2

Accounting Update

3

2019 Final ASUs Issued

ASU 2019- Title BDO Alert

01 Leases (Topic 842): Codification Improvements 2019-01 Alert

02

Entertainment—Films—Other Assets—Film Costs (Subtopic 926-20) and Entertainment—

Broadcasters—Intangibles—Goodwill and Other (Subtopic 920-350): Improvements to

Accounting for Costs of Films and License Agreements for Program Materials

N/A

03 Not-for-Profit Entities (Topic 958): Updating the Definition of Collections N/A

04Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815,

Derivatives and Hedging, and Topic 825, Financial Instruments2019-04 Alert

05 Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief 2019-05 Alert

06

Intangibles—Goodwill and Other (Topic 350), Business Combinations (Topic 805), and Not-

for-Profit Entities (Topic 958): Extending the Private Company Accounting Alternatives

on Goodwill and Certain Identifiable Intangible Assets to Not-for-Profit Entities

2019-06 Alert

08

Compensation—Stock Compensation (Topic 718) and Revenue from Contracts with

Customers (Topic 606): Codification Improvements—Share-Based Consideration Payable

to a Customer

Coming Soon

Current as of November 13, 2019

4

Clarifies certain aspects of new leases guidance

• Allows non-manufacturer/dealer lessors to use cost, reflecting any volume or trade discounts, as

the fair value of the underlying asset

• Lessors that are depository/lending institutions will present all principal payments received under

leases as investing cash flows. Other lessors will present all cash receipts from leases as operating

cash flows.

• Provides an exception to the paragraph 250-10-50-3 interim disclosure requirements in the ASC 842

transition disclosure requirements (applies to lessees and lessors).

ASU 2019-01, Leases (Topic 842): Codification Improvements

Effective Dates Public Business Entities Other Entities

FYs beginning after 12/15/2019 FYs beginning after 12/15/20191

1 Refer to subsequent slide on proposed deferral for nonpublic entities

5

Narrow improvements and clarifications to scope, recognition, measurement,

presentation, and disclosure guidance issued in the following recent ASUs:

See summary – next slide

ASU 2019-04, Financial Instruments Codification Improvements

•Effective for FYs beginning after 12/15/19, including interim periods within those fiscal years

ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10):

Recognition and Measurement of Financial Assets and Financial

Liabilities

•Effective concurrent with ASU 2016-13 (or FYs beginning after 12/15/19 if already adopted 2016-13)

ASU 2016-13, Financial Instruments—Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments

•Effective concurrent with ASU 2017-12 (or beginning of first annual period after issuance of 2019-04 if already adopted 2017-12)

ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities

6

Topic Issues addressed

Financial Instruments

(ASU 2016-01)

HTM debt security FV disclosures; applying ASC 820 to the FV

measurement alternative; and remeasuring equity securities at

historical f/x rates.

CECL

(ASU 2016-13)

Accrued interest; transfers between classifications or categories of

loans and securities; asset recoveries;

reinsurance recoverables; projecting variable interest rates; effect

of prepayments on effective interest rate; costs to sell when

foreclosure is probable; vintage disclosures for LOC arrangements

converted to term loans; and contract renewals.

Hedging

(ASU 2017-12)

Partial-term FV hedges of interest rate risk; amortization and

disclosure of FV hedge basis adjustments; consideration of hedged

contractually specified interest rate in the hypothetical derivative

method; scope of NFP entities; hedge documentation for private

companies; first-payments-received cash flow hedging technique;

and transition.

ASU 2019-04, Financial Instruments Codification Improvements

7

Provides alternative to irrevocably elect the fair value option for eligible

financial assets measured at amortized cost upon adoption of ASU 2016-13

(credit losses standard)

For an instrument to be eligible:

• Asset must be within the scope of the new credit losses standard, and

• Asset must be eligible for applying the fair value option in ASC 825-10

Apply on instrument-by-instrument basis

Not available for available-for-sale or held-to-maturity debt securities

Effective concurrent with ASU 2016-13, or FYs beginning after 12/15/19 if

already adopted 2016-13

ASU 2019-05, Credit Losses: Targeted Transition Relief

8

Allows NFPs to elect private company accounting alternatives:

Goodwill (ASC 350)

• Option to amortize goodwill on a straight line basis over a period of 10 years (or less if

appropriate)

• If elected, entity must test goodwill when a triggering even occurs at either the entity

level or reporting level.

Certain identifiable intangible assets in a bizcom (ASC 805)

• Option to subsume the following into goodwill:

- Customer-related intangible assets that are incapable of being sold or licensed independently

from other assets acquired, and

- All non-complete agreements

• If elected, must also elect ASC 350 goodwill alternative

Effective immediately with same open-ended one-time election available to

private companies

ASU 2019-06, Extending Private Company Alternatives on Goodwill and Certain Identifiable Intangible Assets to Not-for-Profit Entities

9

Effective Dates Public Business Entities Other Entities

FYs beginning after 12/15/2019 FYs beginning after 12/15/20191

1 And interim periods beginning after 12/15/2020, unless entity adopted ASU 2018-07, in which case it would be for interim

periods beginning after 12/15/2019.

ASU 2018-07 on Improvements to Nonemployee Share-Based Payment

Accounting require that share-based payment awards granted to a customer in

conjunction with selling goods or services be accounted for under ASC 606

Lack of guidance on measuring share-based payment awards granted to a

customer could result in diversity, because entities may apply:

• ASC 606 noncash consideration guidance (measure at contract inception), or

• ASC 718 guidance (measure at grant date)

ASU 2019-08 requires measurement and classification of share-based payment

awards granted to a customer by applying ASC 718

ASU 2019-08, Codification Improvements—Share-Based Consideration Payable to a Customer

10

2019 Select Proposals

Title Comment Deadline

Proposed ASU, Financial Instruments—Credit Losses (Topic 326),

Derivatives and Hedging (Topic 815), and Leases (Topic 842):

Effective Dates

September 16, 2019

BDO comment letter

BDO alert

Invitation to Comment, Identifiable Intangible Assets and

Subsequent Accounting for Goodwill

October 7, 2019

BDO comment letter

Proposed ASU, Reference Rate Reform (Topic 848): Facilitation of

the Effects of Reference Rate Reform on Financial Reporting

October 7, 2019

BDO comment letter

Proposed ASU, Debt with Conversion and Other Options (Subtopic

470-20) and Derivatives and Hedging—Contracts in Entity’s Own

Equity (Subtopic 815-40): Accounting for Convertible Instruments

and Contracts in an Entity’s Own Equity

October 14, 2019

BDO comment letter

Proposed ASU, Debt (Topic 470): Simplifying the Classification of

Debt in a Classified Balance Sheet (Current versus Noncurrent)

October 28, 2019

BDO comment letter

11

Reflects new FASB viewpoint about effective dates that would stagger the

implementation dates of new major accounting standards:

Larger public entities, followed by

All other entities, including smaller public companies, private companies, employee

benefit plans, and not-for-profit organizations

Expected1 deferrals of pending standards as follows:

Proposed ASU, Credit Losses, Derivatives and Hedging, and Leases: Effective Dates

1 FASB affirmed its decision on 10/16/19; a final ASU is expected mid-November

12

Solicits feedback on:

Whether to change the subsequent accounting for goodwill

• Explores possibilities of amortizing goodwill, modifying the impairment test, costs and

benefits of recent simplifications to goodwill model

Whether to modify the recognition of intangible assets in a business

combination

• Explores whether to subsume all or some intangible assets into goodwill, principles-

based approach, or status quo

Whether to add or change disclosures about goodwill and intangible assets

Comparability and scope

Other topics for consideration

Invitation to Comment, Identifiable Intangible Assets and Subsequent Accounting for Goodwill

13

Reduce the number of models in ASC

470-20 (convertible instruments)

Revise the guidance in ASC 815-40

(derivatives scope exception)

Update diluted EPS models (ASC 260)

Expand related disclosures

Overview of Proposed ASU – Convertible Instruments and Contracts in an Entity’s Own Equity

14

Convertible Instruments* - Existing GAAP Proposed GAAP

Embedded derivative model (ASC 815-15) to account for convertible debt instruments with

embedded conversion features that are not clearly and closely related to the host contract,

meet the definition of a derivative, and do not meet the criteria for the derivatives scope

exception. Conversion features are bifurcated as derivatives from the host contract and

measured at fair value.

Model retained

Cash conversion model (ASC 470-20) to account for convertible debt instruments that may be

settled entirely or partially in cash upon conversion. Host contract is measured at the fair value

of a similar debt without conversion features, and conversion features are recorded as equity

components at the residual amount.

Model eliminated

Beneficial conversion feature model (ASC 470-20) to account for convertible debt

instruments with conversion features that are in the money at the commitment date or that

become in the money at a later date after the occurrence of a contingent event. Conversion

features are recorded as equity components at intrinsic value, and the host contract is

recorded at the residual amount.

Model eliminated

Substantial premium model (ASC 470-20) to account for convertible debt instruments issued

at substantial premiums. Conversion features are recorded as equity components.

Model eliminated

Traditional convertible debt model (ASC 470-20) to account for other convertible debt

instruments as a single debt instrument measured at amortized cost.

Model retained

Proposed ASU – Convertible Instruments and Contracts in an Entity’s Own Equity

* Proposed amendments have a similar effect on convertible debt and convertible preferred stock guidance

15

Revise the guidance in ASC 815-40 (derivatives scope exception), as follows:

Layer a likelihood threshold to existing indexation guidance

• Evaluating any potential adjustments that have a remote likelihood of occurring no

longer would be required

• Will create new requirement for companies and auditors to analyze and document

whether a triggering event is probable, involving time, effort, and judgment.

Remove the following from the settlement guidance:

• Requirement to evaluate provisions that could require net cash settlement but have a

remote likelihood or occurring

• Condition regarding settlement in unregistered shares

• Condition regarding collateral

• Condition regarding shareholder rights

Proposed ASU – Convertible Instruments and Contracts in an Entity’s Own Equity

16

Update EPS guidance to align with amendments to convertible debt and derivatives

scope exception, as follows:

Require the if-converted method for convertible instruments (versus treasury

stock method); should not change practice in most cases

Require share settlement presumption for calculating diluted EPS when an

instrument may be settled in cash or shares (i.e., remove current guidance

allowing a rebuttable presumption)

Include equity-classified convertible preferred stock that includes a down round

feature in the scope of the recognition and measurement guidance for down-

rounds in EPS guidance.

Require average market price to calculate diluted EPS denominator when the

exercise price or number of shares to be issued varies based on share price.

Proposed ASU – Convertible Instruments and Contracts in an Entity’s Own Equity

17

Expand convertible debt (instrument) disclosures to compensate for reduction in

accounting models:

Add disclosure objective

Add information about events or conditions that occur during the reporting

period that significantly affect the conversion conditions

Add information on which party controls the conversion rights

Align disclosure requirements for contingently convertible instruments with

other convertible instruments

Require that existing fair value disclosures in ASC 825, Financial Instruments, be

provided at the individual instrument level rather than in the aggregate

Proposed ASU – Convertible Instruments and Contracts in an Entity’s Own Equity

18

Proposes a principles-based model for determining classification:

An entity would classify an instrument as noncurrent if either of the following

criteria is met as of the balance sheet date:

1. Liability is contractually due to be settled more than one year (or operating

cycle, if longer) after B/S date

2. Entity has a contractual right to defer settlement of the liability for a period

greater than one year (or operating cycle, if longer) after B/S date

Continue to classify debt as noncurrent (separate from other noncurrent) if

waiver received for covenant violation

Additional disclosures proposed

Would apply to all debt arrangements, including convertible debt instruments,

liability-classified mandatorily redeemable financial instruments, and lease

liabilities

Proposed ASU, Simplifying the Classification of Debt (Current versus Noncurrent)

19

ASC 606 Reminders

20

THE FIVE STEP MODEL

Core Principle:

Steps to Apply the Core Principle Are:

Recognize revenue to depict the transfer of goods or services to customers in an

amount that reflects the consideration to which the entity expects to be entitled in

exchange for those goods or services.

STEP 1:

Identify The

Contract

STEP 2:

Identify

Separate

Performance

Obligations

STEP 3:

Determine

Transaction

Price

STEP 4:

Allocate

Transaction

Price to

Performance

Obligations

STEP 5:

Recognize

Revenue

When/As

Performance

Obligations

Satisfied

21

STEP 1: IDENTIFY THE CONTRACT

Assessing collectibility

Must expect to collect “substantially all” of consideration

• Does contract represent a substantive transaction? Consider:

- Customer ability and intent to pay

- Entity’s exposure to credit risk and ability to mitigate credit risk

• When contract criteria not met, addresses when revenue is recognized

(Clarified by ASU 2016-12)

22

STEP 1: IDENTIFY THE CONTRACT

Contract modifications:

Contract modifications are changes in the scope and/or price of the

contract.

– i.e. create new or amend existing enforceable rights and obligations

A contract modification must be approved in writing, orally, or otherwise

as implied by the entity’s business practices.

Depending on the circumstances may be accounted for as follows:

– A separate contract

– Termination – replace the old contract with the new contract

– Continuation – treat modification as part of the original contract

23

Can the customer benefit from the good or service, either

on its own, or with other readily available resources?

