ASU 2016-14 – Liquidity and Availability Disclosure Issues

By Tammy Ricciardella, CPA

As calendar-year-end nonprofits have worked through the implementation of Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, we have seen quite a bit of diversity in the preparation of the liquidity and availability disclosure required by the ASU.

To improve the ability of financial statement users to assess a nonprofit entity’s available financial resources and the methods by which it manages liquidity and liquidity risk, the ASU requires specific disclosures including:

  • Qualitative information that communicates how a nonprofit entity manages its liquid available resources to meet cash needs for general expenditures within one year of the statement of financial position (balance sheet) date
  • Quantitative information that communicates the availability of a nonprofit’s financial assets to meet cash needs for general expenditures within one year of the statement of financial position date. Items that should be taken into consideration in this analysis are whether the availability of a financial asset is affected by its (1) nature, (2) external limits imposed by grantors, donors, laws and contracts with others, and (3) internal limits imposed by governing board decisions

The following information can be displayed either on the face of the statement of financial position, or in the notes to the financial statements, unless otherwise required to be on the face of the statement of financial position:

  • Relevant information about the nature and amount of limitations on the use of cash and cash equivalents (such as cash held on deposit as a compensating balance)
  • Contractual limitations on the use of particular assets. These include, for example, restricted cash or other assets set aside under debt agreements, assets set aside under collateral arrangements or assets set aside to satisfy reserve requirements that states may impose under charitable gift annuity arrangements
  • Quantitative information and additional qualitative information in the notes, as necessary, about the availability of a nonprofit’s financial assets at the statement of financial position date

An entity can provide additional information about liquidity in any of the following ways:

  • Sequencing assets according to their nearness of conversion to cash and sequencing liabilities according to the nearness of their maturity and resulting use of cash
  • Classifying assets and liabilities as current and noncurrent
  • Disclosing in the notes to financial statements any additional relevant information about the liquidity or maturity of assets or liabilities, including restrictions on the use of particular assets

Liquidity is defined in the Accounting Standards Codification (ASC) Master Glossary as “an asset’s or liability’s nearness to cash. Donor-imposed restrictions may influence the liquidity or cash flow patterns of certain assets. For example, a donor stipulation that donated cash be used to acquire land and buildings limits an entity’s ability to take effective actions to respond to unexpected opportunities or needs, such as emergency disaster relief. On the other hand, some donor-imposed restrictions have little or no influence on cash flow patterns or an entity’s financial flexibility. For example, a gift of cash with a donor stipulation that it be used for emergency-relief efforts has a negligible impact on an entity if emergency relief is one of its major programs.”

Based on this definition, an entity will have to carefully look at its assets and consider any donor-imposed restrictions that may exist when determining the presentation of liquidity.

A simple measure of liquidity per the ASU is the availability of resources to meet cash needs for general expenditures within one year of the date of the statement of financial position. The ASU does not define general expenditures but does provide some suggestions regarding limitations that would preclude financial assets from being available for general expenditures. Some of these items noted in the ASU include:

  • Donor restrictions on the use of assets for particular programs or activities
  • Donor restrictions on the time period in which assets are used
  • Board designations that commit certain assets to a particular purpose
  • Loan covenants that require certain reserves or collateralized assets to be kept on hand
  • Compensating deposit balances required by financial institutions

To provide the liquidity and availability disclosure, entities should likely consider combining both a narrative description of their method for managing revenue with donor restrictions and a table that lists the dollar amounts expected to be released from various sources. Entities should develop a liquidity management program that allows them to determine what portions of donor restricted funds will be released from restriction and available for both direct program costs as well as shared expenses that support those programs.

In addition, entities should have a program in place to assess what resources are available. These should only include the portion of funding commitments that are expected to be received in the next year. To assist in this determination, as well as the overall liquidity management, entities should consider utilizing a rolling cash flow projection that covers at least a 12-month period.

Entities should also provide, in the qualitative component of the disclosure, information about other methods they use to manage liquidity and maintain financial flexibility. Examples of these could include:

  • The use of lines of credit
  • Established operating reserve policies
  • Cash management process

It is important to develop this disclosure to present an accurate picture of the liquidity and availability of resources utilizing both financial information and supporting narrative to fully explain the financial health of the organization.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

Presentation of Restricted Cash and Cash Equivalents in the Statement of Cash Flows

By Amy Guerra, CPA

Historically there has been diversity in practice among nonprofits with regard to presentation of restricted cash and cash equivalents in the statement of cash flows.

