Tax Executives Institute, Inc. — Detroit Chapter

Tax Executives Institute, Inc. — Detroit Chapter
2016 spring session — 14 June 2016

Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. This presentation is © 2016 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.

Objective Discuss hot topics in income taxes and applicable income tax accounting considerations

2016 spring session agenda Time Topic Speaker CPE 7:15
Registration/continental breakfast 7:50 – 8:00 Opening remarks TEI 8:00 – 8:50 Country-by-Country Reporting/ BEPS and Transfer Pricing Update Mark Mukhtar/John Ridgeway 50 min 8:50 – 9:35 SEC, FASB and PCAOB update on Tax Accounting and other Hot Topics Dave Mullett/Scot Kettlewell 45 min 9:35 – 9:50 Break 9:50 – 10:40 Accounting Methods, UNICAP, Section 199, Research Credit Matt Bouw/Jeff Carter 10:40 – 11:30 Indirect Tax Update and VAT Update Smitha Hahn/Ela Choina 11:30 – 12:00 The Digital Tax Function Brian Morris 30 min 12:00 – 1:00 Lunch 1:00 – 1:50 Stock Based Compensation and Hot Tax Topics in Executive Compensation Danyle Ordway/Bill Murphy 1:50 – 2:15 Transaction Cost Analysis Allison Somphou 25 min 2:15 – 3:05 Subchapter C Update; Dispositions, Reorganizations and Spin-Offs Howard Tucker 3:05 – 3:20 3:20 – 4:10 Legislative Update Jefferson P VanderWolk 4:10 – 5:30 Hospitality Reception Hosted by Ernst & Young LLP

Country-by-country reporting, BEPS and transfer pricing update
Presented by Ernst & Young LLP’s: Mark Mukhtar — Partner, John Ridgeway — Senior Manager,

Objectives Provide an overview of the Organisation for Economic Co-operation and Development (OECD) BEPS project, with a specific focus on country-by-country (CbC) reporting Discuss recent developments in treatment of tax rulings/advance pricing agreements (APAs) as state aid Review of proposed Section 385 regulations Review implications for Financial Accounting Standards (FAS) 109/Accounting Standards Codification (ASC) 740

OECD BEPS project

OECD BEPS project Background
The OECD’s Action Plan on Addressing Base Erosion and Profit Shifting (BEPS) is aimed at government concern about the potential for multinational companies (MNCs) to reduce their tax liabilities through shifting of income to no- or low-tax countries. Final reports addressing the 15 focus areas described in the OECD’s Action Plan on BEPS were released on 5 October 2015. Individual governments and other international bodies, e.g., the United Nations (UN) and the European Union (EU), have made or proposed changes to international tax rules that are closely linked to the BEPS project. The BEPS project may impact business arrangements with respect to a variety of considerations, including supply chains and the deployment of intangible property (IP). Multilateral Competent Authority Agreement was signed by 31 countries on 27 January 2016, for the automatic exchange of CbC reporting information. Draft EU Anti-Tax Avoidance Directive published on 28 January 2016, lays down rules against tax avoidance practices.

OECD BEPS action plan Tax challenges of digital economy
Hybrid mismatch arrangements Controlled foreign company rules Deductibility of interest and other financial payments Harmful tax practices Treaty abuse Artificial avoidance of permanent establishment status Transfer pricing for intangibles Transfer pricing for risks and capital Transfer pricing for other high-risk transactions Development of data on BEPS and actions addressing it Disclosure of aggressive tax planning arrangements Transfer pricing documentation and country-by-country reporting Effectiveness of treaty dispute resolution mechanisms Development of a multilateral instrument for amending bilateral tax treaties

What is Action 13 and why does it matter
What is Action 13 and why does it matter? Guidance on transfer pricing documentation and CbC reporting Designed to increase transparency by providing tax authorities with sufficient information to allow them to conduct transfer pricing risk assessments and consider whether groups have engaged in BEPS-type activities. Requires companies to use a consistent three-tier framework for providing information on global allocation of income, economic activity and intercompany pricing across all of a company’s global operations. Master file High-level information about the multinational enterprise’s (MNE) business, transfer pricing policies and agreements with tax authorities in a single document available to all tax authorities where the MNE has operations CbC report High-level information about the jurisdictional allocation of profits, revenues, employees and assets Local file Detailed information about the local business, including related-party payments and receipts for products, services, royalties, interest, etc.

Action 13: CbC reporting What it is: High-level information about an MNC’s jurisdictional allocation of revenue, profit, taxes, assets and employees to be shared with tax authorities where the MNC has operations; purpose is to provide greater transparency. Who is affected: Multinational groups with consolidated revenue of €750m or more. When it becomes effective: Fiscal years beginning on or after 1 January 2016, with first CbC reports to be filed, at most, one year from fiscal year-end. Where companies will have to file: Filing with tax authority in parent country, to be shared with tax authorities in countries where group has entities or branches. How reporting will be managed: Information on revenue, profit, tax (cash and accrued), stated capital, accumulated earnings, tangible assets and employees provided on a CbC-aggregated basis. Other considerations: CbC report needs to be consistent with master and local files. Public disclosures: On 12 April 2016, the European Commission released a draft proposal that would require CbC data to be publicly posted on a company’s website. Note that this is a very preliminary proposal and it is subject to multiple rounds of debate and approval. At a minimum, the directive would not take effect until two years after formal adoption. See Appendix A for CbC reporting templates.

Significant transfer pricing developments

Significant transfer pricing developments
BEPS As discussed, the OECD BEPS initiative is increasing tax authority visibility into international tax planning and tax structures. Taxpayers should be mindful of the continually evolving regulatory environment and increased transfer pricing scrutiny. State aid In the EU, governments are more aggressively pursuing perceived tax avoidance gained through rulings, APAs, and special tax regimes. Taxpayers should evaluate whether their structures are at risk for this type of challenge and determine whether that risk is material for financial statement purposes. Proposed Section 385 Regulations Taxpayers should review their existing instruments and processes to determine whether the US tax treatment of transactions could be altered.

Questions?

Appendix A CbC templates

OECD CbC template Main reporting table — country-aggregated data
18 September, 2018 OECD CbC template Main reporting table — country-aggregated data Tax jurisdiction Revenues Profit (loss) before income tax Cash tax paid (Corporation Income Tax and Withholding Tax) Current year tax accrual Stated capital Accumulated earnings Tangible assets other than cash and cash equivalents Number of employees Unrelated party Related party Total 1. 2. 3. 4. 5. 6. 7. Etc. Notes: Aggregated rather than consolidated data Flexibility in data sources allowed Entity data aggregated on the basis of tax residence Revenue defined to include turnover, royalties, property, interest Revenue specifically excludes intercompany dividends Profit/loss before income tax includes extraordinary items Cash tax paid includes tax withheld by other parties on payments to the constituent entity Current year tax accrual is tax on current year operations only Number of employees may include external contractors

OECD CbC template Table 2 — entity details
18 September, 2018 OECD CbC template Table 2 — entity details Tax jurisdiction Constituent entities resident in the tax jurisdiction Tax jurisdiction of organization or incorporation if different from tax jurisdiction of residence Main business activity(ies) R&D Holding or managing Intellectual property Purchasing or procurement Mfg or production Sales, mktg or distribution Admin., mgmt or support services Provision of services to unrelated parties Internal group finance Regulated financial services Insurance Holding shares or other equity instruments Dormant Other Etc. Notes: Constituent entities rather than legal entities Multiple activities may be chosen

Appendix B Additional discussion of state aid considerations

State aid The European Commission (executive branch of the EU, also referred to as the EC), in its broad tax evaluation, has begun to review international tax planning on the basis of state aid rules. In particular, the EC has focused on tax rulings and advance pricing agreements made by: Ireland Luxembourg The Netherlands Various R&D/IP regimes (also known as patent/IP boxes) The EC wants to restore “fair” competition and will require companies that were subject to state aid to pay back its tax benefits (including interest) over the past 10 years, unless one of the following holds: Justified (e.g., industry-specific economic downfall) Legitimate expectations raised by EU institution(s) Existing state aid (e.g., a rule existed before entering the EU)

What is state aid in the EU?
State aid exists where the following conditions are met: It provides an advantage to the taxpayer; for example: Reduction of the tax base Reduction in the amount of tax Relief with respect to the collection of taxes due It is granted by a member state or through state resources: E.g., government subsidy It affects competition and trade between member states. It is selective, in that it favors certain undertakings in comparison to other undertakings, which are in a legal and factual comparable situation (by individual, sector or region): E.g., ruling or waiver According to the EC, “an approval of a transfer pricing arrangement which does not reflect a market outcome and which favors a particular undertaking must be considered as prima facie selective.”

Appendix C Additional discussion of proposed Section 385 regulations

Section 385 — proposed regulations Overview
On 4 April 2016, the US Treasury Department and Internal Revenue Service released proposed regulations under Section 385 that would: Treat as stock certain related-party interests that would otherwise be treated as debt Authorize the IRS to treat certain related-party interests in a corporation partly as debt and partly as stock Establish significant documentation requirements in order to treat certain related-party interests in corporations as debt Overview of the draft regulations: Proposed § : definitions and operating rules Proposed § : documentation requirements Proposed § : certain per se characterization rules Proposed § : special rules applicable groups

Section 385 — proposed regulations Key definitions
Expanded group Section 1504(a) affiliated group, including 1504(b)(1)-(8) corporations Expanded to include indirect ownership under 1504(a)(1)(B)(i) Indirect ownership is determined by reference to 304(c)(3) Changing 1504(a)(2)(A) to 80% vote or value (from vote and value) Expanded group instrument (EGI) An applicable instrument where the issuer and holder are members of the same expanded group Modified expanded group An expanded group, determined by reducing 80% ownership to 50% Controlled partnership Partnership in which at least 80% of the interests in capital or profits are directly or indirectly owned by one or more members of an expanded group Modified controlled partnership A partnership in which at least 50% of the interests in capital or profits are directly or indirectly owned by one or more members of a modified expanded group

Section 385 — proposed regulations Key takeaways
The draft regulations provide the Commissioner (not taxpayers) with the ability to characterize an EGI or modified EGI as partly debt and partly equity (Proposed § ). Existing law characterizes an instrument as entirely debt or equity. Each EGI must satisfy strict documentation requirements or the interest will be characterized as equity for tax purposes, with certain exceptions for small issuers (Proposed § ). Certain debt instruments will be per se treated as equity (Proposed § ). If partnership debt is recharacterized as equity, numerous issues need to be addressed: Including implications under the disguised sale and Section 752 rules, as well as under the capital account maintenance and allocation provisions Timing: Generally, proposed § and § are expected to apply on finalization of the regulations. Proposed § has retroactive effect to 4 April 2016, with a transition rule limited recharacterization until 90 days after finalization.

Questions

Tax accounting insights and challenge areas
Please remember to delete this box before printing. For guidance regarding allowable tax accounting services for audit clients, see BB1088, Independence Considerations Regarding Our Involvement With An SEC Audit Client's Income Tax Provision (November 2003) and CA0020, Considering and Evaluating the "Auditing Your Own Work" Principle of Auditor Independence and Related Independence Rules When Providing Tax Services to an Audit Client (November 2005). For guidance regarding services for public audit clients related to uncertainty in income taxes, see CA0038, Supplemental Independence Guidance and Tools Relating to FIN 48 Implementation and the PCAOB Tax Rules (December 2006). EY policies related to internal control services for public audit clients are provided in CA0051, Independence Guidance Relating To Our Services To Assist Audit Clients With Implementing Or Continuing Compliance With Section 404 Or Other Similar Internal Control-Related Services (October 2007, rev. June 2010). EY policies related to tax accounting services for nonaudit clients are addressed in BB1178, Providing Accounting Advice on Income Taxes to Nonaudit Clients (April 2005) Tax accounting insights and challenge areas Presented by Ernst & Young LLP’s: Dave Mullett — Partner, Scot Kettlewell — Executive Director,

Agenda Developments Tax provision challenges and current issues
Accounting standard updates Financial Accounting Standards Board (FASB) project status Internal control over financial reporting Public Company Accounting Oversight Board (PCAOB) focus areas Securities and Exchange (SEC) focus areas Tax provision challenges and current issues Restatement trends and common causes of tax restatements Other current tax accounting issues Reduce risk in tax accounting calculations Tax provision process recommendations and action items Tax accounting considerations Appendix Valuation allowance Unrepatriated earnings — Accounting Standards Codification (ASC) (APB 23)

Accounting standards updates (ASUs)

Revenue recognition standard Effective date
The new revenue recognition standard 19 June 2014 Revenue recognition standard Effective date Revenue recognition accounting standard issued on 28 May 2014 Supersedes virtually all industry and interpretive guidance Requires more estimates and judgments than current guidance The FASB has issued a one-year deferral of the original effective date of ASU Standard will be effective for public entities for annual periods beginning after 15 December 2017 (2018 for calendar-year companies) Nonpublic entities will still have the option of an additional year (effective for annual periods beginning after 15 December 2018) Early adoption will be allowed for both public and nonpublic entities — using original effective dates (2017 for calendar-year companies) The deferral was issued in ASU on 13 August 2015 After considering feedback on their Exposure Draft (ED), the IASB voted to move forward with a one-year deferral as well

Revenue recognition standard Effective date
The new revenue recognition standard 19 June 2014 Revenue recognition standard Effective date Dates shown are for calendar year-end entities Mandatory adoption Public Nonpublic Early adoption 1 January 2019 1 January 2017 1 January 2018 31 December 2017 annual F/S Effective date First presentation 31 March Q 31 December 2019 annual F/S 31 March Q 31 March 2017 interim F/S 31 December 2018 annual F/S 31 March 2018 interim F/S 31 March 2019 interim F/S

Revenue recognition standard Tax technical considerations
Taxpayers will need to determine when and how any change in revenue recognition for financial reporting purposes is recognized for tax purposes For taxpayers applying a deferral method for advance payments, the amounts deferred for tax purposes are determined by reference to the amounts deferred for financial statement purposes Consider whether a change in revenue recognition for financial statement purposes is also a permissible method for tax purposes In certain jurisdictions, local tax liability is based upon statutory financial statements When local statutory financial statements are prepared under international financial reporting standards (IFRS), the statutory financial statements may change with adoption of the standard Evaluate whether a foreign subsidiary’s earnings and profits (E&P) or local tax change the amount by which a distribution is taxable as a dividend, the amount of Subpart F inclusion, or deemed paid foreign tax credits Evaluate intercompany prices and transfer pricing policies where adoption changes revenue, profits or third-party comparables used in determining transfer pricing Companies may need to review the methodology for compiling sales apportionment data

Revenue recognition standard Income tax accounting considerations
New temporary differences may arise; existing temporary differences may be computed differently Companies may need to revise processes and data collection tools Valuation allowance considerations may change Change in deferred tax assets, temporary difference reversals or expected future taxable income may affect judgments regarding the realizability of deferred tax assets Multinational companies will need to consider the effects of changes in revenue recognition for financial reporting purposes at foreign subsidiaries Jurisdiction-by-jurisdiction analysis necessary to assess whether the change in revenue recognition for financial reporting results in temporary differences due to differences in timing and amount of revenue recognized for financial reporting and tax purposes Current and deferred tax consequences of the cumulative effect adjustment reported in the period of adoption Requires careful consideration of the income tax accounting effect of individual items included in the cumulative effect adjustment A change in an accounting method for tax purposes requires careful consideration of the period the change in method is considered for financial reporting purposes

FASB project status

Presentation of unrecognized tax benefits Final standard
ASU , Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists Effective for fiscal years, and interim periods within those years, beginning after 15 December 2013 for public entities and fiscal years beginning after 15 December 2014 for nonpublic entities Determine whether a deferred tax asset (DTA) is available for offset based on the DTAs that exist at the reporting date and assume tax position is disallowed at the reporting date Present liability associated with unrecognized tax benefits as a reduction to related DTA for net operating loss, similar tax loss or tax credit carryforward if such settlement is required or expected Present unrecognized tax benefit as a liability; not combined with DTA if net settlement is not required or expected Does not change disclosure of unrecognized tax benefits, which are required to be presented gross Applied prospectively with retrospective application permitted

Webcast title 9/18/2018 FASB income taxes simplification project Final standard — classification of deferred taxes FASB issued ASU , Balance Sheet Classification of Deferred Taxes, which requires the classification of all deferred tax assets and liabilities as noncurrent No longer allocate valuation allowances between current and noncurrent No change to jurisdictional offsetting requirements For public business entities, standard effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, standard effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption permitted for all entities in any interim or annual period Entities may elect either a prospective or retrospective transition approach

Webcast title 9/18/2018 FASB income taxes simplification project Redeliberations — intercompany scope exception Proposal would eliminate exception that requires deferral of the income tax effects of intercompany sales/transfers of assets Would recognize income tax expense in the period of the sale/transfer Would recognize deferred tax effects of difference between the tax basis of the asset in the buyer’s jurisdiction and its book basis after elimination of the intercompany profit For public business entities, FASB expects proposed amendments effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, FASB expects proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption permitted, but not before the effective date for public business entities Modified retrospective transition approach In October, the FASB asked its staff to research the costs and benefits of deferring the income tax effects only for intercompany inventory transactions

FASB share-based payment project Final standard
Would recognize all excess tax benefits and tax deficiencies in the income statement Would account for excess tax benefits and tax deficiencies as discrete items in the interim period in which they occur Prospective transition Requirement that excess tax benefits not be recognized until they are realized would be eliminated Modified retrospective transition with a cumulative catch-up adjustment to retained earnings For public business entities, would be effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities, would be effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption would be permitted for all entities in any interim or annual period

FASB income taxes disclosure project Initial deliberations — foreign earnings
The FASB tentatively decided to require additional disclosures related to foreign earnings and indefinite reinvestment assertions: Pre-tax income disaggregated between domestic and foreign earnings, with foreign earnings disaggregated for any country that is significant to total earnings Domestic tax expense recognized on foreign earnings Undistributed foreign earnings that are no longer indefinitely reinvested with an explanation of the circumstances that caused the entity to change its assertion and separate disclosure for any country that represents a significant portion of the disclosed amount Foreign earnings that are indefinitely reinvested for any country that represents at least 10% of the entity’s total foreign earnings that are indefinitely reinvested

FASB income taxes disclosure project Initial deliberations — uncertain tax positions
The FASB tentatively decided to add requirements that public entities disclose as part of the tabular rollforward of unrecognized tax benefits the following: Settlements disaggregated between those that are cash and noncash (e.g., an existing net operating loss carryforward used to settle with the taxing authority) A breakdown of the total amount of unrecognized tax benefits by the balance sheet line item in which the amounts are presented The FASB also tentatively decided to eliminate for all entities the requirement to disclose certain information when it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date

FASB income taxes disclosure project Initial deliberations — other
The FASB also made tentative decisions for other income tax disclosures that would require entities to disclose: Information about an enacted change in tax law if it is probable that the change will affect the entity in a future period Income taxes paid disaggregated by domestic income taxes paid and foreign taxes paid An explanation of the nature and amounts of valuation allowances recorded and released during the reporting period

The FASB also made tentative decisions for other income tax disclosures that would require: Nonpublic entities to disclose income tax rate reconciliations consistent with the requirement for public entities and all entities to disclose: Individual reconciling items of more than 5% of amount of pretax income multiplied by the applicable federal statutory income tax rate A qualitative description of items that have caused a significant change in the rate Entities to disclose where deferred taxes are recorded on the balance sheet if not presented as separate line items Entities to disclose the amounts and expiration dates of tax carryforwards recorded on the tax return (not tax-effected) and in the financial statements (tax-effected) and the total amount of unrecognized tax benefits that offsets carryforwards

The FASB plans to perform outreach on its tentative decisions in the disclosure project before issuing a proposal Before amending today’s guidance, the FASB would issue an exposure draft on the proposal

FASB government assistance disclosure project — proposal
The FASB proposal would require for-profit entities to make certain disclosures about assistance they receive from legally enforceable agreements with governments: The nature of the assistance, including a general description of the significant categories and the form in which the assistance has been received The accounting policy used to account for the government assistance The line items on the balance sheet and income statement that are affected by government assistance and the amounts The amounts of government assistance received that are not directly recorded in the financial statements (e.g., loan guarantees, loans with below-market rates, tax abatements) unless impracticable to do so

FASB government assistance disclosure project — proposal
The disclosure requirements would apply to certain arrangements accounted for under the income tax guidance in addition to grants, loan guarantees and other types of government assistance The guidance would be applied prospectively to all agreements existing at the effective date and those entered into after the effective date Entities would be permitted to apply the guidance retrospectively The FASB will determine the effective date based upon feedback received during the comment period Comment letters were due by 10 February 2016

Internal control over financial reporting (ICFR)

ICFR — focus areas Complete understanding of the process and the related controls Completeness and accuracy of data used in the performance of controls Evidence of control operation, particularly for management review controls Another thing that we have seen in PCAOB inspection activities, the ACD publication, and the SEC staff’s compliance and enforcement activities is a continued focus on internal control. Many of the ICFR hot topics affecting auditors could have implications for management. Specifically, management may want to consider the design of an entity’s internal controls and/or the level of evidence maintained to support management’s assessment of the internal control environment. For auditor’s, the main ICFR focus areas include: A complete understanding of the process and related controls – Management needs to maintain and the auditor needs to develop, a robust understanding of the process and related controls to demonstrate that the control environment is designed to effectively prevent or detect errors or fraud that may be material to the financial statements. Developing this understanding relies on management’s documentation of the process, policies and controls, and complete descriptions of the steps performed when executing the control Completeness and accuracy of system-generated data reports used in the performance of other controls – Most controls rely on data produced from the company’s IT systems, therefore processes and controls need to validate that the data being used in the performance of controls is complete and accurate. The evidence obtained when testing a control’s operating effectiveness, particularly for management review controls Management review controls have really been getting a lot of attention lately and I’m sure many people in our audience have seen an increase in their auditor’s focus on understanding and testing these controls. So we thought it best to spend a little more time on this area (next slide).

