23rd Annual Health Sciences Tax Conference - Ernst & Young

23rd Annual Health Sciences Tax Conference Accounting for income tax developments and hot topics for life sciences companies

Disclaimer Ź

Ź Ź

Ź

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. For more information about our organization, please visit www.ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global operating in the U.S. This presentation is © 2013 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 U.S. 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.

Page 2

Accounting for income tax developments and hot topics for life sciences companies

Non-reliance disclosure Ź

Ź

Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. These slides are for educational purposes only and are not intended, and should not be relied upon, as tax or accounting advice.

Page 3


Presenters Ź

Tricia Brosnan Vice President, Global Tax Operations Pfizer Inc. [email protected]

Ź

Brian Foley Ernst & Young LLP 155 North Wackler Drive Chicago, IL 60606 +1 312 879 3862 [email protected]

Ź

Catherine Sullivan Vice President of Corporate Tax Charles River Laboratories [email protected]

Ź

Joan Schumaker Ernst & Young LLP 5 Times Square New York, NY 10036 +1 212 773 8569 [email protected]

Agenda Ź

Developments Ź Ź Ź Ź Ź

Ź

Legislative and regulatory developments PCAOB considerations Income tax review controls New COSO internal control framework Standards update

Tax provision challenges and best practice responses Ź Ź Ź

Page 5

Restatement trends and root causes Outside basis differences Reduce risk in accounting calculations


Developments

Changes in tax laws or rates continue Ź

Ź

Through September 2013, approximately 30 countries (e.g., U.S. and U.K.) and 16 states (e.g., CT, TX, NC) enacted tax law changes Several jurisdictions are considering tax law changes that could be enacted by 31 December 2013

Page 7


U.S. “extenders” set to sunset Ź

American Taxpayer Relief Act – extended expired 2011 tax provisions through December 31, 2013 Ź Ź Ź Ź Ź Ź Ź Ź

Ź

Research and experimentation tax credit Work opportunity tax credit 50% bonus depreciation Subpart F exception for active financing income Controlled foreign corporation look through provision for Subpart F Renewable energy tax credits Incentives for biodiesel and renewable diesel New markets tax credit

Key reminders Ź Ź

Page 8

Fiscal year EAETR does not include extenders for portion of year after 31 December 2013 Deferred taxes should also be measured consistent with enacted tax law (extenders are not extended beyond 31 December 2013) Accounting for income tax developments and hot topics for life sciences companies

Final tangible property regulations Tax accounting considerations Ź

Tax accounting method changes that are effective for taxable years beginning on or after 1 January 2014 where a Section 481(a) adjustment is required Ź Ź

Ź

Page 9

Two temporary differences (ASC 740-10-55-59 through -61) Can affect the tax basis of an asset or liability and the associated temporary difference for capitalized assets and/or amounts paid in periods prior to 2014 481(a) adjustment is deferred income for tax purposes and a temporary difference


Final tangible property regulations Tax accounting considerations Ź

Accounting method changes effective for amounts paid or incurred in taxable years beginning on or after 1 January 2014 and exceptions to the above methods for amounts paid or incurred in taxable years beginning on or after 1 January 2014 Ź

Page 10

No financial statement implication for the reporting period that includes 13 September 2013 as transactions have not yet occurred


Latin America Developments and areas of focus Ź

Ź

Ź

Ź

Argentina – new tax on dividends and capital gains effective 23 September 2013; assess risk in Chilean Holding Company structures (Argentine Federal Tax Court recently upheld the application of general anti-avoidance rules to prevent application of the dividend withholding tax exemption provided by the Treaty with Chile); Chile – consider whether loans to foreign shareholders may be a taxable deemed dividend under legislation enacted 27 September 2012 Colombia – CREE – Portion of tax based on capital is NOT an ASC 740 income tax Mexico – elimination of IETU; elimination of tax consolidation regime; royalty tax on mining activities; 10% withholding tax on dividend distributions; non-deductibility of certain payments of interest, royalties or technical assistance to related parties

