2013 tax accounting update - slides

Tax Accounting Update2013

10 December 2013

Tax Accounting Update - 2013

Today’s Agenda

► 2013 AQR results ► Changes to income tax supplement

► Required professional practice consultations;► Transfer pricing appendix

► Audit risks for income taxes in the current environment;► Accounting for recently enacted international tax

measures;► Presentation of unrecognized tax benefits► Accounting for uncertain tax positions;

2013 AQR results


AQR - Findings

► Working papers do not contain sufficient referencing and documentation to conclude that appropriate procedures were performed to agree the balances of foreign entities to the source records and the financial information to the audited working papers.

► Based on the file in GAMx, the audit manager signed off on the work steps and foreign and consolidated TARs. However, an audit manager or higher did not sign off on all tax working papers indicating a detailed review as done by the audit team. It appears the required detailed second level review was not completed by the assurance team. The tax partner signed-off on substantially all of the tax working papers including the TAR, U281 and rate reconciliation, however did not sign off on the deferred tax working paper which would be considered a significant working paper. As this is a listed entity, it is required for a tax partner sign off on all significant tax working papers reviewed in addition to the detail and second level reviewer.


AQR Findings – cont’d

► Various reviews of the tax working papers are absent prior to the release date. The majority of the tax working papers are signed off by the audit senior manager subsequent to the audit report date. Similarly, the tax partner's review is also documented subsequent to the audit report date.

► US tax working papers were not archived in the file. The US Tax partner did not provide the team with the working papers or information necessary to assess the provision.



► An incorrect superseded version of the deferred tax working papers were included in the archived GAMx file and/or working papers appeared to be missing documentation.

► The financial statements disclose there are no uncertain tax positions, but no evidence existed in the file to assess this.



Several identified errors relating to deferred taxes recorded on intangibles and ITC's from a purchase equation, as well as government tax credits. These errors were not appropriately included on the SAD and communicated to management and those charged with governance. Details are as follows:► Deferred income taxes were not initially recorded on indefinite life intangibles

in the purchase equation in 2010. ► Deferred income taxes were not initially recorded on the ITC’s in the purchase

equation in 2010. ► Deferred income taxes were calculated on the federal SRED pool and the

Ontario ORDTC. The federal SRED pool should have a deferred tax asset recorded. The Ontario ORDTC is a tax credit and is taxed in the current year. It should have been recorded as an ITC (subject to valuation of the ITC’s overall) and not tax effected.

► On the tax return, severance expenses were treated as not currently deductible. However, a deferred tax asset was not recorded. Therefore the deferred tax expense was overstated. The ITC’s utilized and the ending balance of ITC’s were correctly recorded based on the tax return so there appears to be a missing tax entry to record the DTA.



► The TAR memo identifies the reasoning for recognizing the deferred tax asset being future projections, however there was no file documentation connecting the audit work regarding future accounting projections and future taxable profits or explaining the work done to get comfortable for tax purposes. In addition, there is no documentation in the file regarding the assessment and/or need for a PPD consult given future projections are being relied on and losses in the immediate history.

► In addition, UK deferred tax liability related to goodwill is indicated as “maintained at top CDN consolidation”. However, there is no documentation or evidence in the Canadian tax working papers this amount was evaluated. Based on discussions with the audit team, this amount is an isolated adjustment for a difference between UKGAAP and IFRS and ties directly to their financial information. Since this DTL amount is material, it should be tied out and documented as such. The UK TAR only refers to the deferred tax asset relating to losses but does not address the deferred tax liability. Further, at the local UK level, realizability of the DTA relied on future taxable profits pursuant to the TAR, but documentation of the procedures completed to arrive at this conclusion was not evident. Although the UK was subject to specific scope, “income taxes including related deferred tax accounts” were determined by the audit team to be part of the specified scope components.



