Hot topics in internal restructuring transactions

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

Your presenters John Simon: Partner, Transaction Tax
Phone: Brian Reed: Senior Manager, Transaction Tax Phone:

Disclaimer This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US. This presentation is © 2015 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are not necessarily those of Ernst & Young LLP.

Agenda Common internal restructuring steps Domestic restructuring Cross-border restructuring

Common internal restructuring steps

Leveraged distributions

Leveraged distributions: example
Step 1: FinCo loans $100 to Foreign HoldCo Step 2: Foreign HoldCo distributes $100 to USP. Current law – Tax-free return of basis (Section 301(c)(2)) USP $100 Basis = $100 $100 Foreign HoldCo FinCo E&P = $0 Note E&P = $100 Foreign Sub 1 Foreign Sub 2

Leveraged distributions
Reasons for change: Earnings and profits (E&P) of a foreign corporation can be repatriated without being characterized as a dividend if corporation funds a distribution from a second, related corporation that does not have E&P, but in which the distributee shareholder has sufficient tax basis to characterized the distribution as a return of stock basis. Proposal: To the extent a corporation (funding corporation) funds a second, related corporation (distributing corporation) with a principal purpose of avoiding dividend treatment on distributions to a US shareholder, the US shareholder’s basis in the stock of the distributing corporation will not be taken into account for purposes of determining the treatment of the distribution under Section 301. Funding transactions include capital contributions, loans or distributions to the distributing corporation, whether the funding occurs before or after the distribution.

All cash D reorganizations

All cash D reorganization – example
Parent owns 100% of (foreign) Target and (foreign) Acquiring: FMV and basis in Target stock $100 Transaction: Step 1: Parent sells Target to Acquiring for $100. Step 2: Target checks the box to be disregarded from Acquiring. Intended to be an “all cash” D reorganization Parent to recognize $0 of income because it has $0 of gain in its Target stock Parent 1 $100 Target stock v: $100 b: $100 Target Acquiring E&P: $80 E&P: $30 2 Target Target CTB

Section 356 – boot within gain rule
Section 356(a) provides that if “boot” is received in a reorganization, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property: Gain may be characterized as a dividend depending on facts. Referred to as the “boot within gain” limitation, limits income to a target shareholder to the gain in the share, not the amount of boot received.

Previously proposed amendments to Section 356
Past proposals would have eliminated the boot within gain limitation in any reorganization (i.e., domestic or cross-border), in which the US shareholder’s exchange has the effect of the distribution of a dividend, pursuant to section 356(a)(2). Proposals also adopt E&P sourcing rules similar to the E&E sourcing rules of Sections 304(b)(2) and (5).

E&P elimination through stock distributions

E&P elimination transaction Example steps
Pre-transaction: FS1 owns 100 shares of FS2 stock; each share has a $1 value and $1 basis. FS2 has $100 of E&P. Step 1: FS2 redeems 90 shares of its stock held by FS1: Redemption is treated as a dividend under Section 302(d). FS1’s basis in the its remaining FS2 stock is increased by its basis in the redeemed shares. Pre-transaction Step 1: USP USP FS1 FS1 E&P = $0 E&P = $0+$90=$90 ▲= 100 V = 100 ▲= 100 V = 100-$90 = $10 $90 FS2 FS2 E&P = $100 E&P=$100-$90=$10

E&P elimination transaction Example steps
Step 2: FS1 distributes its 10 shares of FS2 stock: Fair market value (FMV): $10 Basis: $100 Current law – Under Section 312(a)(3), FS1’s E&P is reduced (but not below zero) by the basis of the FS2 stock distributed ($100). Step 2: USP FS2 stock FS1 E&P = $90—$90 = $0 ▲= 100 V = 100-$90 = $10 FS2 E&P=$100-$90=$10

Prevent elimination of E&P through distributions of stock
Reasons for change: There has been a proliferation of transactions in which corporations distribute stock in subsidiaries having artificially high bases but minimal value in an effort to reduce E&P prior to making large distributions in the subsequent taxable period. These transactions do not result in an economic loss and thus no diminution of dividend- paying capacity. Proposal: A corporation’s distribution of stock of another corporation would reduce the distributing corporation’s E&P in any taxable year by the greater of the stock’s fair market value or the corporation’s basis in the stock. For this purpose, the distributing corporation’s basis in the distributed stock would be determined without regard to any adjustments as a result of actual or deemed dividend-equivalent redemptions by the corporation whose stock is distributed and without regard to any series of distributions or transactions undertaken with a view to create and distribute high-basis stock of any corporation.

Domestic restructuring

Overview Taxability of interest income to FinCo: State nexus of FinCo
Separate company state interest expense deduction for OpCo? Consider add-back provisions? Combined/unitary state interest expense deduction for OpCo? Can FinCo be excluded from combined/unitary group? 80/20 company Controlled foreign corporation (CFC) Parent OpCo FinCo $2,000 5% Operating income: $ 500 Less: Interest expense: ($100) Taxable income: $400 Interest income: $ 100 Less: Interest expense: ($0) Taxable income: $100

Intercompany leverage – all cash D reorganization
Parent 3 Transaction steps: Step 1: OpCo 1 buys the stock of OpCo 2 from Parent in exchange for a $100 note (OpCo 1 Note). Step 2: OpCo 2 converts to an LLC. Step 3: Parent contributes the OpCo1 Note to FinCo. FMV: $100 Basis: $100 1 1 FinCo OpCo 1 OpCo 2 E&P: $100 (unitary) E&P: $100 (pre-unitary) OpCo 2 2 Final structure Parent OpCo 1 FinCo OpCo 2 Note

Intercompany leverage – all cash D reorganization
Parent 3 Separate company federal treatment: Parent income recognition limited to gain in its shares of OpCo 2 stock: FMV=basis, thus no gain Parent’s basis in its OpCo 2 stock is effectively converted into basis in the OpCo 1 Note. Federal consolidated (Treas. Reg. § (f)(3)): OpCo 1 treated as acquiring OpCo 2 solely for OpCo 1 stock, followed by a deemed redemption of the OpCo 1 stock in exchange for the OpCo 1 Note. Redemption treated as a dividend from OpCo 1 to Parent. Consider whether OpCo 2’s E&P inherited by OpCo 1 at time of redemption. Relevant for states that conform to consolidated (e.g., California) FMV: $100 Basis: $100 1 1 FinCo OpCo 1 OpCo 2 E&P: $100 (unitary) E&P: $100 (pre-unitary) OpCo 2 2 Final structure Parent OpCo 1 FinCo OpCo 2 Note

Intercompany leverage – forward merger
Parent 2 3 Transaction steps: Step 1: HoldCo contributes (at least) $40 of its stock to OpCo 1. Step 2: OpCo 2 merges into OpCo 1, with Parent receiving $40 of HoldCo stock and a $60 note owing from OpCo 1 (OpCo 1 Note): State law merger is required; merger could be into an LLC under OpCo 1. Step 3: Parent contributes the OpCo1 Note to FinCo. FMV: $100 Basis: $100 FinCo HoldCo OpCo 2 E&P: $0 E&P: $100 (pre-unitary) 1 OpCo 1 2 E&P: $100 (unitary) Final structure Parent FinCo HoldCo OpCo 1 Note OpCo 1