Page 11


Mexico tax law changes Ź Ź Ź

Expected to be effective 1 January 2014 Corporate tax rate of 30% (repeals planned rate reductions) 10% withholding tax imposed on dividends to non-residents and individuals. Dividends includes: Ź Ź Ź Ź

Loans to shareholders Transfer pricing adjustments by tax authorities Capital redemptions Treaty benefits may be available to reduce or eliminate tax Ź Ź

Ź

Tax applies to earnings after 2013 Ź

Page 12

Beneficial ownership test Limitation of benefits provisions – extra formalities and subject to tax test to access treaties Measured based on CUFIN account at end of 2013


Mexico tax law changes Ź

Ź

Ź

After tax earnings account (CUFIN) rules still apply as a tax on Mexican distributing entity Elimination of the flat rate business tax (IETU) results in no alternative minimum tax Certain domestic withholding tax rates increase to 35% Ź

Ź

Capital gains on sale of shares

Denial of deduction for payments of interest, royalties or technical assistance to certain related parties if Ź

Ź

Ź

Page 13

Payment is made to a foreign entity that is fiscally transparent, unless the shareholders or partners are subject to tax on the income of entity Payment is not deemed to exist for tax purposes in the country or territory where the entity is resident, or Foreign entity does not recognize the payment as taxable income



Base broadening provisions Ź

Ź Ź

Payments deducted in another jurisdiction would be nondeductible unless the income of the Mexican taxpayer is also recognized in the foreign jurisdiction Elimination of immediate deduction for fixed assets Non-deductible payroll related to exempt income of employees (e.g., Christmas bonus, savings funds, profit sharing, vacation premium, seniority premium, and severance) Ź Ź

Page 14

General rule is 53% non deductible Final rule states that 53% of the expense may be deducted (disallowing 47%), to the extent that the amount of the benefit being paid to the employees has not decreased from the prior year



Changes to Maquiladora regime – income tax Ź

Ź

Ź

Ź

Ź

Permanent establishment exemption subject to local entity having 100% of productive income derived from Maquiladora operations 30% of machinery and equipment used in Maquiladora operations must be owned by foreign related party for PE exemption consigned inventory must be temporarily imported and subsequently exported by physical or virtual export Must use safe harbor TP or APA

Repeal of tax consolidation regime, 31 December 2013 Ź

Ź Ź

Page 15

Deferred tax paid over a five year period unless deconsolidate prior to year-end 2013 Expanded rules on the calculation of the recapture of the deferred tax New optional regime subject to transition rules including benefit recapture


PCAOB considerations Balance sheet reclassification adjustments Ź

Ź

PCAOB guidance has increased focus on balance sheet classification adjustments, requiring auditors to disclose to audit committees identified misstatements related to balance sheet classifications, consistent with reporting other identified misstatements The auditor should accumulate misstatements identified during the audit, other than those that are clearly trivial Ź Ź

Ź

“Clearly trivial” is not another expression for “not material.” Clearly trivial is inconsequential, whether taken individually or in aggregate and whether judged by any criteria of size, nature, or circumstances. When there is any uncertainty about whether one or more items is clearly trivial, the matter is not considered trivial.

Are your tax provision processes and controls designed and operating to identify and address balance sheet classification and disclosure matters at a level consistent with other areas of the tax provision?

Page 16


PCAOB considerations Internal control over financial reporting (ICFR) Ź

Ź

Income taxes has been selected as a focus area by the PCAOB, and we continue to see an increase in the focus on income taxes PCAOB has found deficiencies in auditors’ reviews of internal controls related to income taxes Ź

Ź

Failed to understand the likely sources of potential misstatement (i.e. identify What Could Go Wrong (“WCGW”)) Failed to obtain an understanding of the review procedures performed Ź Ź Ź

Ź

Failed to sufficiently test the operating effectiveness of review controls Ź

Ź

Page 17

Scope of review activities Level of precision at which the review is performed Source and reliability of information used to perform the control Testing limited to management inquiries and observation of sign offs

Failed to test controls separately outside of substantive testing


Income tax review controls Auditor considerations Ź

Ź

Review controls typically are a significant component of the suite of controls over the income tax accounts Use of a mix of procedures to test the operating effectiveness of tax review controls (e.g., inquiry, observation, inspection and reperformance) Ź

Ź

Inspecting that an effective tax rate reconciliation or analysis was “signedoff” is not adequate evidence that the control functioned as designed – examining the signature only provides evidence that the analysis was signed, rather than evidence of the level of review that actually took place.

