Marketplace Fairness ACT of 2013: Impact on Cloud Service Providers

I know there is a lot of buzz around sales tax when I see it in the associated press as I have recently around the Marketplace Fairness Act of 2013, and other “internet tax” legislation. My interest in this legislation extends beyond the implications of requiring small and medium businesses and internet retailers to collect sales/use taxes nationwide, even if they are “remote sellers” with no locations or physical presence in those states.

Most of my clients are large, high-growth Software-as-a-Service (SaaS) or other Cloud Services companies. Their sales/use tax concerns are mostly focused on potential prior-period exposure as the company approaches a liquidity event. Questions from their financial statement auditors, Board of Director members, or acquisition due diligence professionals may bring the issue to prominence quickly.

Sales/use tax typically is not high on the priority list for CFOs of fast growing technology companies, given the resource requirements of rapid growth and international expansion. Many are surprised by the magnitude of the issue (e.g., size of the proposed financial statement accrual or purchase escrow amount) when brought to their attention.

The reason for this surprise frequently is that they believe the company does not have nexus in different states (a sufficient physical presence such that the state can require the company to collect the tax,  which may be established simply by regular solicitation of sales in that state by a regional or nonresident sales team). Or they believe that SaaS is a service and therefore not taxable, currently (SaaS is taxable in 15 states plus D.C.).

If the Marketplace Fairness Act or similar legislation ultimately is signed into law, the nexus issue may become moot, and the company may have a collection duty in every state, regardless of its physical activities, or lack thereof, in those states.

When and if this legislation passes, it should immediately elevate awareness of sales/use taxes for the CFO of any high-growth company on the path to a public offering or other liquidity event. Evaluating potential prior-period exposure and developing a prospective sales/use tax collection and compliance plan will be addressed earlier in the companies’ lifecycle if this legislation becomes law than in years past.

If you've got any thoughts or opinions on this, please feel free to comment.

8 Common Issues and Problems with International Assignees

One of the challenges of expanding across country borders is the tax treatment of international assignees. Below are 8 common issues and problems to consider before sending an employee on an overseas assignment.

 

1. The normal rules of the road change from when a domestic move is considered. In a domestic move, the employer only has to consider the relocation expense and the employee is left to do any planning. When considering posting an employee outside of his or her home country, it is generally temporary i.e.; not a permanent move. As such, the employer has to plan around maintaining the employee’s after tax purchasing power with additional allowances that make up for differences in tax and costs of living. Allowances that only last while the assignment lasts are the best way to do this, as a salary increase is almost always permanent.
2. Most US companies that send employees on international assignment adopt tax reimbursement policies to cover not paying all taxes, but just those in excess of the normal tax. This makes perfect sense because without a policy to cover this the employer either winds up paying all taxes, or if not, then employee likely quits unless posted to a low or no tax country.
3. The employer controls almost all levers to reduce the foreign tax during an assignment including the length of assignment, whether or not the employee maintains US employee status, the timing of compensation, and how compensation is delivered. For instance, housing provided is not taxable in many countries but a cash allowance is taxable everywhere. Since the company has adopted a excess tax reimbursement plan, then any savings holds down the employers costs.
4. Since US citizens are taxable in the US on world income regardless of where they reside, continuing US compliance costs as well as foreign compliance costs need to be considered.
5. Most US employees feel that US social taxes are too high but the US has the second lowest social taxes behind Canada. The US has Social Security Tax Treaties with 26 other countries that allow one to stay in his or her home country system if the assignment is for 5 years or less, if the home employer agrees to collect and pay them. This creates payroll complexity because the US payroll must maintain and report on world income so social taxes are paid on all compensation. Typically the assignment location country also requires reporting and payroll taxes thus also complicating payroll problems in the US and foreign location. Under payments and over payments to assignees routinely occur.
6. Many companies outsource their payroll. The outsourced payroll companies do not have personnel that understand a split payroll like outlined above and the company generally lose payroll expertise rapidly after the payroll is outsourced. This creates further confusion and payroll problems.
7. Many employers do not understand that when a company sponsors an employee into a foreign country that there is a clear expectation by the foreign country that the employer will be responsible for any debt the employee leaves behind when repatriating including taxes unpaid.
8. Employee's that do not know about additional reporting, record keeping requirements, and details required to do an expatriate US return and the foreign return find it extremely difficult to comply. A little briefing goes a long way to solve this problem.

