Tax and fiscal enviroment in Puerto Rico today

2016 Kevane Grant Thornton. All rights reserved.

Conference -Tax and fiscal environment in Puerto Rico today

December 13, 2016

Caparra Country ClubSan Juan, Puerto Rico

@2016 Kevane Grant Thornton LLP. All rights reserved.

Disclaimer

DISCLAIMER: These presentations and their content do not represent a consulting. Participants should not act solely on the basis of this material and its content. Its usefulness is for information only and should not be used as a specific consulting. In addition, you must obtain the consultation of an expert before acting or taking a decision on any topic addressed in this presentation.


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Fiscal and financial oversightin Puerto Rico

Ojel RodrguezAdvisory partnerCPA/ABV, CVA, CIRA, CISA, CIA, CFE

Marta RodrguezAdvisory managerCPA/CVA, CGMA

2016 Kevane Grant Thornton LLP. All rights reserved.

Governance and management aspects of the Puerto Rico

Oversight Board

Requirements of fiscal plan

Economic growth under PROMESA

Infrastructure revitalization

Public debt restructuring and

issuance

Agenda

1 2 43 5


Overview of PROMESA

Signed into law by President Obama on June 30, 2016 Creates a structure for exercising federal oversight of the fiscal

affairs of Puerto Rico Establishes an oversight board with plenary authority over Puerto

Rico's financial, budgetary, and legislative processes Provides relief from creditor lawsuits through the enactment of a

temporary stay on litigation Creates two alternative methods to adjust unsustainable debt Expedites approvals of key energy projects and other "critical

projects" in Puerto Rico


Overview of PROMESA

Title I Establishment & Organization of Oversight Board

Title II Responsibilities of Oversight Board

Title III Adjustment of Debts

Title IV Miscellaneous Provisions

Title V Puerto Rico Infrastructure Revitalization

Title VI Creditor Collective Actions

Title VII Sense of Congress Regarding Permanent, Pro-Growth Fiscal Reforms


Eligibility and requirements of Board members

PROMESA requires the Board's members to meet the following criteria: has expertise in finance, municipal bond markets, management,

law, or the organization or operation of business or government is not a candidate for elected office is not an elected or appointed official is not an employee of the territorial government is not a former elected official of the territorial government

Tenure of members: the term of a member of the Board shall be three (3) years

beginning the date of appointment the term of the Chair will be two (2) years or until a successor is

appointedReference: Section 101


Board's composition

Speaker of the House of

Representatives

Speaker of the House of

Representatives

Senate Majority Leader

Minority Leader of the House

Minority Leader of the Senate

Presidents discretion

Nominee 1Nominee 2Nominee 3

President of the United States

Governor or his/her designee


Nominee 1Nominee 2Nominee 3Nominee 4



Member 1 Member 2 Member 3 Member 4 Member 5 Member 6 Member 7 Member 8 (non-voting)

Reference: Section 101


Board's composition (continued)

Republican Nominees Democratic Nominees

Carlos Garcaformer president

of the Puerto Rico Government Development

Bank

President of the United States

Arthur Gonzlezformer chief judge

of the US Bankruptcy court in Manhattan, NY

Jos Carrin IIIinsurance

executive based in San Juan

Andrew BiggsAmerican Enterprise

Institute fellow

Ana MatosantosCalifornia's

finance director from 2009 to 2013

Jos Gonzlezchief executive of the Federal Home Loan Bank of New

York

David Skeellaw professor at the University of

Pennsylvania

Reference: https://juntasupervision.pr.gov/

Governor's designee

Elias Snchez


Executive Director and Staff

Appointed by the Chair with the consent of the Board members Will execute the instructions of the Board and be subject to the

supervision and control of the Board Will have general supervision and direction of the business affairs of the

Board Subject to the approval of the Board, may enter into and execute on

behalf of the Board contracts as he/she deems appropriate The Board is responsible for establishing the salary compensation (no

ceiling or limits are established) The Executive Director may hire and fix the pay of, and remove

additional personnel employed by the Board, as he/she deems appropriate



Board's bylaws

The Board's bylaws were approved on September 30, 2016 during the Board's first meeting in New York the bylaws are based on PROMESA's sections

All actions of the Board shall be taken by an affirmative vote of no fewer than four (4) members and in accordance to section 206(v) of the Act, an affirmative vote of no fewer than five (5) members is required to issue a restructuring certification

Board must meet at least quarterly To the greatest extent possible, the Board shall produce all of its written

materials in English and Spanish The Board shall submit and make public an annual report which will

include audited financial statements and adopted budget



Scope of the Board

63 public entities are covered under PROMESA's dispositions and therefore under the supervision of the Fiscal and Oversight Board, among them: PR Aqueduct and Sewer Authority (PRASA) PR Electric Power Authority (PREPA) Fiscal Agency and Financial Advisory Authority (AAFAF) PR Sales Tax Financing Corporation (COFINA) Puerto Rico Industrial Development Company (PRIDCO) University of Puerto Rico Governmental Development Bank for PR (GBD) Public Corporation for the Supervision and Deposit Insurance of

Puerto Rico Cooperatives (COSSEC)Reference: https://juntasupervision.pr.gov/


Procedures on Transactions Involving Covered Entities

On a letter dated November 23, 2016, the Board shared additional procedures regarding transactions involving covered entities

The Board stipulated that: transactions of covered instrumentalities that are subject to

Approval under PROMESA, must be submitted to the Board no less than 15 calendar days prior to its required approval

the clock for such 15 days will start when the Board confirms it has received all the information required for its review

the Board can delay the transaction and take additional time for its review in the case of complex transactions or in the case the Board believes it requires additional information



Procedures on Transactions Involving Covered Entities (continued)

In addition, the approval request must include at least the following information: a detailed memorandum explaining all the details of the transaction

including purpose, reasons why the transaction is the best public interest, financial resources required and summary of all principal legal documents required to execute

letter evidencing approval by the Fiscal Agency and Financial Authority of Puerto Rico and its rationale for approval

letter from the Office of the Governor of Puerto Rico endorsing the transaction and rationale

legal opinion supporting why the transaction is covered under PROMESA and under what legal basis the transaction can be approved by the Board



Litigation stay

PROMESA suspends certain legal actions against Puerto Rico for debt payments and remedies allowing Puerto Rico to: address its immediate fiscal crisis negotiate with creditors instead of defending itself against

multiple lawsuits improve its governance pursue debt restructuring and liability adjustments resolve long-standing fiscal issues so it can return to

economic growth The stay would remain in effect until February 15, 2017 or six

months after the Board is establishedReference: Section 405


Who will pay for the Board?

Members shall serve without compensation but may be reimbursed for reasonable and necessary expenses

Puerto Rico Government shall designate a dedicated funding source within 30 days of the enactment of the bill

The Board may use its powers to ensure that there are sufficient funds to cover its operation

$370 million*over a 5 year period (FY2017-FY2022)* CBO estimate

Reference: Section 107; Congressional Budget Office

How powerful is the Oversight Board?

How powerful is the Oversight Board?


