Many startup businesses incur significant startup and organizational costs. What actions or decisions can businesses make with respect to the tax treatment of startup and organizational costs? How has your organization treated such costs?

3. Many businesses handle payroll and HR functions through a professional employer organization (PEO). What are the tax issues associated with this practice? How does your organization handle the processing of these functions?

4. The Further Consolidated Appropriations Act 2020 and its recently issued final regulations created a mandatory deadline extension for taxpayers in federal disaster areas. What are the main provisions of the Act? How has the Act impacted you, your role, or your organization?

Discussion Questions

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

Group Live Option

For additional information concerning CPE requirements, see page vi of this guide.

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s5. The 2017 Tax Cuts and Jobs Act (TCJA)

changed the recovery period for residential rental property. What are the requirements for taxpayers to use the new recovery period? Have your clients or organization been impacted by the change?

6. The 2021 American Rescue Plan Act made changes in the child tax credit that will help many families get advance payments starting in the summer of 2021. What are the primary changes made to the law? Do you agree with the changes? Why or why not?

7. Each year the IRS releases a data book detailing its activities during the prior fiscal year. What are some of the major findings from the IRS’ activities? How have these findings impacted your organization, if at all?

Discussion Questions (continued)

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Suggested Answers to Discussion Questions4. Whistleblower Program, Updates on Final Regulations &

Moon Tax!1. The Internal Revenue Code (IRC)

allows the Secretary of the Treasury to pay out awards to whistleblowers. What are the main provisions of the IRC regarding whistleblower payments? Have you or your organization had any experience with this provision? l The Whistleblower program is

contained in IRC section 7623(a) v It allows the Secretary of the

Treasury to pay amounts deemed necessary for detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same.

l Major changes to IRC section 7623 include: v 1996

k Clauses were added b Allowing payments to be

made “for detecting underpayments of tax” as another basis for an informant award

b Making awards based on payments from proceeds collected, rather than appropriated funds

k The Treasury Department issued a regulation to implement the law

k The IRS has had a series of policies to define the scope and procedures for the program.

v 2006 k Awards are no longer

discretionary under IRC section 7623

k Compensation is 15% to 30% of collected proceeds

k Added whistleblower appeal rights

k Creation of a Whistleblower Office

l Two avenues for recovery for whistleblowers

v IRC section 7623(a) k Whistleblower awards are

discretionary by the IRS b Not reviewable by the Tax

Court v IRC section 7623(b)

k Mandatory award based on an IRS action for unpaid taxes b Upon collection of taxes

k Tax Court has jurisdiction to review and deny the award.

l Section 7623(b) does not have any mechanism for preserving the anonymity of a whistleblower v Whistleblowers must file a

motion under tax court rule 345(a) and present sufficient fact-specific basis for anonymity

l Participant response based on personal/organizational experience

2. Many startup businesses incur significant startup and organizational costs. What actions or decisions can businesses make with respect to the tax treatment of startup and organizational costs? How has your organization treated such costs? l Startup Costs

v Deductions capped at $5,000 v Reduced dollar for dollar for

excess startup costs exceeding $50,000

v Excess amortized over 15 years v The deduction applies to costs

that would otherwise be deductible as ordinary and necessary business expenses if the business had been operational

l Organizations may take a long time to be considered an active trade or business eligible to claim deductions v A business is considered in active

conduct of a trade or business when the company is positioned to begin generating revenue su

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Suggested Answers to Discussion Questions (continued)l Participant response based on

personal/organizational experience

3. Many businesses handle payroll and HR functions through a professional employer organization (PEO). What are the tax issues associated with this practice? How does your organization handle the processing of these functions? l A PEO handles payroll and HR

functions for client companies v The client companies retain the

right to hire and fire and fix the amount of wages and benefits k The PEO issues checks

v It is not always clear whether the PEO or the client company is entitled to the FICA tax credit on tips under IRC Section 45(b)

v The credit is equal to the amount of FICA tax paid by the employer on the portion of tips exceeding the amount treated as wages for purposes of satisfying the federal minimum wage requirements

l An appellate court recently ruled on a PEO claiming the FICA tax credit because it was the statutory employer v Under the agreement with client

companies, the PEO was referred to as a co-employer and assumed responsibility for the payment of wages

v The court acknowledged that the parties can agree to allocate responsibilities, which bolsters the PEO position

v The IRS issued a non-acquiescence in the case

l Participant response based on personal/organizational experience

4. The Further Consolidated Appropriations Act 2020 and its recently issued final regulations created a mandatory deadline extension for taxpayers in federal disaster areas. What are the main provisions of the Act? How has the Act impacted you, your role, or your organization? l The Further Consolidated

Appropriations Act 2020 created a

mandatory 60-day extension for certain tax deadlines for taxpayers in federal disaster areas.

l Final regulations for the Act were recently issued v Regulations generally apply to

federally declared disasters on or after December 19th 2019, the date the mandatory rule was enacted

v Mandatory rule does not supplant IRS discretionary rule

v May extend certain deadlines up to 1 year

v Details time-sensitive acts covered by the Mandatory Extension Rule.

l Mandatory 60-Day Extension Applies to: v Time-sensitive actions v Contributions, rollovers and

distributions v Individuals with

k Principal residence in a disaster area

k Principal place of business in a disaster area

k Records maintained in disaster areas

v Visitors killed or injured by the disaster

v Joint filers – only one spouse needs to qualify

l The 60-day extension period begins on the earliest incident date specified by FEMA, and it ends 60 days after the latest incident date

l Participant response based on personal/organizational experience

5. The 2017 Tax Cuts and Jobs Act (TCJA) changed the recovery period for residential rental property. What are the requirements for taxpayers to use the new recovery period? Have your clients or organization been impacted by the change? l The TCJA cut the recovery period for

residential rental property under the alternative depreciation system (ADS) su

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Suggested Answers to Discussion Questions (continued)

v From 40 years to 30 years for property placed in service before December 31, 2017

l The Consolidated Appropriations Act 2021 extended this break to property placed in service before January 1, 2018 v Residential rental property placed

in service before 2018 to change from 27 ½ years to 30 years

l Per IRS guidance, the shorter recovery period may be used by a taxpayer or anyone to whom the property was transferred if the property v Was placed in service before

January 1, 2018 and v Didn't have to use ADS before

TCJA l Eligible Taxpayers Can:

v Make the change retroactively by filing an k Accounting method change, or k Amended return

l Partnerships can file an administrative adjustment request

l Participant response based on personal/organizational experience

6. The 2021 American Rescue Plan Act made changes in the child tax credit that will help many families get advance payments starting in the summer of 2021. What are the primary changes made to the law? Do you agree with the changes? Why or why not? l American Rescue Plan Act

dramatically changed the child tax credit v The credit is fully refundable,

providing a higher amount for a child under age six, and

v IRS is required to send half of the amount to eligible taxpayers during the second half of 2021 k The IRS commenced these

payments on July 15th

l IRS also created tools to help individuals determine the amount of their credit and other aspects of the credit v Child tax credit eligibility

assistant v Advanced child tax credit 2021

information page k Includes link to non-filer sign-

up tool v Child tax credit update portal

k View eligibility and payments k Unenroll from advance

payments l Participant response based on

personal/organizational experience

7. Each year the IRS releases a data book detailing its activities during the prior fiscal year. What are some of the major findings from the IRS’ activities? How have these findings impacted your organization, if at all? l Fiscal Year 2020 – The IRS:

v Processed over 240 million tax returns and forms

v Collected close to $3.5 trillion in federal taxes

v Issued over $736 billion in refunds k Including $268.3 billion in

economic impact payments. l Audits of 2018 returns during the

government's 2020 fiscal year decreased significantly v Only 0.2% of individuals were

audited v Many audits were letters to

taxpayers informing them of math errors on their return

v No breakdown of the audits for Schedule C or Schedule F filers

v Only 0.1% of S corporations were audited

v Less than 0.5% of partnerships

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Suggested Answers to Discussion Questions (continued)l Only C corporations with balance

sheets of $10 million or more had significant audit activity

k C corporations with sizable balance sheets ($5 billion or more) had more significant audit activity

k Over 36% of C corporations with balance sheets greater than $20 billion were audited

l Participant response based on personal/organizational experience

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1. The changes made by the IRS to the Whistleblower Awards Program include:

a) the creation of a Whistleblower Office

b) making awards discretionary

c) payment to whistleblowers of up to 50% of the collected proceeds

d) the removal of the appeal process for whistleblowers

2. When it comes to the review of whistleblower awards, the Tax Court:

a) has jurisdiction to review all whistleblower awards

b) never has jurisdiction to review a whistleblower award

c) has jurisdiction to review certain whistleblower awards

d) can decide for itself the whistleblower awards it wants to review

3. Startup costs may be deducted of up to ______ and any excess _____.

a) $10,000; is amortized over 20 years

b) $5,000; amount is nondeductible

c) $5,000; is amortized over 15 years

d) $10,000; is amortized over the life of the business

4. Under the Further Consolidated Appropriations Act of 2020, taxpayers in federal disaster areas:

a) do NOT have to file returns in the year the disaster takes place

b) receive a mandatory 60-day extension for filing their returns

c) receive a mandatory 1-year extension for filing their returns

d) receive a mandatory 60-day extension for filing that overrides the IRS discretionary rules

5. Current rules require taxpayers seeking to make a change in the recovery period of residential property to:

a) file an accounting method change or an amended return

b) file an accounting method change

c) file an amended return

d) request an administrative adjustment request

6. The tools created by the IRS to help individuals determine the amount of Child Tax Credit to which they are entitled include all of the following EXCEPT:

a) the online Child Tax Credit Eligibility Assistant

b) the Advanced Child Tax Credit information page

c) the Child Tax Credit update portal

d) 24-hour live assistance from IRS personnel

7. If enacted, the American Space Commerce Act would extend _____ bonus depreciation for qualified domestic space launch property.

a) 10%

b) 27.5%

c) 40%

d) 100%

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the reading for self-study that starts on page 4–13.

4. Whistleblower Program, Updates on Final Regulations & Moon Tax!

Objective Questions

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8. The IRS whistleblower program caps the potential awards to whistleblowers at ____ of the proceeds collected.

a) 50%

b) 40%

c) 30%

d) there is no cap on the award amount a whistleblower could potentially collect

9. According to a recent survey conducted by the IRS, ______ of the taxpayers surveyed felt that cheating on their income taxes was not acceptable.

a) 100%

b) more than 85%

c) less than 10%

d) none

10. _____ of taxpayers who had an interaction with the IRS felt very or somewhat satisfied by their personal interactions with the IRS.

a) None

b) Less than 10%

c) More than 85%

d) 100%

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

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WHISTLEBLOWER OFFICE

Source: https://www.irs.gov/compliance/whistleblower-office

The IRS Whistleblower Office pays monetary awards to eligible individuals whose information is used by the IRS. The award percentage depends on several factors, but generally falls between 15 and 30 percent of the proceeds collected and attributable to the whistleblower's information. Awards can only be issued once a final determination can be made, and as such, award payments cannot be made until the taxpayer has exhausted all appeal rights and the taxpayer no longer can file a claim for refund or otherwise seek to recover the proceeds from the government.

l How to submit a whistleblower claim

l Claim eligibility

l What are the rules for getting an award?

l Annual Report to Congress

l More Information

l News from the Whistleblower Office

Submit a Whistleblower Claim

Individuals must use IRS Form 211, Application for Award for Original Information PDF, and ensure that it contains the following:

l A description of the alleged tax noncompliance, including a written narrative explaining the issue(s).

l Information to support the narrative, such as copies of books and records, ledger sheets, receipts, bank records, contracts, emails, and the location of assets.

l A description of documents or supporting evidence not in the whistleblower's possession or control, and their location.

l An explanation of how and when the whistleblower became aware of the information that forms the basis of the claim.

l In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Gov/Not-for-Profit Update

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l A complete description of the whistleblower's present or former relationship (if any) to the subject of the claim (for example, family member, acquaintance, client, employee, accountant, lawyer, bookkeeper, customer).

l The whistleblower's original signature on the declaration under penalty of perjury (a representative cannot sign Form 211 for the whistleblower) and the date of signature.

Individuals must then mail the Form 211 with supporting documentation to:

Internal Revenue Service Whistleblower Office – ICE 1973 N Rulon White Blvd. M/S 4110 Ogden, UT 84404

Claim eligibility Any individual, other than an individual described below, is eligible to file a claim for award and to receive an award under section 7623.

The Whistleblower Office will reject any claim for award filed by an ineligible whistleblower and will provide written notice of the rejection to the whistleblower. The following individuals are not eligible to file a claim for award or receive an award under section 7623:

l An individual who is an employee of the Department of Treasury or was an employee of the Department of Treasury when the individual obtained the information on which the claim is based;

l An individual who obtained the information through the individual's official duties as an employee of the Federal Government, or who is acting within the scope of those official duties as an employee of the Federal Government;

l An individual who is or was required by Federal law or regulation to disclose the information or who is or was precluded by Federal law or regulation from disclosing the information;

l An individual who obtained or had access to the information based on a contract with the federal government; or

l An individual who filed a claim for award based on information obtained from an ineligible whistleblower for the purpose of avoiding the rejection of the claim that would have resulted if the claim was filed by the ineligible whistleblower.

What are the rules for getting an award?

Internal Revenue Code (IRC) section 7623 provides for awards, in some cases mandatory, when the Internal Revenue Service (IRS) takes action based on a whistleblower's information. Claims for award that provide specific and credible information regarding tax underpayments or violations of internal revenue laws and that lead to proceeds collected may qualify for an award.

The Bipartisan Budget Act of 2018 defined proceeds as penalties, interest, additions to tax, and additional amounts provided under the internal revenue laws, as well as any proceeds arising from laws for which the IRS is authorized to administer, enforce, or investigate. This includes criminal fines, civil forfeitures, and violations of reporting requirements.

In general, the IRS will pay an award of at least 15 percent, but not more than 30 percent of the proceeds collected attributable to the information submitted by the whistleblower. The award percentage decreases for claims based on information from public sources or if the whistleblower planned and initiated the actions that led to the noncompliance. Awards will be processed as either a section 7623(a) or 7623(b) award.

