DECRYPTING CRYPTOCURRENCY TAXES
NOVEMBER/DECEMBER 2018 Mazars USA LLP is an independent member firm of Mazars Group. CONTENTS
2 | Mazars USA Ledger CONTENTS
NOVEMBER/DECEMBER 2018
4 | Questions Healthcare Companies Should Ask About the Data Driven 23 | Healthcare Policy and Procedure Best Practices Revenue Cycle 26 | FICE Discussion Paper: The Board's Preferred Approach to Classifying 6 | What’s Broken in Healthcare Financial Instruments as Liabilities or Equity
8 | Decrypting Cryptocurrency Taxes 33 | Why Provider Organizations Should Be Proponents of Capitation
12 | Cryptocurrency Attracting the Next Generation of Renters 37 | IFRS Alerts
14 | Lease Accounting for Broker Dealers 39 | Real Estate Alert
19 | Puts on Non-Controlling Interests: What Changes Are Proposed in the 41 | Tax Alerts FICE Discussion Paper
*The Mazars USA Ledger contains articles and alerts published from October 1, 2018 - November 30, 2018.
November/December 2018 | 3 HEALTHCARE
QUESTIONS HEALTHCARE COMPANIES SHOULD ASK ABOUT THE DATA-DRIVEN REVENUE CYCLE BY DOUG BARRY
A WHILE BACK, WHEN YOU FIRST READ ABOUT THE EQUIFAX CYBER BREACH WERE YOU SURPRISED? IT SEEMED ODD, CON- SIDERING THEY ARE ONE OF THE LARGEST ORGANIZATIONS IN THE BUSINESS OF HOUSING AND SELLING YOUR PERSONAL AND FINANCIAL DETAILS.
I THINK MANY OF US THOUGHT COMPANIES LIKE THEIRS WERE BULLET-PROOF. THERE MAY HAVE EVEN BEEN A CASUAL CONFIDENCE AND ASSUMPTION THAT COMPANIES LIKE THAT WOULD EMPLOY SOME OF THE STRICTEST DATA PROTECTION MEASURES AVAILABLE. THEY WERE ALSO IN THE BUSINESS OF ACCURATELY ANALYZING YOUR FINANCIAL BEHAVIOR.
THE INTEGRITY OF THIS DATA WAS ENORMOUSLY IMPORTANT, CONSIDERING CREDIT MARKETS RELY ON IT TO MAKE SOUND DECISIONS AS TO WHETHER OR NOT YOU ARE LIKELY TO REPAY A DEBT. THIS BREACH CHANGED THE WAY WE LOOK AT OUR OWN IDENTITY PROTECTION AND LESSENED OUR TRUST IN THE BIG THREE REPORTING AGENCIES.
COMPANIES LIKE EQUIFAX DO MUCH MORE THAN ASSIST THE CREDIT MARKETS. THE BIG THREE - EXPERIAN, TRANS UNION AND EQUIFAX - HAVE GROWN TO BE SIGNIFICANT PLAYERS IN THE HEALTHCARE SPACE. THEY ARE DATA PARTNERS SUP- PORTING EFFORTS TO REFINE WORK-FLOW AND REDUCE COSTS TO COLLECT FOR SOME OF THE LARGEST HEALTH SYSTEMS IN THE COUNTRY.
PROVIDERS EMBRACED ANALYTICS THAT PROVIDED THEM WITH INFORMATION REGARDING A PATIENT’S PROPENSITY TO PAY THEIR BILL. THEY EMBRACED HAVING THE ABILITY TO MOVE INDIGENT PATIENTS OUT OF THEIR COLLECTION TEAMS AND STRAIGHT TO PRESUMPTIVE ELIGIBILITY FOR A CHARITABLE WRITE-OFF. EMPLOYING THESE AUTOMATED MANAGEMENT TECHNIQUES MEANT HOSPITALS COULD COLLECT MORE MONEY AT A LOWER COST.
SO WHAT NOW? THERE ARE NUMEROUS QUESTIONS THAT NEED TO BE ANSWERED. WAS YOUR PATIENT DATA PART OF THE BREACH?
4 | Mazars USA Ledger Most likely there won’t be any implications for the majority of providers demand to stop that facility’s information from being made public. The data with the exception of those hospitals that chose to place their patients who can contain medical and demographic information including social security failed to pay timely into one of the three credit bureaus with the hopes of and date of birth, which are frequently sold on the black market for profit. securing payment in the future. But what about patients who are processed IT Security Officers should frequently be at senior management meetings through the three credit agencies to determine eligibility or the likelihood of keeping them informed of potential threats and conveying current steps paying their debt? taken to shore-up defenses.
With so many news stories highlighting a solution or protective measure What about the vendors who provide services to the organization? Health- requiring consumers to “freeze” their credit, it begs the question as to what care providers tend to have numerous buyers of products and services that will ultimately mean for hospitals and physician practices who utilize in a single organization. Frequently, receivable vendors are engaged this data on a regular basis. without the level of IT scrutiny needed in order to protect an organization from possible threats. When I was in the provider space, I can’t remember How many patients will opt to take this freezing measure? Will this begin to ever having to share a desired tool with an IT Security professional before impact the integrity of the financial modeling you apply today? Doesn’t your moving forward. automated receivable flow for propensity to pay and presumptive charity el- igibility rely on the financial information provided by these credit agencies? In Revenue Cycle there are numerous technical applications sold on the It most certainly relies on a large portion of it. market intended to help improve financial performance. The contracting phase usually concludes before the IT professionals get an opportunity to So what is the potential impact on your operations? Will patients who dig into the details. Allowing executives to engage vendors without having freeze their personal credit files provide you with incomplete or less their IT Security team dictate the strength and minimum standards required accurate data on which to base your decisions? Will it simply reduce the for technology invites trouble. number of patients you can automate into a preferred work flow? These products are sought after by Revenue Cycle professionals because One thing is for sure; you need to explore the impact with your current ven- of their perceived technical superiority when compared to the offerings of dor, and you need to plan to address it. A significant reduction in available most HIS systems. The perception of advanced technical capability often data could ultimately impact your staffing should you begin reverting back can be misinterpreted by the buyer to mean they have somehow met very to more manual processes when assessing patients’ abilities to resolve stringent security guidelines. It can leave one with a false sense of security. their debts. When we perform assessments of clients, we often see these types of con- tracts have not been appropriately vetted. It is essential to have a qualified It is by now clear that we live in an era in which healthcare organizations cyber security expert assess your situation. are forced to allocate valuable dollars away from delivering patient care and towards improving information systems security. Whether you use data to streamline your workflow, technology to enhance performance, or just want to protect patients’ identities from being compro- Facilities must invest heavily to protect their patient’s information from be- mised, the need to be more collaborative and to engage in interdepartmen- ing hacked or accessed by an increasing number of outside threats. More tal reviews and discussions prior to making any decisions to provide a third and more we read about attacks on healthcare organizations by foreign party with your data has never been more important. and domestic cyber criminals. Doug is a Principal in our New York Practice. He can be reached at Those successful in accessing a provider’s system can bring internal op- 212.375.6558 or at [email protected]. erations to a grinding halt. Frequently the attack is coupled with a ransom
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November/December 2018 | 5 HEALTHCARE
WHAT’S BROKEN IN HEALTHCARE BY MARK MARTEN
While many in this nation are confused about the direction of healthcare, we look toward the future. Regardless of the design, one thing is clear – we need more accountability in healthcare. There still isn’t a clear understanding of risk-based contracting in the industry. This value-based payment model is inevitable and will ultimately shape the future of health- care in a way that will be mutually beneficial to patients, providers, and payers. So why are the details still so murky, and where does all this trepidation come from?
As with many visionary endeavors, risk-based payment sharing can require heavy collabora- tion, strategic planning, complex contracts, a slow return on investment, and uncertainty in the near term.
Risk Sharing 101 Risk-based payments are meant to provide more accountability by requiring providers and hospitals to share in the risk of treating the entire spectrum of a population. Physicians are required to lower costs by providing quality care to reduce utilization, while hospitals must learn to deliver care more efficiently and coordinate with others.
6 | Mazars USA Ledger TRUE RISK True risk is accountability for the total cost of care for the lifetime of a pop- ulation. Some members are healthy and rarely access care, while others require intense services provided by multiple professionals. We must get to a point where we as collective providers are responsible for the cost of care for an entire population. This can be done through working with a communi- ty and taking on the payment and administration of services.
One successful true risk model is Medicare Advantage, wherein a plan is paid a monthly capitated fee to provide care for its assigned members. This is most often delivered through a network of physicians and providers who are responsible for some or all of the prepaid amount. They must keep the cost of care less than the payment in order to make a margin so they can MEDICARE LEADS THE WAY continue to reinvest in the lifetime care of their patients. Over the last 50 years, we have seen Medicare take the lead on reforming the delivery of healthcare. Some of their initiatives have already succeed- Generally, using the alternative MTM method is more beneficial to a major- ed and others are still a work in progress. Medicare introduced DRGs to ity of taxpayers. It allows taxpayers who failed to make timely elections to control costs and better manage the episode of care in a hospital by paying utilize the simpler MTM method and avoid being taxed at maximum rates a set amount per diagnosis, thereby reducing the hospital’s incentive to along with an interest charge. Of course, there are instances in which the extend stays and encouraging them to provide care more efficiently. More alternative MTM method may not be the best option. Taxpayers who did recently, Medicare introduced bundled payments to manage the cost of a not dispose of, or receive, distributions from their PFIC investments, and case from pre-admission through discharge to follow up. taxpayers who disposed of PFIC investments at a loss are two examples of situations that call for a further analysis. PARTIAL RISK Both DRGs and bundled payments are examples of partial risk. If the cost of DRAWBACKS care is higher than the set payment, the hospital and/or provider will take a Commercial Plans are beginning to implement risk-based payments, but a loss. This arrangement encourages innovation, quality care, and efficiency major drawback of following the Medicare Advantage model is that mem- in order to drive down medical costs and turn a profit. This is in direct oppo- bership changes often in today’s transient society. When the health plan sition to the fee-for-service (FFS) model, which incentivizes a high quantity invests heavily in their member’s treatment and the newly healthy patient of care rather than quality. Many believe that FFS withholds and discounts changes their insurance, this significantly inhibits the plan’s ability to realize are risk, but they are not. These models have shared savings, not shared an ROI on that treatment. Why invest in the health of a member that will risk. However, even these forms of risk are not true risk because they do not change plans? Without limiting the patient’s choice in health plans, perhaps account for the total cost of care for a population. there could be a risk-sharing arrangement among commercial plans, wherein a small tax is imposed on all commercial premiums that would fund SHARED RISK POOLS an incentive pool. This would provide value-based payments to health plans The first step for many health plans has been to set up shared risk pools, when their member leaves after receiving care that substantially improves wherein groups of physicians with a payment incentive arrangement work their health. with health plans and other providers in the community to manage costs. When they are successful, they have a reserve in the pool attributed to NEXT STEPS those members. These reserves allow the group to invest in additional Sharing risk can be complicated and intimidating, but it’s a step in the right services to prevent diseases and better manage chronic conditions. direction for the healthcare industry as a whole.
This limited shared risk arrangement will evolve into taking global risk where As Medicare and Medicaid push to shift from fee-for-service to value-based the entity is responsible for physician, hospital and other provider costs for care, we should embrace the change and be proactive in taking on this the population. Some of the investments that are put into place with these new responsibility. If you need help with risk-based contracting, contact the savings are home-based services, chronic care centers, dedicated nurses Mazars Healthcare Consulting Group at mazarsusa.com/hc. for case management and coverage of items needed to ensure a healthy population that often require unique services not covered by insurance. Mark is a Principal in our Los Angeles Practice. He can be reached at 949.584.7247 or at [email protected].