Intercompany leverage – forward merger
Parent 2 3 Separate company federal treatment: There is no gain/loss to Parent because OpCo 2 stock has FMV=basis. Parent’s $100 basis in OpCo 2 stock is effectively converted into $40 of basis in HoldCo stock and $60 basis in OpCo 1 Note. Federal consolidated (Treas. Reg. § (f)(3)): OpCo 1 is treated as acquiring OpCo 2 solely for HoldCo stock, followed by a deemed redemption of the HoldCo stock in exchange for the OpCo 1 Note. Redemption is likely treated as a dividend from HoldCo to Parent. HoldCo does not inherit OpCo 2’s E&P. FMV: $100 Basis: $100 FinCo HoldCo OpCo 2 E&P: $0 E&P: $100 (pre-unitary) 1 OpCo 1 2 E&P: $100 (unitary) Final structure Parent FinCo HoldCo OpCo 1 Note OpCo 1

Intercompany leverage – “killer” triangular reorganization
Parent 2 Transaction steps: Step 1: OpCo 1 buys $100 of HoldCo stock from HoldCo in exchange for a $100 note (OpCo 1 Note). Step 2: OpCo 2 merges into OpCo 1, with Parent receiving $100 of HoldCo stock: Alternatively, OpCo 2 could be contributed to OpCo 1 and convert to an LLC. Step 3: HoldCo transfers the OpCo 1 Note to FinCo in exchange for FinCo stock. FMV: $100 Basis: $100 FinCo 3 HoldCo OpCo 2 E&P: $0 E&P: $100 (pre-unitary) 1 OpCo 1 2 E&P: $100 (unitary) Final structure Parent HoldCo FinCo OpCo 1 OpCo 1 Note

Intercompany leverage – “killer” triangular reorganization
Parent 2 Separate company federal treatment: There is no gain/loss to Parent (Parent receives solely HoldCo stock; no boot). Parent’s $100 basis in OpCo 2 stock is converted into $100 of basis in HoldCo stock. No gain/loss to HoldCo or OpCo 1 on purchase/use of HoldCo 1 stock. Federal consolidated (Treas. Reg. § (f)(3)): No deemed redemption because no boot issued in reorganization FMV: $100 Basis: $100 FinCo 3 HoldCo OpCo 2 E&P: $0 E&P: $100 (pre-unitary) 1 OpCo 1 2 E&P: $100 (unitary) Final structure Parent HoldCo FinCo OpCo 1 OpCo 1 Note

Cross-border restructuring

Section 267 transactions

Section 267 example–facts
CFC 1 has a built-in loss asset (Asset). Potential opportunities for US tax benefit of loss asset? Basis step-down upon inbound liquidation or reorganization. See Sections 334(b)(1)(B) and 362(e)(1)(B) USP CFC 1 V: $1,000 B: $1,000 V: $80 B: $200 Asset Subs Subs Subs

Section 267(f) planning Step 1: CFC 1 sells Asset to CFC 2 for $80:
Asset is not “sub all” of CFC 1’s assets. CFC 1’s $120 loss is deferred under Section 267(f). Step 2: CFC 1 checks the box. If CFC 2 later sells Asset to an unrelated party, does USP recognize the $120 deferred loss? Separate return limitation year (SRLY) limit? USP 1 CFC 2 CFC 1 Asset $80 2 CTB Asset Subs Subs Subs

Triangular reorganizations

Cross-border triangular reorganization – common fact pattern
USP 1 USP stock Property USP stock 2 FS USS FT stock FT FS acquires USP stock for property (e.g., cash, note), then uses the USP stock to acquire FT in a triangular reorganization. Historically viewed as allowing for inappropriate repatriation, IRS attacked through various notices, and ultimately through a regulation – Treas. Reg. §1.367(b)-10.

Final regulations – deemed distribution and contribution rules
In the case of a triangular reorganization to which Treas. Reg. §1.367(b)-10 applies, adjustments must be made that are consistent with the adjustments that would have been made if S had distributed property to P under Section 301(c) in an amount equal to the sum of the money and the fair market value of other property used to acquire the P stock (the Deemed Distribution Rule) In addition, adjustments must be made that are consistent with the adjustments that would have been made if P had contributed the same property to S (the Deemed Contribution Rule) This deemed contribution has the effect of increasing P’s basis in its S stock by the amount of the deemed distribution.

Example based on final regulations
USP USP 1 FV = $100 AB = $30 $70 USP stock (FV = $70) USP stock FV = $100 AB = $30 $100 2 FS USS FS USS FT stock E&P = $80 FV = $70 AB = $10 E&P = $10 FV = $70 AB = $10 FT FT Transaction steps: Step 1: FS purchases $70 worth of USP’s stock from USP for cash. Step 2: FS exchanges the USP stock acquired in step 1 for all FT’s stock in a triangular B reorganization subject to Treas. Reg. §1.367(b)-10. Adjustments to USP’s basis in FS: Deemed dividend of $70 from FS to USP Deemed contribution of $70 from USP to FS; thus USP increases its basis in FS by $70, from $30 to $100 Compare to result if FS had distributed $70 of cash to USP as a dividend

IRS issues Notice 2014-32 on 25 April 2014
The Internal Revenue Service (IRS) and the Treasury Department intend to revise the regulations under Treas. Reg. §1.367(b)-10 to: Eliminate the deemed contribution rule Clarify the no-US-tax exception to Treas. Reg. §1.367(b)-10 Modify the Section 367(a) and Section 367(b) priority rules by adjusting the amount of income or gain that is considered Section 367(b) income for this purpose Clarify the scope of the anti-abuse rule of Treas. Reg. §1.367(b)-10(d) In general, the regulations will apply to a triangular reorganization completed on or after 25 April 2014.

Elimination of the deemed contribution rule under the notice
“The IRS and the Treasury Department are aware that taxpayers are engaging in transactions designed to avoid US tax by exploiting the deemed contribution provided under the final regulations. The IRS and the Treasury Department believe that the deemed contribution is inconsistent with the purpose of §1.367(b)-10…” The IRS and the Treasury Department intend to revise the final regulations to eliminate the deemed contribution rule In addition, the rule in §1.367(b)-10(b)(4) will be modified to provide that “P’s adjustment to the basis of its S stock under § will be determined as if P provided the P stock or pursuant to the plan of reorganization, notwithstanding that S in fact acquired the P stock or securities in exchange for property.”

Example based on the notice
USP USP 1 FV = $100 AB = $30 USP stock (FV = $70) $70 FV = $100 AB = $30 $40 2 FS USP stock USS FS USS FT stock E&P = $80 FV = $70 AB = $10 FV = $70 AB = $10 FT E&P = $10 FT Transaction steps: Step 1: FS purchases $70 worth of USP’s stock from USP for cash. Step 2: FS exchanges the USP stock acquired in step 1 for all FT’s stock in a triangular B reorganization subject to Treas. Reg. §1.367(b)-10. Adjustments to USP’s basis in FS: Deemed dividend of $70 transfers from FS to USP. USP’s adjustment to the basis of its FS stock under Treas. Reg. § are determined as if USP provided the USP stock pursuant to the plan of reorganization. Thus, USP’s basis in FS is increased by $10 (the basis of the FT stock in USS’s hands), from $30 to $40.