To qualify for the IRC section 7623(b) award program, the information must:

l Relate to a tax noncompliance matter in which the tax, penalties, interest, additions to tax, and additional proceeds in dispute exceed $2,000,000; and

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l Relate to a taxpayer, and for individual taxpayers only, one whose gross income exceeds $200,000 for at least one of the tax years in question.

If a submission does not meet the criteria for IRC section 7623(b) consideration, the IRS will consider it for the discretionary program under IRC section 7623(a) of the Code.

Annual Report to Congress The Secretary of the Treasury reports to Congress each fiscal year on the use of Internal Revenue Code section 7623. The Whistleblower Office Report to Congress PDF for the fiscal year ending September 30, 2020 was released on December 29, 2020. Reports for prior years are also available.

More Information l Fiscal 2021 Sequester Notice from Whistleblower Office effective October 1, 2020 PDF: Impact on whistleblower payments.

l What Happens to a Claim for an Informant Award (Whistleblower) and Publication 5251 PDF

Procedures used and the criteria followed to identify and process informant cases.

l Whistleblower Law: A brief synopsis of what the new whistleblower law entails. This is the most significant change to the Service's approach to informant awards in 140 years.

l How Do You File a Whistleblower Award Claim and Publication 5251 PDF

Step by step procedures to follow to file an informant claim for award.

l Confidentiality and Disclosure for Whistleblowers

The rules governing confidentiality of informant information.

l IRC Section 7623(b) – The requirements of the new rules enacted in

IRC Section 7623(b), the Whistleblower Program.

l IRC Section 7623(a) – The requirement of the rules governing claims that do not meet the requirements of the provisions in IRC Section 7623(b).Form 211, Application for Award for Original Information PDF

l History of the Whistleblower Program: Historical information on the evolution of the concept of paying for leads from its inception up to the current law followed today.

l Reporting other information to the IRS

l Whistleblower Office At-a-Glance

News from the Whistleblower Office

l On July 1, 2019, the President signed the Taxpayer First Act into law. The new law includes several important provisions to help improve taxpayer service, ensure we are continuing to enforce the tax laws in a fair, impartial manner and ultimately support the continued success of our nation. The Act included law changes pertaining to the notification process to whistleblowers and made available protection for whistleblowers against retaliation.

l The Bipartisan Budget Act of 2018 adds a new Internal Revenue Code subsection – 7623(c) expanding the definition of proceeds for whistleblower awards. This applies to any open whistleblower claim.

l Deputy Commissioner for Services and Enforcement Memorandum on Debriefing dated August 4,2017 PDF

l IRS and TTB formalize process to support processing of claims made to the IRS Whistleblower Office – Read the press release to learn more about the formal agreement.

l 6103(n) Contract Guidance PDF – Whistleblower Office Director provides guidance to the IRS Operating Divisions on

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using 6103(n) contracts for Whistleblower claim submissions.

l Treasury issued final regulations to implement section 7623 effective on August 12, 2014 – The regulations generally apply to claims that are open as of the effective date. Section 301.7623-4, which contains the rules for determining the amount and payment of awards, applies to claims for award under section 7623(b) that are open as of August 12, 2014, and to information submitted after that date. The amount and payment of awards under 7623(a) for information received prior to August 12, 2014 will be paid under the rules described in the Internal Revenue Manual.

ADVANCE CHILD TAX CREDIT ELIGIBILITY ASSISTANT

Source: https://www.irs.gov/credits-deductions/advance-child-tax-credit-eligibility-assistant

Important changes to the Child Tax Credit will help many families get advance payments of the Child Tax Credit starting in the summer of 2021.

The IRS will pay half the total credit amount in advance monthly payments. You will claim the other half when you file your 2021 income tax return.

How It Works Use the assistant to:

l Check if you might be eligible for advance payments of the Child Tax Credit

What You Need Your tax return filed for 2020, or your 2019 tax return if you haven't filed for 2020.

If you don't have a copy of the return and know your filing status and number of qualifying children you claimed, you may be able to estimate the total income from

your tax return to answer all the questions. You can use the following to make estimates:

l Income statements such as W-2s and 1099s

l Amount of any expenses or adjustments to your income

You may still be able to benefit from the credit even if you aren’t working now or didn’t work in 2020.

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Source: https://www.irs.gov/pub/irs-pdf/p55b.pdf

Table of content, acknowledgements and Commissioner’s letter were omitted. Full publication can be found on the link above.

IRS Response to the COVID-19 Pandemic

The COVID-19 pandemic impacted nearly every facet of life during 2020. In response to the pandemic, IRS modified the way it conducted day-to-day activities, provided tax administration relief to millions of taxpayers, and served an essential role by implementing legislative programs that provided financial assistance. The impact of these activities is evident in almost every table included in the Fiscal Year 2020 Data Book. Highlights of these activities are described below. Protecting Employees and Providing Administrative Relief to Taxpayers The IRS’s top priority throughout the COVID-19 pandemic has been to protect the health and safety of taxpayers and the IRS workforce. This required extraordinary actions such as closing taxpayer assistance centers, submission processing centers, and offices nationwide following Federal, State and local executive Stay At Home orders. Nonetheless, core IRS functions continued, and the IRS delivered the filing season with e-filing still in place.

The IRS also accelerated the introduction of new technology that allowed thousands of employees to work from home. Still, some taxpayer interactions, especially those that rely on in-person or paper transactions, were delayed relative to previous years. The IRS also eased the burden on people facing tax issues during the COVID-19 pandemic by

extending the deadline for individuals to file and pay Federal income tax from April 15, 2020, to July 15, 2020, and by launching the People First Initiative on March 25, 2020. This initiative reduced the burden on people with tax uncertainties by easing payment guidelines, postponing compliance actions, and suspending most collection enforcement activities, such as new notices of lien or levy from April 15, 2020, to July 15, 2020. The IRS also discontinued field visits and in-person meetings to protect the safety and health of its employees and taxpayers. These decisions resulted in decreases in some examination activities relative to prior fiscal years, although in most cases these activities rebounded by the end of the calendar year.

Facilitating Financial Assistance to Millions of Taxpayers The pandemic presented our nation with challenges to which the IRS responded by quickly facilitating financial assistance to millions of Americans. The Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted in March 2020, created a refundable tax credit for individuals. The advance payment of this “2020 recovery rebate for individuals” is referred to as the first round of Economic Impact Payments (EIPs). The IRS issued 161.9 million EIPs in the first round: 122.5 million by direct deposit, 35.8 million by check, and nearly 3.6 million by debit card. The COVID-Related Tax Relief (CRTR) Act of 2020 was enacted in December, creating a second round of EIPs. The IRS issued 146.5 million second-round EIPs, including 112.8 million by direct deposit, 25.7 million by check, and 8 million by debit card. Combined, the IRS provided $412.9 billion in relief under these programs. For information on EIPs issued by State during Fiscal Year 2020, see Tables 7 and 8.

INTERNAL REVENUE SERVICE DATA BOOK, 2020

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The IRS also administered legislative provisions providing economic relief to businesses included in the Families First Coronavirus Response (FFCR) Act, which was extended by the CRTR, and the Tax Certainty and Disaster Tax Relief Act of 2020. Major provisions included: the Credit for Sick and Family Leave; the Employee Retention Credit, which was designed to encourage businesses to keep employees on their payroll; and a carryback for net operating losses, which allowed businesses to carry back net operating losses over 5 years. Serving Taxpayers With New Online Tools and Web Pages To help taxpayers claim COVID-19- related relief payments and tax credits, and stay informed about issues related to the pandemic, IRS released online tools and published new coronavirus pages on IRS.gov: • Get My Payment (GMP) enabled users to check the status of their EIPs or enter their bank account information to receive their payment electronically.

l Economic Impact Payment Information Center provided detailed information and answers to frequently asked questions.

l Coronavirus Tax Relief Web page consolidated news releases, statements, FAQs, guidance, partner materials, tax help, social media, and other resources.

l New Employer Tax Credits Web page provided a breakdown of which employers qualify for the new credits.

IRS also coordinated with Ta x Software industry partners, who built the Non-Filer: Enter Payment Info Here tool. This tool, which was hosted outside of IRS.gov and linked from the IRS.gov Website, allowed people who normally do not have a filing obligation to enter basic information so that they could receive their payment. The Non-Filer tool was available for the first set of EIP payments.

Protecting Employees While Ensuring Continued Operations The IRS quickly implemented new procedures to accommodate a rapidly expanding remote workforce as the IRS shifted operations online. About 20,000 laptops were supplied to employees, enabling them to work from home, ensuring continuity of critical services. To support the newly expanded teleworking employees, the IRS doubled its network capacity and increased network bandwidth to support maximum telework. By early June, the IRS hit a new peak of more than 56,000 remote employees working online simultaneously, which more than doubled the previous peak of about 25,000. To ensure the continuation of planned hiring and to protect new employees from any unnecessary in-person contacts, the IRS modified the onboarding process and conducted its first-ever virtual orientation on March 30, 2020, for more than 170 new hires, with additional new hires in the weeks and months that followed.

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Taxpayer Attitudes and Service Channel Preferences More than 2,000 taxpayers participated in the 2020 Comprehensive Taxpayer Attitude Survey (CTAS), providing important information about their points of view and service channel preferences. These taxpayer opinions, captured by CTAS through cell phone, landline phone, and online interviews, have informed IRS decision-making since 1999.

For more details from the 2020 Comprehensive Taxpayer Attitude Survey, go to https://www.irs.gov/pub/irs-pdf/p5296.pdf

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Source: https://www.irs.gov/pub/irs-pdf/p3415.pdf

HOW TO READ THIS REPORT ETAAC organized this report to provide brief critical insights through a high-level overview and deeper context in our full-length analysis. ETAAC organized this report into three sections that are consistent with our charter.

l Recommendations for Congressional consideration

l Recommendations for the IRS focused on Electronic filing

l Recommendations for the IRS focused on Security

For a high-level overview, review the

l Letter from the Chair and Vice-Chair

l Summary List of ETAAC 2021 Recommendations

To gain a deeper context for our 2021 recommendations, review the

l Current Environment for Electronic Tax Administration

l About the IRS Security Summit

l Detailed Support for ETAAC 2021 Recommendations

Finally, review the entire report to get the full context and analysis. We included a summary of our Committee's scope in Appendix A.

LETTER FROM THE CHAIR AND VICE-CHAIR

On behalf of the Electronic Tax Administration Advisory Committee, we are pleased to deliver its 2021 Annual Report to Congress.

Our Evaluation Process. As we contemplated our recommendations, we considered the IRS and taxpayers' environment during the last year. The COVID crisis has highlighted the challenges faced by the IRS in delivering its core mission of facilitating the voluntary tax compliance system by helping taxpayers understand and meet their tax responsibilities. 1 Congress continues to expand the IRS's mission beyond mere tax administration as they have now charged the IRS with distributing payments to taxpayers. On three separate occasions, the IRS sent Economic Impact Payments (EIP) to taxpayers. Congress has also directed the

ELECTRONIC TAX ADMINISTRATION ADVISORY COMMITTEE ANNUAL REPORT TO CONGRESS

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IRS to pay an Advance Child Tax Credit monthly. Rising to the challenge, the IRS will create an online portal to simplify the taxpayer's experience with the Advance Child Tax Credit. We have observed the IRS working admirably to serve Americans in need.

We also worked to ensure that our recommendations align with the Taxpayer First Act (TFA). Throughout this year's report, a common thread assesses how each recommendation would improve the taxpayer experience. In our view, improving taxpayer experience requires root cause analysis. In many cases, a poor taxpayer experience may occur well before any taxpayer interaction with the IRS.

We identified what we view as the most significant risks to effective electronic tax (and social program) administration by the IRS through our research.

1. Budget – Congress must establish flexible and predictable multi-year funding for the IRS. Without appropriate funding, the consistently high-quality taxpayer experience desired by Congress will be impossible to achieve.

2. Secure Access – Taxpayers and tax professionals must have greater digital access without a reduction in security.

3. Digital Taxpayer Experience – The IRS must continue to modernize its processes toward the goal of a paperless environment.

4. Transparency – As the IRS increases its digital interaction, taxpayers must have a high level of transparency in their tax returns and accounts.

5. Reducing the Tax Gap – Reporting requirements for information returns, particularly Forms 1099, must be tightened. The utilization of information returns is a proven method to reduce the tax gap.

6. Security – Identity Theft Tax Refund Fraud (IDTTRF) is an ongoing, everchanging threat. The IRS and Security Summit must continue to evolve their strategies, tactics, and policies to combat

this ever-changing threat combat successfully this ever-changing threat.

7. Staffing – Congress must provide authority and funding for needed staffing increases. The IRS must revamp its hiring and training protocols for a successful paperless environment. While staffing is not directly in ETAAC's scope, technological advancements alone will not achieve the desired taxpayer experience.

Each of our recommendations contains elements that we believe will improve one or more of these risk areas.

The IRS's Taxpayer First Act Report Offers an Optimistic and Ambitious Vision for Serving Taxpayers. The IRS issued the Taxpayer First Act Report (TFA Report) in January 2021. The IRS articulates its taxpayer-centered approach in the report: to "meet taxpayers where they are." This high standard aims to provide an individualized and seamless experience to each taxpayer. Consistently providing this high level of service is an aspirational yet achievable goal over the ten-year horizon outlined in the report. We commend the IRS's vision for the future. Achieving that vision requires a commitment from Congress to predictable multi-year funding. The integrated IRS operational structure envisioned by the IRS requires funding that can be allocated among priorities as they evolve during planning cycles that do not neatly coincide with the legislative timelines. Using the IRS's proposed cost accounting approach enhances accountability within the IRS and transparency to Congress and taxpayers. ETAAC's first recommendation discusses this further.

The TFA Report reflects the IRS's confidence in its ability to deliver a 21st-century experience. Still, it recognizes that critical parts of the experience will not happen when the backbone technology relies on outdated computer languages. We echo that concern. The foundation of a high-quality taxpayer experience is modern and

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effective technology and information systems.