(‘readily available resources’ are those that the customer possess or is able to

obtain from the entity or another third party)

The good or service is not

‘distinct’

(these are then grouped into ‘bundles’

of goods and services that are

themselves ‘distinct’)

No

Yes

Is the promise to transfer a good or service separate from the other promised goods or services in the contract?

Indictors that it is not separately identifiable may include:

The good or service IS

‘distinct’

The entity provides a significant service of integrating the

goods and services.

A good or service significantly modifies or

customizes the other goods and

services.

A good or service is highly dependent

or interrelated with the other goods and services.

No

Definition of a ‘Distinct’ Good or Service:

STEP 2: IDENTIFY SEPARATE PERFORMANCE OBLIGATIONS

Yes

Page 23

24

STEP 3: DETERMINE TRANSACTION PRICE

Definition of Transaction Price:

• The transaction price is the amount of consideration to which an entity expects to be

entitled in exchange for transferring promised goods or services to a customer.

– Excluding amounts collected on behalf of third parties – e.g. sales taxes etc.

• The consideration promised in a contract with a customer can vary in terms of nature

and timing, and this affects the determination of the transaction price.

• Specific consideration is given to:

(i) Variable consideration (including constraints on estimates of variable consideration)

(ii) The existence of a significant financing component in the contract

(iii) Non-cash consideration

(iv) Consideration payable to a customer

25

STEP 4: ALLOCATE TRANSACTION PRICE TO PERFORMANCE

OBLIGATIONS

• An entity allocates/splits the transaction price (determined in Step #3) between

its performance obligations (identified in Step #2).

• The allocation is based on the relative ‘standalone selling prices’ of each

identified performance obligation, being:

– ‘The price at which an entity would sell a promised good or service separately to a

customer’.

• Specific consideration is given to:

(i) Determining the Standalone Selling Price of a Performance Obligation

(ii) Methods of Estimating the Standalone Selling Price

(iii) Variable Consideration – Determining Allocation

(iv) Discounts – Determining Allocation

26

(ii) Methods of Estimating the Standalone Selling Price:

STEP 4: ALLOCATE TRANSACTION PRICE TO PERFORMANCE

OBLIGATIONS

(a) Adjusted Market Approach

• Estimate the price customers in the market would be willing to pay.

• May also consider reference to competitors prices for similar goods and services.

(b) Expected Cost Plus a Margin Approach

• Forecast the expected costs and then add an appropriate margin.

(c) Residual Approach

• Total transaction price less the observable standalone selling prices of other performance obligations

• However, must meet either of the below criteria:i. The selling price varies significantly (the same good or service is sold at the same time to other

customers for a very broad range of prices)

ii. The selling price is uncertain (selling price has not yet been established and the good or service has

not previously been sold)

• Can only be used after the allocation of any discounts (refer to next slide).

Contrast to existing U.S. GAAP: Currently, use of the residual method allocates the entire discount to the delivered item.

In contrast, a residual approach under the new standard is used to estimate the standalone selling price, not to allocate

consideration to a performance obligation.

Page 26

27

STEP 5: RECOGNIZE REVENUE

A vendor satisfies a performance obligation and recognizes revenue over time

when one of the following three criteria is met:

(i) The customer simultaneously receives and consumes the economic

benefits provided by the vendor’s performance.

(ii) The vendor creates or enhances an asset controlled by the customer.

(iii)

The vendor’s performance does not create an asset for which the

vendor has an alternative use, and the vendor has an enforceable

right to payment for performance completed to date.

28

SEC Matters Update

29

SEC Rulemaking – Focus Areas

29

Capital

Formation

Disclosure

Effectiveness

Investor

Protection

30

SEC FINAL RULEMAKING

31

Streamline and simplify disclosure requirements, discourage repetition and

disclosure of immaterial information

Include changes to:

• MD&A

• Confidential treatment requests

• Cross-referencing

• Property Disclosures

• Risk Factors

• XBRL and hyperlinks

Refer to BDO SEC Alert

SEC Rulemaking – FAST Act Modernization & Simplification of Regulation S-K (Final Rules)

32

Amendments to MD&A:

• Omit reference to year-to-year comparisons and allow registrants to use any

presentation that enhances an investors understanding of the registrant’s financial

condition and results

• Option to generally omit MD&A discussion of the earliest of the three years presented

in the financial statements if the discussion is included in any of prior filings

• Disclose location in prior filing where discussion can be found

Ability to omit confidential information from exhibits without first asking the

staff for confidential treatment

Refer to BDO SEC Alert

SEC Rulemaking – FAST Act Modernization & Simplification of Regulation S-K (Final Rules)

33

Extends the “test-the-waters” accommodation currently only available to

emerging growth companies to ALL issuers

Enables issuers to gauge market interest in possible offering with certain

institutional investors prior to, or following, the filing of a registration

statement

Final Rule is effective December 3, 2019

Refer to Press Release for more information

SEC Rulemaking – Solicitations of Interest Prior to a Registered Public Offering (Final Rules)

33

34

COMMENT LETTER TOPICS

35

Comment Letter Topics HIGH FOCUS AREAS

35

Revenue Recognition (“Topic 606”)

Non-GAAP Financial Measures

MD&A

36

Comment letters seek clarity on Topic 606 accounting and disclosures, including:

The identification of performance obligations

The type and nature of variable consideration, including whether any variable

consideration is constrained

Information regarding the method used to recognize revenue for performance

obligations and why the method is appropriate

The analysis for presenting revenue on a gross vs. net basis (i.e., principal vs.

agent considerations)

Disaggregation of revenue that reflect how economic factors affect the nature,

amount, timing and uncertainty of revenue and cash flows

Revenue Recognition (“Topic 606”)

37

Comments focus on measures that appear to:

• Modify GAAP recognition and measurement principles (i.e., constitute an

individually tailored accounting principle)

• Exclude normal cash operating expenses from performance measures

• Be applied inconsistently period to period (i.e., changing measures over

time)

Expense associated with the reduction of the right-of-use asset for operating

leases over time is a component of rent expense and should not be reflected as

“amortization” in EBITDA or Adjusted EBITDA performance measures.

Non-GAAP Financial Measures

38

The staff frequently commented on MD&A disclosures. The nature of these

comments:

• Increasing specificity in describing “why” changes have occurred period over

period.

• Seeking more information about the underlying causes and effects of known

trends, events, and uncertainties.

• Focusing the discussion of critical accounting estimates on the significant

judgements and estimates that, if changed or varied, will significant impact

their results.

• Providing more detail about performance indicators, financial or

nonfinancial that are used to manage the business.

MD&A

39

Other perennial favorites

• Fair value measurements

• Intangible assets and goodwill

• Income taxes

• Segment reporting

Other potential topic areas

• Accounting and disclosures related to ASC 842 (Leases)

• SAB 74 Disclosures related to CECL

• LIBOR transition

• Cybersecurity

Other Comment Letter Topics

40

SEC REPORTING REMINDERS

41

Takeaways from recent SEC enforcement actions against companies with long-

outstanding material weaknesses in internal control over financial reporting

• Disclosure of material weaknesses isn’t enough without meaningful

remediation

• Refer to press release for more information

Internal Control over Financial Reporting

42

ASU 2016-13 Financial Instruments – Credit Losses (Topic 326) will be effective

for SEC filers excluding Smaller Reporting Companies for periods beginning after

December 15, 2019 (December 15, 2022 for all other entities).

• Final ASU deferring effective dates for certain companies pending as of

November 12

Standard will require companies to measure all expected credit losses for

financial assets (including trade receivables) based on historical experience,

current conditions and reasonable supportable forecasts about collectability.

SAB 74 disclosures are to provide investors with information about the impact

that recently issued accounting standard will have on the financial statements.

SAB 74 Disclosures - Current and Expected Credit Losses (CECL)

43

Disclosure of the future maturities of operating lease obligations is required in

the financial statement footnotes.

ASC Topic 842 defines what should be included in the future minimum lease

payments disclosure. For example, Topic 842 requires lessees to include

renewal options that are reasonably certain of being exercised. This is a change

from Topic 840 which did not provide such guidance.

The payment obligations included in the contractual obligations table in MD&A

should be consistent with the future minimum lease payments schedule.

Contractual Obligations Table Reporting

44

Completion of the financial reporting process requires careful attention to

detail. Processes should ensure that:

• The EDGARized version of the 10-K is complete and accurate (i.e., no

missing paragraphs or columns from tables, no truncation of information in

tables, etc.)

• All relevant dates appear within the audit reports, consents, and signatures

• The form and content of registrants’ annual certifications are accurate

• All material contracts are included within the exhibits to the filing.

Form 10-K Process Reminders

45

Corporate Governance: Audit Committee Tools and Resources

46

Click here for Top 5

Takeaways publication

2019 BDO Board Survey

47

The Board's Direction: Steadying the Ship in Times of

Turbulence

Faced with a deluge of competing and often volatile

priorities, public company board directors’ oversight

responsibilities have reached new heights. Sustaining long-

term value today means responding diligently to geopolitical

tensions, unrelenting technology disruption, changing

regulation, pressures to embrace diversity in the boardroom

and more.

According to our 2019 BDO Board Survey, public company

boards, of varying market caps*, are busy navigating these

issues while evolving the way they communicate key

decisions, actions and company performance to meet new or

changing stakeholders’ demands.

2019 BDO Board Survey

48

Access the full report here.

The BDO 600: 2019 Study of Board Compensation Practices

49

https://www.the

caq.org/archive-

audit-committee-

transparency-

barometer/

Key findings from 2019 Audit Committee Barometer:

The CAQ concludes that year over year finding trends

indicate that while progress is encouraging, AC can do more

to increase transparency and, as a result, investor confidence

in voluntarily providing robust disclosures to inform investors.

CAQ 2019 Audit Committee Barometer

Positive Trends Concerns

Increases in discussion of

• non-audit services and

independence

Many disclosure levels are stagnant

or slowing for all size companies

• auditor tenure Low disclosure continues around:

• Criteria for evaluating the

auditor

• Significant areas addressed w/

auditor

• Involvement in audit

partner selection

• Auditor compensation

• Cybersecurity • Audit fees and audit quality

50

• New mandate for board

leaders is emerging as a

result of deeply connected

and intensifying megatrends

• Pace and scale of

change are redefining how

companies create and

preserve value, requiring a

new board governance

model

• Board leaders must

transform how the board is

composed, operates,

interacts with management

and holds itself accountable

Five major shifts that board leadership should help orchestrate:

1. Deeper, more proactive board engagement with management on entirely

new & fast-changing drivers of strategy and risk

2. More strategic, forward-looking approach to board renewal through the

lens of shifting needs of the business

3. More dynamic, flexible board operating model and structure

4. Increased internal & external transparency about workings of the board

5. More rigorous accountability for board & individual-director performance

Access the NACD report and resources here.

2019 NACD Blue Ribbon Commission Report

51

Center for Audit Quality: Main Street Investor Survey

Source: CAQ 2019 Main Street Investor Survey

52

Center for Audit Quality: Main Street Investor Survey

53

This edition of Profession in Focus features Christopher Tower, National Assurance Managing Partner for

Audit Quality and Professional Practice at BDO USA LLP. Tower provides an overview of the many ways that

BDO communicates the firm’s strong commitment to audit quality, both externally and internally. He also

provides insights into how BDO developed its 2019 Audit Quality Report, including its use of the CAQ’s

Audit Quality Disclosure Framework to help inform the report’s structure and content.

CAQ Profession in Focus: Communicating the Commitment to Audit Quality

54

Delivering Sustained Audit Quality

Source: BDO 2019 Audit Quality Report

55

Source: BDO 2019 Audit Quality Report

Delivering Sustained Audit QualityClear Priorities and Activities

56

Source: BDO 2019 Audit Quality Report

Delivering Sustained Audit QualityClear Priorities and Activities

57

The roles and

responsibilities of the

Audit Committee continue

to evolve adding to the

continuing need to stay on

top of accounting and

audit regulations and

mandatory and voluntary

disclosures.

BDO continues to compile

tools and resources to

assist Audit Committees in

fulfilling their obligations

and documenting their

activities, designed so

that members may focus

on the risks at hand.

Stay tuned for more tools

being released this

summer and fall!

BDO Audit Committee Resources

Recommended Resources Intended Use

BDO Audit Committee Self

Assessment

Tool to assist in evaluating how the Audit

Committee is executing governance

responsibilities.

BDO Audit Committee

Requirements Practice Aid

Tool to assist Audit Committees in fulfilling their

oversight responsibilities and documenting their

activities.

BDO Audit Committee Illustrative

Charter

Tool with example to assist Audit Committees in

constructing their own company-specific charter

to be used as a working document or practical

roadmap of responsibilities and duties.

BDO Professional Judgment

Framework

Tool to assist professionals in their capacity to

logically assess situations or circumstances and

to draw sound, objective conclusions that are not

influenced by cognitive traps and biases or by

emotion.

58

April 2019 – The Center for Audit Quality (CAQ) issued an

updated tool with sample questions for ACs to consider in

assessing the external auditor on a “1-5 satisfaction” scale:

Quality of services & sufficiency of resources provided

within the audit engagement team

Quality of services & sufficiency of resources provided by

the audit firm

Communication & interaction with the external auditor

Auditor independence, objectivity, & professional

skepticismLearn more by

reading BDO’s flash

report

CAQ Updated External Auditor Assessment Tool

59

In addition to educating

stakeholders on ICFR, this

publication includes the

addition of significant research

demonstrating the importance

and impact of ICFR and

integrated audits on the quality

of financial reporting.