ICFR Precision and evidence of review controls
Precision (the nature or level at which the review control operates): Is the control capable of identifying errors? Would the control identify errors or fraud that could be material to the financial statements? Does the control address the relevant risks? Does the control identify errors? Nature of the errors? Examples? If not, why? Nature of the questions identified: follow-up; outcome? Is there contradictory evidence indicating the control is not suitably designed? What evidence of the control exists? Is evidence sufficient to support the assessment? A signature is not sufficient Many company’s descriptions of review controls may not readily describe the review control’s precision and the person performing the review control may not find it easy to describe the sensitivity of the review procedures he or she performs. Nonetheless, auditors are responsible for evaluating the design of controls and the control’s ability to prevent or detect misstatements, and auditors need to gather and evaluate evidence to support conclusions on the design of those review controls that are important to the audit. The slide lists some common questions that company’s should consider regarding review controls. Some additional considerations include: The control owner should focus on what is important to them in performing the review control. What specifically do they do as part of their review? What types of items would they look for at in a reconciliation or variance analysis? What types of items are they typically asked about in subsequent reviews by higher levels of management? These items may be quantitative or qualitative. Consider what is important in the actual execution of the control. The reviewer’s agreement of inputs into underlying data, recalculations, agreeing items to supporting documentation may all be elements that factor into the design of the review control precision. Auditors need evidence to support the execution these procedures to complete the audit trail. When evidence such as document drafts, tickmarked schedules or checklists aren’t available, auditors need to supplement the documentation with other corroborating procedures. Some review controls are focused on making sure a certain accounting objective is achieved. The control owner should be able to explain how the procedures they perform meet this objective. Understand how the control can effectively mitigate the risk. Broad general statements by the company such as “I review for unusual items” or to determine the amounts “appear reasonable” generally are not sufficient for auditors. Inquiry alone is not sufficient for the auditor to conclude about the effectiveness of controls.

Management review controls
The objectives of management review controls typically involve determining whether: Accounting is appropriate There are potential errors or misstatements Information is complete and accurate Other controls were performed in a timely and effectively manner Detect and correct controls — may be manual or dependent on IT Performed by an individual(s) with appropriate competence and authority Management review controls are very common in income tax processes Management review controls are very common in income tax processes, we have listed some examples on the slide. Management review controls are detect and correct controls and, as I discussed on the last slide, they usually dependent on data provided by IT systems or calculated in an IT tool – for example general ledger balances, book and tax basis depreciation reports or schedules of uncertain tax positions. They must be performed by an individual or individuals with appropriate competence and authority and they should involve determining whether: Accounting is appropriate There are potential errors or misstatements Information is complete and accurate Other controls were performed timely and effectively Review of the income tax provision Review of uncertain tax positions Review of realizability of deferred tax assets

When designing review controls, management should consider Risk of material misstatement (i.e., importance of the control) Verification of the completeness, accuracy and integrity of data and reports used Precision of the control Criteria used by the reviewer to identify matters for investigation How items identified for investigation are resolved Review control documentation Evidence of control operation Policies and procedures — design of the review control Some important management review control considerations include: Consideration of the risk of material misstatement – Is the control designed in such a way so as to effectively address the risk of material misstatement that it is intended to? If the control is the critical control for addressing a risk of material misstatement, the control should be well defined and more evidence will need to be retained to support that it is designed and operating effectively. Verification of the completeness, accuracy and integrity of data and reports used – Does the control address the completeness, accuracy and integrity of the data/reports used in performance of the control or are there other specific controls that address those risks? Precision of the control – What criteria are used to identify matters for investigation, including how the reviewer develops expectations and the level of aggregation of the data used. Review controls commonly investigate “unusual” items – but how does the reviewer determine if something is “reasonable” or “unusual” How items identified for investigation are resolved Review controls should be documented. Management’s guidance in this area (which is included in SEC Release No ) emphasizes that management must maintain reasonable support for its internal control assessment, and documentation of the design of the controls is an integral part of reasonable support. This includes evidence demonstrating that the control operated as designed (i.e., that the control was executed in accordance with management’s documented policies and procedures). Principle 12 of the 2013 COSO framework also includes an expectation that entities formally document policies and procedures when they are subject to external party review. Lets look at some examples of evidence of management review controls that you may maintain and your auditor may be requesting in the next slide.

Control evidence can include any of the following: PCAOB standard five-auditor testing of design and operating effectiveness of a control includes a mix of Inquiry of appropriate personnel (inquiry alone does not provide sufficient evidence) Observation of the company's operations Inspection of relevant documentation Re-performance of the control Draft documents or documents with tickmarks, notes, questions s Meetings (participation/ observation) Calculation reiterations Evidence of management review control operation may include: Multiple drafts of documents that undergo revision or copies of management tickmarks, notes, and resolution on a document while performing a review correspondence between the tax department and others at the company or externally with 3rd party providers Participation in review meetings where matters are reviewed and discussed within the tax department or with other individuals at the Company, for example a meeting to review the provision between the director of tax and the CFO The auditors may ask for evidence of all of these items and/or to observe the meetings that occur. This is because there are four ways audit teams can test the operating effectiveness of internal controls (that is all internal controls – not just review controls) that are included in PCAOB Standard No 5 – inquiry, observation, inspection and re-performance. As noted here on the slide, auditing standards are very clear that inquiry alone does not provide sufficient evidence to conclude on the operating effectiveness of a control (PCAOB AS 5.50) so the auditor will need to perform additional procedures beyond inquiry. The tests that the auditor might perform are presented on the slide in the order of the evidence that they would ordinarily produce (from least to most). That is, inspection of relevant documentation ordinarily provides more evidence than observation; and re-performance of the control, when possible, can produce even more evidence. The above are examples of documentation of management review controls and items that the audit team may request to test review control operation. The approach that the auditor selects is based on how much evidence is required to test the control which is determined based on the importance and precision (the factors we just discussed) of the control. The key for management is to understand the auditor’s planned approach so that the appropriate documentation is maintained – well before all of these activities and documentation occur.

Attributes of a review control
Who performs the control? Do they possess competence and authority? Who When or how often is the control performed (timeliness)? When What procedures are performed? What info or data is used? What does the reviewer evaluate? What precision is encompassed? What types of errors are identified? What actions are taken or result? What

ICFR Design example Poor example Better example
Appropriate personnel review the return to provision true-up calculation. On an annual basis, in the period in which the federal income tax return is filed (when), the Chief Accounting Officer (who) reviews the return to provision calculation ensuring all positions taken on the income tax return were appropriately considered in the prior year income tax provision (what, why). All return to provision items $250k or greater (net of tax) are evaluated for the effect on the current year or prior year income tax provision (what). Considerations are documented within the return to provision workpaper file and supported with supplemental evidence, if necessary (how).

ICFR Other considerations
Review control design Control owner has appropriate authority and competency Precision considerations can be qualitative and/or quantitative thresholds Data — understand and document effectiveness of controls related to source data and inputs to tax provision calculations Completeness and accuracy Integrity of underlying reports Appropriate evidential support to document both the design and operating effectiveness of controls (required for all controls, but can be challenging for review controls) Evaluate effectiveness of internal controls design and operation based on current business and procedures Perform assessment of control execution and testing of control design

PCAOB focus areas

PCAOB Income tax continues to be a hot topic. As US issuers continue to grow their profits in lower-tax jurisdictions, the spotlight on undistributed earnings and cash held overseas raises the risk in this area. We have seen audit issues in the past inspection cycle in this area — most commonly related to controls over these aspects of income tax accounting and disclosures. Helen Munter, Director, Division of Registration and Inspections of the PCAOB 10 December 2014, American Institute of Certificated Public Accountants (AICPA) Conference on Current SEC and PCAOB Developments Income taxes and income tax controls continue to be hot topics in today’s environment. Helen Munter commented on this at the December 2014 AICPA conference on Current SEC and PCAOB Developments highlighting undistributed earnings and cash held overseas as areas of focus as noted in the quote on this slide.

PCAOB 7 May 2015 audit committee dialogue
Identified deficiencies related to: Auditing estimates (including tax- related estimates) — auditing the estimate and related internal controls Identified emerging risk area: Auditing of management’s indefinite reinvestment assertion and the related internal controls Questions to consider: How is understanding of critical assumptions and methods obtained? What is the nature of evidence gathered regarding management’s assertions? How is contrary evidence evaluated? Are indefinite reinvestment assertions consistent with other disclosures (e.g., MD&A)? Consistent with Helen’s comment on the last slide, the PCAOB discussed indefinite reinvestment assertions in it’s Audit Committee Dialogue publication on May 7th, 2015 and audit firm deficiencies in auditing estimates, including tax-related estimates. The Audit Committee Dialogue document was the first in a series of publications the PCAOB expects to publish aimed at providing insights from the PCAOB’s oversight activities of the six largest audit firms and potential emerging risks to consider to help audit committee members oversee their auditors. The PCAOB identified auditing estimates, including tax-related estimates, as one of the 4 areas (1) with a large number of significant deficiencies in the auditing of the estimate and related internal controls. Indefinite reinvestment was one of 4 emerging risks the PCAOB highlighted (2). The discussion document provides background information on the issue and questions the audit committee should consider discussing with the auditor. As audit teams and audit committees are discussing these items, management could also expect to receive similar questions and discussions and expect the auditor to focus on auditing tax-related estimates and the indefinite reinvestment assertion and controls this year. You may consider reviewing this short 15 page document for more information. ____________________________________________________________________________________ (1) Other deficiencies identified were: Auditing internal control over financial reporting, Assessing and responding to risks of material misstatement, Referred work in cross-border audits (2) others emerging risk areas identified were: increase in mergers and acquisitions, falling oil prices, and maintaining audit quality while growing other businesses)

AICPA national conference — December 2015 PCAOB staff remarks on tax
PCAOB staff stated that inspections will likely focus on the following areas of emerging risks in 2016: Risks associated with mergers and acquisitions Income taxes, specifically matters related to a company’s assertions related to undistributed cash held in overseas subsidiaries Cybersecurity risks

SEC focus areas

AICPA national conference — December 2015 SEC staff remarks on income tax
Focus on quality and clarity of management discussion and analysis (MD&A) disclosures, including those related to income tax rate reconciliations, valuation allowances and earnings that have not been repatriated Enhance disclosures in MD&A when: Income tax expense is material to financial statements — both recorded expense and expense based on statutory tax rate There are material fluctuations or lack of fluctuations that were expected in the effective tax rate (ETR) There are risks and uncertainties Provide transparent disclosure in MD&A of significant foreign earnings, including earnings and tax rates within specific jurisdictions and jurisdictions’ effects on the ETR

Regulatory focus — income taxes
Foreign earnings Realizability of deferred tax assets Effective tax rate reconciliation

SEC comment focus Comment area 2014 ranking 2013 ranking
2014 and 2013 % of total registrants that received comment letters Management’s discussion and analysis 1 51% Fair value measurements 2 25% Signatures, exhibits and agreements 3 7 18% Income taxes 4 6 16% Revenue recognition 5 17% Non-GAAP financial measures Intangible assets and goodwill 8 15% Executive compensation disclosures 10 14% Segment reporting 9 13% Acquisitions and business combinations 11 12%

SEC comment focus — foreign earnings
Indefinite reinvestment Not an all-or-nothing assertion Positive assertion requires specific documentation and evidence of plans each reporting period Consider financial reporting implications of tax planning SEC staff comments are becoming more focused earlier in the comment letter process Example SEC staff comment: We note your disclosure that you “have not provided US income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries as of December 31, because we intend to permanently reinvest such earnings outside the US” Please explain to us how you evaluated the criteria for the exception to recognition of a deferred tax liability in accordance with ASC and 18 for undistributed earnings that are intended to be indefinitely reinvested. Describe the type of evidence and your specific plans for reinvestment for these undistributed earnings that sufficiently demonstrate that remittance of earnings will be postponed indefinitely.

Realizability of deferred tax assets
How evidence was weighted Cumulative losses Consideration of the four sources of taxable income, including the prominence of each source and the material uncertainties, assumptions or limitations associated with each source Timing and reason for changes in valuation allowance Consistency of assumptions Consistency of accounting with MD&A disclosures SEC comments: Please substantially revise your disclosure in future filings to provide investors with quantitative and qualitative information of the material positive and negative factors that you considered when arriving at your conclusion that it is more likely than not that the deferred tax assets will be realized. Please discuss the significant estimates and assumptions used in your analysis, including the specific factors that changed during fiscal 2012 and led you to determine the reversal was appropriate at this time.

SEC comments (cont.) Please discuss how you determined the amount of valuation allowance to reverse Please disclose the amount of pre-tax income you need to generate to realize these deferred tax assets. Include an explanation of the anticipated future trends included in your projections of future taxable income. Confirm to us that the anticipated future trends included in your assessment of the realizability of your deferred tax assets are the same anticipated future trends used in estimating the fair value of your reporting units for purposes of testing goodwill for impairment and any other assessment of your tangible and intangible assets for impairment. If you are also relying on tax-planning strategies, please disclose the nature of your tax planning strategies, how each strategy supports the realization of deferred tax assets, the amount of the shortfall that each strategy covers, and any uncertainties, risks or assumptions related to these tax-planning strategies. Please show us in your supplemental response what your revisions to future filings will look like.

Effective tax rate reconciliation
Clearly label items in the income tax rate reconciliation For material rate reconciling items associated with foreign jurisdictions, disclose the specific jurisdictions that materially affect the effective tax rate, their tax rates and information about the effects of such foreign jurisdictions (e.g., magnitude and mix) on the effective tax rate May question whether large “provision to return” or “true-up” adjustments reflect prior year errors rather than changes in estimates Registrants should determine that rate reconciliation information is consistent with other disclosures in MD&A or footnotes

Tax provision challenges and current issues

Tax-related restatements and material weaknesses Summary of the numbers*
Year 2011 2012 2013 2014 2015 Total restatements 97 111 102 108 126 “Big R” restatements 33 24 13 15 16 Notes on restatements Tax remains a “hot issue” for tax departments, based on the number of companies that have restated their financial statement for tax reasons The total number of reported restatements due to tax increased fairly significantly during 2015, and tax remains one of the top reasons for financial statement restatements. Total restatements include both “little r” and “big R” or revision restatements. Year 2010 2011 2012 2013 2014 2015 Material weakness 94 75 65 55 88 77 Notes on material weaknesses During the first few years of Sarbanes-Oxley (SOX) reporting, more than 200 companies reported tax-related material weaknesses each year. In recent years, the number of companies reporting material weaknesses has declined significantly, but tax remains one of the biggest drivers of material weaknesses. * Data based on Ernst & Young LLP search of Form 10-K and 10-Q filings January 1, 2011 through December 31, 2015.

Restatements Common errors
Historically, and continuing into 2015, three most common causes of restatements are: Deferred tax accounting Accounting for acquisitions/dispositions (specifically purchase accounting and goodwill impairment calculations) Valuation allowance adjustments During 2015, issues relating to the accounting for stock- based compensation cropped up more frequently Improper classification of current and noncurrent deferred tax assets is also commonly cited “Other” errors often cited: Errors relating to intercompany activities (allocation of sales, sale of assets) Treatment of federal and state carryforwards Foreign taxes (foreign tax credits, currency translation adjustments Capitalization, depreciation or amortization of tangible and intangible assets for accounting purposes Pension plan accounting (foreign and domestic)

Material weaknesses Causes
The primary causes of tax-related material weaknesses can be divided into three general areas: People Processes and controls Accounting errors People issues are typically described as: Personnel with insufficient technical knowledge, experience and training in tax accounting Lack of investment, resources and focus in tax reporting Process and control issues include the following: Lack of adequate policies and procedures to ensure the completeness, accuracy, preparation and review of the income tax provision Lack of documentation Lack of timely reconciliation of tax accounts Inadequate monitoring of significant transactions and new reporting requirements Financial close and work compressions Improper segregation of duties During 2015, companies are more frequently citing specific accounting errors. Specific items treated improperly include the following: Valuation allowances Net operating losses (NOLs) Pensions State taxes Leasing Impairment

Appropriate application of tax basis
Essential starting point: maintaining a detailed and accurate record of the tax basis of all assets and liabilities, including those without a book basis A fluctuation analysis of tax basis supporting the deferred tax balances may not provide sufficient audit evidence Common pitfall: Not properly identifying a tax basis or attribute or not appropriately recording and tracking the tax basis or attribute in subsequent periods Requires technical understanding of tax law Often for multiple taxing jurisdictions May be simple or complex How is the tax basis evaluated?

Intraperiod allocation
Be mindful of the complexity of the intraperiod allocation rules Common pitfalls: Failure to apply the exception (losses from continuing operations and income from other sources) Failure to consider interaction of exception with the interim reporting rules Inappropriate “backwards tracing” Failure to follow two-step process when income from discontinued operations is recognized in an interim period and losses from continuing operations are expected for the year Are there losses from continuing operations and income from another source? Does the financial reporting reflect the exception to the intraperiod allocation rules?

Intraperiod allocation
Exceptions to the general rule apply in all situations where there is: A loss from continuing operations Cumulative income from all other sources Exception also applies to interim periods when company anticipates an ordinary loss from continuing operations for the year Applicable even to periods of a full valuation allowance Does not change overall annual tax provision (benefit) However, may change tax provision (benefit) between interim periods The result of this computation (as well as the need to do the computation) is often counterintuitive.

Accounting for outside basis differences
Outside basis differences may not be recognized if certain exceptions are applicable Section of Income taxes Financial Reporting Developments, Exceptions to deferred tax accounting for outside basis differences: summary of application of exceptions and common entity types Common pitfalls: Not providing taxes for outside basis difference related to investments in partnerships or equity method investments No longer qualifying for exception with changes in investment ownership Are the exceptions to outside basis differences appropriately applied?

Realizability of DTAs Same framework
Establishing a valuation allowance for the first time Determining whether a valuation allowance continues to be necessary Have all four sources of taxable income been considered? Is there taxable income in carryback periods of the appropriate character? Are tax planning strategies considered appropriately?

Realizability of DTAs Future reversals of existing taxable temporary differences Evaluate DTAs on a gross basis Consider the timing of reversal of existing taxable temporary differences Common pitfall: DTAs evaluated on a net basis Common pitfall: Naked credits are used as a source of taxable income Will the deferred tax liabilities result in taxable income in the appropriate period? Are there deferred tax liabilities associated with book balances that do not have a known period when they may affect the income statement?