Example review controls Ź

Ź

Page 18

US federal provision is reviewed and approved for accuracy and completeness by the Tax Director on a quarterly basis Manager of Tax Reporting reviews and approves the uncertain tax position analysis.


Income tax review controls Auditor considerations Ź

Workpapers that include appropriate evidential support to document both the design and operating effectiveness of review controls Ź

Ź

Page 19

Precision of the control Ź

Precision of the control is the sensitivity to which it functions (i.e. is the control sensitive enough to prevent or detect errors or fraud that could result in a material misstatement in the financial statements)

Ź

Qualitative and quantitative thresholds established by the reviewer for follow up

Completeness and accuracy of the underlying data


Income tax review controls Example procedures: evidence of precision Ź

Ź

Control: On a quarterly basis, the current income tax payable account is reviewed by the federal income tax manager to determine that all activity has been properly recorded. Examples of procedures that auditors may perform: Ź Inquiries of the federal income tax manager regarding prior history of errors identified through his/her review Ź Discussion of what he/she considers to be a material adjustment Ź Inspection of email correspondence with other tax managers (State and Local, International and Compliance) regarding estimated tax payments recorded Ź Observation of his/her review of detailed accruals as compared to the quarterly tax projections Ź Inquiries and discussion of the quarterly review control with two other tax managers, confirming the types of inquiries they receive as a result of the federal income tax manager’s review

Page 20


ICFR — Other observations Ź

Ź Ź

Ź Ź

Process flowcharts are being requested, if not required, by some auditors How precise are your review controls? Can you document the level of precision at which your controls operate? Have all risks and WCGWs been identified? As tax footprints and business operations change, it is also important to refresh internal controls, processes and documentation

Page 21


Best practices responses Internal controls refresh Ź

Ź

Evaluate effectiveness of internal controls design and operation based on current business and procedures Walk-through procedures and assess process narrative/flowchart is up to date Ź

Ź Ź

Are current procedures designed to minimize risk today? Document performance of review controls (signature is not sufficient) Ź

Ź Ź

Ź

Ź

Will a flowchart be required?

Document the precision of review controls – frequency, nature and extent of issues identified Retain evidence of issues identified and resolution of those issues Document review thresholds and procedures that support manual controls (e.g., quantitative and qualitative)

Understand and document effectiveness of controls related to source data and report inputs to tax provision calculations/processes Perform internal self-assessment of control execution and testing

Page 22


New COSO internal control framework Ź

In May 2013, COSO (“Committee of Sponsoring Organizations”) released the Internal Control – Integrated Framework: 2013 (2013 framework) to provide additional guidance and reflect changes in the business environment since the 1992 Internal Control – Integrated Framework (the original framework) Ź

Ź

The original framework is valid through 15 December 2014, after which it will be superseded by the 2013 framework

Implementing the 2013 framework will be another opportunity for tax departments to engage their organization for budget and closure of gaps while company-wide changes may be occurring

Page 23


Appendix — COSO Framework

What is not changing?

What is changing?

Ź Retains the core definition of internal control Ź Retains the five components of internal control (control environment, risk assessment, control activities, information and communication, and monitoring) Ź Retains the requirement of five components for an effective system of internal control Ź Retains importance of judgment in designing, implementing, and conducting internal control, and in assessing effectiveness of internal control

Ź Formalizes fundamental concepts underlying the five components as principles Ź Considers changes in business, operating and regulatory environments Ź Expands financial reporting objective to include other important forms of reporting (operations, compliance, nonfinancial) Ź Provides additional approaches and examples relevant to operations, compliance, and non-financial reporting objectives

Page 24


Appendix — COSO Framework Principles of effective internal control Control environment

Risk assessment

Control activities

Information and communication

Monitoring activities Page 25

1. 2. 3. 4. 5.