Access BDO’s Alert here.

After the SEC recently fined a number of companies for failing

to remedy material weaknesses in ICFR, the PCAOB released a

Staff Preview of its 2018 Inspection Observations, highlighting

the testing of ICFR remains a common audit deficiency.

ICFR remains an important component to fostering confidence in

a company’s financial reporting, and ultimately, trust in our

capital markets. To assist in these concerns, the Center for

Audit Quality (CAQ) has updated and re-released its popular

Guide to Internal Control over Financial Reporting as an

overview to assist stakeholders in understanding key ICFR

concepts, roles and responsibilities, and what ICFR means for

companies, investors, and the markets.

CAQ Guide: Internal Control over Financial Reporting

60

Learn more by

reading BDO’s

release discussing

the CAQ’s

publication

The CAQ has released Emerging Technologies, Risk and the Auditor’s

Focus: A Resource for Auditors, Audit Committees, and Management

to highlight the financial reporting implications of the evolving use

of technology together with the benefits, risks, and associated

auditor considerations. Building on the previously released 2018 CAQ

Emerging Technologies: An Oversight for Audit Committees, the CAQ

provides insight to key stakeholders in the following areas:

CAQ: Digital Transformation & Audit

EMERGING

TECHNOLOGIES –

RISK ASSESSMENT

AND THE AUDIT

TECHNOLOGY

IMPACT –

POTENTIAL AREAS

OF AUDITOR FOCUS

KEY TECHNOLOGY

DEVELOPMENTS –

THE BASICS AND

AUDITOR

IMPLICATIONS

61

Resources

62

A resource center with the continual education needs

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financial reporting in mind!

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63

Title DateWhat’s on the Minds of Boards: BDO 2019 Board Survey (Part 2) Feb 2020

What’s on the Minds of Boards: BDO 2019 Board Survey (Part 1) Jan 2020

Quarterly Technical Update – Q4 2019 Jan 2020

2019 Board Pay and Governance Outlook for Mid-Cap Companies - Are You Prepared?

(coming soon)Dec 2019

2019 CEO/CFO Pay Outlook for Mid-Cap Companies - Are You Prepared? (coming soon)Dec 2019

Transforming Internal Audit Methodology Into Agile IA Nov 2019

BDO Board GovernanceUPCOMING WEBINARS

For a complete listing of BDO webinars and archived webinars, refer here.

64

Title DateDemystifying Critical Audit Matter (CAM) Reporting Oct 2019

Quarterly Technical Update – Q3 2019 Oct 2019

How Audit Committees Manage Difficult Moments Sep 2019

Top IT Audit Risks Sep 2019

Quarterly Technical Update – Q2 2019 July 2019

Audit Speed – Opportunities for Enhancement Jun 2019

Building Tomorrow’s Business: What Does Digital Transformation Mean for Middle-

Market Companies in 2019Jun 2019

California Consumer Privacy Act: 6 Mont Countdown for Retailers Jun 2019

Power Growth: Complexities of Accounting in a Global World May 2019

Getting to the Point – Effective Audit Ratings Apr 2019

Corporate Governance – Spotlight on Evolving Diversity on the Board Apr 2019

2019 Shareholder Meetings – What’s On Deck? Part 1 Apr 2019

2019 Shareholder Meetings – What’s On Deck? Part 2 Apr 2019

Quarterly Technical Update – Q1 2019 Apr 2019

Innovative Use of Robotics in Internal Audit Feb 2019

BDO’s 2019 IPO Outlook Survey and Key Takeaways from a Successful IPO Feb 2019

BDO Board GovernanceARCHIVED WEBINARS

For a complete listing of BDO webinars and archived webinars, refer here.

65

Title DateQuarterly Technical Update – Q4 2018 Jan 2019

2018 Executive and Board Pay Outlook for Mid-Cap Companies – Are Your Prepared? Dec 2018

Adding Value Via Internal Audit Transformation: Finding the Right Balance Nov 2018

What’s on the Minds of Boards – BDO 2018 Cyber Governance Survey Nov 2018

What’s on the Minds of Boards - BDO 2018 Board Survey Nov 2018

New SOC 2 Guidance and What It Means for Your Company Nov 2018

The New GILTI Proposed Regulations: What Have We Learned Nov 2018

Quarterly Technical Update – Q3 2018 Oct 2018

Cybersecurity: Protecting Your Organizations from Today’s Everchanging Threats Oct 2018

GDPR: What U.S. Boards of Directors Need to Know Sep 2018

Cybersecurity - Resources Boards Want to Know About Sep 2018

How To Deal With the Impacts of Wayfair Aug 2018

Quarterly Technical Update – Q2 2018 July 2018

BDO Board GovernanceARCHIVED WEBINARS

For a complete listing of BDO webinars and archived webinars, refer here.

66

Title DateImpact of Tax Reform on Corporate Strategic M&A Transactions Jun 2018

From Scandals to Serious Setbacks: How a Poor Company Culture Can Impact… Jun 2018

Impact of U.S. Income Changes on Cross Board Mobility May 2018

The New Leasing Standard – Are Your Ready? May 2018

2018 Shareholder Meetings – What’s on Deck? Apr 2018

Quarterly Technical Update – Q1 2018 Apr 2018

Compensation Committee: Tax Reform Impacts & Other Trends… Feb 2018

Understanding the New Hedging Standard Feb 2018

Tax Reform and the Board’s Role Jan 2018

BDO Board GovernanceARCHIVED WEBINARS

For a complete listing of BDO webinars and archived webinars, refer here.

67

Title DateInternal Audit’s Role in Monitoring and Controlling International Exposure Nov 2017

Building an Effective Compensation Committee Oct 2017

Harnessing the Power of Data and Data Analytics and Continuous Monitoring Sep 2017

Applying the New Revenue Standard (Part 2) Aug 2017

Applying the New Revenue Standard (Part 1) Aug 2017

ASC 606, Revenue from Contracts with Customers Aug 2017

Internal Audit’s Role in Highly Acquisitive Organizations Jun 2017

AICPA SOC for Cybersecurity - What You Need to Know Now Jun 2017

Director Diversity – Striking the Right Balance in the Boardroom Jun 2017

Board Leadership – How to Onboard Your Board May 2017

Reducing the Burden of Sox Compliance Apr 2017

What Boards Need to Know About Cybersecurity (But May Be Afraid to Ask) Mar 2017

BDO Board GovernanceARCHIVED WEBINARS

For a complete listing of BDO webinars and archived webinars, refer here.

68

Title DateBoards as Catalysts for Intrapreneurship and Innovation Feb 2017

Small Cap Boards – Realities and Strategies for Capital Structuring Jan 2017

Board Collaboration: Leveraging Communication Tools and Technology Oct 2016

Navigating the Rising Tide of Cybersecurity Regulation – How Is Your Board Preparing? July 2016

M&A Execution: Planning with Post-Integration in Mind May 2016

How Is Your Board Positioned to Respond to Illegal Acts? May 2016

When and Why Should a Board Require an Independent Fairness Opinion May 2016

Executive Performance Goals Which Do Not Create Enterprise Risk Apr 2016

BDO Board GovernanceARCHIVED WEBINARS

For a complete listing of BDO webinars and archived webinars, refer here.

69

BDO Board GovernancePUBLICATIONS

For a complete listing of BDO publications, refer to: https://www.bdo.com/insights/

Title Date3 Reasons Why You Need to Forge Ahead with Lease Accounting Implementation Nov 2019

2019 SEC Reporting Insights Nov 2019

BDO Knows Lease Accounting Nov 2019

BDO Knows Lease Accounting: Road to Compliance Checklist Nov 2019

BDO Comment Letter – Simplifying the Classification of Debt in a Classified Balance

SheetNov 2019

The BDO 600 – 2019 Study of Board Compensation Practices Oct 2019

2019 Board Survey Oct 2019

Tax Reform Impact Continues Oct 2019

FASB Affirms Decisions to Defer Effective Dates of Major New Accounting Standards Oct 2019

BDO Comment Letter – Accounting for Convertible Instruments and Contracts in an

Entity’s Own EquityOct 2019

BDO Comment Letter – Identifiable Intangible Assets and Subsequent Accounting for

GoodwillOct 2019

BDO Comment Letter – Reference Rate Reform (Topic 848) (File Reference No. 2019-770) Oct 2019

70

BDO Board GovernancePUBLICATIONS

For a complete listing of BDO publications, refer to: https://www.bdo.com/insights/

Title Date2019 Board Survey – Top 5 Takeaways Sep 2019

SEC Proposes to Update Disclosures Requirements for Banking Registrants Sep 2019

2019 Tax Planning Timeline Sep 2019

CECL for Non-Financial Institutions Sep 2019

2020 Cybersecurty Guidelines for C-Suite Executives Sep 2019

BDO Comment Letter – Financial Instruments—Credit Losses (Topic 326) Sep 2019

BDO Comment Letter – Clarifying the Interactions Between Topic 321, Topic 323, and

Topic 815Aug 2019

Delivering Sustained Audit Quality Aug 2019

FASB Proposes to Defer Effective Dates of Major New Accounting Standards Aug 2019

SEC Proposes More Changes to Modernize Regulation S-K Disclosure Aug 2019

71

BDO Board GovernancePUBLICATIONS

For a complete listing of BDO publications, refer to: https://www.bdo.com/insights/

Title DateBDO Comment Letter – Codification Improvements to Topic 326, Financial Instruments

– Credit LossesJuly 2019

The Future of Auditor Reporting is Here July 2019

BDO Cyber Threat Insights - 2019 2nd Quarter Report July 2019

Significant Accounting & Reporting Matters Q2 2019 July 2019

PCAOB Issues CAM Resources For Non-Auditors July 2019

Illustrative Audit Committee Charter July 2019

CAQ Issues External Auditor Assessment Tool: A Reference For U.S. Audit Committees July 2019

PCAOB Preview of 2018 Inspection Observations July 2019

CAQ Issues External Auditor Assessment Tool: A Reference for U.S. Audit Committees July 2019

Illustrated Audit Committee Charter July 2019

72

BDO Board GovernancePUBLICATIONS

For a complete listing of BDO publications, refer to: https://www.bdo.com/insights/

Title DateBDO Comment Letter - Disclosure Improvements Jun 2019

CAQ Issues Emerging Technologies, Risk, and the Auditor's Focus Jun 2019

ASC 842 Implementation for Private Companies: Lessons Learned from Public

CompaniesJun 2019

Six Month Countdown to CCPA: The 10 Information Governance Steps Needed for

ComplianceJun 2019

FASB Simplifies Accounting for Goodwill & Certain Identifiable Intangible Assets for

NFPsJun 2019

Benefits of Independent Analysis of Lease Portfolios Jun 2019

CAQ Issues a Tool For Audit Committees: Preparing for the New Credit Losses Standard Jun 2019

Understanding ICFR Jun 2019

Three Ways to Reduce Income Tax Reporting Risk Jun 2019

FASB Issues Transition Relief for Credit Losses Standard Jun 2019

Understanding Complex Financial Instruments Jun 2019

Understanding Internal Control over Financial Reporting Jun 2019

BDO Professional Judgment Framework Jun 2019

73

BDO Board GovernancePUBLICATIONS

For a complete listing of BDO publications, refer to: https://www.bdo.com/insights/

Title DateBDO Comment Letter - Disclosure Framework Changes to the Disclosure Requirements

for Income TaxesMay 2019

Audit Committee Self Assessment May 2019

GDPR One Year Later: A Data Privacy Retrospective May 2019

FASB Issues Targeted Improvements to Financial Instruments Standards May 2019

BDO Knows California Consumer Privacy Act May 2019

SEC Proposes Amendments to Disclosures About Acquired and Disposed Businesses May 2019

SEC Proposes Amendments to Accelerated and Large Accelerated Filer Definitions May 2019

FASB Targets Improvements to Financial Instruments Standards May 2019

74

BDO Board GovernancePUBLICATIONS

For a complete listing of BDO publications, refer to: https://www.bdo.com/insights/

Title DateBDO Knows California Consumer Privacy Act May 2019

SEC Proposes Amendments to Disclosures About Acquired and Disposed Businesses May 2019

SEC Proposes Amendments to Accelerated and Large Accelerated Filer Definitions May 2019

FASB Targets Improvements to Financial Instruments Standards May 2019

BDO Comment Letter – Revenue from Contracts with Customers Apr 2019

Data Ethics Part 1: California and Beyond Apr 2019

Tax Transformation: Value Drivers of Change Apr 2019

Additional CAM Resources for Audit Committees Mar 2019

BDO 2019 Shareholder Meeting Agenda Mar 2019

PCAOB 2019 Inspections Outlook for Audit Committees Mar 2019

FASB Issues Improvement to Leases Standard for Lessor Financial Institutions Mar 2019

ERISA Roundup – Q1 2019 Mar 2019

75

BDO Board GovernancePUBLICATIONS

For a complete listing of BDO publications, refer to: https://www.bdo.com/insights/

Title DateMuch Ado About Tariffs: Preparing for March 1 and Beyond Feb 2019

BDO Comment Letter: Extending Private Company Accounting Alternative on GW and

Certain Intangible AssetsFeb 2019

For a Smoother Landing into the New Leases Standard Feb 2019

2019 BDO IPO Outlook Feb 2019

Significant Accounting & Reporting Matters – Q4 2018 Feb 2019

Tax Transformation Guide Feb 2019

De-Mystifying Cyber Threat Intelligence Feb 2019

Getting ‘On Board’ with Gender Diversity Jan 2019

Eight Key Tax Planning Opportunities for 2019 Jan 2019

2018 Audit Committee Round Up Jan 2019

2018 Accounting Year in Review Jan 2019

76

BDO Board GovernancePUBLICATIONS

For a complete listing of BDO publications, refer to: https://www.bdo.com/insights/

Title DateBDO’s Integrated Thinking and Reporting Journey Guide Jan 2019

FASB Issues Narrow-Scope Improvements of Lessors Jan 2019

Cryptocurrency: The Top Things You Need to Know Jan 2019

2019: The Year of Legal Digital Transformation Jan 2019

SEC 2018 Year in Review Jan 2019

Embracing Digital Transformation Jan 2019

BDO’s 2019 Middle Market Digital Transformation Survey Jan 2019

CECL Update Jan 2019

SEC Examination Priorities for 2019 Jan 2019

Auditor Communications: CAQ Issues Audit Quality Disclosure Framework Jan 2019

BDO Cyber Threat Insights – 2018 Q4 Report Jan 2019

SEC Releases Request for Comment on Quarterly Reporting Jan 2019

CAQ CAM Implementation Tool: Early Lessons Being Learned Jan 2019

77

Questions?