Final regulations – anti-abuse rule
The final regulations provide that appropriate adjustments shall be made if, in connection with a triangular reorganization, a transaction is engaged in with a view to avoid the purpose of Treas. Reg. §1.367(b)-10. For example, the E&P of S will be deemed to include the E&P of a corporation related to P or S for purposes of determining the consequences of the adjustments provided in the final regulations, if S is created, organized or funded to avoid the application of Treas. Reg. §1.367(b)-10 with respect to the E&P of a related corporation.

Anti-abuse rule The notice
“The IRS and the Treasury are concerned that some taxpayers may be interpreting the anti-abuse rule too narrowly.” The anti-abuse rule will be clarified to provide that: S’s acquisition of P stock or securities in exchange for a note may invoke the anti-abuse rule. The E&P of a corporation (or a successor corporation) may be taken into account for purposes of determining the consequences of the adjustments provided in the final regulations. A funding of S may occur after the triangular reorganization. A funding of S includes capital contributions, loans and distributions.

Thank you

The future of tax analytics Tony Ferrante, Ernst & Young, LLP Tax technology and data analytics services

? Data analytics for tax Analytics: why and what?
Current state of tax analytics Designing the path forward

Benefits of analytics Significant economic returns and competitive advantage
Financial performance of companies good with analytics Over three-quarters (77%) of companies good with analytics are also ahead in year-over-year (YOY) growth compared to peers. Ahead Somewhat ahead On par Somewhat behind Substantially behind *Source: Economic Intelligence Unit. Survey conducted with 530 senior executive across industries (Feb 2013) % of companies indicating a competitive advantage with analytics Over two-thirds (67%) of companies gained a significant competitive advantage from using analytics . (15% increase from last year and 80% increase from two years ago) 2010 2011 2012 *Source: MIT Sloan Management Review Survey conducted with more than 2,500 executives across industries (Mar 2013)

Reason #1: The confluence of electronic data, processing power and software
Summarize Then Now Transactions Tax JANUARY 1

Reason #2: Taxing authorities are using analytics
Taxing authorities around the world are requesting or mandating taxpayers to provide greater detail than previously required. The taxing authorities are using analytics to understand the data, improving audit selection and tax compliance. Australia United States Mexico Brazil Netherlands China

Reason #3: Unlocking value for the tax department
Control/risk management Efficiency and cost reduction Tax-affected business decisions Better stakeholder communication

Analytics components and capabilities

Analytics components and capabilities Overview
Interactive presentation Statistical analysis/modeling Large datasets Visualization Data science Big data

Analytics components and capabilities Big data
Growth of digital information Big data Not so big data Volume Terabytes/petabytes/zettabytes megabytes/gigabytes Variety Unstructured (text, voice, video) structured/relational Velocity Data in motion (streaming) data at rest Veracity Untrusted/uncleansed trusted/cleansed Internet of things Falling data storage and processing costs

Analytics components and capabilities Data sciences
Overwhelmed with data Signal in the noise Automated analysis for scale Rich statistical tools Predictive models —————— —————————— —————— —————————— 10 1010 010

Analytics components and capabilities Interactive visualizations
Spot the trend

Analytics components and capabilities Interactive visualizations

Analytics components and capabilities New skills required
17 April 2017 Analytics components and capabilities New skills required Tax Stats Tech

Data analytics applied for tax

Analytics ascendency model
? Prescriptive How can we make it happen? Predictive What will happen? Diagnostic Why did it happen? Descriptive What happened?

Case study Unlocking the value of the compliance and reporting data
Proactively identify and manage compliance and reporting risk through improved visibility and control Deliver greater value from the global tax function while managing risk Facilitate integration of the record-to-report to achieve efficiency and cost reduction Enhance business decision-making capability Control Compliance Analytics

Tax agenda A strategic discussion of your tax function
Tax life cycle Strategic alignment with business Help to improve value Alignment with risk profile Cash flow and financial impact Integrated global process Accurate, supportable tax accounts Tools and technology End-to-end reporting Internal influences External influences Strategy Regulatory Enterprise Economic Risk management Audit-ready documentation Integrated with compliance Binding rulings and voluntary disclosures Leverage provision data Consistent global process Timely visibility and status reporting Real-time submission of transaction data Governance Industry

Case study Connecting the phases of the tax life cycle
Leveraging analytics to gain insights and enable decisions to support all phases of the tax life cycle Planning Accounting Controversy Compliance Control Analytics Tax performance management

Case study Unlocking the value of the compliance and reporting data
Lessons learned: Don’t take data for granted Plan to educate stakeholders Solicit broad input Iterate rapidly

Case study Shift from compliance to value
Securities trading

Case study New visibility into global mobility
Program costs Short-term business traveler

Case study Identifying risk
Risk matrix Calculation layer

Case study Keep designing to find value
Compliance key performance indicators (KPIs) Thresholds and trends

Analytics future applications across tax
Supply chain analysis Transactional analytics Accounts payable/ receivable transactional line level analysis Tax coding and posting error detection One-off or embedded solution Tax reporting Interactive visualizations instead of spread sheets Automated control checks and tests Data-triggered notification Risk analysis and monitoring Risk analysis and heat maps Transaction profile trend monitoring Automated transaction risk escalation Targeted analytics Pricing/margin modeling for indirect taxes Transactional keyword analysis Credits and incentives modeling Supply chain mapping using transactional line level data Analysis of actual tax treatment against expected Customs sourcing considerations Transfer pricing analytics Variance from forecast alerts Automated comparable matching algorithms Policy execution monitoring

EY insight If I were in your shoes, what would I be doing?
Establish what the analytics landscape looks like within your organization Assign responsibility for owning analytics within tax Consider how analytics can support and grow your tax function Encourage innovation Growth drivers: Increased awareness of benefits New analytics tools and capabilities Availability of data Adoption barriers: Lack of analytics specialists Resistance to replace gut instinct decision-making Lack of best practices

Thank you The future of tax analytics Tony Ferrante Tax Technology and Data Analytic Services

Global tax in a BEPS world Steve Stoffel , Ernst & Young, LLP Graham Shaw, Ernst & Young, LLP Patty Burleson, Ernst & Young, LLP Patti Iribarren, Ernst & Young, LLP

Agenda Update on the latest developments in the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) Action Plan Holding and financing IP ownership European Union (EU) state aid Country review – UK diverted profits tax Summary/closing thoughts

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

Snapshot of OECD’s BEPS Action Plan
Technical response Execution Source-based taxation Action 1: Tax challenges of digital economy Action 7: Permanent establishment (PE) status Action 8: Intangibles Action 9: Risks and capital Action 10: Other high-risk transactions Action 2: Hybrid mismatch arrangements Action 3: Strengthening CFC rules Action 4: Limiting interest deductibility Action 6: Preventing treaty abuse Action 5: Harmful tax practices Action 11: Economic analysis of BEPS activities and measures Action 12: Disclosure of aggressive tax planning Action 13: TP documentation Action 14: Dispute resolution Action 15: Multilateral instrument Disclosure and transparency pricing (TP) Transfer

