LEDGER · 10/1/2018 · 34 | Mazars USA Ledger is the same, i.e., it is a fixed amount of money that must be managed well to ensure the timely provision of high quality and cost-effective

LEDGER

NOVEMBER/DECEMBER 2018 Mazars USA LLP is an independent member firm of Mazars Group.

DECRYPTING CRYPTOCURRENCY

TAXES

2 | Mazars USA Ledger

CONTENTS

November/December 2018 | 3

CONTENTS

*The Mazars USA Ledger contains articles and alerts published from October 1, 2018 - November 30, 2018.

4 | Questions Healthcare Companies Should Ask About the Data Driven Revenue Cycle

6 | What’s Broken in Healthcare

8 | Decrypting Cryptocurrency Taxes

12 | Cryptocurrency Attracting the Next Generation of Renters 14 | Lease Accounting for Broker Dealers

19 | Puts on Non-Controlling Interests: What Changes Are Proposed in the FICE Discussion Paper

23 | Healthcare Policy and Procedure Best Practices

26 | FICE Discussion Paper: The Board's Preferred Approach to Classifying Financial Instruments as Liabilities or Equity

33 | Why Provider Organizations Should Be Proponents of Capitation

37 | IFRS Alerts

39 | Real Estate Alert

41 | Tax Alerts

NOVEMBER/DECEMBER 2018


QUESTIONS HEALTHCARE COMPANIES SHOULD ASK ABOUT THE DATA-DRIVEN REVENUE CYCLE

A WHILE BACK, WHEN YOU FIRST READ ABOUT THE EQUIFAX CYBER BREACH WERE YOU SURPRISED? IT SEEMED ODD, CON-SIDERING THEY ARE ONE OF THE LARGEST ORGANIZATIONS IN THE BUSINESS OF HOUSING AND SELLING YOUR PERSONAL AND FINANCIAL DETAILS.

I THINK MANY OF US THOUGHT COMPANIES LIKE THEIRS WERE BULLET-PROOF. THERE MAY HAVE EVEN BEEN A CASUAL CONFIDENCE AND ASSUMPTION THAT COMPANIES LIKE THAT WOULD EMPLOY SOME OF THE STRICTEST DATA PROTECTION MEASURES AVAILABLE. THEY WERE ALSO IN THE BUSINESS OF ACCURATELY ANALYZING YOUR FINANCIAL BEHAVIOR.

THE INTEGRITY OF THIS DATA WAS ENORMOUSLY IMPORTANT, CONSIDERING CREDIT MARKETS RELY ON IT TO MAKE SOUND DECISIONS AS TO WHETHER OR NOT YOU ARE LIKELY TO REPAY A DEBT. THIS BREACH CHANGED THE WAY WE LOOK AT OUR OWN IDENTITY PROTECTION AND LESSENED OUR TRUST IN THE BIG THREE REPORTING AGENCIES.

COMPANIES LIKE EQUIFAX DO MUCH MORE THAN ASSIST THE CREDIT MARKETS. THE BIG THREE - EXPERIAN, TRANS UNION AND EQUIFAX - HAVE GROWN TO BE SIGNIFICANT PLAYERS IN THE HEALTHCARE SPACE. THEY ARE DATA PARTNERS SUP-PORTING EFFORTS TO REFINE WORK-FLOW AND REDUCE COSTS TO COLLECT FOR SOME OF THE LARGEST HEALTH SYSTEMS IN THE COUNTRY.

PROVIDERS EMBRACED ANALYTICS THAT PROVIDED THEM WITH INFORMATION REGARDING A PATIENT’S PROPENSITY TO PAY THEIR BILL. THEY EMBRACED HAVING THE ABILITY TO MOVE INDIGENT PATIENTS OUT OF THEIR COLLECTION TEAMS AND STRAIGHT TO PRESUMPTIVE ELIGIBILITY FOR A CHARITABLE WRITE-OFF. EMPLOYING THESE AUTOMATED MANAGEMENT TECHNIQUES MEANT HOSPITALS COULD COLLECT MORE MONEY AT A LOWER COST.

SO WHAT NOW? THERE ARE NUMEROUS QUESTIONS THAT NEED TO BE ANSWERED. WAS YOUR PATIENT DATA PART OF THE BREACH?

BY DOUG BARRY

HEALTHCARE


Most likely there won’t be any implications for the majority of providers with the exception of those hospitals that chose to place their patients who failed to pay timely into one of the three credit bureaus with the hopes of securing payment in the future. But what about patients who are processed through the three credit agencies to determine eligibility or the likelihood of paying their debt?

With so many news stories highlighting a solution or protective measure requiring consumers to “freeze” their credit, it begs the question as to what that will ultimately mean for hospitals and physician practices who utilize this data on a regular basis.

How many patients will opt to take this freezing measure? Will this begin to impact the integrity of the financial modeling you apply today? Doesn’t your automated receivable flow for propensity to pay and presumptive charity el-igibility rely on the financial information provided by these credit agencies? It most certainly relies on a large portion of it.

So what is the potential impact on your operations? Will patients who freeze their personal credit files provide you with incomplete or less accurate data on which to base your decisions? Will it simply reduce the number of patients you can automate into a preferred work flow?

One thing is for sure; you need to explore the impact with your current ven-dor, and you need to plan to address it. A significant reduction in available data could ultimately impact your staffing should you begin reverting back to more manual processes when assessing patients’ abilities to resolve their debts.

It is by now clear that we live in an era in which healthcare organizations are forced to allocate valuable dollars away from delivering patient care and towards improving information systems security.

Facilities must invest heavily to protect their patient’s information from be-ing hacked or accessed by an increasing number of outside threats. More and more we read about attacks on healthcare organizations by foreign and domestic cyber criminals.

Those successful in accessing a provider’s system can bring internal op-erations to a grinding halt. Frequently the attack is coupled with a ransom

demand to stop that facility’s information from being made public. The data can contain medical and demographic information including social security and date of birth, which are frequently sold on the black market for profit. IT Security Officers should frequently be at senior management meetings keeping them informed of potential threats and conveying current steps taken to shore-up defenses.

What about the vendors who provide services to the organization? Health-care providers tend to have numerous buyers of products and services in a single organization. Frequently, receivable vendors are engaged without the level of IT scrutiny needed in order to protect an organization from possible threats. When I was in the provider space, I can’t remember ever having to share a desired tool with an IT Security professional before moving forward.

In Revenue Cycle there are numerous technical applications sold on the market intended to help improve financial performance. The contracting phase usually concludes before the IT professionals get an opportunity to dig into the details. Allowing executives to engage vendors without having their IT Security team dictate the strength and minimum standards required for technology invites trouble.

These products are sought after by Revenue Cycle professionals because of their perceived technical superiority when compared to the offerings of most HIS systems. The perception of advanced technical capability often can be misinterpreted by the buyer to mean they have somehow met very stringent security guidelines. It can leave one with a false sense of security. When we perform assessments of clients, we often see these types of con-tracts have not been appropriately vetted. It is essential to have a qualified cyber security expert assess your situation.

Whether you use data to streamline your workflow, technology to enhance performance, or just want to protect patients’ identities from being compro-mised, the need to be more collaborative and to engage in interdepartmen-tal reviews and discussions prior to making any decisions to provide a third party with your data has never been more important.

Doug is a Principal in our New York Practice. He can be reached at 212.375.6558 or at [email protected].

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WHAT’S BROKEN IN HEALTHCAREBY MARK MARTEN

HEALTHCARE

While many in this nation are confused about the direction of healthcare, we look toward the future. Regardless of the design, one thing is clear – we need more accountability in healthcare. There still isn’t a clear understanding of risk-based contracting in the industry. This value-based payment model is inevitable and will ultimately shape the future of health-care in a way that will be mutually beneficial to patients, providers, and payers. So why are the details still so murky, and where does all this trepidation come from?

As with many visionary endeavors, risk-based payment sharing can require heavy collabora-tion, strategic planning, complex contracts, a slow return on investment, and uncertainty in the near term.

Risk Sharing 101Risk-based payments are meant to provide more accountability by requiring providers and hospitals to share in the risk of treating the entire spectrum of a population. Physicians are required to lower costs by providing quality care to reduce utilization, while hospitals must learn to deliver care more efficiently and coordinate with others.


MEDICARE LEADS THE WAYOver the last 50 years, we have seen Medicare take the lead on reforming the delivery of healthcare. Some of their initiatives have already succeed-ed and others are still a work in progress. Medicare introduced DRGs to control costs and better manage the episode of care in a hospital by paying a set amount per diagnosis, thereby reducing the hospital’s incentive to extend stays and encouraging them to provide care more efficiently. More recently, Medicare introduced bundled payments to manage the cost of a case from pre-admission through discharge to follow up.

PARTIAL RISKBoth DRGs and bundled payments are examples of partial risk. If the cost of care is higher than the set payment, the hospital and/or provider will take a loss. This arrangement encourages innovation, quality care, and efficiency in order to drive down medical costs and turn a profit. This is in direct oppo-sition to the fee-for-service (FFS) model, which incentivizes a high quantity of care rather than quality. Many believe that FFS withholds and discounts are risk, but they are not. These models have shared savings, not shared risk. However, even these forms of risk are not true risk because they do not account for the total cost of care for a population.

SHARED RISK POOLSThe first step for many health plans has been to set up shared risk pools, wherein groups of physicians with a payment incentive arrangement work with health plans and other providers in the community to manage costs. When they are successful, they have a reserve in the pool attributed to those members. These reserves allow the group to invest in additional services to prevent diseases and better manage chronic conditions.

This limited shared risk arrangement will evolve into taking global risk where the entity is responsible for physician, hospital and other provider costs for the population. Some of the investments that are put into place with these savings are home-based services, chronic care centers, dedicated nurses for case management and coverage of items needed to ensure a healthy population that often require unique services not covered by insurance.

TRUE RISKTrue risk is accountability for the total cost of care for the lifetime of a pop-ulation. Some members are healthy and rarely access care, while others require intense services provided by multiple professionals. We must get to a point where we as collective providers are responsible for the cost of care for an entire population. This can be done through working with a communi-ty and taking on the payment and administration of services.

One successful true risk model is Medicare Advantage, wherein a plan is paid a monthly capitated fee to provide care for its assigned members. This is most often delivered through a network of physicians and providers who are responsible for some or all of the prepaid amount. They must keep the cost of care less than the payment in order to make a margin so they can continue to reinvest in the lifetime care of their patients.

Generally, using the alternative MTM method is more beneficial to a major-ity of taxpayers. It allows taxpayers who failed to make timely elections to utilize the simpler MTM method and avoid being taxed at maximum rates along with an interest charge. Of course, there are instances in which the alternative MTM method may not be the best option. Taxpayers who did not dispose of, or receive, distributions from their PFIC investments, and taxpayers who disposed of PFIC investments at a loss are two examples of situations that call for a further analysis.

DRAWBACKSCommercial Plans are beginning to implement risk-based payments, but a major drawback of following the Medicare Advantage model is that mem-bership changes often in today’s transient society. When the health plan invests heavily in their member’s treatment and the newly healthy patient changes their insurance, this significantly inhibits the plan’s ability to realize an ROI on that treatment. Why invest in the health of a member that will change plans? Without limiting the patient’s choice in health plans, perhaps there could be a risk-sharing arrangement among commercial plans, wherein a small tax is imposed on all commercial premiums that would fund an incentive pool. This would provide value-based payments to health plans when their member leaves after receiving care that substantially improves their health.

NEXT STEPSSharing risk can be complicated and intimidating, but it’s a step in the right direction for the healthcare industry as a whole.

As Medicare and Medicaid push to shift from fee-for-service to value-based care, we should embrace the change and be proactive in taking on this new responsibility. If you need help with risk-based contracting, contact the Mazars Healthcare Consulting Group at mazarsusa.com/hc.

Mark is a Principal in our Los Angeles Practice. He can be reached at 949.584.7247 or at [email protected].


FINANCIAL SERVICES

DECRYPTING CRYPTOCURRENCY TAXES LIMITED GUIDANCE ON TAXATION

DESPITE THE BILLIONS OF DOLLARS (WHICH IS PROJECTED TO BE TRILLIONS IN 2018 ACCORDING TO A SEPTEMBER 2018 SATIS GROUP REPORT) FLOWING IN AND OUT OF THE VARIOUS CRYPTOCURRENCIES SUCH AS BITCOIN, ETHEREUM AND LITECOIN, THE UNITED STATES TAXATION OF THESE PRODUCTS IS GOVERNED MOSTLY BY INTERNAL REVENUE SERVICE (IRS) NOTICE 2014-21 ISSUED BACK ON MARCH 25, 2014. WITH REGARDS TO THE NUANCES AND UNCERTAINTIES NOT COVERED BY THE NOTICE, THE IRS HAS CHOSEN TO REMAIN MOSTLY SILENT.

WHAT IS CRYPTOCURRENCY

What is a cryptocurrency? Unlike United States Dollars, British Pounds or Euros, cryptocurrencies only exist in the virtual universe, meaning there is no tangible paper bill or metal coin that can be physically touched. Nor are they considered legal tender. Instead the Internet and only the Internet is used to transfer Bitcoin or Ethereum tokens from their originators to every subsequent owner. A price is set at an Initial Coin Offering (ICO) or Initial Public Coin Offering (IPCO) and then trading begins in the virtual universe. This is done through a secure Internet portal account sometimes called a coin wallet.

