IRS Focuses on Employment Tax Issues During Tax-Exempt Organization Audits

By Robert Kaelber, J.D.

With tax filing season well underway, organizations of all sizes are beginning to identify areas of potential noncompliance and, for nonprofits, a common culprit is employment tax issues.
The IRS has emphasized employment tax compliance during its tax-exempt audits for many years. As we’ve noted in multiple prior Nonprofit Standard blog posts (see “IRS Issues 2017 Work Plan for Tax Exempt Organizations” and “UBI Issues: Is Your Organization at Risk?”), the IRS has officially stated that this employment tax focus will continue into 2017. In the IRS’ Tax Exempt and Government Entities FY 2017 Work Plan, which details its priorities and mission for the coming year, the IRS disclosed that more than 25 percent of closed audits had a “primary issue” related to employment tax. At the end of June 2016, 1,323 audits involved primarily employment tax issues, out of a total 4,984 closed examinations. Further, the IRS continues to include employment tax issues within its list of high-risk areas of noncompliance.

The IRS states in its 2017 Work Plan that, “Employment Tax includes unreported compensation, tips, accountable plans, worker reclassifications and noncompliance with FICA, FUTA and backup withholding requirements.” While this definition covers a wide range of areas, our experience with IRS employment tax audits and associated information document requests (IDRs) indicates that likely issues for review may include, but are not limited to, the following:

• Expense reimbursements and accountable plan compliance;
• Fringe benefits (e.g., relocation/moving, automobiles, group term life, cell phone reimbursement, prizes/awards, spousal travel and education benefits);
• Independent contractor classification and income reporting;
• Supplemental pay reporting and processes, including timing of wage inclusion for various tax and wage types (including retirement pay and incentives);
• Form W-9 process, Form 1099 TIN matching procedures and backup withholding compliance;
• Forms W-2c and 941-X processes;
• International cross-border employment tax issues; and
• General compliance procedures for employment tax filing obligations.

The IRS appears to be trying to streamline its processes for audit target identification, focusing on increasing efficiency as it works with fewer resources. As such, the agency has implemented a “data-driven case selection process,” and is seeking new ways to identify data that can indicate patterns of noncompliance. Other 2017 IRS priorities include working to develop an employment tax knowledge database (the “Employment Tax K-Net”) to track and disseminate what is learned during audits, and to use it to further train employees in this area. It is likely that with enhanced training, IRS examiners will more readily identify more complex potential employment tax issues for review rather than merely focusing on the “low hanging fruit.”

Based upon the IRS’ continued focus on employment tax issues, it is imperative that tax exempt entities review their policies and processes and invest in initiatives and resources to ensure compliance. Organizations should also document all policies and processes so that they may readily demonstrate upon audit that IRS compliance protocols are followed. Being proactive and completing an internal employment tax process review or even a “mock audit” may help to identify issues and result in the early implementation of corrections before the IRS is involved. Failure to comply with employment tax reporting obligations can result in the imposition of significant tax, penalties and interest. Additional wage inclusion due to employment tax noncompliance could also trigger further questions from the IRS pertaining to inurement or private benefits.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

PROPTECH – IS 2017 THE YEAR THINGS CHANGE FOR THE PROPERTY INDUSTRY?

By Ian Shapiro

Technology has been a disruptive force in most industries and sectors over recent years. But in the real estate and construction (REC) sector, widespread adoption of new technologies has lagged somewhat. Indeed, the adoption of technology in property – or ‘PropTech’ – has fallen a little short of its anticipated take-up. For example, in the U.S., the construction industry is several years behind many other industries with regards to technology with many companies still using manual systems for project planning and management. That’s why construction remains far behind in reaping the benefits of advanced data and analytics, drones, automation and robotics.

However, 2017 is set to be the year the floodgates open for PropTech in the global REC sector, and we’ve looked at some key technologies you should be keeping an eye on in the industry this year.