Powers of the Board

Section 104 of PROMESA describes the Board's broad powers. The Board has the power to:

hold hearings and seek testimony, and receive evidence obtain information and records from federal agencies, Puerto Rico and its

creditors issue subpoenas for testimony or records enforce a law that prohibits public sector employees from participating in a

strike or lockout ensure the electronic payment and administration of taxes seek judicial enforcement of its authority investigate and publicize disclosure and sales practices related to bonds

purchased by retail investors accept gifts, bequests and devises of services or property, as long all gifts

and donors are disclosed within 30 days



What does the Board's fiscal plan entails?

The Board requires the Governor to develop compliant five-year fiscal plans (at least)

If the government fails to develop a compliant fiscal plan, the Board shall develop and certify a fiscal plan

Development and

submissionReview by

BoardNotice of violation

Revision by Governor Approval



Means to approve the fiscal plan

Submitted by the Governor and approved by the Board the plan meets the 14 requirements outlined in PROMESA

Developed and approved by the Board if the Governor fails to take corrective actions on the

recommendations of the Board Jointly developed by the Board and the Governor

the bill allows the Board and the Governor to work collaboratively to develop a consensus plan



PROMESA Fiscal Plan Requirements

1. Provide for estimates of revenues and expenditures in conformance with agreed accounting standards and be based on (i) applicable laws, or (ii) specific bills that require enactment in order to reasonably achieve the projections of the Fiscal Plan

2. Ensure the funding of essential public services 3. Provide adequate funding for public pension systems4. Provide for the elimination of structural deficits5. For fiscal years covered by a Fiscal Plan in which a stay under titles III or IV

is not effective, provide for a debt burden that is sustainable6. Improve fiscal governance, accountability and internal controls7. Enable the achievement of fiscal targets8. Create independent forecasts of revenues for the period covered by the

Fiscal Plan



PROMESA Fiscal Plan Requirements contd

9. Include a debt sustainability analysis (DSA)10. Provide for capital expenditures and investment necessary to promote

economic growth11. Adopt appropriate recommendations submitted by the Oversight Board (under

Section 205(a) of PROMESA)12. Include such additional information as the Oversight Board deems necessary13. Ensure that assets, funds, or resources of a territorial instrumentality are not

loaned to, transferred to, or otherwise used for the benefit of a covered territory, unless permitted by the constitution of the territory, an approved plan of adjustment under title III, or a Qualifying Modification approved under title VI

14. Respect the relative lawful priorities or lawful liens, as may be applicable, in the constitution, other laws, or agreements of a covered territory or covered territorial instrumentality in effect prior to the date of enactment of PROMESA



Puerto Rico Government Fiscal Plan

Governor Garcia Padilla formally presented Puerto Rico's Fiscal Plan on October 14, 2016

On November 9, 2016, the Board open an invitation to comment on the Fiscal Plan (November 23 was the extended its due date for comments submission) A total of 114 comments were received, fifty percent coming from Puerto

Rico residents. Made public by the Board on December 8. On November 23, 2016, the Board issued an assessment of the fiscal plan in

which the following was addressed: convey the reasons why the Board rejected the fiscal plan submitted by

Governor Garca Padilla provide a timeline for the Board to certify a fiscal plan

The Board understand that "more policy adjustment, particularly with respect to structural reforms, is necessary for the Puerto Rico economy to return to sustainable growth



Rebuttal of fiscal plan evaluation principles

The Board established five (5) principles, in addition to the criteria set forth in PROMESA Section 201(b), which the plan must meet in order to be accepted:

Cover at least the next 10 fiscal years with meaningful progress in the next five (5)

Meet the standards set forth in the law (14 requirements)

Achieve the Board's main objective

Assume no additional federal support beyond that which is already established by law (e.g. no Affordable Care Act support extension and no reliance on Act 154 revenues)

Include an appropriate mix of structural reform, fiscal adjustment, and debt restructuring supported by the relevant analytical tools (e.g. debt sustainability analysis and a detailed economic projection)

Achieve the following: stabilize current

economic situation

increase the economy's resilience

shore up public finances

support long-term growth

meet basic needs of citizens

Must include relevant operational plans that show the Government will achieve the changes and reforms it proposes

Principle Principle Principle Principle Principle



Fiscal Plan certification timeline

Publication of Baseline Projections for the Fiscal Plan and principles for achieving balance

December 9th

Working Session on Fiscal and Economic Plan

Fiscal and Economic Plan Draft presented

Meeting to discuss revised version of Fiscal Plan

Distribution to the public of revised Fiscal Plan and invitation to open good-faith negotiations with creditors

Week of December 19th

December 12thDecember 15th

Revisedversion of Fiscal Plan to be submitted to the Board

Week of January 16th

January 31st

Target Date for Certification of Fiscal Plan



Annual and quarterly budgets

Once a fiscal plan is approved, the governor shall submit annual and quarterly budgets compliant with the fiscal plan the Board will be submitting revenue estimates for the period

covered by the budget approval process is similar as the one for the fiscal plans

The Governor would also be required to submit quarterly "budget vs actual" reports in the following areas:

revenues expenditures cash flowsReference: Section 202


Inconsistencies in the budget vs actual reports

Inconsistencies would require explanation and corrective action by the Governor if the Governor fails to take corrective action, the Board would be

required to notify the US House and Senate the Board has the powers to address directly the inconsistencies

identified



Financial stability and management responsibility

The Board may submit recommendations, at any time, to address fiscal and management matters, e.g. privatization of public entities alternatives for paying employee pensions performance-based personnel systems modification or transfers of the type of services delivered by

governmental entities reduce government's non-debt expenditures implement hiring freezes / layoffs in the public sector

The government would have to adopt the recommendations within 90 days if rejected, the governor must submit a statement to the President and

Congress explaining why the recommendations were rejected



Review of laws, contracts and executive orders

Under PROMESA, the Governor would be required to prepare and maintain a public registry of all contracts executed

New contracts must be reviewed and approved by the Board the Board may enter into new contracts without Governor's approval

Board may revoke any existing contract For any newly enacted law, the Governor shall submit a formal cost

estimate the Board has the power to certify and amend any proposed or new

law also has the power to revoke or amend any existing law, regulation

or executive order



Tax abatements and relief agreements

PROMESA requires the Governor to submit a report documenting all existing tax abatement or similar tax relief agreements

The Board reserves the power to execute or modify any tax abatement or relief agreement without limits to what constitutes the limit of power

This report would not be disclosed to the public in order to comply with regulation regarding confidential taxpayer information



For how long would the Board operate?

The Board would be operating until it determines and certifies that Puerto Rico has achieved the following: obtained access to short-term and long-term credit markets at

reasonable rates of interest, and balanced budgets for four (4) consecutive fiscal years



Detroit vs Puerto Rico Fiscal Boards

Reference: Dentons

Economic growth under PROMESAEconomic growth under PROMESA


Overview of Puerto Rico's economy

2.7%1.9%

0.5%

-1.2%

-2.9%-3.8% -3.6%

-1.7%

0.5%

-0.1%

-1.7%-0.6%

-2.2%-2.8%

-3.3%

-1.7%

-5.0%-4.0%-3.0%-2.0%-1.0%0.0%1.0%2.0%3.0%4.0%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Annual Real GNP Growth

The local economy has experienced secular deceleration in economic growth since the mid 1970s

GNP growth has been negative every year since 2007 with the exception of 2012 (0.5%)

Significant decrease in investment weakened the economy investment in construction fell from nearly $7.0 billion (1999) to around $3.4

billion (2014)

Reference: Government Development Bank for Puerto Rico


Government overspending lies at the root of the current the fiscal crisis from 2001 to 2013, accumulated budget deficits exceeded $20 billion.