Other current issues Interim reporting
Concept The tax provision for the year is the same whether a company only prepares annual financial statements or prepares interim financial statements in addition to annual financial statements ASC 270 rejects the discrete approach to interim reporting ASC 740 is based on a discrete approach that measures a deferred tax liability or asset as of a given point in time Specific items are recognized as discrete events when they occur Katrina/Jeremy

Other current issues Disclosure related to reinvestment of foreign earnings
Certain disclosures required when the deferred tax liability is not recognized ( ) The cumulative amount of the temporary difference (i.e., outside basis difference in which the book basis of the investment exceeds its tax basis before application of a tax rate) ( (b)) The amount of the unrecognized deferred tax liability related to the difference or statement that it is not practicable to determine ( (c)) Types of events that would cause the temporary difference to become taxable ( (a)) Notably, there is no practicability exception for disclosing the temporary difference required by ASC (b) Katrina/Jeremy

Reducing risk in tax accounting calculations

Reduce risk in tax accounting calculations
Uncertain tax positions Automate unrecognized tax benefit calculations and rollforwards and interaction with tax attributes, valuation allowances, interest and penalties, and cumulative translation account Fixed assets Improve reporting of tax return deductions and deferred taxes Reconcile subledgers and general ledgers to source data and tax systems Share-based payments Support balances for deferred tax assets, additional paid-in capital (APIC) pool and Section 162(m) adjustments; consider deductibility of payments to foreign employees and intercompany charges Tax basis balance sheets Support cumulative temporary differences by entity with book and tax basis balance sheets that agree to tax returns and general ledgers; automate inputs and calculations Legal entity calculations Improve legal entity data and engage finance for items outside tax department’s direct control (e.g., forecasts, legal entity reporting, intercompany profit elimination)

Reduce risk in tax accounting calculations
Intercompany transactions Review intercompany transactions for compliance with tax accounting rules Improve spreadsheets and tools to minimize risk of errors, reduce hours and manage risk. Consider implementing a standardized process and/or tool for: Tax basis balance sheets to validate deferred taxes Unrecognized tax benefit computations and tracking NOL tracking Indefinite reinvestment assertion documentation and outside basis difference calculations Share-based payment tax accounting, APIC pools and deferred tax proofs Section 162(m)(6) deferred tax computations Fixed asset deferred tax reconciliations More than 50% of Fortune 1000 companies use Excel spreadsheets to compute global income tax provision Consider third party to test and improve Excel spreadsheets for enhanced efficiency, accuracy and controls

Tax provision process recommendations and action items

Tax provision process recommendations
Refresh internal controls for income taxes Develop work plan for enhancements and remediation items; assign tasks Review work plan and timeline with auditor Assign technical tax accounting white papers for issues and judgments Accelerate work during quarters and interim to avoid surprises Evaluate and record return-to-provision adjustments Prove out deferred tax assets/liabilities, current taxes payable/receivable Leverage tax provision-to-return process for completed tax returns Document and analyze state tax rates, including apportionment changes and the impact on deferred taxes, and foreign tax rates for changes Document outside basis differences, including indefinite reinvestment assertions, and prepare outside basis difference calculations (consider previously taxed income and unrecaptured Subpart F income) Document valuation allowance considerations (four sources of taxable income) and prepare position paper Document uncertain tax positions Consider tool to improve efficiency and accuracy of computations

Analyze and document unique transactions and events and effects on tax provision, unremitted earnings assertions, uncertain tax positions and valuation allowances (e.g., acquisitions, dispositions, financing, internal restructuring, cash flow forecasts) Evaluate intercompany transactions and tax provision effects Ensure tax accounting judgments align with business results and disclosures and update disclosures of factors that influenced judgments Review for consistency with tax and nontax disclosures Liquidity (foreign reinvestment and parent or domestic cash requirements) Commitments and contingencies Acquisitions and dispositions Cash flow Equity movements Share-based payments MD&A

Institute regular meetings with external auditors regarding contemporaneous issues (significant transactions, changes in business, etc.) Challenge prior year processes annually to identify areas for improvement Simplify and standardize existing Excel templates Address technical issues early and prepare white papers for consideration by management and external audit Implement standardized global procedures Consider the tax provision process a year-round area of continued focus Identify a third party to assist with preparation or review the provision (pre- audit review) or co-source or out-source to free up internal time for review Obtain assistance researching and documenting issues or preparing white papers on tax accounting positions

Appendix Valuation allowance and unrepatriated earnings

Valuation allowance

A deferred tax asset (DTA) must be reduced by a valuation allowance (VA) if, based upon the weight of available evidence, it is more likely than not that some portion, or all, of the DTA will not be realized. Future realization ultimately depends on the existence of sufficient taxable income of the appropriate character in either the carryback or carryforward period under the tax law.

All available evidence, both positive and negative, should be considered to determine whether a VA is needed. Weight given to the potential effect of negative and positive evidence shall be commensurate with the extent to which it can be objectively verified.

Evaluating the need for a VA
DTAs represent future tax deductions (or tax carryforwards/tax credits) Reduced by a VA if it is more likely than not (>50%) that some portion, or all, of the DTAs will not be realized Evaluation made on a gross basis Based on weight of all available evidence Depends on sufficient taxable income Not existence of DTA; only realizability Consider presentation of VA (current/noncurrent) Common pitfall Common pitfall

Sources of taxable income
Taxable income in carryback years (if permitted) One Future reversals of existing taxable temporary differences Two Tax planning strategies Three Future taxable income (not reversing temporary differences and carryforwards) Four Consider the sources in order of the least subjective to the most subjective

Evaluation of positive and negative evidence
Weight given to evidence should be commensurate with the ability to objectively verify it Examples of positive and negative evidence include: Negative evidence Positive evidence Cumulative pretax losses in recent history (generally three years) or projections of cumulative pretax losses Existing contracts or firm sales backlog History of carryforwards expiring unused Strong earnings history, exclusive of loss that created the future deductible amount, coupled with evidence that the loss is an aberration Brief carryback, carryforward periods Implemented cost reduction plans that can be objectively verified (however, consider any effects on revenues) Common pitfall

Cumulative losses in recent years
Calculation Cumulative pre-tax income/loss for three years (current year and two preceding) Annual calculation Exclude only the cumulative effect of accounting changes Not an “on/off switch” Does not, in itself, result in a conclusion of the realizability of deferred tax assets Quantitative considerations Qualitative considerations Is a significant piece of negative evidence that is often difficult to overcome Common pitfall Common pitfall

Releasing a valuation allowance
What framework do I apply when determining whether to release a valuation allowance? Same framework Change in circumstance causes change in judgment about realization in future years Key considerations Extent of positive and negative evidence that exists Ability to rely on future projections of income Return to profitability Not an “on/off” switch No quarterly rolling reversal

Classification Valuation allowances
In a classified balance sheet, an enterprise shall separate DTAs and Deferred Tax Liabilities into current and noncurrent amounts based on the classification of the related financial reporting asset or liability If not related to a financial reporting asset or liability, classify based upon the expected reversal date of the temporary difference Valuation allowance for a particular tax jurisdiction shall be allocated between current and noncurrent DTAs for that tax jurisdiction on a pro rata basis Adoption or early adoption of recent guidance on presentation as noncurrent will simplify presentation

Key takeaways Must consider all sources of income in assessing realizability Determination of whether a company is or is not in a cumulative loss position does not, in itself, result in a conclusion as to the realizability of deferred tax assets Avoid common valuation allowance pitfalls

Unrepatriated earnings ASC 740-30-25 (APB 23)

Inside versus outside basis difference?
What is an inside basis difference? Assets and liabilities held by an entity that have different book and tax basis Must always be accounted for

Inside versus outside basis difference?
What is an outside basis difference? Book and tax basis difference in parent’s investment in another entity’s stock Example: Prior to consolidation, parent has an investment in a wholly owned subsidiary Some outside basis differences need not be recognized Book Tax Outside basis difference 500 300 200

Outside basis differences — six-step process
Bottom-up approach (start at the bottom of the organizational chart) Step one Determine legal form of the investee (subsidiary, partnership) and investee type (wholly owned, equity method) Step two Remember, the focus is on the book and tax basis of an investment in an investee PRIOR to consolidation by the immediate parent Determine parent/sub relationship (domestic or foreign) Step three Determine tax and book basis of parent’s investment in investee Step four Determine whether basis difference is a DTA or DTL Step five Determine that an exception to recognizing the DTA or DTL exists Step six

Outside basis differences — six-step process
Bottom-up approach (start at the bottom of the organizational chart) Step one Determine legal form of the investee (subsidiary, partnership) and investee type (wholly owned, equity method) Step two Determine parent/sub relationship (domestic or foreign) Step three Determine tax and book basis of parent’s investment in investee Step four Determine whether basis difference is a DTA or DTL Step five Determine that an exception to recognizing the DTA or DTL exists Step six

Step six Step six DTA exception
Determine that an exception to recognizing the DTA or DTL exists Step six DTA exception Exception applies to both domestic and foreign subsidiaries or corporate joint ventures No DTA recognized if not apparent difference will reverse in foreseeable future Changes in assumptions recorded as discrete events in period assumption and/or underlying event occurs

Step six Step six DTL exception — domestic subsidiaries
Determine that an exception to recognizing the DTA or DTL exists Step six DTL exception — domestic subsidiaries Applies only to more than 50% owned domestic subsidiary (not domestic corporate joint venture) No DTL recognized if both: Tax law provides means to recover investment tax free Parent expects to use that means

Step six Determine that an exception to recognizing the DTA or DTL exists Step six DTL exception — foreign subsidiaries and foreign corporate joint ventures Presumption that all undistributed earnings will be repatriated Applies only to foreign subsidiaries and corporate joint ventures No DTL recognized if: Permanently reinvested (i.e., “indefinite reversal criterion” met) Parent’s ability and intent Overcome presumption that all undistributed earnings will be repatriated Net investment remitted tax-free Within parent’s control and presently available .

Foreign subsidiaries — indefinite reversal criterion assessment
Not an all-or-nothing determination Continually assess indefinite reinvestment of undistributed earnings assertion Assessment considerations Are market conditions declining? What are the projected working capital and long-term capital needs where earnings are generated (or other foreign locations)? Why are the funds generated by the foreign subsidiary not needed upstream?

Additional considerations — indefinite reversal criterion assessment
Changes to indefinite reinvestment assertion Should not regularly change the assertion A significant event may represent change in facts and circumstances related to ability and intent to indefinitely reinvest Recognize deferred taxes on repatriated earnings in period assertion changes Generally not the same period as repatriation Income tax expense (continuing operations) Discrete event

Key takeaways Outside basis difference is the difference between the tax and book basis of an investment in an entity’s stock prior to consolidation Nature of the legal entity matters when applying deferred tax recognition exceptions Use the six-step process when evaluating outside basis differences

Questions?

Federal tax planning update
Presented by Ernst & Young LLP’s: Matt Bouw — Senior Manager, Jeff Carter —Executive Director

Agenda Accounting methods Uniform Capitalization (UNICAP) Section 199
R&D Credit Tax accounting considerations

Accounting methods — depreciation
Extension of bonus depreciation: 2015–2017 50% 2018 40% 2019 30% Permanent extension of qualified improvement property

Accounting methods — other
IRS hot topics: book vs. tax Commonly overlooked favorable book-tax differences Accrued bonus Repairs UNICAP Real vs. personal property depreciation Revenue recognition Software development costs Accrued Bonus Fixed and determinable Example of employee quitting after year end Should we fix it or not? UNICAP IRS sees people rolling forward the same percentage every year 2-8% additional costs is typical Revenue recognition Advance payments! Cannot defer for as long as book if go more than one year-end out Lobbying expenses

Accounting methods — incentives to correct
Filing a taxpayer-initiated accounting method change usually: Provides “audit protection” Prevents the assessment of interest and penalties Allows for the spread of an unfavorable adjustment over a four-year period May allow for the choice of permissible methods

UNICAP New regulations expected Modified simplified production method
Taxpayer-favorable impact Multiple absorption ratios Negative 263A costs Adoption likely to involve filing Form 3115

Section 199 Domestic Production Deduction — court decisions
ADVO, Inc. v. Commissioner Involved a taxpayer that contracted print ads delivered to customers Taxpayer substantially involved in content and production of the ads Court found taxpayer did not have any benefits and burdens of ownership during manufacturing (printing) process, factors in its favor

Section 199 — court decisions
United States v. Dean Taxpayer purchased various items and then assembled items as gift baskets Taxpayer’s activities were not solely packaging and repackaging, but changed the form and function of items with a different demand as a result Transformed the individual “raw materials” into a “gift” Court cited examples in regulations that demonstrated where the form and function were not changed, and held that in this example there was sufficient change

Section 199 and NOLs Companies using up net operating losses (NOLs)
Taxable income is a requirement for Section 199 Can take Section 199 if paying alternative minimum tax (AMT), even if regular taxable income is 0 Evaluating the requirements and putting a process in place

Section 199 — top 10 considerations
Documentation Expanded affiliated group (EAG) determination Section 861 Online software Cost allocations Manufacturing, production, growth, and extraction determination Substantial in nature Contract manufacturing arrangements Companies coming out of NOLs State-only Section 199 calculations

Questions?

Research credit

Research credit Agenda
The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) Final Section 174 regulations offer significant opportunities Alternative simplified credit (ASC) final regulations Internal-use software (IUS) proposed regulations IRS controversy update State research incentives Global research incentives

Research credit 2015 PATH Act
Permanent extension — can you believe it?! Since its enactment in 1981, the research credit provisions have been temporary, with the credit most recently expiring on 31 December 2014. The PATH Act removes the termination provision in Section 41, seamlessly extending the research credit permanently for amounts paid or incurred after 31 December 2014.

Credit allowed against AMT for eligible small businesses The PATH Act also modifies Section 38(c)(4) to allow eligible small businesses to claim the Section 41 research credit against alternative minimum tax (AMT) liability for tax years beginning after 31 December 2015. “Eligible small business” includes sole proprietorships, partnerships and non-publicly-traded corporations whose average annual gross receipts for the preceding three tax years does not exceed $50m.

Treatment of credit for certain start-up companies The PATH Act adds new sections 41(h) and 3111(f) to allow qualified small businesses to apply the research credit against the employer’s payroll tax liability (of up to $250,000 annually) for tax years beginning after 31 December 2015. For these purposes, a “qualified small business” is generally defined as a corporation, partnership or sole proprietorship with: (1) gross receipts of less than $5m for the tax year and (2) no gross receipts for any tax year before the five tax years ending with the election year.

Final Section 174 regulations
Section 174 provides the rules for the deductibility of research and experimental costs paid or incurred.

The Section 174 regulations state that: Research or experimental expenditures include “all such costs incident to the development or improvement of a product.” “Expenditures represent research and development costs in the experimental or laboratory sense if they are for activities intended to discover information that would eliminate uncertainty concerning the development or improvement of a product.” “Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the product or the appropriate design of the product.”

Note that Treas. Reg. § defines the term product to include any: Pilot model Process Formula Invention Technique Patent Similar property And includes products to be used by the taxpayer in its trade or business as well as products held for sale, lease or license

The final regulations issued in July 2014 under Section 174 provide that “the ultimate success, failure, sale, or use of the product is not relevant to a determination of eligibility under section 174.”

The regulations define the term “pilot model” to mean “any representation or model of a product that is produced to evaluate and resolve uncertainty concerning the product during the development or improvement of the product. The term includes a fully-functional representation or model of the product or … a component of the product.”

Under prior Section 174 law, if an asset resulted from the research and experimentation and was placed in service by the taxpayer, the taxpayer was required to capitalize and depreciate “the costs of the component materials of the depreciable property, the costs of labor or other elements involved in its construction and installation,” and “costs attributable to the acquisition or improvement of the property.” The new regulations remove this requirement and make it clear that such costs are deductible under Section 174, provided that the other Section 174 qualification criteria have been met.

Effective date The Section 174 regulations apply to tax years ending on or after 21 July 2014. Taxpayers may apply the final regulations to tax years for which the limitations for assessment of tax have not expired.

Impact on the research credit Section 174 is the first qualification criteria for the research credit under Section 41.

Section 41 provides the definition of qualified supplies Section 41(b)(2)(C): “The term supplies means any tangible property other than (i) land or improvements to land, and (ii) property of a character subject to the allowance for depreciation.”

Query: Is the cost of an asset that: Results from research and experimentation Is deductible under Section 174 Is subsequently placed in service by the taxpayer “Property of a character subject to the allowance for depreciation” for purposes of the research credit?

ASC amended return final regulations
Allow taxpayers to elect the ASC on an amended return, provided the taxpayer did not previously elect the regular credit for that tax year. The election is available to taxable years open to assessment. Alexa – 1:10 – 1:12

Internal-use software (IUS)
The development of internal-use software generally must satisfy additional requirements to satisfy the definition of qualified research. Issues to address: What is internal-use software? What additional tests must the internal-use software development activities satisfy to constitute qualified research? Both of these issues have been the subject of some controversy in the past. Dave – 1:25 – 1:27

Internal-use software
2015 proposed Treasury Regulations Qualified research includes the development of computer software that is developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s internal use only if the research involves: Software development that satisfies the requirements of Section 41(d)(1) (i.e., the four-part test) Software development that is not otherwise excluded under Section 41(d)(4) Software that satisfies the high threshold of innovation test Alexa – 1:31 – 1:34

Definition of internal-use software: General and administrative functions: Financial management functions Human resources management functions Support services or other functions Alexa – 1:34 – 1:37

Excluded from IUS definition: Software developed to be commercially sold, leased, licensed or otherwise marketed to third parties Software developed to enable a taxpayer to interact with third parties Dual-function software safe harbor: intended use by third parties of at least 10% results in inclusion of 25% of development costs Alexa – 1:34 – 1:37

Proposed regulations’ high-threshold-of-innovation tests Innovation tests Reverts to Tax Reform Act of 1986 legislative history/T.D. 8930 Reduction in cost, improvement in speed or other metric-based Eliminates 2001 proposed regulations standard requiring software to be “unique or novel and differ in significant and inventive ways from prior software implementations and methods” Alexa – 1:37 – 1:40

Significant economic risk test Still does not define “significant” economic risk Clearly states does not require a risk of failure Limits risk to technical uncertainty involving the “capability” or “method” — not uncertainty of “appropriate design” Not-commercially-available test is unchanged Alexa – 1:37 – 1:40

Effective date The rules contained in the 2015 proposed regulations are proposed to apply to tax years ending on or after the date of publication of the Treasury decision adopting the rules as final regulations in the Federal Register. Notwithstanding the prospective effective date, the IRS stated that it will not challenge return positions consistent with the proposed regulations for tax years ending on or after the date the proposed regulations were published in the Federal Register (i.e. 20 January 2015). Alexa – 1:40 – 1:43

IRS exam trends Standard information document requests (IDRs)
Support activities IRS statistical samples Strong focus on documentation Reliance on “Googled” information Elizabeth – 1:45 – 1:49

Areas of IRS concerns Executive compensation
Seemingly inappropriate industries Nexus between project and time spent Departmental costing vs. project costing Supplies “Look back” studies Alexa – 1:49 – 1:54

Best practices Timeliness Being “audit ready” Documentation
Preparing for exam meetings Elizabeth – 1:54 – 1:58

State research incentives
Don’t forget to assess state research incentives! Alexa – 1:49 – 1:54

Global research incentives
Don’t forget to assess global research incentives! Alexa – 1:49 – 1:54

Questions?