The Widespread Use of Drones

Drones have been in the news for various reasons recently – both good and bad. Thankfully, they are being put to good use in the construction industry and we’re seeing things get far more efficient on projects because of them. They can be used during surveys to check the condition of hard to reach places and can be equipped with lenses that are able to read serial or model numbers, meaning that surveys can be performed in detail.

Drones not only save time (and therefore money!) but also improve safety for construction workers. For example, a roof survey would normally involve human workers climbing onto the roof, which naturally involves considerable risk. By using drones, construction companies are able to bypass this risk, without losing much, if anything, in the way of accuracy.

For this reason, we are now seeing a wider adoption of drones by construction companies. However, the popularity of this technology has had the knock-on effect of bringing in increased regulation: aviation authorities around the world have introduced regulations for drones because of perceived privacy and security concerns, with many countries now demanding licenses or permits to use drones for certain activities or around important landmarks.

Virtual Reality – From Gimmick to Legitimate Tool

The use of virtual reality (VR) in property is already a $1 billion global industry and Goldman Sachs estimates that it is set to treble by 2020. VR has its obvious uses in the real estate sector: for example, VR is used for sales and marketing in the prime residential market, where investors often live miles away from the properties they want to view.

VR is also viewed as the next phase of Building Information Modeling (BIM), and as an enhancement to computer-aided design (CAD): developers can use VR to create more realistic and detailed renderings, which are now transitioning into virtual reality walkthroughs.

Certainly, 2017 will see virtual reality transition from gimmick to a legitimate tool across the REC sector as the emergence of VR headsets, interactive hand controllers and movement sensors revolutionize how designers and contractors experience the construction process.

The Cloud and Real‑Time Data

Increasingly, supervisors are turning to the cloud and real-time data to stay abreast of construction jobs. With the help of smart devices, such as an iPad or an iPhone, foremen and supervisors can follow a project in real time and identify specific “milestones” that can be checked off as a job progresses, causing invoices and payments to vendors or subcontractors to automatically generate accordingly.

Smart Tech for Smart Buildings

The term “smart building” has been in use for some time but smart technology is now making a real impact on the real estate sector. Buildings are now designed to be “smart,” which is making tenants’ and property managers’ lives easier.

By using smart devices to control things like heating and lighting, residents can decrease their bills and energy waste. Similarly, elevators can be programmed to reduce usage and automatically tell building managers when they need to be serviced. Here, PropTech is not only improving efficiency but also safety.

Robots in Real Estate

The construction industry has yet to really adopt robotics although human-controlled machine equipment is widely used. The use of robots for high-precision activities is not new (consider welding or vehicle painting) but advances that allow robots to “see” via sensors mean that robots can now be used to perform previously human-only tasks, such as “couriering,” cleaning or gardening in hotels, warehouses or office buildings. I was recently given a coffee by a robot at a PropTech conference!

Cyber Attacks Drive Interest in Security

In construction, cybersecurity issues are only now making an impression but in real estate, it is a real issue, especially as buildings become increasingly “smart” and therefore vulnerable. Thanks to the Internet of Things, everything down to your Christmas tree lights can now be controlled electronically; thus, buildings are becoming the new target of cyber attacks.

The use of ransomware is increasing and becoming more targeted to property. In recent years, it was claimed hackers stole the blueprints to Australia’s secret service agency HQ, presenting obvious terrorist threat concerns. It is therefore understandable that landlords and building owners would be concerned for the security of their assets, and must work with cybersecurity experts to protect their business.

Given the REC industry’s poor track record on innovation and the adoption of new technologies, tools and approaches, governments, developers and deliverers need to invest collectively to achieve these shared goals and future-proof the industry. In order to achieve this, firms need to develop digital road maps, appoint dedicated staff to think boldly about the digital agenda and partner with technology firms. BDO recently took a huge step toward this by partnering with Microsoft (read press release here).

