6 minute read 10 Nov 2020
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How to prepare for year-end tax accounting during a pandemic

By Brian Foley

EY Global Tax Accounting and Risk Advisory Services Leader

Passionate about creating value in and through tax accounting. Drummer who is always looking for a gig. Husband and father.

6 minute read 10 Nov 2020

The pandemic adds new complexities and challenges to the year-end tax provision.

In brief
  • Year-end close presents many challenges under normal circumstances.
  • The COVID-19 pandemic continues to impact the global tax landscape – organizations need to view tax through a COVID-19 “lens”.
  • Pre-pandemic tax challenges remain as pressing as ever entering 2021 – the tax function needs to ensure they haven’t lost sight of these issues.

Well before the arrival of COVID-19, tax departments around the world were beset by the need to respond to new tax policies, regulations and controversy, but pre-existing conditions like the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) initiative and now BEPS 2.0 are only part of the current tax landscape.

The COVID-19 pandemic has caused enormous disruption in terms of societal, commercial, regulatory and ultimately tax impacts. Responses to the virus have driven profound changes in where and how business is conducted. Meanwhile, the combination of diminished government tax revenues and the added costs of fiscal and policy response to COVID-19 mean tax authorities will eventually begin searching for new or unpaid taxes. So as year-end draws near, it is important the CFO and the head of tax ensure all relevant tax matters related to COVID-19 and the broader tax landscape have been accounted for, and the company is, from a tax perspective, in a sound position.  To help guide the discussion, we offer two sets of questions – those driven largely by COVID-19 itself and those that remain ongoing in the world of taxation.

Set 1: What are we doing to address the tax impacts from COVID-19?

The arrival of, and evolving responses to, this pandemic are affecting businesses across a wide spectrum of issues, causing fundamental shifts in business, tax law and policy, as well as tax processes and controls.

The pandemic is forcing most if not all businesses to evolve both rapidly and dramatically. On the front lines, companies have responded to a combination of regulatory and consumer pressures by accommodating physical distancing or even “low-touch” or “no touch” business models. Nearly all businesses have been forced to ramp-up online capabilities while other businesses are experiencing unprecedented traffic on already well-established digital outlets.

Out of view of customers, numerous businesses have seen wholesale transformation of their supply chains as they race to find new sources of supply from accessible markets. Similarly, for many businesses, the workforce no longer arrives at a central office. Workflows have been redesigned to meld with “work-from-home” mandates.

From a tax perspective, the above shifts can lead to risks and opportunities across a range of topics. Some of the most notable questions to answer include:

Has our jurisdictional or legal entity mix of earnings changed?

Businesses whose operations experience varying levels of lockdown or surge may have shifted functions, work, risks, inventories or other key business elements between jurisdictions or entities. Certain intercompany agreements may even tilt into force majeure as group members find themselves unable to meet contractual obligations.

All of these factors lead to a potentially significant shift in the mix of revenue, expense and profits across jurisdictions and ultimately impact the effective tax rate (ETR) of the company. As such, companies need to examine their transfer pricing, making adjustments where appropriate. In particular, businesses should re-evaluate changes to sourcing, personnel, risk or related location made under emergency conditions. And executives should be prepared to explain to key stakeholders any dramatic changes in ETR, including whether changes are temporary or permanent.

Are we taking full advantage of stimulus-driven tax laws and policy changes?

Governments have responded to COVID-19 by enacting laws and executing policies to support local businesses and economies amid travel and social distancing restrictions. Worldwide, the value of such stimulus exceeds US$27 trillion.

Many of the tax-related stimulus programs take the form of deferral of tax payments. For example, companies may be able to defer payment of estimated income taxes or payroll taxes, delivering a boost in short-term liquidity. In addition, many jurisdictions have offered outright grants which need never be repaid, or alternatively government loans which in many cases will be “forgivable”. Both of these latter arrangements provide permanent cash benefits. Careful analysis may be required to determine not only whether grants, loans or other incentives are taxable, but also whether these arrangements are accounted for as a component of income taxes or elsewhere in the financial statements.

Yet another form of stimulus takes the form of new, often short-term changes to tax rules. For example, certain countries that previously denied companies the right to carry-back tax net operating loss (NOLs) are now allowing companies to use 2020 NOLs to obtain refunds of income taxes paid in 2019 or 2018. In other cases, jurisdictions are suspending their interest deduction limitations, enabling companies to reduce taxable earnings as a means of stimulus.

Have we appropriately adjusted internal controls to changing circumstances?

COVID-19 also may introduce new or different risks across control environments. Many companies are necessarily reducing spending in accord with revenue reductions. Meanwhile, the creation of new business models introduces new processes and a new network of potential risks.

For tax, the question becomes: Is the existing/historical control environment for tax accounting and reporting still adequate, given changes in personnel, roles and responsibilities?

To respond to this question, the CFO and the head of tax may ask: Are we still able to perform tax accounting and reporting processes and conduct timely and effective review of the tax provision? Do we have access to the right information and right competencies? Is our remote work arrangement prepared for the scope of year-end reporting? Do we need to supplement our resources, perhaps with temporary support or outside advisors to ensure we’re addressing the right issues?

Set 2: How are we addressing ongoing change in the global tax environment?

Even before the arrival of COVID-19, businesses were already facing an onslaught of evolution in global tax policy. Beyond COVID-19: Have we evaluated and accounted for latest developments related to:

US Tax Cuts and Jobs Act (TCJA)

Although passed in 2017, significant final and proposed Federal interpretations continue to be released. Ongoing change is also evident at the State level, as local jurisdictions, conform or diverge from the TCJA, in additional to addressing chronic or COVID-19-driven budget gaps.