A register, accessible to all owners extemporaneously, tracks everyone’s ownership and is called a blockchain. This register is updated every time ownership changes. The details of your ownership represented in this blockchain that all others can see is sometimes called your public key. Access to spend any of your cryptocurrency in your coin wallet is provided by a private key. This private key is a long list of numbers and letters which needs to be kept secure to prevent losing access.

There are three types of cryptocurrency tokens generally – utility, security and payment:

§ Utility or user tokens enable the holder access to a future service being developed – Filecoin, Flipcoin and Storj are examples.

§ Equity security tokens are similar to stock shares in that they carry an ownership element, may have voting rights and can earn “dividends.” Digix is an example. Debt security tokens act as short-term loans to a company and earn the equivalent of interest – Steem utilizes such a scheme.

§ Currency or payment tokens are used as their name implies – Bitcoin, Litecoin, ZCash and Monero are examples.

HOW CRYPTOCURRENCY IS EXCHANGED

Cryptocurrencies can be exchanged in a few ways. They can be sold for cash on certain websites that act as exchanges such as Coinbase, Bitstamp or Kraken. They can be exchanged for other types of cryptocurrency on sites such as Shapeshift. They can be sold directly to another person at a price you set that is accepted on sites such as LocalBitCoins or BitQuick. They can even be converted to a local currency and withdrawn from an ATM at places found on Coinatmradar.

For investors not wanting to own cryptocurrencies directly or wanting to use a manager to invest in them, options have begun to open up. Privately traded partnerships such as hedge funds or private equity funds have begun to trade in cryptocurrencies and offer investors access to their appreciation (or depreciation) through the private placement of these partnership interests.

Coinbase’s institutional arm has been approved as a qualified custodian by the state of New York and BitGo by South Dakota. This license allows them to securely hold deposits of cryptocurrencies much like a bank account.

ORIGINS

Fluctuations in cryptocurrency value depend mostly on people’s perception of the value and are not necessarily tied to anything – such as earnings of a company, the value of gold or what your dog wants for breakfast that morning. Their creation came from a desire to allow fast, better secured, less costly transfers of value between consumers and producers without

BY GREGORY KASTNER


the use of bank accounts or credit cards. Ability to avoid use of trusted intermediaries while retaining anonymity was also coveted.

Ideally, they would be immune to fluctuations in just one country’s currency and to counterfeiting or theft. Obviously, as the market has grown and speculators have stepped in, cryptocurrency’s utility has increased from a way to pay for goods or services to also an avenue for speculative investment. Because of the sometimes extreme volatility in values created by these speculative investments, some merchants or individuals won’t accept these highly fluctuating cryptocurrencies in lieu of more traditional forms of payment.

Cryptocurrencies are generally taxed in one of two ways, depending on how they were acquired. One area the IRS has not addressed is whether their use affects their taxation as well.

MINING CLASSIFIED AS A U.S. TRADE OR BUSINESS

When involved in the “mining” or creating of cryptocurrencies, the taxpayer could be considered as engaged in a trade or business. The implications of such can be significant. Income generated from a United States (U.S.) based trade or business is generally Effectively Connected Income (ECI) – that is, U.S. sourced and subject to federal tax withholding if any profits flow through a partnership or joint venture to a foreign entity or individual.

If a partnership interest involved in producing such income is sold, the proceeds would also be subject to withholding under the new Tax Cuts and Jobs Act (TCJA) changes to Internal Revenue Code (IRC) §864 and §1446 taking effect in 2018. Such income will presumably also be treated as subject to self-employment tax under IRC §1401 if not received by an incorporated entity. If any of the income flows to a pension plan, charity or IRA account, it could also create an unexpected tax liability as this income


FINANCIAL SERVICES

will also be classified as Unrelated Business Taxable Income (UBTI) under IRC §512.

For amounts flowing to an individual, such income would be treated as ordinary income and not receive any preferential tax rate such as those available to long term capital gains or qualifying dividends. A limited partner would classify such income as passive under IRC §469 and generally avoid paying self-employment tax on any profits. General partners and limited liability company (LLC) managing members would receive non-passive income subject to the self-employment tax. If the self-employment tax element is a concern, structuring the entity as a limited partnership (LP) instead of as an LLC might be preferable. By statute, limited partners in an LP are not subject to the self-employment tax. LLC members are not distinctly protected by that same statute.

Another possible unexpected consequence of “mining” is that such income could also be classified as state-sourced and have state income taxes and withholdings due. If where customers reside and where the “mining” is done differ, different states’ sourcing rules could possibly subject more than 100% of the income to state income tax as there is not universal uniformity across states with regards to such rules.

Cryptocurrency is not tangible personal property nor is it services and so its sale would not incur sales or use tax as would be due in other retail businesses.

MINING CLASSIFIED AS A HOBBY

If the “mining” of a cryptocurrency does not rise to the level of a trade or business, the IRS could argue any losses incurred should be classified as hobby losses under IRC §183 and not be allowed. Generally, a good faith expectation of profit governs such classification. Usually, a single occurrence does not rise to the level of trade or business.

HELD FOR INVESTMENT

If the taxpayer is not “mining” and only involved in buying and selling cryptocurrency created by others, it is treated as an investment in property. As such, gain or loss is treated as capital in character. For individuals, if it is held one year or less, it is treated as short term capital gain or loss and long term if held longer.

Under the TCJA, long term capital gains carry a maximum federal rate of 20% and short-term capital gains carry a maximum federal tax rate of 37%. Only $3,000 of capital losses in excess of capital gains are allowed to an individual per year and any of these unused losses can be carried forward indefinitely. Such income is also net investment income for purposes of the 3.8% tax on individuals with modified adjusted gross income over $200,000 ($250,000 for married couples filing jointly).

For corporations, no capital losses in excess of capital gains are allowed and there is not a different federal income tax rate for long term versus short term. With some restrictions, capital losses may be carried back three years for corporations and forward only 5 years, dissimilar to the rules for individuals.

Under the TCJA, however, corporations are subject to a maximum federal tax rate of only 21%. In the past, long-term investments were probably held at the individual level because of the tax rate differential providing a more beneficial answer. Now, if long-term investments’ appreciation help fund a business, it may make more sense to leave them in a corporation. Most states do not have a different rate for capital versus other types of income.

Such capital gains or losses on sales of cryptocurrency are presumably portfolio and not passive for purposes of limited partners in a fund that invests in cryptocurrency. As such, income would not be able to be offset against other passive losses such as from a real estate limited partnership interest.

Presumably, if one were to buy and sell cryptocurrency continually throughout the year, losses would be subject to the wash sale rules under IRC §1091. Different types of cryptocurrency probably would not be treated as “substantially identical” for this section but if such a trading strategy were employed, these rules need to be considered.

To avoid having to analyze the historical trading for purposes of such tracking, could the Bitcoin or Ethereum be treated as a security and be eligible for the mark-to-market rules of IRC §475(f) if a timely election is made? Since cryptocurrencies are not traded on what is defined as a qualified exchange at this time, presumably they would not be eligible for IRC §1256 mark-to-market treatment as 60% long term capital gains/losses and 40% short term capital gains/losses. Cryptocurrency does not create foreign currency gains or losses as defined by IRC §988.

Shorting a cryptocurrency (borrowing with the promise to repurchase in the future in the hopes the value will drop) would also require looking at the straddle rules of IRC §1092.

Debt tokens, presumably, would be subject to the market discount and original issue discount rules of IRC §1276 and §1272. Some of the gains might need to be reclassed as ordinary income or a current inclusion of income might be required depending on the interest actually paid.

After the TCJA took effect at the beginning of 2018, only exchanges of real property are eligible for a tax-free exchange under IRC §1031. Prior to the new tax law, this was uncertain as the law did not specify real property, but only property.

Expenses attributable to the trading or investing in Bitcoin as an investment


would be subject to the same rules as investing in other securities, i.e. either being classified as an “above-the-line” ordinary deduction or as a miscellaneous itemized deduction whose benefit was eliminated for individuals by the TCJA. For corporations and PFICs, there is no such limit on these expenses and they are essentially treated as deductible expenses.

ASSIGNMENT OF BASIS FOR SALES AND FORKS

In terms of which layer is sold and how to assign a tax basis to such layer held for investment, the default method for sales of stock under Treasury Regulation §1.1012-1 would be first in, first out (FIFO). However, the option to identify the highest priced layer as being sold first is allowed. Such identification must be made at the time of the sale. Despite the regulation referring to sales of stock, many practitioners are applying these rules to cryptocurrency because of the similarities and not the average cost method available to holders of mutual fund (Regulated Investment Company) shares. No Form 1099s are currently issued from cryptocurrency operators, so the taxpayer would have to track the various layers and tax basis of each layer.

Another area of uncertainty with regards to tax treatment is that of forks of cryptocurrency (such as Bitcoin Cash for holders of Bitcoin). Forks generally occur when there is a change in the software that cryptocurrency miners use, sometimes because of a dispute, and owners of the current cryptocurrency receive new keys that give them value on a new blockchain.

Should this transaction be treated the same as a stock split and just some of the cost basis assigned proportionately to it? Is no basis assigned under the argument that no ascertainable value exists for the new cryptocurrency? Is income recognized to the extent that the new fork has a market value? If the old cryptocurrency is eliminated, is this some sort of tax-free exchange similar to those offered for stock under IRC §368, even if this does not all happen all at once? On these questions, the IRS has so far remained silent. However, there is a Supreme Court case from 1955, Commission vs. Glenshaw Glass Co. that many practitioners site as perhaps the governing doctrine.

According to the case, when a taxpayer receives undeniable accessions to wealth, clearly realized, and over which the taxpayer has complete dominion, a recognition of income must occur. If the new cryptocurrency, the fork, has value and can be traded without hindrance immediately, it appears there could be a taxable event upon the fork.

Unlike a stock split where the price has just been altered per share, something new has been created: a new cryptocurrency. If, however, a value cannot be placed on the fork or it cannot be traded now or with any definite timeframe in the future, it may not have to be recognized as income today. The IRS, however, is generally not too keen on deferrals of what they deem to be income and so these restrictions would have to have merit.

Regardless, forks have not been directly addressed by the IRS and so either approach is not definitively correct and each case should be analyzed individually.

USED TO PAY PERSONAL EXPENSES

What if cryptocurrency is directly used to pay for personal expenses? A gain or loss might be incurred. If it’s a loss, the taxpayer would have to argue that the cryptocurrency was held for investment and then a capital loss could be recognized. Personal-use asset losses are not deductible – such as losses on sale of a car or a personal residence like a house or boat.

If it’s a gain, the taxpayer would be required to recognize the gain under IRC §61. Failure to report such a gain could extend the statute of limitations from the normal three years the IRS has to assess additional tax to 6 years if the excess is substantial. Substantial is defined in this context as over 25% of gross income for the year. Some states extend the statute even longer than the federal government. If the omission is deemed fraudulent, however, there is no time limit.

If cryptocurrency is received for services as an employee, income still needs to be recognized for income tax purposes and all required payroll taxes paid by the employee and employer.

REQUIRED DISCLOSURES

Besides properly reporting the income tax consequences of any cryptocurrency transaction, any direct or indirect holdings of cryptocurrency could potentially be subject to information reporting as well. The filing requirements of Form 114, Report of Foreign Bank and Financial Accounts or the so-called FBAR, and Form 8938, Statement of Specified Foreign Financial Assets should both be considered if the cryptocurrencies are held by an offshore vehicle or held in an offshore coin wallet. Failure to file these forms in some cases can be argued as willful and the penalties severe.

Owners of cryptocurrency also need to comply with the Anti-Money Laundering rules initiated by the Bank Secrecy Act of 1970 and possibly file Currency Transaction Reports or Suspicious Activity Reports. All carry stringent recordkeeping requirements.

While there is a lack of specific guidance on the taxability of cryptocurrencies, the proper treatment and consequences can be extrapolated from other sources in most examples. Proper disclosures should be considered to prevent possibly severe penalties for non-compliance.

Gregory is a Director in our New York Practice. He can be reached at 212.375.6583 or at [email protected]


CRYPTOCURRENCY ATTRACTING THE NEXT GENERATION OF RENTERS

BY BISNOW, SPONSORED BY MAZARS

Tenants are beginning to pay their rent via a new type of currency.

Bitcoin, Ethereum and other cryptocurrencies have taken the business world by storm over the past year as new forms of payment that run on blockchain technology. Now, landlords and property managers are getting a piece of the pie by incorporating the

emerging trend into their operations to attract and retain a new generation of tenants.

"Our buyer has evolved, they've moved from mom and pops to young people who want to pay with various forms of payment," Magnum Real Estate Group President Ben Shaoul said to CNBC. "Cryptocurrency is something that has been asked of us — 'Can you take cryptocurrency? Can we pay that way?' — and of course when somebody wants to pay you with a different form of payment, you're going to try to work with them and give

them what they want, especially in a very busy real estate market."

REAL ESTATE


Shaul is among several owners and developers that believe offering cryptocurrency payment plans will give them an edge over their competition. The real estate industry is constantly looking for new ways to connect with an increasingly millennial

customer-base, and Bitcoin is one way to help them bridge this gap.

