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Dallas CPA Society: Convergence 2013 Repairs and Research Credit Update May 8, 2013.

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Presentation on theme: "Dallas CPA Society: Convergence 2013 Repairs and Research Credit Update May 8, 2013."— Presentation transcript:

1 Dallas CPA Society: Convergence 2013 Repairs and Research Credit Update May 8, 2013

2 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 1 ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

3 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 2 Agenda and discussion topics Bonus Depreciation and Repairs - Overview R&D Tax Credit - Overview

4 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 3 Your KPMG Team MICHAEL B. FISHMAN Tax Managing Director PETER BALTMANIS Principal

5 Bonus Depreciation and Repairs Peter Baltmanis

6 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 5 The American Taxpayer Relief Act of 2012 – Business Tax Provisions Extension of Expired Provisions: General Business Provisions (Bonus Depreciation and Recovery Period) Depreciation of certain real property improvements. The Act extends retroactively from January 1, 2012, through December 31, 2013, the 15-year cost recovery period for certain leasehold improvements, restaurant buildings and improvements, and retail store improvements that are placed in service before January 1, 2014. Accelerated depreciation for business property on an Indian reservation. The Act extends for two years the placed-in-service date for the special depreciation recovery periods for qualified Indian reservation property to property placed in service before January 1, 2014. Extension of seven-year (7-year) straight line cost recovery period for motorsports entertainment complexes. The Act extends for qualified property placed in service before January 1, 2014, the seven-year cost recovery period for property used for land improvement and support facilities at motorsports entertainment complexes. Extension of railroad track maintenance credit. The Act extends retroactively for tax years beginning after December 31, 2011, and before January 1, 2014, the railroad track maintenance credit. Election to expense advanced mine safety equipment. The Act extends for two years retroactively from January 1, 2012, through December 31, 2013, the provision that provides businesses with 50% bonus depreciation for certain qualified underground mine safety equipment. Energy Provisions Special allowance for cellulosic biofuel plant property. The Act extends the 50% additional first-year depreciation deduction for cellulosic biofuel plant property one year to property placed in service prior to 2014.

7 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 6 Bonus Depreciation Extension Rules for 2013 50% Bonus Depreciation is extended for property placed in service in 2013; an additional 50% first-year depreciation deduction for investments under the MACRS rules with a recovery period of 20 years or less, 25 year water utility, computer software (36-month period) or qualified property. – 100% bonus depreciation deductionfor qualified property acquired and placed in service on or after September 9, 2010, through December 31, 2011. – But before or after this period, for qualified property acquired or placed in service in 2010 through 2012, 50% of the basis of the qualified property is allowed as a deduction in the tax year the property is placed in service. An additional year is allowed for certain long-production period property and certain aircraft. There is no change to the definition of qualified property. The Act allows corporations to elect to take additional AMT credits in 2013 if they agree to forego the use of bonus depreciation on qualified property placed in service in those years and depreciate such property using the straight-line method. The additional credit (which is refundable) is limited to 6% of the amount of such credits that had been generated before 2006 and had not been used in tax years ending before April 1, 2008. Also, the additional credit cannot exceed $30 million. Expensing of Certain Depreciable Property The limitation on the amount of property that can be expensed under section 179 is increased to $500,000 for tax years beginning in 2013, with a phase-out beginning when the total amount of eligible section 179 property exceeds $2 million.

8 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 7 The Tangible Property Regulations Temporary Regulations Issued in December 2011 Effective for tax years beginning on or after January 1, 2014 Organization of regulations – three buckets Acquisition costs – Compliance with de minimis rule and materials and supplies Repair and maintenance costs – Compliance with capitalization standards and unit of property definitions Dispositions – Asset retirements including stranded basis & General asset accounts IRS Notice 2012-73 – IRS and the Treasury Department expect to issue final regulations in 2013 Effective date is for taxable years beginning on or after January 1, 2014, and Taxpayers may apply the temporary regulations to taxable years beginning on or after January 1, 2012.

9 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 8 Repair vs. Improvement Analysis Improvement standards – an amount paid must be capitalized if it results in a: B etterment to the unit of property A daptation of the unit of property to a new or different use R estoration to the unit of property Material condition or defect at acquisition or production Material addition or expansion Material increase in Quality, Capacity, Productivity, Efficiency, or Strength Replacement and recognition of a loss on disposed of component Gain/loss on sale of a component Basis adjustment as a result of a casualty loss Return to former operating condition – no longer functioning Rebuild the property to like new condition after the class life Replacement of major component or substantial structural part

10 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 9 Dispositions – Comparison Default Treatment General Asset Account Election Depreciation stops Gain or loss recognized 1.Depreciation continues - no immediate recovery of basis 2.Optional Termination of GAA if: Disposition of all or last asset in GAA, or Qualifying disposition

