2013 - Issue 50—Every year-end brings with it annual rituals and traditions, and even corporate tax departments are not immune. Hence, now is the time to take stock of 2013 and plan for 2014. The year-end planning ritual is becoming more important as corporations rely more than ever on tax departments to become profit centers and contribute to the bottom line. Various factors such as the growing complexity of U.S. tax laws and compliance obligations, looming corporate tax reform at home and abroad, and the growing role of international operations have made year-end planning more complicated with every passing year. This edition of Tax Advisor Weekly highlights some of the technical developments that occurred in 2013 and important deadlines for 2014, but at the same time provides an approach that tax departments can follow as they tackle year-end planning for their company.
Technical Developments at Home and Abroad
Generally, year-end planning begins with an assessment of the technical developments that occurred during the year for both domestic and foreign operations. This year did not bring with it any comprehensive U.S. tax reform, since Congress continues the gridlock that has become its new normal. However, the Internal Revenue Service did manage to finalize the regulations under the Foreign Account Tax Compliance Act (FATCA) and the tangible property regulations (known as the “Repair Regulations”). There are also various tax provisions that, barring any last-minute deal, are set to expire on December 31, 2013 (e.g., bonus depreciation, Subpart F look-through rules and active financing exception, research and development credit, etc.).
The Service also published statistical results of the 2011 Schedule UTP filings. Not so surprisingly, we learned that the top two uncertain tax positions related to research credits and transfer pricing, while a distant third was capitalization. With regards to Service examinations, directive LB&I-04-0613-004 was issued in June requiring that agents discuss information document requests (IDRs) with taxpayers prior to issuance. More recently, the Service issued a new directive, LB&I-04-1113-0009, which provides a rigid enforcement on new IDRs. Under the recent directive, revenue agents will have significantly less discretion in granting extensions for taxpayers to comply with an IDR, and delinquent IDRs will result in a deficiency notice. Many are already contemplating how these recent procedural changes will impact a company’s approach during the examination process.
Abroad there seems to be more appetite or ability to implement tax reform. For example, Mexico’s Congress passed significant tax reform measures that impact companies with operations in Mexico. China is another country that continues to update and develop its tax system each year. This year, China is implementing a VAT program and is well on its way to having a tax code as complicated as the U.S. tax code. The Organization for Economic Co-operation and Development, or OECD, is also hard at work on its Base Erosion and Profit Shifting, or BEPS, project. At a high level, BEPS is aimed at addressing perceived tax abuses in the international context (e.g., treaty shopping, avoidance of permanent establishments, use of hybrid entities and instruments, etc.). However, since countries compete to attract the local employment opportunities that multinational companies can offer, international tax arbitrage is likely to be with us for many years to come. At the same time, if multinationals continue to gain notoriety in the press for what is perceived as low effective tax rates on foreign earnings, the governments may have to enact tax reforms or face political pressure.
Although one often thinks to look for tax planning opportunities in new technical developments, opportunities and risks can also arise from changes in how a company does business. Accordingly, tax departments need to take inventory of the changes in business operations, as they may have tax implications that need to be considered. This would likely require the tax department to develop and maintain a relationship with other departments in the company in order to ensure good communication.
For example, a corporation that engages in contract manufacturing may change its relationship with its contract manufacturers over time. Such changes could impact various items on the company’s return, such as the domestic production deduction, UNICAP (uniform capitalization) calculations, and Subpart F analysis. Likewise, the company’s sales department may be deploying personnel in a state for which the company does not file a state tax return or abroad in a country where the company does not have a registered branch.
Another area for opportunities and pitfalls relates to withholding obligations. For example, the accounts payable department may update the payee legal entity for an existing vendor that operates via various entities and forget to confirm the withholding implications with the tax department. The tax department may continue to assume that no withholding obligation exists with regard to that vendor, when in fact payments to the new payee are subject to withholding.
In summary, tax planning risks and opportunities arise from changes in how the company does business, as well as from changes in tax rules. However, such changes can occur subtly over time, and tax departments may not become aware until it is too late.
Once the company’s tax department maps out the technical developments and changes in business operations, it needs to prioritize and allocate resources accordingly. What is a priority generally depends on the impact that a particular matter will have on the company’s income tax expense and the timing thereof.
Accordingly, a thorough review of the regulations and the company’s operations is required to determine if the Repair Regulations should be prioritized. Breaking down the Repair Regulations into manageable components and analyzing each component separately may facilitate this work. For example, the repair regulations can be broken down into (a) materials and supplies, (b) acquisition and repair costs and (c) dispositions. With regard to materials and supplies, companies will need to review their current accounting policy on capitalization and confirm that practice reflects that policy. This analysis needs to be completed prior to December 31, 2013, as accounting polices related to materials and supplies need to be in place prior to the calendar year-end. Companies should also consider the benefits of making a de minimis safe harbor election and potential planning opportunities for expenditures in excess of the safe harbor amount. Likewise, with regard to dispositions, companies will need to consider the availability to make partial dispositions and the potential benefits of accelerating deductions. In addition, companies may need to carefully analyze the repair capitalization portion of the rules. Due to its emphasis on the “unit of property,” without careful planning, companies may capitalize more than necessary, since the unit of property will entail only a portion of the entire asset, and repairs will thus be measured against the lower cost represented by the unit of property.