Demonstrates commitment to integrity and ethical values Exercises oversight responsibility Establishes structure, authority and responsibility Demonstrates commitment to competence Enforces accountability

6. 7. 8. 9.

Specifies suitable objectives Identifies and analyzes risk Assesses fraud risk Identifies and analyzes significant change

10. Selects and develops control activities 11. Selects and develops general controls over technology 12. Deploys through policies and procedures 13. Uses relevant information 14. Communicates internally 15. Communicates externally 16. Conducts ongoing and/or separate evaluations 17. Evaluates and communicates deficiencies Accounting for income tax developments and hot topics for life sciences companies

Overview of ICFR Entity level control assessment Area

Control environment

Considerations The control environment reflects the tone set by top management and the overall attitude, awareness and actions of the board of directors, management, owners, and others concerning the importance of internal control and the emphasis placed on control in the company’s policies, procedures, methods, and organizational structure. It is the foundation for all other components of internal control, providing discipline and structure. Focus/pressure on Effective Tax Rate (attitudes, control consciousness)

Risk assessment

Risk assessment is the entity’s identification and analysis of relevant risks (both internal and external) to the achievement of its objectives, forming a basis for determining how the risks should be managed. Ability to anticipate, identify and react to late changes in PBT (risk assessment)

Information and communication

Control activities

Information and communication systems support the identification, capture, and exchange of information in a form and time frame that enable management and other appropriate personnel to carry out their responsibilities. Quality and frequency of tax sensitive data elements received from outside Tax Dept. Control activities are the policies and procedures that help ensure that Management’s directives are carried out. Integration of tax controls throughout provision process

Monitoring

Monitoring is a process that assesses the quality of internal control performance over time. Role and integration of internal audit in test of controls of tax accounts

Page 26


Accounting Standards Update (ASU) 2013-11 Ź

Ź

In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit (UTB) When a Net Operating Loss (NOL) Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists Provides that a liability related to a UTB would be offset against a deferred tax asset for an NOL carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed (i.e., net presentation) Ź

Ź

Ź

The determination of whether a deferred tax asset is available is based on the unrecognized tax benefit and the deferred tax asset that exist at the reporting date and presumes disallowance of the tax position at the reporting date

Effective for fiscal years, and interim periods within those years, beginning after 15 December 2013 for public entities and 15 December 2014 for nonpublic entities. Early adoption is permitted. Applied prospectively to unrecognized tax benefits that exist at the effective date. Retrospective application is permitted.

Page 27


EITF Issue 13-B: Accounting for Investments in Affordable Housing Projects Ź

EITF reached final consensus at 14 November 2013 meeting: Ź

Ź

Ź

Ź

Allows reporting entity to elect to change the method of amortizing a low income housing tax credit (LIHTC) investment from the effective yield method to a proportional amortization method (i.e., amortization would be proportional to the tax credits and tax benefits received). Decided not to provide guidance about the balance sheet classification of the LIHTC investment or whether deferred tax assets should be recognized for the difference between the book value and the tax basis of the LIHTC investment. The EITF recommended that the FASB issue a separate proposal to extend the new guidance to other tax credit investments.

Status Ź Ź

Ź

Ź

Page 28

Subject to ratification by the FASB at its 11 December 2013 meeting. Effective for public entities for fiscal years beginning after 15 December 2014 and interim periods within those years. Effective for nonpublic entities for annual periods beginning after 15 December 2014. Applied on a retrospective basis. For existing LIHTC investments that an entity accounts for under the effective yield method on the date of adoption, a reporting entity would have the option to continue using that method. Early adoption would be permitted.


