Hot topics in internal restructuring transactions John Simon, Ernst & Young LLP Brian Reed, Ernst &...

Hot topics in internal restructuring transactions

John Simon, Ernst & Young LLPBrian Reed, Ernst & Young LLP


Your presenters

John Simon:► Partner, Transaction Tax► Email: [email protected]► Phone: +1 404 817 5265

Brian Reed:► Senior Manager, Transaction Tax► Email: [email protected]► Phone: +1 202 327 7889


Disclaimer

This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.

These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US.

This presentation is © 2015 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.

Views expressed in this presentation are not necessarily those of Ernst & Young LLP.


Agenda

► Common internal restructuring steps► Domestic restructuring► Cross-border restructuring


Common internal restructuring steps


Leveraged distributions


Leveraged distributions: example

Step 1: FinCo loans $100 to Foreign HoldCo

Step 2: Foreign HoldCo distributes $100 to USP.

Current law – Tax-free return of basis

(Section 301(c)(2))

USP

Foreign HoldCo

FinCo

$100

Note

$100

Basis = $100

E&P = $100

E&P = $0

ForeignSub 1

ForeignSub 2


Leveraged distributions

Reasons for change:

► Earnings and profits (E&P) of a foreign corporation can be repatriated without being characterized as a dividend if corporation funds a distribution from a second, related corporation that does not have E&P, but in which the distributee shareholder has sufficient tax basis to characterized the distribution as a return of stock basis.

Proposal:

► To the extent a corporation (funding corporation) funds a second, related corporation (distributing corporation) with a principal purpose of avoiding dividend treatment on distributions to a US shareholder, the US shareholder’s basis in the stock of the distributing corporation will not be taken into account for purposes of determining the treatment of the distribution under Section 301.

► Funding transactions include capital contributions, loans or distributions to the distributing corporation, whether the funding occurs before or after the distribution.


All cash D reorganizations


All cash D reorganization – example

► Parent owns 100% of (foreign) Target and (foreign) Acquiring:► FMV and basis in Target stock $100

Transaction:

Step 1: Parent sells Target to Acquiring for $100.

Step 2: Target checks the box to be disregarded from Acquiring.

► Intended to be an “all cash” D reorganization

► Parent to recognize $0 of income because it has $0 of gain in its Target stock

Parent

Target Acquiring

v: $100b: $100

$100 Targetstock

Target Target CTB

2

1

E&P: $80

E&P: $30


Section 356 – boot within gain rule

► Section 356(a) provides that if “boot” is received in a reorganization, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property:

► Gain may be characterized as a dividend depending on facts.

► Referred to as the “boot within gain” limitation, limits income to a target shareholder to the gain in the share, not the amount of boot received.


Previously proposed amendments to Section 356

► Past proposals would have eliminated the boot within gain limitation in any reorganization (i.e., domestic or cross-border), in which the US shareholder’s exchange has the effect of the distribution of a dividend, pursuant to section 356(a)(2).

► Proposals also adopt E&P sourcing rules similar to the E&E sourcing rules of Sections 304(b)(2) and (5).


E&P elimination through stock distributions


E&P elimination transactionExample steps

Pre-transaction: ► FS1 owns 100 shares of FS2

stock; each share has a $1 value and $1 basis.

► FS2 has $100 of E&P.

Step 1: FS2 redeems 90 shares of its stock held by FS1:► Redemption is treated as a

dividend under Section 302(d).

► FS1’s basis in the its remaining FS2 stock is increased by its basis in the redeemed shares.

USP

FS1

FS2

E&P = $0

▲= 100V = 100

E&P = $100

USP

FS1

FS2

E&P = $0+$90=$90

▲= 100V = 100-$90 = $10

E&P=$100-$90=$10

$90

Pre-transaction Step 1:


E&P elimination transactionExample steps

Step 2: FS1 distributes its 10 shares of FS2 stock:► Fair market value (FMV): $10► Basis: $100

Current law – Under Section 312(a)(3), FS1’s E&P is reduced (but not below zero) by the basis of the FS2 stock distributed ($100).

USP

FS1

FS2

E&P = $90—$90 = $0

▲= 100V = 100-$90 = $10

E&P=$100-$90=$10

Step 2:

FS2 stock


Prevent elimination of E&P through distributions of stock

Reasons for change:► There has been a proliferation of transactions in which corporations distribute stock in

subsidiaries having artificially high bases but minimal value in an effort to reduce E&P prior to making large distributions in the subsequent taxable period.

► These transactions do not result in an economic loss and thus no diminution of dividend-paying capacity.

Proposal:► A corporation’s distribution of stock of another corporation would reduce the distributing

corporation’s E&P in any taxable year by the greater of the stock’s fair market value or the corporation’s basis in the stock.

► For this purpose, the distributing corporation’s basis in the distributed stock would be determined without regard to any adjustments as a result of actual or deemed dividend-equivalent redemptions by the corporation whose stock is distributed and without regard to any series of distributions or transactions undertaken with a view to create and distribute high-basis stock of any corporation.


Domestic restructuring


Overview

► Taxability of interest income to FinCo:► State nexus of FinCo

► Separate company state interest expense deduction for OpCo?► Consider add-back provisions?

► Combined/unitary state interest expense deduction for OpCo?► Can FinCo be excluded from

combined/unitary group?► 80/20 company► Controlled foreign corporation

(CFC)

Parent

OpCo FinCo

Operating income: $ 500

Less: Interest expense:($100)

Taxable income: $400

Interest income: $ 100

Less: Interest expense: ($0)

Taxable income: $100

$2,000 note @ 5%


Intercompany leverage – all cash D reorganization

Transaction steps:

Step 1: OpCo 1 buys the stock of OpCo 2 from Parent in exchange for a $100 note (OpCo 1 Note).

Step 2: OpCo 2 converts to an LLC.

Step 3: Parent contributes the OpCo1 Note to FinCo.

Parent

OpCo 1FinCo OpCo 2

FMV: $100

Basis: $100

E&P: $100

(pre-unitary)

E&P: $100

(unitary)

1 1

OpCo 2 2

3

Parent

OpCo 1FinCo

OpCo 2

OpCo 1

Note

Final structure


Intercompany leverage – all cash D reorganization

Separate company federal treatment:► Parent income recognition limited to gain in

its shares of OpCo 2 stock:► FMV=basis, thus no gain

► Parent’s basis in its OpCo 2 stock is effectively converted into basis in the OpCo 1 Note.

Federal consolidated (Treas. Reg. §1.1502-13(f)(3)):► OpCo 1 treated as acquiring OpCo 2 solely

for OpCo 1 stock, followed by a deemed redemption of the OpCo 1 stock in exchange for the OpCo 1 Note.

► Redemption treated as a dividend from OpCo 1 to Parent.

► Consider whether OpCo 2’s E&P inherited by OpCo 1 at time of redemption.► Relevant for states that conform to

consolidated (e.g., California)

Parent

OpCo 1FinCo OpCo 2

FMV: $100

Basis: $100

E&P: $100

(pre-unitary)

E&P: $100

(unitary)

1 1

OpCo 2 2

3

Parent

OpCo 1FinCo

OpCo 2

OpCo 1

Note

Final structure


Intercompany leverage – forward merger

Transaction steps:

Step 1: HoldCo contributes (at least) $40 of its stock to OpCo 1.

Step 2: OpCo 2 merges into OpCo 1, with Parent receiving $40 of HoldCo stock and a $60 note owing from OpCo 1 (OpCo 1 Note):

► State law merger is required; merger could be into an LLC under OpCo 1.

Step 3: Parent contributes the OpCo1 Note to FinCo.

Parent

HoldCoFinCo OpCo 2

FMV: $100

Basis: $100

E&P: $100

(pre-unitary)

E&P: $100

(unitary)

2

1

3

Parent

HoldCoFinCo

OpCo 1OpCo 1

Note

Final structure

OpCo 1

E&P: $0

2


Intercompany leverage – forward merger

Separate company federal treatment:► There is no gain/loss to Parent because

OpCo 2 stock has FMV=basis.► Parent’s $100 basis in OpCo 2 stock is

effectively converted into $40 of basis in HoldCo stock and $60 basis in OpCo 1 Note.

Federal consolidated (Treas. Reg. §1.1502-13(f)(3)):► OpCo 1 is treated as acquiring OpCo 2

solely for HoldCo stock, followed by a deemed redemption of the HoldCo stock in exchange for the OpCo 1 Note.

► Redemption is likely treated as a dividend from HoldCo to Parent.

► HoldCo does not inherit OpCo 2’s E&P.

Parent

HoldCoFinCo OpCo 2

FMV: $100

Basis: $100

E&P: $100

(pre-unitary)

E&P: $100

(unitary)

2

1

3

Parent

HoldCoFinCo

OpCo 1OpCo 1

Note

Final structure

OpCo 1

E&P: $0

2


Intercompany leverage – “killer” triangular reorganization

Transaction steps:

Step 1: OpCo 1 buys $100 of HoldCo stock from HoldCo in exchange for a $100 note (OpCo 1 Note).