OECD BEPS action plan Tax challenges of digital economy – September 2014 Hybrid mismatch arrangements – September 2014 Strengthening CFC – September 2015 Limiting interest deductibility – September/December 2015 Harmful tax practices – September 2014/September 2015/December 2015 Preventing treaty abuse – September 2014 PE status – September 2015 TP for intangibles – September 2014/ September 2015 TP for risks and capital – September 2015 TP for other high-risk transactions – September 2015 Economic analysis of BEPS activities and measures – September 2015 Disclosure of aggressive tax planning – September 2015 TP documentation – September 2014 Effectiveness of treaty dispute resolution mechanisms – September 2015 Multilateral instrument – September 2014/December 2015

View from the US US Treasury is an active participant in the BEPS project and is: Strongly supportive of elements of the BEPS project Skeptical of other elements of the BEPS project Seeking to forge consensus in the BEPS project Many of the international tax provisions included in the Obama Administration’s fiscal year 2016 budget proposals are focused in the same areas as the BEPS actions and reflect ideas that are similar or identical to options proposed in BEPS discussion drafts. Congressional international tax reform proposals also reflect a focus on addressing base erosion concerns.

Proposals that include BEPS-related concepts
Addressing BEPS has become element of fundamental international tax reform discussions. Former House Ways and Means Committee Chairman Camp’s comprehensive tax reform discussion draft contains BEPS-related proposals as part of international tax reform, including: Restrictions on interest expense deductions (Action 4) Limitation on treaty benefits (Action 6) Expansion of CFC rules (Action 3) Former Senate Finance Committee Chairman Wyden’s earlier bipartisan tax reform bill contained proposals with a BEPS flavor, including: Very broad expansion of CFC rules (effectively repeal deferral) (Action 3) Administration’s budgets and tax reform proposals contain proposals with BEPS overtones, including: Restrictions or deferral of interest expense deductions (Action 4) Restrictions on use of hybrids (Action 2)

EU perspective on BEPS Governments are balancing public opinion with need to remain competitive. Tax remains high on Board of Governors agenda due to media and public interest in the taxation of corporates. European countries and EU are actively involved in OECD BEPS project. EU led developments and state aid investigations.

Different stakeholders, different views
Source countries: Source countries are jurisdictions typically paying into jurisdictions (destination countries) where a holding, financing, intellectual property (IP) or principal company is located. Source countries are in favor of accelerating the BEPS process. No wait-and-see approach, but various unilateral actions have and are taking place. Destination countries: Most destination countries fully embrace the OECD’s work on the BEPS project and will actively participate at the OECD level in developing international solutions tackling BEPS. The general view is that the issues can effectively be addressed only by coordinated international action.

Action 13 and its implication for taxpayers
Taxpayers will need to address global transfer pricing in anticipation of Action 13 of the OECD’s BEPS project that will be effective on tax years beginning on or after 1 January 2016. Of 15 actions to address global concerns around BEPS, Action 13 focuses on TP documentation and mandates a global masterfile, local files for all country and the country-by-country (CbC) report. For companies that do not have a robust, defensible and consistent global transfer pricing framework, Action 13 will highlight inconsistent transfer pricing policies and likely result in increased controversy. Action 13 will require data gathering that today appears difficult due to inability to reconcile consolidated and statutory profits and losses (P&Ls), intercompany accounts and intercompany segmented P&Ls. Draft for Discussion Only

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

Key points on implementation
First CbC reports to cover fiscal years beginning on or after 1 January and to be filed within 12 months after end of year Revenue threshold of €750m (MNC group annual consolidated revenue in preceding year) for requirement to prepare and file a CbC report No more/no less information than in the template in the September OECD report CbC report generally to be filed with tax authority in home country of MNC group’s parent company and automatically shared with tax authorities in other relevant countries under government information exchange mechanisms Implementation of master file and local file elements of transfer pricing documentation to be done by countries, with taxpayers providing files to tax authorities in each country Next Action 13 guidance by April 2015 Keep watch for unilateral action from countries (e.g., Spain) who put in place additional regulatory requirements Draft for Discussion Only

Unilateral activity around Action 13 – Spain
Amendments have been introduced into the transfer pricing provisions, effective 1 January 2015, to include transfer pricing documentation requirements modified in very similar terms to the revised standards included in the report on Action 13 released by the OECD on 16 September 2014. Spanish rules also establish that the CbC report will have to include the following information per country on an aggregate basis: Group’s revenue, distinguishing between that derived from related and unrelated parties Accounting result before corporate income tax (CIT) or a tax of similar or analogous nature CIT (or tax of similar or analogous nature) effectively paid, including withholding taxes CIT (or tax of similar or analogous nature) accrued, including withholding taxes Share capital and equity at the end of the fiscal year Average number of employees Tangible assets and real estate investments, different to treasury and receivables List of resident entities, including permanent establishments, and the main activities these are engaged in Other information that is considered relevant and, if applicable, an explanation on the data included in such information Draft for Discussion Only

Holding and financing

Recent unilateral activity on BEPS
New anti-hybrid measures All European Union (EU) Member States agreed on a proposal to implement anti-hybrid loan rules in the EU Parent Subsidiary Directive (linking rule). EU Member States are obliged to adopt such rules in their domestic legislation per 31 December 2015. A growing number of European countries have rules denying participation exemption on inbound hybrid payments (already in place for several years in Denmark, Germany, Hungary, UK; adopted in 2014 in France, Poland and Spain). France, Spain and Mexico introduced “subject to tax” requirements for certain deductions; similar draft legislation was tabled in Austria. Further proposals have been made, or are expected to be tabled, in Germany, the US and the UK. Ireland legislated to prevent certain Irish incorporated companies being “stateless” in terms of their tax residence.

Recent unilateral activity on BEPS
Tightened limits on interest deductibility: Canada and France recently introduced rules against foreign affiliate dumping or leveraged acquisitions. Canada introduced rules for back-to-back financing arrangements that mitigate thin capitalization. France introduced a net interest cap. Japan introduced and Finland tightened earnings-stripping rules. Several countries tightened thin-cap legislation (Australia, Korea, Poland).