As the first generation to grow up using digital technology for everything from hailing a cab to ordering food, millennials have become accustomed to paying for things on their devices. They have embraced emerging technology to make their lives easier, and blockchain is the most recent example.

“Millennials are particularly open to embracing new technology in order to create opportunities for themselves--and blockchain, the tech behind crypto, is no different,” blockchain startup StormX CEO Simon Yu said to Forbes. “As masters of the side hustle and challengers of the traditional 9-5 working lives of previous generations, millennials are welcoming blockchain with open arms.”

Property managers who accept payments in cryptocurrency have two options. They can either keep the payment in the form of cryptocurrency and use it to pay for something else, or they can convert it into dollars. If they opt to convert the payment, it is important to know when to do so. Bitcoin fluctuates significantly in valuation, reaching $20K at the end of 2017 and beginning 2018 at a mere $14K. Today, it has dropped to almost half of what it was a year ago, but that number could change in a matter of days. Landlords and property managers who decide to convert cryptocurrency need to be strategic about when they cash in to ensure they are getting the most bang for their buck.

PropTech companies are also getting in on the action. ManageGo, a Brooklyn-based company that provides a platform for renters to make online payments, now gives tenants the option to make payments using Bitcoin

via the company’s app. When a tenant makes a payment using Bitcoin, ManageGo converts the currency into dollars. This allows tenants to pay the way they want, and landlords to receive payments the way they want.

“Industry players are starting to realize that there is major potential for blockchain technology to challenge the status quo above and beyond accepting cryptocurrency as a form of payment or executing transactions," Mazars USA Digital Asset Group Leader Andre Sterley said. "Other areas being targeted include title management, tokenized ownership and automation through the use of smart contacts around payment and agreements.”

Still, many industry professionals are reluctant to adopt the trend. There is still a stigma around cryptocurrency because it is so new.

"Currently we have had zero interest in paying rent through bitcoin," The Bozzuto Group CEO Toby Bozzuto said to CNBC. "You don't know who owns it, and that's the knock on it. It's been considered black market with a dirty reputation.”

Time will tell whether cryptocurrency will continue to transform the commercial real estate landscape, but all signs are pointing up. Slowly but surely, property managers are adopting these new payment methods into their business model. As the next generation of tenants becomes more acquainted with the use of cryptocurrency as a payment method, property managers are making changes to meet their demands.

This feature was produced in collaboration between Bisnow Branded Content and Mazars. Bisnow news staff was not involved in the production of this content.

Andre is the Digital Asset Group Leader in our New York Practice. He can be reached at 212.375.6629 or at [email protected]

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FINANCIAL SERVICES

Broker dealers get ready! The Financial Accounting Standards Board’s (FASB) long-anticipated update to lease accounting, Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASC 842), becomes effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. ASC 842 will have a significant impact on most broker dealers’ financial statements and disclosures. If you have not begun the analyses necessitated by ASC 842, there is no time like the present!

BY CHARLES PAGANO, BONNIE MANN FALK AND JASON GUTMAN

LEASE ACCOUNTING FOR BROKER DEALERS


The required transition disclosures included in the 2018 financial statements need to reflect the effect on the company’s financial reporting with execution beginning in the January 2019 FOCUS report. While the implementation will require broker dealers to

analyze their leases and recognize potentially material assets and liabilities on the financial statements and increase related disclosures, there is good news in that generally the effect on net capital and aggregate indebtedness should be minimal.

WHAT ARE THE MAJOR IMPACTS?

Lessees need classify their leases as either finance or operating; each classification has its own unique accounting treatment. Finance leases cover arrangements that transfer control of assets at the end of their term, include purchase options, cover most of an asset’s useful life, or involve highly specialized assets. These leases have been previously required to be recorded on the financial statements.

Conversely, operating leases do not transfer ownership at the end of the lease, do not include purchase options, have a lease term as part of the economic life, and do not have assets specialized to the use of the lessee. The Implementation Guidance of the standard (ASC 842-10-55-1) includes a decision tree to assist in the classification. In the broker dealer world, much of leasing transactions expect to be classified as operating leases.

Under the existing guidance, lessees recognize the expense of an operating lease ratably over its life. This “straight line” approach results in a more consistent bottom line. Moving forward, in addition to reporting a straight-line lease expense in their financial results, lessees will need to recognize an asset and a corresponding liability on their balance sheet. One of the most significant sources of lessees’ off-balance sheet financing and risk is now front and center in their financial statements, no longer solely delegated to a footnote disclosure.

Initially, the balance sheet gets grossed up to reflect a liability equal to the present value of the lease payments with a corresponding asset, now known as the “right of use” (ROU) asset, which results from a contract which conveys the right to control an “identified asset” for a period of time in exchange for consideration. Most commonly, in the broker dealer industry, the new standard calls for recording assets and liabilities related to the following leases for the use of:

§ Office rent § Trading, communication and information systems equipment § Offsite document storage § Software solutions for case management, billing, and compliance

One would have to be mindful whether a lease or service contract exists when analyzing the transaction. ASC 842 could affect those situations where

expense sharing or an administrative service agreement exists.

When determining the payments to be included in measuring the ROU assets and lease liabilities, one must consider all optional payments related to the lease. Payments to be made during an option period would be included only if the lessee is reasonably certain to exercise an option to extend or not to terminate a lease. Optional payments to purchase the assets at the end of the lease would be included only if the lessee is reasonably certain to exercise that purchase option. Options to extend or not to terminate that are controlled by the lessor need to be considered as well.

Keep in mind, the nature of lease payments impacts the broker dealer’s balance sheet. Variable lease payments are not included in the measurement of a lease liability and ROU, since this liability is not fixed. Common examples of variable lease payments include rental increases based on CPI or inflation rate.

In both examples, the tenant’s initial base rent may be the only payment which, in substance, is fixed. These variable payments can increase or decrease over time and cannot be estimated. Broker dealers may seek to negotiate greater variable terms in their lease payment structure to take advantage of this accounting treatment.

WHAT ABOUT NON-LEASE COMPONENTS?

Many lease arrangements cover services provided by the landlord, such as janitorial, common area maintenance, or onsite IT support. These typically meet the definition of a “non-lease component,” since they do not grant the lessee control over an asset. Lessees must assign a value to non-lease components based on their relative standalone prices or apply a practical expedient electing to account for the lease and non-lease components as a single liability. Performing an allocation may be time consuming, but applying the practical expedient may result in a significantly greater balance sheet obligation and related asset.

TYPICAL EXAMPLE

Let’s take a typical situation in a broker dealer with an operating lease scenario. Assume the broker dealer rents office space for a three-year period with total lease payments over 36 months of $ 36,000 with lease payments of $10,000, $12,000 and $14,000 for each year respectively. Assume a present value (“PV”) factor of 4.24% and no lease escalations. The lease payments and present values of the payments are as follows:


FINANCIAL SERVICES

As payments are made the lease liability is decreased as follows:

Each year the periodic lease expense is recognized using the average lease payment over the life of the lease. The difference between the lease payment and the lease expense is recorded to adjust the ROU asset. See the table and journal entries as follows:


The financial statement impact over the lease term is as follows:

WHAT ABOUT DISCLOSURES?

ASC 842 brings about new disclosures related to leases in order to provide users of the financial statement appropriate information to assess the amount, timing, and uncertainty of cash flows arising from leases. Amongst the highlights of the quantitative and qualitative information to be disclosed include, but are not limited to:

§ The Company’s leases o A general description of the leases o Basis, terms, and conditions on which carriable lease payments are determined o Existence, terms, and conditions of all options to extend or terminate a lease (whether or not they are recognized as part of the ROU asset or lease liability) and any residual value guarantees provided by the leases o Any restriction or covenants imposed by leases o Leases between related parties o Relevant information on short term leases

§ Significantassumptionsandjudgementsmade, including but not limited to: o Determination if a contract contains a lease o Allocation of consideration in a contract between lease components and nonlease components and the detail of any election of using a practical expedient o Determination of the discount rate for the lease

§ Amountsrecognizedinthefinancialstatements relating to those leases o Operating lease cost o Short-term lease cost, excluding expenses relating to leases with a lease term of one month or less o Variable lease cost

o Amounts segregated between those for finance and operating leases for the following: • Cash paid for amounts included in the lease liabilities • Supplemental noncash information on lease liabilities arising from obtaining right-of-use assets • Weighted-average remaining lease term (see the implementation guidance) • Weighted-average discount rate (see the implementation guidance) o Five year and beyond annual undiscounted cash flow maturity analysis of its finance lease and operating lease liabilities separately, including a reconciliation of the to the lease liabilities recognized in the balance sheet.

SEC NO ACTION LETTER OF OCTOBER 23, 2018 The SEC recognized the possible disastrous results on net capital and addressed the effect of ASC 842 two years ago. In a letter to SIFMA, from the SEC on October 23, 2018, the SEC rescinded a previously issued letter dated November 8, 2016. Both letters granted relief to broker dealers whereby an operating lease asset can be added back to net capital to the extent of the associated operating lease liability.

Additionally, the Division per the “No Action” letter “will not recommend enforcement action, if a broker-dealer determining its minimum net capital requirement using the AI (aggregate indebtedness method) does not include in its aggregate indebtedness an operating lease liability to the extent of the associated operating lease asset.” The SEC went on to comment that each lease stands on its own; that is, one cannot offset an operating lease asset on one lease with an operating lease liability of another lease.


REAL ESTATE

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Also remember that the amount of the asset may reflect additional costs such as direct initial costs, prepaid lease payments and lease incentives which will cause the asset to not equal the liability.

WHAT ARE THE STEPS TO IMPLEMENTATION?

§ Gather and catalog your current inventory of leases, store lease data in a centralized repository.

§ Design and implement a new lease accounting process to manage your organization’s lease data.

§ Select a software solution that will support your organization’s adoption of the new lease accounting standards, and ongoing lease monitoring and maintenance. In the case of minimal leases Microsoft Excel may suffice.

§ Compute the amount of the asset and liability and be ready to book for those with calendar years beginning on January 1, 2019.

§ Fully train staff on new software solution, design and implement internal controls.

§ Determine the effect on net capital, if any.

With yearend fast approaching now is the time to assess the effects of ASC 842. Companies need to be ready for 2018 transition disclosures and January reporting for your FOCUS filings. You want to implement processes and establish internal controls to capture the necessary data in your books and records and for disclosure in the notes to the financial statements.

The standards include comprehensive guidance to assist companies in applying the requirements of ASC 842. Once an entity completes its analyses, communication between the auditor and management ensures a smooth transition to a successful implementation.

Charles is a Partner in our Long Island Practice. He can be reached at 516.620.8553 or at [email protected].

Bonnie is a Director in our Long Island Practice. She can be reached at 516.620.8554 or at [email protected].

Jason is a Manager in our New York Practice. He can be reached at 646.225.5992 or at [email protected].


PUTS ON NON-CONTROLLING INTERESTS:

WHAT CHANGES ARE PROPOSED IN THE FICE DISCUSSION PAPER?

IFRS


IFRS

FOLLOWING ON FROM OUR ‘A CLOSER LOOK’ FEATURE ON THE FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF EQUITY (FICE) DISCUSSION PAPER IN THE JULY-AUGUST ISSUE OF BEYOND THE GAAP, THIS MONTH’S FEATURE WILL LOOK SPECIFICALLY AT PUT OPTIONS GRANTED TO MINORITY SHAREHOLDERS (‘PUTS ON NON-CONTROLLING INTERESTS’). 1. How did the current accounting treatment come about?

When IFRS standards were first implemented in 2005, they did not yet include provisions on changes in percentage holdings in a subsidiary, and the requirement to immediately recognize a liability for their obligation to buy back equity instruments in the future came as a surprise to French companies.

IAS 32 required (and still requires) that put options granted to minority shareholders should be recognized as liabilities at the present value of the strike price of the put option but did not give any further guidance on the contra journal entry. This has resulted in diversity in practice, both at the date of initial recognition and subsequently.

At initial recognition, entities have generally chosen one of two approaches, both of which anticipate the eventual buyback of the shares by the entity:• an approach that involves recognizing an additional goodwill for the

difference between the liability and the value of the shares likely to be repurchased; or

• an approach that involves recognizing the difference in group equity, on the assumption that this is permissible in the absence of any clarifications to the contrary.

Similarly, a variety of different accounting methods have been used for subsequent changes in the value of the liability:• recognition in profit or loss, based on the general assumption that

changes in the value of a financial liability have an impact on profit or loss;

• recognition in equity, based on the argument that an obligation relating to own shares should not have an impact on profit or loss (particularly if the strike price depends on the fair value of the underlying shares, which is quite often the case); or

• recognition in goodwill using the ‘partial goodwill’ method, which is consistent with the approach mentioned above that anticipates the buyback of the shares (all other things being equal).

The French Securities Regulator, the AMF, noted this diversity in practice, stating in its 2005 year-end recommendations that entities should give details of the accounting treatment used at initial recognition of the liability and for subsequent changes in its value.

The IFRIC (now the IFRS IC) also tackled the issue, trying to reach a

consensus but failing. Consequently, it decided in 2006 not to add the topic to its agenda.

