8th Annual PricewaterhouseCoopers Like-Kind Exchange Conference

Transcription

1 8th Annual Like-Kind Exchange Conference Session VII-A: Fixed Asset Practice Stuart Finkel, Joe Fischinger, Brad Borgstede, PwC PwC

2 Circular 230 disclaimer This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding tax penalties that may be imposed on the taxpayer.

3 Market Overview Cost Segregation / Fixed Asset Depreciation Repairs and Maintenance R&D Tax Credit Slide 3

4 Market Overview

5 What s happening in the market - Overview Complex economic conditions and frozen capital markets are creating the need for MNCs to more accurately forecast global and US cash tax flow requirements in conjunction with a company s existing free cash flow planning, and implement cash tax savings strategies. Short-term, there are many viable and easily implementable tools to generate cash. Long-term, companies need to develop an ongoing strategy to bolster liquidity. Cash Creates Value. Slide 5

6 What s happening in the market - Overview In the current economic climate, additional free cash flow is a priority for MNCs to sustain corporate activities and fund working capital, dividend payments, pension funding, capital improvements, acquisitions, research and development, stock buy backs, etc. Companies can generate additional cash flow by first scrutinizing their federal, state and non-u.s tax profiles. Companies have than identified the right levers to consider cash tax planning to enhance free cash flow by reducing current tax payments and accelerating quick refunds. Short-term benefit to your company by increasing liquidity pools in the organization. Long-term view is Tax Directors should be working closely with Treasury and Finance to devise an ongoing strategy around recurring cash tax savings. Slide 6

7 Cost Segregation / Fixed Asset Depreciation Slide 7

8 Cost Segregation / Fixed Asset Depreciation Issue, Action and Benefits Issue / Action Fixed asset classifications may not be optimal due to misclassification of tangible personal property as real property or case law changes, resulting in under-depreciation for tax purposes Companies should strive for proper classification of assets in the year placed in service on an originally filed tax return Revenue Procedure provides guidance to reclassify these assets and allow for catch-up depreciation considered a change in accounting method Most taxpayers classify leasehold improvements as 39-year real property An in-depth review allows a company to document and support specific asset reclassifications to 5-year and 7-year personal property and 15-year land improvements Benefits Catch-up deduction in 1 year Internal Revenue Code Section 481(a) Utilize Form 3115, Application for Change in Accounting Method no amended tax return required Accelerates depreciation benefits in future years Improves cash flow Accurate reporting of book-tax differences for complete deferred tax basis reporting Capture 2008 bonus depreciation Recapture missed opportunities such as bonus depreciation Property Tax Savings Slide 8

9 Cost Segregation / Fixed Asset Depreciation Why are Fixed Assets Misclassified? Companies frequently misclassify tangible personal property (IRC Section 1245) as real property (IRC Section 1250) resulting in less than optimal depreciation deductions. The following are some of the reasons fixed assets could be misclassified: Constructed assets are accounted for based on limited invoice detail Purchased assets are pooled, leading to difficult asset tracking Fixed assets are often characterized and recorded in the company's fixed asset ledger with minimal input provided by the tax department Enterprise Resource Planning systems struggle to provide accurate reporting information resulting in the tax accounting for fixed assets being routinely handled off-line with inadequate system support. Slide 9

10 Cost Segregation / Fixed Asset Depreciation : Legislative Update Fixed Asset Depreciation (Revenue Procedure ) Allows for automatic accounting method change of depreciable lives for assets for which depreciation claimed was less than the allowable amount. Catch-up in year of change the amount of missed depreciation from the date the asset was placed in service is deducted in the current year. Examples include an asset method change from non-residential real property (39-year) to MACRS asset class 28.0, Manufacture of Chemicals and Allied Products (5-year). Bonus Depreciation The Economic Stimulus Act of 2008 temporarily re-enacts the additional 50% first-year depreciation deduction for qualified property and leasehold improvements placed in service from January 1, 2008 to December 31, Current economic recovery legislation extends 50% bonus depreciation through December 31, Emergency Economic Stabilization Act of 2008 Qualified leasehold improvement property placed in service after December 31, 2008 and before January 1, 2010 as 15-year property. Slide 10

