The Dbriefs Federal Tax Series presents:

1. The Dbriefs Federal Tax Series presents: Accelerating Out of the Downturn: Recognizing Income, Deferring Deductions Leon Lewis, Deloitte Tax LLP September 21, 2011

2. Agenda • Reverse accounting method planning • Accelerating income and deferring deductions examples • Questions and answers

3. Learning Objectives • Upon completion of this session you will be able to: • Understand why reverse accounting method planning is applicable in today’s economy. • Describe opportunities to accelerate income and defer deductions by analyzing facts, making elections, or filing accounting method changes. • Understand the interplay between U.S. and foreign source income in an accounting methods planning context. 1

4. Reverse Accounting Method Planning

5. Why Now? Who is Affected? • The U.S. is emerging from the recession and many companies with cumulative loss carryforwards are now profitable or near breakeven • Taxpayers may have used prior year NOLs to recover cash through the 5-year carryback provisions; which may have created additional FTC carryforwards that are nearing expiration • Taxpayers may also have historical earnings and profits (E&P) in their controlled foreign corporations (CFCs) and cash available for repatriation • Cash repatriations may have been delayed to avoid wasting the FTC limitation created by repatriating low tax foreign source income (FSI) • Taxpayers may also have general business credit (GBC) carryforwards that are subject to expiration 2

6. Approaches We can plan with accounting method changes or new facts: 3

7. Foreign Source Income Planning • Enter into multi-year pre-paid royalty contract with CFCs that use U.S. owned intangibles • Must avoid treatment as a loan or deposit (see Indianapolis Power and Light Company v. Commissioner); should not be refundable or bear interest or be recoverable as principal • Enter into an advance payment for goods contract with CFCs that purchase goods from the U.S. • Perfect foreign title transfer, should qualify for IRC § 863(b) and 50% sourcing as FSI • Consider repatriation of low-tax CFC dividends 4

8. Foreign Planning: Other Issues to Consider • Potential financial statement impacts related to intercompany income recognition • Foreign jurisdiction tax treatment of intercompany prepayments • Prior U.S. accounting method elections to defer advance payment income; ensure deferral elections have not been made by the taxpayer under either: • Treas. Reg. § 1.451-5 (advance payment for goods) • Rev. Proc. 2004-34 (1-year deferral for advance payments) • Making annual U.S. elections that can be changed year over year before making elections that require consent and 5-years to change again • Business purpose and economic substance issues for the U.S. and foreign jurisdictions for pre-payment planning • Consider reasonable discounts 5

9. Computation of E&P • The E&P of a foreign corporation is computed substantially as if the corporation was a domestic corporation: • Prepare P/L statements from books of account regularly maintained by the corporation for the purpose of accounting to its shareholders • Make adjustments necessary to conform P/L statement to U.S. GAAP • Make adjustments necessary to conform P/L statement to U.S. Tax Accounting Standards 6

10. Computation of E&P: Tax Adjustments • Make adjustments necessary to conform P/L statement to U.S. Tax Accounting Standards including: • Accounting methods under IRC § 446 • Inventories including UNICAP • Depreciation (generally straight-line basis) • Tax elections • Taxable years under IRC §§ 441 and 898 • No adjustment is required unless it is material. Materiality considerations include: • Facts and circumstances • Amount of adjustment • Size relative to corporation’s assets and profit or loss • Consistency of adjustments • Whether recurring or nonrecurring 7

11. Treas. Reg. § 1.964-1: Adoption of Method or Year Timing • A foreign corporation is not required to adopt an accounting method or period until the computation of its earnings and profits is significant for U.S. tax purposes for its controlling domestic shareholders (Treas. Reg. § 1.964-1(c)(6)) • Events include: • A distribution from the foreign corporation to its shareholders • The inclusion of a subpart F or IRC § 956 amount in the gross income of its U.S. shareholders • An amount excluded from subpart F income by reason of IRC § 952(c) (subpart F recapture) • Any event making the foreign corporation subject to tax under IRC § 882 • The use by the controlling domestic shareholders of the tax book value method of allocating interest expense • A sale or exchange of the foreign corporation’s stock subject to IRC § 1248 8