Step 2: OpCo 2 merges into OpCo 1, with Parent receiving $100 of HoldCo stock:

► Alternatively, OpCo 2 could be contributed to OpCo 1 and convert to an LLC.

Step 3: HoldCo transfers the OpCo 1 Note to FinCo in exchange for FinCo stock.

Parent

HoldCoFinCo OpCo 2

FMV: $100

Basis: $100

E&P: $100

(pre-unitary)

E&P: $100

(unitary)

2

1

Parent

HoldCo

FinCo OpCo 1

Final structure

OpCo 1

E&P: $0

2

3

OpCo 1

Note


Intercompany leverage – “killer” triangular reorganization

Separate company federal treatment:► There is no gain/loss to Parent (Parent

receives solely HoldCo stock; no boot).► Parent’s $100 basis in OpCo 2 stock is

converted into $100 of basis in HoldCo stock.

► No gain/loss to HoldCo or OpCo 1 on purchase/use of HoldCo 1 stock.

Federal consolidated (Treas. Reg. §1.1502-13(f)(3)):► No deemed redemption because no boot

issued in reorganization

Parent

HoldCoFinCo OpCo 2

FMV: $100

Basis: $100

E&P: $100

(pre-unitary)

E&P: $100

(unitary)

2

1

Parent

HoldCo

FinCo OpCo 1

Final structure

OpCo 1

E&P: $0

2

3

OpCo 1

Note


Cross-border restructuring


Section 267 transactions


SubsSubs

Section 267 example–facts

► CFC 1 has a built-in loss asset (Asset).

► Potential opportunities for US tax benefit of loss asset?► Basis step-down upon inbound

liquidation or reorganization.► See Sections 334(b)(1)(B) and

362(e)(1)(B)

USP

Asset

V: $80B: $200

CFC 1

Subs

V: $1,000B: $1,000


Section 267(f) planning

► Step 1: CFC 1 sells Asset to CFC 2 for $80:► Asset is not “sub all” of CFC 1’s

assets.► CFC 1’s $120 loss is deferred

under Section 267(f).

► Step 2: CFC 1 checks the box.

► If CFC 2 later sells Asset to an unrelated party, does USP recognize the $120 deferred loss?► Separate return limitation year

(SRLY) limit?

USP

CFC 2 CFC 1Asset

$80CTB

SubsSubsSubs

2

1

Asset


Triangular reorganizations


Cross-border triangular reorganization – common fact pattern

► FS acquires USP stock for property (e.g., cash, note), then uses the USP stock to acquire FT in a triangular reorganization.

► Historically viewed as allowing for inappropriate repatriation, IRS attacked through various notices, and ultimately through a regulation – Treas. Reg. §1.367(b)-10.

USP

FS USS

FT

FTstock

Property

USPstock

USPstock

1

2


Final regulations – deemed distribution and contribution rules

► In the case of a triangular reorganization to which Treas. Reg. §1.367(b)-10 applies, adjustments must be made that are consistent with the adjustments that would have been made if S had distributed property to P under Section 301(c) in an amount equal to the sum of the money and the fair market value of other property used to acquire the P stock (the Deemed Distribution Rule)

► In addition, adjustments must be made that are consistent with the adjustments that would have been made if P had contributed the same property to S (the Deemed Contribution Rule)

► This deemed contribution has the effect of increasing P’s basis in its S stock by the amount of the deemed distribution.


Example based on final regulations

Transaction steps:

Step 1: FS purchases $70 worth of USP’s stock from USP for cash.

Step 2: FS exchanges the USP stock acquired in step 1 for all FT’s stock in a triangular B reorganization subject to Treas. Reg. §1.367(b)-10.

Adjustments to USP’s basis in FS:► Deemed dividend of $70 from FS to USP ► Deemed contribution of $70 from USP to FS; thus USP increases its basis in FS by $70, from $30 to $100 ► Compare to result if FS had distributed $70 of cash to USP as a dividend

USP

FV = $70AB = $10

FS USS

FT

USP stock(FV = $70)

E&P = $80

$70

USP

FS USS

FT

FV = $100AB = $30

FV = $100AB = $30 $100

FV = $70AB = $10

E&P = $10

1

FTstock

USPstock2


IRS issues Notice 2014-32 on 25 April 2014

► The Internal Revenue Service (IRS) and the Treasury Department intend to revise the regulations under Treas. Reg. §1.367(b)-10 to:► Eliminate the deemed contribution rule► Clarify the no-US-tax exception to Treas. Reg. §1.367(b)-10► Modify the Section 367(a) and Section 367(b) priority rules by

adjusting the amount of income or gain that is considered Section 367(b) income for this purpose

► Clarify the scope of the anti-abuse rule of Treas. Reg. §1.367(b)-10(d)

► In general, the regulations will apply to a triangular reorganization completed on or after 25 April 2014.


Elimination of the deemed contribution rule under the notice

► “The IRS and the Treasury Department are aware that taxpayers are engaging in transactions designed to avoid US tax by exploiting the deemed contribution provided under the final regulations. The IRS and the Treasury Department believe that the deemed contribution is inconsistent with the purpose of §1.367(b)-10…”

► The IRS and the Treasury Department intend to revise the final regulations to eliminate the deemed contribution rule

► In addition, the rule in §1.367(b)-10(b)(4) will be modified to provide that “P’s adjustment to the basis of its S stock under §1.358-6 will be determined as if P provided the P stock or pursuant to the plan of reorganization, notwithstanding that S in fact acquired the P stock or securities in exchange for property.”


Example based on the notice

Transaction steps:

Step 1: FS purchases $70 worth of USP’s stock from USP for cash.

Step 2: FS exchanges the USP stock acquired in step 1 for all FT’s stock in a triangular B reorganization subject to Treas. Reg. §1.367(b)-10.

Adjustments to USP’s basis in FS:► Deemed dividend of $70 transfers from FS to USP.► USP’s adjustment to the basis of its FS stock under Treas. Reg. §1.358-6 are determined as if USP provided the USP stock

pursuant to the plan of reorganization. Thus, USP’s basis in FS is increased by $10 (the basis of the FT stock in USS’s hands), from $30 to $40.

USP

FV = $70AB = $10

FS USS

FT

USP stock(FV = $70)

E&P = $80FT stock

$70

USP

FS USS

FT

FV = $100AB = $30 FV = $100

AB = $30 $40

FV = $70AB = $10

E&P = $10

USP stock

1

2


Final regulations – anti-abuse rule

► The final regulations provide that appropriate adjustments shall be made if, in connection with a triangular reorganization, a transaction is engaged in with a view to avoid the purpose of Treas. Reg. §1.367(b)-10.

► For example, the E&P of S will be deemed to include the E&P of a corporation related to P or S for purposes of determining the consequences of the adjustments provided in the final regulations, if S is created, organized or funded to avoid the application of Treas. Reg. §1.367(b)-10 with respect to the E&P of a related corporation.


Anti-abuse ruleThe notice

► “The IRS and the Treasury are concerned that some taxpayers may be interpreting the anti-abuse rule too narrowly.”

► The anti-abuse rule will be clarified to provide that:► S’s acquisition of P stock or securities in exchange for a note may invoke

the anti-abuse rule.► The E&P of a corporation (or a successor corporation) may be taken into

account for purposes of determining the consequences of the adjustments provided in the final regulations.

► A funding of S may occur after the triangular reorganization.► A funding of S includes capital contributions, loans and distributions.


Thank you

The future of tax analytics

Tony Ferrante, Ernst & Young, LLPTax technology and data analytics services


Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.



EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US

This presentation is © 2015 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.

Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP.

This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances



Data analytics for tax

Analytics: why and what?

?Current state

of tax analyticsDesigning the path forward


*Source: Economic Intelligence Unit. Survey conducted with 530 senior executive across industries (Feb 2013)

Over three-quarters (77%) of companies good with analytics are also ahead in year-over-year (YOY) growth compared to peers.

Somewhat ahead

Somewhat behind

Substantially behind

23%

49%

28%

None

None

2010 2011 2012Series1

37%

58%67%

Over two-thirds (67%) of companies gained a significant competitive advantage from using analytics .(15% increase from last year and 80% increase from two years ago)

Financial performance of companies good with analytics

% of companies indicating a competitive advantage with analytics

On par

*Source: MIT Sloan Management Review Survey conducted with more than 2,500 executives across industries (Mar 2013)

Benefits of analyticsSignificant economic returns and competitive advantage

Ahead


Reason #1: The confluence of electronic data, processing power and software

Summarize Summarize

Then NowTransactions

Summarize

Tax

Summarize

Transactions

Tax

JANUARY

1


Reason #2: Taxing authorities are using analytics

Taxing authorities around the world are requesting or mandating taxpayers to provide greater detail than previously required. The taxing authorities are using analytics to understand the data, improving audit selection and tax compliance.