November/December 2018 | 7 FINANCIAL SERVICES
DECRYPTING CRYPTOCURRENCY TAXES BY GREGORY KASTNER
LIMITED GUIDANCE ON TAXATION §§ Equity security tokens are similar to stock shares in that they carry an ownership element, may have voting rights and can earn “dividends.” DESPITE THE BILLIONS OF DOLLARS (WHICH IS PROJECTED Digix is an example. Debt security tokens act as short-term loans to a TO BE TRILLIONS IN 2018 ACCORDING TO A SEPTEMBER 2018 company and earn the equivalent of interest – Steem utilizes such a SATIS GROUP REPORT) FLOWING IN AND OUT OF THE VARIOUS scheme. CRYPTOCURRENCIES SUCH AS BITCOIN, ETHEREUM AND LITECOIN, §§ Currency or payment tokens are used as their name implies – Bitcoin, THE UNITED STATES TAXATION OF THESE PRODUCTS IS GOVERNED Litecoin, ZCash and Monero are examples. MOSTLY BY INTERNAL REVENUE SERVICE (IRS) NOTICE 2014- 21 ISSUED BACK ON MARCH 25, 2014. WITH REGARDS TO THE HOW CRYPTOCURRENCY IS EXCHANGED NUANCES AND UNCERTAINTIES NOT COVERED BY THE NOTICE, THE IRS HAS CHOSEN TO REMAIN MOSTLY SILENT. Cryptocurrencies can be exchanged in a few ways. They can be sold for cash on certain websites that act as exchanges such as Coinbase, WHAT IS CRYPTOCURRENCY Bitstamp or Kraken. They can be exchanged for other types of cryptocurrency on sites such as Shapeshift. They can be sold directly What is a cryptocurrency? Unlike United States Dollars, British Pounds or to another person at a price you set that is accepted on sites such as Euros, cryptocurrencies only exist in the virtual universe, meaning there is LocalBitCoins or BitQuick. They can even be converted to a local currency no tangible paper bill or metal coin that can be physically touched. Nor are and withdrawn from an ATM at places found on Coinatmradar. they considered legal tender. Instead the Internet and only the Internet is used to transfer Bitcoin or Ethereum tokens from their originators to every For investors not wanting to own cryptocurrencies directly or wanting to subsequent owner. A price is set at an Initial Coin Offering (ICO) or Initial use a manager to invest in them, options have begun to open up. Privately Public Coin Offering (IPCO) and then trading begins in the virtual universe. traded partnerships such as hedge funds or private equity funds have This is done through a secure Internet portal account sometimes called a begun to trade in cryptocurrencies and offer investors access to their coin wallet. appreciation (or depreciation) through the private placement of these partnership interests. A register, accessible to all owners extemporaneously, tracks everyone’s ownership and is called a blockchain. This register is updated every time Coinbase’s institutional arm has been approved as a qualified custodian by ownership changes. The details of your ownership represented in this the state of New York and BitGo by South Dakota. This license allows them blockchain that all others can see is sometimes called your public key. to securely hold deposits of cryptocurrencies much like a bank account. Access to spend any of your cryptocurrency in your coin wallet is provided by a private key. This private key is a long list of numbers and letters which ORIGINS needs to be kept secure to prevent losing access. Fluctuations in cryptocurrency value depend mostly on people’s perception There are three types of cryptocurrency tokens generally – utility, security of the value and are not necessarily tied to anything – such as earnings and payment: of a company, the value of gold or what your dog wants for breakfast that §§ Utility or user tokens enable the holder access to a future service morning. Their creation came from a desire to allow fast, better secured, being developed – Filecoin, Flipcoin and Storj are examples. less costly transfers of value between consumers and producers without
8 | Mazars USA Ledger the use of bank accounts or credit cards. Ability to avoid use of trusted MINING CLASSIFIED AS A U.S. TRADE OR BUSINESS intermediaries while retaining anonymity was also coveted. When involved in the “mining” or creating of cryptocurrencies, the taxpayer Ideally, they would be immune to fluctuations in just one country’s currency could be considered as engaged in a trade or business. The implications and to counterfeiting or theft. Obviously, as the market has grown and of such can be significant. Income generated from a United States (U.S.) speculators have stepped in, cryptocurrency’s utility has increased from based trade or business is generally Effectively Connected Income (ECI) – a way to pay for goods or services to also an avenue for speculative that is, U.S. sourced and subject to federal tax withholding if any profits flow investment. Because of the sometimes extreme volatility in values created through a partnership or joint venture to a foreign entity or individual. by these speculative investments, some merchants or individuals won’t accept these highly fluctuating cryptocurrencies in lieu of more traditional If a partnership interest involved in producing such income is sold, the forms of payment. proceeds would also be subject to withholding under the new Tax Cuts and Jobs Act (TCJA) changes to Internal Revenue Code (IRC) §864 and Cryptocurrencies are generally taxed in one of two ways, depending on how §1446 taking effect in 2018. Such income will presumably also be treated they were acquired. One area the IRS has not addressed is whether their as subject to self-employment tax under IRC §1401 if not received by an use affects their taxation as well. incorporated entity. If any of the income flows to a pension plan, charity or IRA account, it could also create an unexpected tax liability as this income
November/December 2018 | 9 FINANCIAL SERVICES
will also be classified as Unrelated Business Taxable Income (UBTI) under For corporations, no capital losses in excess of capital gains are allowed IRC §512. and there is not a different federal income tax rate for long term versus short term. With some restrictions, capital losses may be carried back three For amounts flowing to an individual, such income would be treated as years for corporations and forward only 5 years, dissimilar to the rules for ordinary income and not receive any preferential tax rate such as those individuals. available to long term capital gains or qualifying dividends. A limited partner would classify such income as passive under IRC §469 and generally avoid Under the TCJA, however, corporations are subject to a maximum federal paying self-employment tax on any profits. General partners and limited tax rate of only 21%. In the past, long-term investments were probably held liability company (LLC) managing members would receive non-passive at the individual level because of the tax rate differential providing a more income subject to the self-employment tax. If the self-employment tax beneficial answer. Now, if long-term investments’ appreciation help fund element is a concern, structuring the entity as a limited partnership (LP) a business, it may make more sense to leave them in a corporation. Most instead of as an LLC might be preferable. By statute, limited partners in states do not have a different rate for capital versus other types of income. an LP are not subject to the self-employment tax. LLC members are not distinctly protected by that same statute. Such capital gains or losses on sales of cryptocurrency are presumably portfolio and not passive for purposes of limited partners in a fund that Another possible unexpected consequence of “mining” is that such income invests in cryptocurrency. As such, income would not be able to be offset could also be classified as state-sourced and have state income taxes and against other passive losses such as from a real estate limited partnership withholdings due. If where customers reside and where the “mining” is interest. done differ, different states’ sourcing rules could possibly subject more than 100% of the income to state income tax as there is not universal uniformity Presumably, if one were to buy and sell cryptocurrency continually across states with regards to such rules. throughout the year, losses would be subject to the wash sale rules under IRC §1091. Different types of cryptocurrency probably would not be treated Cryptocurrency is not tangible personal property nor is it services and so as “substantially identical” for this section but if such a trading strategy were its sale would not incur sales or use tax as would be due in other retail employed, these rules need to be considered. businesses. To avoid having to analyze the historical trading for purposes of such MINING CLASSIFIED AS A HOBBY tracking, could the Bitcoin or Ethereum be treated as a security and be eligible for the mark-to-market rules of IRC §475(f) if a timely election If the “mining” of a cryptocurrency does not rise to the level of a trade or is made? Since cryptocurrencies are not traded on what is defined as a business, the IRS could argue any losses incurred should be classified qualified exchange at this time, presumably they would not be eligible for as hobby losses under IRC §183 and not be allowed. Generally, a good IRC §1256 mark-to-market treatment as 60% long term capital gains/losses faith expectation of profit governs such classification. Usually, a single and 40% short term capital gains/losses. Cryptocurrency does not create occurrence does not rise to the level of trade or business. foreign currency gains or losses as defined by IRC §988.
HELD FOR INVESTMENT Shorting a cryptocurrency (borrowing with the promise to repurchase in the future in the hopes the value will drop) would also require looking at the If the taxpayer is not “mining” and only involved in buying and selling straddle rules of IRC §1092. cryptocurrency created by others, it is treated as an investment in property. As such, gain or loss is treated as capital in character. For individuals, if it is Debt tokens, presumably, would be subject to the market discount and held one year or less, it is treated as short term capital gain or loss and long original issue discount rules of IRC §1276 and §1272. Some of the gains term if held longer. might need to be reclassed as ordinary income or a current inclusion of income might be required depending on the interest actually paid. Under the TCJA, long term capital gains carry a maximum federal rate of 20% and short-term capital gains carry a maximum federal tax rate of 37%. After the TCJA took effect at the beginning of 2018, only exchanges of real Only $3,000 of capital losses in excess of capital gains are allowed to an property are eligible for a tax-free exchange under IRC §1031. Prior to the individual per year and any of these unused losses can be carried forward new tax law, this was uncertain as the law did not specify real property, but indefinitely. Such income is also net investment income for purposes of the only property. 3.8% tax on individuals with modified adjusted gross income over $200,000 ($250,000 for married couples filing jointly). Expenses attributable to the trading or investing in Bitcoin as an investment
10 | Mazars USA Ledger would be subject to the same rules as investing in other securities, i.e. Regardless, forks have not been directly addressed by the IRS and so either being classified as an “above-the-line” ordinary deduction or as either approach is not definitively correct and each case should be analyzed a miscellaneous itemized deduction whose benefit was eliminated for individually. individuals by the TCJA. For corporations and PFICs, there is no such limit on these expenses and they are essentially treated as deductible expenses. USED TO PAY PERSONAL EXPENSES
ASSIGNMENT OF BASIS FOR SALES AND FORKS What if cryptocurrency is directly used to pay for personal expenses? A gain or loss might be incurred. If it’s a loss, the taxpayer would have to argue that In terms of which layer is sold and how to assign a tax basis to such layer the cryptocurrency was held for investment and then a capital loss could be held for investment, the default method for sales of stock under Treasury recognized. Personal-use asset losses are not deductible – such as losses Regulation §1.1012-1 would be first in, first out (FIFO). However, the option on sale of a car or a personal residence like a house or boat. to identify the highest priced layer as being sold first is allowed. Such identification must be made at the time of the sale. Despite the regulation If it’s a gain, the taxpayer would be required to recognize the gain under IRC referring to sales of stock, many practitioners are applying these rules to §61. Failure to report such a gain could extend the statute of limitations cryptocurrency because of the similarities and not the average cost method from the normal three years the IRS has to assess additional tax to 6 years available to holders of mutual fund (Regulated Investment Company) if the excess is substantial. Substantial is defined in this context as over shares. No Form 1099s are currently issued from cryptocurrency operators, 25% of gross income for the year. Some states extend the statute even so the taxpayer would have to track the various layers and tax basis of each longer than the federal government. If the omission is deemed fraudulent, layer. however, there is no time limit.
Another area of uncertainty with regards to tax treatment is that of forks If cryptocurrency is received for services as an employee, income still of cryptocurrency (such as Bitcoin Cash for holders of Bitcoin). Forks needs to be recognized for income tax purposes and all required payroll generally occur when there is a change in the software that cryptocurrency taxes paid by the employee and employer. miners use, sometimes because of a dispute, and owners of the current cryptocurrency receive new keys that give them value on a new blockchain. REQUIRED DISCLOSURES
Should this transaction be treated the same as a stock split and just some Besides properly reporting the income tax consequences of any of the cost basis assigned proportionately to it? Is no basis assigned under cryptocurrency transaction, any direct or indirect holdings of cryptocurrency the argument that no ascertainable value exists for the new cryptocurrency? could potentially be subject to information reporting as well. The filing Is income recognized to the extent that the new fork has a market value? If requirements of Form 114, Report of Foreign Bank and Financial the old cryptocurrency is eliminated, is this some sort of tax-free exchange Accounts or the so-called FBAR, and Form 8938, Statement of Specified similar to those offered for stock under IRC §368, even if this does not Foreign Financial Assets should both be considered if the cryptocurrencies all happen all at once? On these questions, the IRS has so far remained are held by an offshore vehicle or held in an offshore coin wallet. Failure to silent. However, there is a Supreme Court case from 1955, Commission vs. file these forms in some cases can be argued as willful and the penalties Glenshaw Glass Co. that many practitioners site as perhaps the governing severe. doctrine. Owners of cryptocurrency also need to comply with the Anti-Money According to the case, when a taxpayer receives undeniable accessions Laundering rules initiated by the Bank Secrecy Act of 1970 and possibly to wealth, clearly realized, and over which the taxpayer has complete file Currency Transaction Reports or Suspicious Activity Reports. All carry dominion, a recognition of income must occur. If the new cryptocurrency, stringent recordkeeping requirements. the fork, has value and can be traded without hindrance immediately, it appears there could be a taxable event upon the fork. While there is a lack of specific guidance on the taxability of cryptocurrencies, the proper treatment and consequences can be Unlike a stock split where the price has just been altered per share, extrapolated from other sources in most examples. Proper disclosures something new has been created: a new cryptocurrency. If, however, a should be considered to prevent possibly severe penalties for non- value cannot be placed on the fork or it cannot be traded now or with any compliance. definite timeframe in the future, it may not have to be recognized as income today. The IRS, however, is generally not too keen on deferrals of what they Gregory is a Director in our New York Practice. He can be reached at deem to be income and so these restrictions would have to have merit. 212.375.6583 or at [email protected]
November/December 2018 | 11 REAL ESTATE
CRYPTOCURRENCY ATTRACTING THE NEXT GENERATION OF RENTERS BY BISNOW, SPONSORED BY MAZARS
Tenants are beginning to pay their rent via a new type of currency.
Bitcoin, Ethereum and other cryptocurrencies have taken the business world by storm over the past year as new forms of payment that run on blockchain technology. Now, landlords and property managers are getting a piece of the pie by incorporating the emerging trend into their operations to attract and retain a new generation of tenants.
"Our buyer has evolved, they've moved from mom and pops to young people who want to pay with various forms of payment," Magnum Real Estate Group President Ben Shaoul said to CNBC. "Cryptocurrency is something that has been asked of us — 'Can you take cryptocurrency? Can we pay that way?' — and of course when somebody wants to pay you with a different form of payment, you're going to try to work with them and give them what they want, especially in a very busy real estate market."
12 | Mazars USA Ledger haul is among several owners and developers that believe via the company’s app. When a tenant makes a payment using Bitcoin, offering cryptocurrency payment plans will give them an edge ManageGo converts the currency into dollars. This allows tenants to pay the over their competition. The real estate industry is constantly way they want, and landlords to receive payments the way they want. looking for new ways to connect with an increasingly millennial Scustomer-base, and Bitcoin is one way to help them bridge this gap. “Industry players are starting to realize that there is major potential for blockchain technology to challenge the status quo above and beyond As the first generation to grow up using digital technology for everything accepting cryptocurrency as a form of payment or executing transactions," from hailing a cab to ordering food, millennials have become accustomed Mazars USA Digital Asset Group Leader Andre Sterley said. "Other to paying for things on their devices. They have embraced emerging areas being targeted include title management, tokenized ownership technology to make their lives easier, and blockchain is the most recent and automation through the use of smart contacts around payment and example. agreements.”
