energy industry accounting and tax update july 2013

Energy Industry Update

July 16, 2013 Jake Vossen: Dodd-Frank Section 1504 and 1502 Patrick Hanley & Mei Lin Kis: Foreign Withholding

Dodd-Frank Section 1504 and 1502 July 16, 2013

Agenda for Today

Today we will be covering current developments related to:

The Disclosure of Payments by Resource Extraction Issuers (to governments) (Section 1504)

and Conflict Mineral Disclosures (Section 1502)

© 2013 Hein & Associates, LLP. All rights reserved.

Answer to the first question you have…..

Does the law require disclosure of payments made to the US Government?

Yes


What are the Objectives of 1502 and 1504

- Increase transparency and accountability - 1504- Highlights payments to governments. With that

information Congress believes that public can then hold governments accountable for the use of those funds.

- 1502- The law’s purpose is to indirectly discourage the use

of minerals that are being mined in areas controlled by armed groups in the Democratic Republic of the Congo region.

- 1502, 1503, and 1504 will allow investors to make more

socially responsible investing decisions.


Current developments

-Dodd-Frank was signed into law in July 2010. - On August 22, 2012 the SEC adopted rules to implement

Sections 1504 and 1502 of Dodd-Frank. - Created a new SEC form called Form SD

- In 2012 litigation against the SEC commences on both the 1504 and 1502 rules.

- On July 2, 2013, a judge vacates the SEC rules on section 1504.

- Oral arguments in July 2013 on 1502…Judge expects to make a quick decision.


1504 and Form SD

• Only the SEC’s rules in implementing 1504 were vacated…not the underlying Dodd-Frank section 1504, which is still the law.

• Court order was based on the conclusion that the process/deliberations used by the SEC to develop the rules to implement 1504 were flawed.

• It is possible that the SEC re-deliberates, incorporating the concerns from court, and reaches the substantially the same conclusions.


1504 and Form SD

• The EU has also adopted similar rules in April and June of 2013, albeit for larger enterprises.

• NGO’s, governments and industry players have proposed similar disclosure rules through an organization called the “Extractive Industries Transparency Initiative” or “EITI.”


1504 and Form SD

Disclosure of payments to Governments is….

NOT GOING AWAY.


1504…Who does this apply to? (per Dodd-Frank Act)

Applies to any Company that: 1. Files a annual report with the SEC, and 2. Engages in the commercial development of oil, natural gas, or minerals. (note: includes exploration)


1504…Who does this apply to? (per Dodd-Frank Act)

Also applies to any entity under the control of an extraction company. SEC estimates that 1,100 US Companies are subject to the rule. Cost to comply was estimated by the SEC at $1 Billion. (note: no exemption for small filers)


1504…What types of payments need to be disclosed (per Dodd-Frank Act)

• Taxes (except VAT and Sales Taxes) • Royalties • Fees • Production Entitlements • Bonuses (such as a lease bonus) • Infrastructure Improvement fees


1504…What types of payments need to be disclosed (per Dodd-Frank Act)

• Must be done on Edgar and must use XBRL • Consistent with the EITI • Not de Minimis

– (defined by the SEC and any series of payments over $100,000)


1504…What Information must be disclosed for the payments

Per Dodd-Frank: • Type and total amount for each “project” • Type and total amount paid to each government • Totals amount of payments by category • Currency used • Financial period • Business Segment • The name of the government that received the payment

and the country in which that government is located • The “project” to which the payment relates


1504…Definition of Foreign Government and Federal Government

Foreign Government includes payments made to companies owned by foreign governments.


1504…Definition of Foreign Government and Federal Government

- (SEC) Foreign Governments include subnational governments…i.e. a province, county, district, territory etc. - (SEC) Federal Government means the United States and not subnational U.S. governments (i.e. does not include states or municipalities in the U.S.)


Form SD and timing….(per SEC)

• Form was to be due 150 days after year-end. Note: Q1 will be due shortly before SD will be due

• Payments are disclosed on a CASH basis.

• Disclose method used to translate into reporting currency.

• Form SD is FILED with the SEC not furnished to it (section 18 liability)

Note: SEC says late filing will not preclude S-3 use.



Was scheduled to be due for all years ending after September 30, 2013 First report was scheduled to include all payments from October 1, 2013 to the end of the company’s first fiscal year.