► At the end of 2012, the entity had approximately $56M of ITCs. As part of the impairment analysis, 50% of this balance was written off. The SRM states that "EY has audited this calculation and believes that management's calculation is reasonable". The tax working paper documentation to support this write off is a memo that says that the range of outcomes for writing this amount off is between $0 and $56M, the client has chosen to write off half the amount and that this result is "not unreasonable". The SRM contains the following: "We discussed with management whether they expect to utilize these credits over the next 20 years. Based on the impairment test for the refinery mentioned above management concluded that there was some uncertainty as to the amount of ITCs it would have available. In reviewing management’s VIU calculation, while some tax planning strategies do exist, most of these ITCs would not be utilized until 2018. Accordingly, we concur with management impairment amount of $ 27.7 million." In addition to the ITCs, significant deferred assets exist on the entity's balance sheet so sufficient taxable income will be required to utilize both the deferred tax assets and the ITCs. To retain an ITC asset of $28M and record a $28M write off, additional documentation/analysis should have been included in the working papers.

► The engagement team provided a verbal explanation as to why retaining 50% of the ITCs and write off the remainder was reasonable and documented its support for the existence of the gross amount of the ITCs ($56M). The engagement team had performed extensive procedures on the VIU calculation prepared by management.

Changes to income tax supplement


Background

In early July 2013 a new Global EY GAM Supplement on Audit Procedures for Tax Accounts was released. This supplement now replaces the previous Canadian guidance.► Significant reorganization of the guidance previously

contained in the Canadian supplement► Canadian guidance has largely been retained but is

significantly reorganized► Previously all guidance was contained within one

document, now located in three locations:► GAM supplement – TX_Taxes Supplement► AS_4.14 (O) Income Taxes► AS_4.15 (OO) Non-income Taxes


Tax Supplement

Presentation title

Tax Accounting Update - 2013 Presentation title


Professional Practice Consultations – Income Taxes

Majority of changes are contained in the consultation requirements, which are now listed in TX_12 Consultation and partner in charge requirements

Uncertain tax positionsWe are required to consult with the Sub-Area PPD in instances when: ► The sustainability of tax positions or transactions is necessary for the entity’s

ability to continue as a going concern► The terms and structure of a transaction dictate a required distribution or

otherwise reduce the flexibility of management ► Complex tax-advantaged transactions (consultation to include Tax Q&RM) ► An entity records in the current period a material tax benefit and we are

concerned that the entity’s documented evidence does not indicate a sufficiently strong likelihood of prevailing


Professional Practice Consultations – Income TaxesUncertain tax positions supported by third-party opinionGiven the nature of tax contingencies and diversity in practice, we are required to consult with the Sub-Area PPD when we encounter any of the following circumstances:► We believe that the tax advice (i.e., the tax opinion, earnings-and-profits study, transfer pricing

study, other “tax only” valuation report) of a third-party advisor presents a level of confidence that understates the merits of the position, and the difference affects the accounting or our audit conclusion (e.g., the third-party tax provider’s opinion is “substantial authority” and we believe the facts and circumstances and technical merits warrant an opinion with greater assurance, e.g. a “more-likely-than-not” level opinion). We expect this situation to be rare.

► The entity received a tax opinion from a third-party advisor that implies a high likelihood of success, with which we concur, for a transaction or tax position initially recognized in the current period, but the entity also records a material tax exposure liability related to that tax benefit. The entity needs to document the basis for its tax exposure liability and we include such documentation, as well as the basis for our conclusion on such liability, in the audit work papers.

► The entity, for an open tax period, received an opinion from a third-party advisor that provides a lower level of assurance, namely less than 50% likelihood of success, but has reflected a material benefit in a current or prior period.

► We conclude the third-party advisor’s opinion overstates the merits of the position and the resulting accounting effect is material.

► The entity records in the current period a significant tax benefit and we are concerned that the documented evidence does not indicate a sufficiently strong likelihood of prevailing.



Recognition of deferred tax assetsIn addition, discussion with a professional practice partner, and relevant tax professionals is encouraged in any situation when: ► An entity has recognized significant gross deferred tax assets, the recovery of which is based on

either tax planning strategies or expectations as to future taxable income.

Consultation with a professional practice partner is required in any situation when:► When IFRS is the applicable financial reporting framework: The utilization of deferred tax assets

(those arising from either deductible temporary differences or tax operating loss carry forwards) is dependent on future taxable profits in excess of the profits arising from the reversal of existing taxable temporary differences and the entity has suffered a loss in either the current or preceding period in the tax jurisdiction to which the deferred tax assets relates; or serious consideration is being given to a report modification for material uncertainties relating to the entity's ability to continue as a going concern; or the entity has recently emerged from bankruptcy.