Though secure and flexible technology is the foundation of an effective and efficient tax system, the people and processes are no less important. We commend the IRS's vision for new organizational and training structures that establish opportunities for greater engagement, collaboration, and accountability. The IRS's strategy focusing on taxpayerfirst service requires the integrated whole of the tax system – people, processes, and technology – to work together to deliver real-time, consistent information and assistance competently.

The IRS is diligently working to become a more taxpayer-centric organization. It has begun implementing the legislative changes required by TFA. We appreciate that the IRS has engaged with stakeholders to create feedback loops that make processes better for taxpayers. From ETAAC's vantage point, the IRS has been improving and shows an increasing ability to be nimble. The TFA Report demonstrates vision. In our view, IRS employees look forward to having tools that let them live by the "taxpayer first" motto. ETAAC commends Commissioner Rettig for quickly filling the Chief Taxpayer Experience Officer position and believes that his choice, Ken Corbin, the current Wage and Investment Commissioner, will further the IRS's progress to improve the taxpayer experience. Now, Congress should provide the ultimate tool for success: funding.

The pandemic-era taxpayer experience highlighted gaps in service resulting from chronic underfunding.

Undoubtedly, the taxpayer experience has been less than ideal for a significant number of taxpayers over the past year. COVID restrictions and weather events across the country shuttered or limited operations of processing campuses. Closed or reduced-force campuses mean that paper processing, whether tax returns or other correspondence, is delayed. The pandemic has taught us that eliminating paper processing, continuous process improvement, and digital solutions are requirements to better the taxpayer experience. The lack of transparency of the return's processing status was an issue, and

we discuss options for improvement in Recommendation #7. To its credit, the IRS has worked during the pandemic to accelerate access to digital tools, such as e-filing of Form 1040X and third-party authorizations. Much work remains under the IRS's Technology Modernization Plan. Again, a lack of resources – financial and human – is hindering progress.

Underserved taxpayer communities saw some of the most devastating tax-related challenges during the pandemic. The Volunteer Income Tax Assistance (VITA) program, which prepares tax returns for underserved taxpayers, shut down with the rest of the country in March 2020. Many VITA sites were not equipped to operate virtually, and those that did remain open struggled with increased cleaning costs and difficulty in retaining volunteers. Fortunately, it appears that some of these taxpayers were able to use the IRS's Free File services to file their 2019 returns. For 2021, the IRS provided VITA sites with funding for cleaning supplies and tools for operating virtual sites. Anecdotal information indicates that for the 2021 filing season, VITA sites have continued to operate at a lower capacity than before the pandemic. We discuss the impacts of the pandemic in "Current Environment for Tax Administration" and throughout this report.

For the full report please visit https://www.irs.gov/pub/irs-pdf/p3415.pdf

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SURRAN: The Whistleblower program goes back to March 1867, currently known as Internal Revenue Code (IRC) section 7623(a). It allows the Secretary of the Treasury to pay such amounts as he or she deems necessary “for detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same.”

Prior to 2006, the only substantive change since 1867 was in 1996, when a clause was added allowing payments to be made “for detecting underpayments of tax” as another basis for an informant award, and making the payments from proceeds collected, rather than appropriated funds. The Treasury Department issued a regulation to implement the law, and the IRS has had a series of policies to define the scope and procedures for the program.

In December of 2006, the Tax Relief and Health Care Act of 2006 made fundamental changes to the IRS awards program. The key change in the law was the addition of a new section 7623(b), under which awards are no longer discretionary. The new law says that the whistleblower shall receive 15% to 30% of the collected proceeds. The amendment added whistleblower appeal rights. The IRS was also required to create a Whistleblower Office reporting to the Commissioner to implement the law.

One of the areas we hear about from time to time is recoveries for whistleblowers.

Barbara Weltman, president of Big Ideas for Small Business explains the two avenues for recovery for whistleblowers and discusses an interesting case involving the Large Business and International (LBI) division of the IRS.

WELTMAN: The tax law provides two avenues for recovery for whistleblowers, so-called A and B.

Code Section 7623(a) authorizes awards, which are discretionary by the IRS. The tax court has no jurisdiction to review them.

Section 7623(b) creates a mandatory award where the IRS institutes an action based on whistleblower information and collects taxes on the information. The tax court does have jurisdiction to review a denial of a recovery here. Because whistleblowers are anonymous, the cases go by numbers, not names.

In one recent case, a whistleblower told someone at the LBI unit of the IRS about $500 million of income earned on money market accounts, and then submitted Form 211, application for original information. He did so under the B option, but his claim was denied. He asked the tax court to rule that the IRS should have paid his claim, but the court wouldn't do so. The IRS said the information did not lead to the collection of any tax, and the court agreed. The target in this case had been examined and continued to be under examination for various years and for various issues. But the information from the whistleblower wasn't what generated recovery by the IRS. So no whistleblower award.

Video Transcript

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t SURRAN: Barbara mentioned anonymity of the whistleblower. But is this always the case?

WELTMAN: Surprisingly Section 7623(b) does not have any mechanism for preserving the anonymity of a whistleblower. In fact, a whistleblower must file a motion under tax court rule 345(a) and present sufficient fact-specific basis for anonymity when the matter comes up.

This could happen if a whistleblower might be called upon to testify. One former whistleblower is urging Congress to create a presumption of anonymity in the existing statute. We'll monitor this.

SURRAN: Well, what about retaliation against a whistleblower?

WELTMAN: You may recall that the Taxpayer First Act, which became law in 2019, protects employees from retaliation when they become whistleblowers, and provides information about their employers to the IRS, they can't be subject to retaliation. The tax code says, and I quote,

"No employer or any officer or employee contractor, subcontractor, agent of such employer may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in terms and conditions of employment, including through an act in the ordinary course of such employee's duties in reprisal for any lawful act done by the employee." That's the end of the quote. And this includes whistleblower information to the IRS.

SURRAN: In this case, as Barbara discussed earlier, the whistleblower brought the information to someone at the Large Business and International (LBI) unit of the IRS. How does a whistleblower know if the information has been forwarded to the correct party, and whether it's been acted upon?

WELTMAN: There's been a lot of confusion about what happens once a whistleblower provides information. To remedy this, on June 1st, 2021, the IRS Whistleblower Office made some administrative changes. Procedural changes will help whistleblowers identify whether their information was assigned for consideration. We'll have to see whether these changes are sufficient.

Congress has recognized that the whistleblower program has been successful, bringing in over $6 billion in what would otherwise have been uncollected taxes, but the program could be better.

The IRS Whistleblower Improvement Act of 2021 was introduced as a bipartisan measure to strengthen the program and protect whistleblowers. The bill would provide for de novo review of appeals from IRS determinations heard in tax court. In other words, new evidence could be admitted in court. It would also include a presumption of anonymity, and it would require interest to be paid if the award wasn't made within a year.

SURRAN: And what about state level whistleblower laws? Are there any?

WELTMAN: The rules for whistleblowers at the state level vary by location. Maryland recently enacted a whistleblower law modeled after the one used by the IRS. A resident may provide information about tax fraud and receive an award under certain conditions. Check your state's laws about whistleblowers.

SURRAN: We're in a period of economic recovery when a lot of new businesses are starting up and sometimes it takes a while for businesses to actually commence. As startups play a leading role in the post-COVID phase, they

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t are struggling to obtain funding as cash flow dries out, while often still incurring significant startup and organizational costs. So what does this mean for business deductions?

Barbara Weltman gives us her insights as to the elections businesses have to make with respect to the treatment of startup and organizational costs, the types of deductions allowed and how to handle the excess amount once a cap is reached.

WELTMAN: Businesses may elect to deduct startup and organizational costs once they begin operations by claiming an allowable deduction. Otherwise the costs are capitalized. There are parallel deductions for startup costs for all types of businesses, as well as organizational expenses for partnerships and corporations.

Focusing on the startup costs, the deduction is capped at $5,000, but it's reduced dollar for dollar for excess startup costs exceeding $50,000. Any excess amount is amortized over 15 years, starting in the month in which an active trade or business begins.

The deduction applies to costs that would otherwise be deductible as ordinary and necessary business expenses if the business had been operational. This includes various investigatory costs such as market analysis.

SURRAN: But sometimes it takes years to get going. Owners may pay a lot of money for various business expenses. What then?

WELTMAN: An appellate court recently affirmed a tax court decision denying a deduction for ordinary and necessary business expenses, because the business was still in the startup phase years after the owner began his activities. The case involved an inventor who was developing a product based on his patents, but hadn't brought anything to market when he claimed deductions for salaries and various professional fees. The court noted that while he took significant steps to prepare for the business of selling his invention, he had not yet attempted to market or sell a product, made any sales, or even made a website public. He didn't have an active trade or business.

SURRAN: So when is a business considered to be active?

WELTMAN: Active conduct of a trade or business happens when a company is positioned to begin generating revenue. You can think of this as when a business opens its doors to customers. But a district court several years ago allowed a business to start depreciation, even though its retail stores hadn't opened to the public. The property was still considered to have been placed in service, because it had all the shelving and equipment in place and certificates of occupancy had been issued.

SURRAN: Today many businesses handle payroll and HR functions through a professional employer organization. How does this affect tax breaks and obligations?

WELTMAN: A professional employer organization, or PEO, handles payroll and HR functions for its client companies. The client companies retain the right to hire and fire and fix the amount of wages and benefits. The PEO issues checks and more. When it comes to tax breaks, it's not always clear which party, the PEO or client company, is entitled to them. Last year there was an appellate court case in which a PEO claimed the FICA tax credit on tips under Code Section 45(b).

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t The credit is equal to the amount of FICA tax paid by the employer on the portion of tips exceeding the amount treated as wages for purposes of satisfying the federal minimum wage requirements.

The court said, "Yes, it was entitled to them." The PEO in this case was the employer because it had control over the payments of wages. The PEO wasn't the common law employer because employees didn't perform services for it. But the PEO was the statutory employer. Under the agreement with client companies, the PEO was referred to as a co-employer and assumed responsibility for the payment of wages. The court acknowledged that the parties can agree to allocate responsibilities, which bolsters the PEO position.

SURRAN: Barbara discusses the IRS’s position after this decision.

WELTMAN: The IRS issued a nonacquiescence in this case. It did not give any explanation as to why in the action on the decision. However, we can look back to the IRS' arguments in the case. The service maintained that the client companies were the employers entitled to the tax credits, because the PEO was merely a conduit between the common law employers and their employees. It's interesting that the IRS has won on this argument. When it comes to owing unpaid employment taxes, the common law employers are still on the hook, even if PEOs fail to make deposits.

PEOs within the 11th Circuit can rely on the case, but those in other circuits that claim the tax credit for FICA on tips have to litigate.

SURRAN: The Further Consolidated Appropriations Act 2020, which was passed in December 2019, created a mandatory deadline extension for taxpayers in federal disasters. Now we have final regulations. Barbara Weltman further explains and runs through some of the key points in the final regulations.

WELTMAN: The Further Consolidated Appropriations Act 2020, which was passed in December 2019, created a mandatory 60-day extension for certain tax deadlines for taxpayers in federal disaster areas. Now we have final regulations. They generally apply to federally declared disasters on or after December 19th 2019, the date the mandatory rule was enacted. The final regulations are pretty much the same as proposed regulations issued this past January.

The big point in the final regulations is the fact that this mandatory rule does not supplant the IRS discretionary rule for extending deadlines for filing and certain other actions. The IRS may extend certain deadlines for up to one year. If the IRS chooses to use its discretion, then that overrides the mandatory 60-day period. For example, the IRS granted extensions to August 16th, 2021 for the victims of Louisiana storms that began on May 17th 2021, which is a month more than what these victims would have had under the mandatory rule.

The final regulations also detail which time sensitive acts are covered by the Mandatory Extension Rule. This is something that the tax code section added by CAA 2020 doesn't specify. The regs were needed to clarify this by saying they're the same as the acts for which the IRS discretion applies.

SURRAN: Barbara reviews the mandatory 60-day extension period and what it does apply to.

WELTMAN: The mandatory 60-day extension applies to time sensitive actions, which are filing returns, income employment, excise estate and gift tax, as well as paying estimated taxes.

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t It also includes making contributions and rollovers, removing excess contributions, and taking distributions from qualified retirement plans and IRAs. It doesn't apply to depositing employment taxes, although the IRS may and usually does abate penalties for late deposits for victims impacted by federal disasters.

The law is clear about who is subject to the mandatory extension period. It's any individual with a principal residence located in the disaster area, a taxpayer with a principal place of business, other than the business of being an employee, which is located in the disaster area, a relief worker, any taxpayer with records necessary to meet deadlines which are maintained in a disaster area, and anyone visiting the area who was killed or injured by the disaster. For joint filers, only one spouse needs to qualify.

SURRAN: So how is the 60-day period figured?

WELTMAN: The 60-day extension period begins on the earliest incident date specified by FEMA, and it ends 60 days after the latest incident date. For example, a hurricane whips into an area on September 15th with flooding through September 20th.

The FEMA declaration begins on September 15th, the 60-day extension period ends 60 days after, September 20th.

It's interesting that there's a case before the tax court where a taxpayer is arguing that the mandatory 60-day extension applies to the 30-day and 90-day filing deadlines for tax court petitions during the pandemic. You may recall there was a National Disaster declaration on January 20th 2020 for COVID-19. So does this mean there's automatically more time to file? She says yes. The IRS says no, because there was no specified incident date as required by the 60-day extension rule. There was only the general declaration. Let's see what the court says.

SURRAN: Another law change, first introduced in the Tax Cuts and Jobs Act and extended under the Consolidated Appropriations Act, 2021, concerns the recovery period for residential rental property. We now have guidance. What is the law change and what does the guidance say?

WELTMAN: The Tax Cuts and Jobs Act cut the recovery period for residential rental property under the alternative depreciation system, ADS, from 40 years to 30 years for property placed in service before December 31, 2017, for electing real property businesses.

This is for purposes of Section 163(j), limitation on interest. Then the Consolidated Appropriations Act 2021 extended this break to property placed in service before January 1, 2018, requiring residential rental property placed in service before 2018 to change from 27 and a half years to 30 years. So what difference does this make? IRS guidance explains this.