Australia

United States

Mexico

Brazil

Netherlands

China


Reason #3: Unlocking value for the tax department

► Control/risk management► Efficiency and cost

reduction► Tax-affected business

decisions► Better stakeholder

communication


Analytics components and capabilities


Analytics components and capabilitiesOverview

► Interactive presentation

► Statistical analysis/modeling

► Large datasets

Visualization

Data science

Big data


Analytics components and capabilitiesBig data

► Internet of things► Falling data storage and processing costs

Big data Not so big data

Volume Terabytes/petabytes/zettabytes megabytes/gigabytes

Variety Unstructured (text, voice, video) structured/relational

Velocity Data in motion (streaming) data at rest

Veracity Untrusted/uncleansed trusted/cleansed

► Growth of digital information


——————————————————————

——————————

Analytics components and capabilitiesData sciences

► Overwhelmed with data

► Signal in the noise

► Automated analysis for scale

► Rich statistical tools

► Predictive models101010010


Analytics components and capabilitiesInteractive visualizations

Spot the trend


Analytics components and capabilitiesInteractive visualizations


Analytics components and capabilitiesNew skills required

Tax Stats

Tech


Data analytics applied for tax


Analytics ascendency model

DescriptiveWhat happened?

?

DiagnosticWhy did it happen?

PredictiveWhat will happen?

PrescriptiveHow can we make it happen?


Case studyUnlocking the value of the compliance and reporting data

► Proactively identify and manage compliance and reporting risk through improved visibility and control

► Deliver greater value from the global tax function while managing risk

► Facilitate integration of the record-to-report to achieve efficiency and cost reduction

► Enhance business decision-making capability

Control

Compliance

Analytics


Tax agendaA strategic discussion of your tax function

► Strategic alignment with business

► Help to improve value ► Alignment with

risk profile► Cash flow and

financial impact

► Risk management

► Audit-ready documentation

► Integrated with compliance

► Binding rulings and voluntary disclosures

Tax life cycle

Internal influences

► Integrated global process

► Accurate, supportable tax accounts

► Tools and technology

► End-to-end reporting Strategy

Enterprise

Governance

Regulatory

Economic

Industry

External influence

s

► Leverage provision data

► Consistent global process

► Timely visibility and status reporting

► Real-time submission of transaction data


Case studyConnecting the phases of the tax life cycle

Leveraging analytics to gain insights and enable decisions to support all phases of the tax life cycle

Taxperformance management


Case studyUnlocking the value of the compliance and reporting data

► Lessons learned:► Don’t take data for granted► Plan to educate stakeholders► Solicit broad input► Iterate rapidly


Case studyShift from compliance to value

Securities trading


Case studyNew visibility into global mobility

Program costs

Short-term business traveler


Case studyIdentifying risk

Risk matrix

Calculation layer


Case studyKeep designing to find value

Compliance key performance indicators (KPIs)

Thresholds and trends


Analytics future applications across tax

Supply chain analysis

Transactional analytics

► Accounts payable/receivable transactional line level analysis

► Tax coding and posting error detection

► One-off or embedded solution

Tax reporting

► Interactive visualizations instead of spread sheets

► Automated control checks and tests

► Data-triggered notification

Risk analysis and monitoring► Risk analysis and heat

maps► Transaction profile trend

monitoring► Automated transaction

risk escalation

Targeted analytics

► Pricing/margin modeling for indirect taxes

► Transactional keyword analysis

► Credits and incentives modeling

► Supply chain mapping using transactional line level data

► Analysis of actual tax treatment against expected

► Customs sourcing considerations

Transfer pricing analytics► Variance from forecast

alerts► Transactional keyword

analysis► Automated comparable

matching algorithms► Policy execution

monitoring


EY insightIf I were in your shoes, what would I be doing?

► Establish what the analytics landscape looks like within your organization

► Assign responsibility for owning analytics within tax► Consider how analytics can support and grow your tax function► Encourage innovation

Growth drivers:► Increased awareness of benefits► New analytics tools and

capabilities► Availability of data

Adoption barriers:► Lack of analytics specialists► Resistance to replace gut instinct

decision-making► Lack of best practices


Thank you


Tony FerranteTax Technology and Data Analytic Services

[email protected]

Global tax in a BEPS world

Steve Stoffel , Ernst & Young, LLP Graham Shaw, Ernst & Young, LLP Patty Burleson, Ernst & Young, LLPPatti Iribarren, Ernst & Young, LLP


Agenda

► Update on the latest developments in the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) Action Plan

► Holding and financing► IP ownership► European Union (EU) state aid► Country review – UK diverted profits tax► Summary/closing thoughts


An update on the latest developments in the OECD’s BEPS Action Plans


Snapshot of OECD’s BEPS Action Plan

BEPSActionPlan

Action 1: Tax challenges of digital economy

Action 7: Permanent establishment (PE) status

Action 8: Intangibles

Action 9: Risks and capital

Action 10: Other high-risk transactions

Action 2: Hybrid mismatch arrangements

Action 3: Strengthening CFC rules

Action 4: Limiting interest deductibility

Action 6: Preventing treaty abuse

Action 5: Harmful tax practices

Action 11: Economic analysis of BEPS activities and measures

Action 12: Disclosure of aggressive tax planning

Action 13: TP documentation

Action 14: Dispute resolution

Action 15: Multilateral instrument


OECD BEPS action plan

1) Tax challenges of digital economy – September 2014

2) Hybrid mismatch arrangements – September 2014

3) Strengthening CFC – September 2015

4) Limiting interest deductibility – September/December 2015

5) Harmful tax practices – September 2014/September 2015/December 2015

6) Preventing treaty abuse – September 2014

7) PE status – September 2015

8) TP for intangibles – September 2014/ September 2015

9) TP for risks and capital – September 2015

10) TP for other high-risktransactions – September 2015

11) Economic analysis of BEPS activities and measures – September 2015

12) Disclosure of aggressive tax planning – September 2015

13) TP documentation – September 2014

14) Effectiveness of treaty dispute resolution mechanisms – September 2015

15) Multilateral instrument – September 2014/December 2015


View from the US

► US Treasury is an active participant in the BEPS project and is:► Strongly supportive of elements of the BEPS project► Skeptical of other elements of the BEPS project► Seeking to forge consensus in the BEPS project

► Many of the international tax provisions included in the Obama Administration’s fiscal year 2016 budget proposals are focused in the same areas as the BEPS actions and reflect ideas that are similar or identical to options proposed in BEPS discussion drafts.

► Congressional international tax reform proposals also reflect a focus on addressing base erosion concerns.


Proposals that include BEPS-related concepts

► Addressing BEPS has become element of fundamental international tax reform discussions.► Former House Ways and Means Committee Chairman Camp’s comprehensive tax

reform discussion draft contains BEPS-related proposals as part of international tax reform, including:► Restrictions on interest expense deductions (Action 4)► Limitation on treaty benefits (Action 6)► Expansion of CFC rules (Action 3)

► Former Senate Finance Committee Chairman Wyden’s earlier bipartisan tax reform bill contained proposals with a BEPS flavor, including: ► Restrictions on interest expense deductions (Action 4)► Very broad expansion of CFC rules (effectively repeal deferral) (Action 3)

► Administration’s budgets and tax reform proposals contain proposals with BEPS overtones, including:► Restrictions or deferral of interest expense deductions (Action 4)► Expansion of CFC rules (Action 3)► Restrictions on use of hybrids (Action 2)


EU perspective on BEPS

► Governments are balancing public opinion with need to remain competitive.

► Tax remains high on Board of Governors agenda due to media and public interest in the taxation of corporates.

► European countries and EU are actively involved in OECD BEPS project.

► EU led developments and state aid investigations.


Different stakeholders, different views

► Source countries: ► Source countries are jurisdictions typically paying into jurisdictions

(destination countries) where a holding, financing, intellectual property (IP) or principal company is located.

► Source countries are in favor of accelerating the BEPS process. No wait-and-see approach, but various unilateral actions have and are taking place.

► Destination countries: ► Most destination countries fully embrace the OECD’s work on the BEPS

project and will actively participate at the OECD level in developing international solutions tackling BEPS.

► The general view is that the issues can effectively be addressed only by coordinated international action.


Action 13 and its implication for taxpayers

► Taxpayers will need to address global transfer pricing in anticipation of Action 13 of the OECD’s BEPS project that will be effective on tax years beginning on or after 1 January 2016.

► Of 15 actions to address global concerns around BEPS, Action 13 focuses on TP documentation and mandates a global masterfile, local files for all country and the country-by-country (CbC) report.

► For companies that do not have a robust, defensible and consistent global transfer pricing framework, Action 13 will highlight inconsistent transfer pricing policies and likely result in increased controversy.

► Action 13 will require data gathering that today appears difficult due to inability to reconcile consolidated and statutory profits and losses (P&Ls), intercompany accounts and intercompany segmented P&Ls.