Tax provision challenges and best practice responses

Restatement trends — top three topics Restatement topics

No.

%

Income taxes

22

21%

Revenue recognition

8

8%

Statement of cash flows

6

6%

Income taxes

18

20%

Revenue recognition

9

10%

Statement of cash flows

5

6%

Revenue recognition

21

17%

Income taxes

15

12%

Derivatives

9

7%

2012:

2011:

2010:

Page 30


Income tax restatements — root causes Ź

Application of tax technical rules Ź

Ź

Realizability of DTAs Ź

Ź

Improper consideration of naked tax credits as a source of taxable income

Business combinations Ź

Ź

Incorrect identification or calculation of tax basis and carryback/carryforward periods

Failure to recognize deferred taxes on temporary differences in purchase accounting

Accounting for outside-basis differences Ź

Inappropriate application of exceptions to deferred tax liability recognition for outside-basis differences Ź

Page 31

Not providing taxes for basis differences related to investments in partnerships and equity method investments


Tax provision challenges Outside basis — permanent reinvestment Ź

ASC 740-30-25-17 (emphasis added) – “…A parent entity shall have evidence of specific plans for reinvestment of undistributed earnings of a subsidiary which demonstrate that remittance of the earnings will be postponed indefinitely. These criteria required to overcome the presumption are sometimes referred to as the indefinite reversal criteria. Experience of the entities and definite future programs of operations and remittances are examples of the types of evidence required to substantiate the parent entity’s representation of indefinite postponement of remittances from a subsidiary….”

Page 32



A deferred tax liability is not recognized if the parent overcomes the presumption that all undistributed earnings of a subsidiary will be transferred to the parent entity by asserting that Ź Ź

Ź

Page 33

Foreign earnings are indefinitely reinvested (intent) and Remittance of the foreign earnings to the parent will be postponed indefinitely (ability) Only applies to foreign subsidiary or foreign corporate joint venture


Tax provision challenges Outside basis — permanent reinvestment Ź Ź

Recent increase in tax planning activities Consider financial reporting implications of tax planning Ź

Changes to indefinite reinvestment assertion Ź

What if the company has not determined which portion of foreign earnings will be repatriated? Ź

Ź

Do indefinite reinvestment plans need to be consistent with actions company is taking or plans to take? Ź

Page 34

Default is all earnings are repatriated Ź Questions and interpretive responses are included in Chapter 14 of EY’s Financial reporting developments (FRD) publication, Income taxes

Yes, including any tax planning activities


Tax provision challenges Outside basis — permanent reinvestment Ź Ź Ź Ź

Ź

Should not regularly change the assertion Not an all or nothing assertion Evaluate each reporting period Positive assertion requires specific documentation and evidence of plans Recognize deferred taxes on earnings in period assertion changes Ź Ź Ź

Page 35

Generally not the same period as repatriation Income tax expense (continuing operations) Discrete event



Current regulatory environment Ź

Ź

Page 36

Regulatory agencies (SEC, PCAOB) have placed increased focus over the past several years on the existence of “sufficient evidence” to support the permanent reinvestment assertion Inquiries appear to be across industries and not focused on a particular industry



Evidence to support assertion: Ź Ź Ź

Ź Ź

Ź Ź

Page 37

Working capital and long-term capital projections FP&A budgets and cash forecasts “Bottoms up” analysis of relationships between foreign subsidiaries and direct parent(s) within a financial statement group Analysis of why funds are not needed upstream Availability of debt or equity in the market to fund parent’s operations Foreign M&A or strategic investment plans Plant expansion/capital expenditure plans



Evidence to support assertion (cont.): Ź

Plans evidencing the ability to remit earnings on a tax-free basis Ź

Ź

Page 38

Analysis requires a careful understanding of the specific facts and circumstances of the planned remittance Ability must be within the company’s control and presently available (that is, it is not contingent on some future action that is not completely under the company’s unilateral control)