This is the digital age of collaboration, and the industry will soon come to realize that digital tools can be more powerful than the ones in a rusty toolbox. We all need to embrace this catalyst for change to attract a new generation of talent.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Summer 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

The Importance of Civic Reach

By Lewis Sharpstone, CPA
Ensuring sustainability is a top priority for almost every nonprofit organization. But one sometimes overlooked piece of the sustainability puzzle is managing critical external relationships and ensuring their longevity. This is especially important in a climate characterized by pervasive change. As we’ve covered in our Nonprofit Standard blog posts, executive retirements are impacting nonprofits of all sizes as leaders age, many of whom have tenured long careers at their organizations. The industry is also seeing an uptick in merger and acquisition (M&A) activity aimed at consolidating costs, back-office and administrative functions, and building efficiencies to expand scope and reach. How new priorities in the executive branch will impact charitable organizations is also a big unknown.

Whether an organization is approaching succession planning, post-merger integration or other organizational transition, or simply examining its long-term sustainability, it’s important to invest in key relationships.

Paul Vandeventer, CEO of Community Partners, describes this concept especially well with what he’s coined “The Civic Power Grid.” He defines an organization’s civic reach as “the essential third leg of a nonprofit board’s sustainability platform,” with fundraising and governance as the first and second legs. As Paul explains, the term “civic reach” refers to an organization’s ability to develop, maintain and grow relationships with individuals who have influence over resources across the sectors in which it operates.

Most nonprofit executives can attest that a grant proposal is received differently when you have a relationship with the program officer who receives it. Similarly, consider how your views about a regulatory issue might be taken when you already have a relationship with the official listening to you. What about how an influential person might look at an invitation to join your board when the board is already home to well-connected and influential members?

While building civic reach may sound like mere networking, Vandeventer contends it’s much more important than that. It’s essential that every organization have a sustainability plan. See Laurie De Armond’s, partner and national co-leader of BDO’s Nonprofit & Education practice, article on page 1 discussing this topic in detail. Her advice was that “To prevent gaps in relationship management during an executive transition, organizations can encourage shared ownership and an open flow of information so that key relationships don’t become siloed with one individual.” Extending an organization’s civic reach is an often-forgotten, but essential, element of building a sustainable enterprise. In this article from Stanford Social Innovation Review’s archives, Vandeventer dives deeper into the concept of civic reach and gives plenty of examples illustrating how increasing civic reach led to great results.

Over the course of my career working with nonprofit organizations, I’ve met a host of inspiring and remarkable people. While they built well-respected organizations that carry on wonderful and impactful legacies in the communities they served, many didn’t devote resources to building ties with the wider community and may have been able to leverage their connections for even more meaningful results if they had invested in civic reach.

To illustrate what civic reach can do for an organization, let’s consider a nonprofit in my area that was facing foreclosure. When we were first engaged to work with them, we were able to stave off foreclosure on a temporary basis, buying the organization time. Three years later, though, when the financial issues bubbled up again, they had cultivated a strong civic reach. They engaged local and even some national politicians, businesspeople and community leaders to advocate against foreclosure—and it worked. A favorable long-term loan, a win-win for the organization and the bank, was put in place and the nonprofit is now moving from uncertainty to strength. I am convinced that leveraging the increased civic reach of this organization is the only thing that could have achieved this result.

Here you can find a self-assessment tool to identify gaps and target areas for growth, which will help you put in place a specific plan to increase your organization’s civic reach. Happy “reaching!”

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

IRS Stresses New Processes at Annual Tax Exempt and Government Entities Meeting

By Laura Kalick, JD, LLM in Taxation

The 2017 Internal Revenue Service (IRS) Joint TE/GE (Tax Exempt and Government Entities) Council Meeting was held in Baltimore in February. These annual meetings were designed to maintain open communication between practitioners and the IRS TE/GE Division. Attendees include members of the five regional TE/GE Councils. Each regional council is comprised of two subgroups: Exempt Organizations (EO) and Employee Plans, and includes representatives from the legal, accounting, consulting and in-house EO community. This year, the theme of the meeting, in keeping with the message IRS TE/GE Commissioner Sunita B. Lough included in the 2017 Tax Exempt Work Plan, focused on transparency, efficiency and effectiveness.