78

Tax Update

79

Draft Disclosure RequirementsOVERVIEW

New partnership disclosures will be required by partnerships for 2019

income tax returns

Tax basis capital reported by partner

Beginning and ending of year partner share of Section 704(c) built-in

gain/loss

Partner share of Section 751 ordinary income or loss, as applicable

Guaranteed payment for services versus use of capital disclosure

Disregarded entity disclosure detail

Additional liability reporting

80

Draft Disclosure RequirementsREASON FOR THE CHANGES

The IRS Office of Chief Counsel is taking a three-pronged approach to

improving tax compliance among partnerships, including:

1.Better training within the IRS. The office is implementing an elective,

multi-year training program. The first component of the program will deal

with partnership issues.

2.Increased electronic tax filing. Higher electronic filing will allow the IRS

to dedicate more resources to substantive issues rather than transcribing

data from paper returns onto computer systems.

3.Revisions to key tax forms. The changes are focused on improving the

information the IRS gathers from partnerships.

81

Draft Disclosure RequirementsTAX BASIS CAPITAL

Item L on Schedule K-1, Partner’s Capital Account Analysis must now be

prepared solely on the tax basis

Previously, partnerships could report partner capital on Schedule K-1 on a

GAAP, tax, Section 704(b) book, or “other” basis

Beginning in 2018, partnerships were required to report negative tax basis

capital accounts

The IRS is continuing to attempt to identify situations where “outside” tax basis

is significant relative to a partner’s tax liability, e.g., deductibility of losses and

debt-financed distributions

See IRS FAQs discussing the calculation of tax basis capital for reporting

purposes

82

Draft Disclosure RequirementsSECTION 704(C) BUILT-IN GAINS/LOSSES

Schedule K-1, Item N will require disclosure of each partner’s share of net

unrecognized Section 704(c) gain or loss

Schedule K-1, Line 20, Code AA may require additional Section 704(c)

information to be specified in forthcoming instructions

This will require partnerships to track changes in a partner’s share of section

704(c) built-in gain and losses. Waiting until an exit event isn’t an option

For partnerships that have had numerous revaluations and property

contributions/distributions of appreciated/depreciated property, tracking

multiple Section 704(c) layers can be a complex and time-consuming endeavor

Section 704(c) amounts are important for the accurate allocation of

nonrecourse liabilities – another area of focus by the IRS

83

Draft Disclosure RequirementsSECTION 751 ORDINARY INCOME/LOSS CHARACTERIZATION

Line 20, Code AB will require reporting of Section 751 gain or loss to be

specified in forthcoming instructions yet to be released by the IRS

Previously, this information did not need to be included on Form 1065 or

Schedule K-1

Form 8308 will likely continue to be a required filing since it is statutorily

required under Section 6050K

By quantifying Section 751 gains or losses, the IRS will likely target situations

where partners who recognize income from sales or exchanges of partnership

interests are neglecting to properly recharacterize a portion of their gain or loss

as ordinary income

Note that the determination of accurate Section 751 amounts will require

accurate tracking of Section 704(c) layers

84

Draft Disclosure RequirementsGUARANTEED PAYMENT REPORTING

Guaranteed payments to partners will now be broken out between those made

for services and those made for the use of capital

In the past, the breakdown between different types of guaranteed payments

was not required

In proposed regulations, the IRS included guaranteed payments for the use of

capital (GPUC) in its definition of business interest expense subject to the

limitations contained in Section 163(j). This additional disclosure may help the

IRS identify when GPUCs are paid or accrued.

85

Draft Disclosure RequirementsDISREGARDED ENTITY DISCLOSURES

Schedule K-1, Line H2 asks if the partnership interest is owned through a

disregarded entity, and if it is, to identify the name and taxpayer ID number of

the disregarded entity

Previously, partnerships did not have to disclose the name or TIN of the

disregarded entity, just the name and TIN of the beneficial owner

This disclosure may relate to liability allocations to a disregarded entity under

the anti-abuse rules contained in Prop. Regs. Sec. 1.752-2 as well as identifying

the ultimate taxpayer that will include the income, gain, loss, deduction and

credit from Schedule K-1

86

Draft Disclosure RequirementsSECTION 752 LIABILITY ALLOCATIONS

Item K on Schedule K-1 now asks whether reported liability amounts include

amounts from lower tier partnerships

This is a new reporting requirement and may indicate that the IRS is preparing

for future audits by identifying losses or distributions that potentially exceed

tax basis when covered with liability allocations

Note that under recently finalized regulations, incorrect allocations of

partnership liabilities can create an imputed underpayment obligation to the

partnership

Recently finalized regulations under section 752 contain a number of rules that

will need to be considered

87

Consolidated

Issues in Section

163(j) (Business

Interest Expense

Limitation)

88

Limits business interest expense (“BIE”) deductions to the sum of:

• business interest income (“BII”),

• 30% of adjusted taxable income (“ATI”),and

• the taxpayer’s floor plan financing interest for the tax year

ATI is defined as the taxable income of the taxpayer computed without regard to:

• items properly allocable to an excepted trade or business,

• BIE and BII,

• NOL deductions,

• deductions under section 199A,

• depreciation, amortization, or depletion deductions (“depreciation”) not capitalized to inventory,

but only for tax years beginning before January 1, 2022,

• capital losses, and

• certain dispositions of property, partnership interests, and stock of a consolidated group

member to the extent prior depreciation deductions increasedATI

Section 163 (j) – Overview For Corporations

89

Section 381(c)(20) treats the carryover of disallowed BIE as an item to which the

acquiring corporation succeeds in a section 381(a) transaction.

The Proposed Regulations:

Clarify that the carryover item includes disallowed BIE from the taxable year

ending on the date of distribution or transfer; and

Limit the acquiring corporation’s ability to use carryforwards in its first taxable

year ending after the acquisition, consistent with treatment of NOL

carryforwards under Treas. Reg. §§ 1.381(c)(1)-1 and 1.381(c)(1)-2.

The Proposed Regulations generally provide that the disallowance and

carryforward of a deduction for a C corporation’s BIE will not affect whether or

when such BIE reduces the taxpayer’s E&P (i.e., E&P reduced when BIE is paid

or accrued).

Section 163(j) - Section 381 and E&P

90

Section 382(d)(3) treats a carryover of BIE under section 163(j)(2) as a “pre-change loss”

subject to section 382, under rules similar to NOLs in section 382(d)(1).

Proposed Regulations provide that the term “section 382 disallowed business interest

“carryforward” consists of:

The loss corporation’s disallowed business interest expense carryforwards and disallowed

BIE in the year of the change allocable to the period prior to the ownership change

The loss corporation’s disallowed BIE in the pre-change period is determined by using a

daily proration method, regardless of whether the loss corporation has made a closing-of-

the-books election under Treas. Reg. § 1.382- 6(b)(2)

Treas. Reg. § 1.382-6(d) provides that if Treas. Reg. § 1.1502-76 applies (relating to the

taxable year of members of a consolidated group), an allocation of items is determined

after applying Treas. Reg. § 1.1502-76.

Proposed Regulations would provide that pre-change disallowed BIE is absorbed before

NOLs, and losses subject to a section 382 limitation before non-limited losses of same type

from same taxable year.

Section 382 – Application to Disallowed BIE

91

The Proposed Regulations set forth rules somewhat similar to those in Treas. Reg. §

1.1502-21(c) for disallowed BIE carryforwards from SRLYs.

Disallowed BIE carryforwards of a member arising in a SRLY that are included in the

consolidated group’s BIE deduction may not exceed the group’s section 163(j) limit,

determined by reference only to the member’s items of income, gain, deduction and loss for

that year.

No cumulative register -- the limitation is determined on a year by year basis.

Deduction of SRLY BIE carryforward is only available if the group has any remaining section

163(j) limitation for the current year after the deduction of

current year BIE,

disallowed BIE carryforwards from earlier years, and

only to the extent that section 163(j) SRLY limitation for the current year exceeds the

amount of the SRLY member’s current year BIE deducted by the group.

SRLY limited disallowed BIE carryforwards are deducted on a pro rata basis with non- SRLY

limited disallowed BIE carryforwards from years ending on the same date.

Prop. Treas. Reg. § 1.163(j)-5(f) would also apply the principles of Treas. Reg. § 1.1502-

21(g) to disallowed BIE carryforwards when the application of the SRLY limitation would

overlap with the application of section382.

SRLY Limitations – Application to Disallowed BIE

92

Consolidated return approach

The Proposed Regulations generally apply the section 163(j) limitation at the

consolidated group level, with the consolidated group having a single

limitation.

The Proposed Regulations provide a multi step process for determining how

members BIE may be utilized.

Step 1: Determine the group’s section 163(j) limitation

For group’s ATI, begin with consolidated taxable income (Treas. Reg. § 1.1502-

11).

For group’s ATI, disregard intercompany transaction items to the extent that

such items offset in amount.

Step 2: Identify member’s with BIE, BII, and floor plan financing interest

Intercompany obligations (Treas. Reg. § 1.1502-13(g)) are disregarded in

determining a member’s BIE and BII.

Consolidated Section 163(j) Limitation

93

Step 3: Allocate the consolidated 163(j) limitation among the members

of the group

If the group’s section 163(j) limitation for the current year exceeds the group’s

aggregate current-year BIE, none of the current year BIE would be subject to

disallowance.

If the members’aggregate current year BIE exceeds the group’s section 163(j) limitation

for the current year, each member deducts its current year BIE up to the amount of its

BII (netting by member).

If the group has any section 163(j) limitation remaining, each member with

remaining current year BIE would deduct its current year BIE pro rata.

If the group has any section 163(j) limitation remaining after deducting current year BIE,

then carryforwards are permitted to be deducted in the order of the year in which they

arose. Carryforwards from the same year are deducted on a pro rata basis.

Consolidated Section 163(j) Limitation

94

Allocation of tax items between an excepted and a non-excepted trade or

business applies on a consolidated basis, i.e., all members of a consolidated

group are treated as one corporation. For example, the group (rather than a

particular member) is treated as engaged in excepted or non-excepted trade or

business.

A departing member retains its current year BIE (through the date of departure)

and disallowed BIE carryforwards to the extent not used by the consolidated

group for the taxable year including the departure date, or otherwise reduced

(e.g., under the unified loss rule of Treas. Reg. § 1.1502- 36).

In general, stock basis adjustments apply under Treas. Reg. § 1.1502-32 at

time BIE is absorbed by the group.

Disallowed BIE is treated as a “deferred deduction” and, thus, may be

reduced or reattributed under Treas. Reg. § 1.1502-36(d) (addressing

“duplicated loss” in a member’s stock and its inside tax attributes).

Consolidated Section 163(j) Limitation

95

Prop. Treas. Reg. § 1.163(j)-1(b)(1)(ii)(C) provides that on thesale or other

disposition of depreciable property, ATI is reduced by the lesser of:

Gain recognized on the sale or other disposition of such property

Any depreciation previously added to ATI with respect to such property

Prop. Treas. Reg. § 1.163(j)-1(b)(1)(ii)(D) provides that on the sale or other

disposition of stock of a member of a consolidated group that includes the selling

member, ATI is reduced by the investment adjustments with respect to such stock

that are “attributable to deductions” taken for depreciation.

Similar rule applies to the disposition of a partnership interest

Section 163(j) – Depreciation

96

Section 163(j) is generally applied at the partnership level.

Excess business interest expense (EBIE) means, with respect to a partnership, the amount of

disallowed BIE of the partnership for a taxableyear.

If BIE is limited at the partnership level, partners receive an allocation of EBIE that is

carried forward at the partner level.

Such EBIE is treated as business interest paid or accrued by the partner in the next

succeeding taxable year in which the partner is allocated excess taxable income from such

partnership, but only to the extent of such excess taxable income, and any portion of such

EBIE remaining is generally treated as business interest paid or accrued in succeeding

taxable years.