In 2008, phase II of the Business Combinations project brought us a step further towards the current accounting treatment for puts on non-controlling interests, by reducing the number of permitted approaches. After this, IAS 27 was amended to stipulate that the impact of changes in percentage holdings in subsidiaries should be recognized in equity.

Logically, following these amendments, the AMF’s year-end recommendations for 2009 clarified that the use of the ‘partial goodwill’ method at initial recognition could still be retained for existing puts, but would no longer be permissible for new put issues. The AMF also stated that its preferred approach for subsequent changes in the value of the liability was recognition in equity, rather than in profit or loss; however, both approaches were still permissible.

In March 2011, the IFRIC tried to resolve the practical issues submitted to it by proposing to exclude put options written on non-controlling interests of subsidiaries, to be settled by the physical delivery of shares, from the scope of IAS 32. This would have meant that these puts would be accounted for under IAS 39 (now IFRS 9) in line with all other derivative instruments, i.e. at fair value through profit or loss.

A few months later, in September 2011, this proposal was rejected by the IASB.

The IFRIC continued its discussions on the subject and in March 2012 it published a draft interpretation that would require subsequent changes in the value of the liability to be recognized in profit or loss.

In January 2013, after receiving comments on the draft interpretation, the IFRIC stated that the draft was a correct interpretation of the existing standard (and specifically of paragraph 23 of IAS 32) but that it remained convinced that its proposal from March 2011 – that these put options should be accounted for like any other derivative – would provide better quality financial information. With this in mind, the IFRIC asked the IASB to reconsider its position on paragraph 23 of IAS 32.

In March 2013, the Board responded by cancelling the IFRIC’s draft interpretation, putting a halt to its efforts to clarify the issue.

Since then, the IFRS IC has still not reached a conclusion, despite receiving further requests for clarification, particularly as regards the accounting treatment of written put options to be settled by a variable number of the parent company’s shares (in 2016). The IFRS IC noted at the time that the issue was too broad for it to address, and that the Board’s ongoing work on the FICE project could provide some answers.


Against this background, this summer’s FICE Discussion Paper (DP) proposes a new approach for determining what shall be classified as a liability, applicable to both derivatives and non-derivative instruments. Here, we analyzes the potential repercussions of the DP.

2. What does the FICE DP say about puts on non-controlling interests?

Let’s begin with a reminder of the Board’s preferred approach: an instrument would be classified as a liability if a) the entity has an obligation to transfer economic resources before liquidation (timing feature) or b) the entity has an obligation to transfer an amount independent of the entity’s economic resources (amount feature).

In addition, the Board is proposing a specific accounting treatment for derivatives that are physically settled in the entity’s own shares (meaning they are extinguished in accounting terms). Under the proposed accounting treatment, written put options would be classified together with the underlying own shares as a single transaction.

Thus, in the case of puts on non-controlling interests (NCI puts), the Board notes that the entity faces two potential outcomes:• either the minority shareholders exercise their put options and the

entity is obliged to repurchase its own shares at the price agreed in the contract, resulting in the extinguishment of its own shares;

• or the minority shareholders do not exercise their put options and the shares are not extinguished.

In this case, as the exercise of the puts is at the option of the minority shareholders, it is possible that the entity will have an obligation to transfer economic resources before liquidation. Under the Board’s preferred approach, this would mean that the instrument meets the criterion for the timing feature, and thus should be recognized as a liability. The contra journal entry for the liability would be the extinguishment of the shares held by the non-controlling interests, at the date when the entity issues the put options.

The Board proposes that the existence of NCI puts should be viewed in the same way as a bond convertible to own shares, as both have the same outcomes: either an obligation to transfer economic resources, or own shares still outstanding. The Board believes that this justifies using the same accounting treatment. It should however be noted that this approach ignores one difference: the shares already exist in the case of shares + NCI puts, but are yet to be issued in the case of convertible bonds.

Having looked at the accounting treatment at initial recognition, how should an entity account for subsequent changes in the value of the liability it has recognized? It is interesting, in the light of the past discussions reviewed above, that the Board is proposing that they should by default be booked to profit or loss.

However, the Board has also introduced a new presentation requirement. Liabilities that do not meet the criterion for the amount feature (i.e. the amount transferred is dependent on the entity’s economic resources) are to be presented separately in the balance sheet. Subsequent changes in the value of these instruments would then be recognized in other comprehensive income (OCI) without recycling to profit or loss.

The Board suggests that the separate presentation principle should be applied consistently to derivatives that do not have an underlying variable that is independent of the entity’s economic resources (with the exception of interest rates, which by definition affect all derivatives, and foreign currency exposures under certain circumstances).

Thus, if an entity issues put options on its non-controlling interests with a strike price equal to the fair value of the shares, the separate presentation requirement would de facto apply.

The accounting treatment would thus be as follows:• at the date when the puts are issued, the entity recognizes a liability

for the fair value of the shares (the strike price of the puts) with a contra journal entry for an equivalent reduction in equity. The liability is presented separately in the balance sheet;

• subsequent changes in the share price will require the entity to remeasure the liability, with a contra journal entry as a separate line item in OCI (not recyclable).

To cover all the bases, we also need to look at the accounting treatment for fixed-price puts on non-controlling interests. Once again, we start by analyzing the rights and obligations of the instruments in conjunction with the underlying shares. Effectively, these are treated as fixed-price puttable shares; the holders (i.e. the minority shareholders) have the option

of putting them back to the entity. As the entity cannot avoid the obligation to transfer a fixed amount of economic resources, the IASB’s position in the DP is that the entity should recognize a liability for the present value of the strike price. The Board also believes that underlying own equity should be reduced by an amount equal to the fair value of the shares at the issue date of the put. In the previous case, the amount of the liability was equal to the amount of equity extinguished. But in this case, there is a discrepancy.

The Board acknowledges that it is also possible that the minority shareholders will not exercise the put option. Economically speaking, there is no incentive for a minority shareholder to put its shares back to the entity at a price that is lower than their actual value. Therefore the shares could remain outstanding. Attempting to represent this in financial terms would effectively give us a written call option. The Board considers that the residual amount is a component of the call option, which is a component of equity.

We can represent this as follows:


IFRS

Written put option (original instrument) = forward contract (represented by a liability for the amount of the strike price) + written call option (representing the possibility that the put may not be exercised)

It is also interesting to note that recognizing a liability and a written call option in this way corresponds exactly to the accounting treatment of a convertible bond; thus, the Board’s analogies are consistent.

In summary, a fixed-price, physically-settled put on non-controlling interests would be accounted for, under the Board’s proposed approach, as follows:1. the extinguishment of the shares held by the non-controlling interests

at an amount equal to the fair value of the shares at the issue date of the put

2. recognition of a liability for an amount equal to the present value of the strike price of the put

3. a call option written on own shares, with an initial value of the difference between i) and ii).

In conclusion, this Discussion Paper represents a shift in the Board’s position on the complex issue of NCI puts with a strike price equal to the fair value of the underlying shares. In this case, the Board is moving towards the position put forward by the AMF in 2009. In contrast, the Board’s proposal for fixed-price NCI puts is more innovative. We have no doubt that many comments on this topic will be submitted to the Board before the closing date of its consultation on 7 January 2019!

3. Key Points to Remember

• A lot of ink has been spilt on the topic of puts on non-controlling interests since IFRS came into effect in 2005, and in the absence of clear guidance on the subject, a diverse range of accounting methods have been used.

• The IASB has proposed a new accounting treatment as part of its FICE project, differentiating between NCI puts with a strike price equal to the fair value of the underlying shares, and fixed-price NCI puts.

• For NCI puts with a strike price equal to the fair value of the underlying shares, an entity would recognize a liability (presented separately) for the fair value of the shares, with a contra journal entry for a reduction in equity, at the date when the put is issued. Subsequent changes in the value of the liability would be recognized in OCI without recycling to profit or loss.

• For fixed-price, physically-settled NCI puts, an entity would recognize a liability for an amount equal to the present value of the strike price of the put, with a contra journal entry for the extinguishment of the shares held by the non-controlling interests at an amount equal to the fair value of the shares at the issue date of the put, and a call option written on own shares for an amount equal to the difference between the first two components.

For more information contact the Mazars USA Accounting Help Desk at [email protected].

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HEALTHCARE POLICY AND PROCEDURE BEST PRACTICES

The touchstone for measuring compliance program effectiveness istheOfficeofInspectorGeneral’sSevenElementsofanEffectiveCompliance Program (Seven Elements) derived from the Organiza-tional Sentencing Guidelines promulgated by the U.S. Sentencing Commission.1

Entire treatises could be written on each of the elements, but they basically boil down to: designation of a compliance officer and committee; written policies, procedures, and a standard, or code, of conduct; open lines of communication; training and education; monitoring and auditing; enforcing standards through well-publicized disciplinary guidelines; and promptly responding to detected offenses and taking corrective action. Arguably, the most underappreciated, overlooked, and important of these elements is that of written policies and procedures (P&Ps). P&Ps are the workhorse of a compliance program, i.e., if done right, they will dependably serve an organization for years. WHY ARE EFFECTIVE P&PS IMPORTANT?

Why are effective P&Ps so valuable from a compliance standpoint? If utilized properly, they:• Establish organizational goals, set tone and culture, describe expected

behaviors, and contribute to other employee accountability tools• Train and educate employees not only at onboarding but on an ongoing

basis• Facilitate succession planning and contribute to sound business conti-

nuity, e.g., the old adage of “what if key employee Sally is hit by a bus, who will do her job?” applies here

• Provide legally defensible documentation that complies with regulatory, accreditation, and contractual requirements, which may help avoid litigation, fines, and loss of business, i.e., function as a critical risk mitigation tool

• Serve as a foundation for business process improvement

In the health care sector, it is not an exaggeration to state that effective P&Ps can also literally save lives. HOW TO START (AND FINISH!)?

Most medium to large-sized organizations have at least some basic written policies and procedures, most likely human resource-related, although their quality, completeness, and currency may be lacking. However, even small business can benefit from having effective P&Ps.

Whether starting from scratch or working to improve existing P&Ps, the entire process and even getting started can be overwhelming IRAC FOR P&PS

Instead of tackling P&P creation and improvement wholesale, or, worse, ignoring it completely, take a step-by-step approach along the lines of the IRAC (Issue, Rule, Analysis, Conclusion) method for briefing a legal issue.

Issue.

First, identify key organizational risks, i.e., what is the issue or concern that needs to be addressed? This process may be as formal as undertaking

BY MELISSA BORRELLI

HEALTHCARE


HEALTHCARE

enterprise risk management or as simple as a sense of an organization’s highest risk areas based on the legal and other authority or contracts to which the organization are subject.

Considering what other similarly situated organizations have identified as common risks may also be useful. For most organizations, human resourc-es (think classification issues and wage-and-hour litigation) and information security (what organization does not have at least some confidential data, let alone personally identifiable information?) will be among the highest-risk areas. In health care in particular, add to that safeguarding protected health information and the obligations that come with receiving government money, and you have the start of a good list of organizational risk areas.

Rule.

Second, determine what authority the organization is subject to; that is, what are the rules with which your organization must comply? Think broad-ly—this is one area you do not want to give short shrift. Look to statutes, regulations, opinions and other regulatory guidance, court cases, accred-itation standards, and key contracts, not the least of which is government contracts.

Analysis.

Next, rally the troops. Bring in the business owners, key stakeholders, and subject matter experts that will have to abide by the P&Ps to draft and analyze the requirements and describe how policies are actually imple-mented at your organization. Again, think broadly. With today’s software and process integrations, it may be difficult to know whether the work of one area will impact that of another.

Check for interactions with other departments, software, business process-es, and existing P&Ps. Perhaps most importantly, never reinvent the wheel. Look for samples from colleagues, professional associations, and other similarly situated organizations.

One caveat: while organizational policies may be similar, their procedures most likely are not. For example, the policy of most health care entities is (should be!) to prevent and detect fraud, waste, and abuse. The procedures each organization employs in pursuit of that policy, however, will vary significantly. Leave time for ample and broad review by all stakeholders, including legal, compliance, management, and the line staff that implement the procedures on a day-to-day basis. Management may be chagrined to find that line staff are not following the procedures they thought they were for numerous reasons, including that they are not up-to-date, onerous, inefficient, or are intentionally being skirted for possibly questionable or bad-faith reasons.

Also, avoid falling into the trap of using legalese and overly technical language wherever possible. It is great to have written P&Ps, but not so great if the intended audience (staff, but don’t forget about regulators and accreditors) cannot understand them.

Conclusion.

Unfortunately, even with a polished final product, the work is not finished. Rather, that shiny new P&P must be publicized to those to whom it applies and thorough training and education must be undertaken. Ideally, who received the training and when is documented. Additionally, best practice dictates that all P&Ps be reviewed at least annually and updated as needed; for example, when a law is changed, an accreditation standard tweaked, or new hardware, software, or a business process is implemented. What Should P&Ps Include?

There are literally dozens of P&P templates available online. The most effective will have the following sections at minimum:

Why Are Effective P&Ps Important?

Why are effective P&Ps so valuable from a compliance standpoint? If utilized properly, they:• Scope: What is the scope of the P&P? Who or what does it apply

to? For some organizations, it will be a line of business for another, a particular customer, and others, a department.

• Roles and Responsibilities: Who is responsible for what with regard to that P&P? Roles and Responsibilities are best defined by department and/or job title, and not by a specific employee’s name, for business continuity purposes.