As we have previously reported, the IRS, and especially the Exempt Organizations division, is working with fewer resources and, with additional budget cuts looming, this challenge will likely persist. Lough reported that the workforce is down by 20 percent, requiring the division to find new ways to work efficiently, including more targeted examinations, information requests and the use of digital communications.

Commissioner Lough said the IRS does not want to burden organizations that appear to be tax compliant and is, therefore, making examination decisions based on red flags in an organization’s Form 990. In addition, the IRS may even be obtaining data from individuals associated with organizations to see if there are private inurement or private benefit indicators. To make their process more efficient, the IRS will combine the data mining and research staff into one compliance-focused unit. The commissioner indicated that this is a dynamic effort, and mentioned the agency is constantly tweaking its processes to gain better results.

Lough noted that, like other government agencies, the IRS has a hold on regulations based on President Trump’s recent “one in, two out” executive order. Since there is currently no Assistant Secretary for Tax Policy, there is no one to administer which two regulations will be eliminated to promulgate a new one. Despite this hold, the IRS is still implementing new procedures for exempt organizations.

New Audit Process for Information Document Requests (IDRs)

The commissioner indicated there is a new audit process in place for information gathering once an organization has been identified as having a specific audit issue (or issues). Under the new process, the IRS and the organization will discuss the issues and the information needed before the IRS sends the Information Document Requests (IDRs) and the IRS will provide the organizations with a timeline to respond to the requests. Issue identification before the IDRs are sent represents a major procedural breakthrough for both the IRS and exempt organizations. In the past, even though both sides knew what issues were at play, the IRS would bombard the organization with multiple IDRs (sometimes in the hundreds) that would cause an audit to last for extended periods of time. Also, many IDRs were duplicative and requested information that was possibly irrelevant.

With the new process, it appears that the IRS will be flexible in granting extensions to provide the information, if an organization has good cause to request one. However, if an extension is granted, the IRS will expect the response to come by the extended deadline. Additionally, the IRS is making a commitment to respond to information it receives in response to an IDR in a reasonable time frame.

In April 2017, the IRS will also implement a new process for those organizations that do not respond to IDRs on time. If the organization does not respond within the given time period, the IRS will issue a notice of deficiency. If the IRS still does not receive the documents in time, including extensions, a summons will be issued. The goal of this process is to ensure issues are addressed in a transparent and timely fashion.

Digital Communication

Commissioner Lough also discussed a trial test of digital communications. The IRS will be testing a process for sending IDRs through secure messaging, rather than through “snail mail,” which could also save time.

She also indicated that they are testing electronic return readers that remove personal information, allowing the information from Forms 990 to be online faster. The Form 1023-EZ information is now available online, so a Freedom of Information Act (FOIA) request is no longer required to obtain the application. The IRS will also create a section on the Form 1023-EZ where the organization will input an explanation of the exempt purpose.

Another advancement is that the Form 990-EZ now has 29 electronic help icons that will hopefully reduce the errors on this return. Currently, the paper-filed Form 990-EZ has an error rate of 34 percent. Under new procedures, if a return is not complete, it will be sent back to the organization and will not be considered filed and the organization will have to refile. The IRS is hoping that the new electronic form will lower the error rate and encourage organizations to ensure all necessary information is included on the form so it is not returned by the IRS.

Final Note

Recent Statistics of Income published for Tax Year 2012 showed that over 46,000 tax-exempt organizations filed a Form 990-T with the IRS that year, and over half of those organizations did not report unrelated business income tax liability after subtracting deductions from gross unrelated business income. The new procedures and initiatives that the IRS is implementing should help address this issue, and others.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

PErspective in Manufacturing

A feature examining the role of private equity in the manufacturing sector.

As the healthcare industry embraces value-based payment models and providers evolve their business models to focus on outcomes, they’re looking to achieve more with less and optimize productivity. All the while, new technologies and automation are opening the door for innovation in manufacturing facilities across industries and enabling faster, smarter production—which is particularly good news for manufacturers serving the healthcare and life sciences industries.