During the same period $42 billion in debt was issued, half of which was used to cover budget deficits


463.9

1,671.6

201.3

937.6 1,013.0

1,855.8

844.6 965.0

3,180.1 2,651.9 2,464.7

3,298.6

1,322.8

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Fiscal deficits

Reference: Office of Management and Budget


Outmigration reached historical levels with the loss of approximately 331,000 people or 9% of the total population in the period between 2006 and 2015. This has led to an aging of the remaining population, a decreased net birth rate and declines in Puerto Ricos tax base.

Recent data also suggest that the rate of outmigration continues to increase


Reference: Office of Management and Budget

- 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000

3.43.453.5

3.553.6

3.653.7

3.753.8

3.85

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(in

mill

ions

)

Total population and outmigration

Population Annual outmigrationSource: U.S. Census Bureau



Puerto Rico and its various government instrumentalities owe around $68.7 million in debt extraordinarily complex

18 different issuers, including the Commonwealth itself, financing entities, and operating entities that provide essential public services

debt is held by countless and diverse creditors, including retail holders (both on- and off- island), hedge funds, mutual funds, local credit unions and mainland institutional investors, each with different interests and motivations in a potential restructuring

Reference: PROMESA Overview Presentation Government of Puerto Rico


Congress's point of view

Section 701 expresses Congress's point of view regarding fiscal reforms for Puerto Rico:

any durable solution for Puerto Ricos fiscal and economic crisis should include permanent, pro-growth fiscal reforms that feature, among other elements, a free flow of capital between possessions of the United States and the rest of the United States.



Congressional Economic Task Force

Composed of eight (8) members, this task force is responsible of issuing a report by December 31, 2016, that would examine: the relation of federal laws and economic growth in Puerto Rico; economic consequences of a Puerto Rico Department of Health

Regulation 346, which relates to natural products, natural supplements, and dietary supplements; and would

recommend changes to federal laws to spur sustainable, long-term economic growth;

recommend changes to federal law and programs that would reduce child poverty; and

include additional information as deemed necessary



Congressional Economic Task Force(continued)

On September 15, 2016, the Task Force issued its first status update in which the Task Force highlighted its concerns regarding "the relative lack of reliable data pertaining to certain aspects of the economic, financial, and fiscal situation in Puerto Rico"

They received over 335 proposal submissions from individuals and organizations regarding economic growth initiatives for Puerto Rico

The Task Force would be terminated once the report is issued by December 31, 2016

Congressional Task Force membersCongressional Task Force members are:1. Senator Orrin Hatch (R-UT)2. Senator Robert Menndez (D-NJ)3. Senator Marco Rubio (R-FL)4. Senator Bill Nelson (D-FL)5. Representative Tom MacArthur

(R-NJ)6. Resident Commissioner Pedro

Pierluisi (PR)7. Representative Sean Duffy (R-

WI)8. Representative Nydia Velzquez

(D-NY)

Reference: https://pierluisi.house.gov/


Economic growth proposals (most discussed)

Reference: http://pierluisi.house.gov/; Private Sector Coalition; US Department of Health and Human Services

Health Parity in Medicare and Medicaid Federal funding Elimination of HIT Tax in Puerto Rico End the exclusion of territories from Part D of Low-Income Subsidy Program

Jones Act and Maritime Transportation Reform Reform or modification of the Jones Act Amend Section 808 of Law 108-176 of December 2003, also known as the Stevens

Amendment (United States presence in global air cargo industry)

Energy Extend the authority of the Federal Energy Regulatory Commission to review and

regulate local energy industry Extend the Investment Tax Credit for Renewable Energy in Puerto Rico until 2018Social Security Implement a 50% reduction in the social security tax for workers, employers and the

self-employed for a period of six (6) years


Economic growth proposals (most discussed)

Reference: http://pierluisi.house.gov/; Private Sector Coalition; US Department of Health and Human Services

Other exemptions 85% exemption on dividends (or repatriation payments) from eligible Puerto Rico

companies, as defined Reduction in half of the full US statutory tax for active Puerto Rico source income on

the remaining 15%

Medicaid Lift the Federal cap on Medicaid funding to Puerto Rico and other US territories Raise the Federal Medicaid share from 55% to 83% over time Expand eligibility of Medicaid program to anyone who is earning less than 100% of the

Federal poverty levelMedicare Improve hospital payments related to low income patients and uncompensated care Increase payment rates for hospitalsExtend the Earned Income Tax Credit to Puerto RicoExtend the Child Tax Credit to Puerto Rico


An opportunity for growth HUBZone

Designed to encourage economic development and job creation in historically underutilized business zones through a certification and designation process

Companies and small businesses that become HUBZone-certified by the SBA receive preferential treatment in Federal government contracting over regular businesses

HUBZone program requires that 3% of all Federal government's contracting dollars be assigned specifically to HUBZone certified businesses

Reference: Section 412; SBA.gov


An opportunity for growth HUBZone

Section 412 of PROMESA eliminates the 20% restriction from the qualified census tract definition (for Puerto Rico only) until the first of the following events occur: 10 years after the date that the SBA Administrator implements the

amendment; or the date on which the Board ceases to exist

With this amendment, more areas could now qualify for the HUBZonedesignation providing local small businesses the chance to benefit from federal contracting opportunities



Other provisions

Reference: Title IV

PROMESA allows Puerto Rico (with the Board's approval) to establish a $4.25 minimum wage for employees younger than 25

The rate could last as long as four years or until the board terminates

Current federal minimum stands at $7.25 an hour for non-exempt employees ($15.00 in some states)

The bill won't restrict Puerto Rico's right to determine its future political status by plebiscite

PROMESA excludes PR from the USLD's overtime pay rule which is scheduled to take effect on December 1, 2016

The rule would raise the salary threshold for white-collar workers (exempt workers) from $23,660 to $47,476

Employees who earn less than the threshold amount would be eligible for overtime pay

The exemption would be in effect until GAO determines that the rule wouldn't negatively affect the island's economy

Minimum wageExemption from Overtime Pay Political status

Infrastructure revitalizationInfrastructure revitalization


How will infrastructure be revitalized?

Title V of PROMESA establishes a process to accelerate the development of infrastructure projects that provide essential services or address threats to public health or safety

Creates the position of "Revitalization Coordinator" and grants it the following powers: a role in reviewing and permitting critical projects establish an expedited review process for such projects add related provisions intended to ease the permitting process and

increase the federal oversight role Critical project is defined by section 503 as:

one that is intimately related to addressing an emergency whose approval, consideration, permitting and implementation shall be expedited and streamlined

Reference: Section 502 and 503


How will infrastructure be revitalized? (continued)

Physical infrastructure could involve projects related to:

Projects could be proposed by a Puerto Rican agency or private entity The application would have to describe how the project addressed an

emergency, provide for estimated costs and the availability of funds to support the project

energy water & sewage

roads telecommunications other systems


Public debt restructuring and issuance


Summary of Debt Outstanding

Issuer Total Bonds and Private Loans (000's)GO $12,896 COFINA 17,294 HTA 4,317 PBA 4,005 GBD 4,015 ERS 3,141 PRIFA 2,158 PFC 1,147 UPR 496 PRCCDA 386 PRIDCO 159 AMA 28 Other Central Gov't Entities 242 Plus/Less: Missed bond interest, GBD and MFA Bonds 1,635Total debt outstanding $68,707


How will the debt be restructured?

