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Sales and Use Tax Reserve StrategiesSetting Reserves Under Heightened Government and Audit Scrutiny

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, MARCH 15, 2011

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

William Ault Director Multistate Tax Group Deloitte Tax Stamford ConnWilliam Ault, Director, Multistate Tax Group, Deloitte Tax, Stamford, Conn.

Myron Vansickel, Director, State and Local Tax Center, Jefferson Wells, Washington, D.C.

Robert Schulte, Member, Board of Advisors, Avalara Inc., San Diego

John Daly, Tax Manager, WithumSmith+Brown, Princeton, N.J.

For this program, attendees must listen to the audio over the telephone.

John Daly, Tax Manager, WithumSmith Brown, Princeton, N.J.

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S l d U T R St t i Sales and Use Tax Reserve Strategies Seminar

March 15, 2011

John Daly, [email protected]

Will Ault, Deloitte [email protected]

Robert Schulte, Avalara Inc. robert.schulte@avalara

Myron Vansickel, Jefferson Wells [email protected]

Today’s Program

ASC 450 (FAS 5) Review[Will Ault]

Slide 7 – Slide 28

Developments With SEC Oversight[John Daly]


Sales Tax Reserving: A Hypothetical Taxpayer Scenario[Myron Vansickel and Robert Schulte]


ASC 450 (FAS 5) REVIEWWill Ault, Deloitte Tax

ASC 450 (FAS 5) REVIEW

Basic Provisions Of ASC 450

Liability vs. contingency

Probable

Estimable

Rangesg

Disclosures of possible liabilities

Copyright © 2011 Deloitte Development LLC. All rights reserved.8

Liability Vs. Contingency

• ASC 450 contingenciesContingency: An existing condition, situation or set of circumstances involving uncertainty as to possible gain or loss that will ultimately beinvolving uncertainty as to possible gain or loss that will ultimately be resolved when one or more future events occur or fail to occur.

• Known obligations are “liabilities” — not contingencies. In general, transaction taxes tend to be liabilities rather than contingencies.


Liability Vs. Contingency (Cont.)

• There are certain situations in which transaction taxes represent contingencies under ASC 450. These situations can include:

Uncertainty about whether certain transactions are subject to the tax– Uncertainty about whether certain transactions are subject to the tax (e.g., questions of classification or of nexus)

– Uncertainty about the cost to resolve the uncertaintyN ti t d ttl t• Negotiated settlements

• Litigated amounts



• A liability for transaction taxes is not typically a contingency, if the laws of the taxing jurisdictions clearly apply to the transactionof the taxing jurisdictions clearly apply to the transaction.

• If the transaction is a known liability, the provisions of ASC 450 do not lapply.



• However, accruals or reserve amounts for general or unspecified business risks are not permittedbusiness risks are not permitted.


ASC 450 Accruals

• An estimated loss from a transaction tax liability shall be accrued by a charge to income (accrued liability), if both of the following conditions are met:are met:– It is PROBABLE that the liability has been incurred at the date of the

financial statements, ANDThe amount of the liability is reasonably ESTIMABLE– The amount of the liability is reasonably ESTIMABLE.

• Probable: Likely to occur

• Higher level of likelihood than more likely than not


ASC 450 Accruals (Cont.)

When a loss contingency, such as the incurrence of a transaction tax li bili i h lik lih d h h f ill filiability, exists, the likelihood that the future event or events will confirm the incurrence of the liability can range from probable to remote.• Probable: The future event or events are likely to occur (higher level of

lik lih d h lik l h i d i FIN 48)likelihood than more likely than not contained in FIN 48).• 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.


ASC 450 Accruals (cont.)

A contingency is accrued only if it is probable that a liability has been incurred, and the amount is reasonably estimable.

I it ti th b bilit th h ld t b t• In some situations, the probability threshold may not be met.• In some situations, the amount may not be estimable.



• Timing of events is also a consideration Accrual is not appropriate untilTiming of events is also a consideration. Accrual is not appropriate until an event or condition occurs.

• Accruals for contingencies are specific• Accruals for contingencies are specific.

• Reserves for general or unspecified risks “cushions” are not permitted.

• Specific reserves are required for overall sales and use tax issues (e.g., California sales and use tax issue).



As it relates to determining whether to apply ASC 450 to a matter i h d i i h h h ld b ff dconcerning tax, the decision on whether to accrue should not be affected

by the risk of audit detection.