“Millennials are particularly open to embracing new technology in order Still, many industry professionals are reluctant to adopt the trend. There is to create opportunities for themselves--and blockchain, the tech behind still a stigma around cryptocurrency because it is so new. crypto, is no different,” blockchain startup StormX CEO Simon Yu said to Forbes. “As masters of the side hustle and challengers of the traditional 9-5 "Currently we have had zero interest in paying rent through bitcoin," The working lives of previous generations, millennials are welcoming blockchain Bozzuto Group CEO Toby Bozzuto said to CNBC. "You don't know who with open arms.” owns it, and that's the knock on it. It's been considered black market with a dirty reputation.” Property managers who accept payments in cryptocurrency have two options. They can either keep the payment in the form of cryptocurrency Time will tell whether cryptocurrency will continue to transform the and use it to pay for something else, or they can convert it into dollars. If commercial real estate landscape, but all signs are pointing up. Slowly but they opt to convert the payment, it is important to know when to do so. surely, property managers are adopting these new payment methods into Bitcoin fluctuates significantly in valuation, reaching $20K at the end of 2017 their business model. As the next generation of tenants becomes more and beginning 2018 at a mere $14K. Today, it has dropped to almost half of acquainted with the use of cryptocurrency as a payment method, property what it was a year ago, but that number could change in a matter of days. managers are making changes to meet their demands. Landlords and property managers who decide to convert cryptocurrency need to be strategic about when they cash in to ensure they are getting the This feature was produced in collaboration between Bisnow Branded most bang for their buck. Content and Mazars. Bisnow news staff was not involved in the production of this content. PropTech companies are also getting in on the action. ManageGo, a Brooklyn-based company that provides a platform for renters to make online Andre is the Digital Asset Group Leader in our New York Practice. He can payments, now gives tenants the option to make payments using Bitcoin be reached at 212.375.6629 or at [email protected]
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November/December 2018 | 13 FINANCIAL SERVICES
LEASE ACCOUNTING FOR BROKER DEALERS BY CHARLES PAGANO, BONNIE MANN FALK AND JASON GUTMAN
Broker dealers get ready! The Financial Accounting Standards Board’s (FASB) long-anticipated update to lease accounting, Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASC 842), becomes effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. ASC 842 will have a significant impact on most broker dealers’ financial statements and disclosures. If you have not begun the analyses necessitated by ASC 842, there is no time like the present!
14 | Mazars USA Ledger he required transition disclosures included in the 2018 financial expense sharing or an administrative service agreement exists. statements need to reflect the effect on the company’s financial reporting with execution beginning in the January 2019 FOCUS When determining the payments to be included in measuring the ROU report. While the implementation will require broker dealers to assets and lease liabilities, one must consider all optional payments Tanalyze their leases and recognize potentially material assets and liabilities related to the lease. Payments to be made during an option period would on the financial statements and increase related disclosures, there is good be included only if the lessee is reasonably certain to exercise an option news in that generally the effect on net capital and aggregate indebtedness to extend or not to terminate a lease. Optional payments to purchase should be minimal. the assets at the end of the lease would be included only if the lessee is reasonably certain to exercise that purchase option. Options to extend or not WHAT ARE THE MAJOR IMPACTS? to terminate that are controlled by the lessor need to be considered as well.
Lessees need classify their leases as either finance or operating; each Keep in mind, the nature of lease payments impacts the broker dealer’s classification has its own unique accounting treatment. Finance leases balance sheet. Variable lease payments are not included in the measurement cover arrangements that transfer control of assets at the end of their term, of a lease liability and ROU, since this liability is not fixed. Common include purchase options, cover most of an asset’s useful life, or involve examples of variable lease payments include rental increases based on CPI highly specialized assets. These leases have been previously required to be or inflation rate. recorded on the financial statements. In both examples, the tenant’s initial base rent may be the only payment Conversely, operating leases do not transfer ownership at the end of the which, in substance, is fixed. These variable payments can increase or lease, do not include purchase options, have a lease term as part of the decrease over time and cannot be estimated. Broker dealers may seek economic life, and do not have assets specialized to the use of the lessee. to negotiate greater variable terms in their lease payment structure to take The Implementation Guidance of the standard (ASC 842-10-55-1) includes a advantage of this accounting treatment. decision tree to assist in the classification. In the broker dealer world, much of leasing transactions expect to be classified as operating leases. WHAT ABOUT NON-LEASE COMPONENTS?
Under the existing guidance, lessees recognize the expense of an operating Many lease arrangements cover services provided by the landlord, such as lease ratably over its life. This “straight line” approach results in a more janitorial, common area maintenance, or onsite IT support. These typically consistent bottom line. Moving forward, in addition to reporting a straight-line meet the definition of a “non-lease component,” since they do not grant the lease expense in their financial results, lessees will need to recognize an lessee control over an asset. Lessees must assign a value to non-lease asset and a corresponding liability on their balance sheet. One of the most components based on their relative standalone prices or apply a practical significant sources of lessees’ off-balance sheet financing and risk is now expedient electing to account for the lease and non-lease components as a front and center in their financial statements, no longer solely delegated to a single liability. Performing an allocation may be time consuming, but applying footnote disclosure. the practical expedient may result in a significantly greater balance sheet obligation and related asset. Initially, the balance sheet gets grossed up to reflect a liability equal to the present value of the lease payments with a corresponding asset, now TYPICAL EXAMPLE known as the “right of use” (ROU) asset, which results from a contract which conveys the right to control an “identified asset” for a period of time in Let’s take a typical situation in a broker dealer with an operating lease exchange for consideration. Most commonly, in the broker dealer industry, scenario. Assume the broker dealer rents office space for a three-year the new standard calls for recording assets and liabilities related to the period with total lease payments over 36 months of $ 36,000 with lease following leases for the use of: payments of $10,000, $12,000 and $14,000 for each year respectively. Assume a present value (“PV”) factor of 4.24% and no lease escalations. §§ Office rent §§ Trading, communication and information systems equipment The lease payments and present values of the payments are as follows: §§ Offsite document storage §§ Software solutions for case management, billing, and compliance
One would have to be mindful whether a lease or service contract exists when analyzing the transaction. ASC 842 could affect those situations where
November/December 2018 | 15 FINANCIAL SERVICES
As payments are made the lease liability is decreased as follows:
Each year the periodic lease expense is recognized using the average lease payment over the life of the lease. The difference between the lease payment and the lease expense is recorded to adjust the ROU asset. See the table and journal entries as follows:
16 | Mazars USA Ledger The financial statement impact over the lease term is as follows:
WHAT ABOUT DISCLOSURES? o Amounts segregated between those for finance and operating leases for the following: ASC 842 brings about new disclosures related to leases in order to provide • Cash paid for amounts included in the lease liabilities users of the financial statement appropriate information to assess the • Supplemental noncash information on lease liabilities arising amount, timing, and uncertainty of cash flows arising from leases. Amongst from obtaining right-of-use assets the highlights of the quantitative and qualitative information to be disclosed • Weighted-average remaining lease term (see the include, but are not limited to: implementation guidance) §§ The Company’s leases • Weighted-average discount rate (see the implementation o A general description of the leases guidance) o Basis, terms, and conditions on which carriable lease payments o Five year and beyond annual undiscounted cash flow maturity are determined analysis of its finance lease and operating lease liabilities o Existence, terms, and conditions of all options to extend or separately, including a reconciliation of the to the lease liabilities terminate a lease (whether or not they are recognized as part of recognized in the balance sheet. the ROU asset or lease liability) and any residual value guarantees provided by the leases SEC NO ACTION LETTER OF OCTOBER 23, 2018 o Any restriction or covenants imposed by leases o Leases between related parties The SEC recognized the possible disastrous results on net capital and o Relevant information on short term leases addressed the effect of ASC 842 two years ago. In a letter to SIFMA, from §§ Significant assumptions and judgements made, including but not the SEC on October 23, 2018, the SEC rescinded a previously issued letter limited to: dated November 8, 2016. Both letters granted relief to broker dealers o Determination if a contract contains a lease whereby an operating lease asset can be added back to net capital to the o Allocation of consideration in a contract between lease extent of the associated operating lease liability. components and nonlease components and the detail of any election of using a practical expedient Additionally, the Division per the “No Action” letter “will not recommend o Determination of the discount rate for the lease enforcement action, if a broker-dealer determining its minimum net capital §§ Amounts recognized in the financial statements relating to those requirement using the AI (aggregate indebtedness method) does not include leases in its aggregate indebtedness an operating lease liability to the extent of the o Operating lease cost associated operating lease asset.” The SEC went on to comment that each o Short-term lease cost, excluding expenses relating to leases with lease stands on its own; that is, one cannot offset an operating lease asset a lease term of one month or less on one lease with an operating lease liability of another lease. o Variable lease cost
November/December 2018 | 17 REAL ESTATE
Also remember that the amount of the asset may reflect additional costs such With yearend fast approaching now is the time to assess the effects of as direct initial costs, prepaid lease payments and lease incentives which will ASC 842. Companies need to be ready for 2018 transition disclosures and cause the asset to not equal the liability. January reporting for your FOCUS filings. You want to implement processes and establish internal controls to capture the necessary data in your books WHAT ARE THE STEPS TO IMPLEMENTATION? and records and for disclosure in the notes to the financial statements.
§§ Gather and catalog your current inventory of leases, store lease data in The standards include comprehensive guidance to assist companies a centralized repository. in applying the requirements of ASC 842. Once an entity completes its §§ Design and implement a new lease accounting process to manage your analyses, communication between the auditor and management ensures a organization’s lease data. smooth transition to a successful implementation. §§ Select a software solution that will support your organization’s adoption of the new lease accounting standards, and ongoing lease monitoring Charles is a Partner in our Long Island Practice. He can be reached at and maintenance. In the case of minimal leases Microsoft Excel may 516.620.8553 or at [email protected]. suffice. §§ Compute the amount of the asset and liability and be ready to book for Bonnie is a Director in our Long Island Practice. She can be reached at those with calendar years beginning on January 1, 2019. 516.620.8554 or at [email protected]. §§ Fully train staff on new software solution, design and implement internal controls. Jason is a Manager in our New York Practice. He can be reached at §§ Determine the effect on net capital, if any. 646.225.5992 or at [email protected].
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Are You Ready For Year-End Planning? Identifying Performance Obligations under Everything You Need To Know For Year-End ASC 606 2018 And Beyond Time: 12:00 – 1:00 PM EST Time: 12:00 – 1:00 PM EST Speakers: Mike Crown and Ayal Cohn Speakers: Chimudi Egbuna, Sheila Grice and Azmat Hussain
18 | Mazars USA Ledger IFRS
PUTS ON NON-CONTROLLING INTERESTS: WHAT CHANGES ARE PROPOSED IN THE FICE DISCUSSION PAPER?
November/December 2018 | 19 IFRS
FOLLOWING ON FROM OUR ‘A CLOSER LOOK’ FEATURE ON THE consensus but failing. Consequently, it decided in 2006 not to add the topic FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF EQUITY to its agenda. (FICE) DISCUSSION PAPER IN THE JULY-AUGUST ISSUE OF BEYOND THE GAAP, THIS MONTH’S FEATURE WILL LOOK SPECIFICALLY AT In 2008, phase II of the Business Combinations project brought us a step PUT OPTIONS GRANTED TO MINORITY SHAREHOLDERS (‘PUTS ON further towards the current accounting treatment for puts on non-controlling NON-CONTROLLING INTERESTS’). interests, by reducing the number of permitted approaches. After this, IAS 27 was amended to stipulate that the impact of changes in percentage holdings 1. How did the current accounting treatment come about? in subsidiaries should be recognized in equity.