► When US GAAP is the applicable financial reporting framework: Deferred tax assets (those arising from either deductible temporary differences or tax operating loss carry forwards) are recognized by an entity based on projections of future income, and the entity is in a cumulative loss position (as described in 6.6.1, “Cumulative losses,” in the US FRD, Income Taxes); or serious consideration is being given to a report modification for material uncertainties relating to the entity's ability to continue as a going concern; or the entity has recently emerged from bankruptcy.

http://gaait-aa.ey.net/Document.aspx?NodeId=1132849&ProductId=111&Title=I1.1.6%20%20Valuation%20allowances



Addressing entity concerns regarding documentation of tax exposure accruals ► If management attempts to restrict the nature and extent of our procedures and/or our

documentation we maintain in our work papers related to tax exposure items, we are required to consult with the Sub-Area PPD.

Addressing entity concerns regarding our tax work papers► Any requests to gain access to our tax work papers are discussed promptly with the

engagement partner (and generally the tax reviewer) who is required to obtain the advance approval of the Sub-Area PPD and Sub-Area Tax Quality and Risk Management and general counsel prior to granting access to our tax work papers.

► If, after discussion and review of our policy regarding access to our work papers, the entity requests additional information about our precautions regarding the nature extent and timing of our documentation of tax exposure items, the engagement team consults with the Sub-Area PPD and others as appropriate.


Tax Supplement - Transfer Pricing

The new guidance contains TX_Appendix_1 Transfer Pricing► Previous Canadian guidance had no similar section► This appendix provides teams with additional guidance on completing

audit procedures around transfer pricing► Key points:

► Audit of transfer pricing, like other tax accounts is the responsibility of the audit team – the inclusion of transfer pricing professionals is a matter of professional judgment;

► If it is determined that transfer pricing professionals are involved, they should attend the team planning event;

► Appendix provides guidance on significant classes of transactions, IT and internal controls, design and execution of audit procedures, and documentation requirements;

► All audits of transfer pricing should be conducted in accordance with the guidance in the Appendix.


Tax Supplement – Transfer Pricing

► Audit Objectives:► Tax expense reflects transactions between related parties that

have been recorded at arm’s length;► Tax expense reflects transactions that have been recorded in

accordance with an agreed up Advance Pricing Arrangement;► Uncertain tax positions associated with transfer pricing are

appropriately recognized;► Disclosures are appropriate



The following factors are considered to assess the need to involve transfer pricing professionals / and whether transfer pricing is considered a significant risk:► Proper pricing of transactions:

► Material related party transactions;► Transactions between countries that do not have a tax treaty with one another;► Transactions between countries with significant differences in tax rates;► Significant losses resulting from intercompany transactions;► Intangible property transactions;► Cost sharing arrangements;► Restructuring – functions and risks moved between entities;► Fundamental industry changes;► Entity has a business model which differs from the industry generally;► Extensive use of intercompany debt financing;► Use of complex transfer pricing methods;► Existence of transfer pricing controversy



► Additional factors to be considered in assessing the need to involve transfer pricing professionals / and whether transfer pricing is considered a significant risk:► Proper documentation to support pricing:

► Non-documented / non-compensated transactions;► Insufficient evidence to support non-arms length pricing;► Equity accounted for investments with significant transactions;

► Proper accounting for the documented price► Significant number of intercompany transactions;► Potential for intercompany transactions not to be recorded;► Accounting records are inconsistent with the arm’s length price

documented in transfer pricing studies


New Form U281

► US Firm issued a new Form U281 in November 2013. ► Canadian version of U281 currently being updated, and

should be available for December 31, 2013 audit engagements;

► Ensure using the correct U281 for all audit engagements


New Form U281 - Continued

► New U281 contains new or clarified procedures to address recurring quality inspection findings, including:► Additional steps for reviewing assertions with respect to the

reversal of outside basis differences in investments in subsidiaries, branches, associates and joint ventures;

► Additional steps related to the audit of transfer pricing; ► Additional steps for income tax matters associated with business

combinations;

► New U281 also clarifies guidance on when a technical subject matter professional should be part of the engagement team.