Under the Proposed Regulations, the adjusted basis of a partner’s interest in a partnership

is reduced by the amount of EBIE allocated to the partner, but such basis is increased upon

a “disposition” of the partnership interest by the amount of any such EBIE that was not

treated as paid or accrued at the partner level.

Prop. Treas. Reg. § 1.163(j)-4(d) provides that a transfer of a partnership interest in an

intercompany transaction that does not result in the termination of the partnership is

treated as a disposition for purposes of section12

163(j)(4)(B)(iii)(II).

Section 163(j) - Partnerships

97

Consolidated Issuesin Section 168(k) (BonusDepreciation)

98

§168(k) allows for 100% expensing for purchases of new and used “qualified property.”

For used property to qualify, it must satisfy the following acquisition requirements:

The property was not used by the taxpayer (or a predecessor) before its acquisition (“No

Prior Use Requirement”);

The property was not acquired from a related person (see §179(d)(2)(A) and (B)) (a

“Related Party Acquisition”); and

The property was acquired in a cost-basis transaction (i.e., the basis was not determined

in whole or in part based on the basis of the transferor) as defined in §179(d)(2)(C) (or

§1014) (the “Cost-Basis Requirement”).

A Related Party Acquisition is defined as any acquisition of property:

For which any loss would be disallowed under §§267 or 707(b) (generally a more than

50% value standard);

By one component member of a controlled group from any component member of the

same group as defined in §1563 (generally an 80% or more vote or value standard); and

Property acquired by the “new target” as a result of a §338 election or a §336(e) election

is treated as acquired by purchase. See §1.179-4(c)(2) and Prop. §1.179-4(c).

Overview of New §168(k)

99

Prop. §1.168(k)-2(b)(3)(iii)(B) would provide that an acquisition of “used”

property would not meet the requirements for additional depreciation if

The taxpayer or a predecessor used the property at any time prior to the

acquisition

For this purpose, prior use is defined as whether the taxpayer (or its

predecessor) had a depreciable interest in the property

Application to Consolidated Groups: Prop. §1.168(k)-2(b)(3)(iii)(B)(3)(i) would

provide that

A consolidated group will be treated as having a depreciable interest in

property during the time any current or previous member had a depreciable

interest in the property while a member of the group

The Preamble to the Proposed Regulations requested comments on whether a

safe harbor should be provided on how many taxable years a taxpayer, its

predecessor, or a consolidated group must look back to determine whether there

has been “prior use” with respect to acquired property.

Proposed §168(k) Regulations and “Prior Use”

100

Proposed §168(k) Regulations

Series of Related Transactions – Consolidated Groups

Prop. §1.168(k)-2(b)(3)(iii)(B)(ii) would provide that a consolidated group would be

treated as having previously used the property if, in a series of related transactions

• Qualified property is acquired by a member of the consolidated group; and

• A corporation that had a depreciable interest in the property becomes a member of

the group.

Prop. §1.168(k)-2(b)(3)(iii)(B)(iii) would provide that if, in a series of related

transactions, property is acquired by a member of a consolidated group and the

transferee ceases to be a member, whether the transferee is a member of the group is

tested immediately after the last transaction in the series

Series of Related Transactions – All Taxpayers

Prop. §1.168(k)-2(b)(3)(iii)(C) would provide that for an acquisition as part of a series of

related transaction

• The property is treated as directly transferred from the original transferor to the

ultimate transferee; and

• The relation between the original transferor and the ultimate transferee is tested

immediately after the last transaction in the series

101

§168(i)(7) provides that if property is transferred in certain tax-free transactions

or in an intercompany transaction, the transferee is treated as the transferor for

purposes of computing the depreciation deduction to the extent of the basis in the

hands of the transferor.

The tax-free transactions include those described in §§332, 351, 361, 721, or

731.

This provision effectively bifurcates the assets into two assets, one with a

carryover basis and one with a purchased basis.

The Proposed Regulations do not expressly address whether a sale of property to

which §168(i)(7) applies fails to satisfy the Cost Basis Requirement for additional

depreciation.

Proposed §168(k) Regulations - Cost BasisRequirement

Prop. §1.168(k)-2(b)(3)(v), Example 19

Facts:

• Parent owns all of the stock of B Corp and C Corp; all three are members of a consolidated group. C Corp has a

depreciable interest in Equipment #1. In 2018, C Corp sells Equipment #1 to B Corp. B Corp never had a

depreciable interest in the equipment.

Analysis:

• B Corp’s acquisition of Equipment #1 is not eligible for expensing under §168(k) as it does not satisfy the no

“Prior Use” requirement.

– B Corp and C Corp are related parties within the meaning of §179(d)(2)(B) and §1.179-4(c)(2)(iii).

– B Corp is treated as previously having a depreciable interest in Equipment #1 because (i) B Corp is a member

of the Parent consolidated group, and (ii) C Corp had a depreciable interest in Equipment #1 while amember

of the Parent consolidated group.

Parent

Equipment #1

B Corp C Corp

Equipment #1

Equipment #1

Consolidated

Group

103

Questions?

104

Wayfair Updates for Sales & Use Tax and Income Tax

105

Experience

10 years in sales & use tax experience

Former Texas Comptroller Auditor

Audit Defense and Sampling

Reverse audits / Refund reviews

Nexus reviews, research and VDAs

With You Today

Viriam Vazquez, CMI

Senior Manager

State and Local Tax

214-665-0674

vvazquez@bdo.com

106

Overview of the Wayfair decision

State sales/use tax economic nexus laws and regulations

Marketplace Facilitators

What should businesses do?

ASC 450 considerations

Wayfair and state corporate income tax consequences

Agenda

107

Overview of the Wayfair decision

108

As a result of the

Wayfair decision, a

physical presence is

no longer required for

substantial nexus

under the Commerce

Clause.

Wayfair Decision

• On June 21, 2018, the U.S. Supreme Court issued its

decision in South Dakota v. Wayfair.

• In a 5-4 decision, the Court ruled in favor of South Dakota

and overruled Quill Corp. v. North Dakota (1992)

and National Bellas Hess, Inc. v. Illinois DOR. (1967)

• The Court concluded that “the physical presence rule

of Quill is unsound and incorrect.”

• The decision is not limited to sales and use taxes. It also

removes the physical-presence rule for purposes of income,

franchise, and gross receipts taxes.

109

The Court’s holding

presents new

constitutional questions,

including:

• Is the South Dakota

economic threshold

the minimum?

• If not, what standard

will determine the

minimal economic

threshold for

substantial nexus?

• Could a physical,

“non-economic”

presence not

constitute

substantial nexus?

Wayfair – The Threshold

• Wayfair’s substantial nexus threshold

• $100,000 of sales delivered into South Dakota, or

• 200 or more separate transactions for delivery into South

Dakota

• Why U.S. Supreme Court picked this case?

• Reasonable threshold

• Could only be enforced prospectively

• South Dakota’s membership in the SSUTA - (Uniform

sales/use tax definitions, single state/local rate, uniform

state/local tax base, etc.)

110

Most states are

enforcing their sales/use

tax economic nexus

statutes prospectively.

Some may attempt

retroactive

enforcement.

Wayfair – Open Issue - Retroactivity

• The Wayfair decision created numerous open

questions for multistate retailers that have relied

upon the physical presence standard.

• Retailers should monitor State publications to

determine whether potential liability States are

purporting to apply Wayfair on a retroactive basis.

• If currently under audit, the taxpayer should

aggressively resist any attempts to apply economic

nexus on a retroactive basis.

111

State Enacted Economic Nexus Laws and Regulations

112

States with Sales/Use Tax Economic Nexus Statutes(As of 8/7/2018)

113

States with Sales/Use Tax Economic Nexus Statutes(As of 11/20/2019 - www.bdo.com/wayfair)

CA

OR

WA

NV

UT

AZ

NM

CO

MT

WY

ID

ND

SD

KS

NE

OK

LATX

MO

AR

IA

MN

WI

IL IN

TN

KY

ALMS

FL

GA

MI

SC

NC

WVVA

PA

OH

NY

ME

NH

DE

RI

NJ

DC

HI

AK

Enacted

statute/rule/admin

No sales/use tax

Statute/Rule not

enacted to date

*DE, MT, NH, OR have

no sales/use tax

**Nome, AK imposes

economic nexus

VT

MD

CT

MA

114

115

In Direct Marketing

Ass’n v. Brohl (2015),

the U.S. Supreme Court

ruled that Colorado’s

use tax notice and

reporting statute was

constitutional.

*States are trending

towards removing

notice/reporting options

if they statutorily

require remote sellers or

marketplace facilitators

to register and collect.

Use Tax Notice and Reporting

• Colorado began enforcing 7/1/2017 (1/1/2018 for

online marketplaces)

• Option in lieu of economic nexus sales/use tax

collection:

- Alabama

- Georgia (repealed eff. 4/28/2019)

- Iowa (marketplace facilitators)

- Louisiana

- Oklahoma (repealed eff. 11/1/2019)

- Pennsylvania

- Rhode Island

- Vermont

- Washington (repealed eff. 7/1/2019)

116

In Wayfair, the U.S.

Supreme Court

identified use tax

notice, “click-through

nexus,” and “cookie

nexus” as examples for

the failure of the

physical presence rule

“likely” to create

“technical and arbitrary

disputes.”

Other “Physical Presence” Expansion Techniques• Prior to Wayfair, states have also enacted statutes to

impose sales/use tax collection responsibilities based

on:

- Affiliate nexus – remote sellers with affiliated ownership

with an entity that has an in-state physical presence.

- Click-through nexus – remote seller enters into an

agreement with a resident of a state in which the

resident directly or indirectly refers potential customers

to the retailer for a commission or other consideration.

- “Cookie” nexus – remote seller is treated as having

physical presence with a state based on the “presence”

of “cookies” on customers’ or prospective customers’

computers.

117

Marketplace Facilitators

118

• As of November 2019, roughly 37 states have adopted marketplace

facilitators rules

- For the most part, the thresholds are identical to each State’s remote seller economic nexus

thresholds

• Marketplace - physical or electronic place, platform, forum, store, website, catalog, or other

sales software application where TPP is offered for sale

• Marketplace Facilitator or Providers- entity that owns and operates the marketplace,

and directly or indirectly processes transactions on behalf of marketplace sellers

- Facilitators are required to charge/collect/remit sales tax on taxable transactions made

through its marketplace

- Considered the “retailer” under some states marketplace schemes

• Marketplace Sellers - a seller, other than the marketplace facilitator/provider that sells

through the marketplace

Be aware: If a marketplace seller has nexus in a state, and it makes any taxable sales that are not

through a marketplace, then it would be required to collect/remit sales tax on those transactions

Marketplace Facilitator Rules

119

States with Marketplace Facilitator Rules(As of 11/27/2019)

120

121

What Should Businesses Do?

122

Businesses Impacted

• Retail and Consumer Products

- e-Commerce

- Service providers

• Technology

- Online services (SaaS, sellers of digital products)

• Private Equity/M&A

- PE firms and strategic buyers will need to address Wayfair exposure and ongoing

compliance requirements of their portfolio companies and targets.

• Non-U.S. Businesses

- U.S. tax treaties generally do not apply at the state level.

- A foreign business with no US permanent establishment may still be subject to

state economic nexus provisions.

All industries are likely to

see an impact from the

Wayfair decision, but

these are likely the most

widely impacted.

123

Tax Types Impacted

• Sales/use taxes

• Gross receipts taxes

• State corporate income taxes

- Caveat: Public Law 86-272 still applies!

• State franchise taxes

124

Risks of Taking no Action

• Financial risks:

- Sales tax: Detection risk by departments of revenue

- Due diligence valuations

- Use tax notification penalties

- Qui Tam lawsuits: Detection risk by non-government persons

- Class action lawsuits: Complying – but not properly – resulting in overcharging tax

• Reputational risks

• Regulatory risks

125

Suggested Action PlanFIVE STEP APPROACH TO SALES/USE TAX COMPLIANCE IN THE WAKE OF WAYFAIR

Nexus

Determination

Taxability

Evaluation

Exposure

Quantification

Mitigation and

Disclosure

Sales Tax System

Selection and

Implementation

Sales Tax

Compliance

126

Sales Tax RemediationSIX STEP APPROACH (SUMMARY)

Step 1 – Determine Nexus and Filing Obligations

• Determine where the company may have nexus

• Determine where the company has a filing obligation

Step 2 – Determine the Taxability of Products and Services

• Evaluate the Company’s revenue streams to determine the taxability

• Evaluate the Company’s customer base for possible exemptions

Step 3 – Quantify Potential State Tax Exposure

• Compile sales tax data

• Destination based sourcing

• State & Local Tax, Interest & Penalty Rates

• Compute Exposure Amount

127

Sales Tax RemediationSIX STEP APPROACH (SUMMARY)

Step 4 – Mitigation and Disclosure of Historical Liabilities

• Filing and Paying All Prior Tax Returns

• Voluntary Disclosure – Anonymous basis

• Negotiated Settlement

• Do Nothing

Step 5 & 6 – Prospective Compliance and Automation

• Indirect Tax Automation

• Utilization of rate software

• In-house or outsource tax return function

128

ASC 450 Considerations

129

ASC 450 Considerations

• If a business maintains GAAP financial statements, then it must apply

Accounting Standard Codification (ASC) 450, contingent liabilities, to account

for Wayfair’s sales/use tax effect.