To address this diversity, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016‑18, Statement of Cash Flows (Topic 230): Restricted Cash. As a result of this ASU, a nonprofit will be required to present the total change in cash, cash equivalents, restricted cash and restricted cash equivalents for the period covered by the statement of cash flows. Thus, cash flows that directly affect restricted cash will be presented in the body of the statement of cash flows regardless of how they are classified in the statement of financial position and the timing of the establishment and release of the restrictions.

The ASU does not define restricted cash and restricted cash equivalents, so how a nonprofit defines these will not be impacted. What will be impacted is how these amounts are presented in the statement of cash flows. Oftentimes, a nonprofit will have these items presented in separate lines throughout its statement of financial position and may not even have them labeled as restricted cash or restricted cash equivalents.

Under the ASU, a nonprofit will show the net cash provided by or used in the operating, investing and financing activities of the nonprofit and the total increase or decrease as a result of these activities on the total of cash, cash equivalents and amounts considered restricted cash and restricted cash equivalents.

Internal transfers between cash and cash equivalents and amounts considered restricted cash and restricted cash equivalents are not deemed to be operating, investing or financing activities and thus the details of any transfers would not be presented in the statement of cash flows.

If a nonprofit identifies cash, cash equivalents, restricted cash and restricted cash equivalents in separate lines in the statement of financial position, these amounts should reconcile to the statement of cash flows. The nonprofit needs to present a reconciliation of the various cash and cash equivalents line items presented in the statement of financial position that shows the total that is presented in the statement of cash flows for each year presented. This reconciliation can be presented either on the face of the statement of cash flows or in the notes to the financial statements. The disclosure may be either in narrative or tabular format. The requirement to provide this reconciliation will allow users of the financial statements to identify where the restricted cash and restricted cash equivalents are included in the statement of financial position and how much is included in these line items.

In addition, a nonprofit must disclose information about the nature of the restrictions on its cash and cash equivalents.

For those nonprofits considered public business entities because they have issued or are a conduit bond obligor for securities that are traded, listed or quoted on an exchange or an over-the-counter market, the ASU is effective for fiscal years beginning after Dec. 15, 2017, and interim periods within those fiscal years. For all other entities, the ASU is effective for financial statements issued for fiscal years beginning after Dec. 15, 2018, and interim periods within fiscal years beginning after Dec. 15, 2019. The adoption of the ASU should be done on a retrospective basis. A nonprofit may opt to adopt the provisions of the ASU early.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

 

FASB Issues ASU 2019-03, Updating the Definition of Collections

By Lee Klumpp, CPA, CGMA

The Financial Accounting Standards Board (FASB or the Board) issued Accounting Standards Update (ASU) 2019-03, Updating the Definition of Collections, to address the issue that the definition of the term collections in the Master Glossary of the FASB Accounting Standards Codification (ASC) was not fully aligned with the definition used in the American Alliance of Museums’ (AAM) Code of Ethics for Museums (the Code).

This ASU was issued to improve the definition of collections in the Master Glossary by realigning it with the definition in the Code. The ASU also makes a technical correction to ASC Topic 360, Property, Plant and Equipment, to clarify that the accounting and disclosure guidance for collections applies to business entities, as well as nonprofit entities, that maintain collections.

The differences in the two definitions is outlined in the excerpts from the full definitions below:

ASC MASTER GLOSSARY: 

Works of art, historical treasures, or similar assets that are subject to an organizational policy that requires the proceeds of items that are sold to be used to acquire other items for collections.

AAM DEFINITION:

Disposal of collections through sale, trade or research activities is solely for the advancement of the museum’s mission. Proceeds from the sale of nonliving collections are to be used consistent with the established standards of the museum’s discipline, but in no event shall they be used for anything other than acquisition or direct care of collections.

The ASC criterion requiring that collection sales proceeds be used to buy other items for the collection, did not reflect the AAM’s guideline that the proceeds from a sale of a collection can also be used for the direct care of current collections. As a result, museums have been confused about what is in the AAM’s policy guidelines against the FASB’s definition of a collection under ASC Topic 958.

The ASU modifies the ASC definition of collections to permit that the proceeds from sales of collection items can be used to support the direct care of existing collections in addition to the current requirement that proceeds from sales of collection items be used to acquire other items for the collection.

In addition, an entity that holds collections should disclose its organizational policy for the use of proceeds from deaccessioned collection items. The disclosure should include whether the proceeds can be used for acquisitions of new collection items, the direct care of existing collections or both. If an entity that holds collections permits the proceeds to be utilized for direct care, the entity shall disclose its definition of direct care.

The changes, as a result of adopting the provisions of the ASU, will provide readers with more information about how an entity defines collections as well as provide information on what an entity deems to be direct care.