Use the court order as an extension to get ready! - Identify types of payments that will be scoped in. - Develop policies and procedures. - Train accountants on coding and work on

standardizing data inputs. - Begin collecting the data and work on reporting.


1504

Any questions on 1504 before we move onto 1502?


1502 Conflict Minerals

“Conflict Mineral” is a defined term in Dodd-Frank Act. Conflict Minerals are

– Gold – Columbite-Tantalie (Coltan) – Cassiterite – Wolframite – Any derivative of the above.


1502 Conflict Minerals

- ANY of these minerals from ANY area or country are “Conflict Minerals”

- If your product has gold in it, you are using a Conflict Mineral and are subject to the requirements on 1502. Gold is a “Conflict Mineral”

- Depending on where the gold in your product comes from, you will be subject to various levels of reporting.

- SEC estimates that 6,000 issuers will be impacted, with initial compliance cost of $3B to $4B.


1502 Really Simplified

Step 1: Do you manufacture (or contract to manufacture) a product that must contain gold, solder, tungsten (or other components made from a Conflict Mineral) ? If not, stop. Step 2 Perform a “Reasonable Country of Origin Inquiry” or RCOI. After this inquiry, did the gold (etc.) possibly come from the Congo (DRC) region? If not, FILE A FORM SD, then stop. If yes, continue. Step 3 Preform Due Diligence. File a FORM SD, obtain and audit, and disclose products that are not DRC conflict free, or (during a transition period), disclose DRC conflict undeterminable.



SEC estimates that 75% of Companies that have to file a form SD, will need to go all the way to Step 3, and file a report (and obtain an audit.)


1502 RCOI

Steps needed for “Reasonable Country of Origin Inquiry” are not defined. - Must be reasonably designed - Must be performed in good faith


1502 RCOI

If you must move on to the Third Step, then you must perform Due Diligence.

- Must use a nationally or internationally recognized framework.

- A framework for Due Diligence has been designed by the Organization for Economic Co-operation and Development (OECD Framework .)

- Audit is to ensure compliance with OECD criteria…not to determine if minerals are from a Conflict Area. (Similar to the objective of a 404(b) audit)


1502 Mining Companies

In a change from the proposed rules, mining companies will not have to make disclosures unless they also manufacture.

– FAQ clarifies that standard mining activities are not manufacturing


1502 Mining Companies

• Question: Instruction 1 to Item 1.01 of Form SD states that an issuer that mines conflict minerals would not be considered to be manufacturing those minerals for purposes of the rule. Does this Instruction exclude all of the activities customarily associated with mining from the rule? For example, gold mining of lower grade ore often involves, in addition to mining the ore, transporting the mined ore to a processing facility; crushing and milling the ore; mixing crushed/milled ore with cyanide solution; floating cyanide mixture through a leaching circuit; extracting gold from a leached circuit; melting leached gold, which is often referred to as smelting, into ingots or bars, which are often referred to as doré gold; and transporting the doré gold to refinery for refining process.

• Answer: Yes. An issuer that only engages in those activities customarily associated with mining, including gold mining of lower grade ore, is not considered to be manufacturing those minerals.


THANK YOU

Please call with any other questions for comments:

Jake Vossen, National Director of Audit and Accounting Hein & Associates LLP [email protected] 303-298-9600

From SEC's small business guide to Conflict Minerals


Buyer Beware: How Domestic Companies Get Stuck Paying the U.S. Tax Burden for Foreigners

Significance to the Energy Industry

• Raising capital from foreigners

• Payments to foreign vendors and service

providers

• Acquisitions and divestitures with foreign parties


Foreign Withholding - Exposure

• The U.S. mechanism for taxing foreign persons. • The responsibility for foreign withholding lies with the

U.S. person who is considered the “withholding agent”.

• Potential civil and criminal penalties can apply.


Penalties The exposure associated with non-compliance may include any under withheld tax, interest, and the following civil penalties:

Penalty IRC § Amount Failure to file correct information return 6721 $100/ea Failure to provide correct payee statement 6722 $100/ea Failure to File (e.g., Form 1042) 6651(a)(1) 5%/month Failure to Pay 6651(a)(2) 0.5%/month Failure to Deposit 6656 10% Accuracy related penalties 6662 20%


Classification of Payee

The payee should provide you with one of the following forms prior to payment:

• Form W-9 – With an EIN/SSN declaring they are a US resident

• Form W-8ECI – With an EIN declaring they are a foreign company doing business and paying taxes in the U.S.