11 Cost Segregation / Fixed Asset Depreciation Eligibility for Bonus Depreciation Section 168(k) allows a taxpayer to take advantage of 50% bonus depreciation for qualified properties and leasehold improvements Property must be acquired by the taxpayer after January 1, 2008 and before December 31, Property must be placed in service before January 1, Taxpayer must be the original, or first, user of the property Must be Qualified Property as follows: MACRS property with a GDS recovery period of 20 years or less Water Utility property Computer Software other than Sec. 197 property Qualified leasehold improvement property ( QLHI ) Written Binding Contract Considerations Slide 11

12 Cost Segregation / Fixed Asset Depreciation Potential Missed Depreciation - Leasehold Improvements The American Jobs Creation Act of 2004 provides that qualified leasehold improvement property placed in service after October 22, 2004 and before January 1, 2006, is 15-year MACRS property with a 15-year recovery period (Code Sec. 168(e)(3)(E)(iv)). For the leaseholds to qualify, the following must apply: Improvements are made under or pursuant to a lease by the lessee, any sublessee or the lessor; The lease is not between related persons; The building is occupied exclusively by the lessee or sublessee; The improvements are section 1250 property; and The improvements are placed into service more than 3 years after the date that the building was first placed into service. Slide 12

13 Cost Segregation / Fixed Asset Depreciation Personal Property Defined Section 1245 Personal Property - Property of a character subject to depreciation provided in section 167 and is: Personal property; Other property (not including a building or structural components) if used in manufacturing, production, extraction of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services; constituted a research facility; constituted a facility used for the bulk storage of fungible commodities; Single purpose agricultural or horticultural structure; or Storage facility. Slide 13

14 Cost Segregation / Fixed Asset Depreciation Real Property Defined Section 1250 Real Property - Any real property (other than section 1245 property, as defined in section 1245(a)(3)) which is or has been property of a character subject to the allowance for depreciation provided in section 167. Slide 14

15 Cost Segregation / Fixed Asset Depreciation Key Definitions Tangible Personal Property Regulation (c) defines tangible personal property as: Tangible personal property includes all property (other than structural components) which is contained in or attached to a building. Thus, such property as production machinery, printing presses, transportation and office equipment, refrigerators, grocery counters, testing equipment, display racks and shelves, and neon and other signs, which is contained in or attached to a building constitutes tangible personal property for purposes of the credit allowed by section 38. Treas. Reg. Sec (c) (emphasis added). Slide 15

16 Cost Segregation / Fixed Asset Depreciation Key Definitions Structural Component of a Building Regulation (e)(2) defines the phrase structural component of a building as: The term structural components includes such parts of a building as walls, partitions, floors, and ceilings, as well as any permanent coverings therefore such as paneling or tiling; windows and doors; all components (whether in, on, or adjacent to the building) of a central air conditioning system, including motors compressors, pipes and ducts; plumbing and plumbing fixtures, such as sinks and bathtubs; electric wiring and lighting fixtures; chimneys; stairs, escalators, and elevators, including all components thereof; sprinkler systems; fire escapes, and other components relating to the operation or maintenance of a building. Treas. Reg. Sec (c) (emphasis added). Slide 16

17 Cost Segregation / Fixed Asset Depreciation Case Law Hospital Corp. of America v. Commissioner 109 TC 21, July 24, This was a pro-taxpayer decision that magnified the benefits of Rev. Proc In HCA, the Tax Court narrowly defined what is considered real property for income tax purposes. The court rejected the IRS argument that personal property attached to a building is transformed into part of the building and must be depreciated over the same life as the building. Personal property is typically depreciated over a life of 5 or 7 years, as opposed to the lives for commercial real property which are 39 years. Slide 17

18 Cost Segregation / Fixed Asset Depreciation Case Law Scott Paper Co. v. Commissioner 74 T.C. 137, April 28, The court ruled primary electric improvements which met four criteria qualified as section 38 property under section 48(a)(1)(B)(I). - The reason that certain portions of the primary electric improvements were not tangible personal property is that they were structural components of buildings. - Thus, only the primary electric improvements which are tangible personal property qualify as section 38 property. Slide 18

19 Cost Segregation / Fixed Asset Depreciation Case Law Whiteco Industries, Inc., et al. v. Commissioner 65 T.C. 664, December 31, 1975 The court relied upon six questions developed through legislative history and case law to conclude, in a taxpayer friendly decision, that outdoor advertising signs constituted Section 38 property, and were therefore eligible for the Investment Tax Credit. - Is the property capable of being moved, and has it in fact been moved? - Is the property designed or constructed to remain permanently in place? - Are there circumstances that tend to show the expected or intended length of affixation (i.e., are there circumstances that show that the property may have to be moved)? - How substantial of a job would it be to remove the property and how time consuming is it (i.e., is it readily removable )? - How much damage will the property sustain upon its removal? - What is the manner of affixation of the property to the land or building? Slide 19