The shorter recovery period may be used by a taxpayer or anyone to whom the property was transferred if the property was placed in service before January 1, 2018 and the property didn't have to use ADS before TCJA.

SURRAN: This certainly seems confusing. What about those who have, or have not, just made the change?

WELTMAN: Eligible taxpayers can make the change retroactively by either filing an accounting method change or by filing an amended return, or for partnerships an administrative adjustment request.

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t A change in accounting results in a Section 481(a) Adjustment. However, those who already made the change using Rev. Proc. 2019-08, no biggie, that Rev. Proc. said there wasn't a change in accounting method.

SURRAN: There were so many changes for 2018, 2019 and 2020 that were retroactive. Normally partnerships must make changes using an administrative adjustment request, but the IRS has provided relief.

WELTMAN: The IRS says that partnerships subject to the BBA Audit Regime may choose to file an amended return instead of an administrative adjustment request or AAR.

The amended return along with the amended schedule K1s must be filed before October 15, 2021. This option only applies to partnerships that filed initial partnership returns before June 17th, 2021. Of course, they have to account for changes under CAA with respect to retroactive recovery and the ADS. The changes we already talked about.

SURRAN: One of the breaks that was put into place during COVID was the ability to get certain documents signed remotely, and now this relief has been extended.

WELTMAN: Last year the IRS provided temporary relief from the physical presence requirement for signing certain documents related to retirement plans. That relief was supposed to end on June 30th of this year. It's now been extended for another year through June 30, 2022.

This relief applies where there's a physical presence requirement for any participant election witnessed by a notary public. The participant may sign remotely using electronic notarization, or before a plan representative. The physical presence requirement is deemed satisfied for an electronic system that uses remote notarization if executed via live audio video technology that otherwise satisfies the requirements of participant elections. The same is true for an election witnessed by a plan representative. An example of these elections are spousal consent.

SURRAN: The American Rescue Plan Act from this March made changes in the child tax credit which will help many families get advance payments starting in the summer of 2021. The IRS will pay half the total credit amount in advance monthly payments. Taxpayers will claim the other half at the time they file their 2021 income tax return. The IRS website offers an eligibility assistant where by answering a set of questions, taxpayers can determine if they are eligible for advance payments of the Child Tax Credit. Barbara Weltman gives us further details.

WELTMAN: As I've mentioned before, the American Rescue Plan Act dramatically changed the child tax credit, making it fully refundable, providing a higher amount for a child under age six, and requiring the IRS to send half of the amount to eligible taxpayers during the second half of 2021. The IRS commenced these payments on July 15th. It also created tools to help individuals determine the amount of their credit and other aspects of the credit.

One online tool is the Child Tax Credit Eligibility Assistant. As the title implies, it's an interactive tool to enable someone to know if they qualify, even those who haven't yet filed either a 2019 or 2020 return.

There's also an advanced child tax credit 2021 page providing information on the credit, including a link to the non-filer sign-up tool.

A third tool is the Child Tax Credit Update Portal, which is a mobile friendly digital tool that allows taxpayers to view their eligibility and

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t payments, and also allow them to unenroll from advance payments. You probably won't be using these tools, but you may want to inform clients about them.

SURRAN: Each year the IRS releases a data book detailing its activities during the prior fiscal year, Barbara explains.

WELTMAN: The IRS releases a data book each year, highlighting its activities, numbers of returns processed, examinations, and more, during its fiscal year. We now have the 2020 data book covering IRS activities from October 1st, 2019 through September 30th, 2020.

This year's book includes the unprecedented challenges faced by the service during COVID-19 and its responses. To protect its workers it had to close many locations and even suspend telephone responses. To protect taxpayers it provided various forms of relief, extending the April 15th tax deadline to July 15th, and giving relief for audits, levies and such.

Nonetheless, in fiscal year 2020, the IRS processed more than 240 million tax returns and forms, and collected nearly $3.5 trillion in federal taxes.

The IRS issued more than $736 billion in refunds, including $268.3 billion in EIPs issued during the fiscal year, which were classified as refunds.

According to the 2020 data book, audits of 2018 returns during the government's 2020 fiscal year were down significantly. Only 0.2% of individuals were audited.

Many of the so-called audits were merely letters to taxpayers informing them of math errors on their return. There's no breakdown of the audits for Schedule C or Schedule F filers. For S corporations only 0.1%. And for partnerships, less than 0.05%. For C corporations, you have to get into the balance sheets of $10 million or more to see any significant audit activity. Yes, C corporations with sizable balance sheets, $5 billion and up, had more significant audit activity. Those with 20 billion or more, over 36% were audited.

SURRAN: The data book wasn't the only report of interest. Barbara discusses another report issued by the Electronic Tax Administration Advisory Committee.

WELTMAN: Electronic Tax Advisory Committee works closely with the Security Summit, a joint effort of the IRS, state tax administrators, and tax leaders in the private sector to fight tax-related identity theft and cyber-crime.

The committee is required to provide an annual report to Congress. This year's report contains recommendations for electronic filing and security, in particular, what can be done to prevent identity theft and refund fraud. Very interesting reading.

SURRAN: As the 2020-2021 U.S. Supreme Court term has come to an end, there have been some tax cases decided. Barbara runs through them, starting with a decision on the Affordable Care Act and where we stand.

WELTMAN: For the third time the U.S. Supreme Court has ruled on the Affordable Care Act. This time they kind of ducked the constitutionality question and decided the case on technical grounds that Texas, the other dozen states and the two individuals who brought the suit lacked standing. This means the court didn't have to listen to the arguments against EISA.

Just to remind you, Congress repealed the individual mandate a few years ago. So the plaintiffs here thought it undercut all of EISA. The court said

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t plaintiffs do not have standing to challenge Section 5000 AA's minimum essential coverage provision, because they have not shown a past or future injury, fairly traceable to the defendant's conduct enforcing the specific statutory provision they attack as unconstitutional.

The states claimed a direct injury resulting from a variety of increased administrative and related expenses by the minimum essential coverage provision. But the court noted that other provisions of EISA, not the minimum essential coverage provision, impose these requirements.

SURRAN: So what does this decision mean for us?

WELTMAN: The decision means that all of the provisions now in place under EISA are effective. For individuals this includes the premium tax credit, and the ability to obtain health coverage through a government marketplace. It also means that the additional Medicare taxes on earned income and net investment income for individuals with MIGA over threshold amounts continue to apply. For large employers it means having to meet the employer mandate to provide affordable minimum essential health coverage to full-time employees, or pay a penalty.

It also means certain filing requirements, Form 1095-C and more. Employers should be on the lookout for changes in premiums for 2022. Typically they start to be revealed late in the summer. This will help employers decide their course of action for the coming year.

SURRAN: Over the past several months Barbara had told us about various tax proposals, but there is another one that seems to come out of, as she calls it, space. And here is why.

WELTMAN: It's time for taxes to come to the new frontier, space. The American Space Commerce Act is a bipartisan bicameral measure related to space exploration.

If enacted, the measure would extend a 100% bonus depreciation for qualified domestic space launch property from December 31, 2023 until January 1, 2033 if the recovery period is less than 20 years.

It defines qualified space launch property as a space transportation vehicle or payload launched from the U.S., or other property or equipment placed in service to facilitate a space launch from the U.S.

This only considers a spacecraft launched from the U.S. if the spacecraft is substantially manufactured in the U.S., or launched from an aircraft on a flight originating from the U.S. The measure is necessary now with so much private investment, SpaceX and such, going into space exploration and partnership with NASA. China is also focused on space exploration. So encouraging U.S. investment is in our national interest.

SURRAN: So are we going to hear more about taxes and … space?

WELTMAN: We are sure to hear more about taxes and space. Some tax professionals are speculating on a moon tax. This is no joke. It's where we're headed. A moon tax might take the form of an excise tax on the use of the lunar surface. Another option is to create an income tax based on what's produced on the moon. Whatever the type of tax, the key is, who would administer it, and who would benefit? An international agreement of some sort likely would be required to nail this down. It could sort of resemble the model for the World Health Organization, but who knows?

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Segment Five – Government / Not-for-Profit

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New Guidance

Segment Overview:

Field of Study:

Recommended Accreditation:

Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date:

Accounting - Governmental

October 13, 2022

Work experience in financial reporting or accounting, or an introductory course in accounting.

None

1 hour group live 2 hours self-study online

Update

“Proposed Statement of the Governmental Accounting Standards Board Accounting Changes and Error Corrections an amendment of GASB Statement No. 62”

See page 5–12.

See page 5–20.

35 minutes

The GASB has issued a number of new Exposure Drafts in 2021. They cover topics such as changes to the methods of accounting for accounting principles, changes in accounting estimates and error corrections. They also deal with accounting for compensated absences and an important name change from Comprehensive Annual Financial Report to the Annual Comprehensive Financial Report. Marks Paneth Partner Warren Ruppel, CPA, explains the proposed changes as well the implication of the proposed rules on government accountants and auditors.

Learning Objectives:

Upon successful completion of this segment, you should be able to: l Recognize the new rules for accounting changes and error

corrections introduced in the GASB’s new Exposure Draft, l Describe the disclosures proposed in the GASB’s Exposure

Draft“ Accounting Changes and Error Corrections,” l Recognize why GASB is proposing to change the

Comprehensive Annual Financial Report to the Annual Comprehensive Financial Report, and

l Describe the new model being proposed by GASB for accounting for compensated absences.

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A. GASB No. 62: Codification of Accounting and Financial Reporting Guidance

i. Catch up of FASB and AICPA guidance not in GASB literature

ii. A full reexamination was not done in GASB No. 62

iii. Guidance related back to APB No. 20 and FAS No. 16

B. Accounting Change Definition

i. Going from one GAAP principle to another

ii. Changes needed to implement new statements

C. Error Correction

i. Switching from unacceptable to acceptable accounting principle

D. Transactions Not Considered an Accounting Change: Examples

i. A new type of transaction to the entity

ii. Transactions that were not originally material but now are

I. Elements of Accounting Changes and Errors

A. Accounting Changes: Types of Changes in the Exposure Draft

i. Changes in accounting principles

ii. Changes in accounting estimates

iii. Change in reporting entity

B. Change in Reporting Entity: Examples

i. Change in component units

ii. Funds that were reported as major but now non-major or vice versa

iii. New component units

iv. Component units going out of the reporting entity

C. Change in Accounting Principle

i .Restate all prior periods

ii. Display the effect on beginning fund/net position in earliest period

iii. Unless the change is impracticable

II. Proposed Changes in Exposure Draft

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A. Change in Accounting Estimates Resulting from Changes in

i. Data inputs

ii. Assumptions

iii. Measurement methods

B. Change in Accounting Estimate

i. Inputs

ii. Methodology

C. Ruppel’s Observations

i. If you’re changing the methodology, you have to justify the new one

ii. Similar to a change in accounting principle from one method to another

III.Change in Accounting Estimate

IV. Related Disclosure RequirementsA. Disclosure Requirements

i. Nature of the change

ii. Why you made the change

iii. Effect on beginning balances

iv. Impact on financial statements

B. Change in Accounting Principle: Supplemental Information Disclosures

i. Make the changes in the required supplemental information

ii. Often done in the MD&A

V. GAAP Name ChangeA. Exposure Draft: Annual Comprehensive

Financial Report

i. Change the name from Comprehensive Annual Report

ii. Change the acronym to ACFR

iii. Still in due process stage

B. Ruppel’s Recommendation

i. Don’t use the new name yet

C. Government Costs Related to Implementing the Exposure Draft

i. Shouldn’t be much

ii. Have to break the habit of using the old acronym

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Outline (continued)

A. Liability for Compensated Absences Recognized if the Absence

i. Accumulates

ii. Is attributable to services rendered

iii. Is more likely than not to be paid or settled

B. Compensated Absences

i. Vacation leave

ii. Sick leave

iii. Certain sabbatical leave

iv. Holidays

C. The Absence Accumulates

i. If it doesn’t, there is no future liability

ii. If the employee didn’t use it, it is lost

iii. Or the employee took the time

• No accounting necessary

D. Purpose of the Exposure Draft

i. Match the costs to when they were earned

ii. Estimate amount to be paid upon termination

VI. Compensated Absence Liability

A. Ruppel’s Observation on “More Likely Than Not”

i. It’s going to require judgment on the part of the government

ii. It’s more complicated than under current rules

B. Why the Pushback?

i. Numbers are not likely to change much

ii. It will require a fair amount of work to comply

C. Calculating the Liability

i. Based on hours accumulated

ii. The amount more likely than not

iii. Then use current salary rates

D. Ruppel’s Suggestions

i. Look at your current method of calculation

ii. Identify the pressure points

iii. Figure out instances where employees lose time

iv. Determine how to support a more likely than not calculation

E. The Three New Exposure Drafts

i. Comprehensive Annual Financial Report name has to be changed

ii. Accounting changes: Be aware of the considerations

iii. Compensated absences: Get a jump on it!

“Accounting changes, error corrections… just be aware of what those are considered, how they're defined, and refer to the guidance when you actually have those situations.”

— Warren Ruppel

VII. Observations Looking Forward

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l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Warren Ruppel explains the proposed changes in recent Exposure Drafts issued by the GASB as well the implication of the proposed rules on government accountants and auditors."

l Show Segment 5. The transcript of this video starts on page 5–20 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 5–7 to 5–9. Additional objective questions are on pages 5–10 and 5–11.

l After the discussion, complete the evaluation form on page A–1.

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5. Accounting Changes and Error Corrections: New Guidance

1. What are the definitions of accounting change and error correction under the new guidance? What transactions are not considered an accounting change? What types of changes in accounting principles or error corrections have you encountered?

2. What are the three types of accounting changes described in the Exposure Draft? What are examples of changes in reporting entities?

3. How are changes in accounting principles and accounting estimates treated in the Exposure Draft? How will these changes improve financial reporting for your clients or organization?

4. What are the disclosure requirements for accounting changes and error corrections under the Exposure Draft?

5. Why is the GASB proposing to change the Comprehensive Annual Financial Report to the Annual Comprehensive Financial Report and what does Mr. Ruppel recommend while the name has not yet changed? How will your organization handle the use of the acronym prior to the name change?