PROMESA contains two methods (Title VI and Title III) to adjust Puerto Rico's debts:

As long as the Board remains in place, the territory including all of its instrumentalities are prohibited of issuing new debt without the Board's approval

Streamlined process to achieve modifications with the consent of a supermajority of creditors

Benefits such as potential speed relative to a traditional restructuring through a formal in-court process

Voluntary adjustments Court-supervised debt-adjustment

process modeled after Chapter 9 Includes "cram-down" power which

may provide Puerto Rico with flexibility in debt adjustment

Gives Board total control over the adjustment process

Includes certain provisions designed to protect creditor interests

Court reviews

Reference: Title III, Title VI


Title VI and Title III Overview Comparison Chart


Area Title VI Title III

Application Bonds, loans, or other borrowings predating enactment of the Act Substantially all liabilities predating the

petition

Eligible issuers

The Commonwealth and also any covered territorial instrumentality explicitly authorized by the Board

The Commonwealth or covered territorial instrumentality for which Board files a petition

Prerequisites to relief

There is no prerequisite to entry, but a successful Title VI modification requires that the modification satisfy certain conditions

Board determines, among other things that the debtor made good-faith efforts at consensual restructuring, adopted procedures to provide timely audited financials, published draft financial statements and other information required to assess restructuring, and adopted a fiscal plan

Proposals The debtor or the Oversight Board makes the restructuring proposal Only the Board may file a petition or a

plan of adjustment


Title VI and Title III Overview Comparison Chart (continued)


Area Title VI Title III

Process

Issuer or holders propose a Modification and the Board places affected bonds in pools based on their priority and security features; with limited exceptions, the proposed modification must provide all holders in all pools the same consideration pro rata

The Board certifies that the modification is consistent with the fiscal plan or, if no fiscal plan exists, that it provides sustainable debt

In order to become effective and bind non-consenting holders, holders of at least two-thirds in amount of the outstanding principal amount of the bonds that vote consent, provided further that such two-thirds must also constitute a majority in outstanding principal amount (for any secured bonds, non-consenting holders either retain their liens or receive property of a value at least equivalent to the value of the lesser of their bond claims or the collateral securing such bond claims)

A federal court approves the binding modification

Board files petition and plan The process and substance otherwise generally

follows Chapter 9 of the U.S. Bankruptcy Code, except that confirmation standards include a modified best interests of creditors test and require that the plan of adjustment must be consistent with the fiscal plan (which must respect priorities and liens existing under relevant constitution, law or agreement, but such determination will be made by the Board)


Questions & feedback


Accounting issues resulting from the actual fiscal environment in Puerto Rico:

Accounting Estimates

Angiee Chico, CPA, CIA, CGMAAudit partner


Accounting Issues Related to Accounting Estimated -Accounts Receivable and Bad Debts Expense

An accounting estimate impacted by the current economic environment is the collectability of receivables.

Global and local economic downturn and fiscal crisis have put at risk accounts receivable and constrained cash flows.



Inevitably, no matter how good the credit department and policies are, a company will have a customer that does pay its debts.

This is simply part of doing business.



General FactsReceivables represent oral promises of the

purchaser to pay for goods and services sold Short-term extension of creditClassify as either current expect collection within

one year or non-current and trade or non-trade receivablesNormally collected within 30 to 60 daysLargest uninsured asset on a companys balance

sheet.


What Do You Do if You Are Having a Hard Time Collecting the Accounts Receivable?

Every company needs a formal system to account for, age, follow up and collect receivables.

Companies should assess more directly and timely the collectability of their receivables.

Some accounts that dont get paid require more persuasive techniques, such as a call from you, an attorney or a collection agency.



Invoicing establish a billing process that ensures accurate invoices are sent on a timely basis. Ask about payment at that time.

Aging Accounts Receivable - age your accounts starting with the project completion date, sale or service date. Choose a payment date or payment terms. If you dont receive payment in that time, send a reminder or past-due reminder. Keep a record of the age of each account that isnt paid under its terms. Accounts older than the required payment terms need your personal attention.



Calling Your Customer effective communication, proactive approach; this gesture might be enough to get payment and avoid a collection agency or attorneys fees.

Using Collection Agency or Attorney should be considered. Many small-business owners choose not to file suit on receivables under a certain amount and write off the transaction as uncollected. You'll save time and keep the transaction out of the public records.


Collectability and estimates for allowance for doubtful accounts

Watch for trends in accounts receivable. Companies should assess more directly and timely the collectability of their receivables, as write-offs or additional reserves may be necessary.

Losses from uncollectible receivables shall be recorded if, based on current information and events, it is probable that the company will be unable to collect all amounts according to the contractual or business terms of the receivable.



Companies should consider to tighten the credit policy and review regularly.

Evaluate each individual customer. Consider prior periods' experience and ability to pay.

Negotiate payment plans to align to corporate collection policies.



After proper evaluation and discussion, determine adjustments required or estimate for uncollectible accounts receivable.

Direct Write-Off vs. Allowance MethodThe company needs to determine how it will

report the money it will not collect.

Companies use either the direct write-off method or the allowance method to record defaulted sales.



Estimating Uncollectible BalancesDetermine how to calculate the portion that is

likely to be uncollected.

Allowances or adjustments should be recorded in the correct period.Be realistic!


How Accounts Receivable Impact the Rest of Accounting

This estimate and corresponding analysis is critical because of its impact in the rest of accounting.

Affects working capital or free capital

Limit investments and growth opportunities

Limit shareholders payouts

Inability to invest in new equipment or introduce new products or services



Accounts Payable and Additional Debtso Cash flow directly impacts the company's ability to

pay short-term liabilities, including any current portion of long-term debt.

o May require to obtain additional financing or lines of credit

Results are reflected in the financial statements and related disclosures, as applicable



Budgeting Implicationso Accounts receivable can impact the future expected income used

to make budgeting decisionso If receivables included in income expectations are not paid as

expected, budgets can quickly become underfunded

Collection Approacho A higher percentage of overdue receivables can distract limited

accounting personnel from their daily routines in small businesses, decreasing departmental productivity

o Aging of receivables can also increase the loss a company takes due to bad debts write-offs or selling them to third-party collections agencies



Ratio Valuationso Oversight and monitoring of metrics and financial

covenants by banks, investors and creditors are more tough when making lending or investment decisions.

o Since receivables are assets, account balances impact any financial ratio based on assets, including the debt-to-assets and assets turnover ratios.

o Because of its impact on cash flows, receivables also impact liquidity ratios such as the current, quick and cash ratios.

o The receivables turnover ratio is directly affected by the average maturity of accounts receivable as well.


What is the next step?

Managing the companys accounts receivable should be one of its priorities. Create a plan!

Work as a team. Business owners, senior managers and key personnel should be highly involved on a day-to-day basis.