In addition, as a result of this ASU, there will no longer be disparity between the Code and generally accepted accounting principles. The ASU resolves the difficulties that museums have been encountering in determining the value of their collections, which include collections, artwork, artifacts and historical treasures in complying with the Code in order to receive their accreditations from AAM.

The ASU is effective for annual financial statements issued for fiscal years beginning after Dec. 15 2019, and for interim periods within fiscal years beginning after Dec. 15, 2020. Early application of the ASU is permitted. The provisions of the ASU should be applied on a prospective basis.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

Lessons Learned from Implementing ASU 2016-14 – Functional Expenses

By Tammy Ricciardella, CPA

Nonprofit organizations with calendar year ends are working to implement the provisions of Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities.

The ASU is effective for annual financial statements issued for fiscal years beginning after Dec. 15, 2017. Specifics of the requirements of the ASU have been highlighted in prior articles in the Nonprofit Standard and can be accessed in the Fall 2016, Winter 2016 and Spring 2017 issues. The ASU can be found here.

As implementation efforts have been undertaken, we have seen one area that is causing more issues than anticipated. This is the presentation of the statement of functional expenses that shows the analysis of expenses by function and natural classifications. As part of developing this information, entities are looking at their current cost allocation methodology as well as what components, both program and natural expense classifications, that they want to include.

Overall, the entity can decide whether to present this information in the statement of activities, as a separate statement of functional expenses that is part of the main financial statements, or as a footnote. The main issue is to determine the most efficient presentation and the one that will be the most beneficial to the readers of the entity’s financial statements.

A word of advice on the presentation: Keep it simple. Yes, the statement of functional expenses should show the natural expenses of the entity by program and supporting activities, but this doesn’t mean that every type of expense should be presented on its own line. A straightforward approach is needed to prevent the presentation from becoming overly complex and unwieldy. Focus on the information that will be useful to the reader of the financial statements in understanding the costs of the activities of the entity. Decide on which natural classification groupings are important and relevant. However, keep in mind that too much detail can overwhelm the reader of the financial statements.

Once the format is determined, entities should look at their allocation methods for their management and general costs (M&G) and determine if the items being allocated are necessary for the direct conduct or direct supervision of programs and supporting activities, such as membership development or fundraising. If not they shouldn’t be allocated. The costs that are allocated should be for the direct benefit of the activity they are being allocated to. For example, occupancy costs can be allocated to the programs if the programs utilize space to conduct their activities. The cost of the space is related to the direct conduct of the program and should be allocated to this functional classification to show the direct benefit the program receives from the use of the space.

An example provided in the ASU addresses the consideration of the CEO’s costs. An organization may have all of the CEO’s salary recorded as M&G. But upon further examination, they may determine that the CEO is directly involved in supervising one or more programs of the entity and that their time should be allocated to these programs. In addition, an entity may find that the CEO is directly involved in contacting donors and personally performing other activities to raise funds for the entity. If this is the case, these costs could be allocated to the fundraising function. The costs for the CEO’s time to oversee the general operations of the entity would remain in M&G.

The ASU made a change to the examples of what constitute management and general activities. The following item was added to the list of what is included in M&G: Employee benefits management and oversight (human resources).  Entities should look at their internal policies to determine how these costs have been traditionally treated and, if allocated, determine the effect on current and prior year numbers.

It is important to note that all expenses, with the exception of external and direct internal investment expenses, should be reported by their natural classification in the analysis of expenses by nature and function. An example of a scenario that is often excluded but shouldn’t be are any salaries or other expenses included in cost of goods sold that are presented net of the related revenue in the statement of activities.

Once these allocations are reviewed by the entity, it should update its policies and develop the new required footnote disclosure that provides a description of the methods used to allocate costs among program and support functions.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

PErspective in Real Estate

A feature examining the role of private equity in the real estate sector.

Federal regulators—the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC)—have increased their scrutiny of commercial real estate loans, urging lenders to strengthen terms amid fears of a real estate bubble. This is deterring small, local banks from issuing new loans, and many are selling off the loans they do own to PE firms, pension funds, foreign banks and other institutional lenders, according to The New York Times. Large banks are also retreating, as they can no longer count on selling portions of large loans to smaller banks.

The absence of other lenders is drawing PE firms, hedge funds and REITs into the debt investing space, with a particular focus on bridge and mezzanine loans. Last year, private equity real estate debt funds raised $15 billion, with just 5 percent of firms targeting bridge loans. Research firm Preqin predicts fundraising will be stronger this year, with 48 percent of firms targeting mezzanine loans and 23 percent considering bridge loans. Just 5 percent of firms were looking at bridge loans last year.

