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 Volume 4 :: Issue 3
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Anticipating Taxes Helps Manufacturers Relieve Anxiety When Going Global
"For Small Businesses, the big World Beckons." So ran the headline on the front page of the Wall Street Journal. "While big companies have been the trailblazers of globalization, a growing number of relatively small businesses are following in their footsteps." That comes as no surprise to us here at UHY Advisors where we have seen companies "going international" at ever earlier stages in their lifecycles. Sometimes their first significant transactions are half a world away. The article goes on to note, "The task often requires bridging cultural differences and navigating complex and unfamiliar bureaucracies."
The world can be a scary place for a business of any size when taxes hike suddenly and a lack of transparency makes it difficult to gauge profits or craft a competitive bid for a foreign project. For smaller sized businesses for which such a foreign project may account for the lion's share of annual revenue, a change involving a couple of percentage points in foreign taxes could make the difference between a resounding success and a costly disaster.
With the Wall Street Journal's article in mind, this is a good time to review some of the foreign taxes to consider, even for seasoned international investors, at a time when governments are looking to raise revenue and may consider doing it by increasing taxes on foreign investors.
First, there is withholding tax. The requirement of a foreign contracting party to collect income tax owed by a U.S. company, through the mechanism of withholding that tax from payments to the U.S. person, is probably not stated in a contract. The first hint of trouble may be when a wire transfer into the U.S. Company's bank account is 20 or 30 percent lower than anticipated. Such a tax on gross income can be difficult for a U.S. company to use as a credit against U.S. tax on foreign source income, which takes into account expenses and other deductions. While it may be possible to build into a contract the requirement that the foreign payor "gross up" any payment so that after withholding the tax the U.S. company will receive 100% of what it is expecting, the economics of the transaction for the payor may change so significantly that the deal will not go forward. In addition, some countries frown on such contractual arrangements and may seek to disallow a deduction for the increased payment when the burden of withholding tax is shifted to the payor. As many of our clients have found, negotiating a contract price that takes into account withholding tax may be the best solution, but is no protection against a sudden spike in withholding tax whose economic impact a "gross up" provision could help relieve.
Secondly, there is good, old-fashioned double taxation that can arise when two countries decide to tax the same income but with no offset. For example, U.S. tax rules consider income earned from the performance of services in the U.S. to be U.S. source income while foreign countries may tax that same income based on the recipient of the services being a resident of that country who is required to withhold tax. In the worst of all possible worlds, the income is taxable in the U.S. because the employees working on the project are physically located in the U.S. It is highly unlikely that the foreign withholding tax would ever provide relief against U.S. tax, particularly if the U.S. taxpayer has no income from foreign sources because all its work is done in the U.S. Again, it is an advantageous to anticipate the tax connected with a project, and how much of it may be creditable in the U.S., before locking in a prica and signing on the dotted line.
Thirdly, there are transaction taxes such as value added tax or "VAT." Sometimes these are collected in the form of withholding tax. More often, they can require a nonresident company to register for VAT and account for it even when not considered to be a "taxpayer" for income tax purposes because of protection under a double taxation treaty. Such treaties cover income taxes but not VAT and other transaction taxes that may end up being an out-of-pocket cost for a U.S. company. While in some countries it is possible to appoint an agent to take care of collecting and accounting for these taxes, there is still an extra cost involved and possible delays in payments. Like the previous example, we have seen this situation arise most often in the case of services performed in the U.S. for a foreign recipient whose "enjoyment" of the services in the foreign country causes the transaction to be subject to VAT.
With over 260 international offices throughout the world, the professionals at UHY LLP and UHY Advisors have assisted numerous companies in making their first investments into international markets. For more about UHY, its member firms around the globe, and their Doing Business Guides detailing what taxes to expect, please visit www.uhy.com.
For more information please contact a member of our UHY's Manufacturing team in Farmington Hills (248) 355-1040 or Sterling Heights (586) 254-1040 or visit us on the Web at uhy-us.com.
Article written by Meril Markley (Houston, TX)
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System Upgrades
Throughout the great recession most companies scaled back on their capital expenditures and that included technology systems. Today many companies are planning or are currently addressing their technology needs and that includes upgrades to ERP systems and in some cases altogether new ERP systems. This article focuses on the financial accounting and tax treatment for new or upgraded ERP systems, something the accounting literature refers to as "internal-use software".
Accounting guidance breaks internal-use software projects into three distinct phases (Preliminary Project, Application Development, and Post Implementation), each of which has its unique accounting requirements. While the accounting guidance breaks the project into three district phases, in practice the phases can bleed into one another and there is not always a clear dividing line. As such it is important to proactively develop a plan to identify and document the key indicators of moving from one stage to another.
The preliminary project phase consists primarily of determination of project needs, evaluating alternative solutions, vendors and consultants and finalizing the selection of the approach as well as vendors and consultants. All costs incurred during this preliminary project phase are required to be expensed. These costs include both internal and external costs incurred. Typically the key indicators of the completion of the preliminary project phase are signed contracts from vendors and consultants or senior management approval for projects developed internally. The tax treatment for these costs generally conforms to the book treatment for this phase.