Medical devices are subject to stringent guidance and jurisdictional regulations–and that brings up costs and liability in spades, including false claims liability, potential recalls and costly subsequent regulatory approvals. More compliance changes, including potential reductions in regulation, could be on the horizon. In March, President Trump nominated Scott Gottlieb (former senior fellow with The BDO Center for Healthcare Excellence & Innovation) to FDA commissioner, whose confirmation at press time was pending final Senate vote. Industry change opens opportunities for private equity firms to invest in medical device manufacturers to help them leverage new technologies, streamline processes and achieve cost savings in the face of a turbulent regulatory environment.

Several notable private equity deals and bids emerged recently in the medical device and pharmaceutical manufacturing sectors, including:

  • MedPlast Inc., a global services provider in the medical device industry backed by private equity firms JLL Partners and Walter Street Healthcare Partners, will acquire Vention Medical’s device manufacturing services in a deal expected to close in the second quarter, reports PE Hub. Terms of the deal were not disclosed. According to a press release, the acquisition will more than double MedPlast’s size. The company aims to expand its capabilities in assembly and packaging with the acquisition and increase its global footprint to 22 manufacturing facilities.
  • European private equity firm EQT Mid Market bought conveyor manufacturer Dorner Holding Co. from Pittsburgh-based private equity firm Incline Equity Partners, the owner since June 2012. The deal closed on March 15 and terms were not disclosed. Dorner services the medical and pharmaceutical industries, as well as packaging and food handling. EQT Mid Market targets companies with strong market positions and potential for global growth in the middle market and plans to grow Dorner organically and strategically, according to Milwaukee Business News.
  • On the pharmaceutical manufacturing side, German drug maker Stada Arzneimittel AG has found itself in a red-hot bidding war. Private equity firms Advent International Corp., Permira, Cinven Ltd. and Bain Capital made offers, with Chinese company Shanghai Pharmaceuticals Holding Co. reportedly showing interest as well. Bloomberg reports Stada’s shares have rallied nearly 70 percent in the past year to $55.81, including a jump in mid-February of 13 percent in a single weekend. In an effort to draw in bigger buyout offers, the company has laid out numerous cost-cutting measures, including optimizing its supply chain management and procurement process, reports FiercePharma.

Future PErspectives: What’s Up Next for Manufacturing Investors

President Trump has connected with cabinet members and members of the business community recently to discuss his infrastructure plan, which will likely lean on public-private partnerships, according to Axios. Building materials, steel and equipment manufacturers who’d be tapped for bridge-and-tunnel infrastructure projects could be primed for investment. Axios also reports digital infrastructure could be a focus of the plan, including rural broadband access, meaning opportunities could emerge for investment in manufacturers of mobile and digital infrastructure.

This article originally appeared in BDO USA, LLP’s “Manufacturing Output” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Supporting Organizations Could Be Putting Their Charity Designation at Risk

By Rebekuh Eley, CPA MST

Supporting organizations have been the subject of scrutiny over the last few years, from the Pension Protection Act in 2006, to Treasury Regulations in 2012 and 2015, to additional disclosure requirements to Form 990 Schedule A in 2014.

Supporting organizations, particularly those of grant-making foundations, are left wondering if their current activities will fall within these published rules. The consequences for not falling within these rules includes an organization being treated as a private foundation instead of a public charity. These organizations would be subject to excise taxes on investment income and would need to abide by stricter operational requirements.

Supporting organizations achieve public charity status by passing four tests, including an organizational test, operational test, relationship test and a control test. For the organizational test, an organization must be organized and operated exclusively for the benefit of, to perform the function of, or to carry out the purposes of one or more specified organizations described in IRC section 509(a)(1) or (2). The organization must also be operated, supervised, or controlled by or in connection with one or more organizations described in IRC section 509(a)(1) or (2). The control must not be direct or indirect by disqualified persons (other than foundation managers or organizations described in IRC sections 509(a)(1) or (2)).