• Responsibilities should also be specific and if at all possible, mea-sureable. For example, a fraud, waste, and abuse P&P may require a claims department manager to review 10% of each claims examiners weekly output. Here, the claims manager’s role is defined and the responsibility is clear and measurable. This section is particularly important to consider when determining whether and how a P&P can be monitored or audited, another of the Seven Elements. Moreover, if staff have questions or concerns, this section provides them with guid-ance on who to consult and aids in enforcing employee accountability.

• DefinitionsandAcronyms:Best practice is to include these near the beginning of the P&P so that the user does not need to page back and forth to understand the multiple acronyms and sometimes highly technical definitions employed in health care.

• Exceptions: Describe any exceptions to the P&P (in some cases, there may be no wiggle room) and how an exception should be requested and whether it should be granted. For example, describe


under what circumstances an exception to an employee’s use of paid time off may be allowed and who should review and decide upon that exception.

• Enforcement: Although it may seem heavy-handed, part of the purpose of P&Ps, particularly in helping to ensure an organization has an effective compliance program, is to publicize the consequences for non-compliance with requirements. Those subject to the P&P should understand what may or will happen if they do not follow the rules.

• References/Authority: While sometimes separated into two sections, at least one section should be dedicated to the legal and other author-ity that require the P&P and to any other related documents, whether internal or external. This is especially helpful in determining what P&Ps are impacted and should be updated when changes to the law and other authority occur.

• Revision History and Reviewer: While the information regarding who is responsible for reviewing and approving the P&P and its review cycle can be kept elsewhere, it is simpler to include this information within the P&P itself. Revision history is particularly helpful when deal-ing with a regulatory action or litigation—tracking down the language of prior P&Ps can be time consuming and sometimes impossible, depending on the sophistication of an organization’s record-retention practices.

Maintaining a master list of P&Ps is another best practice that organizations should consider. This can be as simple as an Excel sheet or as complex as governance, risk, and compliance software.

Regardless, tracking information should include a number of data points, such as the P&P’s name and purpose; owner (department, division, man-ager, etc.); authority; version history; and a description of the review cycle. It is also helpful to include an indicator as to whether a particular P&P must be reviewed and approved by a regulator, accreditor, and/or contractor if it is substantively amended.

There is disagreement about whether P&Ps should be separated into two or more documents, i.e., one document setting forth the policy and a second describing the associated procedure. Each approach has pros and cons that may depend on a particular organization and its culture.

For example, if P&Ps are only available to staff in paper form, it may make more sense to have a single document for both the policy and the procedure so they are less likely to get separated, whereas if they are available elec-tronically, multiple documents are easier to manage.

In some instances, two documents may be the way to go where the organi-zation wants to make the policy available to the general staff—e.g., the HR policy on employee classifications—but limit public access to the related procedure.

Another advantage of separate policy and procedure documents is simpli-fication of annual and other reviews. While most policies will not change from year-to-year, for example, an organization’s commitment to preventing and detecting fraud is not likely to alter, the implementing procedures for that policy may be subject to multiple revisions over time. Keeping separate documents may help maximize flexibility in drafting and review.

Effective written P&Ps can help meet multiple of the Seven Elements, if drafted and maintained in a thoughtful manner.

While creating and maintaining P&Ps can be daunting, keep in mind their unequivocal role in supporting an effective compliance program.

As a leading change facilitator in this era of sweeping health care reform, the Mazars Health Care Group offers health care payors and providers a powerful combination of service and results-oriented strategy to help them meet their business goals, overcome challenges, and improve performance.

For more information about their timely, valuable information and insights into policies, best practices and industry developments, visit mazarsusa.com/hc.

Melissa is a Senior Manager in our Sacramento Practice. She can be reached at 916.696.3683 or at [email protected].

1 https://www.ussc.gov/guidelines/2016-guidelines-manual/2016-chapter-8#NaN


IFRS

FICE DISCUSSION PAPER: THE BOARD’S PREFERRED APPROACH TO

CLASSIFYING FINACIAL INSTRUMENTS AS LIABILITIES OR EQUITY

On 28 June, the IASB published a Discussion Paper (DP) presenting the current state of its deliberations on the Financial Instruments with Characteristics of

Equity project (FICE). This project, which is not being carried out in conjunction with the FASB, focuses on the classification of financial instruments as liabilities or equity in the issuer’s financial statements. The comments received will help the Board to decide whether to publish an exposure draft to amend or replace

IAS 32, and/or non-mandatory implementation guidance.

Here, Beyond the GAAP summarizes the key concepts presented in the DP, with a particular focus on the questions on which the Board is seeking feedback in

order to decide between the various possible approaches.


1.ObjectivesoftheDP Like IAS 32, the scope of the DP is limited to the principles for classifying financial instruments as liabilities or equity from the point of view of the issuer of the instruments [IN2]. Thus, the presentation and measurement principles set out in IFRS 9 – Financial Instruments will not be affected by this DP.

The IASB has identified a number of areas where the current IAS 32 requires improvement. In particular, it wishes to clarify the underlying concepts used to distinguish between liabilities and equity. The Board notes that this lack of clarity has resulted in divergences in the accounting treatment of certain products, such as puts on non-controlling interests or certain types of contingent convertible bonds. Furthermore, the situation makes it difficult to identify the correct accounting treatment for new and increasingly complex financial instruments that are appearing on the market, which combine features of both liabilities and equity.

The IASB has also taken account of feedback from users of financial statements, who have asked for further information to be provided on the features of this type of financial instruments.

The Board wished to address these specific issues without making changes to the classification outcomes for the majority of instruments, which are less complex.

The main objectives of the FICE project are as follows: § to define clear conceptual principles that are consistent with the

current IAS 32; § to improve the consistency of the classification of contractual rights/

obligations linked to an entity’s own equity instruments; § to improve the information provided (through presentation in the

financial statements and disclosures in the notes) about features of financial instruments that are not captured by their classification as liabilities or equity.

2.SummaryoftheclassificationapproachproposedintheDP

The Board’s current preferred approach for classifying a financial instrument as a liability or equity is based on the two following features:

§ Timing feature: there is an unavoidable obligation to transfer economic resources (cash or another financial asset) at a specified time other than at liquidation;

§ Amount feature: there is an unavoidable obligation to transfer an amount independent of the entity’s available economic resources1.

Instruments may only be classified as equity instruments if they possess neither of these features. Otherwise, they are classified as financial liabilities.

These principles are summarized in the table below2.

These general principles are then applied to four types of instruments: non-derivative instruments, derivative instruments, hybrid instruments3 and compound instruments .

Our discussion of the application of the principles will be presented as follows:

The concept of “an amount independent of the entity’s economic resources”For the purposes of the “amount feature”, the entity’s economic resources are defined as the total recognized and unrecognized assets of the entity, minus the recognized and unrecognized claims against the entity (with the exception of the instrument in question). Thus, the concept of “economic resources” covers more than just the elements recognized in the balance sheet.

An amount is deemed to be “independent of the entity’s available economic resources” if:

§ it does not change as a result of changes in the entity’s available economic resources (for example: it is a fixed amount, or it is indexed to an interest rate, or it is linked to only part of the entity’s economic resources, e.g. indexed to the value of a specified asset or to EBIT); or

§ it changes as a result of changes in the entity’s available economic resources but does so in such a way that the amount could exceed the available economic resources of the entity (e.g. due to leverage).

The fair value of the entity’s ordinary shares is an example of a variable that is dependent on the entity’s economic resources.


Principles retained from IAS 32The Board’s preferred approach maintains its position on economic compulsion, i.e. it is not taken into account. In other words, only contractual obligations are taken into account in this approach to liabilities/equity classification. However, the Board may retain the provisions set out in paragraph 20 of IAS 32, which allow some flexibility on this point.

The Board has also reasserted that only contractual requirements should be taken into account in its preferred approach. Thus, if an obligation to remit cash arises from a legal requirement (rather than a contractual requirement), this would not be taken into account when classifying the financial instrument.

IFRIC 2 is an exception to this. The provisions of this interpretation relating to members’ shares in co-operative entities and similar instruments are expected to remain unchanged.

3.Applyingtheclassificationapproachtonon-derivativefinancialinstruments

How the approach applies to non-derivative instrumentsAt this stage, the IASB proposes that a non-derivative instrument should be classified as a financial liability if it contains [3.8]:

§ an unavoidable contractual obligation to transfer cash (or another financial asset) at a specified time other than at liquidation (timing feature); and/or

§ an unavoidable contractual obligation for an amount independent of the entity’s available economic resources (amount feature).

Examples of how this applies to some typical instruments in this categoryTo illustrate this approach, we reproduce below some of the examples discussed by the IASB in its webcasts. We will begin with two very simple examples.

Example 1 from webcast number 2:An entity issues an instrument for 100, containing an obligation to pay an annual coupon of 10 for five years and an obligation to repay the principal amount of 100 at the end of year 5.

In this simple example, the obligation to make coupon payments and repay the principal amount of 100 at maturity means the instrument

meets the criterion for the timing feature. It also meets the criterion for the amount feature, as the amount to be paid is fixed and is thus by definition independent of the entity’s economic resources.

Example 2 from webcast number 2:An entity issues an instrument for 100 today. The instrument contains an obligation to issue 110 own shares in one year’s time, with no interim coupon payments.

Timing feature: this criterion is not met:• the entity has no obligation to transfer cash (or another financial asset

held by the entity)• the obligation to transfer own shares does not meet this criterion, as

these own shares do not form part of the entity’s assets.

Amount feature: this criterion is not met. The amount to be transferred is completely dependent on the entity’s available economic resources and cannot exceed them.

The following example demonstrates that the IASB’s preferred approach continues to place more emphasis on contractual rights and obligations than on the form or denomination of the instrument.

Example 3 from webcast number 2:An entity issues shares for 100 today. The shares contain an obligation to buy them back in one year’s time for their fair value in cash on this date.

Timing feature: this criterion is met. There is indeed an obligation to transfer cash in one year’s time.

Amount feature: this criterion is not met. The amount is completely depen-dent on the entity’s available economic resources as it is based on the fair value of the entity’s own shares.

Example 4 from webcast number 2:

IFRS


An entity issues an instrument for 100, containing an obligation to pay interest at 10% a year and to repay the principal amount of 100 at liquidation. The entity may, at its discretion, defer payment of interest indefinitely until liquidation; however, the deferred amounts will themselves accrue interest.

Although the instrument contains no obligation to transfer cash prior to liquidation, the amount due at this date is predetermined and is independent of the entity’s available economic resources at this date. The approach presented by the Board in this DP would thus require the entity to classify this instrument as a financial liability. This is one of the instances in which the proposed approach differs from the current IAS 32, which would require the entity to classify the instrument as equity based on the fact that there is no obligation to pay cash.

Exception retained for puttable instrumentsIAS 32 includes an exception that permits certain puttable instruments with particular characteristics to be classified as equity even though they meet the definition of a financial liability (cf. IAS 32 para. 16A to 16D).The Board’s preferred approach, as outlined in the DP, is to retain the puttable exception, for reasons similar to those behind the publication of the amendment to IAS 32 in 2008.

The Board acknowledges that classifying these (very specific) puttable instruments as equity does not provide the information required by users of financial statements, particularly as regards liquidity. However, the Board believes that this drawback would be mitigated by retaining the disclosure requirements set out in IAS 1 para. 136A.

Financial liabilities: separate presentation of obligationsto transfer amounts that are dependent on the entity’s economic resourcesIn addition to this general approach to the classification of liabilities and equity, the Board proposes introducing new presentation requirements to make it easier for users to analyze solvency or profitability based on the information provided in the balance sheet and the statement of comprehensive income.

Thus, instruments that are classified as financial liabilities because they possess the “timing” feature, but not the amount feature as they contain an obligation to transfer an amount that is dependent on the entity’s available economic resources, would be:

§ presented separately in the balance sheet; and § their related income and expense would be recognized in other

comprehensive income (OCI). This income and expense would not

be recyclable, i.e. it would not be subsequently reclassified to profit or loss.[DP para. 6.53].

Decisiontreenumber1:Non-derivativefinancialinstruments

4.Applyingtheclassificationapproachtoderivativesonownequity(DP Section 4)Derivatives within the scope of this sectionFirst, a reminder that a derivative always involves a contractual right and/or contractual obligation to exchange financial assets, financial liabilities and/or equity instruments with another party. Thus, a derivative could be described as an exchange contract that has two “legs”, with each leg representing one side of the exchange.


IFRS

In the context of this DP, derivatives on own equity are: § derivatives that will be settled in whole or in part in own equity; or § derivatives where the underlying of one of the “legs” is the entity’s own

equity.

The DP identifies three broad types of derivatives on own equity: § Asset/equity exchanges:

these are contracts to receive cash (or another financial asset) in exchange for delivering own equity instruments.

§ Liability/equity exchanges in which the equity component is not extinguished: these are contracts to extinguish a financial liability in exchange for delivering own equity instruments.

§ Liability/equity exchanges in which the equity component is extinguished. The DP also refers to these contracts as “redemption obligation arrangements”.

The approach described in part 4 of this article below applies to all derivatives that are recognized separately (irrespective of whether they are standalone financial instruments or embedded derivatives recognized separately) with the exception of derivatives that may require the extinguishment of equity instruments.