Indirect tax updates Presented by Ernst & Young LLP’s:
Smitha Hahn — Senior Manager, Ela Choina — Principal, For information on applying this template onto existing presentations, refer to the notes on slide 2 of this presentation. The Input area of the Beam can be customized to reflect the content of the presentation. The Input area is an AutoShape with a picture fill. To change this, ensure you have the image you wish to use (ideally a.jpg or a.png file) in an accessible folder. The image should have a ratio of 1:1 to ensure it does not appear distorted. Acceptable images for importing into the Input area of the Beam are the three approved graphics (lines), and black and white photography or illustrations which follow the principles laid out on The Branding Zone. Color images should never be imported into this area. To create a thank you slide with a picture in the Input area of the Beam, duplicate this master slide and create a new master slide. If using the graphic on the title slide the same should be used on the thank you slide. If using a picture in the Input area of the Beam in the title slide, the same or different but related picture can be used on the thank you slide. Customize the Input area of the Beam as described below. Click on the View tab from the menu bar and select Master>Slide Master Right-click on the Input graphic and select Format AutoShape From the Fill menu, under the Color and Lines tab, click on the drop-down arrow next to Color and select the Fill Effects menu From the Picture tab, click on Select Picture. Navigate to the folder containing the image you wish to insert in the Input area. Highlight the image and tick the Lock picture aspect ratio box. Click on OK. You can now preview the image before continuing. If you are happy with how it looks, click Ok to continue. Otherwise, repeat the process until you are happy with your selected image To exit from Master View, click on View>Normal. The change you made to the Input graphic should now be visible on the title slide

Agenda Interplay between Nexus and apportionment
Major tax reform Louisiana Connecticut New York State and City Tennessee Interplay between Nexus and apportionment Nexus expansion Move toward single sales factor apportionment and market-based sourcing for services and non-tangible property Interplay between state and international ALAS and transfer pricing State implications of Section 385 regulation proposal Tax havens MTC apportionment election cases Tax accounting considerations

Major tax reform

Major tax reform Louisiana New York State and City
Expansion of the franchise tax (effective 1 January 2017) Cap net operating loss (NOL) deduction clarification (effective for returns filed on or after 1 July 2015) Change use of NOL ordering to LIFO (effective 1 January 2017) Related party add-back required for interest, intangible and management fee expenses (effective 1 January 2016) Expansion of Dividends Received Deduction provisions (effective for returns filed on or after 1 July 2015) Possible change from graduated tax rate to flat 6.5%, rate but only if voters approve removal of corporate deduction for federal income taxes paid (would be effective 1 January 2017) New York State and City Merger of bank franchise tax into corporate franchise tax Adoption of more traditional mandatory combined reporting Disconnects between New York State and New York City law (e.g., nexus, apportionment)

Major tax reform Connecticut Tennessee
Mandatory combined reporting, with tax haven provisions (effective 1 January 2016) Adoption of a single sales factor apportionment (effective 1 January 2016) Limit use of NOLs and tax credits (effective 1 January 2015) Accounting Standards Codification (ASC) 740 deduction (deduction available in 2018 tax year) 20% corporate tax surcharge is extended to the 2016 and 2017 tax years (previously set to expire after income tax year 2015) Tennessee Economic and factor presence nexus standards (effective 1 January 2016) Major constitutional problem: Tenn. courts say physical presence required J.C. Penney National Bank v. Johnson, 19 S.W.3d 831 (Tenn. App. 1999) Move to market-based sourcing for services and intangible property (effective 1 July 2016) Adopt a triple-weighted sales factor apportionment formula (effective 1 July 2016)

Nexus expansion

Nexus expansion since 2007 Economic nexus — factor presence standards
Bright-line sales factor presence standards adopted Alabama — effective 1 January 2015 California — effective 1 January 2011 Colorado — effective 30 April 2010 Michigan — effective 1 January 2008 Nevada — effective 1 July 2015 (Commerce Tax) New York — for credit card banks only effective 1 January 2008; expanded to all Article 9-A taxpayers 1 January 2015 New York City — for credit card banks only effective 1 January 2011 Ohio — effective 1 July 2005 (Commercial Activity Tax) Tennessee — effective 1 January 2016 (but see J.C. Penney, which requires physical presence) Washington — effective 1 June 2010 (Business and Occupation Tax)

Nexus expansion since 2007 Economic nexus — purposeful direction
Purposeful direction of business to the state/doing business in the state Connecticut — effective 1 January 2010* New Hampshire — effective 1 July 2007 Oregon — effective 8 May 2008 Rhode Island — effective 12 January 2016 Wisconsin — effective 1 January 2009 Be aware that a challenge to Quill is gathering force as states, including Alabama and South Dakota, have enacted economic nexus provisions for sales and use tax purposes. These new provisions are in direct challenge to Quill, and a constitutional challenge to these provisions could make it to the Supreme Court of the United States. *Does not apply to foreign corporations unless they have effectively connected income — effective 1 January 2011

Move toward single sales factor apportionment and market-based sourcing

2000: states with a single sales factor
3-factor formula: equal weighting 3-factor formula: unequal weighting Single sales factor formula No income tax DC ME VT NH MA NY CT PA DE WV NC SC GA FL IL OH IN MI WI KY TN AL MS AR LA TX OK MO KS IA MN ND SD NE NM AZ CO UT WY MT WA OR ID NV CA VA MD RI NJ AK HI

2016: states with a 3-factor formula As of 27 April 2016
3-factor formula: equal weighting 3-factor formula: unequal weighting Single sales factor formula No income tax NJ ME VT NH MA NY CT PA (2016) WV NC* ** SC GA** FL IL OH IN MI WI KY TN AL MS** AR LA** TX OK** MO* KS IA MN ND SD NE NM** AZ* CO UT WY MT WA OR ID** NV CA** VA* MD DC (2015) RI DE* (2017) AK HI ** Different apportionment rules apply to certain industries * Single sales factor is either electable or being phased in

2000: sourcing of multistate service revenue
18 September, 2018 2000: sourcing of multistate service revenue Source to state where greater portion of income producing activity performed (“all or nothing”) Source to state to the extent services performed in state (“to the extent of” or “direct”) Source to state where benefit of service received (“benefit” or “market”) No income tax AK HI ME VT NH MA NY CT PA WV NC SC GA FL IL OH IN MI WI KY TN AL MS AR LA TX OK MO KS IA MN ND SD NE NM AZ CO UT WY MT WA OR ID NV CA VA MD NJ RI DE DC Notes: Arkansas: Multistate receipts are included in sales factor numerator based on the current year apportionment factor calculated without such multistate receipts. Arizona: Beginning in 2014, taxpayers may elect to use market-based sourcing. The option is being phased in gradually, from 85% of sales in 2014 to 100% of sales in 2016 California: Effective for tax years beginning on or after Jan. 1, 2011 California follows the Service Benefit sourcing rules. For tax years prior, the Cost of Performance sourcing rules are followed. Beginning on Jan. 1, 2013, market-based sourcing is adopted. Colorado: Effective Jan. 1, 2009, receipts are sourced to where the services are rendered or performed. For tax years prior, the Cost of Performance sourcing rules are followed. Illinois: Effective for tax years ending on or after Dec. 31, 2008, sales of services are sourced to Illinois if the services are received in Illinois. For tax years prior, the Cost of Performance sourcing rules are followed. Maine: In general, receipts are sourced to the state where the services are received. However, the state follows the Cost of Performance sourcing rules when the purchaser is the US or the receipt is attributable to a state in which the taxpayer is not taxable. Massachusetts: For tax years beginning on Jan. 1, 2014, the state adopts market-based sourcing Michigan: Under the Single Business Tax, repealed effective for tax years beginning after Dec. 31, 2007, the state followed the Cost of Performance sourcing rules. Missouri: Under the state’s three-factor apportionment, receipts are sourced according to the Cost of Performance rules. For single sales factor method taxpayers, receipts are sourced based on the “source of income” test as either wholly within, partly within, or wholly without sales. Nebraska: Switched to market-based sourcing, effective Jan. 1, 2014 Oklahoma: No clear guidance, but incorporates market-based language, receipts are sourced to the state if: “receipts are derived from customers within this state or if the receipts are otherwise attributable to the state’s marketplace.” Utah: Effective Jan. 1, 2009, receipts are sourced to the state with the greatest benefit. For tax years prior, the Cost of Performance sourcing rules are followed.

2016: sourcing of multistate service revenue As of 27 April 2016
18 September, 2018 2016: sourcing of multistate service revenue As of 27 April 2016 Source to state where greater portion of income producing activity performed (“all or nothing”) Source to state to the extent services performed in state (“to the extent of” or “direct”) Source to state where benefit of service received (“benefit” or “market”) No income tax AK HI ME VT NH MA NY 2015 CT PA 2014 WV NC SC GA FL IL OH IN MI WI KY TN Mid-2016 AL MS AR LA TX OK MO KS IA MN ND SD NE NM AZ CO UT WY MT WA OR ID NV CA VA MD NJ MA 2014 DE RI 2015 DC 2015 2015 legislative proposals Single sales factor New York City, North Dakota, Tennessee Market-based sourcing Indiana, New Mexico, New York City, Tennessee, Virginia (study commission)

ALAS and transfer pricing

Multistate Tax Commission (MTC) transfer pricing program
MTC will run Arm’s-Length Adjustment Services (ALAS) program. Purpose/vision: The MTC holds multistate transfer pricing audits akin to the income and sales/use tax audits they currently do ALAS staff would work in conjunction with participating states on: Training Transfer pricing analysis Information exchange, process improvement and case assistance Case resolution and litigation support services Optional joint audits Minimum commitment of 10 states required for economic viability Six states have formally committed (AL, HI, IA, KY, NJ and PA). Eight states have expressed strong interest (CT, DC, FL, GA, IN, LA, NC and TN). ALAS hopes to garner support from additional states going forward. Training held in 2015, conducted by developer of many Internal Revenue Code (IRC) § 482 rules — Ednaldo Silva

State transfer pricing activity
Some states have enacted a statutory provision similar to IRC Section 482, while other states have adopted (explicitly or implicitly) IRC Section 482. With few exceptions, most states can make transfer pricing-type adjustments. Most states without an intangible addback have exercised these powers as a mechanism to force combination (or some settlement) of intangible expense deductions. Few states have attempted to perform actual transfer pricing analysis. Some are states are using automated software. States are hiring outside consultants to do transfer pricing audits based on IRC Section 482 standards. More consultants will be hired as required in appeals (NY, MN, etc.) Litigation is pending in the District of Columbia. Multiple service firms are offering transfer pricing services to states.

What should taxpayers do about transfer pricing?
Before the audit starts Make sure transfer pricing is aligned with business Value drivers Substance Document arm’s-length nature of transfer prices Create and follow intercompany agreements After the audit starts If arm’s-length nature of transfer prices are not already documented, do so! Evaluate whether proposed adjustment is based on transfer pricing principles Perform cost-benefit analysis on audit defense efforts

State implications of Section 385 regulation proposal

Section 385 regulation proposal
IRC § 385 authorizes the Treasury Department to issue regulations necessary or appropriate to determine whether certain interest in corporations should be treated as stock or indebtedness — enacted in 1969 No regulations currently in effect under § 385 On 4 April 2016, proposed REG under § 385 was introduced The proposed regulations would: Treat as stock certain related-party interests that otherwise would be treated as indebtedness for federal tax purposes Authorize the Commissioner of the IRS to treat certain related-party interests in a corporation as indebtedness in part and stock in part for federal tax purposes Establish extensive documentation requirements in order for certain related-party interests in a corporation to be treated as indebtedness for federal tax purposes

State tax considerations of the proposed Section 385 regulation
Impact on state tax could be significant. Key issues to consider include: Debt versus equity characterization State versus federal application — e.g., federal consolidated returns versus state combined and separate returns Timing of state adoption — because it is a regulation, is it automatically adopted? Impact on traditional capital structures Co-obligor arrangements Implications on ownership percentage for reorganization provisions and dividend received deductions Impact on exceptions to state related-party add-back provisions

Tax havens

Tax haven legislation in states
12/14/2015 Tax haven legislation in states

Two approaches to identify tax havens
12/14/2015 Two approaches to identify tax havens

States that have enacted tax haven legislation
12/14/2015 States that have enacted tax haven legislation Tax haven laws adopted by six states and D.C. Blacklist approach: Montana Oregon (amended its blacklist in 2015) Factor or criteria approach: Alaska (unique tax rate/intercompany transactions test) Connecticut (enacted in 2015) DC (enacted in 2015 but repealed its blacklist on 23 November 2015) Rhode Island West Virginia Various exemptions from inclusion included in such laws. States considering tax haven legislation in 2016: AL, CO, KY, ME, MN, NJ

MTC apportionment election cases

Multistate tax compact apportionment election cases
In Gillette, the California Supreme Court held the Multistate Tax Compact equally weighted apportionment election is unavailable in the state. The case is being appealed to the US Supreme Court — name change to Proctor and Gamble. Michigan Supreme Court upheld the use of the Compact election, BUT in response the state enacted legislation retroactively repealing the Compact. Michigan Court of Appeals (COA) upheld the constitutionality of the Compact repeal legislation; taxpayers are appealing this ruling. COA held Compact election available for Single Business Tax, retroactive repeal not applicable. Minnesota Tax Court rejected Kimberly-Clark’s use of the Compact election, upheld state’s repeal of the provision. The Minnesota Supreme Court heard arguments in the case on 11 January 2016. In Health Net, the Oregon Tax Court granted state’s motion for summary judgment upholding the legislation disabling the Compact election. Decision has been appealed. Texas Court of Appeals denied Graphic Packaging’s use of the Compact election, holding the revised franchise (Margin) tax is not an income tax. The decision has been appealed.

Questions? Show SL, Questions, and ask if the class has any questions about the program before continuing. Facility Arrangements Discuss all of the following that are applicable to your facility and course arrangements: Class hours, including the importance of returning from breaks and lunches on time Times and places for coffee breaks, lunches and dinners Meal arrangements Group dinner arrangements, if applicable Group cocktail hour, if applicable Location of restrooms Any security arrangements – classroom and sleeping rooms Computer security, if applicable Recreation facilities Transportation sign-up sheets Any other items relating to your facility (e.g., location of telephones, where messages will be posted) Ground Rules: No cell phones No laptops Standard of dress Proceed to the next module.

VAT update

Agenda Growing importance of value-added tax
VAT from a business perspective VAT risks and opportunities (including accounting considerations) Legislative update

Growing importance of value-added tax (VAT)
Consumption taxes are rising throughout the world. VAT is a growing concern for companies doing business globally. Many governments use VAT as a tool for fiscal policy: Reduce to stimulate consumption Increase to reduce deficits More than 160 countries have a VAT regime. The US is the only country in the Organisation for Economic Co-operation and Development (OECD) without VAT. Other countries considering VAT include many in the Middle East. The EU average VAT rate is approaching 21.5% (and rising). The trend is toward increasing rates and anti-avoidance measures to defend yields and reduce the “tax gap.”

Shift toward indirect taxation
The tax mix is shifting to a greater burden collected through indirect taxes. VAT accounts for more than 20% of total tax revenue collections. Source: OECD’s “Consumption Tax Trends 2014” European Commission, 2014 Jeff to mention the trend. Robert can comment on the new VAT/GST regimes with special emphasis on Puerto Rico and India because they are trying to capture more revenue. Maybe ask Loren, how/if we see companies doing the TP and tax planning following this trend. With a lead in to the next slide about BEPS. Tax authorities are seeking to expand the tax base by introducing new systems, increasing coverage and increasing rates. This trend will continue.

VAT from the business perspective
VAT is a transaction-based tax — it impacts all aspects of doing business such as supply chain, procurement and logistics. Although VAT compliance is a part of the R2R (report to return) processes, VAT processing is embedded in O2C (order to cash) and P2P (procure to pay) processes. VAT compliance traditionally is a Finance function. Inefficient/ineffective VAT processes negatively impact overall Finance performance. A modern VAT function is highly technology driven. Native enterprise resource planning (ERP) system/bolt-on solutions (tax engines) are used.

VAT Cost to the business
Cash flow Pay and reclaim later Some countries do not repay excess input VAT over output VAT Have to carry forward (notably South American and Eastern European countries) Compliance Penalties and interest Failure to reclaim input VAT or recoverable VAT

VAT Areas of risk Amounts involved can be significant:
High VAT throughput Very high penalties and interest Potential profit and loss (P&L) impact VAT can result in a “tax” material weakness: “The Company did not maintain effective controls over the accuracy of VAT applied to various cross-border transactions …. Specifically, the control was not designed to operate at the appropriate level of precision to adequately monitor and account for the VAT being applied to these types of transactions in order to assess the exposure, and if necessary, record a liability.” VAT can lead to revision/restatement of prior year financials Reputational risk Criminal responsibility of the board members VAT receivables: Excess VAT credits are not always refundable/can be monetized Growing VAT receivables in the balance sheet — frequent audit problem Valuation allowance — significant P&L hit

VAT agenda A strategic discussion of your VAT management function
Tax life cycle Strategic alignment with business Help to improve value through strategic VAT planning Alignment with risk profile Cash flow impact How are you accounting for VAT transactions? Using tax engines or other automated solutions? Tools and technology End-to-end reporting Internal influences External influences Strategy Regulatory Enterprise Economic Managing global VAT risks VAT audits (e.g., e-audits) on the increase VAT refunds and credits Integrated with compliance Binding rulings and voluntary disclosures Consistent global process Outsource, co-source or centralize Timely visibility and status reporting Real-time submission of transaction data Governance Industry

Trend of US multinational companies managing VAT at HQ
Not every organization has the same VAT structure. Where are you on this timeline? Consistent investment First in class in global VAT management High involvement Toward global VAT management Global VAT manager in Europe or other region HQ involvement Build-out phase HQ starts asking for centralized VAT resource Global VAT manager at HQ VAT manager anywhere Some VAT responsibility at HQ Low involvement No VAT manager

Legislative changes New VAT and goods and services tax (GST) regimes:
Webcast title 9/18/2018 Legislative changes New VAT and goods and services tax (GST) regimes: Puerto Rico VAT China VAT pilot India GST Other VAT/GST regimes in the pipeline: Gulf Cooperation Council (GCC) members (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE) Egypt

It’s a business transformation Not just a tax change
New VAT/GST regimes – driving business transformation 9/18/2018 It’s a business transformation Not just a tax change Information technology System changes Auditability Compliance Automation Tax accounting Supply chain Procure to pay Tax payments Order to cash Tax accounting Tax credits Sourcing/distribution strategies Make vs. buy Supply/inventory management VAT/GST Sales/purchases Business analytics Costing/pricing Forecasting Contract arrangement Business structure changes Incentive regime Working capital/cash flow Compliance Change management VAT registrations Tax credit transitions Return reporting VAT awareness training VAT communication Organization structure

Digital economy Key VAT/GST changes

Questions?

The digital tax function
Presented by Ernst & Young LLP’s: Brian Morris — Executive Director,

Agenda Disruptors affecting the tax function
Building a digital tax function using: Content management Data acquisition Analytics and visualization Tax accounting considerations

The global tax picture. Your priorities?
Get the right resources consistent with your company’s strategy to meet your changing tax obligations Receive timely and complete information from all companies on tax risks and tax liabilities Quickly respond to global tax issues and related investments Increase tax efficiency and reduce tax risks of your companies Today’s discussion Transforming to the digital tax function Understanding the global and digital disruptors that are changing our tax world Learning from what other leading global companies are doing to adjust in creating the digital tax function Practical steps you can take today to prepare Revolution? Evolution?

The global and digital disruptors
Increased transparency Process Data provided to the government Improvements in technology and access

Implementation measures for special tax adjustments
Process transparency United Kingdom: New finance bill to encourage publication of risk strategy online and UK Financial Reporting Council demanding increased disclosure of prospective tax risks Australia: ATO public reporting requirement for Commissioner of Taxation to disclose taxable income and income tax payable The Netherlands: Horizontal monitoring requirements to submit a new format of CbC Report, including strict penalties for noncompliance Singapore: New legislation regarding disclosure of tax policy, especially for transfer pricing South Africa: New filing obligation for nonresident companies and trusts to disclose all derived service income from South African sources South Korea: Drafting legislation to require a disclosure of transaction levels and assets above a certain threshold China: Implementation measures for special tax adjustments Mexico: Broad transparency requirements now include full BEPS Action 13 inclusion Israel: The new reporting requirements will apply to “tax advice” and “reportable tax positions” related to income tax, VAT, excise tax, customs and purchase tax

Data transparency Many different answers
Spain: Invoices submitted to government within four days and matched with regular VAT filing Sweden: In 2014, 7.5m individual prepopulated tax returns sent China: Fapiao invoicing system preregisters transactions Mexico: Mandated XML filing of COA and trial balances; invoice detail Brazil: SPED and eSocial requires generating balances and transactions for both financial and HR systems

Data transparency Base erosion and profit shifting (BEPS) and country-by-country reporting (CbCR) Common Reporting Standard (and its cousin foreign account tax compliance act) Questions Will there be a consistent global standard? Will there be a global assembler and transmitter of data, and will it be secure?