When IFRS standards were first implemented in 2005, they did not yet Logically, following these amendments, the AMF’s year-end include provisions on changes in percentage holdings in a subsidiary, and recommendations for 2009 clarified that the use of the ‘partial goodwill’ the requirement to immediately recognize a liability for their obligation to method at initial recognition could still be retained for existing puts, but would buy back equity instruments in the future came as a surprise to French no longer be permissible for new put issues. The AMF also stated that its companies. preferred approach for subsequent changes in the value of the liability was recognition in equity, rather than in profit or loss; however, both approaches IAS 32 required (and still requires) that put options granted to minority were still permissible. shareholders should be recognized as liabilities at the present value of the strike price of the put option but did not give any further guidance on the In March 2011, the IFRIC tried to resolve the practical issues submitted to contra journal entry. This has resulted in diversity in practice, both at the date it by proposing to exclude put options written on non-controlling interests of of initial recognition and subsequently. subsidiaries, to be settled by the physical delivery of shares, from the scope of IAS 32. This would have meant that these puts would be accounted for At initial recognition, entities have generally chosen one of two approaches, under IAS 39 (now IFRS 9) in line with all other derivative instruments, i.e. at both of which anticipate the eventual buyback of the shares by the entity: fair value through profit or loss. • an approach that involves recognizing an additional goodwill for the difference between the liability and the value of the shares likely to be A few months later, in September 2011, this proposal was rejected by the repurchased; or IASB. • an approach that involves recognizing the difference in group equity, on the assumption that this is permissible in the absence of any The IFRIC continued its discussions on the subject and in March 2012 it clarifications to the contrary. published a draft interpretation that would require subsequent changes in the value of the liability to be recognized in profit or loss. Similarly, a variety of different accounting methods have been used for subsequent changes in the value of the liability: In January 2013, after receiving comments on the draft interpretation, • recognition in profit or loss, based on the general assumption that the IFRIC stated that the draft was a correct interpretation of the existing changes in the value of a financial liability have an impact on profit or standard (and specifically of paragraph 23 of IAS 32) but that it remained loss; convinced that its proposal from March 2011 – that these put options • recognition in equity, based on the argument that an obligation relating should be accounted for like any other derivative – would provide better to own shares should not have an impact on profit or loss (particularly quality financial information. With this in mind, the IFRIC asked the IASB to if the strike price depends on the fair value of the underlying shares, reconsider its position on paragraph 23 of IAS 32. which is quite often the case); or • recognition in goodwill using the ‘partial goodwill’ method, which is In March 2013, the Board responded by cancelling the IFRIC’s draft consistent with the approach mentioned above that anticipates the interpretation, putting a halt to its efforts to clarify the issue. buyback of the shares (all other things being equal). Since then, the IFRS IC has still not reached a conclusion, despite receiving The French Securities Regulator, the AMF, noted this diversity in practice, further requests for clarification, particularly as regards the accounting stating in its 2005 year-end recommendations that entities should give details treatment of written put options to be settled by a variable number of the of the accounting treatment used at initial recognition of the liability and for parent company’s shares (in 2016). The IFRS IC noted at the time that the subsequent changes in its value. issue was too broad for it to address, and that the Board’s ongoing work on the FICE project could provide some answers. The IFRIC (now the IFRS IC) also tackled the issue, trying to reach a
20 | Mazars USA Ledger Against this background, this summer’s FICE Discussion Paper (DP) However, the Board has also introduced a new presentation requirement. proposes a new approach for determining what shall be classified as a Liabilities that do not meet the criterion for the amount feature (i.e. the liability, applicable to both derivatives and non-derivative instruments. Here, amount transferred is dependent on the entity’s economic resources) are to we analyzes the potential repercussions of the DP. be presented separately in the balance sheet. Subsequent changes in the value of these instruments would then be recognized in other comprehensive 2. What does the FICE DP say about puts on non-controlling interests? income (OCI) without recycling to profit or loss.
Let’s begin with a reminder of the Board’s preferred approach: an instrument The Board suggests that the separate presentation principle should be would be classified as a liability if a) the entity has an obligation to transfer applied consistently to derivatives that do not have an underlying variable economic resources before liquidation (timing feature) or b) the entity has that is independent of the entity’s economic resources (with the exception of an obligation to transfer an amount independent of the entity’s economic interest rates, which by definition affect all derivatives, and foreign currency resources (amount feature). exposures under certain circumstances).
In addition, the Board is proposing a specific accounting treatment for Thus, if an entity issues put options on its non-controlling interests with a derivatives that are physically settled in the entity’s own shares (meaning strike price equal to the fair value of the shares, the separate presentation they are extinguished in accounting terms). Under the proposed accounting requirement would de facto apply. treatment, written put options would be classified together with the underlying own shares as a single transaction. The accounting treatment would thus be as follows: • at the date when the puts are issued, the entity recognizes a liability Thus, in the case of puts on non-controlling interests (NCI puts), the Board for the fair value of the shares (the strike price of the puts) with a notes that the entity faces two potential outcomes: contra journal entry for an equivalent reduction in equity. The liability is • either the minority shareholders exercise their put options and the presented separately in the balance sheet; entity is obliged to repurchase its own shares at the price agreed in the • subsequent changes in the share price will require the entity to contract, resulting in the extinguishment of its own shares; remeasure the liability, with a contra journal entry as a separate line • or the minority shareholders do not exercise their put options and the item in OCI (not recyclable). shares are not extinguished. To cover all the bases, we also need to look at the accounting treatment In this case, as the exercise of the puts is at the option of the minority for fixed-price puts on non-controlling interests. Once again, we start by shareholders, it is possible that the entity will have an obligation to transfer analyzing the rights and obligations of the instruments in conjunction with economic resources before liquidation. Under the Board’s preferred the underlying shares. Effectively, these are treated as fixed-price puttable approach, this would mean that the instrument meets the criterion for the shares; the holders (i.e. the minority shareholders) have the option timing feature, and thus should be recognized as a liability. The contra journal entry for the liability would be the extinguishment of the shares held of putting them back to the entity. As the entity cannot avoid the obligation to by the non-controlling interests, at the date when the entity issues the put transfer a fixed amount of economic resources, the IASB’s position in the DP options. is that the entity should recognize a liability for the present value of the strike price. The Board also believes that underlying own equity should be reduced The Board proposes that the existence of NCI puts should be viewed in by an amount equal to the fair value of the shares at the issue date of the the same way as a bond convertible to own shares, as both have the same put. In the previous case, the amount of the liability was equal to the amount outcomes: either an obligation to transfer economic resources, or own of equity extinguished. But in this case, there is a discrepancy. shares still outstanding. The Board believes that this justifies using the same accounting treatment. It should however be noted that this approach ignores The Board acknowledges that it is also possible that the minority one difference: the shares already exist in the case of shares + NCI puts, but shareholders will not exercise the put option. Economically speaking, there is are yet to be issued in the case of convertible bonds. no incentive for a minority shareholder to put its shares back to the entity at a price that is lower than their actual value. Therefore the shares could remain Having looked at the accounting treatment at initial recognition, how should outstanding. Attempting to represent this in financial terms would effectively an entity account for subsequent changes in the value of the liability it has give us a written call option. The Board considers that the residual amount is recognized? It is interesting, in the light of the past discussions reviewed a component of the call option, which is a component of equity. above, that the Board is proposing that they should by default be booked to profit or loss. We can represent this as follows:
November/December 2018 | 21 IFRS
Written put option (original instrument) = forward contract (represented 3. Key Points to Remember by a liability for the amount of the strike price) + written call option (representing the possibility that the put may not be exercised) • A lot of ink has been spilt on the topic of puts on non-controlling interests since IFRS came into effect in 2005, and in the absence of It is also interesting to note that recognizing a liability and a written call option clear guidance on the subject, a diverse range of accounting methods in this way corresponds exactly to the accounting treatment of a convertible have been used. bond; thus, the Board’s analogies are consistent. • The IASB has proposed a new accounting treatment as part of its FICE project, differentiating between NCI puts with a strike price equal to the In summary, a fixed-price, physically-settled put on non-controlling interests fair value of the underlying shares, and fixed-price NCI puts. would be accounted for, under the Board’s proposed approach, as follows: • For NCI puts with a strike price equal to the fair value of the underlying 1. the extinguishment of the shares held by the non-controlling interests shares, an entity would recognize a liability (presented separately) for at an amount equal to the fair value of the shares at the issue date of the fair value of the shares, with a contra journal entry for a reduction the put in equity, at the date when the put is issued. Subsequent changes in 2. recognition of a liability for an amount equal to the present value of the the value of the liability would be recognized in OCI without recycling to strike price of the put profit or loss. 3. a call option written on own shares, with an initial value of the difference • For fixed-price, physically-settled NCI puts, an entity would recognize between i) and ii). a liability for an amount equal to the present value of the strike price of the put, with a contra journal entry for the extinguishment of the shares In conclusion, this Discussion Paper represents a shift in the Board’s position held by the non-controlling interests at an amount equal to the fair on the complex issue of NCI puts with a strike price equal to the fair value of value of the shares at the issue date of the put, and a call option written the underlying shares. In this case, the Board is moving towards the position on own shares for an amount equal to the difference between the first put forward by the AMF in 2009. In contrast, the Board’s proposal for fixed- two components. price NCI puts is more innovative. We have no doubt that many comments on this topic will be submitted to the Board before the closing date of its For more information contact the Mazars USA Accounting Help Desk at consultation on 7 January 2019! [email protected].
FEATURED WHITEPAPER
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22 | Mazars USA Ledger HEALTHCARE
HEALTHCARE POLICY AND PROCEDURE BEST PRACTICES BY MELISSA BORRELLI
The touchstone for measuring compliance program effectiveness • Provide legally defensible documentation that complies with regulatory, is the Office of Inspector General’s Seven Elements of an Effective accreditation, and contractual requirements, which may help avoid Compliance Program (Seven Elements) derived from the Organiza- litigation, fines, and loss of business, i.e., function as a critical risk tional Sentencing Guidelines promulgated by the U.S. Sentencing mitigation tool Commission.1 • Serve as a foundation for business process improvement
Entire treatises could be written on each of the elements, but they basically In the health care sector, it is not an exaggeration to state that effective boil down to: designation of a compliance officer and committee; written P&Ps can also literally save lives. policies, procedures, and a standard, or code, of conduct; open lines of communication; training and education; monitoring and auditing; enforcing HOW TO START (AND FINISH!)? standards through well-publicized disciplinary guidelines; and promptly responding to detected offenses and taking corrective action. Most medium to large-sized organizations have at least some basic written policies and procedures, most likely human resource-related, although their Arguably, the most underappreciated, overlooked, and important of these quality, completeness, and currency may be lacking. However, even small elements is that of written policies and procedures (P&Ps). P&Ps are the business can benefit from having effective P&Ps. workhorse of a compliance program, i.e., if done right, they will dependably serve an organization for years. Whether starting from scratch or working to improve existing P&Ps, the entire process and even getting started can be overwhelming WHY ARE EFFECTIVE P&PS IMPORTANT? IRAC FOR P&PS Why are effective P&Ps so valuable from a compliance standpoint? If utilized properly, they: Instead of tackling P&P creation and improvement wholesale, or, worse, • Establish organizational goals, set tone and culture, describe expected ignoring it completely, take a step-by-step approach along the lines of the behaviors, and contribute to other employee accountability tools IRAC (Issue, Rule, Analysis, Conclusion) method for briefing a legal issue. • Train and educate employees not only at onboarding but on an ongoing basis Issue. • Facilitate succession planning and contribute to sound business conti- nuity, e.g., the old adage of “what if key employee Sally is hit by a bus, First, identify key organizational risks, i.e., what is the issue or concern that who will do her job?” applies here needs to be addressed? This process may be as formal as undertaking
November/December 2018 | 23 HEALTHCARE
enterprise risk management or as simple as a sense of an organization’s Also, avoid falling into the trap of using legalese and overly technical highest risk areas based on the legal and other authority or contracts to language wherever possible. It is great to have written P&Ps, but not so which the organization are subject. great if the intended audience (staff, but don’t forget about regulators and accreditors) cannot understand them. Considering what other similarly situated organizations have identified as common risks may also be useful. For most organizations, human resourc- Conclusion. es (think classification issues and wage-and-hour litigation) and information security (what organization does not have at least some confidential data, Unfortunately, even with a polished final product, the work is not finished. let alone personally identifiable information?) will be among the highest-risk Rather, that shiny new P&P must be publicized to those to whom it applies areas. In health care in particular, add to that safeguarding protected health and thorough training and education must be undertaken. Ideally, who information and the obligations that come with receiving government money, received the training and when is documented. and you have the start of a good list of organizational risk areas. Additionally, best practice dictates that all P&Ps be reviewed at least Rule. annually and updated as needed; for example, when a law is changed, an accreditation standard tweaked, or new hardware, software, or a business Second, determine what authority the organization is subject to; that is, process is implemented. what are the rules with which your organization must comply? Think broad- ly—this is one area you do not want to give short shrift. Look to statutes, What Should P&Ps Include? regulations, opinions and other regulatory guidance, court cases, accred- itation standards, and key contracts, not the least of which is government There are literally dozens of P&P templates available online. The most contracts. effective will have the following sections at minimum:
Analysis. Why Are Effective P&Ps Important?