In good times and bad times the company needs to ensure the accounts receivable are as current as possible.


Impairment of investments

Johanna Prez, CPA, CFE, CAMS, CGMAAudit partner


Agenda

Impairment definition Impairment indicators Accounting for other-than-temporary impairment

of investments Example Disclosure requirements New accounting standards


What is an Impairment of Investments?

If, on each reporting date, a security is impaired because its fair value is less than its amortized cost basis, management must decide if the impairment is either temporary or other than temporary.

An other than temporary impairment does not mean the investment has been permanently impaired, but that the carrying value is not expected to recover through the holding period of the security.


Impairment Indicators

Significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee;

Significant adverse change in the regulatory, economic, or technological environment of the investee;

Significant adverse change in the general market condition or either the geographic area or the industry in which the investee operates;

A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar security for an amount less than the cost of the investment;

Factors that raise significant concerns about the investees ability to continue as a going concern;

Among others.


Impairment Indicators Applicable to Puerto Rico investments

Overall shrinkage of Puerto Rico's economy

Default of bond payments by Puerto Rico Government

Degraded rating of Puerto Rico bonds by principal credit rating agencies: Fitch, Standard & Poor and Moody's

Among others.


Impairment Indicators Applicable to Puerto Rico investments

Rating Agency Date Rating Outlook

Standard & Poor's

October 1983 A N/A

April 2016 CC Negative

Moody's September 1970 A N/A

April 2016 Caa3 Negative

Fitch January 2011 BBB+ Stable

April 2016 CC Rating Watch Negative

sources: http://www.gdbpr.com/investors_resources/UBS Municipal Brief April 7, 2016


Accounting for Other-Than-Temporary Impairment of Investments

Guidance on other than temporary impairments is prescribed by ASC 320-10-35 Investments Debt and Equity Securities Overall Subsequent Measurement



For equity securities, an other-than-temporary impairment loss should be recognized in earnings for the difference between the amortized cost and fair value of the security at the balance sheet date. The fair value becomes the new amortized cost and should not be adjusted for subsequent recoveries in fair value. (FASB ASC 320-10-35-34)

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For debt securities, the recognition of an other-than temporary impairment loss depends on whether the entity intends to sell the security (or whether it is more likely than not it will be required to sell the security) before recovery of the amortized cost basis less any current-period credit loss.



If the entity intends to sell the security (or more likely than not will be required to sell the security), the other-than-temporary impairment should be recognized in earnings for the entire difference between the amortized cost and fair value at the balance sheet date.



If there is no intention to sell the security or it is not more likely than not the entity will be required to sell, the other-than-temporary impairment should be separated into amounts pertaining to (a) the credit loss and (b) all other factors. The amount relating to the credit loss should be recognized in earnings and the remaining amount should be recognized in other comprehensive income (net of taxes).



Compare the present value of the expected cash flows versus the amortized cost

PV of expected cash flow < amortized cost = credit loss



When developing an estimate of cash flows expected to be collected, management should consider: Past events, current conditions, and reasonable and

supportable forecasts Remaining payment terms of the security Prepayment speeds Financial condition of the issuer Expected defaults Value of any underlying collateral



The prior amortized cost less the impairment loss recognized in earnings becomes the new amortized cost. This amount should not be adjusted for subsequent recoveries in fair value, but should be adjusted for accretion and amortization. (FASB ASC 320-10-35-34A through 34E)

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Example

A company has an investment portfolio on which management identified investments in debt securities (government securities Puerto Rico) with a fair value significantly lesser than its amortized cost.

IssuerAmortized Cost

as of 12/31/2015

Coupon Rate

Maturity Date

Credit Rating (Moody's/S&P)

Market Value as of 12/31/2015

Market Value as of 12/31/2015

Diff. between BV and MV

%

Government Development Bank for Puerto Rico (I)

5,000,000$ 4.150% 8/1/2017 CA/CC 28.244 1,412,200$ 3,587,800$ 72%

Government Development Bank for Puerto Rico (II)

5,000,000$ 4.500% 8/1/2019 CA/CC 27.791 1,389,550$ 3,610,450$ 72%

10,000,000$ 2,801,750$ 7,198,250$

Sheet1

IssuerAmortized Cost as of 12/31/2015Coupon RateMaturity DateCredit Rating (Moody's/S&P)Market Value as of 12/31/2015Market Value as of 12/31/2015Diff. between BV and MV%

Government Development Bank for Puerto Rico (I)$ 5,000,0004.150%8/1/17CA/CC28.244$ 1,412,200$ 3,587,80072%

Government Development Bank for Puerto Rico (II)$ 5,000,0004.500%8/1/19CA/CC27.791$ 1,389,550$ 3,610,45072%

$ 10,000,000$ 2,801,750$ 7,198,250

GT_Custom

C1Custom 1

C2Custom 2

C3Custom 3

C4Custom 4

C5Custom 5

C6Custom 6

C7Custom 7

C8Custom 8


Example

0

50

100

150

2011 2012 2013 2014 2015

Market Value

Bond #1 Bond #2Source: Bloomberg


Example

Circumstances for an OTTI have occurred and impairment analysis:

The entity intends to sell the security

It is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis

The entity does not expects to recover the entire amortized cost basis of the security


Example

Management assumptions:

Assumption Bond #1 Bond #2

Principal hair cut -20% -25%

Coupon interest adjustment -10% -10%

Maturity term extension (years)

5 5


Example

Revised scenario based on management assumptions:

New terms Bond #1 Bond #2

Adjusted principal obligation $4,000,000 $3,750,000

Adjusted coupon interest 3.735% 4.050%

Monthly interest payments $12,450 $12,656

Term to maturity date (months) 79 103

New maturity date 8/1/2022 8/1/2024


Example

Impairment calculation: Credit related impairment loss estimate for the Government Development Bank securities is based on the probability of default and loss severity in the event of default in consideration of the debt securities credit ratings and the latest available information about the Puerto Ricos Governments financial condition, including the Puerto Rico Governments intention to restructure its outstanding bond obligations.

Bond #1 Bond #2 Total

Amortized cost $5,000,000 $5,000,000 $10,000,000

Present value of expected cash flows

$3,904,517 $3,630,034 $7,534,551

Impairment amount (credit loss portion)

($1,095,483) ($1,369,966) ($2,465,449)


Journal Entry

Account Description Debit Credit

Impairment losses - current earnings 2,465,449$ -$ Unrealized losses - other comprehensive income 4,732,801 - Impairment loss on investments - 7,198,250

7,198,250$ 7,198,250$

Sheet1

Account DescriptionDebitCredit

Impairment losses - current earnings$ 2,465,449$ - 0

Unrealized losses - other comprehensive income4,732,801- 0

Impairment loss on investments- 07,198,250

$ 7,198,250$ 7,198,250

GT_Custom

C1Custom 1

C2Custom 2

C3Custom 3

C4Custom 4

C5Custom 5

C6Custom 6

C7Custom 7

C8Custom 8


Presentation of Other-Than-Temporary Impairment (Balance Sheet)

Balance Sheet

Investment in marketable securities 2,801,750$

Sheet1

Balance Sheet

Investment in marketable securities$ 2,801,750

GT_Custom

C1Custom 1

C2Custom 2

C3Custom 3

C4Custom 4

C5Custom 5

C6Custom 6

C7Custom 7

C8Custom 8


Presentation of Other-Than-Temporary Impairment (Income Statement)