Technology change in the digital world
All data expected to be digitally available — not just the numbers, but the process The effort to assemble data is quickly diminishing as a limitation — e.g., SAP HANA Technology alternatives for data acquisition and analysis are exploding and well priced Data acquisition: PowerQuery (currently FREE!) Analytics tools

The new digital tax function
Note: You can access this video and use it in discussions with your CFO and tax team at:

How companies are building the digital tax function
Better control framework Improved use of technology Content management/dashboards Data acquisition Analytics After the event/recording and periodic reporting At or near the source Third-party availability Changing the global organization

The successful control framework
Country risk profile 1 Operational risk profile 2 Tax technical profile Aggressiveness of tax auditors Penalty and reputational risk Process efficiency/complexity Systems maturity/tax capability Skills and communication Comprehensive risk profile Formal ratings approach Responsibilities assigned Policies written and communicated Key Performance Indicators established and assessed Systems collect and notify Elevation procedures activated Risk rating determination 3 Active monitoring 4

What is content management
What is content management? File management, search, dashboards, workflow Wrapper contains: Name Where produced Nutrition etc. Content: Cereal Search Item Juris Tax year Date Signoff Tax return US 2015 1 September 2016 Joe Plan memo China N/A Jane Forecast Q1, 2016 12 December 2015 Sara Thousands of additional items …

What is a dashboard? Item Juris Tax year Date Signoff Tax return US 2015 1 September 2016 Joe Plan memo China N/A Jane Forecast Q1, 2016 12 December 2015 Sara Thousands of additional items … Dashboards allow users to quickly view key information at a glance (rather than working though thousands of records) For example, returns that missed their internal due date

What is workflow? Steps predefined Execution enforces rules
State notice received Identify preparer and state notice – workflow task Send response to authority Review notice Research & provide response Update tracker – workflow task – workflow task Review and signoff Typically tracked: Who prepared Who reviewed Dates due (internal, external) Dates completed Current step in process Documents produced Correspondence received/sent Steps predefined Execution enforces rules Tracking data automated Versioning enabled

Content management examples
Basic — workflow, dashboard, file management, etc. Tax return preparation — HQ and global Notices and document requests from governments Replacing shared drives Specialized (not difficult, just unique) Tracking incentives agreements by taxing jurisdiction looking for expiration dates and collecting supporting detail (Asia) Collecting and complying with transactions to nonresidents involving services and intangibles (Brazil SISCOSERV) Collecting basic data for global reporting (e.g., Europe BEPS/CbCR information not available in general ledger)

Tax information (e.g., hierarchy) ONESOURCE or other apps
Data acquisition What is ONESOURCE DataFlow? What is Microsoft Power Query? Transformed data ready for use in Excel workpaper or loading into another system Tax information (e.g., hierarchy) Finance databases ONESOURCE or other apps CSV or xlsx output, etc., Power Query

Analytics and visualization
Definitions (by Brian) Analytics — determining the key questions and aligning the data and rules to answer the questions Visualizations — quickly finding or communicating the answer Example of a key question: What is the biggest driver of the change in our forecasted and actual effective tax rate? +1.1% overall increase in ETR over forecast +0.3% explained mostly from transaction

Analytics with visualization Examples looking at periodic data
CbCR — profit per head or employee expense generated by each tax jurisdiction. VAT — supplier mismatch analysis Other examples Fixed asset Work order analysis Supply chain analysis Transfer pricing Tax accounting with period over period trending Vat Supplier mismatch – To identify instances where invoices are normally posted from a particular supplier with VAT, but some invoices have been posted without VAT, and vice versa. This test reviews all the invoices posted from each supplier and lists the number of invoices which have been received with and without VAT. Where the majority of the invoices from a particular supplier are subject to VAT, the test assumes that those without VAT are incorrect and calculates a potential VAT underclaim; the reverse is shown as an overclaim

Analytics applied at the source Examples running (near) real time
Major automotive company embedding analytics to spot potential VAT and transaction tax problems and fix before it is ever passed to external taxing authorities Analytics modeled after Mexico’s SAT being implemented at companies to pre-audit the data Example of a key question for VAT – are invoices being created at month end and canceled at the start of the next month in jurisdictions where the tax is non-refundable? Automated detection and routing — exceptions/analysis Follow-up

Changing global organization
Traditional allocation of functions Advanced allocation of functions Tax accounting HQ FS Tax accounting HQ FS SSC Tax reporting HQ FS Tax reporting HQ FS SSC Business support HQ FS Business support HQ FS SSC Tax methodology HQ FS Tax methodology HQ FS Tax control HQ FS Tax control HQ FS Tax risk management HQ FS HQ functions (HQ) Subsidiary functions (FS) Shared service center functions (SSC) Tax effectiveness HQ International tax function In the digital tax function, some tax processes are transferred to SSC, other tax processes are allocated between HQ and local tax [company/third-party] functions. Associated processes, controls and monitoring are documented and initiated. HQ tax function Local tax function Shared service center Business divisions

Practical steps to begin moving to the digital tax function
Review and enhance your global control framework Process Data Investigate tools that are available to you today Look inside your IT environment — SharePoint, analytics tools Download and learn tools like Power Query Consider whether new global tools are applicable to you Develop a training plan to create better tax technologists Anticipate and prepare for more tax activities in shared service centers (captive or third-party)

Questions?

Stock-based compensation and executive compensation
Presented by Ernst & Young LLP’s: Bill Murphy — Principal, Danyle Ordway — Partner,

Agenda ASC 718 update Executive compensation trends
Tax accounting considerations

ASC 718 update This is a predetermined divider slide and should not be modified.

Stock compensation ASU 2016-09
Accounting Standards Update (ASU) , Improvements to Employee Share-Based Payment Accounting, issued in March 2016 Excess tax benefits and tax deficiencies recognized in the income statement (prospective transition) Account for excess tax benefits and tax deficiencies as discrete items in the interim period in which they occur Eliminates the requirement that excess tax benefits not be recognized until they are realized (modified retrospective transition with a cumulative catch-up adjustment to retained earnings) Excess tax benefits presented as an operating activity in the statement of cash flows (prospective or retrospective transition)

Stock compensation ASU 2016-09
Accounting for forfeitures Recognizing forfeitures of awards as they occur (e.g., when an award does not vest because the employee leaves the company) or Estimating the number of wards expected to be forfeited and adjusting the estimate when it is likely to change, as is currently required. Net Share withholding No longer required to withhold the number of shares to satisfy minimum statutory withholding requirements May not withhold shares based on the maximum tax rate (see discussion below)

Stock compensation Adoption
For public business entities: effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For nonpublic business entities: effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption is permitted for all entities in any interim or annual period for which financial statements have not been issued

Tax technical executive compensation trends
This is a predetermined divider slide and should not be modified.

Global equity compliance
Tax withholding Accounting Standards Codification (ASC) 718 amendments allow for companies to withhold shares to cover taxes at the maximum rate rather than at the minimum statutory withholding amount Impact on foreign country tax withholding Increased IRS audit activity on equity awards and on mobile employees Taxation of “impats”

Forthcoming guidance Section 457(f) Section 409A
Upcoming guidance should address the inconsistency between the approaches to proper income deferral under 457(f) and 409A. Section 409A Section 409A technical corrections will propose amendments to the final regulations but will not reopen them, and the IRS intends to consolidate prior guidance on 409A corrections. Some changes are not amendments but rather clarifications on the IRS’s current position. The IRS is also looking to finalize the Section 1.409A-4 income inclusion regulations (REG ).

Section 409A A recent Chief Counsel Advice memorandum (CCA ) ruled that a correction of a document failure under Section 409A made in the year of vesting, but before the compensation vested, would not effectively cure a failure under Section 409A or exempt the employee from the additional 20% tax and interest. Even though the amendment removed the employer’s impermissible discretion, since the bonus vested as of the end of the same year in which the correction was made, the full bonus was includable in the executive’s income for that year and subject to Section 409A. Notice might offer relief?

Section 162(m) Key issues The IRS has issued final regulations that settle two key issues under Section 162(m): First, whether an individual share limit is necessary for equity compensation to be exempt from Section 162(m). Second, how the so-called IPO transition rule applies to restricted stock units (RSUs) and certain other equity compensation. The final regulations adopt regulations proposed in 2011 (REG ) with a few modifications. Treatment of CFOs under 162(m): Although a CFO is not covered under Section 162(m) at larger reporting companies, a CFO can be considered a covered employee for smaller reporting companies.

Bonus accrual audits Under Section 461, using an accrual method of accounting, the all events test is satisfied if: All events have occurred to establish a fact of liability The amount of liability can be determined Economic performance has occurred Bonuses are paid within 2.5 months following the taxable year It is not sufficient that it is unlikely or improbable that the fact of liability (or obligation to pay) will change.

Bonus accrual audits (cont.)
According to IRS guidance, it appears there must be a legal obligation on behalf of the employer to pay the bonus. The legal obligation or fact of liability does not exist if the bonus is subject to reduction or forfeiture. The IRS contends that any change to the bonus at any time prior to payment would disallow the accrued bonus, including agreements that might require the employee to forfeit his or her bonus if no longer employed.

Section 280G and IRS audits
Parachute payments are frequently an area of risk. If payments are made contingent upon a change in control, as defined by Section 280G, and exceed three times the executive’s average annual compensation, any amount above the executive’s base amount could be subject to excise taxes and may not be deductible to the employer. Such payments can result in substantial lost corporate tax benefit.

Section 280G and IRS audits (cont.)
Parachute payments are frequently an area of risk. The IRS is focusing on who are disqualified individuals (DIs) and the process the company employs to validate that every DI was reviewed. Audits will identify forms of change in control payments that employers may not think to include (e.g., continuation of benefits or allowances, acceleration of equity). Seeking an exemption from Section 280G penalties through shareholder approval will be highly scrutinized; precise methods must be followed. Parachute payments that are recharacterized as not contingent, reasonable compensation for services (or refraining from services) will be closely examined by the IRS; employers must have documentation in place to support these decisions.

Questions?

Transaction cost analysis (TCA)
Presented by Ernst & Young LLP’s: Allison T. Somphou — Executive Director

Agenda Overview of transaction costs rules under Treas. Reg. section 1.263(a)-5 Cost location considerations: legal entity, jurisdictional Tax accounting methods considerations

Overview of transaction costs rules

Overview $3.8t was spent on M&A in 2015, beating the previous record set in 2007 before the financial crisis. Q global M&A spend was $627.8b. Half of businesses surveyed by EY plan acquisitions in the next year, with 40% determined to form alliances with other businesses or competitors. Financial buyers (private equity, etc.) have about $1.3t to spend on deals. Companies incur significant professional fees in deals — 1% to 3%+ of deal value. Transaction costs are deducted for US GAAP. An analysis should be performed to document issues and determine how the costs should be treated for the income tax provision and/or the income tax return, as rules differ for tax. Tax issue beyond just deductibility: “Location” Geography

Treas. Reg. §1.263(a)-5 Overview
General rule: costs that “facilitate” certain transactions are required to be capitalized. Exceptions: Simplifying conventions under Treas. Reg. §1.263(a)-5(d) “Bright line date rule” under Treas. Reg. §1.263(a)-5(e)(1) Special rules for “success-based fees”: Safe harbor election under Rev. Proc Documentation required without election in accordance with Treas. Reg. §1.263(a)-5(f)

Treas. Reg. §1.263(a)-5(a) Transactions subject to rules
Costs that “facilitate” these transactions are required to be capitalized: An acquisition of assets that constitutes a trade or business (acquirer or target) An acquisition by the taxpayer of an ownership interest in a business entity if more than 50% of the business entity is owned after the acquisition An acquisition of an ownership interest in the taxpayer A restructuring, recapitalization or reorganization of the capital structure of a business entity Incorporations and partnership formations Formation or organization of a disregarded entity Acquisition of capital Issuance of stock Borrowing Writing an option

Treas. Reg. §1.263(a)-5(d) Simplifying conventions
Employee compensation and overhead never facilitative Not facilitative under this section; however, other provisions may limit the deduction or impact the timing of recognition with respect to these items De minimis costs (less than $5,000/transaction) not facilitative Election to capitalize Made on a transaction-by-transaction basis

Treas. Reg. §1.263(a)-5(e) Certain acquisitive transactions
Non-“inherently facilitative” costs for pre-“bright-line” date services are not capitalized if they relate to a “covered transaction.” Types of covered transactions Taxable asset acquisitions Assets constituting a trade or business (including those covered by §§338 and 338(h)(10)) Taxable stock (partnership) acquisitions 50% or more interest Tax-free stock or asset acquisitions Acquisitive reorganizations described in §368(a) “A” statutory merger “B” stock acquisition “C” merger Acquisitive “D”

Treas. Reg. §1.263(a)-5(e) Certain acquisitive transactions
Inherently facilitative activities: Securing appraisal, formal written evaluation or fairness opinion Structuring the transaction, including negotiating the structure and obtaining tax advice on the structure Preparing and reviewing the documents that effectuate the transaction Obtaining regulatory approval Obtaining shareholder approval Conveying property between the parties

Bright-line date for covered transactions
Amounts deemed to facilitate the transaction Certain amounts deemed to “facilitate the transaction” if they relate to activities performed on or after the earlier of Date A or B Beginning of deal timeline Date A: Letter of intent, exclusivity agreement or similar communication executed by representatives of both parties Date B: Material terms of transaction are authorized or approved by the relevant taxpayer’s board of directors* Close date *If the transaction does not require authorization or approval of the board, this date is the date on which the acquirer and transferor execute a binding written contract.

Treas. Reg. Section 1.263(a)-5(f) Success-based fees
Rebuttable presumption that success-based fees are facilitative. Presumption can be overcome with “sufficient” documentation to establish allocation of fee to non-facilitative activities. General requirements Timing — documentation must be “completed” by due date (including extensions) of return for tax year in which transaction occurs. Content — documentation must be more than merely an allocation between facilitative and non-facilitative activities.

Treas. Reg. Section 1.263(a)-5(f) Success-based fees
Documentation Must include “supporting records” identifying (a) various activities performed, (b) allocation of time/fees to such activities, (c) allocation to activities before and after any relevant dates, and (d) name, address and business phone number of advisor

Rev. Proc. 2011-29 Success-based fees
Rev. Proc : Success-based fee safe-harbor election Safe-harbor election 70% of the fees are non-facilitative costs 30% of the fees are facilitative costs Application Applies only to “covered transactions” Applies only to the transaction for which the election is made Applies to all the taxpayer’s success-based fees for that transaction Election is irrevocable, made with statement attached to return Does not apply to milestone payments

Location issues

Location issues One party may engage, another party may pay for the services, while a different party receives the benefits. Where do the costs belong? Location considerations include: Legal-entity level Parent vs. subsidiary Acquirer vs. target Jurisdictional US vs. foreign

Location issues Private equity transactions
Transaction cost rules default location for costs: target or acquirer. In typical private equity (PE) structures, acquirer is newly formed. Before entities are engaged in an active trade or business, otherwise deductible costs are start-up costs. Start-up costs are amortizable over 15 years (including deductible portion of transaction costs). Target companies are not subject to the start-up rules. PE Fund Merger Sub HoldCo Target Seller PE Mgt LLC Providers Engagement letters Mgt co. associated with PE Fund engages providers. At close, Target pays PE service providers.

Location issues Private equity transactions
If one entity initially engaged service providers, a second entity is the legal acquirer, and the target pays the costs of the service providers, where do the costs belong? If they stay with the legal acquirer, subject to 15-year amortization If allocated, or “pushed down,” to the target, immediately deductible

Location issues Cross-border transactions
Parent desires to acquire Foreign Target. Parent hires all the service providers and Parent executives negotiate the terms of the transaction. In addition, Parent’s board approves the transaction. The acquisition consideration is funded by debt for which Parent is liable. Shortly before the transaction is consummated, Parent forms Foreign Holdco to acquire Foreign Target stock. Foreign Holdco does not have any business operations, employees or any assets other than Foreign Target stock. Parent $ Foreign Holdco Target SH Foreign Target Stock Bank

Location issues Cross-border transactions
VAT considerations Local country TCA TCA for “earnings and profits” purposes

Accounting methods

Accounting methods New M&A provision
Accounting method — definition Method changes require “adjustments”: Negative = one-year adjustment period Positive = four-year spread (unless de minimis) New rule  election for a one-year adjustment for all positive (unfavorable) adjustments for the year of change: If an eligible acquisition transaction occurs during the year of change or in the subsequent taxable year on or before the due date (including any extension) for filing the taxpayer’s federal income tax return for the year of change

Accounting methods New M&A provision
For most target corporations, an eligible acquisition transaction means either: An acquisition of a stock ownership interest in the target by another party that either results in the acquisition of control of the target or causes the target’s taxable year to end Or An acquisition of the target’s assets in the case of certain tax-free corporate reorganizations or liquidations For all other targets (including a partnership or S corporation), an eligible acquisition transaction is an acquisition of an ownership interest in the target by another party that does not cause the target to cease to exist for federal income tax purposes.

Lookback transaction cost analyses
Perform TCA for costs related to transactions occurring in a tax year where tax returns have already been filed Method of accounting considerations for transaction costs determined on a transaction-by-transaction basis Generally applies only to non-success-based fees Strongly recommend that the engagement team consult with a member of the TCA Practice for additional guidance

Questions?

Subchapter C update Presented by Ernst & Young LLP’s:
Howard Tucker – Partner,

Objectives Section 385 The objective of this summary of the proposed regulations on Section 385 is to highlight key provisions that may impact common M&A transactions engaged by private equity and corporations. The summary does not cover all of the provisions of the proposed regulations, in particular the rules involving partnerships and consolidated groups. The transactions included after the overview of the proposed regulations are intended provide a context for discussion. F Reorganization Final Regulations T.D. 9739

Section 385 overview Section 385(a): authority to prescribe regulations The Secretary is authorized to prescribe such regulations as may be necessary or appropriate to determine whether an interest in a corporation is to be treated for purposes of this title as stock or indebtedness (or as in-part stock and in-part indebtedness). Section 385(b): factors The regulations prescribed under this section shall set forth factors that are to be taken into account in determining with respect to a particular factual situation whether a debtor-creditor relationship exists or a corporation-shareholder relationship exists. The factors so set forth in the regulations may include among other factors: Whether there is a written unconditional promise to pay on demand or on a specified date a sum certain in money in return for an adequate consideration in money or money's worth and to pay a fixed rate of interest Whether there is subordination to or preference over any indebtedness of the corporation The ratio of debt to equity of the corporation Whether there is convertibility into the stock of the corporation The relationship between holdings of stock in the corporation and holdings of the interest in question Section 385(c): effect of classification by issuer The characterization (as of the time of issuance) by the issuer as to whether an interest in a corporation is stock or indebtedness shall be binding on such issuer and on all holders of such interest (but shall not be binding on the secretary). Except as provided in regulations, paragraph (1) shall not apply to any holder of an interest if such holder on his return discloses that he is treating such interest in a manner inconsistent with the characterization referred to in paragraph (1). The secretary is authorized to require such information as the secretary determines to be necessary to carry out the provisions of this subsection.

Amendments and prior attempts to promulgate regulations
Omnibus Budget Reconciliation Act of 1989 Section 385(a) was amended to expressly authorize the Secretary to issue regulations under which an interest in a corporation can be treated as part stock and part indebtedness. There have been no previously published regulations regarding the 1989 amendment to Section 385(a). Energy Policy Act of 1992 Section 385 was amended to include Section 385(c) to require consistency between issuer and holder on the characterization of corporate instruments. Holder may take an inconsistent treatment provided certain disclosures are made. There have been no previous published regulations regarding the 1992 amendment to Section 385.

Overview of proposed regulations
Debt vs. equity factors In the absence of regulations, case law has evolved and continues to control the characterization of an instrument as debt or equity for federal tax purposes. The proposed regulations impose documentation requirement under Prop. Treas. Reg. Section to support the characterization of an instrument (an Expanded Group Instrument or “EGI”) issued by, and held by, a member of an expanded group (EG) as debt under general federal income tax principles. Failure to meet such requirements will result in the instrument being treated as stock for federal tax purposes: The documentation requirement applies to an EGI if (i) stock of any member of the EG is traded on an established financial market, (ii) on the date the instrument first becomes an EGI, total assets exceed $100m on any applicable financial statement (generally the financial statement of any member of the EG), or (iii) on the date the instrument becomes an EGI, annual total revenue exceeds $50m on any applicable financial statement. If the documentation requirements are satisfied or otherwise do not apply, the instrument may still be recharacterized as stock under Prop. Treas. Reg. Section or -4. The regulations provide that an instrument can be viewed as part debt and part equity.