Settlement percentage expectation is an acceptable criterion HoweverSettlement percentage expectation is an acceptable criterion. However, the methodology used in calculating the anticipated percentage settlement must be documented and reasonable. This may be more relevant in certain industries and with certain types of transactionsrelevant in certain industries and with certain types of transactions.


FASB Exposure Draft — Disclosure Of Certain Loss Contingencies — An Amendment To ASCLoss Contingencies An Amendment To ASC

450

The FASB recently announced that, regarding the proposals in the revised d f i ill b i d lib i f i lexposure draft, it will begin re-deliberations at a future meeting, currently

expected in the second half of 2011.

The significant changes proposed in the revised exposure draft areThe significant changes proposed in the revised exposure draft are subject to change as the FASB re-deliberates those proposals.


FASB Exposure Draft: Certain Disclosures Under ASC 450Under ASC 450

Qualitative disclosures

R i d f b bl bl ibl d i lRequired for probable, reasonably possible and special remote contingencies• Information about the nature and risks of the loss contingency • For individually material contingencies, information to enable users to

obtain additional information from publicly available sources such as documents filed in court in litigation

• When applicable, the basis for aggregation and “information that would enable financial statement users to understand the nature, potential magnitude, and potential timing (if known) of loss”


FASB Exposure Draft: Certain Disclosures Under ASC 450 (Cont.)Under ASC 450 (Cont.)

Qualitative disclosures (Cont.)

In addition for asserted litigation contingencies entities should make theIn addition, for asserted litigation contingencies, entities should make the following disclosures:• During early stages, the contentions of the parties (i.e., the basis for the

claim amount the amount of damages claimed the basis for the entity’sclaim amount, the amount of damages claimed, the basis for the entity s defense or that the entity has not yet formulated its defense)

• More extensive disclosures as additional information about a potential unfavorable outcome becomes available (e g as progress is madeunfavorable outcome becomes available (e.g., as progress is made toward resolution, or as the likelihood and magnitude of a loss increase)

• For individually material asserted litigation contingencies, the anticipated timing/next steps (if known)


timing/next steps (if known)



New quantitative disclosures required for all loss contingencies that are b bl bl ibl d i l i iprobable, reasonably possible and special remote contingencies:

• Publicly available quantitative information (e.g., the amount claimed by the plaintiff or damages indicated through expert witness testimony)

• Other non-privileged information that would help users understand the potential magnitude of the possible loss



Qualitative disclosures (Cont.)• Information about potential recoveries from insurance and other

sources, but only if (1) such information “has been provided to the , y ( ) pplaintiff(s) in a litigation contingency” or “is discoverable by either the plaintiff or regulatory agency”; or (2) a receivable has been recognized. “If the insurance company has denied, contested, or reserved its rights related to the entity’s claim for recovery, an entity shall disclose that fact.”




In addition, if a loss contingency is probable or reasonably possible, an i ld di l i f h ibl l f l dentity would disclose an estimate of the possible loss or range of loss and

the amount accrued (if any), unless an estimate cannot be made, in which case the entity would state that fact and explain its reasons. If an entity has insurance or other recoveries related to its loss contingencies thehas insurance or other recoveries related to its loss contingencies, the potential recovery amounts are not netted (offset) against amounts accrued for loss contingencies.



Tabular reconciliation• Public entities to present a table reconciling the total aggregate amount

of contingencies recognized in the period • Presented separately for each class of contingencies, so that dissimilar

contingencies are not aggregated• Provide a qualitative description of any significant activity included in the

table


Key Terms Of IAS 37

• Provision: A liability of uncertain timing or amount• Liability:Liability:

– Present obligation as a result of past events – Settlement is expected to result in an outflow of resources (payment) C ti t li bilit• Contingent liability: – A possible obligation depending on whether some uncertain future

event occurs, or – A present obligation, but payment is not probable or the amount

cannot be measured reliably • Contingent asset:

– A possible asset that arises from past events, and – Whose existence will be confirmed only by the occurrence or non-

occurrence of one or more uncertain future events not wholly within


the control of the enterprise

IAS 37 Recognition Provisions

An enterprise must recognize a provision if, and only if: [IAS 37.14] • A present obligation (legal or constructive) has arisen as a result of a

past event (the obligating event), • Payment is probable (“more likely than not”), and • The amount can be estimated reliably.


IAS 37 Recognition Provisions (Cont.)