12. Treas. Reg. § 1.964-1: Procedures for Adoption/Change • Satisfy the procedural requirements under IRC § 446 applicable to changes in accounting method • IRC § 446 Requirements • The controlling domestic shareholders must execute a consent confirming the election, adoption or change has been approved by them, which is retained by a designated shareholder • Consent Execution • Each controlling domestic shareholder generally must file the statement required by Treas. Reg. § 1.964-1(c)(3)(ii) describing the nature of the action taken on behalf of the foreign corporation with its timely filed return for the taxable year with or within which ends the taxable year of the foreign corporation for which the election, adoption, or change is made • Treas. Reg. • § 1.964-1(c)(3)(ii) Statement • The controlling domestic shareholders must provide written notice of the action taken on behalf of the foreign corporation to all non-controlling domestic shareholders. Treas. Reg. § 1.964-1(c)(3)(iii) • Written Notice 9

13. Treas. Reg. § 1.964-1: Effect of Inaction/Untimely Action • The election, adoption or change in accounting method or tax year is invalid if the procedural requirements (except notice to non-controlling domestic shareholders) are not satisfied • Inaction • If timely action is not taken on behalf of the CFC, E&P is “computed as if no elections had been made and any permissible accounting methods not requiring an election and reflected in the books of account regularly maintained by the [CFC] for the purpose of accounting to its shareholders had been adopted.” Treas. Reg. § 1.964-1(c)(4)(ii) • Exception if inaction due to reasonable cause • Untimely Action 10

14. Procedures for Accounting Method Changes 11

15. Determining if a CFC is Under Examination 12

16. Accelerating Income and Deferring Deductions Examples

17. Changing Facts/Elections: 13

18. Changing Methods 14

19. IRC § 59(e): Optional 10-Year Writeoff of Certain Tax Preferences • Election to capitalize qualified expenditures and amortize over 10-years, beginning with taxable year expenditure is incurred • Qualified expenditures include amounts deductible under: • Election statement must: • Be attached to timely filed original return (including extensions) for taxable year in which the expenditure is incurred • Include the type and amount of qualified expenditures that the taxpayer elects to capitalize/amortize (can be a portion of the qualified expenditures) • Election is made at partner or S Corp shareholder level • Revocation of election will be granted by IRS only in rare and unusual circumstances 15

20. IRC § 266: Election to Capitalize Taxes and Carrying Charges • Under Treas. Reg. § 1.266-1(b), depending on type of property (real, personal, unimproved or unproductive real property), may apply to: interest on loan/mortgage, certain taxes, carrying charges, and certain necessary expenditures • If election is made, it applies to all expenses of that type for a particular project • Election is effective only for year for which it is made and for certain property is effective until construction complete or until put into use by taxpayer • Election statement must: • Be attached to timely filed original return (including extensions) for taxable year in which the election is made • Include the item or items the taxpayer elects to treat as chargeable to a capital account • UNICAP is applied before IRC § 266 16

21. Election out of Bonus Depreciation • Example: $7M asset (office furniture, fixtures & equipment, class #00.11) • Elect out of bonus • Elect MACRS straight line or ADS: 17

22. Recent IRS Guidance Economic Substance and Transaction Costs

23. Economic Substance – Legislative Summary • Section 7701(o) – enacted March 30, 2010, “clarifies and enhances” the application of the common law economic substance doctrine (“ESD”) • Statute provides uniform definition of “economic substance,” eliminating differences in the definition as developed by various federal courts • Section 7701(o) provides that in the case of any transaction to which the economic substance doctrine is relevant, a transaction is treated as having economic substance only if: • It changes in a meaningful way (apart from federal income tax effects) the taxpayer’s economic position, and • The taxpayer has a substantial purpose (apart from federal income tax effects) for entering into the transaction • Sections 6662(b)(6) imposes a strict liability penalty of 20% (or 40% if not adequately disclosed) if tax benefits are disallowed by reason of a transaction lacking economic substance within the meaning of section 7701(o)) or failing to meet the requirements of any any other similar rule of law (e.g., step transaction doctrine, business purpose, substance over form, or sham transaction) • The provisions are effective for transactions entered into after March 30, 2010