Recharacterization of an EGI as stock Subject to certain exceptions, the proposed regulations treat an EGI as stock under the following rules: Under the General Rule: Distribution of a debt instrument issued by a corporation to a member of the corporation’s EG Issuance of a debt instrument by corporation in exchange for stock of stock of a member of the corporation’s EG (including hook stock) Issuance of a debt instrument by a corporation in an exchange for property in an asset reorganization, but only to the extent that, pursuant to a plan or reorganization, a shareholder that is a member of the issuer’s EG immediately before the reorganization received the debt instrument with respect to its stock in the Transferor Corporation Under the Funding Rule, an EGI is treated as stock if it is treated as a “Principal Purpose Debt Instrument.” An EGI is a Principal Purpose Debt Instrument if the EGI is issued by a corporation (i.e., a funded member) to a member of the funded member’s EG in exchange for property with the principal purpose of funding one of the following distributions or acquisitions: A distribution of property by a funded member to a member of the expanded group, other than a distribution of stock pursuant to an asset reorganization that is permitted to be received without the recognition of gain or income under Sections 354(a)(1) or 355(a)(1) or, when 356 applies, that is not treated as boot or other property An acquisition of expanded group stock, other than in an exempt exchange (i.e., an exchange involving EG stock in which the transferee and transferor are parties to an asset reorganization and either Section 361(a) or (b), or Section 1032 or Treas. Reg. Section , applies) Or An acquisition of property by the funded member in an asset reorganization, but only to the extent that, pursuant to a plan of reorganization, a shareholder that is a member of the funded member’s EG immediately before the reorganization receives boot or other property under Section 356 with respect to its stock in the Transferor Corporation

Recharacterization of an EGI as stock Principal Purpose Determination: Whether a debt instrument is issued with a principal purpose of funding a distribution or acquisition is determined based on all facts and circumstances. Whether a debt instrument is issued before or after such distribution or acquisition is not relevant to the determination. Per Se Rule – A debt instrument is treated as issued with the principal purpose of funding a distribution or acquisition if it is issued by the funded member during the period beginning 36 months before and ending 36 months after the date of the distribution or acquisition: The Per Se Rule will not apply to an instrument that arises in the ordinary course of the issuer’s trade or business in connection with the purchase of property or receipt of services to the extent it is currently deductible under Section 162 or currently included in the issuer’s costs of goods sold. If two or more debt instruments may be treated as a principal purpose debt instrument under the Per Se Rule, the instruments are tested in the order in which they were issued. If a debt instrument may be treated as funding more than one distribution or acquisition, the debt instrument is treated as funding one or more distributions or acquisitions based on the order in which the distribution or acquisition occurred. References to the funded member include references to any predecessor or successor of such member: A predecessor and successor are generally a distributor or Transferor Corporation, or acquiring corporation, in a transaction described in Section 381(a).

Exceptions to the General Rule and Funding Rule under Section (c) The aggregate amount of any distributions or acquisitions described under the General or Funding Rule are reduced by an amount equal to the member’s current year earnings and profits. A debt instrument is not treated as stock if the aggregate adjusted issue price of debt instruments held by members of the expanded group that would be subject to the General or Funding Rules does not exceed $50m. Exception to the Funding Rule An acquisition of EG stock will not be treated as an acquisition of EG stock for purposes of the Funding Rule if: The acquisition results from a transfer of property by a funded member (transferor) to an EG member (issuer) in exchange for stock of the issuer. For the 36-month period immediately following the issuance, the transferor holds, directly or indirectly, more than 50 percent of the total voting power and value of the issuer.

Expanded Group Definition An affiliated group as defined in Section 1504(a) determined: Without regard to paragraphs (1) through (8) of Section 1504(b) By substituting “directly or indirectly” for “directly” in Section 1504(a)(1)(B)(i) By substituting “or” for “and” in Section 1504(a)(2)(A) Effective Date Proposed regulation will become effective generally, and apply to any applicable instrument issued or deemed issued, on or after the date the proposed regulations are published as final. Section would also apply to any applicable instrument treated as issued as a result of an entity classification election under Section made on or after the date the proposed regulations are issued as final regulations. Proposed regulations and will apply to any debt instrument issued on or after 4 April They will also have retroactive effect for any debt instrument issued before 4 April 2016 as a result of an entity classification election made under that is filed on or after 4 April 2016: 90-Day Transition Rule – When (b) and (d)(1)(i) through (d)(1)(v), or of the proposed regulations would treat a debt instrument as stock prior to the date of publication adopting these rules as final, the debt instrument is treated as indebtedness until 90 days after the date of publication adopting these rules as final. To the extent the debt instrument is held by a member of the issuer’s expanded group on the date that is 90 days after the date of publication adopting these rules as final, the debt instrument is deemed to be exchanged for stock on the date that is 90 days after the date of publication adopting these rules as final. For purposes of making principal purpose debt instrument determinations, certain acquisitions or distributions described in (b)(3)(ii) that occur before 4 April 2016 are not taken into account.

Select Operating Rules under Prop. Reg. Section 1.385-3
Timing When a debt instrument is treated as stock under Section (b), the debt instrument is treated as stock when the instrument is issued. When the Funding Rule applies to two or more instruments as Principal Purpose Debt Instruments, the instrument issued earliest is tested first. If a debt instrument may be treated as funding more than one distribution or acquisition, the instrument will be treated as funding one or more distributions or acquisitions with the earliest being treated as the first. Debt Instrument Treated as Stock that Leaves the Expanded Group When the holder and issuer of a debt instrument that is treated as stock cease to be members of the same EG, either because the instrument is transferred to a non-member or the holder or issuer cease to be members of the expanded group, the debt instrument ceases to be treated as stock under this section: The issuer is deemed to issue a new debt instrument to the holder in exchange for the debt instrument that was treated as stock. All other debt instruments, if any, of the issuer that are not currently treated as stock are re-tested to determine whether those instruments should be treated as Principal Purpose Debt Instruments. Treatment of Partnerships Partnerships are treated as an aggregate, and therefore partners in a partnership are treated as having a share of partnership assets. Therefore, if a partnership holds or issues a debt instrument, it is treated as though held or issued by the individual partners in proportion to their interest in the partnership. Disregarded Entity If a debt instrument of a disregarded entity is treated as stock, such debt instrument is treated as stock of the disregarded entity’s owner rather than as an equity interest in the disregarded entity.

Illustrations of examples set forth in Proposed Regulations Section 1

§1.385-3 Certain distributions of debt instruments and similar transactions
§ (g) – examples Assumed facts Example 1 – Distribution of a debt instrument Example 2 – Debt instrument issued for expanded group stock that is exchanged for stock in a corporation that is not a member of the same expanded group Example 3 – Issuance of a note in exchange for expanded group stock Example 4 – Funding occurs in same taxable year as distribution Example 5 – Additional funding Example 6 – Funding involving multiple interests Example 7 – Re-testing Example 8 – Distribution of expanded group stock and debt instrument in a reorganization that qualifies under §355 Example 9 – Funding a distribution by a successor to funded member Example 10 – Asset reorganization; §354 qualified property Example 11 – Triangular reorganization Example 12 – Funded acquisition of subsidiary stock by issuance; successor Example 16 – Distribution of another member’s debt instrument Example 17 – Threshold exception and current year earnings and profit (E&P) exception Example 18 – Distribution of a debt instrument and issuance of a debt instrument with a principal purpose of avoiding the purposes of this section

§ (g)(1) Assumed facts (i) FP is a foreign corporation that owns 100% of the stock of USS1, a domestic corporation; 100% of the stock of USS2, a domestic corporation; and 100% of the stock of FS, a foreign corporation. (ii) USS1 owns 100% of the stock of DS, a domestic corporation, and CFC, which is a controlled foreign corporation (CFC) within the meaning of §957. (iii) At the beginning of Year 1, FP is the common parent of an expanded group comprised solely of FP, USS1, USS2, FS, DS and CFC (the FP expanded group). (iv) The FP expanded group has more than $50m of debt instruments described in paragraph (c)(2) at all times. (v) No issuer of a debt instrument has current year E&P described in §316(a)(2). (vi) All notes are debt instruments described in paragraph (f)(3). (vii) No notes are eligible for the ordinary course exception described in paragraph (b)(3)(iv)(B)(2). (viii) Each entity has as its taxable year the calendar year. (ix) PRS is a partnership for federal income tax purposes. (x) No corporation is a member of a consolidated group, as defined in § (h). (xi) No domestic corporation is a US real property holding corporation within the meaning of §897(c)(2). (xii) Each note is issued with adequate stated interest (as defined in §1274(c)(2)).

§ (g)(1) Structure FP USS1 USS2 FS DS CFC

§1.385-3(g)(3) Example 1 Distribution of a debt instrument
FP (i) Facts. On Date A in Year 1, FS lends $100x to USS1 in exchange for USS1 Note A. On Date B in Year 2, USS1 issues USS1 Note B, which has a value of $100x, to FP in a distribution. (ii) Analysis. USS1 Note B is a debt instrument that is issued by USS1 to FP, a member of USS1’s expanded group, in a distribution. Accordingly, USS1 Note B is treated as stock under paragraph (b)(2)(i). Under paragraph (d)(1)(i), USS1 Note B is treated as stock when it is issued by USS1 to FP on Date B in Year 2. Accordingly, USS1 is treated as distributing USS1 stock to its shareholder FP in a distribution that is subject to §305. Because USS1 Note B is treated as stock for federal tax purposes when it is issued by USS1, USS1 Note B is not treated as property for purposes of paragraph (b)(3)(ii)(A) because it is not property within the meaning specified in §317(a). Accordingly, USS1 Note A is not treated as funding the distribution of USS1 Note B for purposes of paragraph (b)(3)(ii)(A). USS1 Note B B $100x USS1 USS1 Note A FS A

§ (g)(3) Example 2 Debt instrument issued for expanded group stock that is exchanged for stock in a corporation that is not a member of the same expanded group FP USS1 UST USS1 Note FP stock SH’s A B (i) Facts. UST is a publicly traded domestic corporation. On Date A in Year 1, USS1 issues USS1 Note to FP in exchange for FP stock. On Date B of Year 1, USS1 transfers the FP stock to UST’s shareholders (SH’s), which are not members of the FP expanded group, in exchange for all of the stock of UST. (ii) Analysis. (A) Because USS1 and FP are both members of the FP expanded group, USS1 Note is treated as stock when it is issued by USS1 to FP in exchange for FP stock on Date A in Year 1 under paragraphs (b)(2)(ii) and (d)(1)(i). This result applies even though, pursuant to the same plan, USS1 transfers the FP stock to persons that are not members of the FP expanded group. The exchange of USS1 Note for FP stock is not an exempt exchange within the meaning of paragraph (f)(5).

§ (g)(3) Example 2 Debt instrument issued for expanded group stock that is exchanged for stock in a corporation that is not a member of the same expanded group FP USS1 UST USS1 Note FP stock SH’s A B (B) Because USS1 Note is treated as stock for federal tax purposes when it is issued by USS1, pursuant to section §1.367(b)-10(a)(3)(ii) (defining property for purposes of §1.367(b)-10), there is no potential application of §1.367(b)-10(a) to USS1’s acquisition of the FP stock. (C) Because paragraph (b)(2) treats USS1 Note as stock for federal tax purposes when it is issued by USS1, USS1 Note is not treated as indebtedness for purposes of applying paragraph (b)(3).

§1.385-3(g)(3) Example 3 Issuance of a note in exchange for expanded group stock
FP USS1 FS USS1 Note 40% of FS A (i) Facts. On Date A in Year 1, USS1 issues USS1 Note to FP in exchange for 40% of the FS stock owned by FP. (ii) Analysis. (A) Because USS1 and FP are both members of the FP expanded group, USS1 Note is treated as stock when it is issued by USS1 to FP in exchange for FS stock on Date A in Year 1 under paragraphs (b)(2)(ii) and (d)(1)(i). The exchange of USS1 Note for FS stock is not an exempt exchange within the meaning of paragraph (f)(5) because USS1 and FP are not parties to a reorganization. (B) Because USS1 Note is treated as stock for federal tax purposes when it is issued by USS1, USS1 Note is not treated as property for purposes of §304(a) because it is not property within the meaning specified in §317(a). Therefore, USS1’s acquisition of FS stock from FP in exchange for USS1 Note is not an acquisition described in §304(a)(1). (C) Because USS1 Note is treated as stock for federal tax purposes when it is issued by USS1, USS1 Note is not treated as indebtedness for purposes of applying paragraph (b)(3).

§1.385-3(g)(3) Example 4 Funding occurs in same taxable year as distribution
FP CFC B $400x A $200x CFC Note A USS1 (i) Facts. On Date A in Year 1, FP lends $200x to CFC in exchange for CFC Note A. On Date B in Year 1, CFC distributes $400x of cash to USS1 in a distribution. CFC is not an expatriated foreign subsidiary as defined in § T(a)(9). (ii) Analysis. Under paragraph (b)(3)(iv)(B), CFC Note A is treated as issued with a principal purpose of funding the distribution by CFC to USS1 because CFC Note A is issued to a member of the FP expanded group during the 72-month period determined with respect to CFC’s distribution to USS1. Accordingly, under paragraphs (b)(3)(ii)(A) and (d)(1)(i), CFC Note A is treated as stock when it is issued by CFC to FP on Date A in Year 1.

§1.385-3(g)(3) Example 5 Additional funding
FP (i) Facts. The facts are the same as in Example 4, except that, in addition, on Date C in Year 2, FP lends an additional $300x to CFC in exchange for CFC Note B. (ii) Analysis. The analysis is the same as in Example 4 with respect to CFC Note A. CFC Note B is also issued to a member of the FP expanded group during the 72-month period determined with respect to CFC’s distribution to USS1. Under paragraph (b)(3)(iv)(B), CFC Note B is treated as issued with a principal purpose of funding the remaining portion of CFC’s distribution to USS1, which is $200x. Accordingly, $200x of CFC Note B is a principal purpose debt instrument that is treated as stock under paragraph (b)(3)(ii)(A). Under paragraph (d)(1)(ii), $200x of CFC Note B is deemed to be exchanged for stock on Date C in Year 2. The remaining $100x of CFC Note B continues to be treated as indebtedness. USS1 CFC Note A CFC Note B A C $400x B CFC $200x $300x

§1.385-3(g)(3) Example 6 Funding involving multiple interests
FP (i) Facts. On Date A in Year 1, FP lends $300x to USS1 in exchange for USS1 Note A. On Date B in Year 2, USS1 distributes $300x of cash to FP. On Date C in Year 3, FP lends another $300x to USS1 in exchange for USS1 Note B. (ii) Analysis. (A) Under paragraph (b)(3)(iv)(B)(3), USS1 Note A is tested under paragraph (b)(3) before USS1 Note B is tested. USS1 Note A is issued during the 72-month period determined with respect to USS1’s $300x distribution to FP and, therefore, is treated as issued with a principal purpose of funding the distribution under paragraph (b)(3)(iv)(B)(1). Beginning on Date B in Year 2, USS1 Note A is a principal purpose debt instrument that is treated as stock under paragraphs (b)(3)(ii)(A) and (d)(1)(ii). (B) Under paragraph (b)(3)(iv)(B)(3), USS1 Note B is tested under paragraph (b)(3) after USS1 Note A is tested. Because USS1 Note A is treated as funding the entire $300x distribution by USS1 to FP, USS1 Note B will continue to be treated as indebtedness. A C USS1 Note A USS1 Note B $300x B USS1 $300x $300x CFC

§1.385-3(g)(3) Example 7 Re-testing
USS1 Note A (i) Facts. The facts are the same as in Example 6, except that on Date D in Year 4, FP sells USS1 Note A to Bank. (ii) Analysis. (A) Under paragraph (d)(2), USS1 Note A ceases to be treated as stock when FP sells USS1 Note A to Bank on Date D in Year 4. Immediately before FP sells USS1 Note A to Bank, USS1 is deemed to issue a debt instrument to FP in exchange for USS1 Note A in a transaction that is disregarded for purposes of paragraphs (b)(2) and (b)(3). (B) Under paragraph (d)(2), after USS1 Note A is deemed exchanged, USS1’s other debt instruments that are not treated as stock as of Date D in Year 4 (USS1 Note B) are re-tested for purposes of paragraph (b)(3)(iv)(B) to determine whether other USS1 debt instruments are treated as funding the $300x distribution by USS1 to FP on Date B in Year 2. USS1 Note B was issued by USS1 to FP within the 72-month period determined with respect to the $300x distribution. Under paragraph (b)(3)(iv)(B)(1), USS1 Note B is treated as issued with a principal purpose of funding the $300x distribution. Accordingly, USS1 Note B is a principal purpose debt instrument under paragraph (b)(3)(ii)(A) that is deemed to be exchanged for stock on Date D in Year 4, the re-testing date, under paragraph (d)(1)(iv). See § (c) for rules regarding the treatment of this deemed exchange. FP D A C USS1 Note A USS1 Note B $300x B USS1 $300x $300x CFC

$150x DS2 stock and $100x DS2 Note
§ (g)(3) Example 8 Distribution of expanded group stock and debt instrument in a reorganization that qualifies under §355 FP USS2 DS2 $150x DS2 stock and $100x DS2 Note assets B $200x A USS2 Note (i) Facts. On Date A in Year 1, FP lends $200x to USS2 in exchange for USS2 Note. In a transaction that is treated as independent from the transaction on Date A in Year 1, on Date B in Year 2, USS2 transfers a portion of its assets to DS2, a newly- formed domestic corporation, in exchange for all of the stock of DS2 and DS2 Note. Immediately afterwards, USS2 distributes all of the DS2 stock and the DS2 Note to FP with respect to FP’s USS2 stock in a transaction that qualifies under §355. USS2’s transfer of a portion of its assets qualifies as a “D” reorganization. The DS2 stock has a value of $150x and DS2 Note has a value of $50x. The DS2 stock is not NQPS as defined in §351(g)(2). Absent the application of this section, DS2 Note would be treated by FP as “other property” within the meaning of §356. (ii) Analysis. (A) The contribution and distribution transaction is a reorganization within the meaning of §368(a)(1) involving a transfer of USS2’s property described in §361(a). Thus, DS2 Note is a debt instrument that is issued by DS2 to USS2, both members of the FP expanded group, pursuant to an asset reorganization (as defined in paragraph (f)(1)), and received by FP, another FP expanded group member, with respect to FP’s USS2 stock. Accordingly, DS2 Note is treated as stock when it is issued by DS2 to USS2 on Date B in Year 2 pursuant to paragraphs (b)(2)(iii) and (d)(1)(i).

$150x DS2 stock and $100x DS2 Note
§ (g)(3) Example 8 Distribution of expanded group stock and debt instrument in a reorganization that qualifies under §355 FP USS2 DS2 $150x DS2 stock and $100x DS2 Note assets B $200x A USS2 Note (B) Because DS2 Note is treated as stock when it is issued, §355(a)(1) rather than §356 may apply to FP on FP’s receipt of DS2 Note. Alternatively, depending on the terms of DS2 Note and other factors, DS2 Note may be treated as NQPS that is not treated as stock pursuant to §355(a)(3)(D). If DS2 Note is treated as NQPS, such stock would continue to be treated by FP as “other property” for purposes of §356 under §356(e). In that case, USS2’s distribution of DS2 Note would be treated as “other property” described in §356, and thus the distribution of DS2 note preliminarily would be described in paragraph (b)(3)(ii)(A). However, under paragraph (b)(5), because DS2 Note is treated as stock under paragraph (b)(2)(iii), USS2’s distribution of DS2 Note to FP pursuant to the plan of reorganization is not also treated as a distribution or acquisition described in paragraph (b)(3)(ii) that could cause USS2 Note to be a principal purpose debt instrument. (C) USS2’s distribution of $150x of actual DS2 stock is a distribution of stock pursuant to an asset reorganization that is permitted to be received by FP without recognition of gain under §355(a)(1). Accordingly, USS2’s distribution of the actual DS2 stock to FP is not a distribution of property by USS2 for purposes of paragraph (b)(3)(ii)(A).