BEPS: What should you do to be ready?
Review intragroup holding and financing structures: Are the financing entities in the group structure (reverse) hybrid entities or tax haven entities? Are there hybrid loans in the structure? What is the substance of the holding and/or financing entity? In your CbC reporting assessment, how are the financing entities reflected in the CbC template? Monitor (developments around) local country interest deduction limitation rules, withholding tax, beneficial ownership and anti-treaty-shopping rules Identify alternatives that can be considered to reduce risks (in the short term and in the long term) In a BEPS world, there are still opportunities for financing: Use of company with net operating losses as financing entity Use of no-tax jurisdiction to finance countries that do not have domestic interest withholding tax Use of low- or medium-tax jurisdiction (e.g., Ireland) with tax treaty network to finance treaty countries Use of companies with relevant substance, e.g., treasury center or existing operating companies

IP ownership

Trends in IP ownership Implications as a result of OECD BEPS and legislative developments
Principal companies: Principal’s remuneration needs to be in line with its functions, assets and risks. Two-sided analysis is needed to justify principal’s profits. Implications of Action 2 on deductible hybrid royalty/interest payments to IP owner. Concerns about reduced withholding or withholding tax exemption on royalty and interest payments under Action 2 Operating models where activities undertaken in a local territory without a taxable presence (e.g., through commissionaire arrangements, commission agents, service providers and marketing support companies) Ownership of inventory in a regional distribution center or tolling site Tax haven/low tax IP structures: Greater scrutiny expected – IP owner to deploy (developing, enhancing, maintaining, protecting and exploiting) functions to be entitled to the residual IP profits Remuneration of IP owner should be in line with functions, assets and risk profile Funders to receive funding return, legal owners to receive return for legal administrative functions Concerns about reduced withholding or withholding tax exemption on royalty and interest payments Intercompany TP: Profit split analyses: review of value-creating activities, which leads to method, which leads to price. Transparency of company operations Assess potential impact of country-by-country reporting now Page 87

IP ownership in a BEPS world
17 April 2017 IP ownership in a BEPS world There are still opportunities for efficient IP ownership. US MNCs can still consider setting up an offshore IP Co (e.g., a CV, a UK LLP or low-tax jurisdiction) for existing, newly migrated or funded IP as an incubator structure for future onshoring of IP. IP committees can be established to drive control over DEMPE functions in the short/medium term – recognizing full-time DEMPE functions will ultimately be needed under BEPS. In the medium or longer term, consider onshoring IP to align value chain profits associated with the IP with the DEMPE functions as well as: Intangible and other R&D regimes in IP/principal location Local country planning in IP/principal location: Amortization of IP acquired at fair market value, e.g., move IP currently owned in Irish NRI/CV/UK LP onshore to entity with appropriate functionality with step up for fair market value Use of debt to acquire IP Accounting implications from shifting IP from a low- or zero-tax jurisdiction Effective tax rate and book impact of IP movement IP exit strategy Changes to the operating model to minimize PE risks for principal companies

Trends in IP ownership Onshore IP ownership
17 April 2017 Trends in IP ownership Onshore IP ownership Overview: Principal acts as onshore IP owner. Principal owns non-US rights to IP. Principal is responsible for sales of products/services outside of US. Residual profit associated with non-US business flows back to Principal. Principal’s effective tax rate determined by: Application of patent box regime Tax credit/deduction for R&D activities Amortization of intangible property Arm’s-length transfer pricing for services and HQ recharges (e.g., marketing intangibles) Tax deductions for financing costs Sale of goods Intercompany services Cost sharing IP development Contract Manufacturer Local Distributors R&D Providers US Parent Principal

Trends in IP ownership Offshore IP ownership
17 April 2017 Trends in IP ownership Offshore IP ownership Overview: IP ownership is offshore. IP owner could purchase, license or cost share IP with US Parent. IP owner licenses the IP to Master Distributor in return for an arm’s-length return Activity of Master Distributor depends on business. Key drivers of effective tax rate (ETR) of IP owner and Master Distributor: Pricing of royalty paid by Master Distributor and split of functionality between it and IP owner Withholding tax, if any, on royalties paid by to IP owner Other technical considerations: Exit of IP out of foreign parent Anti-avoidance measures PE analysis for IP owner Master Distributor IP Owner e.g. (i) Sale (ii) License, or (iii) Cost sharing US Parent Sub-license Contract Manufacturer R&D Providers Local Distributors Sale of goods Intercompany services

BEPS: What should you do to be ready?
Review IP ownership structure Is the IP (economically) owned in a reverse-hybrid entity or low-tax jurisdiction? What kind of governance and substance are in place at the level of the IP entity? Are the contracts consistent with how an arm’s-length contract would look given DEMPE functions? When you model CbC reporting and identify likely audit risks, how is the IP owner reflected in the CbC template? Identify alternatives that can be considered to reduce risks (in the short term and the long term)

EU state aid

EU state aid What is it? Included in Article 107(1) of the Treaty on the Functioning of the European Union: “Any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the common market”

EU state aid Why do we care?
Illegal state aid can give rise to recovery of received benefits and interest. Recovery period of 10 years starts on the day on which the state aid was awarded. Are your EU entities at risk of being challenged?

Country review – UK diverted profits tax

UK – General approach to BEPS
UK government’s approach to BEPS project: An international issue that cannot be solved by the UK alone Best solved globally through the mediums of the G8, G20, the EU and the OECD While the UK supports the BEPS initiative, any changes being proposed by the OECD should be compatible with the government’s two objectives: Ensuring that the UK remains “open for business” Working with international partners to prevent unfair tax avoidance/aggressive tax planning by multinationals “Low taxes, but taxes that will be paid” George Osborne, Chancellor of the Exchequer

UK – Recent BEPS initiatives
UK/Germany joint proposal on new rules for all preferential IP regimes. Seeks to achieve a balance between ability to offer tax benefits for IP-related investment and preventing the misuse of such benefits Consultation released regarding changes to the UK anti-hybrid rules in line with the OECD recommendations in respect of Action 2: New law predicted to apply from 1 January 2017 Legislation enabling the implementation of annual country-by-country reporting; report must include: Revenue; profit before tax; income tax paid and accrued Total employment; capital, retained earnings; tangible assets Identity of each entity in a particular tax jurisdiction and provide an indication of their business activities Introduction of UK diverted profits tax from 1 April 2015

Overview of diverted profits tax (DPT)
A new tax to deal with “aggressive avoidance” by multinational companies making sales in the UK A response to political and public pressure in the UK, aligned to the wider BEPS agenda DPT is a new tax: Not covered by existing double tax treaties Cannot offset existing corporation tax losses, e.g., stock option deductions Requires taxpayer, in many situations, to notify Her Majesty's Revenue and Customs (HMRC) of potential DPT liability HMRC to then issue charging notice if appropriate

UK diverted profits tax (DPT)
25% tax on profits diverted from UK to a low substance entity (“section 80 charge”) or of an avoided PE (“section 86 charge”) Companies at risk from 1 April 2015 where entity or transaction with “insufficient economic substance” No formal clearance mechanism other than advance pricing agreement (APA): APA will not be agreed without full visibility on supply chain. Law allows for informal agreement of no DPT notification by ‘‘an officer of HMRC,’’ i.e., customer relationship manager. Could base initial tax charge on disallowance of 30% of payment made by UK/deemed PE expenses Tax payable within 30 days of charging notice, no TP defense Tax not recoverable until DPT profits agreed

Charging provisions Section 80 – Lack of economic substance
A UK resident company (C) A provision between C and another person (P) C and P connected Results of provision – an effective tax mismatch outcome The insufficient economic substance condition met C and P not both small or medium-sized enterprises (SMEs) The provision not an excepted loan relationship Section 86 – avoidance of a PE A non-UK resident company carrying on a trade (or part of it) A person carrying on activity in the UK in connection with the supplies of goods, services or other property as part of trade Reasonable to assume activity designed to ensure no UK PE (ignoring other commercial benefits) Meets either tax mismatch or tax avoidance conditions (or both) Person and non-UK resident company not SMEs Exemption for independent agents Exemption for limited sales (<£10m) and expenses (<£1m)

Company has 30 days from receipt of notice to make representations.
17 April 2017 Assessment process Duty to notify Company must notify if potentially within DPT scope within three months after end of accounting period (six months during transitional period, i.e. periods ending prior to 31 March 2016). Company may be liable to penalty if it does not make notification. HMRC issues preliminary notice HMRC may issue preliminary notice of chargeability within two years after end of accounting period (four years if no notification). Company makes representations Company has 30 days from receipt of notice to make representations. HMRC may consider representations on threshold conditions and factual matters. DPT must be paid within 30 days from issue of charging notice and no right to appeal at this stage or postpone. HMRC issues charging notice HMRC will either issue charging notice or confirm no charging notice to be issued, within 30 days from end of representation period. HMRC reviews/ considers the charging notice Twelve-month period begins from relevant payment date for HMRC to review charging notice and may issue supplementary/amending notice increasing or reducing the DPT. Company has 30 days from end of review period to appeal or DPT becomes final.