Draft for Discussion Only


CbC reporting

► The CbC reporting template will require multinational corporations (MNCs) to report the following items annually for each country where they have an entity or permanent establishment:► Revenue, related and unrelated party► Profits► Income tax paid and taxes accrued► Stated capital and retained earnings► Employees► Tangible assets► Also identification of each entity in the country and the business activities

of each


Key points on implementation

► First CbC reports to cover fiscal years beginning on or after 1 January 2016 and to be filed within 12 months after end of year

► Revenue threshold of €750m (MNC group annual consolidated revenue in preceding year) for requirement to prepare and file a CbC report

► No more/no less information than in the template in the September 2014 OECD report

► CbC report generally to be filed with tax authority in home country of MNC group’s parent company and automatically shared with tax authorities in other relevant countries under government information exchange mechanisms

► Implementation of master file and local file elements of transfer pricing documentation to be done by countries, with taxpayers providing files to tax authorities in each country

► Next Action 13 guidance by April 2015

► Keep watch for unilateral action from countries (e.g., Spain) who put in place additional regulatory requirements



Unilateral activity around Action 13 – Spain

► Amendments have been introduced into the transfer pricing provisions, effective 1 January 2015, to include transfer pricing documentation requirements modified in very similar terms to the revised standards included in the report on Action 13 released by the OECD on 16 September 2014.

► Spanish rules also establish that the CbC report will have to include the following information per country on an aggregate basis: ► Group’s revenue, distinguishing between that derived from related and unrelated parties ► Accounting result before corporate income tax (CIT) or a tax of similar or analogous nature ► CIT (or tax of similar or analogous nature) effectively paid, including withholding taxes ► CIT (or tax of similar or analogous nature) accrued, including withholding taxes ► Share capital and equity at the end of the fiscal year ► Average number of employees ► Tangible assets and real estate investments, different to treasury and receivables ► List of resident entities, including permanent establishments, and the main activities these are

engaged in ► Other information that is considered relevant and, if applicable, an explanation on the data

included in such information



Holding and financing


► New anti-hybrid measures► All European Union (EU) Member States agreed on a proposal to implement

anti-hybrid loan rules in the EU Parent Subsidiary Directive (linking rule). EU Member States are obliged to adopt such rules in their domestic legislation per 31 December 2015.

► A growing number of European countries have rules denying participation exemption on inbound hybrid payments (already in place for several years in Denmark, Germany, Hungary, UK; adopted in 2014 in France, Poland and Spain).

► France, Spain and Mexico introduced “subject to tax” requirements for certain deductions; similar draft legislation was tabled in Austria. Further proposals have been made, or are expected to be tabled, in Germany, the US and the UK.

► Ireland legislated to prevent certain Irish incorporated companies being “stateless” in terms of their tax residence.

Recent unilateral activity on BEPS


► Tightened limits on interest deductibility:► Canada and France recently introduced rules against foreign affiliate

dumping or leveraged acquisitions.► Canada introduced rules for back-to-back financing arrangements that

mitigate thin capitalization.► France introduced a net interest cap.► Japan introduced and Finland tightened earnings-stripping rules. ► Several countries tightened thin-cap legislation (Australia, Korea, Poland).

Recent unilateral activity on BEPS


► Review intragroup holding and financing structures:► Are the financing entities in the group structure (reverse) hybrid entities or tax haven

entities?► Are there hybrid loans in the structure? ► What is the substance of the holding and/or financing entity?► In your CbC reporting assessment, how are the financing entities reflected in the CbC

template?► Monitor (developments around) local country interest deduction limitation rules,

withholding tax, beneficial ownership and anti-treaty-shopping rules► Identify alternatives that can be considered to reduce risks (in the short term and in the

long term)► In a BEPS world, there are still opportunities for financing:

► Use of company with net operating losses as financing entity► Use of no-tax jurisdiction to finance countries that do not have domestic interest

withholding tax► Use of low- or medium-tax jurisdiction (e.g., Ireland) with tax treaty network to finance

treaty countries► Use of companies with relevant substance, e.g., treasury center or existing operating

companies

BEPS: What should you do to be ready?


IP ownership


Trends in IP ownershipImplications as a result of OECD BEPS and legislative developments

Principal companies:► Principal’s remuneration needs to be in line with its functions, assets and risks. Two-sided analysis is needed to justify

principal’s profits.► Implications of Action 2 on deductible hybrid royalty/interest payments to IP owner.

► Concerns about reduced withholding or withholding tax exemption on royalty and interest payments under Action 2► Operating models where activities undertaken in a local territory without a taxable presence (e.g., through

commissionaire arrangements, commission agents, service providers and marketing support companies)► Ownership of inventory in a regional distribution center or tolling site

Tax haven/low tax IP structures:► Greater scrutiny expected – IP owner to deploy (developing, enhancing, maintaining, protecting and exploiting)

functions to be entitled to the residual IP profits► Remuneration of IP owner should be in line with functions, assets and risk profile► Funders to receive funding return, legal owners to receive return for legal administrative functions► Concerns about reduced withholding or withholding tax exemption on royalty and interest paymentsIntercompany TP:► Profit split analyses: review of value-creating activities, which leads to method, which leads to price. ► Transparency of company operations► Assess potential impact of country-by-country reporting now

Page 87


IP ownership in a BEPS world

► There are still opportunities for efficient IP ownership. ► US MNCs can still consider setting up an offshore IP Co (e.g., a CV, a UK LLP or low-tax

jurisdiction) for existing, newly migrated or funded IP as an incubator structure for future onshoring of IP.

► IP committees can be established to drive control over DEMPE functions in the short/medium term – recognizing full-time DEMPE functions will ultimately be needed under BEPS.

► In the medium or longer term, consider onshoring IP to align value chain profits associated with the IP with the DEMPE functions as well as:► Intangible and other R&D regimes in IP/principal location► Local country planning in IP/principal location:

► Amortization of IP acquired at fair market value, e.g., move IP currently owned in Irish NRI/CV/UK LP onshore to entity with appropriate functionality with step up for fair market value

► Use of debt to acquire IP► Accounting implications from shifting IP from a low- or zero-tax jurisdiction ► Effective tax rate and book impact of IP movement► IP exit strategy► Changes to the operating model to minimize PE risks for principal companies


Trends in IP ownership Onshore IP ownership

Overview:► Principal acts as onshore IP owner.► Principal owns non-US rights to IP.► Principal is responsible for sales of

products/services outside of US.► Residual profit associated with non-US

business flows back to Principal.► Principal’s effective tax rate determined

by: ► Application of patent box regime ► Tax credit/deduction for R&D

activities ► Amortization of intangible property► Arm’s-length transfer pricing for

services and HQ recharges (e.g., marketing intangibles)

► Tax deductions for financing costs

Sale of goods

Intercompany services

Cost sharing IP development

Contract Manufacturer

Local Distributors R&D Providers

USParent

Principal


Trends in IP ownershipOffshore IP ownership

Overview:► IP ownership is offshore.► IP owner could purchase, license or cost

share IP with US Parent.► IP owner licenses the IP to Master Distributor

in return for an arm’s-length return► Activity of Master Distributor depends

on business.► Key drivers of effective tax rate (ETR) of IP

owner and Master Distributor:► Pricing of royalty paid by Master

Distributor and split of functionality between it and IP owner

► Withholding tax, if any, on royalties paid by to IP owner

Other technical considerations:► Exit of IP out of foreign parent► Anti-avoidance measures► PE analysis for IP owner

Master Distributor

IP Owner

e.g.(i) Sale(ii) License, or(iii) Cost sharing

USParent

Sub-license

Contract Manufacturer

R&D ProvidersLocal Distributors

Sale of goods

Intercompany services


BEPS: What should you do to be ready?

► Review IP ownership structure► Is the IP (economically) owned in a reverse-hybrid entity or low-tax

jurisdiction?► What kind of governance and substance are in place at the level of

the IP entity?► Are the contracts consistent with how an arm’s-length contract

would look given DEMPE functions?► When you model CbC reporting and identify likely audit risks, how is

the IP owner reflected in the CbC template?► Identify alternatives that can be considered to reduce risks (in the

short term and the long term)


EU state aid


EU state aidWhat is it?

► Included in Article 107(1) of the Treaty on the Functioning of the European Union:

“Any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the common market”


EU state aidWhy do we care?

► Illegal state aid can give rise to recovery of received benefits and interest.

► Recovery period of 10 years starts on the day on which the state aid was awarded.

Are your EU entities at risk of being challenged?