Next, rally the troops. Bring in the business owners, key stakeholders, Why are effective P&Ps so valuable from a compliance standpoint? If and subject matter experts that will have to abide by the P&Ps to draft and utilized properly, they: analyze the requirements and describe how policies are actually imple- • Scope: What is the scope of the P&P? Who or what does it apply mented at your organization. Again, think broadly. With today’s software to? For some organizations, it will be a line of business for another, a and process integrations, it may be difficult to know whether the work of one particular customer, and others, a department. area will impact that of another. • Roles and Responsibilities: Who is responsible for what with regard to that P&P? Roles and Responsibilities are best defined by Check for interactions with other departments, software, business process- department and/or job title, and not by a specific employee’s name, for es, and existing P&Ps. Perhaps most importantly, never reinvent the wheel. business continuity purposes. Look for samples from colleagues, professional associations, and other • Responsibilities should also be specific and if at all possible, mea- similarly situated organizations. sureable. For example, a fraud, waste, and abuse P&P may require a claims department manager to review 10% of each claims examiners One caveat: while organizational policies may be similar, their procedures weekly output. Here, the claims manager’s role is defined and the most likely are not. For example, the policy of most health care entities is responsibility is clear and measurable. This section is particularly (should be!) to prevent and detect fraud, waste, and abuse. The procedures important to consider when determining whether and how a P&P can each organization employs in pursuit of that policy, however, will vary be monitored or audited, another of the Seven Elements. Moreover, if significantly. staff have questions or concerns, this section provides them with guid- ance on who to consult and aids in enforcing employee accountability. Leave time for ample and broad review by all stakeholders, including legal, • Definitions and Acronyms: Best practice is to include these near compliance, management, and the line staff that implement the procedures the beginning of the P&P so that the user does not need to page back on a day-to-day basis. Management may be chagrined to find that line and forth to understand the multiple acronyms and sometimes highly staff are not following the procedures they thought they were for numerous technical definitions employed in health care. reasons, including that they are not up-to-date, onerous, inefficient, or are • Exceptions: Describe any exceptions to the P&P (in some cases, intentionally being skirted for possibly questionable or bad-faith reasons. there may be no wiggle room) and how an exception should be requested and whether it should be granted. For example, describe
24 | Mazars USA Ledger under what circumstances an exception to an employee’s use of paid Another advantage of separate policy and procedure documents is simpli- time off may be allowed and who should review and decide upon that fication of annual and other reviews. While most policies will not change exception. from year-to-year, for example, an organization’s commitment to preventing • Enforcement: Although it may seem heavy-handed, part of the and detecting fraud is not likely to alter, the implementing procedures for purpose of P&Ps, particularly in helping to ensure an organization has that policy may be subject to multiple revisions over time. Keeping separate an effective compliance program, is to publicize the consequences for documents may help maximize flexibility in drafting and review. non-compliance with requirements. Those subject to the P&P should understand what may or will happen if they do not follow the rules. Effective written P&Ps can help meet multiple of the Seven Elements, if • References/Authority: While sometimes separated into two sections, drafted and maintained in a thoughtful manner. at least one section should be dedicated to the legal and other author- ity that require the P&P and to any other related documents, whether While creating and maintaining P&Ps can be daunting, keep in mind their internal or external. This is especially helpful in determining what unequivocal role in supporting an effective compliance program. P&Ps are impacted and should be updated when changes to the law and other authority occur. As a leading change facilitator in this era of sweeping health care reform, • Revision History and Reviewer: While the information regarding the Mazars Health Care Group offers health care payors and providers a who is responsible for reviewing and approving the P&P and its review powerful combination of service and results-oriented strategy to help them cycle can be kept elsewhere, it is simpler to include this information meet their business goals, overcome challenges, and improve performance. within the P&P itself. Revision history is particularly helpful when deal- ing with a regulatory action or litigation—tracking down the language For more information about their timely, valuable information and insights of prior P&Ps can be time consuming and sometimes impossible, into policies, best practices and industry developments, visit mazarsusa. depending on the sophistication of an organization’s record-retention com/hc. practices. Melissa is a Senior Manager in our Sacramento Practice. She can be Maintaining a master list of P&Ps is another best practice that organizations reached at 916.696.3683 or at [email protected]. should consider. This can be as simple as an Excel sheet or as complex as governance, risk, and compliance software. 1 https://www.ussc.gov/guidelines/2016-guidelines-manual/2016-chapter-8#NaN
Regardless, tracking information should include a number of data points, such as the P&P’s name and purpose; owner (department, division, man- ager, etc.); authority; version history; and a description of the review cycle. It is also helpful to include an indicator as to whether a particular P&P must be reviewed and approved by a regulator, accreditor, and/or contractor if it is substantively amended.
There is disagreement about whether P&Ps should be separated into two or more documents, i.e., one document setting forth the policy and a second describing the associated procedure. Each approach has pros and cons that may depend on a particular organization and its culture.
For example, if P&Ps are only available to staff in paper form, it may make more sense to have a single document for both the policy and the procedure so they are less likely to get separated, whereas if they are available elec- tronically, multiple documents are easier to manage.
In some instances, two documents may be the way to go where the organi- zation wants to make the policy available to the general staff—e.g., the HR policy on employee classifications—but limit public access to the related procedure.
November/December 2018 | 25 IFRS FICE DISCUSSION PAPER: THE BOARD’S PREFERRED APPROACH TO CLASSIFYING FINACIAL INSTRUMENTS AS LIABILITIES OR EQUITY
On 28 June, the IASB published a Discussion Paper (DP) presenting the current state of its deliberations on the Financial Instruments with Characteristics of Equity project (FICE). This project, which is not being carried out in conjunction with the FASB, focuses on the classification of financial instruments as liabilities or equity in the issuer’s financial statements. The comments received will help the Board to decide whether to publish an exposure draft to amend or replace IAS 32, and/or non-mandatory implementation guidance.
Here, Beyond the GAAP summarizes the key concepts presented in the DP, with a particular focus on the questions on which the Board is seeking feedback in order to decide between the various possible approaches.
26 | Mazars USA Ledger 1. Objectives of the DP These principles are summarized in the table below2.
Like IAS 32, the scope of the DP is limited to the principles for classifying financial instruments as liabilities or equity from the point of view of the issuer of the instruments [IN2]. Thus, the presentation and measurement principles set out in IFRS 9 – Financial Instruments will not be affected by this DP.
The IASB has identified a number of areas where the current IAS 32 requires improvement. In particular, it wishes to clarify the underlying concepts used to distinguish between liabilities and equity. The Board notes that this lack of clarity has resulted in divergences in the accounting treatment of certain products, such as puts on non-controlling interests or These general principles are then applied to four types of instruments: certain types of contingent convertible bonds. Furthermore, the situation non-derivative instruments, derivative instruments, hybrid instruments3 and makes it difficult to identify the correct accounting treatment for new and compound instruments . increasingly complex financial instruments that are appearing on the market, which combine features of both liabilities and equity. Our discussion of the application of the principles will be presented as follows: The IASB has also taken account of feedback from users of financial statements, who have asked for further information to be provided on the features of this type of financial instruments.
The Board wished to address these specific issues without making changes to the classification outcomes for the majority of instruments, which are less complex.
The main objectives of the FICE project are as follows: §§ to define clear conceptual principles that are consistent with the The concept of “an amount independent of the entity’s economic current IAS 32; resources” §§ to improve the consistency of the classification of contractual rights/ For the purposes of the “amount feature”, the entity’s economic resources obligations linked to an entity’s own equity instruments; are defined as the total recognized and unrecognized assets of the entity, §§ to improve the information provided (through presentation in the minus the recognized and unrecognized claims against the entity (with the financial statements and disclosures in the notes) about features of exception of the instrument in question). Thus, the concept of “economic financial instruments that are not captured by their classification as resources” covers more than just the elements recognized in the balance liabilities or equity. sheet.
2. Summary of the classification approach proposed in the DP An amount is deemed to be “independent of the entity’s available economic resources” if: The Board’s current preferred approach for classifying a financial instrument §§ it does not change as a result of changes in the entity’s available as a liability or equity is based on the two following features: economic resources (for example: it is a fixed amount, or it is indexed §§ Timing feature: there is an unavoidable obligation to transfer economic to an interest rate, or it is linked to only part of the entity’s economic resources (cash or another financial asset) at a specified time other resources, e.g. indexed to the value of a specified asset or to EBIT); or than at liquidation; §§ it changes as a result of changes in the entity’s available economic §§ Amount feature: there is an unavoidable obligation to transfer an resources but does so in such a way that the amount could exceed the amount independent of the entity’s available economic resources1. available economic resources of the entity (e.g. due to leverage).
Instruments may only be classified as equity instruments if they possess The fair value of the entity’s ordinary shares is an example of a variable that neither of these features. Otherwise, they are classified as financial is dependent on the entity’s economic resources. liabilities.
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Principles retained from IAS 32 meets the criterion for the timing feature. It also meets the criterion for the The Board’s preferred approach maintains its position on economic amount feature, as the amount to be paid is fixed and is thus by definition compulsion, i.e. it is not taken into account. In other words, only contractual independent of the entity’s economic resources. obligations are taken into account in this approach to liabilities/equity classification. However, the Board may retain the provisions set out in Example 2 from webcast number 2: paragraph 20 of IAS 32, which allow some flexibility on this point. An entity issues an instrument for 100 today. The instrument contains an obligation to issue 110 own shares in one year’s time, with no interim The Board has also reasserted that only contractual requirements should coupon payments. be taken into account in its preferred approach. Thus, if an obligation to remit cash arises from a legal requirement (rather than a contractual requirement), this would not be taken into account when classifying the financial instrument.
IFRIC 2 is an exception to this. The provisions of this interpretation relating to members’ shares in co-operative entities and similar instruments are expected to remain unchanged. Timing feature: this criterion is not met: 3. Applying the classification approach to non-derivative financial • the entity has no obligation to transfer cash (or another financial asset instruments held by the entity) • the obligation to transfer own shares does not meet this criterion, as How the approach applies to non-derivative instruments these own shares do not form part of the entity’s assets. At this stage, the IASB proposes that a non-derivative instrument should be classified as a financial liability if it contains [3.8]: Amount feature: this criterion is not met. The amount to be transferred is §§ an unavoidable contractual obligation to transfer cash (or another completely dependent on the entity’s available economic resources and financial asset) at a specified time other than at liquidationtiming ( cannot exceed them. feature); and/or §§ an unavoidable contractual obligation for an amount independent of The following example demonstrates that the IASB’s preferred approach the entity’s available economic resources (amount feature). continues to place more emphasis on contractual rights and obligations than on the form or denomination of the instrument. Examples of how this applies to some typical instruments in this category Example 3 from webcast number 2: To illustrate this approach, we reproduce below some of the examples An entity issues shares for 100 today. The shares contain an obligation to discussed by the IASB in its webcasts. We will begin with two very simple buy them back in one year’s time for their fair value in cash on this date. examples.
Example 1 from webcast number 2: An entity issues an instrument for 100, containing an obligation to pay an annual coupon of 10 for five years and an obligation to repay the principal amount of 100 at the end of year 5.
Timing feature: this criterion is met. There is indeed an obligation to transfer cash in one year’s time.
Amount feature: this criterion is not met. The amount is completely depen- dent on the entity’s available economic resources as it is based on the fair value of the entity’s own shares. In this simple example, the obligation to make coupon payments and repay the principal amount of 100 at maturity means the instrument Example 4 from webcast number 2:
28 | Mazars USA Ledger An entity issues an instrument for 100, containing an obligation to be recyclable, i.e. it would not be subsequently reclassified to profit or pay interest at 10% a year and to repay the principal amount of 100 at loss.[DP para. 6.53]. liquidation. The entity may, at its discretion, defer payment of interest indefinitely until liquidation; however, the deferred amounts will themselves Decision tree number 1: Non-derivative financial instruments accrue interest.
Although the instrument contains no obligation to transfer cash prior to liquidation, the amount due at this date is predetermined and is independent of the entity’s available economic resources at this date. The approach presented by the Board in this DP would thus require the entity to classify this instrument as a financial liability. This is one of the instances in which the proposed approach differs from the current IAS 32, which would require the entity to classify the instrument as equity based on the fact that there is no obligation to pay cash.
Exception retained for puttable instruments IAS 32 includes an exception that permits certain puttable instruments with particular characteristics to be classified as equity even though they meet the definition of a financial liability (cf. IAS 32 para. 16A to 16D). The Board’s preferred approach, as outlined in the DP, is to retain the puttable exception, for reasons similar to those behind the publication of the amendment to IAS 32 in 2008.
The Board acknowledges that classifying these (very specific) puttable instruments as equity does not provide the information required by users of financial statements, particularly as regards liquidity. However, the Board believes that this drawback would be mitigated by retaining the disclosure requirements set out in IAS 1 para. 136A.
Financial liabilities: separate presentation of obligations to transfer amounts that are dependent on the entity’s economic resources In addition to this general approach to the classification of liabilities and equity, the Board proposes introducing new presentation requirements to make it easier for users to analyze solvency or profitability based on the information provided in the balance sheet and the statement of comprehensive income. 4. Applying the classification approach to derivatives on own equity Thus, instruments that are classified as financial liabilities because they (DP Section 4) possess the “timing” feature, but not the amount feature as they contain an Derivatives within the scope of this section obligation to transfer an amount that is dependent on the entity’s available First, a reminder that a derivative always involves a contractual right and/ economic resources, would be: or contractual obligation to exchange financial assets, financial liabilities §§ presented separately in the balance sheet; and and/or equity instruments with another party. Thus, a derivative could §§ their related income and expense would be recognized in other be described as an exchange contract that has two “legs”, with each leg comprehensive income (OCI). This income and expense would not representing one side of the exchange.
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In the context of this DP, derivatives on own equity are: §§ derivatives that will be settled in whole or in part in own equity; or §§ derivatives where the underlying of one of the “legs” is the entity’s own equity.
The DP identifies three broad types of derivatives on own equity: §§ Asset/equity exchanges: these are contracts to receive cash (or another financial asset) in exchange for delivering own equity instruments. §§ Liability/equity exchanges in which the equity component is not extinguished: these are contracts to extinguish a financial liability in exchange for delivering own equity instruments. §§ Liability/equity exchanges in which the equity component is extinguished. The DP also refers to these contracts as “redemption obligation arrangements”.
The approach described in part 4 of this article below applies to all derivatives that are recognized separately (irrespective of whether they are standalone financial instruments or embedded derivatives recognized separately) with the exception of derivatives that may require the extinguishment of equity instruments.
The accounting treatment of derivatives in which the equity component is extinguished (redemption obligation arrangements) is addressed in the section on compound instruments.
Main principals of the classification approach for derivatives on their own equity Once again, the Board is here seeking to clarify the principles for classifying derivatives on own equity, without making fundamental changes to the classification outcomes under IAS 32.
The first key principle, which is carried over from IAS 32, is that a derivative on own equity should be classified in its entirety as an equity instrument, a financial asset or a financial liability (i.e. the two “legs” of the exchange are Extracts from webcast no. 3 on the classification of derivatives on own classified together) [4.38]. equity.