The last four years have seen a rush of new bridge lenders coming to market, including Calmwater Capital, Streamline Realty Funding, ACORE Capital, Amherst Capital and RealtyMogul, National Real Estate Investor reports. Existing private lenders—Blackstone and Starwood at the high end, as well as smaller lenders, including PrimeLending, Mesa West Capital and Garrison Investment Group—have increased issuance, providing non-recourse transitional or bridge loans.

Pension funds and institutional investors have been increasing allocations to real estate over the past several years, despite geopolitical uncertainty that has reduced confidence in the market. Average target allocation to real estate among global institutional investors will hit 10.3 percent in 2017 totaling more than $1.07 trillion, up from 9.9 percent in 2016, according to a study from real estate advisory firm Hodes Weill and Cornell University. However, as a defensive strategy ahead of a potential down cycle, these firms are increasingly focused on debt rather than equity, according to The Telegraph.

Despite the maturity of the market, capital will continue flowing into the sector in 2017 as institutional investors seek to achieve their return objectives in the continued low-yield environment, National Real Estate Investor reports. But class-B properties in secondary cities—which can offer higher yields, but are riskier—are becoming less popular. Instead, many core institutional investors are exercising more caution and flocking toward more reliable assets in major market areas with credit tenancy and sold leasing in place.

There is a potential for strong exits and fundraising in the current market. PE titan Blackstone sold $7.2 billion in real estate assets in the third quarter, and raised $68.5 billion in new funds during the first three quarters, lifting the firm’s assets under management to a record-high $361 billion, The Wall Street Journal reported.

As real estate becomes an increasingly mainstream alternative asset class, debt-related funds present a significant opportunity for PE firms and pension funds looking to achieve reliable returns and safeguard against a potential downturn in the real estate market.

Sources: Bloomberg, Mansion Global, National Real Estate Investor Online, New York Times, The Real Deal, The Telegraph, Wall Street Journal

Future PErspectives: What’s Next for Real Estate Investors?

Trump administration policy details are largely still unknown, but proposed tax cuts and infrastructure spending could be a boon for real estate development as well as the construction industry. However, if the tax rate on carried interest is increased, as President-elect Trump has previously advocated, it could dampen PE real estate deal flow, according to Bloomberg. On the other hand, a separate and contradictory proposal could reduce the tax burden for hedge fund, VC and PE fund managers dramatically, having the opposite effect. Meanwhile, protectionist policies could hurt international investment. Cross-border spending reached $100 billion in 2015—18 percent of total U.S. commercial real estate spending, Bloomberg reports. For the near future, uncertainty is the only certainty, and fund managers may seek to diversify their holdings, to the benefit of secondary markets like Melbourne, Amsterdam and Vancouver, according to Mansion Global.

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

A Deeper Dive Into ASU 2016-14 Implementation Issues

By Tammy Ricciardella, CPA

As organizations look to implement ASU 2016-14 and meet its requirements, they must account for how these changes may impact how they collect information. This article will highlight three of these areas:

Investment Expenses

As we have noted, the ASU now requires the netting of investment expenses against investment return; in addition, only the net amount of the investment return is required to be presented in the statement of activities. The investment expenses that should be netted against the investment return are both internal and external. To comply with this presentation, organizations need to fully understand the definitions of these terms and then consider how to appropriately and accurately capture this information.

The ASU states that investment returns related to total return investing and not programmatic investing should be reported net of external and direct internal investment expenses. Programmatic investing is defined as “the activity of making loans or other investments that are directed at carrying out a not-for-profit entity’s purpose for existence rather than investing in the general production of income or appreciation of an asset.” An example of programmatic investing is a loan made to lower-income individuals to promote home ownership.

External investment expenses are those that are reported to the organization by the external money managers and other external investment management firms related to the management of the investment portfolio. This information will be obtained from the external investment firms based on what they have charged.

Direct internal investment expenses are defined in the ASU as those that involve the direct conduct or supervision of the strategic and tactical activities involved in generating investment return. These include, but are not limited to, the following:

  • Salaries, benefits, travel and other costs associated with the officer and staff responsible for the development and execution of investment strategy, and
  • Allocable costs associated with internal investment management and supervising, selecting, and monitoring of external investment management firms.

Direct internal investment expenses do not include items that are not associated with generating investment return. For example, the accounting staff costs associated with reconciling accounts, recording transactions, maintaining the unitization of pooled investment accounts and other such clerical staff time are not direct internal investment expenses, so they would not be included.

Accounting for investment expenses and the related allocation of costs is a process that organizations will have to develop to properly present these investment costs under the provisions of the ASU. The complexity of this will depend on the type of organization and the amount and nature of their investments. For example, the management of a large foundation that handles the strategic aspects of investing their assets internally will have to analyze and establish an allocation methodology for the salaries, benefits and travel related to the total return investing. Entities will need to identify all personnel who participate in the investment process and determine if they have a strategic role or not. In addition, entities may need to develop a process and make modifications to timesheets or other tracking methodologies to capture the time spent aiding the identification and allocation of these costs.