The accounting treatment of derivatives in which the equity component is extinguished (redemption obligation arrangements) is addressed in the section on compound instruments.

Mainprincipalsoftheclassificationapproachforderivativesontheirown equity Once again, the Board is here seeking to clarify the principles for classifying derivatives on own equity, without making fundamental changes to the classification outcomes under IAS 32.

The first key principle, which is carried over from IAS 32, is that a derivative on own equity should be classified in its entirety as an equity instrument, a financial asset or a financial liability (i.e. the two “legs” of the exchange are classified together) [4.38].

Extracts from webcast no. 3 on the classification of derivatives on own equity.


Note that, if there is a choice as to how the derivative is settled, the obligation shall be considered from the point of view of the entity. Thus, in the example above, if the other party has the choice as to how the derivative is settled, the instrument shall be classified as a financial liability. In contrast, if the entity has the choice as to how the derivative is settled, the instrument shall be classified as equity. This differs from IAS 32, which prohibited an instrument from being classified as equity if one of the possible settlement options would result in it being classified as a financial asset or liability.

More details on the concept of an “independent variable”As we have seen above, a derivative on own equity may only be classified as equity if the net amount of the derivative is not affected by a variable that is independent of the entity’s available economic resources (amount feature).

The Board holds that the following variables should always be considered to be independent:

§ amounts indexed to a variable that is independent of the entity’s performance (such as the price of a commodity);

§ fixed amounts in a currency other than the functional currency of the entity issuing the shares [DP paras. 4.49-50];

§ amounts that depend on all or part of the entity’s resources, such as EBIT [DP para. 4.52]. Here, not all of the entity’s obligations are taken into account, and thus the net amount of the derivative could be significant even if the entity makes a net loss.

However, the Board has relaxed the definition of an independent variable to take account of certain inherent characteristics of derivatives on own equity:

§ The time value of money: One might initially assume that interest rates would be considered to be variables that are independent of the entity’s available economic resources. However, the definition of a derivative in IFRS 9 stipulates that it is settled at a future date. Thus, the effect of discounting (and thus sensitivity to interest rates) must be taken into account when measuring the net value of the derivative. As a result, if this criterion were to be applied strictly, all derivatives would be affected by at least one independent variable and thus no derivative could ever be classified as equity. The Board has thus proposed that interest rates should not be considered in the analysis. However, this only applies to simple instruments. Any structured element, such as leveraging or a risk that is not linked to the derivative (e.g. a benchmark interest rate in a currency that differs from that of the underlying), shall be treated as an independent variable [DP para. 4.53].

§ Anti-dilution provisions: The existence or the lack of anti-dilution provisions does not affect the classification of the instrument, provided that the provision does not introduce an independent variable. Essentially, anti-dilution provisions

aim to put the holder of the instrument in the same position as a holder of ordinary shares. Thus, this type of provision would not preclude classification of the instrument as equity. Whether the provision is asymmetric (i.e. protecting solely against dilution) or symmetric (i.e. adjusting for both increases and decreases in the total number of shares) does not in and of itself determine whether an anti-dilution provision is independent [DP paras. 4.55- 58].

§ Dividends/distributions to holders of ordinary shares: By definition, dividends are dependent on the entity’s economic resources. The accounting treatments for contractual terms of this type and for anti-dilution provisions will be the same [DP paras. 4.59-61].

§ Contingencies: The exercise of an option derivative may be at the option of the entity, the holder, or contingent on an external event beyond the control of either the holder or the issuing entity. In the latter two cases, the entity does not have control over the settlement of the derivative. If the entity does not have the right to avoid a settlement outcome that would result in classification of the instrument as a financial asset or liability, the instrument in its entirety shall be classified as a financial asset or liability. Similarly, if a contingency introduces an independent variable that has an effect on the net amount of the derivative, the derivative shall be classified as a financial asset or liability. Conversely, contingencies that do not affect either the timing feature or the amount feature do not affect the classification of the derivative [DP paras. 4.63-66].

§ Derivatives on non-controlling interests: The Board’s proposed approach for derivatives on own equity is applied in the same way to puts on non-controlling interests (see also below for the specific case of written put options on own equity instruments).

Partlyindependentderivatives:aspecificcasePartly independent derivatives are those whose net amounts are affected by both variables that are independent of the entity’s economic resources, and variables that are dependent on the entity’s economic resources. The Board’s preferred approach is to classify them as financial assets or financial liabilities. Classifying these derivatives as equity would not be permitted [DP paras. 4.32 et seq.].

Some derivatives on own equity require separate presentation and impact on OCIAs a complement to the classification approach, the Board is proposing that some derivatives that contain no obligation for an amount that is independent of the entity’s economic resources shall be presented separately in the balance sheet, and related income and expenses shall be recognized in OCI without subsequent recycling to profit or loss [DP para. 6.53]. This is consistent with the presentation required for non-derivative instruments.


IFRS

These requirements apply to the following two types of derivatives:

§ derivatives classified as financial assets or financial liabilities with a net amount (i.e. both legs) that is totally dependent on the entity’s economic resources; and

§ partly independent derivatives, where the only independent variable is a foreign currency (and where the foreign currency exposure is not leveraged and does not contain an option feature, and the currency denomination is required by an external factor such as a law or regulation [DP para. 6.34]).

Decision tree number 2: Derivatives

5. Hybrid instruments containing an embedded derivative on own equity

Readers will remember that, in IFRS 9, a hybrid instrument is defined as an instrument comprising a non-derivative host and an embedded derivative.

For an instrument to be in this category, all its characteristics must have been assessed and no equity component must have been identified.

The approach set out in the DP does not make any changes to the accounting treatment of these hybrid instruments:

§ if the host contract is a financial asset, the hybrid instrument as a whole is classified as at fair value through profit or loss;

§ if the host contract is a financial liability, the embedded derivative is recognized separately, unless the entity opts to measure the instrument as a whole at fair value through profit or loss (FV-PL).

If an embedded derivative on own equity is recognized separately, the accounting treatment shall be the same as for a standalone derivative on own equity. However, the Board is considering the options for presentation in the balance sheet of hybrid instruments that contain an embedded derivative on own equity, where the instrument as a whole is measured at fair value through profit or loss. In practice, this will relate to situations in which the entity has elected to apply the fair value option, which permits the instrument as a whole to be measured at fair value through profit or loss rather than recognizing the embedded derivative separately.

The Board has proposed, and is seeking feedback on, two presentation options (question 7):

§ Option A: embedded derivatives that are not separated from the host contract would be exempt from the separate presentation requirements. However, hybrid instruments which, as a whole, contain no obligation for an amount that is independent of the entity’s economic resources would be presented separately (e.g. shares redeemable at fair value).

For more information contact the Mazars USA Accounting Help Desk at [email protected].


WHY PROVIDER ORGANIZATIONS SHOULD BE PROPONENTS OF CAPITATION

FOR THE PAST 35+ YEARS, WE HAVE BEEN ACTIVELY INVOLVED IN THE DEVELOPMENT, IMPLEMENTATION, AND OPERATION OF HEALTH CARE ORGANIZATIONS THAT HAVE RECEIVED COMPENSA-TION FOR SERVICES RENDERED ON A PREPAID, CAPITATED BASIS.

As more health care organizations embrace the Triple Aim and payors coalesce around provider organizations capable of accepting greater levels of professional and institutional risk, the question remains: “Should health care provider organizations be proponents of capitation?”

Why is it that some organizations thrive when it comes to providing health care services on a capitated basis while others struggle to deliver on quality and cost?

The reason(s) are complicated and often require a deep dive into the

organization and its structure to find the answers. However, there are com-mon themes at the root of most successes or failures relative to capitated agreements.

FirstThingsFirst–TheDefinitionofCapitation

“Capitation” is the payment of a fixed per member per month (“pmpm”) amount:1. as payment in full2. for a given month of service3. for a defined population of eligible members,4. for the provision of a defined range of services.

Capitation is often referred to as a “budget-based” or “value-based” pay-ment methodology or model. Regardless of what you call it, the inference

HEALTHCARE

BY RUSSELL FOSTER, SHEILA STEPHENS, STEPHEN WILSON AND SHAWN DUNPHY


is the same, i.e., it is a fixed amount of money that must be managed well to ensure the timely provision of high quality and cost-effective health care services and provide for a reasonable margin.

There are many places around the country where capitated arrangements exist and there are many different variations of the capitation model in play, depending on the level of sophistication of the provider organizations assuming risk.

There are also places around the country that are still being paid solely on a volume-based, fee-for-service (“FFS”) basis where providers are not accepting any risk: some out of fear, some because the impetus for change has not arrived and others because they lack the necessary knowledge, expertise and administrative infrastructure needed to provide high quality, efficient, cost-effective services in a capitated environment.

In some instances, health plans are generating significant margins annually under the existing FFS structure, which makes the transition to capitation less attractive.

Although there are many different payment models in existence, the most common models include:• Budget-Based: incentive only, no downside risk• Budget-Based: shared risk and incentives; • Full Professional Risk: with or without institutional shared risk, and; • Full/Dual Risk and Global Risk.

Budget-Based: Incentive Only

This contracting method is used when a payor desires to begin a gradual transition of a provider organization from FFS to capitation. For the first year or two, the focus is operating within a pre-determined budget goal that is established by the payor, with monthly or quarterly monitoring of positive and negative variances.

This model may start with a capitation payment to the Primary Care Phy-sicians (“PCPs”) and may include some minimal sharing of utilization and case management duties and responsibilities.

In this model, the provider receives a small administrative allocation on a pmpm basis so that they can start developing their administrative structures, hire staff, and take initial steps toward the monitoring of quality and cost.

Also in this model, the payor processes and pays the claims and PCP capitation; performs most Utilization Management (“UM”), Case Manage-ment (“CM”), and Quality Management (“QM”) functions and; generates the utilization and cost reporting, including production of the year-end financial statement as well as PCP and specialty performance report cards, if any.

Budget-Based: Shared Risk and Incentives

In the Budget-Based Shared Risk and Incentives model, a payor and provider have agreed to share both gains and losses up to a pre-determined level (e.g., not to exceed some pmpm amount, percentage of revenue, or percentage of gain or loss).

Similar to the Budget Based Incentive Only model explained above, in the Shared Risk and Incentives model the payor usually processes and pays claims and PCP capitation payments, performs most UM, CM, and QM functions and produces all utilization and cost reporting, including produc-tion of any year-end settlement statements, PCP and specialty performance report cards and other forms of reporting.

In this model, however, the provider organization will take a more active role in the UM and CM processes and, in turn, may receive a higher administra-tive fee to help cover costs.

Full Professional Risk: With or Without Institutional Shared Risk and Incentives

Full Professional Risk may be used when a provider organization has reached a level of sophistication and financial capacity to justify assumption of full risk for all professional services. Although full risk agreements can, and often do, exclude, i.e., carve-out, certain high cost services (e.g., out of area emergencies, high cost injectables, and certain transplants), the provider organization is at-risk for all losses incurred in the contract year.

In some states that have adopted the model of full delegation of risk and administrative services (e.g., credentialing, claims and capitation payments, UM and CM, provider relations services, contracting, finance, accounting and related services), the provider organization will either develop its own administrative infrastructure or outsource the delegated functions to a professional Management Services Organization (“MSO”) to be performed on its behalf.

In other states, where full delegation has not yet occurred, the payor’s infrastructure is used by the provider and the provider pays the payor a management fee as a percentage of its professional capitation for those services. Depending on the specifics of the arrangement, reporting func-tions may be the sole responsibility of the provider organization, or may be shared with the payor.

In the Full Professional Risk model, payors and providers often enter into a separate shared risk/incentives agreement in which each party shares in the gains and losses associated with the provision of all or some institution-al services (e.g., hospital inpatient and outpatient, skilled nursing facility, home health, durable medical equipment, ambulance and other carve-out services).

HEALTHCARE


Provider organizations that enter into shared risk arrangements are typically those with significant financial reserves that are able to cover their share of losses in down years. The assumption of institutional risk by provider organizations, in some instances, can trigger significant state licensing re-quirements or, at the very least, regulators can limit the risk being assumed based on the provider’s financial capability to assume risk.

Dual Risk

The Dual Risk contracting method may be used when a provider organiza-tion and hospital partner together and enter into separate risk agreements to accept full professional and institutional risk. Most often under a dual risk model, there is a shared risk incentive agreement between the provider organization and hospital to share gains and losses in the institutional risk pool.

Dual Risk agreements most often include delegation of all or most admin-istrative services, including processing of claims and capitation payments, UM and CM services, provider relations services and contracting, certain member services, finance and accounting and related functions. Reporting obligations are typically shared by the organizations.

Global Risk

Global Risk may be used when a provider organization enters into a risk agreement with a payor/plan partner whereby the provider organization accepts full professional and institutional, or global, risk. In this instance, the payor’s hospital partner would remain on a diagnosis-related group, fixed per diem, or another discounted payment methodology and typically enter into an institutional shared risk-incentive pool agreement with the provider organization. Similar to the other full risk models, the Global Risk provider would also be fully delegated for all administrative services.

Global and Dual Risk agreements exist in several markets around the coun-try and are most prevalent with larger health systems or provider organiza-tions that possess state licensure to operate on the same level as a health plan, but are not fully licensed as a health plan.