24. Economic Substance – Recent Guidance • IRS Notice 2010-62 (Sept. 13, 2010) • Indicates that codification will not change the IRS’s approach to analyzing application of the ESD, rather it confirms that both tests must be satisfied • On relevance, the notice says that the IRS will continue to respect authorities that have previously held that the ESD was not relevant and anticipates continued development of case law determining whether the ESD is relevant • LMSB-20-0910-024 (Sept. 14, 2010) • Provides that examiners cannot assess accuracy related penalties under §6662 relating to transactions lacking economic substance without prior review and approval by the appropriate Director of Field Operations (“DFO”)

25. Economic Substance – Recent Guidance (cont.) • LB&I-04-0711-015 (July 15, 2011) • Provides guidance to examiners on when to seek the approval of the DFO in order to raise the ESD, and sets forth a series of inquiries an examiner must develop and analyze in order to seek approval for the application of the ESD • Provides that, until further guidance is issued, the ESD penalty will be limited to transactions that lack economic substance, and may not be imposed due to the application of any other “similar rule of law” or judicial doctrine (e.g., step transaction doctrine, substance over form, or sham transaction) • Lists four situations in which examiners are directed to not raise ESD: • Cases in which the choice between capitalizing a business with debt or equity exists; • A U.S. person’s choice between utilizing a foreign corporation or a domestic corporation to make a foreign investment; • The choice to enter into a transaction or a series of transactions that constitute a corporate organization or reorganization under subchapter C; • The choice to utilize a related-party entity in a transaction, provided that the arm’s length standard of §482 and other applicable concepts are satisfied.

26. Revenue Procedure 2011-29 – Safe harbor election for allocating success-based fees • Revenue Procedure 2011-29 provides a safe harbor election for allocating a success-based fee between activities that facilitate a covered transaction and activities that do not facilitate a covered transaction • Not applicable to non “covered transactions” • Permits electing taxpayers to treat 70% of the success-based fee as an amount that does not facilitate the transaction • The remaining portion of the fee must be capitalized as an amount that facilitates the transaction • Applies to a taxpayer that: • Pays or incurs a success-based fee in taxable years ending on or after April 8, 2011 for services performed in the process of investigating or otherwise pursuing a “covered transaction” and • Makes the safe harbor election

27. Revenue Procedure 2011-29 – Safe harbor election for allocating success-based fees (cont.) Safe Harbor Election • The Service will not challenge a taxpayer's allocation of a success-based fee between activities that facilitate a transaction and activities that do not facilitate the transaction if the taxpayer: • Treats 70% of the amount of the success-based fee as an amount that does not facilitate the transaction; • Capitalizes the remaining 30% as an amount that does facilitate the transaction; and • Attaches a statement to its original federal income tax return for the taxable year the success-based fee is paid or incurred • Stating that the taxpayer is electing the safe harbor, • Identifying the transaction, and • Stating the success-based fee amounts that are deducted and capitalized.

28. Revenue Procedure 2011-29 – Safe harbor election for allocating success-based fees (cont.) Further Considerations • Irrevocable election • Applies only to the transaction for which the election is made • Applies with respect to all success-based fees paid or incurred by the taxpayer in the transaction for which the election is made • Analysis of other transaction costs still required • Election generally does not constitute a change in method of accounting for success-based fees, and thus a §481(a) adjustment is neither permitted nor required

29. Question and Answer

30. Contact info Bob Kilinskis 202 879 4995 rkilinskis@deloitte.com Leon Lewis 313 396 3543 leolewis@deloitte.com

31. 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 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.