• An obligating event is an event that creates a legal or constructiveAn obligating event is an event that creates a legal or constructive obligation, and therefore results in an enterprise having no realistic alternative but to settle the obligation. [IAS 37.10] A constructive obligation arises if past practice creates a valid expectation on the part g p p p pof a third party; for example, a retail store that has a longstanding policy of allowing customers to return merchandise within, say, a 30-day period [IAS 37.10].

• A possible obligation (a contingent liability) is disclosed but not accrued. However, disclosure is not required if payment is remote [IAS 37.86]., q p y [ ]


Contacts

William AultDirector — Stamford, CT +1 203 708 4595 wault@deloitte com+1 203 708 4595, [email protected]

This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting,business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for

such professional advice or services, nor should it be used as a basis for any decision or action that may affect your


such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified

professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

DEVELOPMENTS WITH SEC John Daly, WithumSmith+Brown

DEVELOPMENTS WITH SEC OVERSIGHT

Summary Factsy

• In March 2003, Hudson Highland (HH) was spun off from Monster Worldwide Inc. • HH is in the business of providing professional staffing and talent p g p gmanagement services.• From 2003 to 2007, HH failed to comply with the sales and use tax compliance laws of various states.p• During these years, HH did not implement an adequate sales and use tax collection and remittance system.• As a result of HH’s poor compliance procedures the company As a result of HH s poor compliance procedures, the company became liable for almost $4 million in uncollected sales taxes, which it failed to reserve for in its financial statements.

WithumSmith+Brown, PC ▪ Certified Public Accountants and Consultants ▪ BE IN A POSITION OF STRENGTH30

withum.com

Jan. 10, 2011,

• Culminating an investigation that began in 2007, the Securities & Exchange Commission issued an order to Hudson Highland Group, Inc. to “cease & desist.”• Cease and desist from violating sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 • Sect. 13(b)(2)(A) requires reporting companies to keep books & ( )( )( ) q p g p precords “in reasonable detail,” in order to accurately reflect transactions and dispositions of assets.• Sect. 13(b)(2)(B) requires reporting companies to maintain internal ( )( )( ) q p g pcontrols sufficient to provide reasonable assurances that transactions are recorded accurately, in order to permit preparation of financial statements in accordance with GAAP.


withum.com

Mechanical Difficulties

• States tax services differently. Some states tax HH’s services (CT, PA); some do not (CA, NJ), and the tax rates vary from jurisdiction to ); ( , ), y jjurisdiction.• The SEC determined that HH did not have “accounting software capable of calculating the amounts of sales taxes owed.”p g• In addition to failing to deal with the complex nature of administering sales and use tax compliance in various states, HH was not even managing the most basic aspects of compliance.g g p p• HH was not able to calculate tax based on the location of the work performed.• HH also did not effectively track customer direct pay permits


withum.com

HH also did not effectively track customer direct pay permits.

Systemic Issues At HHy

• Staff turnover was a huge problem at the company.• In 2004, a large accounting firm was hired to identify HH’s reserve issues and fix the broken compliance process.p p• The accounting firm accomplished little, because HH staff could not provide them with needed documents.• In 2004 HH also had problems implementing a new PeopleSoft In 2004, HH also had problems implementing a new PeopleSoft accounting and management reporting system.• With complex state tax regulations to understand and apply to a business it was critical that a knowledgeable accounting staff be business, it was critical that a knowledgeable accounting staff be hired and retained by HH. This did not happen, and this was a major contributing factor to the company’s woes.


withum.com

Compliance Auditsp

• State compliance audits at the end of 2005 caused HH to assign its tax manager to quantify exposure.• That manager encountered many of the same problems the g y paccounting firm had with records-retrieval.• The result was the same, and reserves that were calculated were not sufficient.• In early 2006, a newly hired company CFO, together with HH’s upper management, began to closely monitor the efforts to book adequate reserves. q• This did not happen until the second quarter of FY 2008; however, adequate reserves were booked. • The SEC penalized HH $200 000


withum.com

The SEC penalized HH $200,000.

What Does This SEC A ti M ?SEC Action Mean?

HH i d W ll ti f th SEC i M h 2009 d • HH received one Wells notice from the SEC in March 2009 and one in September 2010.• The SEC had been looking into HH accounting records since at least 2007.• HH represents an extreme case of accounting failures at all levels.• HH’s compliance problems and its inability to reconcile its exposure to is balance sheet spanned approximately seven years.