Liquidity and Availability Disclosures

Under the ASU, specific quantitative and qualitative information related to the new liquidity and availability requirements is required to be disclosed. Organizations should assess how they manage their liquid resources to ensure they can meet their cash needs for general expenditures as of and within one year, respectively, of the statement of financial position date. In addition, organizations will need to evaluate their financial assets to determine their availability to meet cash needs; consider the nature of the assets; examine the external limits imposed by donors, laws, and contracts; and account for any internal limits imposed by governing board decisions. These limitations need to be analyzed and tracked so the organization can identify its available financial assets and provide the necessary disclosures. Other qualitative issues including special borrowing arrangements or instances whereby the entity has not maintained appropriate amounts of cash as required by donor-imposed restrictions and limitations that result from contractual agreements with suppliers, creditors, loan covenants and other sources need to be identified and evaluated to prepare the appropriate disclosures.

Internal Net Asset Designations

Under ASU 2016-14, the accounting treatment for internally designated net assets hasn’t changed; however, the presentation of these amounts and the disclosures have. These changes require entities to properly track these amounts and their related purpose so they can meet the ASU’s disclosure requirements.

As we have noted in the past, organizations should review the ASU now and take these items and others into consideration when developing their implementation plan. Though the ASU does not have to be implemented until calendar year 2018 or fiscal year 2019 year ends, preparing for it takes careful planning, so organizations would be well advised to begin the process as soon as possible.

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

Gotta Get Away: Timeshares, Hotels and the Sharing Economy

By Kevin Riley

It’s a familiar tale: An entrepreneurial business model enters the real estate market, disrupting traditional players. Even now-ubiquitous chain hotels were once a disruptor and, in the 1970s, timeshare executives were the ones shaking up the hospitality market. Timeshares became such a competitive presence that every major hotel conglomerate entered the market and acquired existing, successful companies. Now, in the past few years, timeshare businesses have adapted to the digital age and rapidly diversified their offerings to appeal to a changing consumer base. Perhaps because of its entrepreneurial roots, the timeshare industry may be well-positioned to adapt and weather the market’s newest disruption: the sharing economy and the growth of online rental platforms offering an alternative—and in many cases, more affordable—hospitality experience.

The power is in the hands of the consumer. With an expanding pool of options available for consumers, vacation rental providers are jockeying for travelers’ dollars. Online platforms, such as HomeAway, and its subsidiary VRBO, offer consumers a different travel experience, with accommodations available at their fingertips. The flexibility these platforms provide has particularly resonated with millennials and anyone traveling on a budget.

Because the traditional timeshare model offers an alternative to purchasing a second home, rental platforms have impacted timeshares differently than hotels. Timeshare buyers have long had access to a variety of travel destinations without the hassle of upkeep and maintenance. Destination choices, however, have evolved. For the past 15 years, some timeshare operators have prioritized expanding into urban areas, including major hubs like New York City and Miami, as well as secondary urban markets gaining popularity as cultural destinations, like Boston, San Diego, Vancouver and New Orleans. And competition could get fiercer in those markets, particularly because many customers are swayed by the authentic travel experience online rental platforms can offer via homestays and other non-traditional arrangements.

In addition to providing greater exposure for smaller competitors, the secure automated payment processing capabilities of online rental platforms also removed a barrier to entry into the market for these smaller players. Companies with a modest supply of vacation rentals, for example, may not have had the ability to obtain a merchant account to enable online transactions. While online rental platforms charge a host service fee for each transaction, that fee is a much cheaper alternative to a merchant account and allows small players to offer a convenience on par with larger hotels and timeshare companies.

As a testament to its financial adaptability, the timeshare industry has seen prominent deal activity in 2016. In June, private equity investment firm Apollo Global acquired Diamond Resorts International Inc. Following suit of other major hotel conglomerates, this December, Hilton Worldwide Holdings’ board of directors approved the spinoff of its timeshare business, Hilton Grand Vacations, which represented 12 percent of their top line, and Park Hotels & Resorts, Inc. The spinoffs are expected to be finalized in early January 2017. Starwood Hotels and Resorts also completed the spinoff and sale of its timeshare business, Vistana Signature Experiences this year, before finalizing its merger with Marriott, in September. Because the hotel industry is an entirely different business than timeshares, with different multiples and earnings, spinning off timeshares into a separate public entity is a common strategy.