11 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 10 Updates from Jan. ABA Meeting and other developments Anticipated timing for issuance of final regulations. The government is targeting late spring for the release of the final tangible property regulations. It was noted, however, that this could slip into early summer. Status of industry specific guidance – Industry Issue Resolution (IIR) Program. The government anticipates that it will publish guidance addressing electric generation assets in the coming weeks. The government is also targeting to release guidance addressing cable and natural gas transmission and distribution assets in the next two to five months. Notice 2012-73. In addition to announcing the governments intention to finalize the tangible property regulations in 2013 (with an expected effective date of taxable years beginning in 2014), also alerted taxpayers that certain changes are likely to be made to the de minimis rule, the routine maintenance safe harbor and the disposition rules. However, the government did not provide much additional insight into the changes taxpayers might expect to see. Compliance with Section 263A. Many of the automatic method changes included in the method change guidance (Rev. Proc. 2011-14) require that a taxpayer be in compliance with Section 263A to be within the scope. The government guests noted that they anticipate providing some clarification to taxpayers regarding what the requirement means. Potential for update to LB&I stand down. Per LB&I directive issued March 22, 2013, there will be no extension to the current IRS exam stand down order. IRS exam is allowed for tax years beginning on or after Jan 1, 2014. Implementing the regulations through accounting method changes. The government guests seemed supportive of a staggered approach to implementing method changes under the tangible property regulations, as long as taxpayers are compliant within the period required under the final regulations. The government guests also noted that they hope to issue updated method change guidance concurrent with the issuance of the final regulations.

12 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 11 Planning for the tangible property regulations today Why start this project now? – An analysis of how the taxpayers current procedures and policies compare to the temporary and final regulations will allow the tax department to properly plan over the next couple years. – Policy revisions should be addressed prior to the 1/1/2014 regulations effective date to allow time to make any changes to current policies/procedures and accounting systems e.g. per written capitalization policy as of the beginning of the tax year. – Coordination amongst various departments i.e. tax, financial reporting, fixed asset accounting, facilities, IT, etc…. The Regulations change the tax treatment of: – Repairs & maintenance vs. capital improvement – Dispositions of property and components of property, including buildings – General materials & supplies, and rotable spare parts – Eligible expensed costs that follow the financial reporting de minimis rule(s)

13 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 12 Tangible Property Regulations – Information and Work Activities Main areas of focus Information to review Sample work activities Material and supplies (M&S) treatment Book and tax capitalization policy Tax fixed asset download Book expense GL detail from ERP/financial reporting system Understand existing capitalization policy for M&S Review M&S categories through data mining and analytics exercises Address treatment of rotables and spare parts Provide recommendations for accounting method changes and compliance with new regulations Repairs and maintenance (R&M) Documentation availability and retention policy Fixed asset lifecycle process Tax fixed asset download Past 5 years filed 3115s Any available information or documentation on internal repair programs Offline tax depreciation work papers Identify assets potentially eligible for current period repair and maintenance expense and accelerated cost recovery Estimate additional taxable income or expense Assess post-study fixed asset implementation strategy Assess the various unit of property definitions at plant locations Discussion with NAS engineers around repair and maintenance activities Discussion with ERP personnel for understanding and mapping of fixed assets from procurement to disposal Structural Component Retirements Book and tax retirements policy Detail on prior-year losses and disposals for book and tax Book and tax retirements listing Understand existing treatment of retirements for both book and tax Estimate opportunities and exposures related to historical treatment of building component dispositions Routine Maintenance Safe Harbor Book and tax capitalization policy Tax fixed asset download Book expense G/L detail Machinery and equipment maintenance policy or similar Review of the NAS machinery and equipment repair programs to better understand the different classes and scope of work involved Verify existing policy is in compliance with new temporary regulations Suggest changes to policy if needed

14 Research Tax Credit Update Michael Fishman

15 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 14 Legislative Update: The American Taxpayer Relief Act of 2012 Research Credit Extension – Covers qualified research expenditures incurred January 1, 2012 – December 31, 2013 Some technical modifications included along with extenders – Revision to acquisition and disposition rules – Revised rules for allocating the credit among members of a controlled group