What next? DPT to apply from 1 April 2015; need to determine if it may apply Need to consider impact on ETR from Q1 2015? Determine approach to notification Determine approach to HMRC engagement

Short-term actions Assess whether DPT is likely to apply and need for notification: Estimate of exposure 30% disallowance? Rule of thumb profit split? Develop strategy for dealing with DPT and notification requirement: HMRC engagement? APA program? Composite risk management (CRM) risk assessment? Defense strategy: Transfer pricing methodology Substance vs. profitability assessment Operational and TP documentation

Summary/closing thoughts

Preparation will help you ride the wave of change

Thank you!

Tax accounting insights and challenge 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 Nate English, Ernst & Young, LLP Jon Schneider, Ernst & Young, LLP

Agenda Developments: Tax provision challenges and practice issues:
Accounting Standards Updates Financial Accounting Standards Board (FASB) project status Internal control over financial reporting (ICFR) Public Company Accounting Oversight Board (PCAOB) focus areas Securities and Exchange Commission (SEC) focus areas Tax provision challenges and practice issues: Common causes of tax restatements Best practice responses: Reduce risk in tax accounting calculations Tax provision recommendations

Accounting Standards Updates

Accounting standards effective in 2015
Accounting Standards Update (ASU) , Accounting for Investments in Qualified Affordable Housing Projects: For public business entities, effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2014 For non-public business entities, one year deferral Early adoption permitted Retrospective application ASU , Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity: For public business entities and certain not-for-profit entities, effective for disposals (or classifications as held for sale) occurring in annual periods, and interim periods within those annual periods, beginning on or after 15 December 2014 For all other entities: Same effective date for annual periods One year deferral for interim periods only Prospective transition for disposals (or classifications as held for sale) on or after effective date

Accounting standards that can be early adopted in 2015
ASU , Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items: For all entities, effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2015 Early adoption permitted; however, must occur at the beginning of an annual period Prospective or retrospective transition Reminder: ASU , Presentation of an Unrecognized Tax Benefit (UTB) When a Net Operating Loss (NOL) Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists For public business entities, effective for fiscal years, and interim periods within those years, beginning after 15 December 2013 For non-public business entities, one year deferral Early adoption permitted Prospective or retrospective transition

Revenue recognition standard Overview
Webcast title 4/17/2017 Revenue recognition standard Overview Revenue recognition accounting standard issued on 28 May 2014: Supersedes virtually all industry and interpretive guidance Requires more estimates and judgments than current guidance US generally accepted accounting principles (GAAP) effective dates for calendar year-ends* Transition method Public Nonpublic Early adoption? Retrospective or modified retrospective Q1 2017 2018 No** The FASB has said that they plan to make a decision on their project to potentially delay the effective date in early Q2. Therefore, we should know more about if the effective date will be delayed within the next couple of months. * FASB decided on 1 April 2015 to propose a one-year deferral of the effective date for its new revenue standard for public and nonpublic entities reporting under US GAAP. The proposal also would permit both public and nonpublic entities to adopt the standard as early as the original public entity effective date (i.e., annual reporting periods beginning after 15 December 2016 and interim periods therein). An exposure draft on the proposal with a 30-day comment period is expected. ** Nonpublic companies may early adopt as of public company effective date

Revenue recognition standard A converged standard?
Webcast title 4/17/2017 Revenue recognition standard A converged standard? The FASB and International Accounting Standards Board (IASB) each issued new standards: The standards are consistent except for five areas: FASB establishes a higher collectibility threshold when assessing whether a contract exists (based on existing definitions of “probable” under US GAAP and IFRS). FASB requires more interim disclosures than IASB. IASB allows early adoption. IASB allows an entity to reverse impairment losses on assets recognized. FASB provides relief for nonpublic entities relating to specific disclosure requirements, effective date and transition. While it is still true that the standards are consistent except for five areas, we need to note the following that may be changing: At a joint meeting in February 2015, the Boards agreed that changes to the new revenue recognition guidance on licenses and identifying performance obligations are likely necessary, but they did not agree on the nature and breadth of some changes or on the timing. The new standards are currently converged (except for the five areas noted on the slide), but if the Boards act on the views they expressed at the joint February 2015 meeting, we may see some diversity in practice between US GAAP and IFRS preparers. Any changes made to either revenue standard would be subject to the due process procedures of each Board, including seeking public comment.

Revenue recognition final standard The five-step model
Core principle – recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services Step 1: Identify the contract(s) with the customer Step 2: Identify separate performance obligations Step 3: Determine the transaction price Step 4: Allocate transaction price to separate performance obligations Step 5: Recognize revenue when (or as) each performance obligation is satisfied

Revenue recognition Considerations for public companies
Public entities that choose the full retrospective approach may elect not to push the effects back further than 2015 for their selected financial data tables. Staff Accounting Bulletin (SAB) Topic 11.M requires disclosure of the effects of recently issued accounting standards. Disclosures are expected to evolve as more information about the effects are known (including the chosen transition method). Effective SEC five-year table? Prior periods presented SAB Topic 11.M (SAB 74) 2013 2014 2015 2016 2017 2018 Modified retrospective application date (nonpublic entity) Final revenue standard Retrospective application date Modified retrospective application date (public entity)

Revenue recognition Effective dates
Effective for annual periods beginning after: 15 December 2016 for public US GAAP entities and IFRS filers 15 December 2017 for non-public US GAAP entities. Standard includes an expanded definition of a public entity. Early adoption: Prohibited for public US GAAP entities Permitted for US GAAP nonpublic entities Permitted for IFRS preparers With two years until the effective date, it may appear that companies have ample time to prepare; however, the potential changes to revenue recognition for some companies may be significant. Take advantage of the time you currently have. The FASB has said that they plan to make a decision on their project to potentially delay the effective date in early Q2. Therefore, we should know more about if the effective date will be delayed within the next couple of months.