Additionally, a supporting organization must fall into one of three relationship categories: operated, supervised, or controlled by a supported organization (Type I parent-subsidiary); supervised or controlled in connection with a supported organization (Type II, brother-sister) or; operated in connection with, one or more publicly supported organizations (Type III). The relationship must ensure that the supporting organization is responsive to the needs or demands of the supported organization(s), and the supporting organization will constitute an integral part of, or maintain a significant involvement in, the operations of the supported organization(s). Control is determined through the facts around the organizing documents, operations, and relationship between the supporting organization and the supported organization(s).

Many Type I and II supporting organizations do not make grants to the controlling organization, but rather make grants to other organizations that address the charitable purpose of the controlling organization. This commonplace industry practice could risk failure of the operational test. A supporting organization can only support or grant funds to an organization that is specified within its organizing documents. The rules on how to determine what is a “specified organization” are very complex and can be found in Treasury Regulation 1.509(a)-4(d). Specified organizations may be identified by designating an organization by name or by a charitable class that aligns with the mission of the controlling organization. If the supporting organization provides grants to organizations other than the controlling organization, the organizing documents should designate a supported organization by class rather than by name. The strict requirements for designating a supported organization by class are also found in the Treasury Regulations. This type of designation requires additional disclosures on the supporting organization’s Form 990 Schedule A, which may be scrutinized by the IRS.

Now is a good time to look at a supporting organization’s operations and confirm they are aligned with the governing documents, and grants made properly. If the organizational documents and operations are not aligned, the supporting organization may have to act intentionally to prevent private foundation status.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

The Role of CFIUS in Cross-Border Manufacturing M&A

By John Lash

Since the end of World War II, the United States has maintained and enjoyed an open posture toward foreign investment. In 2016, it remained the largest recipient of foreign direct investment (FDI) globally, with an estimated inflow of $385 billion—a marked 11 percent increase from the year prior. 1 Much of this amount stemmed from several multibillion-dollar cross-border merger and acquisition (M&A) deals, whose total value had increased 17 percent from the 2015 levels.

While foreign buyers remain plentiful and varied, China—with its sights are still set on getting a strategic foothold in the U.S.—is likely to continue to be one of the U.S.’ largest investors, a development that has prompted some national anxiety. National security is an ever-present priority for the U.S. government. As foreign deal-making increases, so will the regulatory scrutiny of cross-border transactions.

The CFIUS Review Process

A critical element of FDI is the involvement of the Committee on Foreign Investment in the United States (CFIUS). Chaired by the U.S. Secretary of the Treasury, this interagency task force is responsible for the review of FDI that could result in the control of a U.S. business or U.S. critical infrastructure—defined as “a system or asset, whether physical or virtual… vital to the United States”—as well as the impact these transactions could have on national security. 2

While CFIUS review is not a mandatory process, many companies involved in cross-border deals will voluntarily notify CFIUS and initiate a review to gain the benefits of a safe harbor provision. This provision prevents future government challenges to the transaction, including unwinding it or requiring mitigating actions, should the review be cleared successfully. The review process includes up to three stages. The first stage begins with a 30-day initial assessment period, at which point a determination can be made. If unresolved concerns remain, the committee may initiate the second stage, a 45-day investigation period. Should that yield unsatisfactory results, a 15-day presidential review period begins, with the president rendering a final decision. Actual presidential decisions are rare, with only two transactions blocked during the Obama administration. Rather, most transactions are approved, adapted to mitigate CFIUS’ concerns or withdrawn by the parties if they suspect that the transaction will not be approved.

Cross-Border Manufacturing M&A

CFIUS filings have steadily increased over the last eight years, with manufacturing companies consistently representing the largest share of any industry since 2010. According to the most recent publicly available data, 69 manufacturing companies filed notices with CFIUS in 2014, comprising nearly half (47 percent) of all filings. Per the table to the right, the majority of notices within the manufacturing industry have come from the computer and electronic product, machinery and transportation equipment sectors.