Tax provision challenges Outside basis — partnership investments Ź

Investments in partnerships may be accounted for under the cost, equity or consolidation method

Ź

Partners/investors need to consider future tax consequences of recovering their financial reporting basis of the investment in the partnership Ź Ź

Represents outside-basis differences Outside basis may be different than partner’s share of inside basis Ź Ź

Ź

Optional basis adjustments Asset/partnership interest transfers

The outside basis difference related to a partner’s investment in a partnership is recognized as a deferred tax asset or liability

Page 39



ASC 740-30-25-9 prohibits recognition of a deferred tax asset for an investment in a subsidiary or corporate joint venture unless it is apparent the temporary difference will reverse in the foreseeable future

Ź

Because the tax attributes of partnerships and other flow-through entities are taxed at the investor/partner level this limitation should not apply to deferred tax assets attributable to partnership outside basis differences

Ź

Valuation allowance considerations should still be considered for any deferred tax asset based upon the provisions of ASC 740-10-30-5 Ź Ź

Page 40

Limitations based upon jurisdictional income Limitations based on character of income



Because partnerships are pass-through entities, there is no ability to indefinitely reinvest the earnings in jurisdictions where earnings are taxed directly to partners

Ź

Special issues with respect to hybrid entities (foreign corporations treated as partnership for US) Ź Ź Ź

Page 41

Withholding taxes on distributions Deferred taxes on cumulative translation adjustments Deferred tax asset for tax basis>book basis



Ź

Ź

Provisions related to the consolidation of partnership interests are provided in ASC 810 Consolidation Requirements for consolidation of a partnership can be very complex If required, consolidation requires the full inclusion of 100% of the income, assets and liabilities of the partnership with separate designations for amounts attributable to non-controlling interests (NCI) Ź Ź

Page 42

Balance Sheet – separate component of equity Income Statement – separately shown on the face of the income statement



Consolidation of partnership interests present unique tax accounting issues Ź

Ź

Page 43

100% of the net assets and liabilities (inside book basis of assets) are included in the consolidated financial statements Deferred taxes are calculated based on the outside basis difference in the partnership interest


Best practice responses Reduce risk in accounting calculations Ź

Uncertain tax positions Ź

Ź

Fixed assets Ź Ź

Ź

Support balances for deferred tax assets, APIC pool, Section 162(m) adjustments, and unrecognized tax benefits by entity; consider deductibility of payments to foreign employees

Tax basis balance sheets Ź

Ź

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 Ź

Ź

Automate unrecognized tax benefit calculations and roll-forwards including interaction with other tax attributes, interest and penalty calculations and cumulative translation adjustments

Support cumulative temporary differences by entity with book and tax basis balance sheets that reconcile to tax returns & general ledgers; automate inputs & calculations

Legal entity calculations Ź

Page 44

Improve legal entity data and engage finance for items outside tax department’s direct control (e.g., forecasts, legal entity reporting, intercompany profit elimination) Accounting for income tax developments and hot topics for life sciences companies

Best practice responses Reduce risk in accounting calculations Ź

Intercompany transactions Ź

Ź

Improve spreadsheets and tools to minimize risk of errors, reduce hours and manage risk. Consider implementing a standardized process and/or tool for: Ź Ź Ź Ź

Ź Ź Ź

Ź

Review intercompany transactions for compliance with tax accounting rules

Tax basis balance sheets to validate deferred taxes Unrecognized tax benefit computations and tracking NOL tracking Indefinite reinvestment assertion documentation and outside basis difference calculations Share-based payment tax accounting, APIC pools and deferred tax proofs Section 162(m)(6) deferred tax computations Fixed asset deferred tax reconciliations

Greater than 50% of Fortune 1000 companies use Excel spreadsheets to compute global income tax provision Ź

Page 45

Consider third party to test and improve Excel spreadsheets for enhanced efficiency, accuracy and controls Accounting for income tax developments and hot topics for life sciences companies

Questions?

23rd Annual Health Sciences Tax Conference - Ernst & Young

Recommend Documents