Country review – UK diverted profits tax


UK – General approach to BEPS

► UK government’s approach to BEPS project:► An international issue that cannot be solved by the UK alone► Best solved globally through the mediums of the G8, G20, the EU and

the OECD

► While the UK supports the BEPS initiative, any changes being proposed by the OECD should be compatible with the government’s two objectives:► Ensuring that the UK remains “open for business”► Working with international partners to prevent unfair tax

avoidance/aggressive tax planning by multinationals► “Low taxes, but taxes that will be paid”► George Osborne, Chancellor of the Exchequer


UK – Recent BEPS initiatives

► UK/Germany joint proposal on new rules for all preferential IP regimes.► Seeks to achieve a balance between ability to offer tax benefits for

IP-related investment and preventing the misuse of such benefits► Consultation released regarding changes to the UK anti-hybrid rules in line

with the OECD recommendations in respect of Action 2:► New law predicted to apply from 1 January 2017

► Legislation enabling the implementation of annual country-by-country reporting; report must include:► Revenue; profit before tax; income tax paid and accrued► Total employment; capital, retained earnings; tangible assets► Identity of each entity in a particular tax jurisdiction and provide an indication

of their business activities► Introduction of UK diverted profits tax from 1 April 2015


Overview of diverted profits tax (DPT)

► A new tax to deal with “aggressive avoidance” by multinational companies making sales in the UK

► A response to political and public pressure in the UK, aligned to the wider BEPS agenda

► DPT is a new tax:► Not covered by existing double tax treaties► Cannot offset existing corporation tax losses, e.g., stock option deductions

► Requires taxpayer, in many situations, to notify Her Majesty's Revenue and Customs (HMRC) of potential DPT liability

► HMRC to then issue charging notice if appropriate


UK diverted profits tax (DPT)

► 25% tax on profits diverted from UK to a low substance entity (“section 80 charge”) or of an avoided PE (“section 86 charge”)

► Companies at risk from 1 April 2015 where entity or transaction with “insufficient economic substance”

► No formal clearance mechanism other than advance pricing agreement (APA): ► APA will not be agreed without full visibility on supply chain.► Law allows for informal agreement of no DPT notification by ‘‘an officer of

HMRC,’’ i.e., customer relationship manager.► Could base initial tax charge on disallowance of 30% of payment made by

UK/deemed PE expenses► Tax payable within 30 days of charging notice, no TP defense► Tax not recoverable until DPT profits agreed


Charging provisions

► Section 80 – Lack of economic substance ► A UK resident company (C)► A provision between C and another

person (P)► C and P connected► Results of provision – an effective tax

mismatch outcome► The insufficient economic substance

condition met► C and P not both small or medium-sized

enterprises (SMEs)► The provision not an excepted loan

relationship

► Section 86 – avoidance of a PE ► A non-UK resident company carrying on a

trade (or part of it)► A person carrying on activity in the UK in

connection with the supplies of goods, services or other property as part of trade

► Reasonable to assume activity designed to ensure no UK PE (ignoring other commercial benefits)

► Meets either tax mismatch or tax avoidance conditions (or both)

► Person and non-UK resident company not SMEs

► Exemption for independent agents► Exemption for limited sales (<£10m) and

expenses (<£1m)


Company must notify if potentially within DPT scope within three months after end of accounting period (six months during

transitional period, i.e. periods ending prior to 31 March 2016).

Company has 30 days from receipt of notice to make representations.

Twelve-month period begins from relevant payment date for HMRC to review charging notice and may issue supplementary/amending

notice increasing or reducing the DPT.

HMRC may issue preliminary notice of chargeability within two years after end of accounting period (four years if no notification).

HMRC will either issue charging notice or confirm no charging notice to be issued, within 30 days from end of representation

period.

Duty to notify

HMRC issues preliminary notice

Company makes representations

HMRC issues charging notice

HMRC reviews/considers the charging notice

DPT must be paid within 30 days from issue of charging notice and no right to appeal at this stage or postpone.

Company may be liable to penalty if it does not make notification.

HMRC may consider representations on threshold conditions and factual matters.

Company has 30 days from end of review period to appeal or DPT becomes final.

Assessment process


What next?

► DPT to apply from 1 April 2015; need to determine if it may apply

► Need to consider impact on ETR from Q1 2015?► Determine approach to notification► Determine approach to HMRC engagement


Short-term actions

► Assess whether DPT is likely to apply and need for notification:► Estimate of exposure► 30% disallowance?► Rule of thumb profit split?

► Develop strategy for dealing with DPT and notification requirement:► HMRC engagement?

► APA program? ► Composite risk management (CRM) risk assessment?

► Defense strategy:► Transfer pricing methodology► Substance vs. profitability assessment► Operational and TP documentation


Summary/closing thoughts


Preparation will help you ride the wave of change


Thank you!

Tax accounting insights and challenge areasNate English, Ernst & Young, LLP

Jon Schneider, Ernst & Young, LLP

Tax accounting insights and challenge areas

Agenda

► Developments:► Accounting Standards Updates► Financial Accounting Standards Board (FASB) project status► Internal control over financial reporting (ICFR)► Public Company Accounting Oversight Board (PCAOB)

focus areas ► Securities and Exchange Commission (SEC) focus areas

► Tax provision challenges and practice issues:► Common causes of tax restatements

► Best practice responses:► Reduce risk in tax accounting calculations

► Tax provision recommendations


Accounting Standards Updates


Accounting standards effective in 2015

► Accounting Standards Update (ASU) 2014-01, Accounting for Investments in Qualified Affordable Housing Projects:► For public business entities, effective for annual periods, and interim periods within those

annual periods, beginning after 15 December 2014► For non-public business entities, one year deferral► Early adoption permitted► Retrospective application

► ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity:► For public business entities and certain not-for-profit entities, effective for disposals (or

classifications as held for sale) occurring in annual periods, and interim periods within those annual periods, beginning on or after 15 December 2014

► For all other entities:► Same effective date for annual periods► One year deferral for interim periods only

► Early adoption permitted► Prospective transition for disposals (or classifications as held for sale) on or after effective date


Accounting standards that can be early adopted in 2015

► ASU 2015-01, Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items:► For all entities, effective for annual periods, and interim periods within those annual

periods, beginning after 15 December 2015 ► Early adoption permitted; however, must occur at the beginning of an annual period ► Prospective or retrospective transition


Revenue recognition standard Overview

► Revenue recognition accounting standard issued on 28 May 2014:► Supersedes virtually all industry and interpretive guidance

► Requires more estimates and judgments than current guidance

US generally accepted accounting principles (GAAP) effective dates for calendar year-ends*

Transition method Public Nonpublic Early adoption?

Retrospective or modified retrospective

Q1 2017 2018 No**

* FASB decided on 1 April 2015 to propose a one-year deferral of the effective date for its new revenue standard for public and nonpublic entities reporting under US GAAP. The proposal also would permit both public and nonpublic entities to adopt the standard as early as the original public entity effective date (i.e., annual reporting periods beginning after 15 December 2016 and interim periods therein). An exposure draft on the proposal with a 30-day comment period is expected.

** Nonpublic companies may early adopt as of public company effective date


Revenue recognition standardA converged standard?

The FASB and International Accounting Standards Board (IASB) each issued new standards:

► The standards are consistent except for five areas:► FASB establishes a higher collectibility threshold when assessing

whether a contract exists (based on existing definitions of “probable” under US GAAP and IFRS).

► FASB requires more interim disclosures than IASB.► IASB allows early adoption.► IASB allows an entity to reverse impairment losses on assets

recognized.► FASB provides relief for nonpublic entities relating to specific

disclosure requirements, effective date and transition.


Revenue recognition final standardThe five-step model

► Core principle – recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services

Step 1: Identify the contract(s) with the customer

Step 2: Identify separate performance obligations

Step 3: Determine the transaction price

Step 4: Allocate transaction price to separate performance obligations

Step 5: Recognize revenue when (or as) each performance obligation is satisfied


Revenue recognitionConsiderations for public companies

► Public entities that choose the full retrospective approach may elect not to push the effects back further than 2015 for their selected financial data tables.

► Staff Accounting Bulletin (SAB) Topic 11.M requires disclosure of the effects of recently issued accounting standards.► Disclosures are expected to evolve as more information about the effects

are known (including the chosen transition method).

2013 2014 2016

Final revenue standard

Prior periods presented

2017

Effective

Modified retrospective application date (public entity)

2015

Retrospective application date

SEC five-year table?

SAB Topic 11.M (SAB 74)

2018

Modified retrospective application date (nonpublic entity)


Revenue recognitionEffective dates

► Effective for annual periods beginning after:► 15 December 2016 for public US GAAP entities and IFRS filers► 15 December 2017 for non-public US GAAP entities.

► Standard includes an expanded definition of a public entity.

► Early adoption:► Prohibited for public US GAAP entities► Permitted for US GAAP nonpublic entities► Permitted for IFRS preparers

► With two years until the effective date, it may appear that companies have ample time to prepare; however, the potential changes to revenue recognition for some companies may be significant.

► Take advantage of the time you currently have.


Revenue recognitionDrivers of complexity

Nature of arrangements

Change management

Diversity of products and

services

Location(s) of business functions

Financial reporting systems

Revenue cycle

Control environment

Implementation effort


Revenue recognitionTax technical considerations

► Taxpayers will need to determine when and how any change in revenue recognition for financial reporting purposes is recognized for tax purposes:► For taxpayers applying a deferral method for advance payments, the amounts deferred

for tax purposes are determined by reference to the amounts deferred for financial statement purposes.

► A change in revenue recognition for financial statement purposes may be a permissible method for tax purposes.