20 Cost Segregation Considerations A cost segregation to enhance cash tax savings should be considered if the company has: - recently purchased, constructed or is building out office space, a manufacturing facility, data center or warehouse; - significant investments in personal property classified as real property; - significant deferred taxes related to Property, Plant and Equipment; or - property that is or was available for bonus depreciation and qualified leasehold improvements. Slide 20

21 Acceleration of Depreciation Deductions Opportunities for companies that rent or lease equipment Many companies that rent or lease equipment have issues related to proper recovery period related to asset lives. Building Construction, leasehold improvements and/or asset acquisitions often contain costs that should be depreciated at a shorter life. With office buildings and retail locations in the leasing and rental industry, PwC has seen that 15-25% of taxpayer long life asset basis is composed of shorter life assets that have been grouped together as one larger 31.5 or 39 year asset. Slide 21

22 Acceleration of Depreciation Deductions Automatic Method Change related to the acceleration of asset recovery periods Revenue Procedure is an automatic method change that provides guidance to reclassify assets and allow for catch-up depreciation. The catch up deprecation (481(a) adjustment) is taken in the current tax year. The method change must be filed on/or before the filing of the tax return. This can also drive very large 481(a) adjustments (the difference in depreciation taken under a 31.5/39 year life vs. 5 or 7 year life) Slide 22

23 Repairs & Maintenance

24 Repairs and Maintenance Current Rules Reg. Sec (a)-1(b) provides that capitalization is required only in the case of expenditures that (1) add to the value of the property; (2) substantially prolong the useful life of the property; or (3) adapt the property to a new or different use. Amounts paid or incurred for incidental repairs and maintenance of property are not capital expenditures. Judicial doctrine has added a fourth step in the capitalization analysis, requiring expenditures related to a Plan of Rehabilitation to be capitalized. Slide 24

25 Repairs and Maintenance Current rules FedEx v. Commissioner FedEx removed engines from airplanes rebuilt them reinstalled Tax Court held Airplane Unit of Property Proper to expense repairs Disregarded Plan of Rehabilitation not applicable Affirmed at District level Slide 25

26 Repairs and Maintenance Opportunities for companies that rent or lease equipment Many companies that rent or lease equipment capitalize significant repairs to those assets. Potential opportunity with Unit of Property expenditures at retail locations Slide 26

27 Repairs and Maintenance Repair - Method Change Opportunity IRS is allowing non-automatic change in accounting method (Rev. Proc ) for costs originally capitalized that are eligible repairs and maintenance expenditures - Non-automatic change with section 481(a) adjustment - Network Assets Bare Consent - Other Assets Require representations that they are not capital expenditures Although it varies by industry, PwC has seen that that between 4-10% of taxpayer capital expenditures can be eligible for re-characterization as an expense This can drive very large 481(a) adjustments (the net tax value of the assets) Slide 27

28 Repairs and Maintenance Repair Regulations In a state of change Re-proposed Capitalization Regulations issued March 7, 2008 for amounts paid to acquire, produce or repair tangible property Major revisions to August 2006 proposed regulations include: - Material & Supplies interface - De Minimis Rule - Unit of property rules - Material increase in value tests - Repair allowance No additional guidance on unit of property for network assets Effective for taxable years beginning on or after date regulations finalized Slide 28

29 Repairs and Maintenance Repair Regulations Implications for Existing Law Plan of Rehabilitation doctrine - Preamble concludes that court-developed doctrine subsumed by 263A - Implication 263A serves to determine the allocable costs that must be capitalized as part of an improvement plan of rehabilitation no longer relevant Unclear whether method changes will be implemented with a section 481(a) adjustment, a modified section 481(a) adjustment, or on a cut-off basis Slide 29

30 Repairs and Maintenance Repair Regulations Implications for Existing Law (cont d) Casualty losses proposed regulation preamble provides that all costs arising from single event must be consistently characterized - Proposed regulations provide that if a taxpayer claims a casualty loss under 165, the restoration costs will be treated as a capitalized replacement of destroyed property - Implication Under present law, taxpayers may currently claim a 165 casualty loss and then deduct replacement costs as ordinary and necessary expenses Slide 30