• Form W-8BEN – This form indicates that they may be eligible for a reduction of withholding under the treaty if properly completed.


Classification of Income

• Effectively Connected Income (ECI) • Dispositions of U.S. Real Property - Foreign

Investment in Real Property Tax Act (FIRPTA) • Fixed or Determinable Annual or Periodical Income

(FDAP)


Effectively Connected Income (ECI)

Effectively Connected Income (ECI)

• U.S. Source income as defined by §861-863, 865 – “Asset-Use Test” - Income derived from assets used/held

for use in a U.S. trade or business. – “Business-Activities Test” – The activities of the U.S. trade

or business are a material factor in the realization of the income.

• Withholding rates: 39.6% ordinary, 20% capital (under §1446)

– Election under Reg §1.1446-7


Withholding Forms to file:

• Annual return for Partnership Withholding Tax - Form 8804, 8805

– Filing deadline: April 15th, Form 7004 extends to October 15th

• Required quarterly tax deposits using Form 8813 • Distribute Form 8805 to recipients


Foreign Investment in Real Property Tax Act

(FIRPTA)

FIRPTA • Withholding tax imposed on sales or exchanges of any US

real property interest (USRPI) by foreign party.

• What is a USRPI? – Land, land improvements – Buildings – Mines – Wells

– Other natural deposits – Stock in a US Real Property

Holding Corporation “USRPHC”

– Some US Partnership interests

• Withholding obligation lies with U.S. purchaser/transferee.

• Withholding is on 10% of the gross amount or fair market value of the USRPI.


FIRPTA (Continued) • What is a US Real Property Holding Corporation

(USRPHC)?

US Corporation is considered a USRPHC if: FMV USRPI . ≥ 50% FMV USRPI + Foreign Real property + trade/business assets IRC §897(c)(2)

Under the alternate valuation test a US Corporation is NOT considered a USRPHC if: NBV USRPI . < 25% NBV USRPI + Foreign Real property + trade/business assets IRC Regulation §1.897-2(b)(2)


U.S. Real Property Holding Corporation Example

Resident of Canada

U.S. Corporation

North Dakota Working Interest

FMV = $3M

Canadian Royalty Interest

FMV = $2M

15%

USRPI = $3M = 60% = USRPHC $5M

Resident of Canada

U.S. Corporation

North Dakota Working Interest

FMV = $3M Debt Secured by ND

Property = $2M

Canadian Royalty Interest

FMV = $2M

15%

USRPI = $3M - $2M = 33.3% ≠ USRPHC $3M


FIRPTA Exceptions

Exceptions to the general rule to withhold are:

• Public company exception for a USRPHC – • Stock is regularly traded on an established securities market, and • The foreign shareholder owns less than 5% on acquisition date.

• Personal residence sold for less than $300K.

• Withholding certificate - The amount required to be withheld cannot

exceed the transferor's maximum tax liability with respect to the transfer of a USRPI as determined by IRS. File Form 8288-B on or before the date of the transfer.


FIRPTA Forms to file:

• U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests- Form 8288, 8288-A

– File within 20 days of the transfer

• Application for Withholding Certificate – Form 8288-B – File on or before the day of transfer - IRS will respond by the

90th day after receipt


Fixed or Determinable Annual or Periodical Income

(FDAP)

Fixed or Determinable Annual or Periodical Income (FDAP) • All other income from a U.S. Payer – some examples

(§861,871,881): – Dividends – Interest – Compensation for Personal Services – Director Fees – Rental income – Royalties

• Withholding rate 30% (under §1441)


FDAP - Treaty Reduction of rates

• Many times, the rate of withholding can be reduced or eliminated under treaty.

• Treaty rates listed in IRS Publication 515, updated annually.

• Documentation required: properly completed Form W-8BEN, or Form 8233.

• There is no reduced rate for natural resource royalties.


Director Fee Considerations

• Location services are performed

• Reimbursed expenses and accountable plan requirements

• Method of payment (i.e. restricted stock, cash, options)


Services

Performed Outside the U.S. Performed Inside the U.S.