16 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 15 Legislative Update: Acquisition/Disposition Update Revised Section 41(f)(3) Acquisition and Disposition Rules – Generally equalizes treatment of stock v. asset acquisitions – Applies to tax years beginning after December 31, 2011 If acquiring and disposing companies are both on calendar year: –Only QREs after the acquisition date are taken into account for current year credit calculation for acquirer –QREs prior to the acquisition date are taken into account for current year credit calculation for the disposing company –Base period – QREs of target increase acquiring companys base period amount by same portion of time QREs are included in current year for the acquiring company –A reciprocal rule allows the disposing company to reduce its base period amount, subject to requirement that it provide acquiring company with the necessary information to make its adjustments If different tax years for acquisition and disposition companies – under ASC acquiring company adjusts its base year QREs for QREs of disposing company that are matched to the acquiring companys three preceding tax years –Meant to be simple but can be complex - see rules for additional guidance

17 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 16 Legislative Update: Controlled Group Allocation Revised Rules For Allocating the Credit Among Members of a Controlled Group – Each member will get proportionate share of the group credit based upon their share of QREs to total QREs of the controlled group – Applies to tax years beginning after December 31, 2011 Significant simplification compared to prior law.

18 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 17 Legislative Update: Current Proposals The research credit is currently scheduled to expire for expenses paid or incurred after December 31, 2013 The House Ways and Means Committee does not intend to enact any tax legislation in 2013 until it deals with tax reform, and is discouraging House members from introducing stand-alone tax bills on expiring tax provisions such as the research credit There have been a few proposals introduced Make the credit permanent, and increase the ASC rate from 14% to 17% (Administrations FY 2014 Budget Proposal; H.R. 905, introduced by Rep. Carney, D-Del, February 28, 2013) Allow certain small business taxpayers to use up to $250,000 a year of their research credit amount as a credit against FICA tax (S. 193, introduced by Sen. Coons, D-Del., January 31, 2013) Increase the credit rate to 30% (20% for ASC) for 2013 and 2014; allow certain small businesses to transfer their research credit to another taxpayer, with any payment for the credit excluded from gross income (H.R. 120, introduced by Rep. Holt, D-N.J.. January 3, 2013) Make the research credit permanent (H.R. 119, introduced by Rep. Holt, D-N.J.. January 3, 2013) The House Ways and Means Committee and the Senate Finance Committee have been informally discussing the role of a research credit in the context of tax reform, and whether any changes would be appropriate

19 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 18 Judicial Update FedEx Corp. v. United States, 2009-1 USTC para. 50,435 (W.D. Tenn. 2009), Doc 2009-16668, 2009 TNT 140-9. On February 27, 2013 judge grants parties request to enter a final judgment in the District Court case, in favor of the taxpayer. June 27, 2011 – Court affirmed its earlier partial summary judgment for the taxpayer. The taxpayer may apply the traditional high threshold of innovation test for internal-use software without the unique or novel requirement, and without the new to the world discovery test. Government still in 90 day window to determine if it will appeal to the 6 th Circuit Court of Appeals. Whether or not the government eventually prevails, the taxpayer is allowed most of its credits for IUS research. United States v. Davenport, 2012-2 USTC P50,568 (N.D. Tex. September 14, 2012) Costs of customizing a commercially available software package were not entitled to a research credit because the process of customizing and testing the software did not constitute a process of experimentation. The court granted the governments motion for summary judgment. The court found that the development activity did not relate to resolving an uncertainty that was present at the beginning of the research. Rather, the customization activity followed established steps to get to the agreed functionality to meet the taxpayers business requirements. The court found the testing performed with the software was done to validate that it had been customized to the agreed upon specifications, and was not done to test or refine a hypothesis about how to reach those specifications. The taxpayer argued that there were uncertainties, but the court found those were uncertainties that arose because the taxpayer wanted a change in the specifications or did not understand the software.

20 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 19 Judicial Update Union Carbide Corp. v. Commissioner, 2012-2 USTC P50,553 (2d Cir. September 7, 2012) 2nd Circuit affirms Tax Court decision for government. Specifically addresses only the holding that the taxpayer may not treat costs of raw materials used in production runs as qualified supply costs when the primary purpose was ordinary production. Does not disturb the other Tax Court holdings on corroboration, oral evidence, Cohan rule, consistency rule, etc. Union Carbides petition for certiorari to the Supreme Court was denied. Shami v. Commissioner, T.C. Memo. 2012-78 (March 21, 2012) Appealed to the 5th Circuit Court of Appeals, on September 13, 2012. Founder and president of a hair products company (an S corporation) had claimed nearly all of his compensation for a couple of years as qualified wage expense for research credit purposes. The Tax Court basically said there was a lack of substantiation for the claim that he spent so much time performing qualified services. The taxpayers argued that the Cohan rule should be applied to allow an estimate of the qualified wages to be used, but the court declined, saying there was not a reasonable basis established upon which the court could make an estimate.