Capitation Support of the Triple Aim

For those organizations that believe in and support the Triple Aim—i.e. they are committed to• Improvement in the health of populations,• Enhancement in the individual experience of health care and• Reductions in per capita costs—capitation supports these goals in

several ways through:1. Continuous quality improvement and operational efficiency;2. Identification and assessment of health risks across the entire popula-

tion of assigned members;

3. Innovation and improvement in the delivery of health care services;4. Identification and management of marginal/poor performers;5. Reimbursement and incentive models that help promote appropriate

utilization and costs;6. Detailed budgeting and variance analysis, monitoring and analysis of

utilization and cost data, provider sub-capitation, and Improved trend analysis and forecasting and;

7. Increased member satisfaction.

To be successful, provider organizations must understand and embrace the Triple Aim, as well as Live It, Sell It, Love It, and do it all over again. In other words, it must become a way of life and not just another line of business.

Why Does Capitation Work for Some and Not Others?

While not every experience is the same, there are several reasons why providers often fail at capitation. The following are just a few of the most common reasons:• When provider organizations enter into a risk relationship, they often

jump in too soon, without sufficient financial reserves, and without sufficient knowledge and expertise or advance planning to help improve their chances for success. To combat this deficiency, provider organizations must invest in data and data integrity, as well as the required organizational education to ensure thorough understanding and the import of the relationship of data management and effective management of risk.

• When the senior leadership of a provider organization accepts a cap-itation agreement but is happy with the status quo, they are typically unwilling to make the cultural shift from FFS to capitation that is neces-sary succeed. While younger physicians are more apt to embrace the change, older physicians typically just want to “stay the course” until they retire. This typically requires extensive provider education, both initially and ongoing.

• When senior leadership sees the need and embraces capitation, but are unwilling to make the necessary infrastructure improvements to manage risk, success is rare. The capitation model requires invest-ment in systems and talent.

• If senior leadership is more concerned about preserving relationships and keeping their colleagues happy rather than confronting marginal/poor performers and focusing on improving quality and reducing cost, the capitation model will flounder. This model requires the ability to redirect referral patterns and establish, monitor, and report on agreed upon performance measures and benchmarks.

• This model is not productive if senior leadership does not establish and support the integral working relationship between quality and pay-ment, which requires commitment to standards of practice or medical guidelines, performance measures, monitoring and reporting.

• The capitation model will not be beneficial if senior leadership of the provider organization does not deploy mechanisms to ensure accurate


HEALTHCARE

encounter data. Capitation does not require a “claim” for the provider to be paid; therefore, the submission of encounter information is critical as it is essential to managing capitation, provider performance, and the ability to collect and report specific and required elements for both the risk-bearing provider and health plan.

Why be a Proponent of Capitation?

Capitation makes sense from several perspectives. A few of the advantages of making the switch include:• Capitation payments are predictable, paid monthly (usually by the 15th

of the month), and help cash flow management.• Accepting capitation can incentivize health plans to steer membership

toward capitated networks, especially toward Dual Risk and Global Risk networks, which increases membership and revenue growth.

• Local health care delivery and decision-making results in higher quali-ty care and improved member satisfaction.

• Local decision-making also results in greater physician satisfaction because physicians are more vested in the delivery system and are able to get answers to their claims inquiries, feedback on utilization decisions and resolution of disputes on a more timely and individual basis.

• Profits generated from the efficient and cost-effective delivery of health care services are retained at the local level, not shared with the health plans.

• Provider organizations that have made/are moving to embrace capita-tion position themselves to be the future of health care in this country. They will figure out how to make it work and become the market leaders of the future; it is time to lead or follow, your choice.

Should Your Organization Choose to Embrace Capitation?

There is little doubt that risk-based contracting, vis-a-vis capitation or some other value-based model, is here to stay and already is the preferred care delivery model throughout the country. FFS as a preferred compensation model has actually been dying for many years, but the resuscitation effort continues in many places around the country.

While there are pockets of resistance to the change, continuing pressure from employers, government (including the Centers for Medicare and Med-icaid Services), and health plans, which are all committed to the Triple Aim, will affect every provider regardless of location or readiness.

Failure to successfully transition will have consequences far beyond the investments that need to be made to embrace it now. For many, holding on to the status quo will adversely impact their ability to compete and stay in business. Timing is everything, and now is the time to make the necessary investments to stay competitive.

As with every great endeavor, establishing the necessary systems and structures, and to learning how to manage capitation successfully will not happen overnight, including implementing mechanisms to bring provider networks into compliance. It is best to step up and start now.

It all begins with the Board of Directors and senior management team mak-ing the commitment to move toward risk-based contracting and learning this model of business. Embrace the change and start making the incremental changes that are needed, including development of a solid business plan that outlines goals, strategies, milestones and the willingness to work with health plans to develop mutually beneficial partnerships.

Execute the business plan and ensure that the systems and structures are in place to support the success of that plan. Be prepared to manage dynamic and interlinking processes that require a focus on quality measures and outcomes, UM, data management, compliance with regulations, and fulfilling and monitoring contractual obligations.

Finally, choose wisely when developing or selecting medical guidelines, information and data retrieval systems, and when bringing in staff. If a few senior leaders are standing in the way of needed change, consider asking them to step aside to ensure the success of the organization for the long term. Most importantly, a quality provider organization with solid leadership and a commitment to success has nothing to fear with capitation.

As Nike tells us, “Just Do It” and do not look back!

As a leading change facilitator in this era of sweeping health care reform, the Mazars Health Care Group offers health care payors and providers a powerful combination of service and results-oriented strategy to help them meet their business goals, overcome challenges, and improve performance.

For more information about their timely, valuable information and insights into policies, best practices and industry developments, visit mazarsusa.com/hc.

Russ is a Senior Advisor in our Sacramento Practice. He can be reached at 916.696.3663 or at [email protected].

Sheila is a Senior Advisor in our Sacramento Practice. She can be reached at 916.696.3663 or at [email protected].

Stephen is a Senior Manager in our Sacramento Practice. He can be reached at 916.696.3674 or at [email protected].

Shawn is a Senior in our Sacramento Practice. He can be reached at 916.696.3680 or at [email protected].


OCTOBER IFRS HIGHLIGHTSOctOber 22, 2018

IFRS

IFRS 17, Insurance Contracts: where are we now?This summer and early autumn we have seen multiple developments regarding IFRS 17, Insurance Contracts, which is currently scheduled to come into effect on 1 January 2021. In July, the European Insurance CFO Forum (a discussion group for major insurance companies) sent a letter to the EFRAG President and IASB Chair recommending the re-opening of IFRS 17. The CFO Forum notes that this could delay the effective date of IFRS 17 by up to two years.

The CFO Forum has made this recommendation after identifying issues with IFRS 17, including difficulties with operational implementation. It has already reported these issues to EFRAG, supported by case studies carried out by various members of the CFO Forum. EFRAG is expected to address these findings as part of its ongoing work towards EU adoption of IFRS 17. In the letter, the CFO Forum also requests that more attention should be paid to interactions with IFRS 9 – Financial Instruments. The letter is available here: http://www.cfoforum.eu/letters/CFO-Forum-letter-to-EFRAG-and-IASB-16-July-2018.pdf.

At the beginning of September, EFRAG sent a letter to the IASB in its turn, with a view to opening discussions with the international standard-setter on the following six points (previously identified by the CFO Forum):

§ acquisition costs (incurred in expectation of contract renewals);

§ contractual service margin (CSM) amortization, particularly for contracts that include investment services;

§ reinsurance (onerous underlying contracts that are profitable after reinsurance, contract boundary where underlying contracts are not yet issued);

§ transition (extent of relief offered by the modified retrospective approach and challenges in applying the fair value approach);

§ annual cohorts (cost-benefit trade-off, including for the variable fee approach (VFA) contracts);

§ balance sheet presentation (cost-benefit trade-off of separate disclosure of groups in an asset position and groups in a liability position and non-separation of receivables and/or payables representing premiums already billed).

NOVEMBER IFRS HIGHLIGHTSNOvember 6, 2018

Implementation of IFRS 9 by European insurersIn August, Mazars published a benchmark study of 16 European insurance and reinsurance groups, and 10 European bank insurers, based on their financial reporting at the end of 2017. The study looks at how they intend to implement IFRS 9 (in 2018 or deferred to a later date) and the expected impacts of first-time application of the standard.

The study found that 94% of the sample of insurance and reinsurance groups intend to defer application of IFRS 9 to 2021, when it will be implemented concurrently with IFRS 17 – Insurance Contracts. Furthermore, 27% of the groups presented disclosures on the level of their predominance ratio for insurance activities. Finally, only five groups specified which of the phases of IFRS 9 they expected would have the greatest impact (classification and measurement, impairment, and/or hedge accounting). The full study is available via the following link:

https://www.mazars.com/Home/News/Latest-News3/Benchmark-Study-on-European-Insurers-IFRS-9 IFRS Foundation consults on length of service for Trustee Chair and Vice-ChairsOn 19 June 2018, the IFRS Foundation published a consultation with a view to permitting its Chair to serve up to three terms of three years each, irrespective of whether they are recruited from the ranks of the Trustees or externally. Vice-Chairs, recruited from among the Trustees, would also be permitted to serve three terms of three years each. This proposal would have the benefit of continuity and would enable the Foundation to profit from the appointees’ experience.

Another proposed amendment would permit a Trustee who has served their maximum term to be reappointed after six years have elapsed, for a three-year term renewable only once. The IFRS Foundation’s consultation was open until 17 September 2018. A

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EFRAG’s letter is available here: https://www.efrag.org/News/Project-329/Letter-to-IASB-on-IFRS-17.

The fourth meeting of the IASB’s Transition Resource Group for IFRS 17, which addresses issues with transition to IFRS 17, took place at the end of September. The group discussed ten topics; a summary of the discussion is available on the IASB’s website via the following link: https://www.ifrs.org/-/media/feature/meetings/2018/september/trg-insurance/trg-for-ic-meeting-summary-september-2018.pdf.

Lastly, at the beginning of October the European Parliament adopted a resolution on IFRS 17, which can be found here: http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//TEXT+TA+P8-TA-2018-0372+0+DOC+XML+V0//EN&language=EN.

Among other things, the resolution draws attention to the fact that IFRS 17, if adopted, must meet the ‘European public good’ criterion and support long-term investment.

The final months of 2018 are likely to see further breaking news on IFRS 17, what with the IASB’s monthly discussions of the points raised in the letters mentioned above, and the fifth meeting of the TRG for IFRS 17, scheduled for the start of December. Meanwhile, EFRAG, which had initially expected to publish its IFRS 17 endorsement advice in the fourth quarter of 2018, has now removed any mention of an expected publication date from its website.

IAS 23: IFRS IC publishes two agenda decisionsAt the end of its September meeting, the IFRS IC decided to publish two agenda decisions relating to IAS 23, Borrowing Costs.

The first decision relates to the amount of borrowing costs eligible for capitalization when an entity that initially has no borrowings is constructing a qualified asset, and borrows funds generally part-way through construction. The question was whether the entity should include expenditures for the asset before it obtained the general borrowings when determining the amount of borrowing costs eligible for capitalization.

In accordance with paragraph 17 of IAS 23, which stipulates when an entity should begin capitalizing borrowing costs, the Committee concluded that the entity would not begin capitalizing borrowing costs until it has obtained the general borrowings, but once it has obtained it, the entity does not disregard expenditures on the qualifying asset incurred before it obtains the general borrowings when determining the expenditures eligible for capitalization.

The second decision relates to the point at which an entity ceases capitalizing borrowing costs on land, when the land has been acquired in order to construct a building on it. The question was whether the entity should cease capitalizing borrowing costs incurred in respect of land expenditures once it starts construction of the building, or whether it should continue to capitalize them during construction.

The Committee concluded that if the land is not capable of being used for its intended purpose during the construction phase, the land and building should be considered together when determining when to cease capitalizing borrowing costs on land expenditures.

European highlight

European Commission to discuss the future of corporate reportingFollowing its ‘Fitness check’ consultation last March (see Beyond the GAAP no. 120, March 2018), the European Commission has announced that it will be hosting a conference on the future of corporate reporting in a digital and sustainable economy. The conference will take place on Friday 30 November 2018 in Brussels and will provide an opportunity to consider participants’ responses to the consultation and to have face-to-face discussions between different types of stakeholders (regulators, preparers and users of financial statements, civil society, etc.). Details of the conference can be found here: https://ec.europa.eu/info/events/finance-181130-companies-public-reporting_en

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IFRS ALERTS CONTACT

MAZARS USA ACCOUNTING HELPDESK646.225.5915 [email protected]


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QUICK UPDATES: ASU 2018-13NOvember 15, 2018

During August 2018 the Financial Accounting Standards Board (“FASB”) released ASU 2018-13 Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement, which alters the disclosures related to the fair value hierarchy, impacting financial statement preparers and users.

KEY CHANGES

§ The FASB removed disclosure related to transfers and valuation processes for the fair value hierarchy.

§ Modifications to the level 3 disclosure requirements, disclosures related to liquidation and redemption of investments in entities that calculate NAV, and the measurement uncertainty disclosure

§ Certain additions were added to the Level 3 disclosure requirements for public entities.