► In certain jurisdictions, local tax liability is based upon statutory financial statements:► When local statutory financial statements are prepared under IFRS, the statutory financial

statements may change with adoption of the standard.

► Evaluate whether a foreign subsidiary’s E&P or local tax change the amount by which a distribution is taxable as a dividend, the amount of Subpart F inclusion or deemed paid foreign tax credits

► Evaluate intercompany prices and transfer pricing policies where adoption changes revenue, profits or third-party comparables are used in determining transfer pricing

► May require companies to review the methodology for compiling sales apportionment data


Revenue recognitionIncome tax accounting considerations

► New temporary differences may arise or existing temporary differences may be computed differently:► Companies may need to revise their processes and data collection tools.

► Valuation allowance considerations may change:► Change in deferred tax assets, temporary difference reversals or expected future taxable

income may affect judgments regarding the realizability of deferred tax assets.

► Multinational companies will need to consider the effects of changes in revenue recognition for financial reporting purposes at foreign subsidiaries:► Jurisdiction-by-jurisdiction analysis necessary to assess whether the change in revenue

recognition for financial reporting results in temporary differences due to differences in timing and amount of revenue recognized for financial reporting and tax purposes

► Current and deferred tax consequences of the cumulative effect adjustment reported in the period of adoption:► Requires careful consideration of the income tax accounting effect of individual items included

in the cumulative effect adjustment

► A change in an accounting method for tax purposes requires careful consideration of the period the change in method is considered for financial reporting purposes


FASB project status


Selected FASB projectsCurrent status

Project Status

Leases Drafting final standard

Financial instruments:

Classification and measurement* Drafting final standard

Impairment Re-deliberations

Hedging Initial deliberations

Clarifying the definition of a business

Initial deliberationsGoodwill for public business entities (PBEs) and not-for-profits (NFPs)

Intangible assets in business combination for PBEs and NFPs

* Amendments to Accounting Standards Codification (ASC) 740, Income Taxes, are expected in final standard.


FASB simplification initiativesCurrent status

Simplification project Status

Measurement date: defined benefit plan assets

Drafting final standard

Customer’s accounting for fees in a cloud computing arrangement

Presentation of debt issuance costs

Subsequent measurement of inventory Re-deliberations

Income taxes – intra-entity asset transfers and balance sheet classification of deferred taxes

Comment period

Employee share-based payment accounting improvements*

Drafting exposure draft

Balance sheet classification of debtInitial

deliberations

* Amendments to ASC 740 are expected in the proposal.


FASB income taxes simplification

► Eliminate exception that requires deferral of the income tax effects of intercompany sales/transfers of assets:► Recognize income tax expense in the period of the sale/transfer► Modified retrospective transition approach► Recognize deferred tax effects of difference between the tax basis in the

buyer’s jurisdiction and the book basis after elimination of the intercompany profit

► FASB expectations:► For public business entities, proposed amendments effective for annual

periods, and interim periods within those annual periods, beginning after 15 December 2016

► For non-public business entities, proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018

► Early adoption permitted, but not before the effective date for public business entities

Comment letters due 29 May 2015


FASB income taxes simplification

► Require the classification of all deferred tax assets and liabilities as noncurrent:► Companies no longer required to allocate valuation allowances between

current and noncurrent ► No change to jurisdictional offsetting requirements► Prospective transition approach

► FASB expectations:► For public business entities, proposed amendments effective for annual

periods, and interim periods within those annual periods, beginning after 15 December 2016

► For non-public business entities, proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018

► Early adoption permitted, but not before the effective date for public business entities

Comment letters due 29 May 2015


FASB share-based payment project

► FASB voted to propose that all excess tax benefits and tax deficiencies be recognized in the income statement:► Prospective transition

► FASB voted to propose elimination of the requirement that excess tax benefits not be recognized until they are realized:► Modified retrospective transition with a cumulative catch-up

adjustment to retained earnings

► An Exposure Draft will be issued for public comment soon.


FASB income taxes disclosure project

► FASB tentatively decided to require additional disclosures related to foreign earnings and indefinite reinvestment assertions:► Pretax income disaggregated between domestic and foreign earnings,

with foreign earnings disaggregated for any country that is significant to total earnings

► Domestic tax expense recognized on foreign earnings► Undistributed foreign earnings that are no longer indefinitely reinvested

with an explanation of the circumstances that caused the company to change its assertion and separate disclosure for any country that represents a significant portion of the disclosed amount

► Foreign earnings that are indefinitely reinvested for any country that represents at least 10% of the company’s total foreign earnings that are indefinitely reinvested


FASB income taxes disclosure project

► FASB decided not to require disclosure of:► Deferred tax liabilities recorded for unremitted foreign earnings by

country► Estimates of unrecognized deferred tax liabilities on the basis of

simplified assumptions for companies that have made indefinite reinvestment assertions

► Past events or current conditions that have changed management’s plans with respect to undistributed foreign earnings

► FASB indicated that it will discuss income tax disclosures related to uncertain tax positions and other income tax topics at a later date.

► An exposure draft is not expected in the near term.


Internal control over financial reporting (ICFR)


Tax ICFRPrecision and evidence of review controls

► Precision (the nature or level at which the review control operates):► Is the control capable of identifying errors?► Would the control identify errors or fraud that could be material to the

financial statements?► Does the control address the relevant risks?► Does the control identify errors?

► Nature of the errors? Examples?► If not, why?

► Nature of the questions identified: follow-up, outcome?► Is there contradictory evidence indicating the control is not suitably

designed?► What evidence of the control exists?

► Is evidence sufficient to support the assessment?► A signature is not sufficient.


Attributes of a review control

► Who performs the control? Do they possess competence and authority?Who

► When or how often is the control performed (timeliness)?When

► What procedures are performed?► What info or data is used?► What does the reviewer evaluate?► What precision is encompassed?► What types of errors are identified? ► What actions are taken or result?

What


Tax ICFR Design example

Poor example Better example

Appropriate personnel review the return to provision true-up calculation.

On an annual basis, in the period in which the federal income tax return is filed (when), the chief accounting officer (who) reviews the return to provision calculation ensuring all positions taken on the income tax return were appropriately considered in the prior year income tax provision (what, why). All return to provision items $250k or greater (net of tax) are evaluated for the effect on the current year or prior year income tax provision (what). Considerations are documented within the return to provision workpaper file and supported with supplemental evidence, if necessary (how).


Tax ICFRConsiderations

► Review control design:► Control owner has appropriate authority and competency.► Precision considerations can be qualitative and/or quantitative thresholds.

► Data – understand and document effectiveness of controls related to source data and inputs to tax provision calculations:► Completeness and accuracy ► Integrity of underlying reports

► Appropriate evidential support to document both the design and operating effectiveness of controls (required for all controls, but can be challenging for review controls)

► Evaluate effectiveness of internal controls design and operation based on current business and procedures

► Perform assessment of control execution and testing of control design


PCAOB focus areas


► PCAOB staff stated that inspections will likely focus on the following areas of emerging risks in 2015:► Risks associated with mergers and acquisitions► Income taxes, specifically matters related to a company’s

assertions related to undistributed cash held in overseas subsidiaries

► The effect of falling oil prices on the audits of affected companies► Audit procedures related to a company’s cash flow statement► Auditing of hard-to-value investments and cybersecurity risks

AICPA National Conference – December 2014PCAOB staff remarks on tax


SEC focus areas


► Focus on quality and clarity of management discussion and analysis (MD&A) disclosures, including those related to income tax rate reconciliations, valuation allowances and earnings that have not been repatriated

► Enhance disclosures in MD&A when:► Income tax expense is material to financial statements – both recorded

expense and expense based on statutory tax rate.► There are material fluctuations or lack of fluctuations that were expected in

the ETR.► There are risks and uncertainties.

► Provide transparent disclosure in MD&A of significant foreign earnings, including earnings and tax rates within specific jurisdictions and jurisdictions’ effects on the ETR

AICPA National Conference – December 2014SEC staff remarks on income tax


Regulatory focus – income taxes

► Foreign earnings

► Realizability of deferred tax assets

► Effective tax rate reconciliation


Foreign earnings

► Indefinite reinvestment:► Not an all-or-nothing assertion► Positive assertion requiring specific documentation and evidence

of plans each reporting period

► Consider financial reporting implications of tax planning

► SEC comments:“Please explain to us how you evaluated the criteria for the exception to recognition of a deferred tax liability in accordance with ASC 740-30-25-17 and 18 for undistributed earnings that are intended to be indefinitely reinvested. Describe the type of evidence and your specific plans for reinvestment for these undistributed earnings that sufficiently demonstrates that remittance of earnings will be postponed indefinitely.”