Audit risks in the current environment


Audit risks in the current environment – Summary of current developments

► Government deficits and debt are now driving a far greater focus on raising tax revenue;

► High rate of tax policy legislative and regulatory change continues, as do changes in tax administration, to improve tax enforcement;

► In many countries, tax activism and media coverage is sparking broad public discussion and political focus on business taxation in a multinational corporation context;

► The G8 and G20 have been swift to express support for the multilateral work of the Organisation for Economic Co-operation and Development (OECD) in this area, and an action plan is now in place

► The European Commission is active in this space► Media attention is increasingly focused on companies accused of not

paying a “fair share” of tax


Audit risks in the current environment – Hearings before Government Committees

► In May 2013, a U.S. Senate subcommittee held hearings to discuss the tax planning strategies of multinational corporations, including questioning of executives of Apple, Hewlett Packard and Microsoft

► Focus on how they used international tax planning structures to reduce their tax liability

► Hearings before the U.K. Public Accounts Committee publicly questioned executives from companies such as Starbucks and Google as well as Big 4 professional services firms and the UK Tax Authority including questions about tax strategies undertaken by multinational corporations to reduce taxes paid in the U.K

► Much of the questioning focused on whether the companies’ current operations were in line with those considered when the initial tax planning was implemented


OECD BEPS project

► The OECD “Action Plan on Base Erosion and Profit Shifting” was released on 19 July 2013

► Plan sets forth 15 Action areas where the OECD will focus work over the next 2 ½ years, including:

► Address concerns with respect to the digital economy (Action 1)

► Establish international coherence of corporate income taxation (Actions 2 through 5)

► Restore the full effects and benefits of international standards (Actions 6 and 7)

► Assure that transfer pricing outcomes are in line with value creation (Actions 8 through 10)

► Ensure transparency while promoting increased certainty and predictability (Actions 11 through 14)

► Address the need for swift implementation (Action 15)


Tax Transparency

► A key issue in the “fair tax” debate is the demand (European Commission, Extractive Industries Transparency Initiative, OECD, G8) that multinational corporation’s should publish more information in order to be “transparent”

► Along with European Council proposals in this area, some countries such as Australia are legislating for increased tax transparency requirements

► Implications of the need for increased transparency include:► The demand for greater public disclosure derives from the

complexity of multinational corporation’s international activities ► Public stakeholders desire greater transparency from companies

but companies are concerned about misleading reporting and maintaining commercial confidentiality

► An increasing number of companies are considering voluntary disclosure of tax and socio-economic contributions


Key areas of risk related to taxation

► Transfer pricing & intercompany transactions;► Intercompany transactions involving intangibles;► Treaty shopping;► Intercompany transfers of assets;► Existing tax structures – increased focus by tax authorities

on the execution of existing structures.


Considerations for our audit of income taxes of multinational corporationsOur client specific audit strategies and procedures may need to be updated to address tax specific risks. Additional procedures may include:

► Reviewing the documentation supporting current tax planning and transfer pricing structures for accuracy and completeness

► Determining whether internal controls are designed to ensure periodic evaluation of compliance with the objectives and requirements of these tax planning structures and that these controls operate as designed

► Assessing potential risks that the company‘s operations are not in line with the its documented structures; continuing to test current tax structures to determine that changes in the business have not increased risk or created exposure where one did not previously exist

► Considering potential permanent establishment exposures and whether the company has sufficient internal controls to identify when such exposures arise

► Reviewing material cross-border intercompany transactions and transfers of intellectual property for potential tax risks; considering potential risks related to hybrid entities or instruments if the tax rules were to change

Accounting for upstream loans – outside basis considerations


Accounting for upstream loans – outsidebasis considerations

► Under new rules, certain loans have consequences to a Canadian parent company. The following are examples of loans that would be caught under these rules.

Loan

CANCO

Loan

Loan to Canco

Loan toForeign Parent

FA

FPCANCO

FA CANCO

FA

FP

FA

Loan

Side to Side Loan



► Income inclusion to the taxpayer resident in Canada for the amount of the upstream loan (special rules if equity percentage in affiliates is less than 100%);

► Loans between controlled foreign affiliates should generally be exempt from these rules;

► Exception to the income inclusion:► Loan is repaid with two years (of the date the loan was made) and

the repayment was not part of a series of loans and repayments;► Loans incurred on or before April 19, 2011 provided transitional

relief – must be repaid prior to April 19, 2016.