Implementation effort
Revenue recognition Drivers of complexity Diversity of products and services Nature of arrangements Control environment Implementation effort Financial reporting systems Revenue cycle Location(s) of business functions Change management

Revenue recognition 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. A change in revenue recognition for financial statement purposes may be a permissible method for tax purposes. In certain jurisdictions, local tax liability is based upon statutory financial statements: When local statutory financial statements are prepared under IFRS, the statutory financial statements may change with adoption of the standard. Evaluate whether a foreign subsidiary’s E&P or local tax change the amount by which a distribution is taxable as a dividend, the amount of Subpart F inclusion or deemed paid foreign tax credits Evaluate intercompany prices and transfer pricing policies where adoption changes revenue, profits or third-party comparables are used in determining transfer pricing May require companies to review the methodology for compiling sales apportionment data

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

FASB project status

Selected FASB projects Current status
Leases Drafting final standard Financial instruments: Classification and measurement* Impairment Re-deliberations Hedging Initial deliberations Clarifying the definition of a business Goodwill for public business entities (PBEs) and not-for-profits (NFPs) Intangible assets in business combination for PBEs and NFPs Financial instruments: Classification and measurement Expected to require companies to make the assessment of realizability of a deferred tax asset related to an available-for-sale debt security in combination with their other deferred tax assets. * Amendments to Accounting Standards Codification (ASC) 740, Income Taxes, are expected in final standard.

FASB simplification initiatives Current status
Simplification project Status Measurement date: defined benefit plan assets Drafting final standard Customer’s accounting for fees in a cloud computing arrangement Presentation of debt issuance costs Subsequent measurement of inventory Re-deliberations Income taxes – intra-entity asset transfers and balance sheet classification of deferred taxes Comment period Employee share-based payment accounting improvements* Drafting exposure draft Balance sheet classification of debt Initial deliberations * Amendments to ASC 740 are expected in the proposal.

FASB income taxes simplification
Webcast title 4/17/2017 FASB income taxes simplification Eliminate exception that requires deferral of the income tax effects of intercompany sales/transfers of assets: Recognize income tax expense in the period of the sale/transfer Modified retrospective transition approach Recognize deferred tax effects of difference between the tax basis in the buyer’s jurisdiction and the book basis after elimination of the intercompany profit FASB expectations: For public business entities, proposed amendments effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For non-public business entities, proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption permitted, but not before the effective date for public business entities Comment letters due 29 May 2015

FASB income taxes simplification
Webcast title 4/17/2017 FASB income taxes simplification Require the classification of all deferred tax assets and liabilities as noncurrent: Companies no longer required to allocate valuation allowances between current and noncurrent No change to jurisdictional offsetting requirements Prospective transition approach FASB expectations: For public business entities, proposed amendments effective for annual periods, and interim periods within those annual periods, beginning after 15 December 2016 For non-public business entities, proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018 Early adoption permitted, but not before the effective date for public business entities Comment letters due 29 May 2015

FASB share-based payment project
FASB voted to propose that all excess tax benefits and tax deficiencies be recognized in the income statement: Prospective transition FASB voted to propose elimination of the requirement that excess tax benefits not be recognized until they are realized: Modified retrospective transition with a cumulative catch-up adjustment to retained earnings An Exposure Draft will be issued for public comment soon.

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

FASB income taxes disclosure project
FASB decided not to require disclosure of: Deferred tax liabilities recorded for unremitted foreign earnings by country Estimates of unrecognized deferred tax liabilities on the basis of simplified assumptions for companies that have made indefinite reinvestment assertions Past events or current conditions that have changed management’s plans with respect to undistributed foreign earnings FASB indicated that it will discuss income tax disclosures related to uncertain tax positions and other income tax topics at a later date. An exposure draft is not expected in the near term.

Internal control over financial reporting (ICFR)

Tax 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.

Attributes of a review control
Who Who performs the control? Do they possess competence and authority? When When or how often is the control performed (timeliness)? What 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?

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

Tax ICFR 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

AICPA National Conference – December 2014 PCAOB staff remarks on tax
PCAOB staff stated that inspections will likely focus on the following areas of emerging risks in 2015: Risks associated with mergers and acquisitions Income taxes, specifically matters related to a company’s assertions related to undistributed cash held in overseas subsidiaries The effect of falling oil prices on the audits of affected companies Audit procedures related to a company’s cash flow statement Auditing of hard-to-value investments and cybersecurity risks

SEC focus areas

AICPA National Conference – December 2014 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 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

Foreign earnings Indefinite reinvestment:
Not an all-or-nothing assertion Positive assertion requiring specific documentation and evidence of plans each reporting period Consider financial reporting implications of tax planning SEC comments: “Please explain to us how you evaluated the criteria for the exception to recognition of a deferred tax liability in accordance with ASC and 18 for undistributed earnings that are intended to be indefinitely reinvested. Describe the type of evidence and your specific plans for reinvestment for these undistributed earnings that sufficiently demonstrates that remittance of earnings will be postponed indefinitely.”

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

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

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

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

Tax provision challenges and practice issues

Tax provision challenges Restatements
General causes: Application of tax technical rules: Tax basis Intra-period tax allocation: Interim periods Accounting for outside basis differences Realizability of deferred tax assets (DTAs): Tax planning strategies Deferred tax liabilities (DTLs) as source of income Income tax errors are a leading cause of restatements.

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

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

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

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

Realizability of DTAs Same framework:
Establishing a valuation allowance for the first time Determining whether a valuation allowance continues to be necessary Have all four sources of taxable income been considered?

Do you know if a carryback is limited?
Realizability of DTAs Taxable income in prior carryback years: Consider character – capital losses may only be available to offset capital gains. Consider limits – the number of years and amount of losses that may be carried back may be limited by jurisdiction. ? Do you know if a carryback is limited?

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 used as a source of taxable income Will the deferred tax liabilities result in taxable income in the appropriate period? Are there deferred tax liabilities associated with book balances that do not have a known period when they may affect the income statement?

Best practice responses

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

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

Tax provision recommendations

Refresh internal controls for income taxes (consider adopting 2013 framework) Develop work plan for enhancements and remediation items and assign tasks Review work plan and timeline with auditor Assign technical tax accounting white papers for issues and judgments Accelerate work during quarters and interim to avoid surprises: Evaluate and record return-to-provision adjustments Prove out deferred tax assets/liabilities, current taxes payable/receivable: Leverage tax provision-to-return process for completed tax returns Document/analyze state tax rates, including apportionment changes and the impact on deferred taxes, and foreign tax rates for changes Document outside basis differences, including indefinite reinvestment assertions, and prepare outside basis difference calculations (consider previously taxed income and un-recaptured Subpart F income) Document valuation allowance considerations (four sources of taxable income) and prepare position paper Document uncertain tax positions. Consider tool to improve efficiency and accuracy of computations

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

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

Thank you!