WHO DOES IT AFFECT AND WHEN?

§ Affects all entities that are required to disclose recurring and nonrecurring fair value measurements.

§ Effective for public and non-public entities for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years.

§ Early adoption of any or part of this ASU is permitted.

REMOVALS

§ The amount of and reason for transfer between Level 1 and Level 2 of the fair value hierarchy.

§ The policy for timing of transfers between levels. § The valuation process for Level 3 fair value

measurements. § For nonpublic entities, the changes in unrealized gains

and losses for the period included in earnings for recurring Level 3 fair value measurements held at the end of the holding period.

Mazars InsightThe reason for the above removals stems from the need to disclose pertinent information to the users of financial statements. The FASB strives to issue guidance for

reporting entities to improve the effectiveness of the disclosures, while maintaining an appropriate amount of discretion. Focusing on meaningful material disclosures assists in keeping the costs from outweighing the benefits of such disclosures.

MODIFICATIONS

§ In lieu of a roll-forward for Level 3 fair value measurements, a nonpublic entity is required to disclose transfers into and out of Level 3 of the fair value hierarchy and purchases and issues of Level 3 assets and liabilities.

§ For investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly.

§ The amendments clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date.

Mazars InsightThe modifications refine and simplify the disclosures to increase the usefulness to the reader of the financial statements. The first modification removes the roll forward, but still requires the financial statements to disclose the changes for the reporting period. The second modification eliminates the need to estimate the timing of future events related to investments in certain entities valued using NAV, but requires disclosure of definitive events when communicated to the investor, which is valuable to the user for planning, evaluating, and forecasting purposes. Enhancing the measurement uncertainty narrative provides insight with respect to the variability of significant unobservable inputs and the impact that variability could have on the fair value measurements as of the reporting date. The overall goal is to improve the users understanding of management’s assumptions and increase the usability of the information contained in the disclosures.

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REAL ESTATE

REAL ESTATE ALERT CONTACTS John [email protected]

Bonnie Mann [email protected]

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ADDITIONS

§ The changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period.

§ The range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information (such as the median or arithmetic average) in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. Note: The above additions are not required for nonpublic companies.

Mazars Insight The above additions add clarity for the users of the financial statements. Enlightening the reader to the relationship between the unrealized gains and losses and the statement of comprehensive income aids the understanding of possible net cash flows resulting from dispositions of assets and liabilities recorded at fair value. The second addition provides the users of the financial statements with the details surrounding the significant inputs used by management to calculate fair value, in order to better understand and analyze

changes in those inputs relative to economic factors. Broadening the information presented in the notes provides management the opportunity to communicate more meaningful information to the users of the financial statements.

WHAT’S NEXT?

§ How will these changes be perceived and executed by preparers of financial statements?

§ Will users of the financial statements find these changes to be beneficial?

§ Will entities experience enriched disclosures while improving the cost of such disclosures?

This ASU advances the goals set out in the FASB’s disclosure framework project. These significant overall changes to the fair value hierarchy disclosures improve reporting by providing management with more discretion on how best to convey information in a manner that will be more meaningful to the users of the financial statements. When evaluating the impact of this ASU, management should consider what will enable the reader to more accurately and effectively understand the assets and liabilities measured at fair value and the impact that external factors have on those measurements.

Source: Accounting Standards Update 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement.

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TAX

TAX

QUALIFIED OPPORTUNITY ZONE GUIDANCE RELEASED BY TREASURYPublished ON OctOber 26, 2018

By Adam Liebman, Bonni Zukof and John Confrey The 2017 Tax Reform Act, commonly referred to as the “Tax Cuts and Jobs Act,” created a new tax incentive program designed to spur economic development and job creation in distressed communities by providing tax benefits to those that invest in specified areas known as Qualified Opportunity Zones. The tax incentive is a potential reduction in one’s capital gains tax.

On October 19, 2018 the Department of Treasury and the Internal Revenue Service released Proposed Regulations in reference to Qualified Opportunity Zones (QOZ). The Proposed Regulations have provided guidance and clarity on what types of gains would qualify, the time period during which amounts must be invested in a Qualified Opportunity Fund (QOF), and the requirements that must be met by such QOFs to provide deferral for the investors. Taxpayers are permitted to rely on the Proposed Regulations until the final regulations are published.

The IRS and Treasury Department have indicated that additional guidance will be released prior to year-end. This alert will highlight key components of the Proposed Regulations which have generated comments from taxpayers.

BenefitsofaninvestmentintoaQualifiedOpportunityFundIf a taxpayer realizes gains from the sale or exchange of property and invests some or all of the realized gain into a QOF within 180 days, the QOF investment allows a taxpayer to:1. Defer those gains from taxable income until the earlier of

(a) selling the investment or (b) December 31, 2026;2. Permanently exclude 10% of the originally-invested gain

from taxable income if the investment is held for at least 5 years (5 year period must be met prior to December 31, 2026);

3. Permanently exclude an additional 5% for a total exclusion of 15% of the originally invested gain from taxable income if the investment is held for at least 7 years (7 year period must be met prior to December 31, 2026);

4. Permanently exclude post acquisition appreciation in

the investment if the taxpayer holds the investment for a minimum of 10 years.

Initially the taxpayer’s basis in the fund is zero. The exclusion described in items two and three above is accomplished through an increase to the basis of the investment. If the investment is held for at least 5 years, the taxpayer’s basis is increased by 10% of the deferred gain. If the investment is held for at least 7 years, the taxpayer’s basis is increased by another 5% of the deferred gain, totaling 15%.

It is important to note that the law requires only the gain to be reinvested in a QOF, which differs from a Section 1031 “like-kind” exchange that also provides tax deferral treatment through reinvestment; Section 1031 requires total sales proceeds to be reinvested in order to achieve deferral treatment.

Election for investments held at least 10 yearsA taxpayer that holds a QOF investment for at least 10 years may elect to increase the basis of the investment to the fair market value on the date the investment is sold or exchanged. The Proposed Regulations clarified that investments that meet the 10-year holding period requirement post December 31, 2026 are eligible for the exclusion as long as they are sold no later than December 31, 2047.

Gains that are eligible for deferral or exclusionThe Proposed Regulations clarify that only “capital gains” for federal income tax purposes are eligible for deferral under IRC Section 1400Z-2. The preamble of the Proposed Regulations state that these gains generally include capital gains from an actual, or deemed, sale or exchange, or any other gain that is required to be included in a taxpayer’s computation of capital gain.

The gain must not arise from a sale or exchange with a related person which, for the purpose of these regulations, means more than a 20% common ownership (instead of 50%).

Who is eligible to make the election?Individuals, corporations, regulated investment companies, REITS, partnerships and other pass-through entities are eligible for the benefits provided by QOFs.

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Special rules for partners of partnershipsThe Proposed Regulations provide that, if a partnership does not elect to defer partnership capital gains, a partner may elect to defer the partner’s allocable share of such capital gains. The partner’s 180-day period with respect to the partner’s allocable share of such capital gains generally begins on the last day of the partnership’s taxable year, as this is the day on which such gains are included the partner’s distributive share of income. Tax attributes of gains deferredThe Proposed Regulations provide that all the deferred capital gains’ tax attributes are preserved. This includes classification of short-term and long-term holding periods, collectibles, Section 1256 Contracts, unrecaptured Section 1250 gain, etc. The taxpayer will report the gains in the year of disposition of the QOF investment in the same manner they would have reported if no deferral election was made. The investment in the QOF does not extend the holding period for gains classification.

Deferral of gain from sale of QOFThe Proposed Regulations provide that a taxpayer who sells their interest in a QOF prior to December 31, 2026 can invest in another QOF and defer the gains associated with the sale by investing within a 180-day period. The taxpayer is required to dispose of its entire initial investment since a taxpayer cannot make a deferral election with respect to a sale or exchange if an election previously made with respect to the same sale or exchange remains in effect.

Eligible investments in a QOFThe Proposed Regulations state that an eligible investment in a QOF must be an equity interest, which can include preferred stock or a partnership interest with special allocations. The “equity interest” can be a combination of eligible gains from sale within 180 days and/or other cash investments. In these instances, the investment is referred to as “investment with mixed funds,” and the taxpayer is treated as having made two separate investments consisting of (a) one investment that includes the amount of the investor’s deferral election, and (b) one investment consisting of other amounts where QOF tax benefits do not apply.The term eligible interest excludes any debt instrument within the meaning of IRC Section 1275(a)(1) and Treasury Regulation §1.1275-1(d).

The Proposed Regulations also clarify that deemed contributions of money under IRC Section 752(a) do not result

in the creation of an investment in a QOF.

Making the electionGuidance from the IRS indicates that the taxpayer will make the deferral election on Form 8949 which will need to be included with the taxpayer’s federal income tax return in the year in which the gains would have been recognized if no election was made.

GUIDANCE IN RELATION TO THE OPERATION OF A QUALIFIED OPPORTUNITY FUND

Eligible entitiesThe Proposed Regulations clarify that a QOF must be an entity classified as a corporation or partnership for Federal income tax purposes. In addition, it must be created or organized in one of the 50 States, the District of Columbia, or a U.S. possession. In addition, if an entity is organized in a U.S. possession, but not in one of the 50 States or in the District of Columbia, then it may be a QOF only if it is organized for the purpose of investing in qualified opportunity zone property that relates to a trade or business operated in the possession in which the entity is organized.

Frequently Asked Questions issued by the IRS provide that entities that are formed as Limited Liability Companies can be QOFs.

Valuation and compliance in relation to the 90% asset testOne of the requirements for a qualified opportunity fund is that 90% of its assets must be qualified opportunity zone property. This 90% threshold is calculated by taking the average percentage of QOZ property held in the fund as measured on the last day of the first six-month period of the taxable year of the fund and on the last day of the taxable year of the fund.

The Proposed Regulations provide that for a QOF that has GAAP financials or other financial statements filed with a federal agency, the QOF will use the asset values on those financial statements to determine if the 90% threshold is met. If the QOF does not have financial statements that meets those requirements, the value of its assets for the 90% test is determined based on the costs of the assets.

Purchase of existing building, substantial improvement requirement and landThe Proposed Regulations provide that if a QOF purchased a building on land within a QOZ, the substantial improvement requirement is only measured on the QOF’s basis in the

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building and not the land. To meet the substantial improvement requirement, the QOF will need to make investments with costs that are at least equal to the original allocated basis to the building within any 30-month period beginning after the date of acquisition of the property.

The QOF is not required to make any improvements to the land upon which the building is located.

Working capital safe harborThe Proposed Regulations, in response to concerns regarding the 90% assets threshold, provide flexibility by creating a working capital safe harbor for QOF investments in qualified opportunity zone businesses that acquire, construct, or rehabilitate tangible business property, which includes both real property and other tangible property used in a business operating in a QOZ. The safe harbor allows QOZ businesses to maintain reasonable amounts of working capital in cash, cash equivalents or debt instruments with a term of 18 months or less for a period of up to 31 months, if:

1. There is a written plan that identifies the financial property as property held for the acquisition, construction, or substantial improvement of tangible property in the opportunity zone;

2. There is a written schedule consistent with the ordinary business operations of the business, that the property will be used within 31 months; and

3. The business substantially complies with the schedule.

Taxpayers would be required to retain any written plan in their records. In addition to the above, please see the Mazars Quick Reference Guide on Opportunity Zones for further details.

Many questions remain unanswered and the Treasury Department has already announced that a second set of Proposed Regulations is expected to be issued before year end. For a more in-depth conversation on the Proposed Regulations and the opportunities available through these funds, please contact your Mazars USA LLP professional for additional information.

NEW JERSEY IMPLEMENTS TAX AMNESTY PROGRAMPublished ON NOvember 26, 2018

By Harold Hecht, Julie Montrone and Seth Rabe

New Jersey Governor Phil Murphy recently signed a law directing the Division of Taxation to create a tax amnesty program. The program, which began November 15, 2018 and will end January 15, 2019, provides an opportunity to file past due tax returns, pay back taxes, and pay half the interest due as of November 1, 2018. The other half of the interest due as of November 1, 2018 and any late payment penalty, late filing penalty, cost of collection, delinquency penalty or recovery fee will be waived. Civil fraud and criminal penalties will not be waived. Amnesty applies to tax liabilities incurred for tax returns due on or after February 1, 2009 and prior to September 1, 2017.

The state has already begun an outreach program, sending letters to businesses and individuals, inferring that they may be subject to a forthcoming audit. This appears to be an attempt by New Jersey to prompt voluntary payments under the program. Taxpayers that previously filed an appeal related to a tax assessment may participate in the program provided they withdraw the appeal. Any payments made are non-refundable. Taxpayers eligible for amnesty, but who did not avail themselves of the program, will be subject to an additional 5% penalty on tax balances remaining after the amnesty period ends. This additional penalty cannot be waived or abated. The New Jersey Tax Amnesty Program provides a great opportunity to become current with one’s New Jersey tax liabilities at a reduced cost. Contact your Mazars USA LLP tax professional for further information.

TAX PRACTICE BOARD Tifphani [email protected] James [email protected]

Howard Landsberg212.375.6604 | [email protected] James [email protected]

Faye [email protected]

Richard Bloom (EDITOR)[email protected]

Mazars USA LLP is an independent member firm of Mazars Group.

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