When evaluating manufacturing M&A transactions for potential national security conflicts, there are several issues to consider. Manufacturers are vulnerable to national security risks ranging from physical facility security—including the security of facilities that produce key elements or products for defense, transportation or energy infrastructure—to location security, such as the proximity to military installations. Other major risks include those that may undermine U.S. and global supply chain reliability and security, as well as global trade compliance. Cybersecurity—and cyber espionage, in particular—is also top of mind, with concerns about threats from nation-state actors on the rise. FDI that involves the critical manufacturing sector—defined by the Department of Homeland Security as those manufacturing industries that are the most crucial for the continuity of other critical sectors and have significant national economic implications—is especially susceptible to scrutiny.

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The Future of CFIUS

With the current administration’s heightened focus on national security and its stated “America First” platform, CFIUS could play a larger role in cross-border M&A activity in the year ahead, with potentially more stringent reviews and/or an increased use of mitigation measures. The practical guidance for identifying factors which constitute a national security risk may also be broadened to include economic security, a net U.S.-benefit test. At his January confirmation hearing, Treasury Secretary Steven Mnuchin discussed using CFIUS as a tool for “protecting American workers.”

The administration’s decisions regarding global trade partnerships—including its decision to withdraw from the Trans-Pacific Partnership (TPP) and promises to renegotiate the North American Free Trade Agreement (NAFTA)—may also lead to heavier scrutiny of deals proposed by geopolitical rivals versus those from “friendly” nations. These shifting relationships may also affect if and how the U.S. chooses to participate in parallel national security reviews with other countries. In addition, reciprocal market access may become a greater consideration factor in CFIUS review, with countries that do not “reciprocate,” or allow comparable U.S. investment in the same sector, facing more difficulties in obtaining CFIUS approvals than those who do.

Regardless of what lies ahead, manufacturers must be cognizant of how an M&A transaction may impact the reliability, availability and integrity of their resources, production activity and intellectual property, as well as any direct or indirect impacts on critical infrastructure. And to avoid a compliance bottleneck, manufacturing organizations (and their potential buyers) must proactively address potential national security risks so as to reduce the security optics of the transaction.

 

1 Global Investment Trends Monitor: February 2017 (Vol. 25, Rep. No. 25). (n.d.). United Nations (UNCTAD). Retrieved from http://unctad.org/en/PublicationsLibrary/webdiaeia2017d1_en.pdf

2 Lash, J. (2016, June 6). National Security a Top Priority in Cross-Border Deals. Retrieved from http://www.themiddlemarket.com/news/business_services/national-security-a-top-priority-in-cross-border-deals-260721-1.html

CFIUS Red Flags

What constitutes a national security threat? U.S. businesses that may come under CFIUS scrutiny include those that:

  • Are in the defense, security and national security-related law enforcement sectors.
  • Provide products and services to the government with potential security or defense applications.
  • Constitute “critical infrastructure,” e.g., energy production, telecom or transportation.
  • Have access to classified or sensitive government information.
  • Engage in activities subject to U.S. export controls.
  • Are in proximity to U.S. government facilities.

This article originally appeared in BDO USA, LLP’s “Manufacturing Output” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Middle Market Manufacturers: Surprisingly Suited to Capitalize on IoT Advantages?

By Eskander Yavar

Manufacturers are waking up to the Internet of Things (IoT) opportunity. According to BI Intelligence, companies will spend nearly $6 trillion on IoT solutions in the next five years, and by 2020, 24 billion devices will be IoT-enabled. Whether you’re a large-scale global manufacturer or a middle market company in growth mode, the IoT holds promise. While middle market companies may be slower on the adoption curve than their larger competitors, they have a critical opportunity to drive innovation and evolve as IoT leaders rather than followers.