Current disclosure requirementsIndefinite reinvestment of foreign earnings

► Certain disclosures required when the deferred tax liability is not recognized (ASC 740-30-50-2):► The cumulative amount of the temporary difference (i.e., outside

basis difference in which the book basis of the investment exceeds its tax basis before application of a tax rate) (ASC 740-30-50-2(b))

► The amount of the unrecognized deferred tax liability related to the difference or statement that it is not practicable to determine (ASC 740-30-50-2(c))

► Types of events that would cause the temporary difference to become taxable (ASC 740-30-50-2(a))

► Notably, there is no practicability exception for disclosing the temporary difference required by ASC 740-30-50-2(b).


Realizability of deferred tax assets

► How evidence was weighted ► Cumulative losses► Consideration of the four sources of taxable income, including the prominence

of each source and the material uncertainties, assumptions or limitations associated with each source

► Timing and reason for changes in valuation allowance► Consistency of assumptions► Consistency of accounting with MD&A disclosures► SEC comments:

► “Please substantially revise your disclosure in future filings to provide investors with quantitative and qualitative information of the material positive and negative factors that you considered when arriving at your conclusion that it is more likely than not that the deferred tax assets will be realized.

► Please discuss the significant estimates and assumptions used in your analysis, including the specific factors that changed during fiscal 2012 and led you to determine the reversal was appropriate at this time.”


Realizability of deferred tax assets

► SEC comments (cont.):► “Please discuss how you determined the amount of valuation allowance to reverse.► Please disclose the amount of pre-tax income you need to generate to realize these

deferred tax assets. Include an explanation of the anticipated future trends included in your projections of future taxable income. Confirm to us that the anticipated future trends included in your assessment of the realizability of your deferred tax assets are the same anticipated future trends used in estimating the fair value of your reporting units for purposes of testing goodwill for impairment and any other assessment of your tangible and intangible assets for impairment.

► If you are also relying on tax-planning strategies, please disclose the nature of your tax planning strategies, how each strategy supports the realization of deferred tax assets, the amount of the shortfall that each strategy covers, and any uncertainties, risks, or assumptions related to these tax-planning strategies.

► Please show us in your supplemental response what your revisions to future filings will look like.”


Effective tax rate reconciliation

► Clearly label items in the income tax rate reconciliation► For material rate reconciling items associated with foreign

jurisdictions, disclose the specific jurisdictions that materially affect the effective tax rate, their tax rates and information about the effects of such foreign jurisdictions (e.g., magnitude and mix) on the effective tax rate

► May question whether large “provision to return” or “true-up” adjustments reflect prior year errors rather than changes in estimates

► Registrants required to determine that rate reconciliation information is consistent with other disclosures in MD&A or footnotes


Tax provision challenges and practice issues


Tax provision challengesRestatements

► General causes:► Application of tax technical rules:

► Tax basis ► Intra-period tax allocation:

► Interim periods► Accounting for outside basis differences► Realizability of deferred tax assets (DTAs):

► Tax planning strategies► Deferred tax liabilities (DTLs) as source of income

Income tax errors are a

leading cause of restatements.


Appropriate application of tax basis

► Essential starting point – maintaining a detailed and accurate record of the tax basis of all assets and liabilities, including those without a book basis:► A fluctuation analysis of tax basis supporting the deferred tax

balances may not provide sufficient audit evidence

► Common pitfall – not properly identifying a tax basis or attribute or not appropriately recording and tracking the tax basis or attribute in subsequent periods:► Requires technical understanding of tax law:

► Often for multiple taxing jurisdictions ► May be simple or complex

How is the tax basis evaluated?


Intra-period allocation

► Be mindful of the complexity of the intra-period allocation rules

► Common pitfalls:► Failure to apply the exception (losses from continuing operations and

income from other sources) ► Failure to consider interaction of exception with the interim reporting rules► Inappropriate “backwards tracing”► Failure to follow two step process when income from discontinued

operations is recognized in an interim period and losses from continuing operations are expected for the year

Are there losses from continuing operations and income from another source?

Does the financial reporting reflect the exception to the intra-period allocation rules?


Intra-period allocation

► Exceptions to the general rule apply in all situations where there is: ► A loss from continuing operations► Cumulative income from all other sources

► Exception also applicable to interim periods when company anticipates an ordinary loss from continuing operations for the year

► Applicable even to periods of a full valuation allowance

► Does not change overall annual tax provision (benefit)

► However, may change tax provision (benefit) between interim periods

The result of this computation (as well as the need to do the computation) is often counterintuitive.


Accounting for outside basis differences

► Outside basis differences may not be recognized if certain exceptions are applicable:► Section 14.1.2 of income taxes FRD, Exceptions to deferred tax

accounting for outside basis differences: summary of application of exceptions and common entity types

► Common pitfalls: ► Not providing taxes for outside basis difference related to

investments in partnerships or equity method investments► No longer qualifying for exception with changes in investment

ownership

Are the exceptions to outside basis differences appropriately applied?


Realizability of DTAs

► Same framework:► Establishing a valuation allowance for the first time► Determining whether a valuation allowance continues to

be necessary

► Have all four sources of taxable income been considered?



► Taxable income in prior carryback years:► Consider character – capital losses may only be available to offset

capital gains.► Consider limits – the number of years and amount of losses that

may be carried back may be limited by jurisdiction.

Do you know if a carryback is limited? ?



► Future reversals of existing taxable temporary differences:► Evaluate DTAs on a gross basis ► Consider the timing of reversal of existing taxable temporary

differences ► Common pitfall – DTAs evaluated on a net basis► Common pitfall – naked credits used as a source of taxable

income

Will the deferred tax liabilities result in taxable income in the appropriate period?

Are there deferred tax liabilities associated with book balances that do not have a known period when they may affect the income

statement?


Best practice responses


Best practice responsesReduce risk in accounting calculations

► Uncertain tax positions:► Automate unrecognized tax benefit calculations and rollforwards, including interaction with

other tax attributes, interest and penalty calculations, and cumulative translation adjustments ► Fixed assets:

► Improve reporting of tax return deductions and deferred taxes► Reconcile sub-ledgers and general ledgers to source data and tax systems to uncover areas

for improvement► Share-based payments:

► Support balances for deferred tax assets, additional paid-in capital (APIC) pool, Section 162(m) adjustments and unrecognized tax benefits by entity; consider deductibility of payments to foreign employees

► Tax basis balance sheets:► Support cumulative temporary differences by entity with book and tax basis balance sheets

that agree to tax returns and general ledgers; automate inputs and calculations► Legal entity calculations:

► Improve legal entity data and engage finance for items outside tax department’s direct control (e.g., forecasts, legal entity reporting, intercompany profit elimination)


Best practice responsesReduce risk in accounting calculations

► Intercompany transactions:► Review intercompany transactions for compliance with tax accounting rules

► Improve spreadsheets and tools to minimize risk of errors, reduce hours and manage risk; consider implementing a standardized process and/or tool for:► Tax basis balance sheets to validate deferred taxes► Unrecognized tax benefit computations and tracking► Net operating loss (NOL) tracking ► Indefinite reinvestment assertion documentation and outside basis difference calculations► Share-based payment tax accounting, APIC pools and deferred tax proofs► Section 162(m)(6) deferred tax computations ► Fixed asset deferred tax reconciliations

► Greater than 50% of Fortune 1000 companies use Excel spreadsheets to compute global income tax provision:► Consider third party to test and improve Excel spreadsheets for enhanced efficiency, accuracy

and controls


Tax provision recommendations



► Refresh internal controls for income taxes (consider adopting 2013 framework)► Develop work plan for enhancements and remediation items and assign tasks► Review work plan and timeline with auditor► Assign technical tax accounting white papers for issues and judgments► Accelerate work during quarters and interim to avoid surprises:

► Evaluate and record return-to-provision adjustments► Prove out deferred tax assets/liabilities, current taxes payable/receivable:

► Leverage tax provision-to-return process for completed tax returns

► Document/analyze state tax rates, including apportionment changes and the impact on deferred taxes, and foreign tax rates for changes

► Document outside basis differences, including indefinite reinvestment assertions, and prepare outside basis difference calculations (consider previously taxed income and un-recaptured Subpart F income)

► Document valuation allowance considerations (four sources of taxable income) and prepare position paper

► Document uncertain tax positions.► Consider tool to improve efficiency and accuracy of computations



► Analyze and document unique transactions and events and effects on tax provision, unremitted earnings assertions, uncertain tax positions and valuation allowances (acquisitions, dispositions, financing, internal restructuring, cash flow forecasts, etc.)

► Evaluate intercompany transactions and tax provision effects► Ensure tax accounting judgments align with business results and disclosures

and update disclosures of factors that influenced judgments ► Review for consistency with tax and nontax disclosures:

► Liquidity (foreign reinvestment and parent or domestic cash requirements)► Commitments and contingencies► Acquisitions/dispositions► Cash flow► Equity movements► Share-based payments► MD&A



► Institute regular meetings with external auditors regarding contemporaneous issues (significant transactions, changes in business, etc.)

► Challenge annually prior year processes to identify areas for improvement► Simplify and standardize existing Excel templates► Address technical issues early and prepare white papers for consideration by

management and external audit► Implement standardized global procedures► Consider the tax provision process a year-round area of continued focus► Identify a third party to assist with preparation or review the provision (pre-

audit review) or co-source/outsource to free up internal time for review► Obtain assistance researching and documenting issues or preparing white

papers on tax accounting positions


Thank you!