31 Repairs & Maintenance /Acceleration of Depreciation Deductions General Examples Capitalized to Expense (dependent on unit of property) Engine Repairs/Replacements Post-construction costs related to: Painting Roofing Parking Lots HVAC Systems Relocation Costs Weather Damage From building to tangible personal property: Millwork / Built in furniture / Cabinetry Carpet / Non-permanent Flooring & Wall-Coverings Land Improvement costs Tele / Data Cabling Equipment Related Electrical Indirect Costs Qualified Leasehold Improvements Bonus Depreciation Slide 31

32 R&D Tax Credit

33 Overview of the R&D tax credit The R&D tax credit is an incentive for companies to create and retain scientific and technological jobs within the United States The regular research credit ( RRC ) is determined based on incremental qualified expenses over an established base amount The net cash impact of the credit is: - 13 cents for every $1 of incremental qualified expenses for the RRC Calculates the base using qualified spend/gross receipts for the years cents for Alternative Simplified Credit ( ASC ) Excess of current year spend over 50% of prior 3 yrs. avg. The credit is a permanent tax benefit which: - Lowers the effective tax rate - Increases earnings per share - Increases cash flow Slide 33

34 Final regulations Alternative simplified research credit regulations The alternative simplified credit (ASC) under Section 41(c)(5) was enacted as part of the Tax Relief and Health Care Act of An ASC election: - Applies to the current tax year Treasury Regulation T - Election made by completing the ASC portion of Form Election is irrevocable for that tax year only Election should evaluated each year - Protective Section 280C election can be made AM A designated member of the group (the one that is allocated the greatest amount of group credit is required to make the election Slide 34

35 Internal-use software may qualify The Four-Part Test Permitted purpose Technological in Nature Process of Experimentation Elimination of Uncertainty Three-Part High Threshold of Innovation Test (Internal-use software tests) Innovative Significant economic risk Not commercially available Slide 35

36 Deduction for Software Development Costs Capitalizing expenses for books and following that methodology for tax Large scale - Development projects (SAP, Oracle, etc.) - IT departments Guidance - Revenue Procedure (modified ) - Section 174 Uncertainty - Section 162 Ordinary and Necessary - Capitalized costs under Section 263, Section 167(f), Section 168, and Section 197 Slide 36

37 New research credit audit techniques guide signals increased IRS scrutiny IRS Audit Techniques Guide (The Guide) has resurrected numerous issues surrounding documentation and substantiation of research credit claims Tier 1 issue for claims Alerts taxpayers of continued scrutiny and may trigger highly detailed questions on examination. The super IDR represents the IRS intention to review contemporaneous documentation. Imposes a project accounting requirement to solve the nexus problem (defined as the inability to connect specific research projects and the underlying activities to the claimed qualified expense) Stresses the importance of the taxpayer s methodology and substantiation surrounding estimates Companies claiming the research credit need to review the substantiation requirements under Section 6001 Slide 37

38 New Industry Directive January 15, 2009 IRS issued an Industry Directive - Contingent fee basis - Definition of a claim Covered under Tier 1 designation Claim for credit or refund not taken into account on an original return - Mandatory Information Document Request ( IDR ) - Notice of centralized filing Effective March 12, 2008 Notice Replaced Notice Assertion of penalties under IRC Section % penalty of the disallowed portion of the claim for refund or credit for which there is no reasonable basis for claiming the R&D tax credit - Moral of the story - get it right on an originally filed tax return Slide 38

39 Anticipate scrutiny Recordkeeping IRS Industry Director Directive Tier I issue - A strategic issue warranting tight control and guidance removes discretion at field level - Exam Team required to perform a risk analysis to determine level of examination - If full examination is warranted, team is directed to other available IRS resources Record Keeping A taxpayer must retain records in sufficiently usable form and detail to substantiate that the expenditures are eligible for the credit. Documentation needs to thoroughly explain the systematic process of eliminating uncertainty, and the amount of time individuals spend on qualifying activities. Lack of documentation provides insufficient evidence to the qualifying nature of 41 activities, and may jeopardize the 174 activities and the associated costs. Slide 39

40 Anticipate scrutiny Recordkeeping (continued) Compliance: No change to 6001 general tax return requirements Consider strategies - Industry issue Resolution - Pre-Filing Agreements Record Retention Limitation Agreements Automate your process Do not wait until the examination begins accumulate contemporaneous documentation now! Slide 40