Exempt Regulation

1.1441.1(b)(4)(v)

Paid To Foreign Corporation/Branch NRA Individual

All Others

Engaged in U.S. Trade or Business

Not Engaged in U.S. Trade or Business

Not Engaged in U.S. Trade or Business

Subject to Withholding

Exempt Reg. 1.441-1(b)(t)(viii)

-4 (a)(1)

Subject to FDAP Withholding Reg. 1.1441-

4(a)(2)

Reduced or Eliminated by

Form 8233 Provided By

NRA

Subject to FDAP

Withholding

Obtain Form W8-ECI

No Form W8-ECI

Services Flowchart


IRS Audit Example - FDAP

In February of 2013 Form 1042 for 2010 is selected for audit and the following is discovered: • Payments of U.S. sourced income during 2010

totaled $300K. (Assume both were paid 12/31) • $100K Dividends (for a 4% owner) • $200K Royalty Payment (landowner)

• Canadian Undocumented recipients = 1 • Withholding = 0 • Forms 1042 and 1042-S filed = 0


IRS Audit Example – FDAP (Continued) • Received Form W-8 from dividend recipient

• With treaty benefits claimed under Article X.

Dividend withholding = $15,000 ($100K x 15%)

Royalty withholding = $60,000 ($200K x 30%)

Total amount underreported and under-withheld = $75,000


IRS Audit Example – FDAP (Continued)

• On May 5,2013 you receive the final Form 4549 with the Income Tax Examination Changes and your amount due is as follows.

Description Amount Tax Liability $75,000 Interest $5,440 Failure to deposit §6656 $7,500 Failure to file §6651(a)(1) $16,875 Failure to pay §6651(a)(2) $9,750 Penalty Interest $1,770 Failure to file form 1042-S $100 Failure to provide payee statement $100 Total Liability $116,535


FDAP Forms to file: • Annual Withholding Tax Return for U.S. Source Income of

Foreign Persons - Form 1042 – Filing deadline: March 15th, Form 7004 extends to

September 15th. • Annual Summary and Transmittal of Forms 1042-S, 1042-

T, 1042-S – Filing deadline: March 15th, Form 8809 extends 30 days

(automatic), 2nd extension for another 30 days (with permission in extreme cases).

– Distribute Form 1042-S to recipients. • Required tax deposits

– EFTPS, Frequency depends on amount due.


Foreign Account Tax Compliance Act (FATCA)

FATCA

What is FATCA – • Withholding under IRC §1471 on payments to certain foreign

financial institutions.

• Reporting specified foreign financial assets on Form 8938

• Intergovernmental agreements


§1471 Withholding

• Who is a withholding agent?

• What amounts are subject to withholding?

• Who is subject to withholding?

• What are the penalties for failure to withhold?


Form 8938

• Who is required to file: Individuals – Entities – pending regulations

• Reporting period – specified person’s taxable year. Reg. §1.6038D-2T(a)(9)

• Due date: return due date including extensions • Penalties: Reg. § 1.6038D-8T

– $10,000 – there is a reasonable cause exception. – Increase in penalties for continued failures to file after receiving

a notice: $10,000/month up to $50,000. – If you do not report income related to these assets the §6662

penalties apply and there are criminal provisions under this section.


Form 8938 Filing Thresholds

Filing Status Domicile

Value of foreign financial assets on the last day of the year > :

OR at any time during the tax year is >:

Single US $ 50,000 $ 75,000 Married Filing Joint US $ 100,000 $ 150,000 Married Filing Separate US $ 50,000 $ 75,000 Single Abroad $ 200,000 $ 300,000 Married Filing Joint Abroad $ 400,000 $ 600,000 Married Filing Separate Abroad $ 200,000 $ 300,000


Intergovernmental agreements

Under the Model IGA: • Foreign Financial Institutions (FFIs) will report

information on U.S. account holders to their national tax authorities, which in turn will provide this information into the U.S. under an automatic exchange of information.

• In addition, the U.S. will reciprocate and provide similar information related to foreigners with accounts in the U.S.


Questions?

Mei Lin Kis, Tax Manager Hein & Associates LLP [email protected] 303-298-9600

Patrick Hanley, Tax Partner Hein & Associates LLP [email protected] 303-298-9600


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