Mark Mesler, Ernst & Young, LLP
Evolving IRS paradigm Mark Mesler, Ernst & Young, LLP

Agenda IRS resource constraints
Large Business and International (LB&I) Division organization changes New LB&I exam process update LB&I Coordinated Industry Case (CIC) pilot Appeals Judicial Approach and Culture (AJAC) Project Questions

IRS resource constraints

IRS resource constraints
Budget: FY2015: $10.9 billion; cut by 1.2 billion or 10% since FY2010 Reduction of approx. 3,000 employees this year and 13,000 employees since FY2010 Training and travel reduced by $248 million or 74% percent since FY2010 Cutbacks and impact: Decline in call service: Less than 50% of calls get answered – down from 64% in FY2014. Average wait time is over 30 minutes per call and more than 45 days to answer most letters. Less audits/rulings/advice More automated notices, especially international information return penalties

LB&I organization changes

LB&I organizational chart
LB&I commissioner Heather C. Maloy Deputy commissioner (domestic) Deputy commissioner (international) Shared support Pre-filing and technical guidance Sergio Arellano (A) Douglas O’Donnell Susan Latham, Dir. Tina Meaux, Dir. Communications, technology and media Cheryl Claybough, Dir. Scott Ballint, DFO NW (A) Rosemary Daley, DFO SW Assistant deputy commissioner, international John Hinding (A) Business systems planning Dean Wilkerson, Dir. (A) Deputy director Pam Drenthe (A) Financial services Catherine Jones, Dir. (A) Jo McGready, DFO Fin Prod Barbara Harris, DFO NY International business compliance Sharon Porter, Dir. (A) Jolanta Sanders, DFO E Margie Maxwell, DFO W (A) William Holmes, Dir. IDM Theodore Setzer, Dir., FPP Management and finance Keith Walker, Dir. Holly Paz Global high wealth Cheryl Claybough, Dir. (A) Planning, analysis, inventory and research Christopher Larsen, Dir. (A) = Acting International Individual compliance David Horton, Dir. Clifford Scherwinski, DFO Heavy manufacturing and pharmaceutical Lavena Williams, Dir. (A) Dennis Figg, DFO NE (A) Donald Sniezek, DFO SE (A) Equity, diversity and inclusion Rona Evans, Dir. Transfer pricing operations David Varley, Dir. (A) Hareesh Dhawale, Dir. APMA Natural resources and construction Kathy Robbins, Dir. Khin Chow, DFO W (A) Kimberly Edwards, DFO E Steve Whitaker, DFO Eng. Division planning, oversight reporting and liaison Michael Boccarossa, Dir. Retailers, food, transportation and health care Lori Nichols, Dir. (A) Elise Gardner, DFO E (A) Lori Caskey, DFO W Paul Curtis, DFO CAS

LB&I update Organizational leadership changes:
Five top executives departures including deputy commissioner (international, transfer pricing director, director APMA, director international strategy, acting deputy commissioner (domestic) Departures due to retirements and departures New cadre of LB&I executive appointments Budget effect on exam resources: Significant headcount reduction and limited attrition hiring Rumor of pending LB&I organization structure Impact to taxpayers: Greater management instability on examinations Potential for delays on audit activity and completion dates Uncertainty in decision-making authorities and accountability Uncertainty on roles/responsibilities for domestic and international examiners

New LB&I exam process update

Proposed new LB&I exam process Publication 5125
Replaces current Quality Exam Process incorporating recent changes: New Information Document Request (IDR) Directive Appeals Judicial Approach and Culture Project Establishment of Issue Practice Groups & International Issue Networks to promote knowledge sharing vision for focused issue examinations Establishes process for centralized issue identification and selection Exam teams to limit audit to pre-identified issues Issues to be managed and audited by “issue teams” Implementation in Spring 2015 with internal revenue manual revisions; however, teams have received training.

LB&I examination process – roles and responsibilities
LB&I expectations: Exam teams and taxpayers working transparently Engage each other in development of examination plan Follow information document request procedures Resolve issues at lowest level using appropriate resolution tools Taxpayers and representatives: Identify personnel for each issue with significant knowledge Collaborate with the exam team to arrive at an: Acknowledgment of the facts Provide support for any additional facts If facts remain in dispute, documenting the dispute

LB&I examination process – planning phase
Initial planning meeting: Exam team and taxpayer will work together to define the scope of the examination and process. Exam team will explain why each issue is being considered. Taxpayer should provide input on how each issue can be examined. Issue team approach: Comprised of both LB&I and taxpayer personnel responsible for examining each issue Collaborate transparently to develop exam procedures for each issue Establish relevant facts and ensure each party’s position is fully understood Examination plan: Issue-focused and jointly reviewed Timelines, audit steps, risk analysis and methods of monitoring progress

LB&I examination process – execution phase
Issue development: Identify and document all relevant facts Present legal positions Communicate both parties’ positions: Identifying areas of disagreement Resolution strategies Attempting to resolve at lowest possible level Facts: LB&I teams to seek taxpayer’s concurrence Resolve any facts in dispute Consistent with AJAC Project: Requires 365 days remain on statute of limitation when received by Appeals

LB&I examination process – resolution phase
Issue resolution tools: Consistently encourages available issue resolution tools Requires consideration of Fast Track Settlement with Appeals Taxpayer responsibility: Ensuring all relevant facts and legal arguments provided during examination Prevent case being referred back to LB&I by Appeals Exit strategy Requires that discussions include efforts to resolve tax controversy for certainty Joint critique of the exam process to recommend improvements Address future tax treatment of issues to eliminate carryover/recurring issues

LB&I examination process – expectations with respect to claims
Informal claims for refund: Provided to the exam team within 30 days of the opening conference After 30 days, must file formal claims Treas. Reg. § standards: Set forth in detail each ground upon which a credit or refund is claimed Present facts sufficient to apprise the IRS of the exact basis for the claim, and Contain a written declaration that it is made under penalties of perjury Claims disallowed if these standards are not met

LB&I examination process – expectations with respect to claims
Risk assessment: Claims will be risk assessed similar to other issues. Fully documented and factually supported claims may permit exam team to make tax determination without use of IDRs. Fully documented claims enable a quick assessment to accept or examine claim. If the claim warrants examination, then: Both the exam team and taxpayer discuss resources and timeline. LB&I could decide that the claim will be worked separately from the current examination.

LB&I Coordinated Industry Case (CIC) pilot

LB&I Coordinated Industry Cases (CIC) pilot
LB&I initiated a new CIC pilot on 30 April 2014: Pilot will run for 18 months. Currently, CIC cases: Front-end staffed into the LB&I compliance plan Limits flexibility to allocate resources to other compliance activities Under the new process, all CIC cases would undergo a consistent classification process to determine tax return compliance risk and to identify issues for examination. New classification process will include issue identification and written explanations on compliance risks, and documentation to support compliance risk conclusions (pre-classification): All information will be included in case file for use during an examination.

Appeals Judicial Approach and Culture (AJAC) Project

18 July 2013 – interim guidance memo for Appeals employees Applies AJAC to examination and collection cases AJAC themes: This is a quasi-judicial approach to Appeals hearing based on case file. No new issues are raised by Appeals. Appeals will attempt to settle a case on factual hazards when the case submitted by Compliance is not fully developed and the taxpayer has presented no new information or evidence. If a taxpayer provides Appeals with new information, Appeals will return the case to LB&I. If a taxpayer raises new arguments at Appeals, LB&I will be given the opportunity to review and comment on the arguments, but Appeals will maintain jurisdiction.

3 July 2014 – second phase of AJAC released by Appeals Statute of limitations – one year remaining prior to acceptance Providing Exam with opportunity to comment (specific time frame, 45 days) or return case to Exam (Appeals releases jurisdiction to Exam) Premature referral of case to Appeals or new information presented by taxpayer during Appeals hearing

Questions?

Thank you

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