Income Statement

Total other-than-temporary impairment losses (7,198,250)$

Portion of loss recognized in other comprehensive income before taxes 4,732,801

Net impairment losses recognized in earnings (2,465,449)$

Sheet1

Income Statement

Total other-than-temporary impairment losses$ (7,198,250)

Portion of loss recognized in other comprehensive income before taxes4,732,801

Net impairment losses recognized in earnings$ (2,465,449)

GT_Custom

C1Custom 1

C2Custom 2

C3Custom 3

C4Custom 4

C5Custom 5

C6Custom 6

C7Custom 7

C8Custom 8


Disclosure Requirements

ASC 320-10-50 Methodology and significant inputs used to measure the

amount related to credit loss (recognized in earnings) Performance indicators such as default rates, delinquency rates,

percentage of nonperforming assets Loan-to-collateral-value ratios Third party guarantees Geographic concentration Credit ratings


Disclosure Requirements

ASC 320-10-50 Roll forward of the amount related to credit losses

recognized in earnings Beg. balance of credit losses for which a portion of an other-than-temporary

impairment was recognized in other comprehensive income Additions to the credit loss for which an other-than-temporary impairment was

not previously recognized Reductions for securities sold during the period (realized) Reductions for securities for which the amount previously recognized in other

comprehensive income was recognized in earnings because the entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis


Disclosure Requirements (cont.)

ASC 320-10-50 Roll forward of the amount related to credit losses

recognized in earnings (cont.) If the entity does not intend to sell the security and it is not more likely than not

that the entity will be required to sell the security before recovery of its amortized cost basis, additional increases to the amount related to the credit loss for which an other-than-temporary impairment was previously recognized

Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security

The ending balance of the amount related to credit losses on debt securities held by the entity at the end of the period for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.


Accounting Standards Update

ASU No. 2016-01 Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities which amends the guidance in U.S. GAAP on the classification and measurement of financial instruments.Changes to the current GAAP model primarily affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities was clarified.

The ASU is effective for public companies for years beginning after December 15, 2017 and for all other entities an additional year after that.


Accounting Standards Update

ASU No. 2016-13 Financial Instruments Credit Losses: Measurement of Credit Losses on Financial Instruments which amend the guidance on the impairment of financial instruments. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination.

ASU is effective for public companies for years beginning after December 15, 2019 and for non-public entities for years beginning after December 2021.


Troubled debt restructuring

Kayra Rivera, CPA, CGMAAudit director


Troubled debt restructuring

ASC 470-60 Debt, Troubled Debt Restructurings by Debtors establishes standards of financial accounting and reporting by the debtor for a troubled debt restructuring.

ASC 405-20 Liabilities, Extinguishments of Liabilities establishes standards of financial accounting and reporting for extinguishments of all liabilities.


Accounting for debt modifications

Basic types of transactions:

Trouble debt restructuringsModification of terms of an existing debtExtinguishment of debt


Definition of troubled debt restructuring

A restructuring of a debt constitutes a troubled debt restructuring if:

(1) the borrower is experiencing financial difficulty, and

(2) the lender grants a concession that it would not have otherwise considered


Factors to determine a troubled debt restructuring

If a borrower's creditworthiness has deteriorated since its debt was originally issued, it should then assess all aspects of its current financial position to determine whether it is experiencing financial difficulty.


TDR Identification Two-Step Process

Step 1:

Determine whether the borrower is experiencing financial difficulties. Indicators include the following:

the debtor is currently in default on any of its debt

the debtor has declared or is in the process of declaring bankruptcy

doubt about ability to continue as a going concern

currently, the debtor has securities that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange.


TDR Identification Two-Step Process

Step 1:

continuation -

the debtor forecasts that its entity-specific cash flows will be insufficient to service debt (both interest and principal) in accordance with the contractual terms of the existing agreement through maturity.

absent the current modification, the debtor cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the market interest rate for a similar debt for a nontroubleddebtor.


TDR Identification Two-Step Process (cont.)

Step 2:

Determine whether modification is a concession.

the effective borrowing rate on the restructured debt is less than the effective borrowing rate of the original debt.

o the effective borrowing rate of the restructured debt is calculated by projecting all the cash flows under the new terms and solving for the discount rate that equates the present value of the cash flows under the new terms to the debtor's current carrying amount of the old debt.


TDR Identification Two-Step Process (cont.)

Step 2:

Examples include the following:

Forgiving principal or interest

Modifying interest rate to a below-market rate

Deferring principal payments(e.g. interest only)

Extending the maturity date


Troubled debt restructuring Settlement of debt

Involves most commonly the following:

Full settlement with assets or equity if the debtor transfers receivables from third parties or other assets or equity to the creditor to fully settle a debt, it should recognize a gain on the transaction in the amount by which the carrying amount of the payable exceeds the fair value of the assets transferred.

Partial settlement with assets or equity if the debtor transfers receivables from third parties or other assets or equity to partially settle a debt, it should only measure the transaction with the fair value of the assets transferred (not the fair value of the payable).


Accounting for a Settlement of debt Example Exchange of assets

ABC, Inc. owes $300,000 plus $20,000 of accrued interest to PR Bank. The debt is a 10-year, 10% note. During 2015, ABC, Inc.s business deteriorated due to a faltering regional economy. On December 31, 2015, PR Bank agrees to accept an old machine and cancel the entire debt. The machine has a cost of $490,000, accumulated depreciation of $321,000, and a fair market value of $290,000.


Accounting for a Settlement of debt Example (cont.)

Journal entries to be recorded:ABC, Inc:

Notes Payable 300,000Interest Payable 20,000Accumulated Depreciation 321,000

Machine 490,000Gain on Disposition of Machine 121,000 (a)Gain on Debt Restructuring 30,000 (b)


Accounting for a TDR involving modification of terms

When a borrower has a troubled debt restructuring (TDR) in which the terms of its debt are modified, it should analyse the future undiscounted cash flows to determine appropriate accounting treatment.

If the future undiscounted cash flows under the new terms is lesser than the adjusted net carrying value of the original debt -- a gain is recorded on the transaction.

If otherwise, no gain would be recorded.


Accounting for a TDR involving modification of terms

In calculating the future undiscounted cash flows specified by the new terms:

All payments under the new terms should be included

Any contingent payments should be included without regard to the probability of those payments being made

If the number of future payment periods may vary because the debt is payable on demand, the estimate of future cash payments should be based on the maximum number of periods that could be required under the terms of the revised debt agreement


Accounting for a TDR involving modification of terms(cont.)


Example of Modification of terms Gain recorded

On December 31, 2012, ABC Bank enters into a debt restructuring agreement with DEF Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications.

Reduce principal obligation from $2,000,000 to $1,300,000. Extend the maturity date from December 31, 2012, to December 31,

2015. Reduce the interest rate from 12% to 10%.

DEF Company pays interest at the end of each year. On January 1, 2016, DEF Company will pay $1,300,000 in cash to ABC Bank.


Example of Modification of terms Gain recorded (cont.)