Discussion Questions

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

Group Live Option

For additional information concerning CPE requirements, see page vi of this guide.

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absences recognized under the proposed GASB statement? What is meant by the term compensated absences and what is the purpose of the Exposure Draft regarding compensated absences? How will the proposed changes affect how your organization handles compensated absences?

7. What does Mr. Ruppel suggest when calculating the compensated absence liability and what government accountants should do now to prepare for the new standard? How will your organization’s current calculation of compensated absences differ from the calculation under the proposed standard?

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Discussion Questions (continued)

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Suggested Answers to Discussion Questions5. Accounting Changes and Error Corrections:

New Guidance1. What are the definitions of accounting

change and error correction under the new guidance? What transactions are not considered an accounting change? What types of changes in accounting principles or error corrections have you encountered? l Accounting change

v Going from one GAAP principle to another

v GASB issues new statements and governments implement them

l Error correction v Switching from the use of an

unacceptable accounting principle to an acceptable accounting principle

l Transactions not considered an accounting change v A new type of transaction to the

entity v Transactions that were not clearly

material or significant to the organization, that are now material and applying the appropriate principle to those transactions

l Participant response based on personal/organizational experience

2. What are the three types of accounting changes described in the Exposure Draft? What are examples of changes in reporting entities? l Accounting changes

v Changes in accounting principles v Changes in accounting estimates v Change in reporting entity

l Change in reporting entity examples v Change in the component units v Funds that were reported as major

funds but are now reported as non-major funds, or vice versa

v New component units that are coming into the overall reporting entity

v Component units going out of the reporting entity

3. How are changes in accounting principles and accounting estimates treated in the Exposure Draft? How will these changes improve financial reporting for your clients or organization? l Change in accounting principles

v Restate all the prior periods that are presented in the financial statements

v Display the effect on the beginning fund balance or net position in the earliest period presented

v Unless the change is impracticable k Must be literally impossible to

do in order to justify saying it is impracticable

l Change in accounting estimate v Accounted for prospectively v If you are changing the

methodology in how and what you are doing with the inputs, you need to justify that the new methodology is preferable to the old methodology

v Similar to when you have a change in accounting principle from one GAAP method to another GAAP method

l Participant response based on personal/organizational experience

4. What are the disclosure requirements for accounting changes and error corrections under the Exposure Draft? l Disclosures for accounting changes

v Nature of the change v Why you are making the change v The effect on the beginning

balances, either in the notes or displayed in the financial statements

v Explain the impact on the financial statements, both the current year and the prior year

l Disclosures for error corrections v Nature of the error su

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Suggested Answers to Discussion Questions (continued)

v The impact on whatever periods are presented as part of the financial statements

v Similar to accounting change disclosures

5. Why is the GASB proposing to change the Comprehensive Annual Financial Report to the Annual Comprehensive Financial Report and what does Mr. Ruppel recommend while the name has not yet changed? How will your organization handle the use of the acronym prior to the name change? l The acronym of Comprehensive

Annual Financial Report when pronounced is a racial slur in South Africa

l The name change changes the acronym to ACFR, which seems to have no issues

l Still in the due process stage l Mr. Ruppel recommends:

v Using the term Comprehensive Annual Financial Report

v Not using the acronym l Participant response based on

personal/organizational experience

6. When is a liability for compensated absences recognized under the proposed GASB statement? What is meant by the term compensated absences and what is the purpose of the Exposure Draft regarding compensated absences? How will the proposed changes affect how your organization handles compensated absences? l A liability for compensated absences

is required to be recognized when l The absence accumulates

v The absence is attributable to services rendered

v The absence is more likely than not to be either paid or settled through other means

l Compensated absences v Vacation leave v Sick leave v Certain sabbatical types of leave v Holidays v The absence has to accumulate v If it does not accumulate, you

would not have a future liability v If the employee did not use the

time and it is lost, or if the employee took the time, no accounting is necessary

l Purpose of the Exposure Draft v Try to match the costs from when

the compensated absences were earned to when the individual actually earned them

v Estimate the amount to be paid upon termination

l Participant response based on personal/organizational experience

7. What does Mr. Ruppel suggest when calculating the compensated absence liability and what government accountants should do now to prepare for the new standard? How will your organization’s current calculation of compensated absences differ from the calculation under the proposed standard? l Calculating the liability

v Based upon the number of hours and the time that people have accumulated

v The amount that more likely than not will result in either repayment or provision of future time

v Use the current salary rates k Sick leave paid at a reduced

amount should be accumulated at that amount instead of the full salary level b You do not have to project

what future salaries might be

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Suggested Answers to Discussion Questions (continued)

l Questions to consider v Do the government employees

really wind up taking the time? v Are they being paid in a lump

sum upon their termination? v What is the percentage of time

that employees actually lose because they do not take it?

l Suggestions for preparing for the new standard v Look at how the compensated

absence liability is currently calculated

v See what kind of pressure points there are in terms of where you may not be paying out the full amount

v Figure out instances where employees lose time in your calculation

v See what factors or data you can use to help you support coming up with the more likely than not calculation

l Participant response based on personal/organizational experience

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1. An error correction is:

a) going from one GAAP principle to another

b) implementing a new accounting principle

c) applying an acceptable accounting principle to transactions that were not originally material but now are

d) switching from the use of an unacceptable accounting principle to an acceptable accounting principle

2. An example of a change in reporting entity is:

a) an acquisition that caused a change in the entities that are being reported

b) a majority equity interest that caused a change in the entities being reported

c) component units going out of the reporting entity

d) a change in accounting estimate

3. A change in accounting principle:

a) requires restatement of all the prior periods that are presented in the financial statements

b) requires the same treatment as a change in accounting estimate

c) is usually impracticable to account for

d) is treated prospectively

4. One of the required disclosures for a change in accounting principle is:

a) the impact on future financial statements

b) the nature of the change

c) a list of other appropriate accounting principles not adopted

d) the date of the last time a change in accounting principle was made

5. Warren Ruppel’s advice is that while the Comprehensive Annual Financial Report name change is still in the due process stage:

a) use the acronym for Annual Comprehensive Financial Report only

b) use the full name Annual Comprehensive Financial Report only

c) do NOT use the new name Annual Comprehensive Financial Report

d) keep using the old acronym

6. Under the proposed statement, a liability for compensated absences is recognized when, among other things:

a) the absence accumulates

b) the absence is paid

c) the absence is taken by the employee

d) the absence is lost

7. For periods that are NOT presented in the basic financial statements, but are affected by a change in accounting principle:

a) supplementary information is required to be restated if those periods are presented

b) supplementary information is NOT required to be restated if those periods are presented

c) supplementary information for those periods can only be presented if those periods are presented for the basic financial statements

d) supplementary information should NOT be presented for those periods

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the reading for self-study that starts on page 5–12.

5. Accounting Changes and Error Corrections: New Guidance

Objective Questions

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8. A change in accounting principle is:

a) the initial adoption of an accounting principle

b) the application of an accounting principle to items that were previously insignificant

c) the implementation of new authoritative accounting pronouncements

d) the change from applying an accounting principle that is not generally accepted to a generally accepted principle to significant items

9. An error can result from:

a) a reclassification within the financial statement

b) the initial application of an accounting principle

c) a change in accounting principle

d) mistakes in the application of accounting principles

10.A change in accounting estimate is treated:

a) prospectively

b) retroactively

c) the same as a change in accounting principle

d) the same as a reclassification in the financial statements

Objective Questions (continued)

5–12

Self-Study Option

Reading (Optional for Group Study)

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ACCOUNTING CHANGES AND ERROR CORRECTIONS

l In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Gov/Not-for-Profit Update

May 20, 2021 Comments Due: August 31, 2021

Proposed Statement of the Governmental Accounting Standards Board

Accounting Changes and Error Corrections an amendment of GASB Statement No. 62

This Exposure Draft of a proposed Statement of Governmental Accounting Standards is issued by the GASB for public comment. Written comments should be addressed to: Director of Research and Technical Activities Project No. 32-1

Source: https://www.gasb.org/jsp/GASB/Document_C/DocumentPage?cid=1176176716760&acceptedDisclaimer=true

ACCOUNTING CHANGES AND ERROR CORRECTIONS WRITTEN COMMENTS Deadline for submitting written comments: August 31, 2021 Requirements for written comments. Comments should be addressed to the Director of Research and Technical Activities, Project No. 32-1, and emailed to director@gasb.org.

OTHER INFORMATION

Public hearing. The GASB has not scheduled a public hearing on the issues addressed in this Exposure Draft. Public files. Written comments will become part of the GASB’s public file and are posted on the GASB’s website. This Exposure Draft may be downloaded from the GASB’s website at www.gasb.org. Final GASB publications may be ordered at www.gasb.org.

______________________

Copyright © 2021 by Financial Accounting Foundation. All rights reserved. Permission is granted to make copies of this work provided that such copies are for personal or intraorganizational use only and are not sold or disseminated and provided further that each copy bears the following credit line: “Copyright © 2021 by Financial Accounting Foundation. All rights reserved. Used by permission.”

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Notice to Recipients of This Exposure Draft

The Governmental Accounting Standards Board (GASB) is responsible for (1) establishing and improving standards of state and local governmental accounting and financial reporting to provide useful information to users of financial reports and (2) educating stakeholders—including issuers, auditors, and users of those financial reports—on how to most effectively understand and implement those standards.

The due process procedures that we follow before issuing our standards and other communications are designed to encourage broad public participation in the standards setting process. As part of that due process, the GASB is issuing this Exposure Draft setting forth proposed standards that would address the accounting and financial reporting for accounting changes and error corrections.

We invite your comments on all matters in this proposed Statement. Because this proposed Statement may be modified before it is issued as a final Statement, it is important that you comment on any aspects with which you agree as well as any with which you disagree. To facilitate our analysis of comment letters, it would be helpful if you explain the reasons for your views, including alternatives that you believe the GASB should consider.

All responses are distributed to all Board members and to staff members assigned to this project, and comments are considered during the deliberative process leading to a final Statement. In deciding on changes in accounting and financial reporting standards, the GASB also takes into consideration the expected benefits and the perceived costs associated with the changes. Only after the Board is satisfied that all alternatives have adequately been considered, and modifications have been made as considered appropriate, will a vote be taken to issue a final Statement. A majority vote of the Board is required for adoption.

Summary

The primary objective of this proposed Statement is to enhance accounting and financial reporting requirements for accounting changes and error corrections to provide more understandable, reliable, relevant, consistent, and comparable information for making decisions or assessing accountability.

This proposed Statement would define accounting changes as changes in accounting principles, changes in accounting estimates, and changes to or within the financial reporting entity and would describe the transactions or other events that constitute those changes.

As part of those descriptions, for (1) a change in accounting principle and (2) a change in accounting estimate that results from a change in measurement methodology, the new principle or methodology would be required to be justified on the basis that it is preferable to the principle or methodology used before the change. That preferability would be based on the qualitative characteristics of financial reporting—understandability, reliability, relevance, timeliness, consistency, and comparability.

This proposed Statement also would address corrections of errors in previously issued financial statements. This proposed Statement would describe the first-time adoption of the U.S. generally accepted accounting principles established by the GASB as the adoption of a new financial reporting framework, not as an accounting change or error correction. This proposed Statement would prescribe the accounting and financial reporting for (1) each type of accounting change and (2) error corrections.

This proposed Statement would require that (a) changes in accounting principles and error corrections be reported retroactively by restating prior periods, (b) changes to or within the financial reporting entity be reported by adjusting beginning balances of the current period, and (c) changes in accounting estimates be reported prospectively by recognizing the change in the current period.

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This proposed Statement also would establish display requirements by requiring the aggregate amount of adjustments to and restatements of beginning net position, fund balance, or fund net position, as applicable, to be displayed by reporting unit in the financial statements. This proposed Statement would require disclosure in notes to financial statements of descriptive information about accounting changes and error corrections, such as their nature. In addition, information about the quantitative effects of each accounting change and error correction would be required to be disclosed in a tabular format by reporting unit to reconcile beginning balances as previously reported to beginning balances as restated.

Furthermore, this proposed Statement would address how information for prior periods that is affected by a change in accounting principle or error correction would be presented in required supplementary information and supplementary information. For periods that are not presented in the basic financial statements but for which information is presented in required supplementary information or supplementary information, information would be required to be restated in required supplementary information and supplementary information for error corrections but not for changes in accounting principles.

Effective Date and Transition

The requirements of this proposed Statement would be effective for accounting changes and error corrections made in reporting periods beginning after June 15, 2023. Earlier application would be encouraged.

How the Changes in This Proposed Statement Would Improve Financial Reporting

The requirements of this proposed Statement would improve the clarity of the accounting and financial reporting requirements for accounting changes and error corrections, which would result in greater consistency in application in practice. In turn, more understandable, reliable, relevant, consistent, and

comparable information would be provided to financial statement users. In addition, the proposed display and note disclosure requirements would result in more decision useful, understandable, and comprehensive information for users about accounting changes and error corrections.

How the Board Considered Costs and Benefits in the Development of This Proposed Statement

One of the principles guiding the Board’s setting of standards for accounting and financial reporting is the assessment of expected benefits and perceived costs. The Board strives to determine that its standards address significant user needs and that the costs incurred through the application of its standards, compared with possible alternatives, are justified when compared to the expected overall public benefit. The Board believes that the expected benefits of implementing this proposed Statement—more understandable, reliable, relevant, consistent, and comparable information about accounting changes and error corrections—are significant and justify the perceived costs of implementation and ongoing compliance.

…. Table of Contents …..

Proposed Statement of the Governmental Accounting Standards Board

Accounting Changes and Error Corrections

an amendment of GASB Statement No. 62

May 20, 2021

INTRODUCTION

1. The primary objective of this Statement is to enhance the accounting and financial reporting requirements for accounting changes and error corrections to provide more understandable, reliable, relevant, consistent, and comparable information for making decisions or assessing accountability.

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STANDARDS OF GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING

Scope and Applicability of This Statement

2. This Statement establishes accounting and financial reporting requirements for (a) accounting changes and (b) the correction of an error in previously issued financial statements. The requirements of this Statement apply to the financial statements of all state and local governments.