$150x DS2 stock and $100x DS2 Note $150x DS2 stock and $100x DS2 Note
§ (g)(3) Example 8 Distribution of expanded group stock and debt instrument in a reorganization that qualifies under §355 FP (D) USS2’s transfer of assets to DS2 in exchange for DS2 stock is not an acquisition described in paragraph (b)(3)(ii)(B) because USS2’s acquisition of DS2 stock is an exempt exchange. USS2’s acquisition of DS2 stock is an exempt exchange described in paragraph (f)(5)(ii) because USS2 and DS2 are both parties to a reorganization that is an asset reorganization, §1032 applies to DS2, the transferor of the expanded group stock, and the DS2 stock is distributed by USS2, the transferee, pursuant to the plan of reorganization. Because USS2 has not made a distribution or acquisition that is treated as a distribution or acquisition for purposes of paragraph (b)(3)(ii), USS2 Note is not a principal purpose debt instrument. A $150x DS2 stock and $100x DS2 Note USS2 Note USS2 $200x $150x DS2 stock and $100x DS2 Note B assets DS2

$150x DS2 stock and $100x DS2 Note $150x DS2 stock and $100x DS2 Note
§ (g)(3) Example 9 Funding a distribution by a successor to funded member FP (i) Facts. The facts are the same as in Example 8, except that on Date C in Year 3, DS2 distributes $200x of cash to FP and, subsequently, on Date D in Year 3, USS2 distributes $100x of cash to FP. (ii) Analysis. (A) DS2 is a successor with respect to USS2 under paragraph (f)(11)(i) because DS2 is the acquiring corporation in a “D” reorganization. USS2 is a predecessor with respect to DS2 under paragraph (f)(9)(i) because USS2 is the Transferor Corporation in a “D” reorganization. Accordingly, under paragraph (b)(3)(v), a distribution by DS2 is treated as a distribution by USS2. Under paragraph (b)(3)(iv)(B), USS2 Note is treated as issued with a principal purpose of funding the distribution by DS2 to FP because USS2 Note was issued during the 72-month period determined with respect to DS2’s $200x cash distribution. Accordingly, USS2 Note is a principal purpose debt instrument under paragraph (b)(3)(ii)(A) that is deemed to be exchanged for stock on Date C in Year 3 under paragraph (d)(1)(ii). See § (c) for rules regarding the treatment of this deemed exchange. (B) Because the entire amount of USS2 Note is treated as funding DS2’s $200x distribution to FP, under paragraph (b)(3)(iv)(B)(4), USS2 Note is not treated as funding the subsequent distribution by USS2 on Date D in Year 3. A $150x DS2 stock and $100x DS2 Note USS2 Note USS2 $200x $150x DS2 stock and $100x DS2 Note B assets DS2 FP $100x $200x D C USS2 DS2

§1.385-3(g)(3) Example 10 Asset reorganization; §354 qualified property
FP USS1 USS2 A $100x B USS2 stock USS2 Note FS assets/ liabilities (i) Facts. On Date A in Year 1, FS lends $100x to USS2 in exchange for USS2 Note. On Date B in Year 2, in a transaction that qualifies as a “D” reorganization, USS2 transfers all of its assets to USS1 in exchange for stock of USS1 and the assumption by USS1 of all of the liabilities of USS2, and USS2 distributes to FP, with respect to FP’s USS2 stock, all of the USS1 stock that USS2 received. FP does not recognize gain under §354(a)(1). (ii) Analysis. (A) USS1 is a successor with respect to USS2 under paragraph (f)(11)(i) because USS1 is the acquiring corporation in a “D” reorganization. For purposes of paragraph (b)(3), USS2 and its successor, USS1, are funded members with respect to USS2 Note. Although USS2, a funded member, distributes property (USS1 stock) to its shareholder, FP, pursuant to the reorganization, the distribution of USS1 stock is not described in paragraph (b)(3)(ii)(A) because the property is permitted to be received without the recognition of gain under §354(a)(1). The distribution of USS1 stock is also not described in paragraph (b)(3)(ii)(C) because FP does not receive the USS1 stock as “other property” within the meaning of §356.

§1.385-3(g)(3) Example 10 Asset reorganization; §354 qualified property
FP USS1 USS2 A B assets/ liabilities USS2 stock USS2 Note FS (B) USS2’s exchange of assets for USS1 stock is not an acquisition described in paragraph (b)(3)(ii)(B) because USS2’s acquisition of USS1 stock is an exempt exchange. USS2’s acquisition of USS1 stock is an exempt exchange described in paragraph (f)(5)(ii) because USS1 and USS2 are both parties to a reorganization, §1032 applies to USS1, the transferor of the expanded group stock, and the USS1 stock is distributed by USS2, the transferee, pursuant to the plan of reorganization. (C) Because neither USS1 nor USS2 has made a distribution or acquisition described in paragraph (b)(3)(ii), USS2 Note is not a principal purpose debt instrument.

§1.385-3(g)(3) Example 11 Triangular reorganization
FP stock/ FP Note FP (i) Facts. USS2 owns 100% of the stock of DS2, a domestic corporation. On Date B in Year 1, FP issues FP stock and FP Note to USS1 as a contribution to capital. USS1 does not formally issue additional USS1 stock to FP in exchange for FP stock and FP Note but is treated as issuing stock to FP in an exchange to which §351 applies. Immediately afterwards, USS1 transfers the FP stock and FP Note to DS2 in exchange for all of DS2’s assets, and DS2 distributes the FP stock and FP Note to USS2 with respect to USS2’s DS2 stock in a liquidating distribution. (ii) Analysis. FP Note is issued by FP to USS1 in exchange for stock of USS1 in an exchange that is not an exempt exchange described in paragraph (f)(5). Under paragraph (b)(2)(ii), FP Note is treated as stock beginning on Date B in Year 1. B USS1 USS2 assets FP stock/FP Note FP stock/FP Note DS2

§1.385-3(g)(3) Example 12 Funded acquisition of subsidiary stock by issuance; successor
FP USS1 FS A USS1 Note CFC $100x $20x assets B $20x CFC stock $20x C $50x FS stock D (i) Facts. On Date A in Year 1, FS lends $100x to USS1 in exchange for USS1 Note. On Date B in Year 1, USS1 transfers property that has a value of $20x to CFC in exchange for additional CFC stock that has a value of $20x. On Date C in Year 2, CFC distributes $20 cash to USS1. On Date D in Year 3, CFC acquires stock of FS from FP in exchange for $50x cash. (ii) Analysis. (A) But for the exception in paragraph (c)(3), USS1 Note would be treated under paragraph (b)(3)(iv)(B) as issued with a principal purpose of funding an acquisition of expanded group stock described in paragraph (b)(3)(ii)(B) because USS1 Note is issued to a member of the FP expanded group during the 72-month period determined with respect to USS1’s acquisition of CFC stock on Date B in Year 1. However, because USS1’s acquisition of CFC stock results from a transfer of property from USS1 to CFC in exchange for CFC stock and immediately after the transaction USS1 holds 100% of the stock of CFC, the exception in paragraph (c)(3) applies. Accordingly, USS1’s acquisition of CFC stock on Date B in Year 1 is not treated as an acquisition of stock described in paragraph (b)(3)(ii)(B), and USS1 Note is not treated as stock.

§1.385-3(g)(3) Example 12 Funded acquisition of subsidiary stock by issuance; successor
FP USS1 FS A USS1 Note CFC $100x $20x assets B $20x CFC stock $20x C $50x FS stock D (B) CFC is a successor with respect to USS1 under paragraph (f)(11)(ii). For purposes of paragraph (b)(3)(iv)(B)(1), CFC is a successor only to the extent of the value of the expanded group stock acquired from CFC in the transaction described in paragraph (c)(3). (C) Under paragraph (f)(11)(ii), CFC’s $20x cash distribution to USS1 on Date C in Year 2 is not taken into account for purposes of applying paragraph (b)(3) to USS1 Note. (D) On Date D in Year 3, CFC continues to be a successor to USS1 for purposes of applying the per se rule in paragraph (b)(3)(iv)(B). Accordingly, USS1 Note is a principal purpose debt instrument under paragraph (b)(3)(ii)(A) that is deemed to be exchanged for stock on Date D in Year 3 under paragraph (d)(1) (ii). See § (c) for rules regarding the treatment of this deemed exchange.

§1.385-3(g)(3) Example 16 Distribution of another member’s debt instrument
FP (i) Facts. On Date A in Year 1, CFC lends $100x to FS in exchange for FS Note. On Date B in Year 2, CFC distributes FS Note to USS1. (ii) Analysis. Although CFC distributes FS Note, which is a debt instrument, to USS1, another member of CFC’s expanded group, paragraph (b)(2)(i) does not apply because CFC is not the issuer of the FS Note. USS1 FS $100x FS Note B A FS Note CFC

§1.385-3(g)(3) Example 17 Threshold exception and current year E&P exception
FP USS1 FS CFC A CFC Note ($40m) B USS1 Note ($20m) C $30m DS FS Note B ($19m) E $35m E&P FS Note A $30x D (i) Facts. Before Date A in Year 1, the members of FP’s expanded group hold no outstanding debt instruments that otherwise would be treated as stock under this section. On Date A in Year 1, CFC issues CFC Note, which has an issue price of $40m, to USS1 in a distribution. On Date B in Year 2, USS1 issues USS1 Note, which has an issue price of $20m, to FP in a distribution. On Date C in Year 3, FS distributes $30m in cash to FP. On Date D in Year 3, DS lends $30m to FS in exchange for FS Note A. On Date E in Year 3, FS issues FS Note B, which has an issue price of $19m, to FP in a distribution. In Year 3, FS has $35m in E&P described in §316(a)(2). (ii) Analysis. (A) Because CFC does not have E&P described in §316(a)(2) in Year 1, the exception in paragraph (c)(1) does not apply to CFC Note. Immediately after CFC Note is issued to USS1 on Date A in Year 1, the aggregate adjusted issue price of outstanding debt instruments issued by members of FP’s expanded group that would be subject to paragraph (b) but for the application paragraph (c)(2) does not exceed $50m. Accordingly, the threshold exception described in paragraph (c)(2) applies to the CFC Note.

FP USS1 FS CFC A CFC Note ($40m) B USS1 Note ($20m) C $30m DS FS Note B ($19m) E $35m E&P FS Note A $30x D (B) Because USS1 does not have E&P described in §316(a)(2) in Year 2, the exception in paragraph (c)(1) does not apply to USS1 Note. Immediately after USS1 Note is issued to FP on Date B in Year 2, the aggregate adjusted issue price of outstanding debt instruments issued by members of the FP expanded group that would be subject to paragraph (b) but for the application of paragraph (c)(2) exceeds $50m. Under paragraph (d)(1)(iii), CFC Note is deemed to be exchanged for stock on Date B in Year 2, when debt instruments of the FP expanded group cease to qualify for the threshold exception described in paragraph (c)(2). In addition, the threshold exception described in paragraph (c)(2) does not apply to USS1 Note because, immediately after USS1 Note is issued, the aggregate adjusted issue price of outstanding debt instruments issued by members of the expanded group that would be subject to paragraph (b) but for the application paragraph (c)(2) exceeds $50m. Accordingly, USS1 Note is treated as stock when it is issued on Date B in Year 2.

FP USS1 FS CFC A CFC Note ($40m) B USS1 Note ($20m) C $30m DS FS Note B ($19m) E $35m E&P FS Note A $30x D (C) Under paragraph (c)(1), for purposes of applying paragraphs (b)(2) and (b)(3) to a member of an expanded group with respect to Year 3, the aggregate amount of any distributions or acquisitions by FS that are described in paragraphs (b)(2) or (b)(3)(ii) are reduced by an amount equal to FS’s current year E&P described in §316(a)(2) for Year 3, which is $35m. Thus, $35m of distributions or acquisitions by FS in Year 3 are not taken into account for purposes of applying paragraphs (b)(2) and (b)(3). The reduction is applied first against FS’s $30m cash distribution on Date C in Year 3 and second against FS’s $19m note distribution on Date E in Year 3. Accordingly, under paragraph (c)(1), FS Note A is not treated as stock under paragraph (b)(3). In addition, under paragraph (c)(1), a portion of FS Note B equal to $5m is not treated as stock under paragraph (b)(2). (D) When FS Note B is issued in Year 3, CFC Note, which previously was treated as indebtedness solely because of paragraph (c)(2), remains outstanding. Accordingly, the threshold exception described in paragraph (c)(2) does not apply to FS Note B. Accordingly, the remaining amount of FS Note B equal to $14m after applying the exception under paragraph (c)(1) is treated as stock under paragraph (b)(2).

§ (g)(3) Example 18 Distribution of a debt instrument and issuance of a debt instrument with a principal purpose of avoiding the purposes of this section FP (i) Facts. On Date A in Year 1, USS1 issues USS1 Note A, which has a value of $100x, to FP in a distribution. On Date B in Year 1, with a principal purpose of avoiding the application of this section, FP sells USS1 Note A to Bank for $100x of cash and lends $100x to USS1 in exchange for USS1 Note B. (ii) Analysis. USS1 Note A is a debt instrument that is issued by USS1 to FP, a member of USS1’s expanded group, in a distribution. Accordingly, under paragraphs (b)(2)(i) and (d)(1)(i), USS1 Note A is treated as stock when it is issued by USS1 to FP on Date A in Year 1. Accordingly, USS1 is treated as distributing USS1 stock to its shareholder FP. Because USS1 Note A is treated as stock of USS1, USS1 Note A is not property as specified in §317(a) on Date A in Year 1. Under paragraph (d)(2), USS1 Note A ceases to be treated as stock when FP sells USS1 Note A to Bank on Date B in Year 1. Immediately before FP sells USS1 Note A to Bank, USS1 is deemed to issue a debt instrument to FP in exchange for USS1 Note A in a transaction that is disregarded for purposes of paragraphs (b)(2) and (b)(3). USS1 Note B is not treated as stock under paragraph (b)(3)(ii)(A) because the funded member, USS1, has not made a distribution of property. However, because the transactions occurring on Date B of Year 1 were undertaken with a principal purpose of avoiding the purposes of this section, USS1 Note B is treated as stock on Date B of Year 1 under paragraph (b)(4). USS1 Note A ($100m) A USS1 USS1 Note A ($100m) FP B $100x USS1 Note B USS1 $100x

Final F Reorganization Regulations T.D. 9739

Summary Final regulations regarding qualification under section 368(a)(1)(F) (mere change in identity, form or place of organization of one corporation, however effected): Cover wide range of corporate changes and transaction forms Final regulations regarding outbound F reorganizations (adopting without substantive change 1990 proposed regulations relating to Section 367(a)) Key reasons that F reorganizations can be preferred over other reorganization and nonrecognition provisions are that, in addition to the normal nonrecognition treatment: The Resulting Corporation generally can carry back losses to prior taxable years of the Transferor Corporation The taxable year generally does not close (aside from outbound F reorgs, and Foreign-to-Foreign F reorgs) Final Regulations: These generally adopt 2004 Proposed Regulations (which contained four requirements containing certain exceptions), subject to two additional requirements for F reorganization treatment to address potential overlaps between F reorganizations and other nonrecognition rules.

Important features of final regulations
Continue the “Bubble” Concept: A transaction (or series of related transactions) that begins when the Transferor Corporation begins transferring its assets to the Resulting Corporation and ends when the Transferor Corporation has distributed the consideration it receives from the Resulting Corporation to its shareholders and has completely liquidated for federal tax purposes. See § – 2(m)(3)(ii): Bob Wellen American Bar Association comments: Transactions in the millisecond before and after the bubble are disregarded. The regulations are form driven; you must satisfy requirements while in the bubble. “Potential F reorganization” language used in analyzing which steps in a multi-step transaction should be tested as encapsulating a mere change (i.e., which steps are “in the bubble”) Treat the Resulting Corporation in an F Reorganization as the functional equivalent of the Transferor Corporation and therefore generally give its corporate enterprise the same freedom of action as would be accorded a corporation that remains within its original corporate shell: Example is treatment of distributions and redemptions that occur “in the bubble.”

Requirements First Requirement:
Immediately after the Potential F Reorganization: All the stock of the Resulting Corporation must have been distributed (or deemed distributed) in exchange for stock of the Transferor Corporation in the Potential F Reorganization. An exception allows the issuance of a de minimis amount of stock in the Resulting Corporation to facilitate its organization or maintain its legal existence. Together with the second requirement, ensures that transaction does not shift ownership of the corporation Second Requirement: The same person or persons who own all the stock of the Transferor Corporation at the beginning of the Potential F Reorganization must own all of the stock of the Resulting Corporation at the end of the Potential F Reorganization, in identical proportions: Exceptions: (i) Redemptions (shrinkage) unless the overlap rule (described below) applies and concurrent value-for-value recapitalizations (see Rev. Rul , Rev. Rul )

Requirements Third Requirement:
The Resulting Corporation may not hold any property or have any tax attributes immediately before the Potential F Reorganization: Exceptions allow the Resulting Corporation to hold: A de minimis amount of assets to facilitate its organization or maintain its legal existence Proceeds of borrowings undertaken in connection with the Potential F Reorganization Together with fourth requirement, ensures that F reorganization in substance involves only one corporation. Fourth Requirement: The Transferor Corporation must completely liquidate in the Potential F Reorganization: Exception allows the Transferor Corporation to not dissolve and to retain a de minimis amount of assets for the sole purpose of preserving its legal existence.

Requirements Fifth Requirement:
Immediately after the Potential F Reorganization, no corporation other than the Resulting Corporation may hold property that was held by the Transferor Corporation immediately before the Potential F Reorganization, if such other corporation would, as a result, succeed to and take into account the items of the Transferor Corporation described in section 381(c): A transaction that divides the property or tax attributes of a Transferor Corporation between or among acquiring corporations, or that leads to potential competing claims to such tax attributes, will not qualify as an F Reorganization. This requirement reflects concerns raised in comments regarding “overlap transactions” and ensures that a divisive transaction will not qualify as an F reorganization.

Requirements Sixth Requirement:
Immediately after the Potential F Reorganization, the Resulting Corporation may not hold property acquired from a corporation other than the Transferor Corporation if the Resulting Corporation would, as a result, succeed to and take into account the items of such other corporation described in section 381(c): Simultaneous acquisitions of property and tax attributes from multiple Transferor Corporations (such as in Rev. Rul ) will not qualify as an F reorganization (but can continue to qualify as another type of reorganization). This also reflects the statutory mandate that an F reorganization involve only one corporation and ensures that an acquisitive transaction will not qualify as an F reorganization.

Example Simple cases P P A P S(1) S(2) Newco S P S(1) S(2) Newco
B) C) D) P P A P What happens if 100% of the former assets are dropped into S(2)? 50% merger merger S(1) S(2) Newco S P S(1) S(2) Newco merger merger Rev. Rul ; Reg (k) S(2) Newco S Oldco Basic F § (m)(4), example 4 Mtg. bus § (m)(4), example 10 Fails § (m)(3)(iii)

Example F Reorganization in a Bubble §1.368-2(m)(4), example 6
(1) P forms S(2)/Newco, (2) S(1) merges into Newco, (3) then P sells S(2)/Newco to X for cash. The merger of S(1) into S(2)/Newco qualifies as an F reorganization. See § (m)(3)(ii), F in a bubble. Sale is disregarded for F reorganization status. This is a mere change within a larger transaction. A Potential F Reorganization that qualifies as a reorganization under section 368(a)(1)(F) may occur before, within or after other transactions that effect more than a mere change, even if the Resulting Corporation has only transitory existence. Related events that precede or follow the Potential F Reorganization generally will not cause that Potential F Reorganization to fail to qualify as a reorganization under section 368(a)(1)(F). Qualification of a Potential F Reorganization as a reorganization under section 368(a)(1)(F) will not alter the character of other transactions for federal income tax purposes, and step transaction principles may be applied to other transactions without regard to whether certain steps qualify as a reorganization or part of a reorganization under section 368(a)(1)(F). 3 P X cash Newco stock Forms 1 S(1) merger S(2) Newco 2 P X $ S(2) Newco

Example Distribution A S X Newco
X merges into S; A receives S stock and cash. The merger of X into S can qualify as an F reorganization. The distribution of cash is treated as a section 301 distribution. See Regulation §1.368 – (2)(m)(3)(iii): As provided in paragraph (m)(1)(ii) of this section, a Potential F Reorganization may qualify as a mere change even though a holder of stock in the Transferor Corporation receives a distribution of money or other property from either the Transferor Corporation or the Resulting Corporation. If a shareholder receives money or other property (including in exchange for its shares) from the Transferor Corporation or the Resulting Corporation in a Potential F Reorganization that qualifies as a reorganization under section 368(a)(1)(F), then the receipt of money or other property (including any exchanged for shares) is treated as an unrelated, separate transaction from the reorganization, whether or not connected in a formal sense. See § 1.301–1(l). A S stock + cash X S Newco merger

Example Cash redemption §1.368-2(m)(4), example 2
The merger of X into Y is a mere change of X and qualifies as an F reorganization. A’s surrender of X stock for cash is treated as a transaction separate from the reorganization to which section 302(a) applies. There is no continuity of interest requirement in an 368(a)(1)(F) Reorganization. See § (m)(3)(iii). A B 75% X 25% Newco stock cash X merger Y A B 100% $ Y

Example New shareholder §1.368-2(m)(4), example 1
Y forms Z and transfers cash to it. X merges into Z; Z distributes cash to C. The merger of X into Z does not qualify as an F reorganization: Requirement (i): Immediately after the Potential F Reorganization, all of the stock of the Resulting Corporation must have been distributed (or deemed distributed) in exchange for stock of the Transferor Corporation in the Potential F Reorganization Requirement (ii): The same person or persons who own all the stock of the Transferor Corporation at the beginning of the Potential F Reorganization must own all of the stock of the Resulting Corporation at the end of the Potential F Reorganization, in identical proportions C Y cash cash 1 X Z merger 2 C Y $ Z Fails Requirements (i) and (ii) Assets

Example Other acquiring corporation §1.368-2(m)(4), example 9
Result: P A A Former S assets New S Stock 80% 20% S New S 1 New S 80% of assets 20% of assets Former S Assets S liquidates, distributing assets to P and A. Then, A transfers the assets it received to a newly formed corporation (New S). Requirement (V): Immediately after the Potential F Reorganization, no corporation other than the Resulting Corporation may hold property that was held by the Transferor Corporation immediately before the Potential F Reorganization, if such other corporation would, as a result, succeed to and take into account the items of the Transferor Corporation described in section 381(c). S’s distribution of 80% of its property to P as part of the complete liquidation of S meets the requirements of § 332; thus, § 381(a)(1) applies to P’s acquisition. Under Reg. § (m)(1)(v), the Potential F Reorganization in which 20% of the property of S is transferred to New S cannot be a mere change. Company A fails Requirement (V).