The impact the Repair Regulations will have on companies should be analyzed, as the Regulations include many changes that could have a material effect. Such analysis will need to factor in the materiality of potential changes, administrative costs associated with these changes and the relative timing. A Tax Advisor Weekly article dedicated entirely to the Repair Regulations will be published in the near future.
The end of this calendar year also marks the end of a number of business tax breaks that were introduced under the Bush administration and that remained for several years in one shape or another. Some of the more important expiring provisions include the following:
- Bonus Depreciation: Under the bonus depreciation provisions, taxpayers can claim an additional depreciation allowance equal to 50 percent of the cost of qualified assets placed in service. To qualify, an asset must be depreciable under the Modified Accelerated Cost Recovery System (MACRS) and have a recovery period of 20 years or less.
- Increased Section 179 Deduction: Through the end of 2013, companies may currently expense up to $500,000 of assets placed in service, but this deduction is subject to phase out to the extent the assets placed in service exceed $2 million.
- MACRS Class Life: A shorter depreciable life of qualified leasehold improvements, restaurant equipment and qualified retail improvement property allows for these assets to be depreciated over 15 years rather than 39 years.
- Research and Development Credit: This credit rewards companies for domestic spending on research by allowing a credit rather than a deduction for qualified research expenditures.
- Subpart F Provisions: The look-through rules and active financing exception under the Subpart F rules generally curtail the reach of the Subpart F rules, and thus U.S. companies with foreign subsidiaries will need to plan accordingly.
In addition to the items mentioned above, companies should analyze current tax accounting methods with the goal of identifying potential cash-flow-generating opportunities via the acceleration of deductions or deferral of income. Method changes to be considered include, for example, the potential to defer income with regard to advance payments and disputed income amounts. Such method changes would include the acceleration of deductions for subnormal goods and prepaid expenses. To the extent that such method changes qualify for the automatic procedures, the administrative burden for implementation may also be lower. Companies should also look ahead and plan for new rules that are set to come into effect in 2014.
In 2010, when the Hiring Incentives to Restore Employment (HIRE) Act brought us FATCA, it was generally not thought of as a priority, as its impact on operations was not imminent. However, now the final regulations and various implementation dates are upon us. The impact of the FATCA rules depends on whether the particular entity is a foreign financial institution (FFI) (i.e., generally defined to include companies engaged in banking, custodial, insurance or similar investment business on behalf of others) or a non-financial foreign entity (NFFE). By now, FFIs should have a firm grasp of FATCA and their responsibilities thereunder.
However, many U.S. multinational companies that are not in the financial sector have yet to determine how FATCA will affect their business. Such companies, as part of their year-end planning, should perform an internal assessment that begins with creating a list of foreign payees and the nature of the payments, such as interest versus payment for goods and services. The company can then determine what payments are subject to withholding and what its withholding and reporting responsibilities are. As with other areas of the tax law, penalties and interest are driven by the amount of tax due. Generally, to the extent that a withholding agent fails to withhold, it becomes liable for the withholding tax. Accordingly, by identifying large payments to foreign payees, the company can focus its resources on the payments that entail a greater risk. Armed with a general understanding of the FATCA withholding and reporting rules as they apply to NFFEs (and a list of the various defined terms under FATCA, such as withholdable payment, FFI, NFFE, substantial U.S. owner, expanded affiliated group, etc.), the company should be able to assess FATCA’s impact and to what extent additional resources, including assistance from external tax advisors, may be necessary. Although different parts of the final FATCA Regulations will come into effect at different times, generally the obligation to withhold under FATCA will begin on July 1, 2014, so there is no time to lose.
In the last few years, there has been plenty of talk about corporate tax reform, but there has been little action. Earlier this year, Senate Finance Committee Chairman Max Baucus (D-MT) and House Ways and Means Committee Chairman Dave Camp (R-MI) toured the country listening to taxpayers’ concerns about our current tax system. In November, Chairman Baucus published various tax reform discussion drafts that range from international tax reform to cost recovery and tax accounting reform. These discussion drafts propose significant changes, such as eliminating the portfolio interest exemption on corporate debt, introducing a participation exemption for foreign earnings, and imposing a minimum tax on controlled foreign corporations. Likewise, various changes were proposed regarding various accounting methods, such as depreciation, amortization of intangibles and advertising expenditures, amortization of research and experimental expenditures and inventory (i.e., LIFO repeal).
Although the eventual timing of tax reform is uncertain, the momentum for tax reform is certainly building at home and abroad. Now is the time for companies to assess how the different proposals may affect them and, more importantly, how they will adapt and capitalize on the challenges and opportunities corporate tax reform will bring. To do so, companies will need to have a firm handle on their corporate attributes such as earnings and profits, foreign tax credits, loss carryovers, etc. and the necessary resources such as fully staffed tax departments and the requisite tax technology. Accordingly, tax reform is yet another item that requires planning and resources.
Alvarez & Marsal Taxand Says:
Year-end planning can provide many opportunities for companies to mitigate tax exposures and capitalize on potential opportunities. Changes in the tax law or in the company’s operations can serve as a source for both. Accordingly, it is up to the tax department through its year-end planning to prioritize new developments and assess the overall impact. It is also incumbent upon the tax department to reach out to the other business units within the company, to ascertain whether any business developments have taken place. Armed with this information, the company’s tax department can set a course and plan ahead for the following year. To the extent that a company cannot determine how it wants to proceed, it should consult with its tax advisor.
As provided in Treasury Department Circular 230, this publication is not intended or written by Alvarez & Marsal Taxand, LLC, (or any Taxand member firm) to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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