Evolving IRS paradigm

Mark Mesler, Ernst & Young, LLP


Agenda

► IRS resource constraints► Large Business and International (LB&I) Division

organization changes► New LB&I exam process update► LB&I Coordinated Industry Case (CIC) pilot► Appeals Judicial Approach and Culture (AJAC) Project► Questions


IRS resource constraints


► Budget:► FY2015: $10.9 billion; cut by 1.2 billion or 10% since FY2010► Reduction of approx. 3,000 employees this year and 13,000

employees since FY2010► Training and travel reduced by $248 million or 74% percent since

FY2010

► Cutbacks and impact:► Decline in call service:

► Less than 50% of calls get answered – down from 64% in FY2014.

► Average wait time is over 30 minutes per call and more than 45 days to answer most letters.

► Less audits/rulings/advice► More automated notices, especially international information

return penalties

IRS resource constraints


LB&I organization changes


LB&I organizational chart

LB&I commissioner

Heather C. Maloy

Deputy commissioner (domestic)

Sergio Arellano (A)

Deputy commissioner (international)

Douglas O’Donnell

Shared support

Susan Latham, Dir.

Pre-filing and technical guidance

Tina Meaux, Dir.

Communications, technology and

media

Cheryl Claybough, Dir.Scott Ballint, DFO NW (A)Rosemary Daley, DFO SW

Financial services

Catherine Jones, Dir. (A)Jo McGready, DFO Fin

Prod Barbara Harris, DFO NY

Global high wealth

Cheryl Claybough, Dir. (A)

Heavy manufacturing and

pharmaceutical

Lavena Williams, Dir. (A)Dennis Figg, DFO NE (A)Donald Sniezek, DFO SE

(A)

Natural resources and construction

Kathy Robbins, Dir.Khin Chow, DFO W (A)

Kimberly Edwards, DFO E Steve Whitaker, DFO Eng.

Retailers, food, transportation and

health care

Lori Nichols, Dir. (A)Elise Gardner, DFO E (A)

Lori Caskey, DFO WPaul Curtis, DFO CAS

Assistant deputy commissioner, international

John Hinding (A)

International business

compliance

Sharon Porter, Dir. (A)Jolanta Sanders, DFO EMargie Maxwell, DFO W

(A)William Holmes, Dir. IDM

Theodore Setzer, Dir., FPP

International Individual

compliance

David Horton, Dir.Clifford Scherwinski, DFO

Transfer pricing operations

David Varley, Dir. (A)Hareesh Dhawale, Dir.

APMA

Business systems planning

Dean Wilkerson, Dir. (A)

Management and finance

Keith Walker, Dir.

Planning, analysis,

inventory and research

Christopher Larsen, Dir.

Equity, diversity and inclusion

Rona Evans, Dir.

Division planning, oversight

reporting and liaison

Michael Boccarossa, Dir.

Deputy director Pam Drenthe (A)

(A) = Acting

Holly Paz


LB&I update

► Organizational leadership changes:► Five top executives departures including deputy commissioner

(international, transfer pricing director, director APMA, director international strategy, acting deputy commissioner (domestic)

► Departures due to retirements and departures► New cadre of LB&I executive appointments

► Budget effect on exam resources:► Significant headcount reduction and limited attrition hiring ► Rumor of pending LB&I organization structure

► Impact to taxpayers:► Greater management instability on examinations ► Potential for delays on audit activity and completion dates► Uncertainty in decision-making authorities and accountability► Uncertainty on roles/responsibilities for domestic and

international examiners


New LB&I exam process update


Proposed new LB&I exam processPublication 5125

► Replaces current Quality Exam Process incorporating recent changes:► New Information Document Request (IDR) Directive► Appeals Judicial Approach and Culture Project► Establishment of Issue Practice Groups & International Issue

Networks to promote knowledge sharing vision for focused issue examinations

► Establishes process for centralized issue identification and selection

► Exam teams to limit audit to pre-identified issues► Issues to be managed and audited by “issue teams”

► Implementation in Spring 2015 with internal revenue manual revisions; however, teams have received training.


► LB&I expectations:► Exam teams and taxpayers working transparently► Engage each other in development of examination plan► Follow information document request procedures► Resolve issues at lowest level using appropriate resolution tools

► Taxpayers and representatives:► Identify personnel for each issue with significant knowledge► Collaborate with the exam team to arrive at an:

► Acknowledgment of the facts► Provide support for any additional facts► If facts remain in dispute, documenting the dispute

LB&I examination process – roles and responsibilities


► Initial planning meeting:► Exam team and taxpayer will work together to define the scope of the

examination and process.► Exam team will explain why each issue is being considered.► Taxpayer should provide input on how each issue can be examined.► Issue team approach:

► Comprised of both LB&I and taxpayer personnel responsible for examining each issue

► Collaborate transparently to develop exam procedures for each issue

► Establish relevant facts and ensure each party’s position is fully understood

► Examination plan:► Issue-focused and jointly reviewed► Timelines, audit steps, risk analysis and methods of monitoring

progress

LB&I examination process – planning phase


► Issue development:► Identify and document all relevant facts► Present legal positions ► Communicate both parties’ positions:

► Identifying areas of disagreement► Resolution strategies ► Attempting to resolve at lowest possible level

► Facts:► LB&I teams to seek taxpayer’s concurrence► Resolve any facts in dispute► Consistent with AJAC Project:

► Requires 365 days remain on statute of limitation when received by Appeals

LB&I examination process – execution phase


► Issue resolution tools:► Consistently encourages available issue resolution tools► Requires consideration of Fast Track Settlement with Appeals

► Taxpayer responsibility:► Ensuring all relevant facts and legal arguments provided during

examination► Prevent case being referred back to LB&I by Appeals

► Exit strategy► Requires that discussions include efforts to resolve tax controversy

for certainty► Joint critique of the exam process to recommend improvements► Address future tax treatment of issues to eliminate

carryover/recurring issues

LB&I examination process – resolution phase


► Informal claims for refund:► Provided to the exam team within 30 days of the opening conference► After 30 days, must file formal claims

► Treas. Reg. §301.6402.2 standards:► Set forth in detail each ground upon which a credit or refund is

claimed ► Present facts sufficient to apprise the IRS of the exact basis for the

claim, and ► Contain a written declaration that it is made under penalties of perjury► Claims disallowed if these standards are not met

LB&I examination process – expectations with respect to claims


LB&I examination process – expectations with respect to claims

► Risk assessment:► Claims will be risk assessed similar to other issues.► Fully documented and factually supported claims may permit exam team

to make tax determination without use of IDRs.► Fully documented claims enable a quick assessment to accept or

examine claim.► If the claim warrants examination, then:

► Both the exam team and taxpayer discuss resources and timeline.► LB&I could decide that the claim will be worked separately from the

current examination.


LB&I Coordinated Industry Case (CIC) pilot


LB&I Coordinated Industry Cases (CIC) pilot

► LB&I initiated a new CIC pilot on 30 April 2014:► Pilot will run for 18 months.

► Currently, CIC cases:► Front-end staffed into the LB&I compliance plan► Limits flexibility to allocate resources to other compliance activities

► Under the new process, all CIC cases would undergo a consistent classification process to determine tax return compliance risk and to identify issues for examination.

► New classification process will include issue identification and written explanations on compliance risks, and documentation to support compliance risk conclusions (pre-classification):► All information will be included in case file for use during

an examination.


Appeals Judicial Approach and Culture (AJAC) Project


Appeals Judicial Approach and Culture (AJAC) Project► 18 July 2013 – interim guidance memo for Appeals employees► Applies AJAC to examination and collection cases► AJAC themes:

► This is a quasi-judicial approach to Appeals hearing based on case file.

► No new issues are raised by Appeals.► Appeals will attempt to settle a case on factual hazards when the

case submitted by Compliance is not fully developed and the taxpayer has presented no new information or evidence.

► If a taxpayer provides Appeals with new information, Appeals will return the case to LB&I. If a taxpayer raises new arguments at Appeals, LB&I will be given the opportunity to review and comment on the arguments, but Appeals will maintain jurisdiction.


Appeals Judicial Approach and Culture (AJAC) Project► 3 July 2014 – second phase of AJAC released by Appeals

► Statute of limitations – one year remaining prior to acceptance

► Providing Exam with opportunity to comment (specific time frame, 45 days) or return case to Exam (Appeals releases jurisdiction to Exam)

► Premature referral of case to Appeals or new information presented by taxpayer during Appeals hearing


Questions?


Thank you

EY | Assurance | Tax | Transactions | Advisory

About EY

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Ernst & Young LLP is a client serving member of EYGM in the US.

© 2015 Ernst & Young LLPAll Rights Reserved.

Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

These slides are for educational purposes only and are not intended, and should not be relied upon, as tax or accounting advice.

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