All signs point to sustained growth of the sharing economy in the coming years. Hotel owners and timeshare operators alike would be wise to develop agile service offerings and adaptable marketing strategies to prepare for disruptions on the horizon and secure their share of the market.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Winter 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 space.

Private equity firms continue to exert influence on manufacturers’ global supply chains. There are a number of lucrative opportunities to create efficiencies and reduce operating costs along the entire supply chain, such as the impact of tax and duty on the bottom line.

Apollo Investment recently announced a partnership with Nike to build a regional apparel supply chain in the Americas for the sporting goods company, in contrast to the firm’s long-term strategy of overseas production. The new manufacturing and logistics company—in which Nike will not invest directly—aims to bring production closer to home, partly in response to growing demand for increased sustainability and domestic manufacturing. The vertically integrated manufacturing hub will enable Nike’s supply chain to be nimbler and will make it better suited to manufacture customized products, Forbes reports.

According to Supply and Demand Chain Executive, Apollo’s Special Situations I fund has so far acquired New Holland, a Pennsylvania-based apparel manufacturer, and ArtFX, a Virginia-based textile screen-printing and logistics company. Apollo plans to buy more apparel suppliers and textile firms in North and Central America, and build out new manufacturing plants, warehouses and logistics networks for Nike, Forbes reports.

In the auto manufacturing sector, Bain Capital is partnering with Japanese airbag manufacturer Daicel Group, and Carlyle Group is teaming up with Ningbo Joyson Electronic Corp.-owned Key Safety Systems to bid for Takata, an airbag supplier up for auction after a massive safety recall. KKR is also said to be mulling a bid, according to the Financial Times. With 70 million Takata airbag inflators globally scheduled for replacement by 2019, some of the bidders are considering bankruptcy proceedings to mitigate liabilities, Bloomberg reports. Because some of the world’s largest automakers are expected to spend the next few years recalling airbag parts, Takata set up a committee in February to negotiate with its carmaker customers and other stakeholders.

Following its 2015 purchase of Chinese plastics injection manufacturer Ying Shing Enterprises, Platinum Equity will acquire Singapore-based industrial parts distributor Broadway Industrial Group’s foam plastics and flow control devices divisions for $111 million, according to Mergers & Acquisitions. Platinum specializes in turning divestitures into stand-alone businesses, and has extensive experience in the Asian markets, according to a press release. The Los Angeles-based PE firm plans to grow the Asian business both organically and through strategic add-on acquisitions, Mergers & Acquisitions reports.

In an unusually large Japanese deal, PE firms Bain Capital, KKR and MBK Partners are submitting second-round bids for Nissan’s 41 percent stake in auto parts maker Calsonic Kansei, according to Reuters. The second bidding round is expected to close in October, so the value of bids cannot be ascertained. However, the parts maker has a market value of $2.4 billion, and therefore represents a rare opportunity for a large deal. The drastic restructuring methods often associated with PE have traditionally been a turn-off for Japanese companies, but Nissan invited buyout firms to submit bids after corporate buyers failed to materialize, Reuters reports.

Supply chain optimization is one of several ways PE firms can create value and efficiencies in the manufacturing industry. Whether it is building a manufacturing backbone that helps reduce transportation costs and import duties, or building a platform by acquiring similar supplier and distributor companies within a given industry across the globe, there are significant opportunities for PE firms with an interest in the sector.

Sources: Bloomberg News, Financial Times, Forbes, Insead, Mergers & Acquisitions, Reuters, Supply & Demand Chain Executive, Supply Chain Digest, Tompkins International

This article originally appeared in BDO USA, LLP’s “Manufacturing Output” newsletter (Fall 2016). Copyright © 2016 BDO USA, LLP. All rights reserved. www.bdo.com

How Tax Law Changes May Impact Charitable Giving

By Laura Kalick, JD, LLM in Taxation

Whether we look at the blueprint for tax reform put forth by Republican House Ways and Means Committee members, the deliberations of the Senate Finance Committee’s bipartisan tax reform working groups or the tax proposals of President-elect Trump, there is a very real possibility that tax rates will be lowered in the near future. While the Internal Revenue Code (IRC) hasn’t seen a major overhaul since 1986, the tax law as we know it today may not be the tax law next year.

What does this mean for America’s charitable organizations? In a nutshell, charities should encourage donors to contribute before the end of the year to take advantage of more impactful deductions that may not be available if rates are lowered in the future. Accelerating charitable deductions now could be critical to maximize fundraising if near-term tax reforms include a dollar cap on total itemized deductions like charitable donations. Favorable provisions that now allow fair market value deductions for gifts of appreciated property to charity could come under scrutiny as well, further complicating fundraising potential.