Third F Reorganization Requirement
Requirement (ii): The same person or persons who own all the stock of the Transferor Corporation at the beginning of the Potential F Reorganization must own all of the stock of the Resulting Corporation at the end of the Potential F Reorganization, in identical proportions. Requirement (iii): The Resulting Corporation may not hold any property or have any tax attributes immediately before the Potential F Reorganization. US-P US P NY-1 Continue NJ-1 NJ-1 NY-2 Continue NJ-2 NJ-2 NY-1 and NY-2 simultaneously continue from NY to NJ jurisdiction. Do the continuances qualify as F reorganizations? Does NJ-2 meet Second F Reorganization Requirement (See Treas. Reg. section (m)(1)(ii))? Does NJ-1 meet Third F Reorganization Requirement (See Treas. Reg. section (m)(1)(iii))?

Example Timing of contributions
property 2 1 X Newco X Newco merger merger 1 2 If not an F Reorganization, what is this? P forms Newco; X merges into Newco. S Contributes property to Newco in exchange for Newco stock (outside bubble). Same transaction, but S forms Newco and contributes property to it in exchange for stock before X merges into Newco Violates third requirement See Revenue Ruling

Example Combination of entities §1.368-2(m)(4), example 14
A and B simultaneously merge into Newco The merger of A and B into Newco will not qualify as an F reorganization of A or B (sixth requirement). The mergers can qualify as A, C or D reorganizations. Requirement (VI): Immediately after the Potential F Reorganization, the Resulting Corporation may not hold property acquired from a corporation other than the Transferor Corporation if the Resulting Corporation would, as a result, succeed to and take into account the items of such other corporation described in section 381(c). P Newco stock A B mergers Newco/ S

Overlap rules Comments were received regarding the potential for overlap transactions, due to decision to allow redemptions “in the bubble” in the 2004 proposed regulations: Example – P owns all of S’s stock, S redeems 80 percent of its stock, and immediately thereafter S merges into Newco, a corporation newly organized by P (or by S). Section 332 subsidiary liquidation and a “sideways” or “downstream” F reorganization? If so, would S’s tax attributes move to P or Newco? Addressed in part through Fifth Requirement – no corporation (other than the Resulting Corporation) can hold property held by the Transferor Corporation immediately before the Potential F Reorganization if such other corporation would as a result succeed to the Transferor Corporation’s tax attributes.

Example Redemption with overlap
X distributes 80% of its property to P in redemption of P’s stock in X, X merges into Newco, and S receives all of Newco’s stock. You should assume X’s distribution of property to P meets the requirements of section 332 (a tax-free subsidiary liquidation). The merger of X into Newco will not qualify as an F reorganization of X into Y. P S 80% 20% Newco stock 80% property X merger Newco P S Former X assets Newco

Treas. Reg. 1.368-2(m)(3)(iv) (overlaps)
If the Potential F Reorganization (or a step thereof): Qualifies as a reorganization under another provision of section 368(a)(1). A corporation with section 368(c) control of the Resulting Corporation is a party to such other reorganization (within the meaning of section 368(b)). Then the Potential F Reorganization will not qualify as an F reorganization. Except as provided above, if the Potential F Reorganization would qualify as an A, C or D reorganization and an F reorganization, it will qualify only as an F reorganization. F reorganizations continue to overlap with E reorganizations. See Rev. Rul F reorganizations continue to be trumped by G reorganizations. See Section 368(a)(3)(C).

Overlap (F/Triangular Overlap) §1.368-2(m)(4), example 13
Share -holders X Share -holders 1 X T stock P P $50 cash and $50 of P voting stock 2 T T Merger Newco 3 P purchases the T stock for $50 cash and $50 P stock, then causes T to merge into a wholly-owned Newco. The transaction qualifies as a triangular section 368(a)(1)(A)/368(a)(2)(D) reorganization of T into Newco for P stock. The merger of T into Newco does not qualify as an F reorganization under Treas. Reg (m)(3)(iv)(A), because a corporation in control of the Resulting Corporation is a party to a different types of reorganization of which the Potential F Reorganization is a step.

Overlap (F/(a)(2)(C) Overlap 1) §1.368-2(m)(4), example 10
50% of S assets for Newco stock P 2 P 1 Merger S Newco 50% S assets Newco 50% S assets S merges into P, then P transfers 50% of the S assets to Newco for Newco stock. The Final Regulations provide that there is no F reorganization in this transaction, which is treated as an A reorganization followed by a section 368(a)(2)(C) drop. See Treas. Reg (m)(4), Ex. 10. The transaction will not result in an F reorganization of S into Newco because: (i) immediately after the Potential F Reorganization, P holds 50% of the S assets by reason of a transaction to which section 381 applies, so the Fifth Requirement is failed; and (ii) P is a party to a different reorganization (the A reorganization of S into P) and is in control of Newco (the Resulting Corporation) immediately after the Potential F Reorganization, so Treas. Reg (m)(3) (iv)(A) applies.

Overlap example (downstream vs. upstream)
2 2 T liquidates into P T liquidates into P T T 1 1 Transfer “sub all” assets Transfer all T assets and liabilities Oldco Newco Example 4.1: T transfers “substantially all” of its assets to Oldco, then T liquidates into P Downstream “D” reorganization? Section 351 followed by upstream “C” reorganization? See PLRs ; Upstream C followed by 368(a)(2)(C) drop? See Rev. Rul Treas. Reg. section (k) potentially does not answer the question – “D” reorganization and upstream “C” reorganization both occur on Step 2; thus, there is no “first past the finish line;” see also Rev. Rul , Rev. Rul , section 351(c). Example 4.2: T transfers all assets and liabilities to Newco, then T liquidates into P “F” reorganization? Section 351 followed by upstream “C” reorganization? See Treas. Reg. section (m)(4), Ex. 11. How does the first overlap rule apply? “If the Potential F Reorganization or a step thereof qualifies as a reorganization or part of a reorganization under another provision of section 368(a)(1), and if a corporation in control (within the meaning of section 368(c)) of the Resulting Corporation is a party to such other reorganization (within the meaning of section 368(b)), the Potential F Reorganization will not qualify as a reorganization under section 368(a)(1)(F).”

Overlap example (downstream vs. upstream)
2 2 T liquidates into P T liquidates into P T Newco T 1 Transfer 99.9% of T assets 1 Newco Transfer all assets and liabilities Example 4.3: T transfers all assets and liabilities to Newco, and then T liquidates into P Same analysis as Example 4.2? Example 4.4: T transfers 99.9% of T assets and liabilities to Newco, and then T liquidates into P F reorganization with distribution of 0.1% of assets? See Treas. Reg (m)(3)(iii) (distribution rule). Is the fifth requirement satisfied? (“Immediately after the Potential F Reorganization, no corporation other than the Resulting Corporation may hold property that was held by the Transferor Corporation immediately before the Potential F Reorganization, if such corporation would, as a result, succeed to and take into account the items of the Transferor Corporation described in section 381(c)”).

Questions?

Tax legislative update
Presented by Ernst & Young LLP’s: Jefferson P VanderWolk — Executive Director

Tax legislative update
Timeline of activity Presidential campaigns and tax plans Congressional races Tax extenders: Bonus depreciation Tax reform: Background: history and drivers of tax reform House activities Senate Finance Committee activity

Timeline Congress and presidential race
15 July Federal Aviation Administration authorization, funding expires 30 September Government funding expires 31 December Some tax extenders expire 15 March 2017 Federal debt limit reinstated, likely needs increase 18 July–6 September Congress: summer recess Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar 18–21 July Republican National Convention 25–28 July Democratic National Convention 8 November Election Day

Candidate tax plans Corporate taxes
Trump Clinton Top corporate tax rate (now 35%) 15% “Reform our tax code to reward businesses that invest in workers and production here in America, rather than … overseas” “End the Bermuda reinsurance loophole, and tax gaming through complex derivative trading” Top pass-through rate (now 39.6%) Taxation of future foreign earnings (now worldwide) Immediate worldwide taxation, repeal of deferral Mandatory tax, untaxed accumulated foreign earnings 10% Inversions Lowering taxes is the only way to prevent inversions Exit tax; 50% Sec test; limit earnings stripping; “claw back” prior years’ tax benefits associated with moving jobs abroad Interest “Reasonable cap” on deductibility — R&D (now 20% credit or alternative credit of 14% based on three-year average) Use revenue from closing loopholes to help drive growth and job creation, including strengthening R&D Other business provisions “Reducing or eliminating some corporate loopholes” Eliminate tax incentives for fossil fuels

Candidate tax plans Individual taxes
Trump Clinton Individual tax rates (now 10%, 15%, 25%, 28%, 33%, 35%, 39.6%) 10%, 20%, 25% Buffett Rule to require minimum 30% effective tax rate for annual incomes over $1m; 4% Fair Share Surcharge on annual income over $5m Top capital gains and dividends rate (now 23.8%) 15% for those in 20% bracket; 20% for those in 25% bracket; 3.8% net investment income tax repealed Assets held less than two years taxed as ordinary income; 23.8% capital gains rate on assets held six or more years Carried interest (now capital gains) Ordinary income Estate tax (now 40%, $5.43m exemption) Repealed Return to 2009 regime of $3.5m exemption, 45% rate Individual credits — Tax credit for caregivers of elderly, disabled relatives Charitable contributions (now capped at 50% of adjusted gross income) No change Cap all itemized deductions at a tax value of 28% Mortgage interest (now deduction on first $1m) Other itemized deductions Pared back as tax rate increases Personal exemption phase-out (PEP) and Pease (for income $300k/family $250k/individual Unspecified “steepening the curve” of PEP and Pease Life insurance build-up (now not included in income) Included in income for high earners

First major piece of legislation recent presidents enacted after taking office
Barack Obama Took office 20 January 2009 American Recovery and Reinvestment Act of 2009 Enacted 17 February 2009 Stimulus legislation, included bonus depreciation George W. Bush Took office 20 January 2001 Economic Growth and Tax Relief Reconciliation Act of 2001 Enacted 7June 2001 The “Bush tax cuts” reduced individual rates, estate tax Bill Clinton Took office 20 January 1993 Omnibus Budget Reconciliation Act of 1993 Enacted 10 August 1993 Increased individual, corporate taxes George H. W. Bush Took office 20 January 1989 Omnibus Budget Reconciliation Act of 1990 Enacted 5 November 1990 Increased individual taxes despite “no new tax” pledge Ronald Reagan Took office 20 January 1981 Economic Recovery Tax Act of 1981 Enacted 13 August 1981 Sharply reduced individual, corporate taxes

Congressional profile
Senate, 114th congress House, 114th congress 54/46* * Includes 2 independents 246*/188 *1 vacancy: Boehner (R-OH), election in June Republicans Democrats Republicans Democrats Majority Leader: McConnell Majority Whip: Cornyn GOP Conf. Chair: Thune Democratic Leader: Reid Democratic Whip: Durbin Democratic Conf. Vice Chair: Schumer Strategic Policy Adviser, Democratic Policy and Communications Committee: Warren Speaker: Ryan Majority Leader: McCarthy Majority Whip: Scalise Democratic Leader: Pelosi Democratic Whip: Hoyer Asst. Democratic Leader: Clyburn

2016 Senate elections Seats up for re-election: 10 Democratic, 24 Republican Democrats Republicans Michael Bennet (D-CO) R. Blumenthal (D-CT) Barbara Boxer (D-CA) retiring Pat Leahy (D-VT) Barbara Mikulski (D-MD) retiring Patty Murray (D-WA) Harry Reid (D-NV) retiring Brian Schatz (D-HI) Chuck Schumer (D-NY) Ron Wyden (D-OR) Kelly Ayotte (R-NH) Roy Blunt (R-MO) John Boozman (R-AR) Richard Burr (R-NC) Dan Coats (R-IN) retiring Mike Crapo (R-ID) Chuck Grassley (R-IA) John Hoeven (R-ND) Johnny Isakson (R-GA) Ron Johnson (R-WI) Mark Kirk (R-IL) James Lankford (R-OK) Mike Lee (R-UT) John McCain (R-AZ) Jerry Moran (R-KS) Lisa Murkowski (R-AK) Rand Paul (R-KY) Rob Portman (R-OH) Marco Rubio (R-FL) retiring Tim Scott (R-SC) Richard Shelby (R-AL) John Thune (R-SD) Pat Toomey (R-PA) David Vitter (R-LA) retiring  = state won by President Obama in 2012 presidential election

Spending, interest continue to grow as percent of GDP, while revenue remains flat
Note: Projections for the years 2015 and 2040 are from the Congressional Budget Office (CBO) as noted in its extended alternative fiscal scenario in The 2015 Long-Term Budget Outlook. Sources: CBO, The 2015 Long-Term Budget Outlook, 16 June 2015, and The Budget and Economic Outlook: 2016 to 2026, 25 January 2016; Office of Management and Budget, Table 1.2 — Summary of Receipts, Outlays, and Surpluses or Deficits (-) as Percentages of GDP: 1930–2018; Monthly Treasury Statement, September 2015; Ernst & Young LLP calculations.

Spending and revenue FY 2015
Net interest 1.3% of GDP Individual income taxes $224b Discretionary spending Corporate income taxes 8.7% of GDP $1.5t 6.5 % of GDP 1.9% of GDP $344b Social Security $1.2t Defense 5.0% of GDP $882b 3.3% of GDP $582b Revenues Mandatory spending Spending Payroll (social insurance) taxes $3.2t 12.9% of GDP $3.7t $2.3t Nondefense Medicare 6.0% of GDP $1.1t 3.3% of GDP 3.0% of GDP $583b $539b Medicaid Other Consists of payroll taxes that fund social insurance programs, primarily Social Security and Medicare’s Hospital Insurance program 2.0% of GDP 3.0% of GDP Consists of Medicare spending minus income from premiums and other offsetting receipts $350b Other $528b 1.7% of GDP $299b Consists of spending on unemployment compensation, federal civilian and military retirement, some veterans’ benefits, the earned income tax credit (EITC), the Supplemental Nutrition Assistance Program, and other mandatory programs, minus income from offsetting receipts Consists of spending on certain programs related to transportation, education, veterans’ benefits, health, housing assistance and other activities Consists of excise taxes, estate and gift taxes, customs duties, receipts from the Federal Reserve, and miscellaneous fees and fines Reproduced from CBO: The Federal Budget in 2015

Consolidated Appropriations Act of 2016 — enacted 18 December 2015
Appropriates $1.1t in spending for remainder of FY 2016 Levels set earlier by Bipartisan Budget Act of 2015 Tax provisions: Some permanent business, individual, charitable extender provisions Permanent expansions of child tax credit, EITC, American opportunity tax credit Extends for five years bonus depreciation, credits for wind and solar Suspends 2.3% excise tax on medical devices through 2017 Delay of 40% “Cadillac tax” on high-cost health plans until 2020 IRS reforms, real estate investment trust provisions, partnership audit technical corrections Extension of Internet Tax Freedom Act through 1 October 2016 Health provisions 2016 2017 2018 2019 2020 Cadillac tax Originally effective in 2018 Delayed by omnibus In effect Health insurance tax Suspended Medical device tax Suspended by omnibus

PATH Act and technical corrections
Protecting Americans from Tax Hikes (PATH) Act — December 2015 Permanent: R&D tax credit The 15-year recovery period for qualified leasehold improvements, property and qualified retail improvement property The exception from subpart F income for active financing income Five-year extension: Bonus depreciation: phased down to apply at 50% for property placed in service during 2015, 2016 and 2017; 40% for 2018; and 30% for 2019 Phase-down in 2018 and 2019 Transition rules for longer-lived and transportation property Two-year extension for other expiring provisions Technical corrections bill

Major drivers of US corporate tax reform
Less competitive US tax system, “lock-out” effect High US statutory corporate tax rate Worldwide system of taxing foreign earnings A Less competitive US system means US resident companies may relocate to more favorable jurisdictions through inversions or become vulnerable to acquisition by foreign competitors. Patent box regimes in other countries lure intellectual property income and R&D jobs from the US, especially given the nexus requirement of the Base Erosion and Profit Shifting project of the Organisation for Economic Co-operation and Development. EU state aid investigations are seen as targeting US multinational companies that are accumulating large amounts of tax-deferred income abroad.

Evolution of, and questions for, US tax reform
Before late 2014 Republicans insist on comprehensive tax reform: business, individual and international Early 2015 Republicans focus on business tax reform as President Obama opposes individual rate cuts Since May 2015 Republicans pivot to international-only reform due to opposition from pass- through businesses to corporate-only rate cut Tax reform questions still to be answered: 1 2 3 4 5 Scope of reform — comprehensive, business-only, international-only? Will business tax reform benefit pass-through entities? If so, how? Are individuals convinced of the need/benefit of tax reform? Should there be a specific revenue target for reform? Over what period should revenue be measured? What baseline and methodology?

Latest tax reform developments US House of Representatives
Task force on comprehensive reform: One of six task forces set by Speaker Ryan to craft policy agenda Chairman Brady: Intends to produce a consensus blueprint for comprehensive pro-growth tax reform by June No expectation that the plan will be enacted in 2016 Task force holds weekly idea forums Effort to pass international reform: No timetable Chairman Brady: Not sure how far effort will go; innovation box proposal likely to be included Tax Policy Subcommittee Chairman Boustany: Enactment this year “probably unlikely” Republicans seek to connect global tax pressures and effects on local communities

Latest tax reform developments Senate
Finance Chairman Hatch crafting corporate integration bill Corporate integration attempts to reduce or eliminate double taxation through establishment of a corporate dividends-paid deduction International tax regime likely unchanged Corporation would withhold tax on gross amount of dividend Withheld amount would be a “nonrefundable credit” for the shareholder The 20% preferential rate for qualified dividends would be repealed Corporation would be required to withhold tax, at same rate, on the gross amount of interest paid to creditors Withheld amount would give rise to credit for recipient of payment Withholding tax on interest viewed as curbing “earnings stripping,” thereby helping to address the pace of inversions Ranking Democrat Wyden working on financial products and depreciation reform drafts

Questions?

Thank you.

Tax Executives Institute, Inc. — Detroit Chapter

Similar presentations

Presentation on theme: "Tax Executives Institute, Inc. — Detroit Chapter"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

Tax Executives Institute, Inc. — Detroit Chapter

Similar presentations

Presentation on theme: "Tax Executives Institute, Inc. — Detroit Chapter"— Presentation transcript:

Similar presentations

About project

Feedback