Thi lt d t t l id th t th SEC id • This penalty demonstrates clear evidence that the SEC considers the reporting of sales tax reserves to be a significant issue.• It adds another reason (in addition to state taxes, interest, penalties and state legal actions) that publically traded companies p g ) p y phave to be in compliance with state tax laws AND retain the qualified employees needed to implement and carry out compliance efforts.


withum.com

Additional SEC Action On R IReserve Issues

Matter of Paula J. Norbom CPA; Release 57889; May 30, 2008. Cease-and desist order issued as a result of Centerpulse Ltd. pFinance Department VP releasing reserves set up for likely sales and use tax exposure. The reserves were released by Norbum to cover for a revenue shortfall.


withum.com

Myron Vansickel, Jefferson Wells

SALES TAX RESERVING: A

Myron Vansickel, Jefferson WellsRobert Schulte, Avalara Inc.

HYPOTHETICAL TAXPAYER SCENARIOSCENARIO

C S d A li i Of ASC Case Study: Application Of ASC 450

Sales and use tax reserves have come under more scrutiny as a result of the enactment of the Sarbanes-Oxley Act and pressure on state and local jurisdictions to raise revenue pressure on state and local jurisdictions to raise revenue. Senior company management has become aware of internal controls to understand what is in each reserve, and sales and use taxes have greater visibility before the C suite nowuse taxes have greater visibility before the C-suite now.

38

Case Study: Application Of ASC 450 (Cont.)

Corporation V

Corporation V is a publicly traded media and printing company with $2 billion of annual revenue. In 1999, it was composed of 35 U.S. companies with three major business lines. The

lid d fi i l h d $7 illi ASC 450 consolidated financial statements showed a $7 million ASC 450 sales/use tax contingency. Of that figure, $6.7 million was related to sales tax. Annual additions to the reserve were close to $1 million.

39


Where do you start the analysis to determine whether this y yreserve is adequate for potential exposure?

What caused this reserve to grow?

Should this be greater or less?

40


Information-gathering is the first step. After reviewing prior g g p g psales and use tax audits, it was determined that the majority of assessments were for sales tax on products; then came use tax on purchases of supplies and fixed assets.tax on purchases of supplies and fixed assets.

41


The first areas to review were the order entry, sales tax rates, sales tax determination, and the computation module and billi tbilling system.

The process was to determine how product codes were set up to be taxable or non-taxable.

42


It was discovered that the taxpayer had three different ERP systems, which had varying degrees of sophistication regarding their abilities to tax the companies’ products correctly. their abilities to tax the companies products correctly.

43


The largest ERP system was reviewed to determine the level of li It d t i d th t th l compliance. It was determined that there were several

disconnects within the system, and the tax and IT staffs would have to identify issues and resolve them together. This was an older version of tax software in which coding changes needed to be implemented to make ta correctionsto be implemented to make tax corrections.

44


The other two ERP systems had similar and dissimilar issues related to taxing products related to taxing products.

Issues were identified, and then plans were implemented to , p presolve these issues.

45


New versions of sales tax software now allow the tax New versions of sales tax software now allow the tax department to make the tax determinations directly, due to the data basis nature. This eliminates IT maintenance time and allows for timely changes within the systemand allows for timely changes within the system.

46


Corrective action planpRe-compute the reserve requirements on what was learned and

use this as the benchmark to measure improvement

A product code matrix was developed that included all other A product code matrix was developed that included all other separately stated invoice items, i.e. shipping costs.

47


Review the matrix and add a taxable or non-taxable column

Reference appropriate tax research to support the tax determination

Review this matrix with what was currently in the system and prepare a corrective action plan

48


The tax department continued to investigate whether the i fili g i ll j i di ti h th h d companies were filing in all jurisdictions where they had

created nexus for sales tax purposes.

This required reviewing the business operations including the This required reviewing the business operations, including the sales force, to determine what activities were occurring that might create nexus for collection responsibilities.

49


After coming up with a revised list of taxing jurisdictions, tax met with the legal department to determine where the companies should be registered to “do business” and register for sales tax collection.

50


Subsequently, with the legal department’s and CFO’s support, the tax department became the clearinghouse for determining where the companies needed to qualify to do business and where the companies needed to qualify to do business and register for sales and use taxes.