► Income inclusion can be reduced to the extent of:► Exempt surplus, taxable surplus or hybrid surplus;► Pre-acquisition surplus (i.e. tax basis)

► Meant to replicate the consequences as if an actual dividend had been paid up the chain to the taxpayer resident in Canada

► These rules have significant implications to the accounting for an entities investment in its subsidiaries, associates, branches and joint ventures;



► Upstream loans form part of the assets of an underlying subsidiary, and implicitly form part of the carrying value of the subsidiary;

► Previously, if there was no intention to distribute assets of the subsidiary (including the upstream loan), then the conditions not to record any deferred taxes associated with an inherent outside basis difference may have been met;

► New rules may force the repatriation that was otherwise not expected in the foreseeable future.



► Under these rules, where an upstream loan exists, an income inclusion will result if the loan is not repaid. Since the condition giving rise to this income inclusion already exists (i.e. the loan is in place), this is a temporary difference;

► Canadian entities should include a deferred tax liability in respect of the income inclusion associated with upstream loans, unless rationale for not including exists.



► The following are reasons why an entity may not record a deferred tax liability in respect of an upstream loan:► The entity expect to repay the loan within the 2 year time period.

► Must consider ability to repay loan; ► Must revisit outside basis difference determination – will the funds

repaid remain in the foreign subsidiary or will then be subsequently repatriated?

► The entity has sufficient surplus pools to shelter the income inclusion (i.e. the measurement of the deferred tax liability would be nil as a result of surplus pools or sufficient tax basis);

► The entity can execute tax planning to reduce the exposure to the upstream loan rules (limited tax planning can be considered for the purposes of assessing the deferred tax liability on outside basis differences);

Unrecognized tax benefits



► During July 2013, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) of ASC Topic 740 (income taxes) related to the presentation of unrecognized tax benefits when a net operating loss carry forward, similar tax loss or tax credit carry forward exists.

► ASU 2013-11 provides that a liability related to an unrecognized tax benefit would be offset against a deferred tax asset for a net operating loss carry forward, a similar tax loss or a tax credit carry forward if such settlement is required or expected in the event the uncertain tax position is disallowed. In that case, the liability associated with the unrecognized tax benefit is presented in the financial statements as a reduction to the related deferred tax asset for a net operating loss carry forward, a similar tax loss or a tax credit carry forward.

► In situations in which a net operating loss carry forward, a similar tax loss or a tax credit carry forward is not available at the reporting date under the tax law of the jurisdiction or the tax law of the jurisdiction does not require, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit will be presented in the financial statements as a liability and will not be combined with deferred tax assets.



► The ASU is 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.

► The ASU should be applied prospectively to unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The new guidance will likely change balance sheet presentation of unrecognized tax benefits and deferred tax assets.

Accounting for uncertain tax positions



► As most tax systems are self assessment systems, most GAAP’s have evolved to one of supporting that an enterprise has a right to a tax benefit taken (a benefit or asset model)

► A UTP exists when there are more than one possible outcome related to a tax position taken by a taxpayer

► IFRS, PE GAAP and US GAAP each have similar, but slightly different ways, for accounting for UTPs

► Because of the lack of detailed guidance, varying practice exists for the accounting for uncertain tax positions.



► No specific guidance under IFRS; ► IAS 12 requires taxes to be recorded at the “amount

expected to be paid”► IAS 37 specifically excludes income taxes; ► Significant variance in practice has resulted:

► Use of the principals of IAS 37 (i.e. a two step approach to determining a liability for uncertain tax positions)► Even under this approach, variance in practice over measurement

(single best estimate, weighted average probability, range, other)► Use of a one step model to recording uncertain tax positions (i.e.

Uncertainty of the outcome is reflected in the measurement of the liability and not whether or not a liability is recorded)



US GAAP IFRS ASPE

Initial recognition More likely than not that there is a benefit

Liability method – one step or two step approach

Probable that there is a benefit (MLTN also used in practice)

Measurement Cumulative probability >50%

Amount expected to be paid or recovered – different possible methods acceptable

Single best estimate


2013 Tax Accounting Update

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