21 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 20 Judicial Update Bayer Corp. v. United States, No. 2:09-cv-00351 (W.D. Pa. 2012), Doc 2012-19746, 2012 TNT 185-22 February 20, 2012 - District Court in Western Pennsylvania turns down Bayers request to be allowed to use statistical sampling in a trial to establish qualified research occurred, rather than documenting the qualified research for each business component. September 9, 2012 – Court turns down governments request for summary judgment on grounds that by presenting specific evidence of each business component, Bayer is in variance from the basis of its original claim for research credits. A trial is not expected before mid-2015. Bayer has updated its request to use statistical sampling, saying the documentation provided so far demonstrates that a reasonable methodology can be established, and that otherwise the litigation will continue indefinitely. Lockheed Martin Corp. v. United States, in the U.S. District Court for the District of Maryland Southern Division No. 3725 Suit filed in December in U.S. District Court argues that the Internal Revenue Service had wrongly rejected research tax credits Lockheed claimed for projects related to configurations of its Saturn V space rocket launcher and to a New York City MTA surveillance system. IRS disallowed Lockheed's claims in May 2012. Lockheed has challenged the IRS' position that some retroactive R&D credit claims were impermissible because they involved costs not for research, but for making prototypes resulting from research. Lockheed said in its court filing that some of the credits were claimed for prototypes, but argued that the designs were new and unproven and should qualify as research.

22 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 21 Judicial Update Procter & Gamble Co. v. United States, 2010-2 USTC para. 50,554 (S.D. Ohio 2010), Doc 2010-60, 2010 TNT 2-7 The district court held that under IRC Section 41(f), a taxpayer is not required to include receipts from intercompany transactions in its gross receipts for purposes of computing the research credit. Section 41(f)(1)(A) provides that in determining the amount of the research credit, all members of the same controlled group of corporations shall be treated as a single taxpayer. Consistent with ILM 200620023, the IRS argued that for foreign subsidiaries, section 41(f) applies only to research expenditures, not gross receipts. The district court rejected the IRSs argument based on the plain language of the statute and regulations, neither of which distinguish between calculations of QREs and gross receipts or between international and domestic intercompany transfers. The district court concluded that for a controlled group of corporations, both QREs and gross receipts should be determined on a single taxpayer basis. Hewlett-Packard Company v. Commissioner, Docket Nos. 21976-07, 10075-08 (Filed September 24, 2012) Court held for the IRS that Treas. Reg. Section 1.41-3 is proper in counting dividends, interest, rent, and other income in the taxpayers average annual gross receipts in determining the research credit. The court also held that the IRS properly applied this interpretation of gross receipts to pre-2001 tax years to which the regulation, by its stated terms, did not apply. The decision also granted the taxpayers motion for summary judgment that it did not need to include in its research credit intercompany gross receipts from its controlled foreign corporations. The IRS had no objection to this motion. This development in the Hewlett Packard case had generally been anticipated since the District Court in Procter & Gamble held for the taxpayer on the same issue in June 2010; the IRS had indicated it would not pursue the issue in litigation, though guidance on the issue has been on the IRS Business Plan since then.

23 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 22 Current IRS Issues Tier I Update IRS previously mandated R&D Tax Credit claims as Tier I issue if amending returns – IRS has since stated it is has terminated the Tier system – Reality – Some Tiered system procedures still exist Pharmaceutical Industry Certification The IRS Large Business & International Division (LB&I) on December 7, 2012 issued a memo providing guidance to IRS examiners on standards to apply in reviewing a research credit claim by a taxpayer in the pharmaceutical and biotechnology industries for activities involved in developing new pharmaceutical drugs and therapeutic biologics In some situations, the IRS will not challenge the amount of QREs claimed by a taxpayer for qualified activities that occur during Stage 1, Discovery and Preclinical Stage, or Stage 2, Clinical Trial Stage, of the Pharmaceutical Drug and Therapeutic Biologics Development Process and clinical trials required by the FDA relating to Accelerated Approvals – The taxpayer must provide a signed Certification Statement, included in the memo, to the examiner If there is any defect in the Certification Statement, these Stage 1 and 2 QREs will remain open to full review by the IRS exam. This guidance does not deal with any QREs related to Stage 3, Regulatory Review Stage, or Stage 4, Post Approval Stage, activities. The memo acknowledges that a taxpayer may return to Stage 1 and 2 activities even after it has entered into Stage 3 or 4 of the FDA Development Process, and that QREs in such later Stage 1 or 2 activities will still be covered by this guidance. While, in any case, Stage 3 and Stage 4 QREs would not be protected from IRS scrutiny, the approach the memo takes to substantiation of Stage 1 and 2 activities may promote collaboration with an IRS exam team in developing an approach to review of those later-stage QREs.

24 © 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. NDPPS 145720 The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.


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