3. This Statement supersedes Statement No. 62, Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements, paragraphs 58–89, and Implementation Guide No. 2015-1, Questions 1.57.2, 4.38.3, 4.38.4, 7.22.16, 7.22.17, 7.104.17, and 10.20.5. This Statement amends Statement No. 9, Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting, paragraph 11; Statement No. 18, Accounting for Municipal Solid Waste Landfill Closure and Postclosure Care Costs, paragraph 14; Statement No. 34, Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments, paragraph 112; Statement No. 56, Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing Standards, paragraph 14; Statement 62, paragraphs 50, 53, 94, 209, and 361; Statement No. 69, Government Combinations and Disposals of Government Operations, paragraph 43; Statement No. 79, Certain External Investment Pools and Pool Participants, paragraph 7; and Implementation Guide 2015-1, Questions 3.28.1, 7.14.4, 7.55.7, and Z.51.26.

Classification

Accounting Changes 4. Accounting changes are (a) changes in accounting principles, (b) changes in

accounting estimates, and (c) changes to or within the financial reporting entity.

Change in Accounting Principle

5. Once adopted, an accounting principle should be applied consistently to account for and report transactions and other events of a similar type, except as described in this paragraph. A change in accounting principle results from either:

a. A change from one generally accepted accounting principle to another generally accepted accounting principle that is justified on the basis that the newly adopted accounting principle is preferable to the accounting principle applied before the change. The qualitative characteristics of financial reporting—understandability, reliability, relevance, timeliness, consistency, and comparability—should be the basis for determining whether a new accounting principle would be preferable.

b. The implementation of new authoritative accounting or financial reporting pronouncements (hereafter referred to as new pronouncements).

6. A change in accounting principle is the application of an accounting principle to transactions or other events of a similar type that is different from the accounting principle previously applied to those transactions or other events. Therefore, the initial adoption and application of an accounting principle to transactions or other events that (a) are clearly different in substance from those previously occurring, (b) are occurring for the first time, or (c) were previously insignificant in their effect is not a change in accounting principle. A change from (1) applying an accounting principle that is not generally accepted to transactions or other events that previously were significant to (2) applying a generally accepted accounting principle to those transactions or other events is an error correction. (See paragraphs 12 and 13.)

Change in Accounting Estimate

7. Accounting estimates are outputs determined based on inputs such as data, assumptions, and measurement

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methodologies. As outputs, accounting estimates are amounts subject to measurement uncertainty that are recognized or disclosed in the basic financial statements. A change in an accounting estimate results from changes to the inputs of that estimate. Changes to inputs result from a change in circumstance, new information, or more experience.

8. A change in an accounting estimate that results from a change in the measurement methodology that is used to determine that estimate should be justified on the basis that the change in measurement methodology is preferable to the measurement methodology used before the change. The qualitative characteristics of financial reporting—understandability, reliability, relevance, timeliness, consistency, and comparability—should be the basis for determining whether a new measurement methodology would be preferable.

Change to or within the Financial Reporting Entity

9. Changes to or within the financial reporting entity result from:

a. The addition or removal of a fund that results from the movement of resources within the primary government, including its blended component units

b. A change in the fund presentation as major or nonmajor

c. Except as described in paragraph 10, the addition of a component unit to the financial reporting entity or removal of a component unit from the financial reporting entity

d. A change in the presentation (blended or discretely presented) of a component unit.

10. Acquisitions, mergers, or transfers of operations (as defined by Statement 69) that result in the addition or removal of a discretely presented component unit and component units reported pursuant to Statement No. 90, Majority Equity Interests, should not be considered changes to or within the financial reporting entity, as described by paragraph 9. 11. Transactions or other events that could be classified as

either a change in accounting principle in accordance with paragraph 5a or a change to or within the financial reporting entity should be considered a change to or within the financial reporting entity.

Correction of an Error in Previously Issued Financial Statements

12. An error results from mathematical mistakes, mistakes in the application of accounting principles, or oversight or misuse of facts that existed at the time the financial statements were issued about conditions that existed as of the financial statement date. Facts that existed at the time the financial statements were issued are those facts that could reasonably be expected to have been obtained and taken into account at that time about conditions that existed as of the financial statement date.

13. A change from (a) applying an accounting principle that is not generally accepted to transactions or other events that previously were significant to (b) applying a generally accepted accounting principle to those transactions or other events is an error correction.

First-Time Adoption of the U.S. Generally Accepted Accounting Principles Established by the GASB Financial Reporting Framework

14. The first-time adoption of U.S. generally accepted accounting principles established by the GASB (hereafter referred to as U.S. GAAP) is an adoption of a new financial reporting framework whereby a government asserts for the first time that its basic financial statements are prepared in accordance with U.S. GAAP. The first-time adoption of U.S. GAAP as a financial reporting framework is neither an accounting change nor an error correction.

Accounting and Financial Reporting for Accounting Changes and Error Corrections

Change in Accounting Principle

15. The requirements in paragraphs 16–19 apply in the absence of other specific

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requirements that address how a change in accounting principle should be reported.

16. A change in accounting principle should be reported retroactively by restating financial statements for all prior periods presented, if practicable. The cumulative effect, if any, of the change to the newly adopted accounting principle on periods prior to those presented should be reported as a restatement of beginning net position, fund balance, or fund net position, as applicable, of the earliest period presented. Each individual prior period presented should be restated to reflect the period-specific effects of applying the newly adopted accounting principle.

17. If restatement of all prior periods presented is not practicable, the cumulative effect, if any, of applying the newly adopted accounting principle should be reported as a restatement of beginning net position, fund balance, or fund net position, as applicable, of the earliest period restated (that is, for the earliest period for which it is practicable to apply the newly adopted accounting principle).

Notes to Financial Statements

18. A government should disclose the following in notes to financial statements for each change in accounting principle:

a. The nature of the change in accounting principle, including identification of the financial statement line items (excluding totals and subtotals) affected

b. Except for the implementation of a new pronouncement, the reason for the change in accounting principle, including an explanation of why the newly adopted accounting principle is preferable

c. If prior periods presented are not restated because it is not practicable to do so, the reason why the restatement is not practicable.

19. In addition, the effects on beginning net position, fund balance, or fund net position, as applicable, should be disclosed as required by paragraph 32.

Change in Accounting Estimate

20. The requirements in paragraphs 21 and 22 apply in the absence of other specific requirements that address how a change in accounting estimate should be reported.

21. A change in accounting estimate, as described in paragraph 7, should be reported prospectively by recognizing the change in accounting estimate in the reporting period in which the change occurs.

Notes to Financial Statements

22. A government should disclose the following in notes to financial statements for each significant change in accounting estimate:

a. The nature of the change in accounting estimate, including identification of the financial statement line items (excluding totals and subtotals) affected

b. If the change in accounting estimate results from a change in measurement methodology, the reason for the change in measurement methodology, including an explanation of why the new measurement methodology is preferable.

Change to or within the Financial Reporting Entity

23. A change to or within the financial reporting entity should be reported by adjusting beginning net position, fund balance, or fund net position, as applicable, for the effect of the change as if the change occurred as of the beginning of the reporting period.

Notes to Financial Statements

24. A government should disclose in notes to financial statements the nature of and reason for each change to or within the financial reporting entity.

25. In addition, the effects on beginning net position, fund balance, or fund net position, as applicable, should be disclosed as required by paragraph 32.

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Correction of an Error in Previously Issued Financial Statements

26. A correction of an error in previously issued financial statements should be reported retroactively by restating financial statements for all prior periods presented. The cumulative effect of the error correction on periods prior to those presented should be reported as a restatement of beginning net position, fund balance, or fund net position, as applicable, of the earliest period presented. Each individual prior period presented should be restated to reflect the period-specific effects of correcting the error.

Notes to Financial Statements

27. A government should disclose the following in notes to financial statements for each error correction:

a. The nature of the error and its correction, including the periods affected by the error and identification of the financial statement line items (excluding totals and subtotals) affected by the correction

b. The effect of the error correction on the change in net position, fund balance, or fund net position, as applicable, of the prior period.

28. In addition, the effects on beginning net position, fund balance, or fund net position, as applicable, should be disclosed as required by paragraph 32.

Reclassification in the Financial Statements Resulting from a Change in Accounting Principle or an Error Correction

29. For a change in accounting principle that does not have an effect on beginning net position, fund balance, or fund net position but that results in a reclassification in the financial statements, amounts should be reclassified in all prior periods presented, if practicable. In such circumstances, the disclosures required by paragraphs 18a and 18b should be included in notes to financial statements. If amounts are not reclassified in prior periods presented because it is not practicable to do so, the reason why it is not practicable also should be disclosed.

30. For an error correction that does not have an effect on beginning net position, fund balance, or fund net position but that results in a reclassification in the financial statements, amounts should be reclassified in all prior periods presented. In such circumstances, the disclosures required by paragraph 27a should be included in notes to financial statements.

Other Financial Reporting Requirements

Display in the Financial Statements

31. The aggregate amount of adjustments to and restatements of beginning net position, fund balance, or fund net position, as applicable, should be displayed for each reporting unit.1

Notes to Financial Statements

32. A government should disclose in notes to financial statements the effects on beginning net position, fund balance, or fund net position, as applicable, of the earliest period restated for the following that occurred during the period: (a) each change in accounting principle (including the implementation of new pronouncements that result in restatement, even if there are specific transition provisions in other pronouncements), (b) each change to or within the financial reporting entity, and (c) each error correction. Those effects should be disclosed in a tabular format that reconciles beginning balances as previously reported to beginning balances as adjusted or restated for each reporting unit. If the government has separately displayed in the financial statements the effects of each accounting change or error correction by reporting unit, those effects need not be repeated in notes to financial statements.

33. The note disclosures required by this Statement should correspond to the reporting units. Except for the note disclosure required by paragraph 32, disclosure by reporting unit is subject to the requirements in paragraph 63 of Statement No. 14, The Financial Reporting Entity, as amended. Information that is the same for more than one reporting unit should be

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combined in a manner that avoids unnecessary duplication.

34. The note disclosures required by this Statement should be made in the reporting period in which the accounting change occurs or in the reporting period in which the error is discovered and corrected. If a note disclosure is included in interim financial statements, that disclosure also should be included in the related annual financial statements. For comparative financial statements, if the prior periods presented were restated in the period in which the accounting change occurred or the error was discovered and corrected, subsequent annual financial statements need not repeat the disclosures.

For the full Exposure Draft see https://www.gasb.org/jsp/GASB/Document_C/DocumentPage?cid=1176176716760&acceptedDisclaimer=true

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SURRAN: On June 1st of 2021 the Governmental Accounting Standards Board, GASB, issued a proposal related to the accounting and financial reporting requirements for accounting changes and error corrections. GASB’s current guidance on accounting changes and error corrections goes back to GASB Statement No. 62, Codification of Accounting and Financial Reporting Guidance Contained in Pre- November 30, 1989 FASB and AICPA Pronouncements, which was issued in 2010.

That 2010 guidance was originally established in the 1970s. GASB’s recent research identified diversity in applying the existing standard in practice, including issues with selecting the appropriate category of accounting change or error correction.

The new Exposure Draft is intended to provide guidance that would lead to information that is easier to understand, more reliable, relevant, consistent, and comparable across governments for making decisions and assessing accountability.

Warren Ruppel is a Partner with the Nonprofit, Government & Healthcare Group at Marks Paneth LLP. He tells us what the intent of the new Exposure Draft is.

RUPPEL: Well, the intent is that the guidance related to accounting changes and error corrections that are currently in GASB Statement 62, the viewers might recall that guidance was kind of a catch up of all the FASB and AICPA guidance that hadn't been in the GASB literature.

When the GASB brought the accounting requirements for error corrections and accounting changes into its statements via 62, it didn't really do a full reexamination of them, of the requirements. The requirements now relate back to Accounting Principles Board Opinion 20, which many of the viewers might not have been born when that was instituted, and FASB 16.

The guidance was really pretty old, and it was time for the GASB to take a look and see if it had to be refreshed and kind of put its own stamp on the requirements, and also make sure that they're applicable in the right way to government accounting, as opposed to the FASB world.

SURRAN: Warren gives us the definition of an accounting change under the new guidance.

RUPPEL: The broad definition of accounting change really encompasses two basic things.

One is going from one GAAP accounting principle to another. There are some cases in GAAP where there's some flexibility provided in the accounting, so you could have more than one way to account for something. So we'd go from one acceptable method to another.

The other is as the GASB issues new statements and governments implement them, they have to make changes in accounting principles to implement those new statements.

Video Transcript

5. Accounting Changes and Error Corrections: New Guidance

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t That’s basically what comprises changes in accounting principles. It's probably better to focus on the things that don't constitute a change in accounting principles.

So if you're using an accounting principle that's not acceptable, and you switch to an accounting principle that is acceptable, that's not a change in accounting principle, that's an error correction which we'll talk about in a bit.

Also, if you have not had these types of transactions to account for in the past, it's a new type of transaction to the entity. And you apply an accounting principle to that, that's not a change in accounting principles, there was nothing for you to change from.

That would also apply if you had certain transactions that were clearly not material or significant to the organization or very small. Maybe you accounted for them on a cash basis, instead of an accrual basis and now those transactions become more significant so now you're going to apply the accounting principle for the first time. So going from transactions that weren't significant in the financial statements, to now applying the appropriate principle, not considered a change in accounting principle. That's handled more like a first-time application of the accounting principle.

SURRAN: Warren explains how the new Exposure Draft treats changes in accounting principles.

RUPPEL: When we talk about accounting changes, we really need to view changes in accounting principles as part of a broader group of changes called accounting changes in this Exposure Draft.

If you look at accounting changes as a group, changes in the accounting principles are one of the changes that's within that group. There are two other changes that are considered. One are changes in accounting estimates. So, changes in accounting estimates are where certain estimates are inherent in financial statements.

They could be your allowance for uncollectible receivables, they could be certain warranty reserves, there's all kinds of significant estimates in financial statements. So, if your estimate changes of what , usually they are liabilities, changes as to the amount of the liability going forward. That's considered a change in accounting estimate.