Regardless of what unknown tax code changes are on the horizon, encouraging giving now—while the outcome is predictable—is imperative.

Below are some of the details of tax changes President-elect Trump proposed during his campaign:

Lowering the number of tax brackets for married joint filers from seven to three at the following rates:

• Less than $75,000: 12 percent
• More than $75,000 but less than $225,000: 25 percent
• More than $225,000: 33 percent

Capping itemized deductions and increasing the standard deduction:

• President-elect Trump proposed capping itemized deductions at $200,000 for married joint filers or $100,000 for single filers. These deductions would include charitable deductions, mortgage interest deductions, state tax deductions and others.

• The Trump plan would also increase the standard deduction for joint filers from $12,600 to $30,000, and the standard deduction for single filers will be $15,000. This means fewer people may be itemizing their deductions, and therefore may not be as concerned about generating deductions through charitable contributions.

Estate tax:

• Trump has also proposed eliminating the federal estate tax, currently at 40 percent. Charitable contributions from an estate reduce the overall taxable value of the estate. If there is no estate tax, charitable requests may be significantly reduced.

The future of charitable giving incentives

The charitable deduction is one of the ten largest tax expenditures in the IRC and has long been subject to proposed modifications, including extensive hearings held in 2013, which we covered here in the Nonprofit Standard blog. Proposals to limit the deduction have included dollar caps, floors below which contributions may not be deducted, credits instead of deductions and more. In addition to monetary contributions, many hearings have even included debate on whether the treatment of gifts of property to charities should be revisited. Every time changes are proposed, the nonprofit industry seeks to analyze how the proposals would raise revenue and impact charities.

Not all tax code changes negatively impact charities, however. Last year, Senators John Thune (R-S.D.) and Ron Wyden (D-Ore.) introduced the Charities Helping Americans Regularly Throughout the Year (CHARITY) Act. Among the provisions in the CHARITY Act, the Senate asserted that the promotion of charitable giving should be one of the goals of comprehensive tax reform. The House Tax Reform Blueprint would also provide incentives for charitable giving.

As charities make one final fundraising push to end 2016, they should encourage donors to make gifts now while the tax outcome is certain, rather than waiting until next year when the rules may be changed in a way that negatively affects their bottom line. Despite the interplay between tax deductions and charitable giving, the 2014 U.S. Trust Study of High Net Worth Philanthropy found that a desire to make a difference (73.5 percent) and personal satisfaction (73.1 percent) were the main motivators in giving, while tax benefit was cited by just 34.4 percent of respondents. In looking at those statistics, it’s clear that conveying a compelling mission is key to attracting and retaining donors.

There is enormous competition for charitable donations. It’s essential to make your organization’s mission emotionally compelling and relevant to take advantage of current favorable giving arrangements that may not last.

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

2016 Year in Review: Top Tax Issues Impacting the Real Estate Industry, Part One

By Tanya Thomas and Jeff Bilsky

The next tax filing season may seem far away, but as 2016 ends, taxpayers will begin the task of year-end tax planning. While 2016 was not a year for major tax reform or legislative action, there have been some notable regulatory changes. 2016 saw several pieces of regulatory guidance that could have an impact on acquisition and disposition transactions, entity structuring activities, taxable income calculations and tax accounting method options. As real estate owners and operators, construction companies, developers and REITs embark on analyzing their tax situation for 2016 and beyond, it’s critical to be aware of these new developments.

Though many tax changes proposed or finalized in 2016 could impact the real estate industry, in this article we highlight two areas that should be top of mind for leaders in the real estate industry at the start of the new year, including IRC Section 385 regulations, and a series of final, temporary and proposed regulations under IRC Sections 704, 707 and 752.

IRC Section 385 Regulations

Debt equity regulations under IRC Section 385 were finalized in October. The proposed regulations, issued in April, were set to re-characterize certain intercompany debt instruments as equity, most likely preferred equity. If finalized as they were proposed, these regulations could have adversely impacted REITs and caused qualification issues with the REIT testing provisions. The finalized regulations significantly altered parts of the proposed regulations and, in general, give the IRS authority to re-characterize certain intercompany debt instruments as stock. The new IRC Section 385 regulations are intended to curb certain earnings stripping situations often used as domestic and international tax planning strategies. The regulations were specifically directed at curtailing inversion transactions, or those involving the movement of a multinational U.S. group’s tax residence outside of the United States.