51


This meant that every time there was a new home office or This meant that every time there was a new home office or new state to be established for payroll purposes, the tax department was notified and investigated if nexus was created The tax department initiated all registrations for created. The tax department initiated all registrations for taxes, whether payroll or sales/use, through the legal department. This kept the tax department immediately in the know about any business change that would affect sales and know about any business change that would affect sales and use tax collection.

52


The next phase was to implement the necessary changes for The next phase was to implement the necessary changes for sales tax that were arose from errors identified in sales tax audits. This was done via a product code matrix/tax determination processdetermination process.

53


Fixed-asset purchase procedures were reviewed, and use tax p p ,accrual procedures were developed and implemented. Printers are similar to manufacturers, so in several states, the purchase of their equipment was exempt. However, some states lacked an exemption so use tax needed to be paidstates lacked an exemption, so use tax needed to be paid.

54


Tax audits were reviewed for the types of expense purchases yp p pthat were subject to use tax. A taxability matrix was developed, similar to the product code/tax determination matrix. This was implemented through the purchasing chain to provide for appropriate accrual of use taxesprovide for appropriate accrual of use taxes.

55


Th t d t t d l d t l k h t The tax department developed use tax accrual worksheets that included the appropriate use tax rates, to facilitate the accrual process. Although manual, they did provide a mechanism to facilitate compliance.

56


Th t d t t i l t d li i d d The tax department implemented policies and procedures regarding company purchases, in order to take advantage of resale and manufacturing exemptions where applicable.

57


The tax department, along with the sales force, reviewed customer files to validate whether the customer should complete a resale certificate or an exemption certificate.

58


Policies and procedures were then implemented in the sales-ordering process, in order to obtain appropriate documentation from each new customer. Annual reviews of documentation from each new customer. Annual reviews of customer files were performed to make sure valid resale or exemption documentation was maintained.

59


Th t d t l th $500 000 ithi fi The reserve went down to less than $500,000 within five years, based on the implementation and review of controls. Annually, steps taken reduced the cost of audits by about $900,000. That is a dollar-for-dollar pick-up to the bottom line.

60


Information needed to calculate the ASC 450 sales/use tax reserve

Remember that you may have nexus issues and that the statute Remember that you may have nexus issues, and that the statute of limitations do not run in a taxing jurisdiction until you have filed returns .

I. Listing of all taxing jurisdictions where the entities have sales/use tax nexussales/use tax nexus

II. Date the business began in these taxing jurisdictions

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• Listing of the statute of limitations for each taxing jurisdiction• Listing of the statute of limitations for each taxing jurisdiction

• Date of registration in each jurisdiction

• Starting date for when returns were first filed in each jurisdictionj

• Copies of all sales and use tax audits settlements for the past five years and any current issues from ongoing auditsfive years, and any current issues from ongoing audits

• Develop a spreadsheet to incorporate all this information

62


R i th dit ttl t d d t i if ti Review the audit settlements and determine if corrective action was taken, and the time period when any action was taken

Calculate whether there was a unresolved time period for which an error was noted in an auditwhich an error was noted in an audit

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C l l t th t ti l t f h t t i t f ti Calculate the potential tax for each tax uncertainty for a time period that is still open under the statute of limitation

Accrue the tax calculated in the reserve

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U d t thl t i ti Update your reserve monthly, as new uncertainties are uncovered and a month of the statute of limitations rolls off

This will be the basis of your reserve analysis

65

Case Study: Application Of ASC 450 (Cont.)Sales Tax Accrual Analysis - A/C 000-000-0000

6/30/2009

TaxEstimat

ed Total Average Projected

Audit Amount Date Unpaid AuditNo. Of Audit Next

Audit Open Monthly Reserve

Period Paid Paid Amount Liability StatusAudits Liability

Assessment

Period

Periods

Assessment Accrual

California Jan-84 - Mar-87 352,653 0 352,653 Final 1 36

Jul-87 - Dec-90 450,000 0 450,000 Final 2 361,152,45 1,152,45

Jan-91 - Dec-94 5 0 5 Final 3 651,703 36

Jan-95 - Dec-97 80,000 Final 4 508,777 36

Jan-98 - May-98 Lapsed 5

Apr-98 - Dec-00 333,833 10/01/02 Final 5 473,788 33

Jan-01 97,692Self audit 36

Sep-04 93,511 01/01/06 Final 6 426,691 9p

Oct-04 Dec-07 126,600 05/01/09 Final 7 36

Jan-08 Jun-09 Accrual 100,000 36 18 2,778 50,000

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