Don't let unexpected considerations trigger preventable issues with international assignees. It's important to ask the right questions before taking on an overseas assignment, or sending your employees abroad. Be sure and meet with an international tax expert who understand the laws and can help you to mitigate risk and unnecessary tax exposure.

The Unpaid PR Machine

I’m sitting in the lobby of the California Grand Adventure Hotel at Disneyland-The Happiest Place on Earth. It’s intriguing to watch people coming and going, but what impresses me is the people who work here. They go out of their way to create a positive experience for everyone who visits the hotel. They smile and say hello, ask if you need help, give you tons of information (this is key), and in the process, they engage everyone they meet in a way that opens everyone up to learning more about each other.

The result: A positive experience and excellent PR. Everyone who visits the hotel goes back to their friends, family and colleagues and tells them about their positive experience.

Companies that engage prospective hires this way from the moment they first promote their open position to the point of welcoming a new hire to the company do a much better job of attracting great talent and making key hires that last. The candidness of the job description and career potential, the way the recruiter communicates the opportunity, the manner in which a candidate is greeted at each stage in the process, and how effectively each interviewer engages the candidate creates a strong, lasting impression on potential hires and has a tremendous influence on how interested a candidate will be in joining the company.

But it doesn’t stop there. The candidates you interview will tell everyone they know about their experience and what they think of your company. And those people will tell even more people. Consider them your unpaid PR machine. 

So, what kind of experience do you want candidates to have and how can you create that experience? Here are five things you should do (at a minimum) to create a strong, positive impression and better PR than your competitors:

1. Direct your job description toward key results and career opportunities in the company. This works for everyone involved. You’ll focus your search on candidates who can move things forward and potential hires will be motivated by the opportunities your position creates for them.

2. Make sure the internal and external recruiters who are finding candidates for you are effectively promoting these key results and career opportunities rather than just screening potential candidates based on job responsibilities.

3. Communicate to everyone involved in the hiring process exactly what experience you want candidates to have in the process. Remember to include the person who greets them in the lobby and the person in Human Resources who processes your company’s paperwork. Everyone contributes to the experience.

4. Develop interview questions that engage each candidate in a collaborative conversation about the skills and experiences that showcase their abilities to achieve key results and have a successful career with your company. Remember, this candidate could be the same person who is working through a problem with you at 2am on a Friday night. How you communicate now is just the beginning!

5. Communicate with each candidate in a timely manner and give them useful feedback. The #1 complaint job seekers give about the interview process is that they don’t know what’s going on. It’s important to treat candidates with respect and professionalism. Respect their time, especially if they took time off of work to drive to your office and meet with you, and give them professional feedback that tells them that their time was valued. This applies to all interviews, good and bad.

It’s a job seeker’s market right now—especially in the technology sector, and they have more power than just saying “yes” or “no” to your job offer. They can refer great people to you and they can derail your ability to hire the best talent. The good news is that you have the power to create a great experience, and if done well, you can actually attract even more great talent to your company for other positions.

7 Tips to Simplify Your Tax Return Process

So you survived another tax return season and are thinking of the “could’ve, would’ve, and should’ves”. 

To get a jump on next year's tax return process, here are 7 quick tips to help the process to go smoother and be more efficient: 

1. Plan Ahead
Figure out what needs to be done, when the information will be available, and the deadline.

2. Put Together A Timeline
Remember, many other companies will have the same deadline, so getting information to the service provider sooner is key!

3. Meet With Service Provider
Have a kick off meeting with your service provider to walk through any new developments for the year, new filings, the information request, and timeline.

4. Follow Up With Service Provider
Send the service provider a complete information request and only send the final information to avoid rework, confusion, and delays.

5. Provide A Timely Response
Respond promptly to questions to avoid delays and schedule meetings, as needed with the service provider to confirm progress and to answer any outstanding questions.