While the new regulations do not appear to adversely impact SEC-registered REITs and their interaction with Taxable REIT Subsidiary (TRS) entities and subsidiary REITs, there is some impact to Foreign Investment in Real Property Tax Act (FIRPTA) “blocker” structures involving a C corporation owning controlling interests in subsidiary REITs. The final regulations exempt “non-controlled” REITs from all aspects of the regulations. As a result, unless controlled by 80 percent or more of vote or value by an includible member of an expanded group, such as a non-REIT C corporation, a REIT will not be part of a member of an expanded group. Based on this change, there will not be any requirement of additional documentation or re-characterization of debt for the following:

(1) Lower-tier REITs of non-controlled REITs; or
(2) Taxable REIT subsidiaries of non-controlled REITs.

However, a non-REIT C corporation and its 80 percent-or-more-owned REIT would be within the scope of the final regulations. Because of the new IRC Section 385 regulations, it is critical for taxpayers with “blocker” REIT structures to analyze the new regulations and consider their potential impact and requirements. For more in-depth details of the regulations and the various provisions, refer to our comprehensive alert on Section 385 issued in October.

Final, Temporary and Proposed Regulations under IRC Sections 704, 707 and 752

In October, the U.S. Treasury and the IRS released long-awaited guidance on liability allocations under IRC Section 752, disguised sales under IRC Section 707 and deficit restoration obligations under IRC Section 704. IRC Sections 704, 707 and 752 apply to entities that operate as partnerships, and given that many taxpayers in the real estate industry utilize partnerships in their structures, it is critical to evaluate these new rules. The regulations represent significant changes in partnership taxation and will have a critical impact on planning for partnership formation and restructuring transactions, as well as ongoing operations.

When the IRS proposed these regulations in January 2014, it was widely perceived that the regulations could change whether certain obligations resulted in a partner having economic risk of loss for a partnership liability under IRC Section 752. This, in turn, could impact a partner’s ability to deduct losses and receive tax-deferred cash distributions from the partnership. Additionally, the originally proposed disguised sale regulations and clarified certain aspects of existing exceptions. The final regulations take a multifaceted approach and address some of the provisions that were accepted when proposed, while withdrawing and re-proposing some of the aspects that tax advisors were concerned about.

• Final and temporary regulations under IRC Sections 707 and 752 provide guidance around disguised sales of property to or by a partnership and impact existing regulatory exceptions. The regulations severely limit the effectiveness of the debt-financed distribution exception. This is accomplished by changing the way liabilities must be allocated under IRC Section 752 for purposes of the debt-financed distribution exception. Further, the regulations clarify that the preformation expenditure exception generally applies on an asset-by-asset basis with limited opportunity to aggregate assets. The regulations also eliminate the ability to apply the preformation expenditure exception to expenditures funded with qualified liabilities.

• Final and temporary regulations under IRC Section 752 provide rules around when certain obligations are recognized for the purpose of determining whether a liability is a recourse partnership liability. The regulations effectively eliminate a taxpayer’s ability to use “bottom-dollar guarantees” to create economic risk of loss. Without economic risk of loss, partners may be allocated fewer partnership liabilities, resulting in a lower overall tax basis. A lower tax basis may limit the ability of the partner to deduct allocated losses. Further, partners with negative tax capital accounts may be required to recognize taxable income to the extent at which they are allocated fewer partnership liabilities.

• Proposed regulations withdraw and re-propose regulations under IRC Sections 752 and 704. These proposed regulations strengthen anti-abuse rules in determining whether a partner bears economic risk of loss for partnership liabilities under IRC Section 752, and would create similar anti-abuse rules relating to certain obligations to restore a deficit in a partner’s capital account under IRC Section 704.
The new regulations are important because real estate taxpayers often operate in a partnership format or use partnerships in their organizational structures. Within the REIT industry, these new provisions could significantly impact the operating partnership under REITs or UPREITs, including the formation of UPREITs.

In October, BDO’s National Tax Office issued three alerts related to the new partnership regulations. For an in-depth discussion of these regulations and their applicability, refer to our alert addressing disguised sales under IRCS Section 707 and Section 752, our alert relating to the determination of recourse liabilities under Section 752, and our alert discussing the re-proposed regulations.

Conclusion

As we barrel toward the start of another year and a new president prepares to take office and potentially institute more significant tax reform, the time to review regulatory tax changes is now. Real estate owners and operators, construction companies, developers and REITs face an array of opportunities and challenges in the new year. With forthcoming uncertainty due to market fluctuations and a potential increase in interest rates, getting into compliance with new tax provisions now could establish a sturdier foundation for real estate companies to weather potential disruptions ahead.
Stay tuned for more of this series in future issues of the Real Estate & Construction Monitor, where we’ll continue this discussion, focusing on other key tax developments impacting the real estate industry and developments specifically applicable to REITs. In part two, we’ll examine several recent court decisions and rulings that could have an impact on the real estate industry with respect to acquisitions and dispositions and tax accounting methods.

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