Journal December 31, 2012:Note Payable 310,000

Gain on Debt Restructuring 310,000

Total future cash flows after restructuring: Principal 1,300,000$ Interest ($1,300,000 x 10% x 3) 390,000

1,690,000

Total pre-restructuring carrying amountof note (principal): 2,000,000

Gain ($2,000,000 - $1,690,000) 310,000$

Sheet1

Total future cash flows after restructuring:

Principal$ 1,300,000

Interest ($1,300,000 x 10% x 3)390,000

1,690,000

Total pre-restructuring carrying amount

of note (principal): 2,000,000

Gain ($2,000,000 - $1,690,000)$ 310,000


Example of Modification of terms No gain recorded

On December 31, 2012, ABC Bank enters into a debt restructuring agreement with DEF Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications.

Reduce principal obligation from $2,000,000 to $1,600,000. Extend the maturity date from December 31, 2012, to December 31,

2015. Reduce the interest rate from 12% to 10%.

DEF Company pays interest at the end of each year. On January 1, 2016, DEF Company pays $1,600,000 in cash to ABC Bank.


Example of Modification of terms No gain recorded (cont.)

Under this example, no gain is recorded by DEF Company since total future cash flows after restructuring exceed total pre-restructuring carrying amount of the note (principal):

Total future cash flows after restructuring: Principal 1,600,000$ Interest ($1,600,000 x 10% x 3) 480,000

2,080,000$

Total pre-restructuring carrying amountof note (principal): 2,000,000$

Sheet1

Total future cash flows after restructuring:

Principal$ 1,600,000

Interest ($1,600,000 x 10% x 3)480,000

$ 2,080,000

Total pre-restructuring carrying amount

of note (principal): $ 2,000,000


Extinguishment of liabilities- ASC 405-20General

ASC 405-20-40-1 provides guidance on when a reporting entity should extinguish a debt.

A liability has been extinguished if the debtor either: the debtor pays the creditor and is relieved of its

obligation for the liability the debtor is legally released from primary obligation

under the liability, either judicially or by the creditor


Extinguishment of liabilities- ASC 405-20What is considered?

an exchange of debt with substantially different terms a substantial modification of terms

If the difference between the present value of the cash flows of the new debt and the present value of the remaining cash flows of the original debt is


Extinguishment of liabilities-Measurement of debt extinguishments

For all debt extinguishments, the difference between the reacquisition price and the net carrying amount of the debt extinguished (which includes any deferred debt issuance costs) should be recognized as a gain or loss when the debt is extinguished. Extraordinary item new guidance effective

Transaction with related parties - recognition of gain or loss may not be appropriate (such a restructuring may be in essence a capital transaction).


Accounting for a Debt extinguishment


Troubled debt restructuringChapter 11 bankruptcy proceedings

since debtor would be restating its liabilities generally, this subtopic would not apply to the debtor's accounting for such reduction of liabilities.

this subtopic would apply to an isolated TDR by a debtor involved in bankruptcy proceedings if such restructuring did not result in a general restatement of the debtor's liabilities.


Administrative Determination 16-14Taxation of income due to debt forgiveness

Section 1031.01 (a) (6) of the 2011 Puerto Rico Internal Revenue Code, as amended (the "Code"), provides that, as a general rule, the income or benefit derived from the forgiveness of a debt is considered as part of the gross income subject to income tax.


Administrative Determination 16-14Taxation of income due to debt forgiveness

Certain amounts are excluded: The cancellation is the result of filing an application for

bankruptcy in an action under the provisions of Title 11 of the United States Code.

Student loans, in whole or in part Reorganization of a mortgage loan guaranteed by the

qualifying residence of the taxpayer, provided that the original mortgage loan amount does not exceed $1,000,000.

Insolvency of the taxpayer


Administrative Determination 16-14 Taxation of income due to debt forgiveness

This Administrative Determination establishes the rules to determine the amount exempt from debt forgiveness under the following exclusions and also establishes the way to report the income for debt forgiveness under such circumstances:

reorganization of a mortgage loan guaranteed by the qualifying residence of the taxpayer;

when the taxpayer is insolvent Agreed upon procedures required


Francisco Luis, JD, CPATax partner

Recent tax legislation affecting multinational organizations


Topics

01 Act 40-201302 Circular Letters03 Act 72-201504 Wal-Mart Case05 Where are we now?


Background Act 40-2013

Act 40-2013 was enacted to impose, among others, important limitations to Puerto Rico taxpayers that had transactions with related parties not engaged in a trade or business and not subject to tax in Puerto Rico, as follows:

established certain disallowance of expenses incurred or paid to a related person ; and

added new components to the Alternative Minimum Tax ("AMT") computation.


Non-Deductible Expenses

for ordinary tax purposes, Act 40-2013 established a disallowance of 51% of the expenses incurred with a related party that is not engaged in a trade or business or subject to taxes in Puerto Rico (section 1033.17)


Alternative Minimum Tax

the AMT of a corporation is the excess of, if any, the tentative minimum tax over the regular tax.

important changes:

2011 PR InternalRevenue Code

Act 40-2013

AMT Tax Rate 20% 30%

Book Income Adjustment

50% 60%

NOL Limitation 90% 80%


Alternative Minimum Tax

the tentative minimum tax is composed of the greater of: 30% of the alternative minimum net income,

or the sum of the following two items:

1. 20% of the expenses incurred or paid to related parties and/or the expenses allocated from a home office to a branch located in Puerto Rico, if such payments were not subject to tax in Puerto Rico during the tax year

2. up to 2% on the purchases of tangible personal property from a related person


Authority to the Secretary of Treasury

Act 40-2013 provided authority to the Secretary of Treasury to approve waivers to exclude expenses subject to the disallowance of 51% and the 20% charge in the AMT. It was also authorized to waive also the AMT on the transfer of personal property the Secretary was requested to issue guidelines on the

procedures to request such waivers


Waiver for expenses

Circular Letter 13-06 was issued providing the procedures to request the exclusion of certain expenses incurred or paid to a related person with regards to: deduction of said expenses with regards to the 49%

limitation imposed for income tax purposes 20% tax under the AMT calculation

under these sections, the Secretary may grant an exclusion upon assessment of the nature of the expenses or costs paid to related person or office


Waiver for expenses

Circular Letter 13-06 required that among others a Memorandum in support of the waiver should be filed together with certain Agreed Upon Procedures covering the 4 taxable years prior to the year for which the waiver was being requested. the waiver, if granted would have been valid for 2

taxable years


Waiver for transfers of personal property

Circular Letter 13-07 was issued to provide the procedure for requesting a partial or total waiver from inclusion in the AMT calculation of the purchase value of property acquired from a related person or transferred from home office Secretary may grant a partial or total waiver to reduce the

tax rate limited to .2% when it is determined that the value of the purchased property or transferred property to the taxpayer was the same or substantially similar to the value under which said related person sells the property to an unrelated party.

Pursuant to Act 40-2013, a transfer price study is required.