• If it is certain that a business will be subject to a sales/use tax liability as a

result of Wayfair, the liability is recognized and measured based on the

applicable law. This liability does not represent a loss contingency (accounted

for under ASC 450). Rather, it is a contractual obligation.

- The liability is de-recognized when extinguished in accordance with ASC 405,

Liabilities.

• If it is uncertain that a business will be subject to a sales/use tax liability as a

result of Wayfair, the liability is a contingent liability accounted for under ASC

450.

130

ASC 450 Considerations

• Under ASC 450, an estimated loss from a loss contingency must be accrued as a

charge to income if both of the following conditions are met:

- Information indicates that it is probable that a liability has been incurred as of the

date of the financial statements; and

- The amount of loss can be reasonably estimated.

• If the business concludes that it is probable that it will be subject to sales/use

tax, then the liability should be recognized and measured based on the

provisions of applicable law.

- Probable – The future event or events are likely to occur

- Reasonably Possible – The chance of the future event or events occurring is more

than remote but less than likely

- Remote – The chance of the future event or events occurring is slight

• Accrue the best estimate in a range or lowest amount in the range.

131

Wayfair and State Corporate Income Tax Consequences

132

Based on rulings, Virginia will

also assert corporate income

tax nexus based on any

positive apportionment

factor (although tends to be

used on audit to challenge

filings of nexus combined or

consolidated returns).

P.L. 86-272 still applies, but

only to sellers of tangible

personal property and only if

such seller’s in-state activity

is solicitation of orders or

activities entirely ancillary to

solicitation.

State Corporate Income Tax Economic-FACTOR Presence Nexus Statutes After Wayfair

• Eight states have adopted factor-presence nexus

statutes for corporate income tax or gross receipts

tax purposes: AL; CA; CO; CT; MI; NY; OH (“CAT”);

TN; WA (“B&O”).

• All of these states’ sales thresholds exceed $100,000.

• More states should be expected to adopt factor-

presence nexus statutes after Wayfair.

• Public Law 86-272 protections against state net

income taxes still apply!

133

CA

OR

WA

NV

UT

AZ

NM

CO

MT

WY

ID

ND

SD

KS

NE

OK

LATX

MO

AR

IA

MN

WI

IL IN

TN

KY

ALMS

FL

GA

MI

SC

NC

WV*VA

PA

OH

NY

ME

NH

DE

RI

NJ

MD

DC

HI

AK

Economic nexus

case law

Other economic

nexus statute or

rule

Factor-presence

nexus statutes

States with Income Tax/Gross Receipts Tax Economic Nexus Statutes(AS OF 11/01/2019)

VT

MA

CT

Fullest extent

under US Const.

134

Where Am I Subject to Tax?

• In light of Wayfair, states now have a “green light” to assert economic

presence nexus and factor-presence nexus for state income taxes.

• Review your business’s sales, by state

- Is the data “good data”? Know your source of information!

- Quantify and identify material states.

• For material states:

- Does the business already have an in-state physical presence? → does P.L. 86-272 provide

immunity from the state’s net income tax?

- No in-state physical presence, but material sales → does the state assert economic nexus? → does

P.L. 86-272 provide immunity?

• But don’t forget → Market-based sourcing!

135

• State Nexus Reviews

• State Apportionment Reviews

- No longer a separate study; now a key part of any nexus review

• Exposure Quantification

- Assess Wayfair retroactivity by state

- Quantify historic exposure

- May be part of an assessment under ASC 740

• Audit Defense

• Mitigation and Remediation

- State voluntary disclosure programs and amnesties (if applicable)

- Tax planning

What Solutions Are Available?

136

Questions?

BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax,

and advisory services to a wide range of publicly traded and privately held companies. For more

than 100 years, BDO has provided quality service through the active involvement of experienced and

committed professionals. The firm serves clients through more than 60 offices and over 700

independent alliance firm locations nationwide. As an independent Member Firm of BDO

International Limited, BDO serves multi-national clients through a global network of more than

80,000 people working out of nearly 1,600 offices across 162 countries and territories.

BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International

Limited, a UK company limited by guarantee, and forms part of the international BDO network of

independent member firms. BDO is the brand name for the BDO network and for each of the BDO

Member Firms.

Material discussed is meant to provide general information and should not be acted on without

professional advice tailored to your firm’s individual needs.

© 2019 BDO USA, LLP. All rights reserved. www.bdo.com

Andy Smetana and Allyson Seger

IMPACTS OF REGULATORY CHANGE AND MARKET TRENDS ON M&A PLANNING & STRUCTURING

DECEMBER 5, 2019

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 2

V&E SPEAKERS

ANDY SMETANA

COUNSEL, VENTURE CAPITAL, MERGERS & ACQUISITIONS, AND CAPITAL MARKETS

Austin

+1.512.542.8417

asmetana@velaw.com

Andy is a corporate lawyer who focuses on representing technology and growth companies across a variety of industries in

the formation and operation of their businesses, raising capital through private and public offerings, and buying and selling

companies and assets. Andy also represents investors in venture capital financings, issuers and underwriters in public

offerings, and has extensive experience in mergers and acquisitions, representing both acquirers and targets. Andy also

serves as Co-Chair of the Technology Section of the Austin Bar Association.

Before joining Vinson & Elkins, Andy worked as general counsel for a technology startup that provides edge-based data

centers. Andy has served as legal counsel to emerging companies and the investors that finance them for over 15 years,

including time with other leading law firms in Austin and in San Francisco.

Select Experience

Venture Capital & Growth Equity

• InforMed Data Systems (One Drop), the provider of a mobile app for diabetes management, in rounds of bridge

financing, a Series A financing, and a Series B financing led by Bayer

• GTL Americas, the developer of a gas-to-liquids facility in a qualified opportunity zone, in a Series A financing involving

the sale of LP interests to domestic and foreign investors

• Vapor IO, a provider of edge-based data centers, in debt and equity financings involving Goldman Sachs, a strategic

investor, and a private equity investor

• LiveOak Venture Partners, a venture fund, in its investments in software companies

• Energy Growth Momentum, a UK-based private equity firm, in its minority investment in H2scan

M&A and Capital Markets

• CryoLife, a publicly-traded medical device company, in its acquisition of JOTEC AG and its subsidiaries (including entities

in Europe and South America), and its option to acquire Endospan Ltd. (located in Israel)

• Molecular Imprints in the partial sale of the company to Canon and in a subsequent sale of the retained business to

Magic Leap

• IPOs for Applied Optoelectronics, Bazaarvoice, HomeAway and Q2 Holdings (acting as company or underwriter counsel)

• PIPE transactions for an oilfield service company, and PIPE investments by private equity funds

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 3

V&E SPEAKERS

ALLYSON SEGER

SENIOR ASSOCIATE, TAX

Austin

+1.512.542.8467

aseger@velaw.com

Allyson’s practice focuses on the U.S. federal income tax aspects of complex cross-border and domestic transactions. She

has experience working with clients and other advisers in a broad range of industries, including energy, petrochemicals,

banking and finance, aircraft leasing and sales, medical devices, and real estate. Allyson advises clients with regard to the

formation of various inbound and outbound cross-border structures, joint ventures, “Up-Cs” and other initial public offering

(IPO) vehicles, and private equity structures. She also advises clients with regard to mergers and acquisitions (M&A), line of

equity and credit transactions, and cross-border restructurings. Allyson also has experience in the resolution of tax

controversies with the Internal Revenue Service.

The following is a list of representative matters in which Allyson has assisted.

Select Experience

International Tax

• Huntsman Corporation in its initial public offering of Venator Materials plc, its domestic and internal pigments business

• Soros Fund Management in structuring an investment by Quantum Strategic Partners in Zenium Technology Partners, a

data center development and management company with facilities located in developed and emerging markets

• Talos Energy LLC, as member of a consortium and Operator, in its successful bid for two awarded offshore blocks in

Mexico’s first hydrocarbons auction and other matters in respect of their operation and joint ownership

Mergers & Acquisitions

• Sunoco Logistics Partners LP in its $20 billion merger with Energy Transfer Partners in a unit-for-unit transaction

• Maxar Technologies in its $3.6 billion merger with DigitalGlobe, creating a leading provider of satellites, earth imagery,

geospatial data solutions and analytics

• Focus Financial Partners in an investment by Stone Point Capital and KKR that values Focus at approximately $2 billion

• Shell Oil Company with regard to tax matters in its split-up of Motiva Enterprises LLC, a joint venture with Saudi Aramco

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 4

What regulatory and market changes are impacting M&A transactions most?

• Increasing role of alternative VCs and private equity buyouts

• Continuing impact of tax reforms

• Impact of mega-deals

• Heightened valuations putting a greater priority on post-closing purchase price adjustments

• Continued rise of the use of representation and warranty insurance

• Regulatory changes delaying or restricting foreign investment in U.S. businesses

• GDPR, CCPA and other emerging or changing privacy laws

OVERVIEW

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 5

IMPACT OF ALTERNATIVE VCS AND PRIVATE EQUITY

Traditional Choices vs. New Flexibility

• Choice of entity considerations for emerging technology companies was historically

determined based on the source of funds and exit strategy

• Traditional VCs often avoided investments in partnerships or limited liability companies

to avoid pass-through income or losses, or required corporate blocker structures

• With alternative sources of funding, including corporate venture arms of businesses and

non-US investors, deploying more capital, historic limitation on investment structures

are being relaxed

• With private equity buyouts becoming increasingly common as an exit strategy,

preserving structural options that are attractive to private equity buyers is of increasing

importance

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 6

• Does it make sense to

bifurcate your business into

product lines through a spin-

out if it is likely that the product

lines could be sold as separate

businesses? (consider timing,

transfer pricing, employment

arrangements, IP, etc.)

• Does it make sense to acquire

or invest in new businesses

through a pass-through or

corporate structure?

CONSIDER STRUCTURAL OPTIONS EARLIER TO PRESERVE FLEXIBILITY AND AVOID LOST OPPORTUNITIES

Pass-Through Structure Corporate Structure

Comparison of Tax

Rates

• Pass-through of partnership or LLC’s income and

losses

• Individual members subject to federal income tax at

37%, but may be eligible for a 20% deduction for

qualified business income that can effectively lower

that rate to 29.6%

• Assumed federal income tax on $100 of net income

of the LLC = $37 (or $29.60, if the deduction for

qualified business income applies)

• Income and losses of corporation do not pass through,

allowing deferral for stockholders

• Corporation subject to federal income tax at 21%

• Distributions to stockholders generally be subject to tax

again as dividends (assuming qualified dividend

income, at the capital gains rate of 20% plus the

additional 3.8% Medicare tax)

• Assumed federal income tax on the same $100 of net

income by the C corporation, assuming distributed to

the stockholders = $21 (corporate tax) + $18.80

(dividend tax on net distribution of $79), or $39.80 in

total

Impacts on Cash

Flow

• LLC agreements typically provide for tax

distributions (subject to available cash), often based

on the highest marginal income tax rates applicable

to individual members

• Taxes paid directly by the corporation

Incentive Equity • Generally provides additional flexibility to issue

incentive equity in the form of “profits interests” that

are not taxable upon issuance and are generally

eligible for capital gains treatment upon exit

• Generally be in the form of option grants or under a

restricted stock plan which result in the receipt of

ordinary income to the holder

Flexibility in Non-

Cash Acquisitions

• Generally provides additional flexibility to offer equity

as all or part of the consideration for future

acquisitions, on a tax-deferred basis for the seller

• Generally more difficult to offer stock to a seller on a

tax-deferred basis

Exit / Sales of Assets • Generally allows for greater flexibility for tax-efficient

partial sales or restructuring transactions

• A sale of assets (or interests in pass-through entity)

would give the buyer a “step-up” in the basis of the

acquired assets

• Stock purchase does not deliver a step-up on asset

basis, but may deliver other tax assets (e.g., NOLs)

• A sale of assets (in whole or part) by the corporation

would result in two levels of tax

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 7

STRUCTURAL DIFFERENCES FOR A PRIVATE EQUITY BUYOUT

Distinctions Impacting Management and Employees

• More often structured in a manner that involves at least a partial equity roll-over for management

➢ Tax treatment of roll-over for the management team

➢ Consider future exit opportunities for management

• Private equity buyer often receives a class of equity with a preferred return, followed by a pro rata allocation of proceeds upon a

sale of the company (similar to fully-participating preferred stock)

• If transaction is financed in whole or in part through debt financing, the lender’s due diligence process may impact transaction

timing, and post-closing debt covenants and repayment obligations may impact operations

• Going forward, employee equity is often structured to vest upon a subsequent exit event, with vesting based at least in part on the

return received by the private equity buyer (in lieu of time-based vesting)

• VC-style preferred stock structure in a C-corp often replaced with an LLC or partnership structure to improve flexibility and provide

tax advantages for the private equity buyer

➢ Depending on existing structure, may improve flexibility and provide tax advantages for the private equity buyer

➢ Potential loss of QSBS status for equity rolled over by management

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 8

Structure for acquisition of a foreign target (or foreign subsidiary of a domestic target)

• Existing structure of target and overall foreign structure of buyer should be considered

• Section 338(g) elections:

– Results in a deemed asset sale for federal income tax purposes

– The buyer can make the election unilaterally

– Potential benefits/detriments to a U.S. buyer:

– Generally results in a step-up in the target’s assets for U.S. tax purposes, which can mitigate GILTI exposure in future periods

– Target’s taxable year closes at the end of the closing date, so its U.S. tax history is reset

– Elimination of earnings and profits may decrease potential for exempt dividends under Section 245A (e.g., distributions may be treated as a return of capital)

– Any subpart F income or GILTI from the period prior to closing is not picked up by buyer

– No impact on foreign sellers

– Benefits/detriments to U.S. sellers of CFC:

– Any subpart F income or GILTI for the period prior to closing picked up by sellers

– Gain on the deemed asset sale may give rise to additional subpart F income and/or GILTI to sellers

• Consider whether making the election makes sense, depending on:

– History and assets of the foreign entity

– Whether the foreign entity is a subsidiary of a domestic target vs. directly owned by foreign or domestic sellers

– Deal dynamics

IMPACT OF NEW INTERNATIONAL RULES UNDER TAX REFORM

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 9

Coverage in transaction agreement for potential new issues raised by tax reform:

• Transition Tax (Section 965)

– Applies to entities that were specified foreign corporations on 11/2/2017

– Generally requires income inclusion for all untaxed earnings and profits of the specified foreign corporation

– Although income generally included in 2017, the domestic target may have elected to pay transition tax over 8 years under the installment rules under Section

965(h)

• Subpart F Income (Section 951) + Global Intangible Low-Taxed Income (GILTI) (Sections 951A & 250)

– Subpart F income taxed at full rate with no deferral

– GILTI effectively taxed at 10.5% (13.1% after 2025)

– Foreign targets or subsidiaries of a domestic target may result in buyer picking up subpart F and GILTI inclusions for entire year of closing

• Depending on the history and income of the foreign entity, the above considerations may or may not be material in the context of

the deal

IMPACT OF NEW INTERNATIONAL RULES UNDER TAX REFORM

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 10

New Audit Regime for Tax Partnerships (including LLCs taxed as partnerships)

• Under the BBA:

– A partnership or LLC is by default liable for “imputed underpayment” of tax that would otherwise have been born by its partners/members

– May result in current partners (i.e., buyer) bearing cost of former partners (sellers) taxes

– Options to shift that liability:

– Amended return modification – partners file amended returns and pay any resulting taxes

– “Pull in” modification – partners file stand-alone forms and pay taxes

– “Push out” election – partners file a statement and pay taxes; election made by partnership

• Applies to tax years beginning in 2018

Addressing in M&A transactions

• Contractual protections, e.g.:

– Control Partnership Representative’s actions

– Require or provide flexibility to require push-out or other election

– Coverage under indemnity

IMPACT OF NEW AUDIT PARTNERSHIP REGIME

ACQUISITION OF TAX PARTNERSHIPS

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 11

Withholding on Sale of Partnership Interest

• Under Section 1446(f), as of January 1, 2018, buyers are required to withhold 10% of a sellers’ gain (or loss) from the sale or

exchange of an interest in a partnership that is engaged in a US trade or business to the extent the gain (or loss) from a

hypothetical sale or exchange of the underlying assets held by the partnership would be treated as effectively connected income

allocable to the selling partner

• When purchasing a partnership interest, a buyer can avoid Section 1446 withholding by asking for:

– a W-9

– a joint non-foreign status withholding certificate covering both FIRPTA and Section 1446

– a separate section 1446 withholding certificate upon which it can rely (absent actual knowledge otherwise)

– The withholding certificates must be executed by each seller and must certify the sellers’ non-foreign status

• A FIRPTA certificate without the new additional language will not allow a buyer to avoid section 1446 withholding.

• The partnership may be liable for withholding if a buyer does not properly withhold on a transfer of a partnership interest

WITHHOLDING CERTIFICATES UNDER SECTION 1446

ACQUISITION OF TAX PARTNERSHIPS

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 12

MEGA-DEALS DRIVE RACE FOR HIGHER EXIT VALUE

Financial buyers provide needed exit valve following mega-deals

• Increasing number of unicorns is impacted by larger VC funds, tech-focused PE sponsors,

sovereign wealth funds and later stage investors providing prior IPO capital

• Despite continued IPO opportunities, buy-outs with private equity and other financial buyers

remain a viable option to maximize exit values when public market investors do not validate

private company valuations

• Financial buyers provide a much greater range of enterprise values based on a multiple of

amounts invested (up to 20x, with an average of 10.2), as compared to public company buyers

(average 5.4x), private company buyers (average 5.1x), or foreign buyers (average 6.5x)*

* Source: SRS Acquiom M&A Deal Study, 2019

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 13

Heightened Valuations Bring Heightened Scrutiny

• Inclusion of post-closing purchase price adjustments in M&A deals has increased over the last 4 years*

➢ Adjustments included in the consideration mechanics section of acquisition documents in 68% of transactions in 2015, 72% in 2016, 80% in 2017, and 81% in 2018

➢ The most common adjustments are based on working capital (85% in 2018), cash (84% in 2018), debt (85% in 2018), and other deal-specific factors, with net assets

and earnings (6% and 0% of 2018 deals, respectively) having lesser significance

• This has led to prioritization of Quality of Earnings (QoE) analysis, increased financial diligence, and scrutiny of “debt-like” items

• Tax assets – NOLs remain a focus, with new limitations (typically addressed outside of working capital)

• In working capital adjustments, deferred revenue receives varied treatment

• Documentation of accounting methods remains critical

* Source: SRS Acquiom M&A Deal Study, 2019

INCREASED SIGNIFICANCE IN AN ERA OF HIGHER VALUATIONSPOST-CLOSING PURCHASE PRICE ADJUSTMENTS

Post-Closing Purchase Price Adjustments (PPAs) are now

guaranteed by a separate escrow 56% of the time, more than double

the frequency in 2015 (27%). The favored methodology for

preparing the PPA is still GAAP consistent with past practices, with

67% of 2018 deals, after a dip in popularity in 2016 and 2017.

Thresholds remain rare, used in only 12% of PPA mechanics.

SRS Acquiom

M&A Deal Study, 2019

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 14

RWI Reduces Negotiation About Escrows or Holdbacks

• Many private equity buyers include RWI in their bids, especially in competitive offers, to take off the table negotiations regarding the

size or duration of escrows or holdbacks, and applicable exclusions

➢ First included in American Bar Association’s Deal Points Study in 2018 – study of 139 deals involving public companies buying private companies

in the $30M-$500M range showed 29% that specifically referenced RWI

➢ 2019 SRS Acquiom Buy-Side RWI Deal Terms Study shows RWI noted in 34% of reported deals involving a financial buyer, 19% of deals involving

an industrial buyer, 16% of deals involving a info/tech buyer, and only 3% in deals involving a life sciences buyer

➢ Increasingly deal studies providing stats on escrow size, etc. exclude or distinguish deals with RWI since it changes the analysis

• Historically of limited use due to high cost and exclusions – now more readily available, including for deals from $20M-$1B+

• Cost is based on market rates, with premiums often in the range of 3% of the covered amount, subject to a 1% retention

• Exclusions from RWI coverage generally include information revealed in the buyer’s due diligence, and often tax indemnities

• Continued role of tax indemnities – preserves “your watch, our watch” treatment, even when there is no breach of tax

representations and warranties

➢ 86% of 2018 deals had tax indemnities as line item indemnities, with tax representations surviving to the statute of limitations in 84% of deals, and

tax being carved out from liability caps in 80% of deals - SRS Acquiom Deal Study, 2019

• Tax liability coverage – often can be purchased as a separate policy

IMPACT ON COMPETITIVE SALES PROCESSES AND NEGOTIATIONSCONTINUED RISE OF THE USE OF REPRESENTATION AND WARRANTY INSURANCE

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 15

RESTRICTIONS ON FOREIGN INVESTMENT BEGIN TO PLAY A ROLE

CFIUS Reform threatens to delay or prevent foreign investment

• Committee on Foreign Investment in the United States – inter-agency committee of the U.S. government that reviews foreign

investment for national security concerns

• Jurisdiction historically limited to review of transactions in which a foreign person could acquire control of a U.S. business

• No statute of limitations on CFIUS review, but CFIUS approval confers a “safe harbor” that would prevent a transaction from being

blocked or unwound (can only be blocked or unwound upon the President’s authorization)

• Before reform, enforcement increased significantly – 237% increase in CFIUS notices from 2014 to 2017

• Foreign Investment Review Modernization Act (“FIRRMA”) was enacted in August 2018

National Venture Capital Association

Pitchbook – NVCA Monitor, September 2019

“NVCA believes the expanded authority of the Committee on Foreign

Investment in the United States (CFIUS) continues to affect VC investment

into startups, with delayed financings increasingly becoming an issue for

companies. Many VCs are waiting on the final rules of the CFIUS

expansion to be implemented in February 2020, which will have a major

impact on capital flows from foreign investors into US-based startups.”

➢ Maintains structure and focus of CFIUS on reviews of inbound investment (China

as a main focus)

➢ Expands CFIUS jurisdiction (subject to rulemaking, which is ongoing)

➢ Mandates certain filings with CFIUS (review process is typically 5-6 months under

the formal notice process)

➢ Established a Pilot Program, mandating filings for transactions involving critical

technologies

• Long-term impact remains to be determined

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 16

Which Laws Apply?

• General Data Protection Regulation (“GDPR”) – effective May 25, 2018 – applies to

data of an individual who is physically present in the EU, even if only temporarily

• California Consumer Privacy Act of 2018 (“CPPA”) – effective January 1, 2020 –

applies to all consumer (any resident of California) personal information a business

stores in either physical or electronic form (subject to certain thresholds)

• National U.S. privacy law – passage and effectiveness TBD – could potentially

preempt state privacy laws and create further inconsistency with GDPR

GDPR, CCPA AND OTHER EMERGING OR CHANGING PRIVACY LAWS

In M&A transactions for technology companies, privacy compliance and data security can be some of the most

complex areas of due diligence, especially as the regulations that apply continue to evolve and company compliance

efforts struggle to keep up with the changing landscape and the potential for significant exposure.

➢ As with other areas of due diligence, advanced planning to ensure documentation, policies, and practices are in order

before beginning a sales process can maximize the likelihood of a successful transaction

David Cole, Natan Leyva, and Austin Light

TAX PLANNING FOR GROWTH

DECEMBER 5, 2019

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 18

V&E SPEAKERS

DAVID COLE

PARTNER, TAX

Houston

+1.713.758.2543

dcole@velaw.com

David represents corporations, partnerships, and high-net-worth individuals in a wide range of domestic and international tax

matters. The clients David has represented span an array of industries, including oil and gas exploration and production,

private equity funds, renewable energy, domestic and foreign manufacturing, offshore drilling, shipping, real estate, and

medical devices.

In his tax controversy practice, David has represented clients in all phases, from audit to IRS appeals to litigation. In his

litigation practice, he has represented clients before the U.S. Tax Court, Federal Courts of Appeal, and in the Delaware Court

of Chancery. He also has extensive experience with partnership disputes, having litigated many cases under the Tax Equity

and Fiscal Responsibility Act of 1982 (TEFRA) and having advised clients on the Bipartisan Budget Act of 2015 (BBA).

David also has extensive experience with transfer pricing and has advised companies on numerous U.S. federal income tax

matters, including structuring intercompany operations and transactions between affiliates.

Select Experience

• The Williams Companies, Inc. v. Energy Transfer Equity, L.P., __ A.3d. __ WL 1090912 (Del. 2017), affirming WL 3576682

(Del. Ch. June 24, 2016) (Member of trial team representing Energy Transfer Equity, LP in Delaware Chancery Court in

litigation over termination of merger agreement with The Williams Companies based on failure of condition precedent

relating to the provision of a tax opinion under Section 721 of the Internal Revenue Code; trial result for Energy Transfer

affirmed by Delaware Supreme Court)

• Underwriters to Sunnova Energy International Inc., a residential solar and energy storage service provider, in its $168

million initial public offering of common stock

• An offshore drilling contractor in a transfer pricing dispute with IRS regarding transfer of intangibles; resolved with a full

concession by IRS Appeals

• A partnership in a TEFRA proceeding involving multiple hearings and trial in Tax Court on issues, including jurisdiction,

economic substance, and privilege

• Lucid Energy Group II, an EnCap Flatrock Midstream portfolio company, in the $1.6 billion sale of the company to a joint

venture controlled by Riverstone Holdings and the Goldman Sachs Group

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 19

V&E SPEAKERS

NATAN LEYVA

PARTNER, TAX

Washington

+1.202.639.6793

nleyva@velaw.com

Natan’s practice focuses on international tax planning, with a particular emphasis on foreign tax credits, the subpart F, GILTI,

and BEAT regimes, foreign currency transactions, and other aspects of outbound tax planning. He has extensive experience

advising U.S. based multinationals on offshore restructuring transactions, post-acquisition restructuring, intellectual property

transactions, and the use of partnerships in cross-border structures. Natan also advises foreign companies on inbound tax

matters, including withholding tax questions, the application of tax treaties, and the taxation of U.S. branches. He has

represented clients in connection with IRS challenges relating to foreign tax credits and other international tax issues.

Prior to joining V&E, Natan was a principal in the National Tax Department of Ernst & Young, where he led the firm’s

repatriation and foreign tax credit planning initiatives and was a national resource on the use of cross-border partnership

structures. He also taught international taxation for five years as an adjunct professor in the Georgetown University LLM

Program. Natan is a frequent speaker on international tax developments and transactions.