Then you also have something called the change in the reporting entity, or components of the reporting entity. And that's where the wording is a little bit new.

SURRAN: Warren Ruppel tells us more about the new guidance relating to the change in reporting entity.

RUPPEL: This Exposure Draft would call it changes in the reporting entity and changes within the reporting entity. And that really brings the changes in the accounting requirements. Makes it more government oriented than the previous guidance.

That encompasses more things than what people would normally think of in terms of changes in reporting entities. So, the Exposure Draft would have, for instance, if you had a change in the component units that were included in the primary government, that would be a change in the reporting entity.

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t If you had funds in the past that were reported as major funds, and are now reported as non-major funds, or vice versa, that would be considered a change in the reporting entity.

Also, new component units that are coming into the overall reporting entity would be considered a change in the reporting entity, as well as component units that are going out of the reporting entity.

Because there are changes in their governance structure or in the manner in which they operate. So, it's a broader set of what we normally consider changes in... used to consider changes in the reporting entity, now you have to consider changes within the reporting entity.

SURRAN: But are there any exceptions?

RUPPEL: There are certain exceptions to that. If you had acquisition type accounting or majority equity interest, if that caused a change in the entities that are being reported, that wouldn't be considered a change in the reporting entity or within the reporting entity. So, you have to be a little bit careful in not generalizing what these changes are.

SURRAN: Warren talks about how those changes improve financial reporting.

RUPPEL: What the GASB sets out to do is, really bring some consistency into how those changes were accounted for. So, when we have a change in accounting principle, if we just look at that separately.

What that's going to require is the reporting entity to restate all the prior periods that are presented in the financial statements. To do that, you'd also have to display the effect on the beginning fund balance or net position in the earliest period that's presented, right? That’s pretty standard.

Also the GASB has terminology that says, unless the change is impracticable. So that practicable term is something that GASB's used in a number of new statements. It basically says they don't want you to just say, "Well, it's too hard for us to make the change and go back retrospectively. We're just going to do it in the current period." Practicable is a higher standard. They're basically telling you, you really should do this unless there's something out there that makes it literally impossible for you to do. So that's how you would account for a change in accounting principle.

SURRAN: Unlike a change in accounting principle where we look backwards, a change in accounting estimate is something that’s accounted for prospectively. The new Exposure Draft would require the change in estimate be reported prospectively by recognizing the change in the current period.

The Exposure Draft deals with changes in accounting estimates resulting from changes in the data inputs, assumptions, or measurement methods used to quantify amounts reported in financial statements.

Warren Ruppel offers some additional insights into the change in accounting estimates.

RUPPEL: Change in accounting estimate is really something that's accounted for prospectively, right? So you wouldn't go back and change your prior year numbers, you would just account for the change separately.

What's a little bit new in the Exposure Draft is that, when we think about a change in accounting estimates, we just think of that as one thing, and

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t one type of change, and we'll just apply that going forward. Maybe it's a change in the estimated useful life of an asset that's being depreciated, etc. So that seems straightforward.

This Exposure Draft parses the change into two different pieces. One is inputs. So if you have experience with the useful lives, or if you're estimating a warranty reserve, if you have data that's being analyzed to estimate your potential reserve, past data being analyzed to estimate your potential reserve in the future, that's changes in inputs.

But this statement would parse out changes in methodology. So If you're taking those inputs, and you're going to use a different methodology to calculate the estimate, maybe that's a change in the depreciation method, maybe that's just a different model that's being used to make the estimate.

If you're changing the methodology, in how and what you're doing with the inputs, you need to justify that the new methodology is preferable to the old methodology. That's very similar to when you have a change in accounting principle from one GAAP method to another GAAP method, you need to justify that the new method is preferable.

Can't just kind of pick and choose year to year what method you want to use. You have to make an argument that the new principle that would be used is preferable. So same thing for this change in methodology. You have to be convinced that it's a preferable method and also, there's some disclosure requirements related to that. So that is accounted for prospectively, you would just change your estimate in the current period and kind of going forward. However, you are amortizing or depreciating assets, etc. in future years, that would just have the impact and affect future years.

SURRAN: What should a government disclose in the notes to the financial statements for the changes described in the Exposure Draft? Warren reviews the new requirements.

RUPPEL: If you look at the Exposure Draft there is a set of disclosure requirements, for each type of accounting change, and also for error corrections. They are specific but if you look at them, they're pretty consistent from change to change.

So what they want you to do is have a note that explains the nature of the change, why you're making the change. Even if that's a new accounting principle, you'd want to be able to explain, "Well we made this change, because we're implementing a new accounting principle." You can discuss that you've met the preferability from changes in one GAAP method to another GAAP method, and also changes in the methodology in an accounting estimate.

The effect on the beginning balances should be either included in the notes or displayed in the financial statements. This is some specific requirement relative to that. And just basically kind of explain the impact on the financial statements, both the current year and the prior year. So not terribly onerous disclosure requirements.

But you need to make sure that you include all of the information that's required when and if this Exposure Draft becomes final, and you do have the disclosure requirements to do. I don't think you'll find that the disclosure requirements are all that different from what is currently required.

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t SURRAN: Warren tells us more about the new disclosure requirements by reviewing the ones that relate to correction of an error in previously issued financial statements.

RUPPEL: Correction of an error, you should describe the nature of the error, the impact on whatever periods are presented as part of the financial statements. And just basically describe the impact. Pretty similar to accounting change. But obviously if you're explaining why there was an error in the financial statements, you probably want to be a little bit more specific as to how that error occurred. Because I think a reader of the financial statements would be interested in knowing that.

SURRAN: Next Warren goes over what we need to know about the two types of supplementary information, regular and required supplementary information.

RUPPEL: When it comes down to Required Supplemental Information, RSI or just Regular Supplemental Information. If you have these changes in accounting principle, if the supplemental information includes the years that are presented in the financial statements, then this Exposure Draft would tell you to make the changes in the supplemental information or the required supplemental information.

And you probably see that a lot in MD&A, Management Discussion & Analysis, which is part of RSI. Where if you're doing comparisons from one year to the next, you should really reflect the change in what's being compared.

Where it gets a little trickier is when you have some of the RSI information is, if it's 10-year trend information or three-year trend information, or your supplemental information is 10-year, do you go back and reflect changes in accounting principles for those prior periods?

And basically, you won't have to do that. You don't have to go change the numbers for eight years ago for a number that you have disclosed in that. But you will want to have some footnote disclosure in terms of the fact that there was a change in accounting principle for that period. Error corrections would be a different story, you probably want to go back and change, correct the errors in the prior year, if you could. So just be cognizant of that. There are some disclosure requirements that are inherent in the Exposure Draft and you want to make sure that you include in that supplemental information, whatever explanations that are specifically required which I just kind of recapped for you.

SURRAN: The final issue related to the Exposure Draft on Accounting Changes and Error Corrections is the timetable. Warren Ruppel tells us what’s ahead.

RUPPEL: The effective date is for fiscal years beginning after June 15, 2023. So, I guess there's a due process that continues to play out. When I originally saw that because that would be June 30th, 2024 fiscal year-ends, that seemed to me a little bit far out. But I guess the GASB’s allowing it. There's a lot of standards that are backed up in terms of implementation that were delayed due to COVID. So, I think they're just putting this out a little bit further than they might normally have considered.

SURRAN: On April 13, 2021 the Governmental Accounting Standards Board proposed to change the Comprehensive Annual Financial Report to the Annual Comprehensive Financial Report. The proposed name change was prompted by GASB stakeholders raising concerns that the existing

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t acronym for the report, when spoken, sounds like a profoundly offensive term.

The Exposure Draft proposes to eliminate both the financial report name and the offensive acronym from the GASB standards. It is important to note that no changes have been proposed to the structure or content of the report.

Upon the release of the Exposure Draft, GASB Chair Joel Black stated that “When you pronounce the acronym, it is a highly offensive racial slur directed toward Black South Africans. As we and our global stakeholders are part of a global community, we do not wish to be offensive to anyone, so we have undertaken the project to address this.”

Warren Ruppel gives us his insights about the new GASB Exposure Draft.

RUPPEL: This really deals with an issue that's a little bit sensitive. We have the Comprehensive Annual Financial Report, that's a term that's been in use for about 40 years. Lots of readers and users use an acronym for that, which I'm not going to say. Because the way that acronym is actually pronounced is a racial slur in South Africa. So, this has really actually been something that I think financial statement preparers and the GASB have been somewhat aware of. But I think they kind of came to the time where they wanted to address that.

The Exposure Draft would have the, it would change the name, Comprehensive Annual Financial Report, to Annual Comprehensive Financial Report (ACFR). It would change the acronym; the acronym seems to have no issues. So that's good. We're still in the due process stage. So that term to describe the report really hasn't changed.

But so, I think what most governments are doing is just using the term, Comprehensive Annual Financial Report and not using the acronym, right? Because there's nothing wrong with the term Comprehensive Annual Financial Report. It is the acronym that creates the problem. Some governments said why don't we just adopt the new term early? If you were an accounting purist, you'd say, "Well, the new term doesn't exist in Governmental GAAP right now. So we really don't want to use a term that's not applicable, not in GAAP. So we're going to not do that."

I don't think you'd have too many auditors qualifying the report, if you actually did use the new term. But I'd probably recommend against it. And part of that is, you never know what's going to come up.

One side of you says, "Well, if the GASB noticed this, why don't they just change the name now? Why do we have to go through this whole due process?" But that's not the way the GASB works. And they have to follow their procedures. There is certainly enough information out for people to know to stop using the acronym.

SURRAN: What are the costs that governments would incur as a result of the change and the potential benefits? Warren explains.

RUPPEL: In terms of cost benefit, really most governments’ Comprehensive Annual Financial Reports are in the 200 to 250 page realm. So there's lots of places that you'll have to look. You can do search functions, etc.

So that's a relatively easy change, there shouldn't be much cost. The cost would really be to break people's 40-year-old habit of using the acronym. Because Comprehensive Annual Financial Report or even Annual Comprehensive, it's not the kind of terms that just kind of roll off your

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t tongue and are easy to say. So, it's just changing. It's probably easier for government accountants, and financial statements or accountants in government or auditors to kind of understand that. But people who just kind of marginally follow Governmental GAAP, they may not realize the significance of the change in the name. So, it takes that the viewers can get the word out that we really need to stop using this term, that would be a good thing.

SURRAN: The final topic on this segment is the new GASB Exposure Draft on Compensated Absences.

It was released on February 24, 2021, and it addresses circumstances under which governments would be required to recognize a liability for compensated absences.

It proposes guidance for measuring that liability. The proposed Statement would require that a liability for compensated absences be recognized if

l The absence accumulates

l The absence is attributable to services rendered and

l The absence is more likely than not to be either paid or settled through other means.

Warren Ruppel tells us more about what exactly is meant by the term compensated absences.

RUPPEL: In terms of compensated absences, as the viewers probably know, the GASB has a program to reevaluate standards after a certain period of time. So there's a GASB Standard 16, which covered compensated absences. And compensated absences, we can get into some of the technicalities of what they are.

But think vacation leave, sick leave in certain circumstances, certain sabbatical types of leave, those types of things. That's kind of the nuts and bolts of what we're thinking about in terms of compensated absences. You also have things like holidays are compensated absences, you don't have to be there and you're going to get paid for the holiday.

GASB has included this as it's part of its project to reevaluate the standards, and this actually is going to change the way governments are going to have to figure out and estimate these liabilities. This is one that you need to, financial statement preparers and the auditors, if this becomes finalized the way it is, you need to pay attention to this. Because it will have an impact on how you report the liability. Again, I'll frame this by saying if you're doing accrual statements on the economic resources measurement focus, the changes in the compensated absence liability it's going to impact your main balance sheet.

SURRAN: There are a few characteristics the Exposure Draft spells out with respect to compensated absences. Warren elaborates.

RUPPEL: One, it has to accumulate, right? So if you work a certain time, if during the year, you earn three weeks vacation or four weeks vacation, that's part of compensated absence. If you lose whatever vacation time that you accumulate during the year, at the end of the year, because you haven't taken it or shortly thereafter, then that doesn't accumulate, right?

So, if it doesn't, you wouldn't have a future liability, because if the employee didn't use the time, then they lost it. And they took the time

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t during the year of service that they earned the time. So, there's really no accounting, it all falls within the current period.

SURRAN: Warren discusses what happens when the employee does not use vacation or sick time and the time accumulates.

RUPPEL: So, if you don't use your sick, your vacation time, and that accumulates you're going to be using that vacation or getting that vacation time in future periods. Whereas you're earning it in the current period or past period.

The purpose of this is to try to match the costs of that and measure the liability that you have for these absences and somewhat match the cost to when the individual actually earned them.

So, under the current standards, unless you would estimate what you would have to pay for when a person is terminated for employment.

Let’s say you can accumulate vacation time unlimited, when you leave the employment of the government, you're paid out for whatever unused time that you have. If there's a payment obligation, you would accrue the liability all during the year based upon how much time people have accumulated at the end of the fiscal year, multiplied by the rate that they accumulated it at, and you basically have a liability.

SURRAN: Sick leave is also an example of compensated absences. Warren Ruppel tells us more about sick leave with an example based on personal experiences.

RUPPEL: A lot of times, governments will have sick leave that's able to be carried forward somewhat indefinitely. But when they get to the termination of employment, they might pay some fraction of it.

I know, the city of New York back when I worked there, they would pay you one third of your accumulated sick time when you terminated employment, along with your accumulated vacation days. So that sick time tends to be handled a little bit differently. If you looked at a holiday, holidays fall within the current period. There's no accumulation factor there. So they wouldn't be considered as part of this new proposed statement. And they're earned in the current period and taken in the current period.

SURRAN: In estimating the accumulated leave that is more likely than not to be paid or settled, a government would consider relevant factors, such as employment policies related to compensated absences and historical information about the payment of compensated absences as well as other factors. Warren tells us more about determining “what is more likely than not.”

RUPPEL: This Exposure Draft will require entities to make a judgment as to whether or not it is more likely than not, that you would have to have a... That you will be paying out benefits. So that's kind of a change.