Manufacturing Industry in Growth Mode

With the new administration in Washington and an expected pro-business agenda, anticipation is high for growth in the manufacturing industry. According to the NAM Manufacturers’ Outlook Survey, more than 93 percent of manufacturers feel positive about their economic outlook, up from 78 percent in December. With opportunities for growth within reach, middle market manufacturers will need to shift focus to battle competition and differentiate in the market. We expect an uptick in deal flow and capital investment, and for many manufacturers, investing in the IoT may be just the competitive edge they need.

IoT Adoption Is Increasing, But Strategy Isn’t Keeping Pace

In the new MPI Internet of Things Study, sponsored by BDO, we found that global manufacturers are making significant progress toward IoT integration. Over half of the 374 manufacturers surveyed characterize themselves as IoT-competitive companies, and 14 percent say they’re IoT leaders. IoT-enabled manufacturers are also seeing impressive returns on their investments: 72 percent increased their productivity and 69 percent increased their profitability in the last year by applying the IoT to plants and processes.

Despite the advantages reported, 40 percent of manufacturers do not yet have a strategy in place to apply the IoT to their processes. Whether your organization lacks an IoT strategy, or is in the midst of putting one into action, there are critical components that should be considered in the early stages. For example, our study found that most manufacturers are missing opportunities to take advantage of research tax credits and build in security features. But middle market manufacturers are uniquely positioned to move on the IoT with the right strategy, people, processes and technology to maximize their advantage.

“Crawl-Walk-Run” Mentality Applies to Technology

It’s no secret that middle market companies have to be wise about how they spend and invest. When it comes to the IoT, middle market companies are too big to ignore it, but must avoid mistakes and missteps they can’t afford. Middle market companies often take a measured approach to embracing new technology. That means investments are often more carefully planned and staged, boding well for success. For executives looking at the IoT, it’s critical to confirm your proposed use cases for the technology will align with your business objectives and drive value. It’s critical to first ensure you have the underlying technology and management systems to enable the IoT, understand its performance and measure KPIs that increase value, margins, sales and shareholder value. You can’t build an effective 21st century technology rollout on 1980s software and systems.

Middle Market Characteristics Create IoT Advantages

Once those initial questions are addressed, middle market manufacturers can capitalize on some of the benefits of their size and market position relative to larger competitors. First, they are nimble and able to get buy-in on transformative projects because change leaders have more access to and attention from the C-suite and board. Projects can move faster because they are one of a few, rather than one of hundreds. Finally, middle market companies have had the benefit of observing competitors’ IoT adaption and can now apply lessons learned and cost-saving strategies to their own initiatives.

But that doesn’t mean manufacturers should charge forward without laying the necessary foundation. Our study found that less than half of manufacturers are considering cybersecurity at the product conceptualization and design stage, missing opportunities to build in security at the ground level. And 58 percent of manufacturers are not planning to claim tax credits and incentives available for IoT investments, meaning many are leaving money on the table that could help fund innovation.

IoT adaption is a marathon, not a sprint. Middle market manufacturers are well-positioned to unlock IoT’s potential given their steady strategic approach and flexibility if they ensure the right systems are in place and the use cases are aligned with value.

This article originally appeared in BDO USA, LLP’s “Manufacturing Output” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Construction – Did You Know?

According to an Associated General Contractors of America survey, 73 percent of construction companies surveyed plan to hire new employees in 2017.

In the fourth quarter of 2016, home price gains accelerated in 89 percent of U.S. metropolitan areas, according to the National Association of Realtors.

Overall construction spending in 2016 was 4.5 percent higher than the prior year, according to the Commerce Department.

The data center and specialty REIT sectors outperformed the S&P Index’s 1.9 percent total return rate in January 2017, delivering returns of 8.05 percent and 9.42 percent respectively.

Total construction employment in January increased 2.6 percent from January 2016, or approximately 170,000 jobs year over year, the Associated General Contractors of America reported.

Cross-border transactions in the real estate industry accounted for $65.5 billion in sales—a decline of one-third from 2015 levels, but up from just $43.1 billion in 2014, according to Real Capital Analytics.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com