30 | Mazars USA Ledger Note that, if there is a choice as to how the derivative is settled, the aim to put the holder of the instrument in the same position as a holder obligation shall be considered from the point of view of the entity. Thus, of ordinary shares. Thus, this type of provision would not preclude in the example above, if the other party has the choice as to how the classification of the instrument as equity. derivative is settled, the instrument shall be classified as a financial liability. Whether the provision is asymmetric (i.e. protecting solely against In contrast, if the entity has the choice as to how the derivative is settled, dilution) or symmetric (i.e. adjusting for both increases and decreases the instrument shall be classified as equity. This differs from IAS 32, in the total number of shares) does not in and of itself determine which prohibited an instrument from being classified as equity if one of the whether an anti-dilution provision is independent [DP paras. 4.55- 58]. possible settlement options would result in it being classified as a financial §§ Dividends/distributions to holders of ordinary shares: asset or liability. By definition, dividends are dependent on the entity’s economic resources. The accounting treatments for contractual terms of this More details on the concept of an “independent variable” type and for anti-dilution provisions will be the same [DP paras. 4.59- As we have seen above, a derivative on own equity may only be classified 61]. as equity if the net amount of the derivative is not affected by a variable §§ Contingencies: that is independent of the entity’s available economic resources (amount The exercise of an option derivative may be at the option of the entity, feature). the holder, or contingent on an external event beyond the control of either the holder or the issuing entity. In the latter two cases, the entity The Board holds that the following variables should always be considered to does not have control over the settlement of the derivative. If the entity be independent: does not have the right to avoid a settlement outcome that would §§ amounts indexed to a variable that is independent of the entity’s result in classification of the instrument as a financial asset or liability, performance (such as the price of a commodity); the instrument in its entirety shall be classified as a financial asset or §§ fixed amounts in a currency other than the functional currency of the liability. Similarly, if a contingency introduces an independent variable entity issuing the shares [DP paras. 4.49-50]; that has an effect on the net amount of the derivative, the derivative §§ amounts that depend on all or part of the entity’s resources, such shall be classified as a financial asset or liability. Conversely, as EBIT [DP para. 4.52]. Here, not all of the entity’s obligations are contingencies that do not affect either the timing feature or the amount taken into account, and thus the net amount of the derivative could be feature do not affect the classification of the derivative [DP paras. significant even if the entity makes a net loss. 4.63-66]. §§ Derivatives on non-controlling interests: However, the Board has relaxed the definition of an independent variable to The Board’s proposed approach for derivatives on own equity is take account of certain inherent characteristics of derivatives on own equity: applied in the same way to puts on non-controlling interests (see §§ The time value of money: also below for the specific case of written put options on own equity One might initially assume that interest rates would be considered to instruments). be variables that are independent of the entity’s available economic resources. However, the definition of a derivative in IFRS 9 stipulates Partly independent derivatives: a specific case that it is settled at a future date. Thus, the effect of discounting (and Partly independent derivatives are those whose net amounts are affected thus sensitivity to interest rates) must be taken into account when by both variables that are independent of the entity’s economic resources, measuring the net value of the derivative. and variables that are dependent on the entity’s economic resources. As a result, if this criterion were to be applied strictly, all derivatives The Board’s preferred approach is to classify them as financial assets or would be affected by at least one independent variable and thus no financial liabilities. Classifying these derivatives as equity would not be derivative could ever be classified as equity. The Board has thus permitted [DP paras. 4.32 et seq.]. proposed that interest rates should not be considered in the analysis. However, this only applies to simple instruments. Any structured Some derivatives on own equity require separate presentation and element, such as leveraging or a risk that is not linked to the derivative impact on OCI (e.g. a benchmark interest rate in a currency that differs from that of As a complement to the classification approach, the Board is proposing the underlying), shall be treated as an independent variable [DP para. that some derivatives that contain no obligation for an amount that is 4.53]. independent of the entity’s economic resources shall be presented §§ Anti-dilution provisions: separately in the balance sheet, and related income and expenses shall be The existence or the lack of anti-dilution provisions does not affect the recognized in OCI without subsequent recycling to profit or loss [DP para. classification of the instrument, provided that the provision does not 6.53]. This is consistent with the presentation required for non-derivative introduce an independent variable. Essentially, anti-dilution provisions instruments.
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These requirements apply to the following two types of derivatives: For an instrument to be in this category, all its characteristics must have been assessed and no equity component must have been identified. §§ derivatives classified as financial assets or financial liabilities with a net amount (i.e. both legs) that is totally dependent on the entity’s The approach set out in the DP does not make any changes to the economic resources; and accounting treatment of these hybrid instruments: §§ partly independent derivatives, where the only independent variable §§ if the host contract is a financial asset, the hybrid instrument as a is a foreign currency (and where the foreign currency exposure is not whole is classified as at fair value through profit or loss; leveraged and does not contain an option feature, and the currency §§ if the host contract is a financial liability, the embedded derivative denomination is required by an external factor such as a law or is recognized separately, unless the entity opts to measure the regulation [DP para. 6.34]). instrument as a whole at fair value through profit or loss (FV-PL).
Decision tree number 2: Derivatives If an embedded derivative on own equity is recognized separately, the accounting treatment shall be the same as for a standalone derivative on own equity. However, the Board is considering the options for presentation in the balance sheet of hybrid instruments that contain an embedded derivative on own equity, where the instrument as a whole is measured at fair value through profit or loss. In practice, this will relate to situations in which the entity has elected to apply the fair value option, which permits the instrument as a whole to be measured at fair value through profit or loss rather than recognizing the embedded derivative separately.
The Board has proposed, and is seeking feedback on, two presentation options (question 7): §§ Option A: embedded derivatives that are not separated from the host contract would be exempt from the separate presentation requirements. However, hybrid instruments which, as a whole, contain no obligation for an amount that is independent of the entity’s economic resources would be presented separately (e.g. shares redeemable at fair value).
For more information contact the Mazars USA Accounting Help Desk at [email protected].
5. Hybrid instruments containing an embedded derivative on own equity
Readers will remember that, in IFRS 9, a hybrid instrument is defined as an instrument comprising a non-derivative host and an embedded derivative.
32 | Mazars USA Ledger HEALTHCARE
WHY PROVIDER ORGANIZATIONS SHOULD BE PROPONENTS OF CAPITATION BY RUSSELL FOSTER, SHEILA STEPHENS, STEPHEN WILSON AND SHAWN DUNPHY
FOR THE PAST 35+ YEARS, WE HAVE BEEN ACTIVELY INVOLVED organization and its structure to find the answers. However, there are com- IN THE DEVELOPMENT, IMPLEMENTATION, AND OPERATION OF mon themes at the root of most successes or failures relative to capitated HEALTH CARE ORGANIZATIONS THAT HAVE RECEIVED COMPENSA- agreements. TION FOR SERVICES RENDERED ON A PREPAID, CAPITATED BASIS. First Things First –The Definition of Capitation As more health care organizations embrace the Triple Aim and payors coalesce around provider organizations capable of accepting greater levels “Capitation” is the payment of a fixed per member per month (“pmpm”) of professional and institutional risk, the question remains: “Should health amount: care provider organizations be proponents of capitation?” 1. as payment in full 2. for a given month of service Why is it that some organizations thrive when it comes to providing health 3. for a defined population of eligible members, care services on a capitated basis while others struggle to deliver on quality 4. for the provision of a defined range of services. and cost? Capitation is often referred to as a “budget-based” or “value-based” pay- The reason(s) are complicated and often require a deep dive into the ment methodology or model. Regardless of what you call it, the inference
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is the same, i.e., it is a fixed amount of money that must be managed well Budget-Based: Shared Risk and Incentives to ensure the timely provision of high quality and cost-effective health care services and provide for a reasonable margin. In the Budget-Based Shared Risk and Incentives model, a payor and provider have agreed to share both gains and losses up to a pre-determined There are many places around the country where capitated arrangements level (e.g., not to exceed some pmpm amount, percentage of revenue, or exist and there are many different variations of the capitation model in percentage of gain or loss). play, depending on the level of sophistication of the provider organizations assuming risk. Similar to the Budget Based Incentive Only model explained above, in the Shared Risk and Incentives model the payor usually processes and pays There are also places around the country that are still being paid solely claims and PCP capitation payments, performs most UM, CM, and QM on a volume-based, fee-for-service (“FFS”) basis where providers are not functions and produces all utilization and cost reporting, including produc- accepting any risk: some out of fear, some because the impetus for change tion of any year-end settlement statements, PCP and specialty performance has not arrived and others because they lack the necessary knowledge, report cards and other forms of reporting. expertise and administrative infrastructure needed to provide high quality, efficient, cost-effective services in a capitated environment. In this model, however, the provider organization will take a more active role in the UM and CM processes and, in turn, may receive a higher administra- In some instances, health plans are generating significant margins annually tive fee to help cover costs. under the existing FFS structure, which makes the transition to capitation less attractive. Full Professional Risk: With or Without Institutional Shared Risk and Incentives Although there are many different payment models in existence, the most common models include: Full Professional Risk may be used when a provider organization has • Budget-Based: incentive only, no downside risk reached a level of sophistication and financial capacity to justify assumption • Budget-Based: shared risk and incentives; of full risk for all professional services. Although full risk agreements can, • Full Professional Risk: with or without institutional shared risk, and; and often do, exclude, i.e., carve-out, certain high cost services (e.g., out • Full/Dual Risk and Global Risk. of area emergencies, high cost injectables, and certain transplants), the provider organization is at-risk for all losses incurred in the contract year. Budget-Based: Incentive Only In some states that have adopted the model of full delegation of risk and This contracting method is used when a payor desires to begin a gradual administrative services (e.g., credentialing, claims and capitation payments, transition of a provider organization from FFS to capitation. For the first year UM and CM, provider relations services, contracting, finance, accounting or two, the focus is operating within a pre-determined budget goal that is and related services), the provider organization will either develop its own established by the payor, with monthly or quarterly monitoring of positive administrative infrastructure or outsource the delegated functions to a and negative variances. professional Management Services Organization (“MSO”) to be performed on its behalf. This model may start with a capitation payment to the Primary Care Phy- sicians (“PCPs”) and may include some minimal sharing of utilization and In other states, where full delegation has not yet occurred, the payor’s case management duties and responsibilities. infrastructure is used by the provider and the provider pays the payor a management fee as a percentage of its professional capitation for those In this model, the provider receives a small administrative allocation on a services. Depending on the specifics of the arrangement, reporting func- pmpm basis so that they can start developing their administrative structures, tions may be the sole responsibility of the provider organization, or may be hire staff, and take initial steps toward the monitoring of quality and cost. shared with the payor.
Also in this model, the payor processes and pays the claims and PCP In the Full Professional Risk model, payors and providers often enter into capitation; performs most Utilization Management (“UM”), Case Manage- a separate shared risk/incentives agreement in which each party shares in ment (“CM”), and Quality Management (“QM”) functions and; generates the the gains and losses associated with the provision of all or some institution- utilization and cost reporting, including production of the year-end financial al services (e.g., hospital inpatient and outpatient, skilled nursing facility, statement as well as PCP and specialty performance report cards, if any. home health, durable medical equipment, ambulance and other carve-out services).
34 | Mazars USA Ledger Provider organizations that enter into shared risk arrangements are typically 3. Innovation and improvement in the delivery of health care services; those with significant financial reserves that are able to cover their share 4. Identification and management of marginal/poor performers; of losses in down years. The assumption of institutional risk by provider 5. Reimbursement and incentive models that help promote appropriate organizations, in some instances, can trigger significant state licensing re- utilization and costs; quirements or, at the very least, regulators can limit the risk being assumed 6. Detailed budgeting and variance analysis, monitoring and analysis of based on the provider’s financial capability to assume risk. utilization and cost data, provider sub-capitation, and Improved trend analysis and forecasting and; Dual Risk 7. Increased member satisfaction.