Natan is a member of the American Bar Association’s Section of Taxation, Committee on Foreign Activities of U.S. Taxpayers

(FAUST). In this role, he was part of the team that prepared commentary to the IRS on recent proposed regulations under

the new international tax regime of the 2017 Tax Cuts and Jobs Act.

Select Experience

• Advising U.S.-based upstream company on restructuring of their Latin American investment in light of changes in relevant

local law and treaty provisions

• Advised U.S.-based energy company on structuring a public offering; currently advising on offshore structure for

operations relating to LNG sales and power generation in non-U.S. jurisdictions

• Restructuring several clients’ (including in the technology, energy, and industrial industries) cross-border operations and

transactions to mitigate the consequences of new international tax rules added pursuant to the 2017 Tax Cuts and Jobs

Act, including the GILTI and BEAT regimes

• Buckeye Partners, L.P., as special tax counsel, in its $10.3 billion sale to IFM Investors to take the company private

• Enbridge as special tax counsel with respect to the $6.8 billion simplification (at signing) of its corporate structure via

cross-border mergers of its public corporate and MLP subsidiaries

• Venator Materials PLC in its $522 million initial public offering of ordinary shares by a selling shareholder

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 20

V&E SPEAKERS

AUSTIN LIGHT

ASSOCIATE, TAX

Austin

+1.214.220.7766

alight@velaw.com

Austin’s practice focuses primarily on executive compensation and benefits. His experience includes structuring, drafting and

implementing a variety of compensation-related plans and arrangements, including employment agreements, omnibus equity

incentive plans, change in control and severance agreements, and named executive officer pay packages. Austin’s practice

involves advising clients on a variety of executive compensation and benefits issues, such as tax and securities law,

corporate governance, periodic and event-driven SEC disclosure, and employee-related issues in mergers and acquisitions

and private equity transactions.

The following is a list of representative matters in which Austin has assisted.

Select Experience

• NorthStar Realty Finance in its approximately $16 billion combination with NorthStar Asset Management Group and

Colony Capital in an all-stock merger of equals

• Double Eagle Energy Holdings ll, a portfolio company of Apollo Natural Resources Partners Funds I and II, in its merger

with Veritas Energy, creating one of the largest pure play exploration and production companies focused on the Permian’s

Midland Basin

• Nexeo Solutions, a chemicals and plastics distributor and TPG Capital portfolio company, in its $1.575 billion merger with

WL Ross Holdings Corp., a special purpose acquisition company formed by WL Ross

• Riverstone Energy Limited in a $103 million line of equity commitment to Aleph Midstream S.A., an Argentine midstream

company

• Apollo Global Management in the formation of a strategic partnership with Chisholm Oil and Gas to invest in oil and gas

properties in Oklahoma, and Chisholm’s initial acquisition of STACK assets

• AltaGas in the $6.4 billion acquisition of WGL Holdings, owner of a regulated natural gas utility, a midstream franchise and

non-regulated contracted power and energy marketing businesses throughout the United States

• Quantum Energy Partners in the combination of two of its portfolio companies, Xplorer Midstream and Intensity Midstream

• Underwriters to Noble Midstream Partners LP in its $323 million initial public offering of common units

Tax Issues – The Early Days

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 22

* Deduction expires beginning in 2026

** Without NIIT

Combined rate assumes 100% of corporation’s profits are distributed

THE EARLY DAYSCHOICE OF ENTITY TYPE

Pre-2018 2018+

Corporation Pass-Thru Corporation Pass-Thru

Entity-level tax 35% N/A 21% N/A

Investor-level tax 20% 39.6% 20%37% w/ 20%

deduction*

Total combined effective

tax rate **48% 39.6% 36.8% 29.6%

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 23

Net operating losses (“NOLs”)

• No longer can carry NOLs back to prior tax years—only carry forward

• Can offset only 80% of current income—effective 4.2% minimum tax

Section 382 limitations

• 50% change in 5% shareholders

• Generally a 3-year testing period

Separate Return Limitation Year (“SRLY”)

• “Minnow swallowing the whale”

• Stuffing

THE EARLY DAYSNET OPERATING LOSSES

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 24

“But we don’t pay income tax?”

• NOLs?

Employee vs. independent contractor

• Section 530 relief

• Extent of impact

Affordable Care Act penalties

THE EARLY DAYSIRS AUDIT ISSUES

Tax Issues – International Expansion

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 26

Timing

• Timing of making decisions on international structure

Location

• Location of foreign assets and activities

Flow

• Flow of goods, services, and royalties among affiliated entities

PLANNING FOR INTERNATIONAL GROWTH

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 27

Key areas to consider before expanding offshore

• Taxation of offshore income depends on the structure of non-US entities and US entities.

• Non-US entity structure

– Foreign businesses in separate foreign entities?

– Treat those entities as corporations for U.S. tax purposes or as passthrough entities?

• US entity structure

– Is U.S. parent a corporation or a partnership for US tax purposes?

– Hybrid approach: U.S. partnership for U.S. operations with U.S. corporation as holding company for foreign operations

PLANNING FOR INTERNATIONAL GROWTH

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 28

Compare against 13.125% rate on foreign derived intangible income (FDII) of US corporation

for foreign directed sales, licenses, and services.

GENERALLY APPLICABLE U.S. RATE TO ULTIMATE 10% U.S. INDIVIDUAL SHAREHOLDERACTIVE FOREIGN INCOME - GILTI

Foreign Passthrough Entity Foreign Corporation

US Passthrough Parent

10% US Shareholders with

962 Election

37% (FTCs) 37% (No FTCs)

10.5% (FTCs)

+ 20% (upon distribution)

US Corporate Parent 21% (FTCs)* + 20% 10.5% (FTCs)** + 20%

** Some portion potentially

exempt from U.S. corporate tax

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 29

Loss recapture

• Section 91 – Income recognized by US owner in the amount of prior accumulated losses of foreign branch

Recognition of gain

• Section 367(a) – Gain recognized on tangible assets transferred to foreign corporation

Deemed royalty

• Section 367(d) – Deemed royalty to U.S. transferor in perpetuity with respect to intangible assets (e.g., patents, trademarks,

contracts, goodwill, and workforce in place)

Inversion rules

• Section 7874 – Foreign corporation acquiring substantially all the assets of a U.S. corporation or of a business of a U.S.

partnership is treated as a domestic corporation if certain other requirements are met – Typically at issue if foreign corporation

becomes top company (i.e., foreign public company or foreign parent held by individuals)

COSTS OF LATE OUTBOUNDING

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 30

SECTION 59ABASE EROSION AND ANTI-ABUSE TAX (“BEAT”) – QUICK REFERENCE

BEAT = the excess of 10 percent of modified taxable income (“MTI”),

over

the regular tax liability (“RTL”) reduced by certain tax credits

MTI = a taxpayer’s taxable income for the taxable year

calculated without regard to deductions or other tax benefits

arising from base erosion payments

1. Any amount paid (or accrued) by a taxpayer to a related

foreign person with respect to which a deduction is

allowable under the Code (e.g., interest)

2. Any amount paid (or accrued) by the taxpayer to a related

foreign person in connection with the acquisition of

depreciable or amortizable property from such person

3. Certain reinsurance amounts paid (or accrued) to a

related foreign person

4. Certain amounts paid (or accrued) to related surrogate

foreign corporations and certain foreign persons that are

members of the same expanded affiliated group as the

related surrogate foreign corporations

Base erosion payments include the following payments:

Base erosion

percentage = Base erosion tax benefits

Aggregate deductions and base erosion tax benefits

The BEAT only applies to C corporations that are

applicable taxpayers.

For a C corporation to be an applicable taxpayer for a

taxable year, it must:

1. have average annual gross receipts for the

last three years of at least $500 million, and

2. have a base erosion percentage of 3

percent or higher

Example:

Regular Taxable Income: $100

MTI: $250

10% of MTI: $25

RTL: $21

BEAT: $4

As a rough rule of thumb, the BEAT will be imposed on a

U.S. corporation if:

1. the corporation’s base erosion payments reduce its

regular taxable income by more than approximately 52%

2. approximately 52% of the corporation’s U.S. tax is offset

by applicable tax credits, or

3. a combination of both.

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 31

PAYMENTS INTO AND OUT OF THE UNITED STATESSECTION 59A

Potential Problem

• The statute does not provide for the netting of payments

between a U.S. corporation and a related foreign person

• Example 1:

– US makes a deductible payment for services or use of intellectual

property under licensing agreement to CFC and also receives a

payment from CFC for the same

– The payment to US from CFC does not reduce the amount of base

erosion payments made by US

US

EXAMPLE 1

CFCDeductible payment for services or

use of intellectual property rights

Income from services or use

of intellectual property rights

POTENTIAL SOLUTION

Restructure IP location or service arrangement

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 32

SUBCONTRACTING ARRANGEMENTSSECTION 59A

Potential Problem

• The statute does not provide a look through rule for

payments made by a U.S. corporation to a related foreign

person that then makes payments to an unrelated foreign

person under a subcontracting arrangement

• Example 2:

– US makes a deductible payment for services to CFC and CFC

subcontracts for a portion of those services with Unrelated Foreign

Person

– The entire amount of the payment to CFC is a base erosion

payment

POTENTIAL SOLUTION

The U.S. corporation contracts directly with the

unrelated foreign person to reduce the amount of

the U.S. corporation’s base erosion payments to

the related foreign person

US

EXAMPLE 2

CFCDeductible payment

for services

Unrelated

Foreign

Person

Payments under a

subcontracting

arrangement

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 33

BACK TO BACK PAYMENTS THROUGH THE UNITED STATESSECTION 59A

Potential Problem

• The statute does not provide for the netting of payments

among a U.S. corporation’s related foreign affiliates.

• Example 3:

– CFC1 provides services utilized by CFC2. CFC1 charges US a

fee for these services, which US in turn charges to CFC2

– The payment to US from CFC2 does not reduce the amount of

base erosion payments made by US to CFC1

POTENTIAL SOLUTION

Realignment of the supply chain so that the

services payments are not routed through the

U.S. corporation

US

EXAMPLE 3

CFC2

Deductible Payment

for Intercompany

Services

Income from

Intercompany

Services

CFC1

Executive Compensation and Benefits

Issues

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 36

Type of equity compensation

• Entity structure (e.g., corporation or partnership)

• Market or industry standard

Eligibility

• Founders & non-founders

• Executives & non-executives

Vesting, forfeiture and repurchase provisions

• Accelerated vesting provisions

• Provide for sufficient flexibility following termination or upon corporate events

Securities law considerations

GENERAL CONSIDERATIONSEQUITY COMPENSATION

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 37

Stock Options

• Incentive Stock Options (ISOs)

– ISOs must comply with Code§422

– Favorable tax treatment: no taxable income on grant or exercise/LTCG on disposition

– Disqualifying dispositions and restrictions on modifications

• Nonqualified Stock Options (NQSOs)

– More flexibility than ISOs

– No taxable income on grant

– Ordinary income equal to option “spread” at exercise

TYPES OF EQUITY COMPENSATION: STOCK OPTIONSEQUITY COMPENSATION

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 38

Profits Interests

• Actual partnership interest that is only eligible to participate in appreciation

– Section 83(b) elections

– Provide flexibility but must be structured properly

– Partner/employee considerations

• Favorable Tax Treatment

– Holder recognizes income only when recognized by the company and allocated to such holder

– Generally allows for LTCG treatment on sale of interest

• May not be suitable for non-executive employees

TYPES OF EQUITY COMPENSATION: PROFITS INTERESTSEQUITY COMPENSATION

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 39

Restricted Equity

• Given rights of stockholder

• Taxable at vesting unless Section 83(b) election is made

Cash Incentives

• Can be structured to mirror economics of real equity

• Ordinary income to employees at vesting

Other—RSUs (Phantom Stock) & SARs

TYPES OF EQUITY COMPENSATION: OTHEREQUITY COMPENSATION

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Documenting necessary corporate actions and approvals

• Adoption of compensatory arrangements

• Determination of exercise price or threshold value and grant date information for equity awards

• Establish appropriate procedures and follow them

Proper documentation of compensatory arrangements

• Written plan documents should be required for most arrangements

• Administrative tracking and compliance

Cheap Stock Issues and Section 409A valuations

PREPARING FOR GROWTHCORPORATE GOVERNANCE

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com 41

Health and welfare plans

• Affordable Care Act obligations

• Cafeteria plans

401(k) and other retirement plans

• Tax qualification

• Compliance with ERISA information and reporting requirements

Professional Employer Organizations

• Can help to manage benefits administration and provide other support

PREPARING FOR GROWTHEMPLOYEE BENEFITS

Confidential and Proprietary ©2019 Vinson & Elkins LLP velaw.com

Austin

T +1.512.542.8400

Beijing

T +86.10.6414.5500

Dallas

T +1.214.220.7700

Dubai

T +971.4.330.1800

Hong Kong

T +852.3658.6400

Houston

T +1.713.758.2222

London

T +44.20.7065.6000

New York

T +1.212.237.0000

Richmond

T +1.804.327.6300

Riyadh

T +966.11.250.0800

San Francisco

T +1.415.979.6900

Tokyo

T +81.3.3282.0450

Washington

T +1.202.639.6500

QUESTIONS?

THANK YOU!