BEPS

Businesses must also contend with the OECD’s continuing efforts to address base erosion and profit shifting (BEPS). And although delayed by the arrival of COVID-19, the OECD just published several new documents on it's BEPS 2.0 framework which aims to coordinate multinational taxing rights as well as introduce global minimum tax rules.

Digital services taxes

While BEPS initiatives progress, numerous jurisdictions are taking or considering unilateral measures to evolve their tax bases to an increasingly digital economy. In particular, many jurisdictions are introducing digital services taxes levied on certain cross-border earnings based on customer location (i.e., “market” based approach).

Multilateral instrument (MLI)

Many countries are moving forward with execution of the MLI developed under BEPS. The MLI modifies thousands of bilateral tax treaties and implements standards to protect against treaty abuse and enhance cross-border dispute resolution. The MLI also provides for greater tax data sharing and thus raises the bar for how companies must prepare to defend transfer pricing and other tax positions. The MLI impacts and effective dates vary based on each jurisdictional relationship.

EU Mandatory Disclosure Regime (MDR)

Yet another important development requiring close attention is the EU’s requirement to disclose to EU Member States a wide range of cross-border tax arrangements. Taxpayers and intermediaries must implement policies, procedures and processes to identify and capture details of tax transactions they will need to disclose. On complex arrangements, taxpayers will need to coordinate disclosures with their advisors. Penalties for non-compliance vary by country and can be significant.

Tax controversy

Profound change in not only tax laws and policy but also fundamental business operations is a recipe for controversy. In the US, for example, the IRS is now cycling to reviews of 2017 and 2018 returns. These were two years of high complexity as companies interpreted the just-enacted TCJA. Tax departments should be ready to respond to inquiries and defend positions. On a global basis, new tax laws responding to COVID-19, combined with decreased tax revenues and increased spending on stimulus and health care introduce significant tax complexity which may lead to increased tax controversy activity. Tax departments may anticipate additional inquiries from tax authorities and potentially increased volatility in tax accounting for uncertain tax positions. 

Strategic transactions

Driven by disruption the world is experiencing an active transactions market. On the buy side, opportunists see low interest rates and attractive, often distressed, assets. The sell side, meanwhile, is replete with companies seeking to restructure or reshape to deliver sustainable results or merely survive. Capital markets have been active as companies navigate political uncertainty and access ample liquidity supplies. Initial public offerings and Special Purpose Acquisition Company (SPAC) transactions have been robust.

Strategic transactions increase the likelihood that tax departments, already facing a significant set of challenges, may be called upon to devote resources to assist in planning, executing and/or integrating transactions. Careful attention to the tax elements of a transaction is critical to ensuring the deal achieves its desired outcome and that systems and controls are in place to manage tax risk.

Accounting developments

One final area deserving of close attention is accounting standards. The agencies setting these standards, such as FASB and IASB, continue executing on agendas to improve the quality of financial reporting. Recent changes have targeted revenue recognition, lease accounting and financial instruments. Other changes related to goodwill impairment (US GAAP and IFRS), income tax simplification (US GAAP), accounting for convertible debt instruments (US GAAP), debt-equity classification generally (US GAAP and IFRS), accounting for estimates (IFRS), improvements to financial statement disclosures (US GAAP and IFRS) and several other topics are in different stages of proposal, adoption and execution. Heads of tax need to assess the tax accounting and tax compliance impacts of any adopted accounting standards or interpretations, looking not only at group reporting but also statutory reporting.

Closing 2020 and preparing for beyond

As 2020 comes to a close, CFOs and heads of tax should work closely to understand, evaluate, account for and disclose the varied business and tax matters encountered during the year. Though by no means comprehensive, the above questions provide a solid framework to engage in open discussion on the dynamics impacting companies’ tax accounting and reporting this year-end.

Seven steps to take now to accelerate tax accounting work ahead of the year-end close cycle

Many elements of the year-end tax provision can be concluded well before the end of the year. This year, businesses should consider taking steps to pull work out of the year-end close cycle, to reduce stress and risk related to remote work. Below are a few tangible steps that can be taken now:

  1. Develop a year-end close calendar and align expectations, communication protocol, and timing with your external auditor.
  2. Address changes in personnel and roles and responsibilities to avoid gaps in processes and controls.
  3. Complete the analysis of any COVID-19 impacts on your business.
  4. Complete a technical analysis of tax law and regulatory developments.
  5. Complete provision-to-return calculations, including confirming applicable tax rates, substantiating deferred tax balances and analyzing deferred tax asset realization.
  6. Complete a technical analysis and tax accounting for any significant transactions.
  7. Complete analysis and documentation of transfer pricing.

Evaluate and account for the tax accounting impact of newly adopted accounting standards and interpretive guidance.

Future articles will offer additional questions on topics likely to shape an active 2021 again for tax.

Summary

Tax departments worldwide have for a very long time needed to respond to shifting policies, regulations and controversy. With the COVID-19 pandemic adding to an already complex tax landscape, organizations have to take stock, ensure they have met all their obligations and start to plan the way forward.

About this article

By Brian Foley

EY Global Tax Accounting and Risk Advisory Services Leader

Passionate about creating value in and through tax accounting. Drummer who is always looking for a gig. Husband and father.