So, it goes from you definitely owe the people the money, you're going to have to pay that, to probable. So, it may be probable that people take the time earlier, or they may lose the time, or there could be a whole bunch of factors that enter into why the more likely than not, amount is going to be

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t different from the actual cash payment that you would be obligated to make.

So that's going to require some judgment on the part of the government, to come up with factors to consider in terms of, how they're going to estimate what they think is more likely than not that they'll be actually required to pay.

Now, in some cases the historical experience might be that people would continue to accumulate the time. It's not only that they're going to be paid in the future, it's that they're going to take the time in the future and not lose the time. So, you need to factor that into your more likely than not calculation.

So gets a little bit more complicated than what's currently being done.

SURRAN: There seems to be a little bit of pushback on this Exposure Draft. Warren explains why.

RUPPEL: The differences at the end of the day, for what's going to be recorded as compensated absence in a general-purpose government and the government wide statements, it's kind of going to be lost in other liabilities such as debt, and OPEB liabilities and pension liabilities.

I don't think we're going to be changing the numbers all that much. But it's going to require a fair amount of work, on the part of the government to come up with that more likely than not calculation and apply those judgments to the amounts that are actually going to be recorded.

SURRAN: Another consideration is what salary rate should be used. Warren Ruppel offers his thoughts.

RUPPEL: I guess one other aspect that I should address is, what salary rates should you use when you calculate the liability rate? So, is it, should you project into the future? If your pattern is to have 3 to 5% in increases every year. Should you project those and say, "Okay, we estimate that on average a person's going to terminate in 10 years." No you don't have to do that.

You just calculate the liability based upon the number of hours and the time that people have accumulated. The amount that you believe is more likely than not going to result in either repayment or provision of future time, to that employee. And then use the current salary rates to calculate that.

The only exception to that would be, if you use the example of sick leave being paid at one third of the amount. Obviously, you wouldn't keep accumulating that at the full salary level, you'd take into consideration the fact that the sick leave might be paid at half salary or some reduced amount.

Or not just sick leave, whatever type of leave it is. So, you would take that into consideration. But you wouldn't have to project what the future salaries might be. So, some important changes in the calculation. So really one to pay attention to, and then more likely than not, you're going to have to look at some of your past experience in terms of, do governments’ employees really wind up taking the time? Do they wind up being paid in a lump sum upon their termination? How does that

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t actually work? What's the percentage of time that employees actually lose because they don't take it?

SURRAN: Warren offers his suggestion as to what government accountants should do now to prepare for the new standard on compensated absences.

RUPPEL: So, with this Exposure Draft, what I would suggest governments do, is to take a look at how they're currently calculating their compensated absence liability.

And see what the kind of pressure points are in terms of where you may not be paying out the full amount. Because if you're required to pay out the full amount, that's really going to be the amount that you accrue, you're going to do the more likely than not calculation in instances where you think people will lose time or just not take their time or lose time going forward in the future.

So, figure out where that instance is in your calculation, and then see what factors or what data you can use to help you support coming up with the more likely than not calculation.

Because it will impact that liability, and it will impact the kind of current period charge that's recorded.

SURRAN: We conclude this segment with Warren Ruppel’s final thoughts on the three new GASB Exposure Drafts.

RUPPEL: We spoke about three different potential GASB standards that are being evaluated by the GASB. I think the thing to keep in mind is, the Comprehensive Annual Financial Report, we have to get that done. It's not going to be acceptable.

To the extent you have elected officials that are going to be caught using acronyms at press releases or whatever, that's not going to be a good thing. So really try to get that implemented and applied in the government as soon as you can.

Accounting changes, error corrections, that's more on a kind of ad hoc basis. So just be aware of what those are considered, how they're defined, and refer to the guidance when you actually have those situations.

Compensated absences is the one where I would try to get a jump on implementing. It's not effective for a couple years. If you need to do some data gathering or need to do some data analytics or statistics to kind of come to that more likely than not calculation. It's always better to start those earlier. And since I guess it would be a change in accounting principle, and you're restating the prior periods, you need the prior year's data anyway. So, you might as well get a jump on gathering that data.

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Evaluation Form

Please rate the segments on the August 2021 issue 5 = Excellent, 4 = Very Good, 3 = Good, 2 = Fair, 1 = Poor

Please comment on each segment you used. (Attach additional pages if needed.)

I. Segment

Overall Speakers Format Content Topic

1. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part I _____ _____ _____ _____ _____

2. Global Tax & Transfer Pricing Strategies: What Lies Beneath – Part I _____ _____ _____ _____ _____

3. Will the PCAOB Tighten the Leash? _____ _____ _____ _____ _____

4. Whistleblower Program, Updates on Final Regulations & Moon Tax! _____ _____ _____ _____ _____

5. Accounting Changes and Error Corrections: New Guidance _____ _____ _____ _____ _____

Segment 1:__________________________________________________________________

Segment 2:__________________________________________________________________

Segment 3:__________________________________________________________________

Segment 4:__________________________________________________________________

Segment 5:__________________________________________________________________

Suggested Topics to be covered in future volumes (please comment):

_______________________________________________________________________________

_______________________________________________________________________________

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rm Please rate the discussion leaders 5 = Excellent, 4 = Very Good, 3 = Good, 2 = Fair, 1 = Poor

II. Discussion Leader

Were learning objectives met? o Yes o No

Were prerequisite requirements appropriate?: o Yes o No

Were course materials valuable? o Yes o No

Was course content up-to-date? o Yes o No

Were completion times appropriate? o Yes o No

Were the facilities satisfactory? o Yes o No

III.Summary

Send to:

RFR Kaplan Professional Education

332 Front Street, Suite 501 La Crosse, WI 54061

Name (please print):

Title:

Firm:

City/State:

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Knowledge Discussion Leader/ of Subject Teaching Skills

Segment 1: ___________________ ___________________ ___________________ Discussion Leader’s name

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A. By Citation

Accounting Standards Update – see: ASU

ASU No. 2014-09 June – 5

ASU No. 2016-13 April – 2

ASU No. 2017-02 October – 1

FASB or Financial Accounting Standards Board – see: ASU

IRS Notice 2020-32 January – 2

IRS Notice 2020-65 December – 4

IRS Rev. Proc. 2016-47 December – 1

IRS Rev. Proc. 2020-23 October – 4

IRS Rev. Proc. 2020-46 December – 1

IRS Rev Proc 2020-51 January – 2

SSARS No. 25 December – 1

Statement on Standards for Accounting & Review Services – see: SSARS

B. By Topic

Accounting Changes and Error Corrections, Exposure Draft on August – 5

Accounting, diversity in December – 2

AICPA Audit Guide, 2020 May – 5

American Families Plan, key proposals of the June – 4

American Rescue Plan Act (ARPA) April – 4; May – 4; June – 4

American Space Commerce Act August – 4

Annual Comprehensive Financial Report (ACFR), name change to August – 5

ASC Topic 326, FASB's reasons for issuing April – 2

ASC Topic 606, implementation of January – 4

ASC Topic 842, pandemic and October – 1

ASC Topic 842, transition to Jult – 2

Automobile depreciation September – 3

Bankruptcy, COVID-19 and September – 1

Big data, finance and January – 4

Bitcoin and Ethereum December – 3

Blockchain, accounting and June – 1

Blockchain, managing inventory & transactions with June – 1

Blockchain, tax implications of December – 3

Brand licensing, ethics and January – 3

Brand, personal May – 3

Business roundtable statement May – 2

Index

Note: At the request of several subscribers, this Index reflects the most recent 11 months of CPAR programming rather than the current calendar year.

September 2020 – August 2021

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Businesses, effect of COVID-19 on September – 2

CAA, disaster relief and February – 4

CAA, tax relief and February – 4

CAMs, auditor independence and September – 4

CAMs, inventory observation challenges October – 2

CARES Act February – 1

CARES Act, not-for-profits and February – 5

CECL, COVID-19 and April – 2

Chapter 11 September – 1

Common Reporting Standard (CRS) November – 2

Consolidated Appropriations Act 2021 (CAA) Feb. – 4; April – 4

Corporate misconduct, reasons for May – 2

COVID-19, challenges companies face due to September – 2

Critical audit matters – see: CAM

Cryptocurrency June – 1

Current Expected Credit Losses (CECL) April – 2

Cybersecurity, internal audit and Jan. – 1; June – 1

Data analytics, business vs. audit May- 1

Data security and privacy November – 3

Debt Instruments, significant modifications of October – 4

De minimis use rule November – 1

Digital assets, tax implications of December – 3

Digital currency transactions, IRS and July – 4

Dirty Dozen Tax Scams and COVID-19 September – 3

Diversity, equity and inclusion (DEI) December – 2

Dodd-Frank Act, transparency and October – 4

Dodd-Frank Act, whistleblower complaints and September – 4

Earnings management, reasons to perform September – 4

Earnings per share (EPS) July- 3

Economic Aid Act Feb. – 1; Feb. – 2

Economic Impact Payments, third round (EIP3) May – 4

Economic value added (EVA) July – 3

Employee Retention Credit April – 4

Employee stock options April – 1

Employee stock ownership plan (ESOP) November – 4

Environmental, social and governance (ESG) issues Oct. – 4; April – 3

Ethics and compliance, management of May – 2

ETSC, definition of November – 4

Executive compensation, COVID-19 and October – 2

FASB & GASB Chairman Collaboration April – 5

FASB and IASB convergence project June – 5

FASB, pandemic and February – 3

FATCA, Common Report Standard and November – 2

Five-year lookback rule November – 1

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Flexible Spending Account (FSA) April – 4

Fraud triangle October – 2

FTE Safe Harbor February – 2

Further Consolidated Appropriations Act 2020 August – 4

GASB revenue and expense recognition project June – 5

GASB Statement No. 62 August – 5

Global Forum on Transparency and Exchange of Information November – 2

Going concern analysis October – 2

Going concern considerations February – 5

Goodwill impairment, COVID-19 and October – 1

Governmental Accounting Standards Board (GASB) April – 5

Human capital April – 3

Inspection report, PCAOB July – 2

Internal audit and internal controls, difference between November – 3

Internal auditing, COVID-19 and January – 1

Internal auditing, technology and January – 1

Internal controls programs, advantages and disadvantages of November – 3

Internal controls, not-for-profits and February – 5

Internal controls, risk assessment and November – 3

International Ethics Standards Board for Accountants – see: IESBA

International Standard for Review Engagements 2400 December – 1`

IPOs and SPACs July – 1

IRC Section 409A April – 1

IRC Section 482, transfer pricing and April – 1

IRC section 501(c)(3), tax-exempt organizations and July – 5

IRC section 501(c)(6), tax-exempt status and Feb. – 1

IRC section 7623(a) August – 4

IRC section 7623(b) August – 4

IRS Form 941X, existing and revised October – 3

IRS Notice 2020-69, purpose of GILTI under November – 1

Leases, accounting for July – 2

Licensing, impact of technology on January – 3

Net Investment Income (NII) Tax July – 4

Next generation internal auditing December – 2

Next Generation Internal Audit study, 2020 January- 1

No Action Letter, SEC and September – 4

Not-for-profits, finance and accounting challenges for February – 5

OMB Compliance Supplement, 2020 May – 5

Organization for Economic Co-operation and Development (OECD) April – 1

OSHA, whistleblower complaints and September – 4

Payroll tax deferral Oct. – 3; Dec. – 4

PCAOB inspection report July – 2

Personal brand, auditing your May – 3

PPP loan forgiveness, deductability of expenses for January – 2

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PPP loan obligations January – 2

PPP, changes to February – 4

PPP, second draw Feb. – 1; Feb. – 2

Principal-Agent problem April – 1

Privacy, social media and January – 4

Public Company Accounting Oversight Board (PCAOB) July – 2

Qualified retirement plans November – 4

Regulation S-K April – 3

Retirement plan regulations, changes to February – 4

Return on investment (ROI) July – 4

Revenue and expense recognition, three approaches June – 5

Revised Uniform Unclaimed Property Act (RUUPA) June – 2; June – 3

SSARS No. 25, purpose of December – 1

SBA PPP loans September – 1

SBA, second program February – 1

Schedules K-2 & K-3 September – 3

SECURE Act November – 4

Small Business Reorganization Act of 2019 Sept. – 1

Social credit model January – 4

SOX, whistleblower complaints and September – 4

Special purpose acquisition companies (SPACs) July – 1

State and local taxes, limit on deductibility of September – 1

Stock options, primary forms of April – 1

Strength, weaknesses, opportunities and threats (SWOT) analysis December – 2

Sustainability Accounting Standards Board (SASB) Oct. – 4; April – 3

Sustainability, long-term April – 3

Task Force on Climate-related Financial Disclosures (TCFD) October – 2

Tax challenges with digital and global economy April – 2

Tax Cuts and Jobs Act – see: TCJA

Tax-exempt status, activities that jeopardize July – 5

TCJA, IRC Section 118 and October – 4

Taxpayer First Act August – 4

Tax Relief and Health Care Act of 2006 August – 4

Technology, GASB and April – 5

Transfer pricing April – 1; April – 2

Triggers, single vs. double stock option April – 1

Trusts and estates, final regulations for November – 1

Unclaimed property, audits and June – 3

Unclaimed property laws June – 2; June – 3

Unclaimed property, types of June – 2

Uniform Prudent Management of Institutional Funds Act (UPMIFA) February – 5

Valuation analysis, COVID-19 and September – 2

Virtual currencies, valuation of December – 3

Whistleblower complaints Sept. – 4; Aug. - 4

W-2 reporting & deferral, IRS guidance on December – 4

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Group Attendance and CPE Recordgr

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d Company __________________________________________________ Date __________________

Segment Title _______________________________________________________________________

Location of Seminar _______________________________________________________________

SS# Name State Hours Earned

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I hereby certify that the above individuals viewed this portion of CPA Report, participated in the group discussion, and earned the recommended hours of CPE credit.

Discussion leader _______________________________ Date completed ____________

All CPE hours listed are recommended. They are developed in a manner consistent with AICPA guidelines. Since CPE requirements vary by state and/or professional organization, we suggest you contact the appropriate organization for information about their requirements.