The Dual Risk contracting method may be used when a provider organiza- To be successful, provider organizations must understand and embrace the tion and hospital partner together and enter into separate risk agreements Triple Aim, as well as Live It, Sell It, Love It, and do it all over again. In other to accept full professional and institutional risk. Most often under a dual words, it must become a way of life and not just another line of business. risk model, there is a shared risk incentive agreement between the provider organization and hospital to share gains and losses in the institutional risk Why Does Capitation Work for Some and Not Others? pool. While not every experience is the same, there are several reasons why Dual Risk agreements most often include delegation of all or most admin- providers often fail at capitation. The following are just a few of the most istrative services, including processing of claims and capitation payments, common reasons: UM and CM services, provider relations services and contracting, certain • When provider organizations enter into a risk relationship, they often member services, finance and accounting and related functions. Reporting jump in too soon, without sufficient financial reserves, and without obligations are typically shared by the organizations. sufficient knowledge and expertise or advance planning to help improve their chances for success. To combat this deficiency, provider Global Risk organizations must invest in data and data integrity, as well as the required organizational education to ensure thorough understanding Global Risk may be used when a provider organization enters into a risk and the import of the relationship of data management and effective agreement with a payor/plan partner whereby the provider organization management of risk. accepts full professional and institutional, or global, risk. In this instance, the • When the senior leadership of a provider organization accepts a cap- payor’s hospital partner would remain on a diagnosis-related group, fixed itation agreement but is happy with the status quo, they are typically per diem, or another discounted payment methodology and typically enter unwilling to make the cultural shift from FFS to capitation that is neces- into an institutional shared risk-incentive pool agreement with the provider sary succeed. While younger physicians are more apt to embrace the organization. Similar to the other full risk models, the Global Risk provider change, older physicians typically just want to “stay the course” until would also be fully delegated for all administrative services. they retire. This typically requires extensive provider education, both initially and ongoing. Global and Dual Risk agreements exist in several markets around the coun- • When senior leadership sees the need and embraces capitation, but try and are most prevalent with larger health systems or provider organiza- are unwilling to make the necessary infrastructure improvements to tions that possess state licensure to operate on the same level as a health manage risk, success is rare. The capitation model requires invest- plan, but are not fully licensed as a health plan. ment in systems and talent. • If senior leadership is more concerned about preserving relationships Capitation Support of the Triple Aim and keeping their colleagues happy rather than confronting marginal/ poor performers and focusing on improving quality and reducing cost, For those organizations that believe in and support the Triple Aim—i.e. they the capitation model will flounder. This model requires the ability to are committed to redirect referral patterns and establish, monitor, and report on agreed • Improvement in the health of populations, upon performance measures and benchmarks. • Enhancement in the individual experience of health care and • This model is not productive if senior leadership does not establish • Reductions in per capita costs—capitation supports these goals in and support the integral working relationship between quality and pay- several ways through: ment, which requires commitment to standards of practice or medical 1. Continuous quality improvement and operational efficiency; guidelines, performance measures, monitoring and reporting. 2. Identification and assessment of health risks across the entire popula- • The capitation model will not be beneficial if senior leadership of the tion of assigned members; provider organization does not deploy mechanisms to ensure accurate
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encounter data. Capitation does not require a “claim” for the provider As with every great endeavor, establishing the necessary systems and to be paid; therefore, the submission of encounter information is structures, and to learning how to manage capitation successfully will not critical as it is essential to managing capitation, provider performance, happen overnight, including implementing mechanisms to bring provider and the ability to collect and report specific and required elements for networks into compliance. It is best to step up and start now. both the risk-bearing provider and health plan. It all begins with the Board of Directors and senior management team mak- Why be a Proponent of Capitation? ing the commitment to move toward risk-based contracting and learning this model of business. Embrace the change and start making the incremental Capitation makes sense from several perspectives. A few of the advantages changes that are needed, including development of a solid business plan of making the switch include: that outlines goals, strategies, milestones and the willingness to work with • Capitation payments are predictable, paid monthly (usually by the 15th health plans to develop mutually beneficial partnerships. of the month), and help cash flow management. • Accepting capitation can incentivize health plans to steer membership Execute the business plan and ensure that the systems and structures toward capitated networks, especially toward Dual Risk and Global are in place to support the success of that plan. Be prepared to manage Risk networks, which increases membership and revenue growth. dynamic and interlinking processes that require a focus on quality measures • Local health care delivery and decision-making results in higher quali- and outcomes, UM, data management, compliance with regulations, and ty care and improved member satisfaction. fulfilling and monitoring contractual obligations. • Local decision-making also results in greater physician satisfaction because physicians are more vested in the delivery system and are Finally, choose wisely when developing or selecting medical guidelines, able to get answers to their claims inquiries, feedback on utilization information and data retrieval systems, and when bringing in staff. If a few decisions and resolution of disputes on a more timely and individual senior leaders are standing in the way of needed change, consider asking basis. them to step aside to ensure the success of the organization for the long • Profits generated from the efficient and cost-effective delivery of term. Most importantly, a quality provider organization with solid leadership health care services are retained at the local level, not shared with the and a commitment to success has nothing to fear with capitation. health plans. • Provider organizations that have made/are moving to embrace capita- As Nike tells us, “Just Do It” and do not look back! tion position themselves to be the future of health care in this country. They will figure out how to make it work and become the market As a leading change facilitator in this era of sweeping health care reform, leaders of the future; it is time to lead or follow, your choice. the Mazars Health Care Group offers health care payors and providers a powerful combination of service and results-oriented strategy to help them Should Your Organization Choose to Embrace Capitation? meet their business goals, overcome challenges, and improve performance.
There is little doubt that risk-based contracting, vis-a-vis capitation or some For more information about their timely, valuable information and insights other value-based model, is here to stay and already is the preferred care into policies, best practices and industry developments, visit mazarsusa. delivery model throughout the country. FFS as a preferred compensation com/hc. model has actually been dying for many years, but the resuscitation effort continues in many places around the country. Russ is a Senior Advisor in our Sacramento Practice. He can be reached at 916.696.3663 or at [email protected]. While there are pockets of resistance to the change, continuing pressure from employers, government (including the Centers for Medicare and Med- Sheila is a Senior Advisor in our Sacramento Practice. She can be reached icaid Services), and health plans, which are all committed to the Triple Aim, at 916.696.3663 or at [email protected]. will affect every provider regardless of location or readiness. Stephen is a Senior Manager in our Sacramento Practice. He can be Failure to successfully transition will have consequences far beyond the reached at 916.696.3674 or at [email protected]. investments that need to be made to embrace it now. For many, holding on to the status quo will adversely impact their ability to compete and stay in Shawn is a Senior in our Sacramento Practice. He can be reached at business. Timing is everything, and now is the time to make the necessary 916.696.3680 or at [email protected]. investments to stay competitive.
36 | Mazars USA Ledger IFRS
OCTOBER IFRS HIGHLIGHTS October 22, 2018
Implementation of IFRS 9 by European insurers https://www.mazars.com/Home/News/Latest-News3/ In August, Mazars published a benchmark study of 16 Benchmark-Study-on-European-Insurers-IFRS-9 European insurance and reinsurance groups, and 10 European bank insurers, based on their financial reporting IFRS Foundation consults on length of service for Trustee at the end of 2017. The study looks at how they intend to Chair and Vice-Chairs implement IFRS 9 (in 2018 or deferred to a later date) and the On 19 June 2018, the IFRS Foundation published a expected impacts of first-time application of the standard. consultation with a view to permitting its Chair to serve up to three terms of three years each, irrespective of whether they The study found that 94% of the sample of insurance and are recruited from the ranks of the Trustees or externally. reinsurance groups intend to defer application of IFRS 9 to Vice-Chairs, recruited from among the Trustees, would also 2021, when it will be implemented concurrently with IFRS be permitted to serve three terms of three years each. This 17 – Insurance Contracts. Furthermore, 27% of the groups proposal would have the benefit of continuity and would enable presented disclosures on the level of their predominance the Foundation to profit from the appointees’ experience. ratio for insurance activities. Finally, only five groups specified which of the phases of IFRS 9 they expected would have the Another proposed amendment would permit a Trustee who greatest impact (classification and measurement, impairment, has served their maximum term to be reappointed after six IFRS and/or hedge accounting). years have elapsed, for a three-year term renewable only once. The IFRS Foundation’s consultation was open until 17 The full study is available via the following link: September 2018. A NOVEMBER IFRS HIGHLIGHTS November 6, 2018 L IFRS 17, Insurance Contracts: where are we now? At the beginning of September, EFRAG sent a letter to the This summer and early autumn we have seen multiple IASB in its turn, with a view to opening discussions with developments regarding IFRS 17, Insurance Contracts, which the international standard-setter on the following six points E is currently scheduled to come into effect on 1 January 2021. (previously identified by the CFO Forum): §§ acquisition costs (incurred in expectation of contract In July, the European Insurance CFO Forum (a discussion renewals); R group for major insurance companies) sent a letter to the §§ contractual service margin (CSM) amortization, EFRAG President and IASB Chair recommending the re- particularly for contracts that include investment services; opening of IFRS 17. The CFO Forum notes that this could §§ reinsurance (onerous underlying contracts that are T delay the effective date of IFRS 17 by up to two years. profitable after reinsurance, contract boundary where underlying contracts are not yet issued); The CFO Forum has made this recommendation after §§ transition (extent of relief offered by the modified identifying issues with IFRS 17, including difficulties with retrospective approach and challenges in applying the operational implementation. It has already reported these fair value approach); issues to EFRAG, supported by case studies carried out by §§ annual cohorts (cost-benefit trade-off, including for the various members of the CFO Forum. EFRAG is expected to variable fee approach (VFA) contracts); address these findings as part of its ongoing work towards §§ balance sheet presentation (cost-benefit trade-off of EU adoption of IFRS 17. In the letter, the CFO Forum also separate disclosure of groups in an asset position and requests that more attention should be paid to interactions with groups in a liability position and non-separation of IFRS 9 – Financial Instruments. The letter is available here: receivables and/or payables representing premiums http://www.cfoforum.eu/letters/CFO-Forum-letter-to-EFRAG- already billed). and-IASB-16-July-2018.pdf.
November/December 2018 | 37 IFRS
EFRAG’s letter is available here: https://www.efrag.org/News/ In accordance with paragraph 17 of IAS 23, which stipulates Project-329/Letter-to-IASB-on-IFRS-17. when an entity should begin capitalizing borrowing costs, the Committee concluded that the entity would not begin The fourth meeting of the IASB’s Transition Resource Group capitalizing borrowing costs until it has obtained the general for IFRS 17, which addresses issues with transition to IFRS borrowings, but once it has obtained it, the entity does not 17, took place at the end of September. The group discussed disregard expenditures on the qualifying asset incurred ten topics; a summary of the discussion is available on the before it obtains the general borrowings when determining the IASB’s website via the following link: https://www.ifrs.org/-/ expenditures eligible for capitalization. media/feature/meetings/2018/september/trg-insurance/trg-for- ic-meeting-summary-september-2018.pdf. The second decision relates to the point at which an entity ceases capitalizing borrowing costs on land, when the land Lastly, at the beginning of October the European Parliament has been acquired in order to construct a building on it. The adopted a resolution on IFRS 17, which can be found here: question was whether the entity should cease capitalizing http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-// borrowing costs incurred in respect of land expenditures EP//TEXT+TA+P8-TA-2018-0372+0+DOC+XML+V0// once it starts construction of the building, or whether it should EN&language=EN. continue to capitalize them during construction.
Among other things, the resolution draws attention to the fact The Committee concluded that if the land is not capable of IFRS that IFRS 17, if adopted, must meet the ‘European public being used for its intended purpose during the construction good’ criterion and support long-term investment. phase, the land and building should be considered together when determining when to cease capitalizing borrowing costs The final months of 2018 are likely to see further breaking on land expenditures. A news on IFRS 17, what with the IASB’s monthly discussions of the points raised in the letters mentioned above, and European highlight the fifth meeting of the TRG for IFRS 17, scheduled for the start of December. Meanwhile, EFRAG, which had initially European Commission to discuss the future of corporate L expected to publish its IFRS 17 endorsement advice in the reporting fourth quarter of 2018, has now removed any mention of an Following its ‘Fitness check’ consultation last March (see expected publication date from its website. Beyond the GAAP no. 120, March 2018), the European E Commission has announced that it will be hosting a IAS 23: IFRS IC publishes two agenda decisions conference on the future of corporate reporting in a digital At the end of its September meeting, the IFRS IC decided to and sustainable economy. The conference will take place R publish two agenda decisions relating to IAS 23, Borrowing on Friday 30 November 2018 in Brussels and will provide Costs. an opportunity to consider participants’ responses to the consultation and to have face-to-face discussions between T The first decision relates to the amount of borrowing costs different types of stakeholders (regulators, preparers and eligible for capitalization when an entity that initially has no users of financial statements, civil society, etc.). borrowings is constructing a qualified asset, and borrows funds generally part-way through construction. The question Details of the conference can be found here: https:// was whether the entity should include expenditures for ec.europa.eu/info/events/finance-181130-companies-public- the asset before it obtained the general borrowings when reporting_en determining the amount of borrowing costs eligible for capitalization.
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MAZARS USA ACCOUNTING HELPDESK 646.225.5915 [email protected]
38 | Mazars USA Ledger REAL ESTATE QUICK UPDATES: ASU 2018-13 November 15, 2018
During August 2018 the Financial Accounting Standards reporting entities to improve the effectiveness of the Board (“FASB”) released ASU 2018-13 Disclosure Framework disclosures, while maintaining an appropriate amount of – Changes to the Disclosure Requirements for Fair Value discretion. Focusing on meaningful material disclosures Measurement, which alters the disclosures related to the fair assists in keeping the costs from outweighing the value hierarchy, impacting financial statement preparers and benefits of such disclosures. users. MODIFICATIONS KEY CHANGES §§ In lieu of a roll-forward for Level 3 fair value §§ The FASB removed disclosure related to transfers and measurements, a nonpublic entity is required to disclose valuation processes for the fair value hierarchy. transfers into and out of Level 3 of the fair value §§ Modifications to the level 3 disclosure requirements, hierarchy and purchases and issues of Level 3 assets disclosures related to liquidation and redemption of and liabilities. investments in entities that calculate NAV, and the §§ For investments in certain entities that calculate net RE measurement uncertainty disclosure asset value, an entity is required to disclose the timing §§ Certain additions were added to the Level 3 disclosure of liquidation of an investee’s assets and the date when requirements for public entities. restrictions from redemption might lapse only if the investee has communicated the timing to the entity or A WHO DOES IT AFFECT AND WHEN? announced the timing publicly. §§ The amendments clarify that the measurement §§ Affects all entities that are required to disclose recurring uncertainty disclosure is to communicate information L and nonrecurring fair value measurements. about the uncertainty in measurement as of the reporting §§ Effective for public and non-public entities for fiscal date. years beginning after December 15, 2019 and for interim periods within those fiscal years. Mazars Insight E §§ Early adoption of any or part of this ASU is permitted. The modifications refine and simplify the disclosures to increase the usefulness to the reader of the financial REMOVALS statements. The first modification removes the roll R forward, but still requires the financial statements to §§ The amount of and reason for transfer between Level 1 disclose the changes for the reporting period. The and Level 2 of the fair value hierarchy. second modification eliminates the need to estimate the T §§ The policy for timing of transfers between levels. timing of future events related to investments in certain §§ The valuation process for Level 3 fair value entities valued using NAV, but requires disclosure of measurements. definitive events when communicated to the investor, §§ For nonpublic entities, the changes in unrealized gains which is valuable to the user for planning, evaluating, and losses for the period included in earnings for and forecasting purposes. Enhancing the measurement recurring Level 3 fair value measurements held at the uncertainty narrative provides insight with respect to end of the holding period. the variability of significant unobservable inputs and the impact that variability could have on the fair value Mazars Insight measurements as of the reporting date. The overall goal The reason for the above removals stems from the need is to improve the users understanding of management’s to disclose pertinent information to the users of financial assumptions and increase the usability of the information statements. The FASB strives to issue guidance for contained in the disclosures.