6. Confirm Draft Return
Confirm with the service provider if you wish to review a draft return prior to finalization.

7. Schedule Final Review
Meet with the service provider to walk through the completed returns and sign all e-file authorizations at this time to expedite the e-filing process.

By working closely with your service provider and enacting these 7 tips, the tax return process should flow smoothly and the returns should be completed efficiently and timely.

Favorable and Unfavorable Leases in a Business Acquisition

Acquisition accounting can be a bit tricky, and one item that companies often overlook is the accounting for operating leases in a business combination.

The accounting rules for leases acquired in a business combination are not very intuitive and can raise a host of considerations. If you acquire a business with multiple locations, this should definitely be on your radar.

The basic accounting rule for acquisitions is that all assets and liabilities of the acquiree in an acquisition need to be recorded at fair value upon the acquisition or change of control.

But how do you fair value deferred rent balances?

Interestingly, deferred rent balances don’t get recorded at the acquisition date at all. Instead, companies should perform an analysis of leases acquired to see if there is a favorable lease asset or an unfavorable lease liability that needs to be recorded.

This should be done regardless of whether there is a deferred lease on the balance sheet of the acquiree or not, as long as there are leases assumed by the acquirer.

To illustrate, the Company assumed an office lease for which there was a free rent period (which ended before the acquisition). The lease has escalating payment terms, so the monthly rent going forward will probably be above market, i.e. entering into a new lease agreement for the Company would be on more favorable terms.

That means the Company has an unfavorable lease liability for that particular lease. And vice versa, if the acquiree negotiated a great deal for the whole duration of the lease and the payments going forward will be below market, then the Company has a favorable lease asset to be recorded.

The resulting unfavorable lease liability or a favorable lease asset will then get amortized to lease expense on a straight-line basis over the remaining term of the operating lease.

So how exactly does a company determine the amount of a favorable lease asset and/or unfavorable lease liability?

As with anything at fair value, there is no one correct answer. Some subjective judgment is involved. For each lease a company should find a few comparable properties on the market and run a calculation for the remainder of the term to determine the difference between the market rate and the actual payments for the remaining term of the lease.

And remember to factor in the discount rate and the market growth rate in your calculation, but not the cost to move out. 

Although moving costs would affect the Company’s decision on whether to stay with the current lease or enter into a new lease, they are not taken into consideration for determining whether there is a favorable or unfavorable lease.

For example, one of my clients told me “Although the comparison to market shows that we have unfavorable lease terms, we wouldn't move out as all the moving costs wouldn't make it worthwhile. So common sense tells me these leases are at market”. 

Definitely a good point, but the accounting rule doesn't let you take moving costs into consideration. So my client had to record a liability for those unfavorable leases.

Preventing the High Cost of Employee Turnover

Accounting departments are known for high employee turnover even though great people are a company’s top asset. There are tangible (recruiting, training, signing bonuses) and intangible (morale, additional work until a replacement is found, production delays) costs of employee turnover. The best way to prevent this turnover is to keep current valuable employees engaged and happy. Here are 5 simple tips you can put into practice in order to retain top talent and keep employee morale high.

First, be genuine. People want to work with people who care about them. Ask how they’re doing, ask about their family or weekend activities, and be interested in their response. Find common interests. Being genuine builds rapport.

Second, be polite. Say please and thank you. Yes, it’s their job to do what you say, but saying please and a sincere thank you makes them want to do their best for you.

Third, praise their work. Our best days at work are always the days when our boss tells us we did something well. It makes an employee feel valued and they are more likely to repeat the good work.

Fourth, challenge them. Find opportunities to hand down some of your own work and train them how to do it. It keeps the job exciting and they will feel a sense of accomplishment.

Fifth, be a team player. If someone is overwhelmed, ask how you can help. Don’t participate in office gossip and don’t play favorites. Be available to answer questions and provide thoughtful responses.

Do these 5 simple things and you will keep those key employees engaged and happily employed. Then, you will be on your way to avoiding the high cost of employee turnover and building your team’s morale.