The application development phase consists primarily of coding, configuring the software, installation to hardware, and testing of the system. This phase also includes the costs associated with the development or purchase of software to convert old data to the new or upgraded system. Costs that are eligible for book capitalization include all direct costs for materials and services used. These include fees paid to third parties for software development or purchase, payroll and payroll-related costs for employees used to develop or configure software, travel expenses incurred by those employees, and interest costs. Costs incurred to convert data from the old system to the new system are expensed (software used in the process can be capitalized). Typically the key indicator of the completion of the application development stage is when all substantial testing is complete. The tax treatment of the costs for this phase will vary depending on whether the taxpayer is treated as purchasing versus self-developing the software.
The determination of whether the taxpayer has purchased versus self-developed is based generally on whether the risk of software development is transferred to the vendor versus retaining that risk. In many cases the contract with a vendor can create a component of each where the costs associated with the two aspects would be separated for different treatment. Costs associated with purchased software is capitalized and expensed through amortization over a 3 year life. Costs associated with self-developed software are expensed as incurred or capitalized and amortized over a 5 year life depending on the accounting method previously used or adopted for those costs.
Ongoing software maintenance costs are expensed however software upgrades are capitalized for financial accounting purposes. Distinguishing software upgrades from routine maintenance can be challenging. Accounting guidance indicates that software upgrades provide additional functionality to an existing system, whereas maintenance does not provide such enhancements. When structuring third-party vendor service agreements it becomes important distinguish between the services provided. Many extended service agreements combine maintenance costs with software upgrades. If the service agreements relate to maintenance and unspecified upgrades and enhancements, accounting guidance indicates that the entire agreement should be recognized as an expense over the contract period. On the other hand, if the service agreement identifies specific upgrades and enhancements within the contract, accounting guidance provides that the company allocate the contract costs between maintenance and upgrades and account for those items independently. The software maintenance costs would generally be currently deducted for tax purposes. The software upgrade costs would be capitalized or expensed under an analysis of the risk transfer as discussed above and the taxpayers method of accounting used for self-developed software costs.
The final stage is the post implementation phase which consists primarily of training and application maintenance. All training related costs and maintenance costs are expensed for book purposes. In practice, it may be difficult to distinguish training costs from configuration costs, as many times those can occur simultaneously. Generally in that scenario, the costs incurred for time devoted to configuration should be capitalized even though there could be an element of training involved. The tax treatment of these costs would generally be consistent with the financial accounting treatment.
While the accounting guidance is fairly straight-forward the application can sometimes be difficult. Understanding the rules upfront and proactively distinguished the phases can significantly streamline the process.
For more information please contact a member of our UHY's Manufacturing team in Farmington Hills (248) 355-1040 or Sterling Heights (586) 254-1040 or visit us on the Web at uhy-us.com.
Article written by Gerald Townsend, Dave Calvin and Stacy Winkler (St. Louis, MO)
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Save the Date!
11/1 UHY LLP Annual Manufacturing Outlook
Save the date for UHY LLP Manufacturing Outlook 2013: An American Renaissance. Join us either on-site or on-line via webcast to learn more about the latest industry trends and rebirth of American manufacturing. Topics, speakers and keynote will be announced shortly.
Thursday, November 1, 2012
On-site Breakfast Program On-line Webinar
Central Time 7:30AM-10:45AM 8:00AM-10:45AM
Eastern Time 8:30AM-11:45AM 9:00AM-11:45AM
CPE credit will be offered. Pre-registration for this complimentary program is required. Breakfast will be provided. Space is limited. Multiple registrations are welcome. To RSVP contact Courtney Gray via email cgray@uhy-us.com or phone 586 843 2533. Please declare either on-site or on-line. Formal invitation and webinar log-in instructions will be released at a later date.
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Manufacturing Industry Insight
UHY LLP recognizes that manufacturing companies require their auditors, tax and business advisors to add value to financial reporting activities. We combine the strength of business and financial expertise with a hands-on, "shop floor" approach to solving complex business decisions in these key segments:
· Aerospace & Defense
· Automotive Suppliers
· Consumer Products
· Distribution
· Industrial Manufacturing
The professionals at UHY LLP help lead the industry in identifying and addressing new trends, accounting requirements, and regulations, ensuring our clients' future success. Please contact a member of UHY's Manufacturing team in Farmington Hills (248) 355-1040 or Sterling Heights (586) 254-1040 or visit us on the Web at uhy-us.com.
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Published by UHY LLP News.
Copyright © 2011 UHY LLP. All rights reserved.
Our firm provides the information in this newsletter as tax information and general business or economic information or analysis for educational purposes, and none of the information contained herein is intended to serve as a solicitation of any service or product. This information does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
UHY Advisors, Inc. provides tax and business consulting services through wholly owned subsidiary entities that operate under the name of "UHY Advisors." UHY Advisors, Inc. and its subsidiary entities are not licensed CPA firms. UHY LLP is a licensed independent CPA firm that performs attest services in an alternative practice structure with UHY Advisors, Inc. and its subsidiary entities. UHY Advisors, Inc. and UHY LLP are U.S. members of Urbach Hacker Young International Limited, a UK company, and form part of the international UHY network of legally independent accounting and consulting firms. "UHY" is the brand name for the UHY international network. Any services described herein are provided by UHY Advisors and/or UHY LLP (as the case may be) and not by UHY or any other member firm of UHY. Neither UHY nor any member of UHY has any liability for services provided by other members.
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