November/December 2018 | 39 REAL ESTATE
ADDITIONS changes in those inputs relative to economic factors. Broadening the information presented in the notes §§ The changes in unrealized gains and losses for the provides management the opportunity to communicate period included in other comprehensive income for more meaningful information to the users of the financial recurring Level 3 fair value measurements held at the statements. end of the reporting period. §§ The range and weighted average of significant WHAT’S NEXT? unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an §§ How will these changes be perceived and executed by entity may disclose other quantitative information (such preparers of financial statements? as the median or arithmetic average) in lieu of the §§ Will users of the financial statements find these changes weighted average if the entity determines that other to be beneficial? quantitative information would be a more reasonable and §§ Will entities experience enriched disclosures while rational method to reflect the distribution of unobservable improving the cost of such disclosures? inputs used to develop Level 3 fair value measurements. This ASU advances the goals set out in the FASB’s disclosure Note: The above additions are not required for nonpublic framework project. These significant overall changes to the companies. fair value hierarchy disclosures improve reporting by providing RE management with more discretion on how best to convey Mazars Insight information in a manner that will be more meaningful to the The above additions add clarity for the users of the users of the financial statements. When evaluating the impact financial statements. Enlightening the reader to the of this ASU, management should consider what will enable A relationship between the unrealized gains and losses the reader to more accurately and effectively understand the and the statement of comprehensive income aids the assets and liabilities measured at fair value and the impact understanding of possible net cash flows resulting from that external factors have on those measurements. L dispositions of assets and liabilities recorded at fair value. The second addition provides the users of the Source: Accounting Standards Update 2018-13, Fair Value financial statements with the details surrounding the Measurement (Topic 820): Disclosure Framework — Changes to the E significant inputs used by management to calculate Disclosure Requirements for Fair Value Measurement. R fair value, in order to better understand and analyze REAL ESTATE ALERT CONTACTS
T John Confrey Bonnie Mann Falk 212.375.6610 212.375.6552 [email protected] [email protected]
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40 | Mazars USA Ledger TAX
QUALIFIED OPPORTUNITY ZONE GUIDANCE RELEASED BY TREASURY Published on October 26, 2018
By Adam Liebman, Bonni Zukof and John the investment if the taxpayer holds the investment for a Confrey minimum of 10 years.
The 2017 Tax Reform Act, commonly referred to as the “Tax Initially the taxpayer’s basis in the fund is zero. The exclusion Cuts and Jobs Act,” created a new tax incentive program described in items two and three above is accomplished designed to spur economic development and job creation through an increase to the basis of the investment. If the in distressed communities by providing tax benefits to those investment is held for at least 5 years, the taxpayer’s basis that invest in specified areas known as Qualified Opportunity is increased by 10% of the deferred gain. If the investment is Zones. The tax incentive is a potential reduction in one’s held for at least 7 years, the taxpayer’s basis is increased by capital gains tax. another 5% of the deferred gain, totaling 15%.
On October 19, 2018 the Department of Treasury and the It is important to note that the law requires only the gain Internal Revenue Service released Proposed Regulations to be reinvested in a QOF, which differs from a Section in reference to Qualified Opportunity Zones (QOZ). The 1031 “like-kind” exchange that also provides tax deferral Proposed Regulations have provided guidance and clarity on treatment through reinvestment; Section 1031 requires total TAX what types of gains would qualify, the time period during which sales proceeds to be reinvested in order to achieve deferral amounts must be invested in a Qualified Opportunity Fund treatment. (QOF), and the requirements that must be met by such QOFs L to provide deferral for the investors. Taxpayers are permitted Election for investments held at least 10 years to rely on the Proposed Regulations until the final regulations A taxpayer that holds a QOF investment for at least 10 years are published. may elect to increase the basis of the investment to the fair E market value on the date the investment is sold or exchanged. The IRS and Treasury Department have indicated that The Proposed Regulations clarified that investments that meet additional guidance will be released prior to year-end. the 10-year holding period requirement post December 31, This alert will highlight key components of the Proposed 2026 are eligible for the exclusion as long as they are sold no R Regulations which have generated comments from taxpayers. later than December 31, 2047.
Benefits of an investment into a Qualified Opportunity Gains that are eligible for deferral or exclusion T Fund The Proposed Regulations clarify that only “capital gains” for If a taxpayer realizes gains from the sale or exchange of federal income tax purposes are eligible for deferral under IRC property and invests some or all of the realized gain into a Section 1400Z-2. The preamble of the Proposed Regulations QOF within 180 days, the QOF investment allows a taxpayer state that these gains generally include capital gains from an to: actual, or deemed, sale or exchange, or any other gain that is 1. Defer those gains from taxable income until the earlier of required to be included in a taxpayer’s computation of capital (a) selling the investment or (b) December 31, 2026; gain. 2. Permanently exclude 10% of the originally-invested gain from taxable income if the investment is held for at least The gain must not arise from a sale or exchange with a 5 years (5 year period must be met prior to December related person which, for the purpose of these regulations, 31, 2026); means more than a 20% common ownership (instead of 3. Permanently exclude an additional 5% for a total 50%). exclusion of 15% of the originally invested gain from taxable income if the investment is held for at least 7 Who is eligible to make the election? years (7 year period must be met prior to December 31, Individuals, corporations, regulated investment companies, 2026); REITS, partnerships and other pass-through entities are 4. Permanently exclude post acquisition appreciation in eligible for the benefits provided by QOFs.
November/December 2018 | 41 TAX
Special rules for partners of partnerships in the creation of an investment in a QOF. The Proposed Regulations provide that, if a partnership does not elect to defer partnership capital gains, a partner Making the election may elect to defer the partner’s allocable share of such Guidance from the IRS indicates that the taxpayer will make capital gains. The partner’s 180-day period with respect to the deferral election on Form 8949 which will need to be the partner’s allocable share of such capital gains generally included with the taxpayer’s federal income tax return in the begins on the last day of the partnership’s taxable year, as year in which the gains would have been recognized if no this is the day on which such gains are included the partner’s election was made. distributive share of income. GUIDANCE IN RELATION TO THE OPERATION OF A Tax attributes of gains deferred QUALIFIED OPPORTUNITY FUND The Proposed Regulations provide that all the deferred capital gains’ tax attributes are preserved. This includes classification Eligible entities of short-term and long-term holding periods, collectibles, The Proposed Regulations clarify that a QOF must be an Section 1256 Contracts, unrecaptured Section 1250 gain, etc. entity classified as a corporation or partnership for Federal The taxpayer will report the gains in the year of disposition income tax purposes. In addition, it must be created or of the QOF investment in the same manner they would have organized in one of the 50 States, the District of Columbia, reported if no deferral election was made. The investment or a U.S. possession. In addition, if an entity is organized TAX in the QOF does not extend the holding period for gains in a U.S. possession, but not in one of the 50 States or in classification. the District of Columbia, then it may be a QOF only if it is organized for the purpose of investing in qualified opportunity L Deferral of gain from sale of QOF zone property that relates to a trade or business operated in The Proposed Regulations provide that a taxpayer who sells the possession in which the entity is organized. their interest in a QOF prior to December 31, 2026 can invest E in another QOF and defer the gains associated with the sale Frequently Asked Questions issued by the IRS provide that by investing within a 180-day period. The taxpayer is required entities that are formed as Limited Liability Companies can be to dispose of its entire initial investment since a taxpayer QOFs. cannot make a deferral election with respect to a sale or R exchange if an election previously made with respect to the Valuation and compliance in relation to the 90% asset test same sale or exchange remains in effect. One of the requirements for a qualified opportunity fund is that 90% of its assets must be qualified opportunity zone property. T Eligible investments in a QOF This 90% threshold is calculated by taking the average The Proposed Regulations state that an eligible investment in percentage of QOZ property held in the fund as measured on a QOF must be an equity interest, which can include preferred the last day of the first six-month period of the taxable year of stock or a partnership interest with special allocations. The the fund and on the last day of the taxable year of the fund. “equity interest” can be a combination of eligible gains from sale within 180 days and/or other cash investments. In these The Proposed Regulations provide that for a QOF that has instances, the investment is referred to as “investment with GAAP financials or other financial statements filed with a mixed funds,” and the taxpayer is treated as having made two federal agency, the QOF will use the asset values on those separate investments consisting of (a) one investment that financial statements to determine if the 90% threshold is met. includes the amount of the investor’s deferral election, and (b) If the QOF does not have financial statements that meets one investment consisting of other amounts where QOF tax those requirements, the value of its assets for the 90% test is benefits do not apply. determined based on the costs of the assets. The term eligible interest excludes any debt instrument within the meaning of IRC Section 1275(a)(1) and Treasury Purchase of existing building, substantial improvement Regulation §1.1275-1(d). requirement and land The Proposed Regulations provide that if a QOF purchased The Proposed Regulations also clarify that deemed a building on land within a QOZ, the substantial improvement contributions of money under IRC Section 752(a) do not result requirement is only measured on the QOF’s basis in the
42 | Mazars USA Ledger building and not the land. To meet the substantial improvement requirement, 1. There is a written plan that identifies the financial property as property the QOF will need to make investments with costs that are at least equal held for the acquisition, construction, or substantial improvement of to the original allocated basis to the building within any 30-month period tangible property in the opportunity zone; beginning after the date of acquisition of the property. 2. There is a written schedule consistent with the ordinary business operations of the business, that the property will be used within 31 The QOF is not required to make any improvements to the land upon which months; and the building is located. 3. The business substantially complies with the schedule.
Working capital safe harbor Taxpayers would be required to retain any written plan in their records. In The Proposed Regulations, in response to concerns regarding the 90% addition to the above, please see the Mazars Quick Reference Guide on assets threshold, provide flexibility by creating a working capital safe harbor Opportunity Zones for further details. for QOF investments in qualified opportunity zone businesses that acquire, construct, or rehabilitate tangible business property, which includes both real Many questions remain unanswered and the Treasury Department has property and other tangible property used in a business operating in a QOZ. already announced that a second set of Proposed Regulations is expected The safe harbor allows QOZ businesses to maintain reasonable amounts of to be issued before year end. For a more in-depth conversation on the working capital in cash, cash equivalents or debt instruments with a term of Proposed Regulations and the opportunities available through these funds, 18 months or less for a period of up to 31 months, if: please contact your Mazars USA LLP professional for additional information.
NEW JERSEY IMPLEMENTS TAX AMNESTY PROGRAM Published on November 26, 2018
The state has already begun an outreach program, sending letters By Harold Hecht, Julie Montrone and Seth Rabe to businesses and individuals, inferring that they may be subject to a forthcoming audit. This appears to be an attempt by New Jersey to prompt New Jersey Governor Phil Murphy recently signed a law directing the voluntary payments under the program. Taxpayers that previously filed Division of Taxation to create a tax amnesty program. an appeal related to a tax assessment may participate in the program provided they withdraw the appeal. Any payments made are non-refundable. The program, which began November 15, 2018 and will end January 15, Taxpayers eligible for amnesty, but who did not avail themselves of the 2019, provides an opportunity to file past due tax returns, pay back taxes, program, will be subject to an additional 5% penalty on tax balances and pay half the interest due as of November 1, 2018. The other half of the remaining after the amnesty period ends. This additional penalty cannot be interest due as of November 1, 2018 and any late payment penalty, late waived or abated. filing penalty, cost of collection, delinquency penalty or recovery fee will be waived. Civil fraud and criminal penalties will not be waived. Amnesty applies The New Jersey Tax Amnesty Program provides a great opportunity to to tax liabilities incurred for tax returns due on or after February 1, 2009 and become current with one’s New Jersey tax liabilities at a reduced cost. prior to September 1, 2017. Contact your Mazars USA LLP tax professional for further information.
TAX PRACTICE BOARD
Tifphani White-King Howard Landsberg Faye Tannenbaum 212.375.6523 212.375.6604 | 516.282.7209 212.375.6713 [email protected] [email protected] [email protected]
James Toto James Wienclaw Richard Bloom (EDITOR) 732.205.2014 516.620.8551 732.475.2146 [email protected] [email protected] [email protected]
November/December 2018 | 43 THE FUTURE OF ACCOUNTING IS MAZARS. MeetMazars.com
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