Not All Valuations Experts Are Created Equal

Private technology companies are required by the IRS (Code Section 409A) to  grant their common stock options at a strike price that is not less than the fair market value of common stock. The IR Code recommends that a valuation of common stock be done not less than annually, if not more often.

It’s very important that your valuation expert has experience doing the type of valuation you need for the “audience” the valuation is intended for. Who, other than senior management at the Company, will be examining the valuation?

Let’s take a look at the different audiences that may be reviewing the 409A Valuations and the depth of knowledge you should look for and key question to ask before selecting your third party valuations expert.

409A Valuation - Early Stage Companies

The Company’s Board and the IRS are the two parties that these valuations are intended for. Does your valuation firm regularly do valuations that are examined by the Board of early stage companies? If they do lots of 409A valuations then they probably do, and they will understand what the Board will expect to see. If they have been doing valuations for less than 5 years or if the people doing the valuation don’t do it full time (that is, they do valuations outside of tax season) they may not be aware of recent developments in valuations, especially tech or biotech company valuations. It's a good idea to hire a valuation expert that has experience having their valuations reviewed by the IRS. Valuation experts that do valuations for Estate & Gift tax purposes in addition to 409A valuations will have had their valuations scrutinized by the IRS.

409A Valuaton - Later Stage Companies and Purchase Price Allocation (PPA) Valuations

In addition to the Company’s Board and the IRS, 409A valuations for later stage companies will very likely be reviewed by the Company’s auditor. PPA valuations will be reviewed by the auditor. Audit firms are held to a high standard, and their reviews of valuations reflect this. Additionally, the valuation will be reviewed both by the audit team and by valuation experts at the audit firm. I recently heard a high ranking valuation Partner from a prominent audit firm talking about problems he sees when reviewing valuations, and one of the areas was that the valuation did not take into account recent accounting literature.

Yes, accounting literature. Since I started doing valuations 19 years ago, more and more valuations are being done for financial reporting purposes. This means that a good valuation expert needs to be current on the latest accounting pronouncements that impact valuations. Valuation experts that do 409A and purchase price allocation valuations that work at a strong audit firm benefit from the knowledge of the auditors in their firm. Being able to walk down the hall and talk to an Audit Partner on how the latest FASB pronouncement impacts valuation is a major benefit for a valuation expert that works for a CPA firm.

409A  Valuation - Companies on The IPO Track

In addition to the parties mentioned above, the SEC will also be scrutinizing these valuations.  The SEC intensively reviews and scrutinizes a Company’s S-1 and one of the areas they review is the Company’s common stock (409A) valuations. The SEC will expect certain, more advanced valuation methods to have been used on valuations that are performed close to the time of a Company’s IPO, so it is important to have a valuation expert that has done work for companies that have submitted a filing at the SEC to go public and have achieved an IPO.

Choosing a third party valuations expert with appropriate experience, who understands the different reviewing audiences is vital to getting through a review without complications. When selecting a third party to conduct valuations, consider asking the following key questions.

How many years of experience do you and your team members have?
Appraisers with more years of experience are naturally exposed to different issues and would be more adept in handling a diverse set of valuation issues.

Do you have valuation-related credentials?
Credibility is quite important in business valuation since some practitioners do not have the expertise or credentials needed to perform valuations competently.

Have you valued companies in my industry or a closely-related industry?
It is important that your valuation expert knows, understands, and can defend the chosen valuation methodologies that are commonly accepted for your industry

Who will be working on my valuation?
Stand-alone valuation boutiques lack the resource of a pool of expertise and may lack the flexibility for a fast turnaround time. 

What is your experience with our auditors and the SEC (Company on the IPO Track)?
Having a valuation firm that has had their valuations scrutinized by the SEC is a good idea, since common stock values is one of the issues the SEC has been focusing on in their reviews of S-1

Have any of your reports been submitted to the IRS?
Having a valuations experts with a track record of valuations routinely accepted by the IRS is a good indication of the work quality of the appraisers.

Not all valuations experts are created equal. An experienced valuation expert should be able to prepare a valuation which will pass an audit without complications while also complying with the applicable tax regulations and standards. Other important factors to consider when selecting a valuations expert can be found in the Top 10 Questions to Ask Your Valuations Expert white paper.