Circular Letter No. 13-23

it was issued to clarify the term "eligible charges" to be excluded from the 51% disallowance for ordinary tax purposes and the AMT 20% charge. eligible charges are those that are expenses or directs

costs that are essential and meet the following criteria:1) should be directly related to the operation of the

industry or trade or business in Puerto Rico2) should be indispensable to make the operation viable

in Puerto Rico It also indicated that the eligible charges should be those that although paid to a related party, they are truly reimbursements of expenses paid to non related third parties


Act 72-2015 changes

Act 72-2015 brought the following significant changes to the rules for related party transactions: it limited the amount of the expenses that the

Secretary could waive to 60% from the 51% disallowance for ordinary tax purposes and from the 20% tax for AMT; and

it also eliminated the waiver process for the purchases of personal property and provided an increase on the tax over those purchases from 2% to 6.5%, depending on the taxpayer's gross revenues


Act 159-2015 Technical amendment to Act 72-2015 Waiver on Expenses with Related Parties it provides that the waiver request to exclude 60% of

the expenses incurred with a related party that is not engaged in trade or business in Puerto Rico from the 51% disallowance for ordinary tax purposes and from the 20% tax for AMT, should be made within the first taxable year for which such waiver is being requested. If granted, the waiver will be valid for a maximum of 3 taxable years.


Wal-Mart Action First Instance

on December 4, 2015, Wal-Mart initiated legal action against the Secretary to challenge the changes brought by Act 72-2015.

the main focus of Wal-Mart's claim was particularly with the AMT imposition on the purchases of personal property as it is the area in which it received the most impact.



Wal-Mart requested an injunction against the continued enforcement of the AMT provisions sustaining that they were unlawful under the following: Dormant Commerce Clause Equal Protection Clause Bill of Attainder Clause Federal Relation Acts



on March 28, 2016, the district court issued an order stating its findings of fact and conclusions of law. It held that:1) it had jurisdiction under the Butler Act because of the

lack of a "plain, speedy and efficient remedy" in Puerto Rico courts;

2) the AMT violates the Dormant Commerce and the Equal Protection Clause;

3) the AMT violates the Federal Relations Act;4) the AMT does not violate the Bill of Attainder Clause


Wal-Mart Action The Court of Appeals determination the Court of Appeals affirmed the District Court's

decision, therefore the injunction against the enforcement of the AMT against Wal-Mart continues.

it indicates that the District Court had jurisdiction over Wal-Mart claims.


Wal-Mart Action The Court of Appeals determination Remarkable points the decision states that the AMT dispositions of Act 72-

2015 are discriminatory as it taxes only cross border transactions between a Puerto Rico corporate taxpayer and a related entity outside of Puerto Rico.

furthermore, the Appeal's Panel concluded also that if Act 72-2015 would have been valid, it would prevent multistate corporations from enjoying the functional integration, centralization of management, and economies of scale associated with their interstate business model.


Wal-Mart Action The Court of Appeals determination Remarkable points the decision mentions that Act 72-2015 is based on the

incorrect presumption that all intercorporate transfers to a Puerto Rico branch from a related party are fraudulently priced to evade taxes.

it says that there are alternatives to validate if there is an undue profit shifting as it is the case with "the already existing set of regulations that authorize the PR Treasury to conduct a traditional transfer pricing audit of interstate transactions between related parties and to adjust specific transfer prices to recapture improperly shifted profits."


Wal-Mart Action The Court of Appeals determination Remarkable points certainly, the Appeals Court decision reaffirms, not

only the unconstitutionality of these arbitrary impositions on related party transactions, but emphasizes the fact that Puerto Rico has regulations to review transactions among related parties, similar to those in the Federal Tax System.


Administrative Determination 16-11

the Secretary of Treasury issued the AD 16-11 to clarify the applicability of the AMT after the resolution of the case with Wal-Mart for taxable years beginning after January 1, 2016,

the AMT computation will not include the charge on the transfer of personal property and the 20% charge on expenses with related parties not engaged in a trade or business in Puerto Rico



provides rules stating that if the amount of tax for taxable year 2016, without considering the AMT charges on transfer of personal property and expenses, is already covered with the estimated tax payments made, no additional estimated tax payments are necessary.



what about taxable year 2015? the AD 16-11 indicates that the taxpayer may

amend its 2015 tax return to eliminate the tax portion that was attributable to the AMT computations on personal property and expense, if any. the excess tax paid should be claimed then as a

credit of income taxes or as an AMT credit for future years.

it specifically states that any excess tax paid can not be requested as a refund.



what about the 51% disallowance? the Secretary indicates that even though the AMT

charges on transfers of personal property and expenses with related parties not engaged in trade or business in Puerto Rico were declared unconstitutional, the 51% disallowance continues to be valid.


Transfer Pricing

Isabel Hernndez, CPATax partner


Agenda

Overview Arm's Length History US Regulation OECD Guidelines PR Regulation Transfer Pricing Study BEPS


What is Transfer Pricing?

The pricing of transactions between related parties, such as a parent and a subsidiary.

Companies undertaking transactions with unrelated companies in the marketplace must set competitive prices for goods they sell, services they provide, or the use of intangibles, but companies transferring goods or services between entities do not have to set competitive prices.


Deals with the evaluation of prices charged in transactions between RELATED PARTIES

Parties: Owned or controlled directly or indirectly by the same interests

Transactions: Sale, lease, use of tangible property Sale, license, use of intangible property Services Loans

Scope of Transfer Pricing


Multinational companies operate in different countries with different tax laws/tax rates

Large companies can have difficulty determining where income is earned

Companies have incentives to transfer income to lowest tax jurisdictions

Companies can use transfer pricing as a planning opportunity to reduce taxes

In many countries, enforcing transfer pricing regulations is perceived to be a significant revenue raising strategy used by the local tax authorities

In many countries, the local tax authority imposes significant penalties for noncompliance with the transfer pricing regulations

Importance of Transfer Pricing


Any multinational company that has intercompany transfers of tangible property, services or intangibles

Multi-state companies with intercompany pricing issues Companies with management objectives of determining

intercompany prices Companies whose transfer pricing policies are being audited Companies who have related party transactions involving

entities not part of a consolidated tax return Companies which require an analysis of the value of certain

functions and risks (ex: value of intangible property)

Types of Companies that Benefit from a Transfer Pricing Analysis


There are two options for meeting regulatory requirements: annual report and Advance Pricing Agreements (APA)

Meeting Regulatory Requirements

This is typically considered to be the standard way to meet regulatory compliance

Companies must annually document their activities (documentation requirements vary by country) and be ready to support a tax return filed

This approach to regulatory compliance is most common among the clients as it is still the dominantly chosen means for compliance

An APA is an agreement between the taxpayer and the Tax Authorities concerning the methods the taxpayer will use to set its transfer prices over some specified period of time

The main advantage of an APA is that it reduces uncertainties both for taxpayers and tax authorities, reducing the threat of penalties

The main obstacle to an APA is the cost of time and resources involved in negotiating one successfully

Under an APA, a company must still carry-out the agreed methodology in order to determine the appropriate allocation of profits

APAANNUAL REPORTING


The arms-length standard is the fundamental basis of worldwide transfer pricing regulations.

A transaction is at arms-length if the transaction is consistent with results of uncontrolled taxpayers engaged in comparable transactions.

Specific methods for analyzing intercompany transfers of tangible goods, services and intangible goods are outlined in regulations under Section 482 of the US IRC and Section 1040.09 of the PRIRC.

When two or more transfers occur withi

Tax and fiscal enviroment in Puerto Rico today

Economy & Finance

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