With the 2017 hurricane season starting on June 1, businesses in South Florida and all along the east coast should have an emergency plan in place to safeguard their organizations before and after a disaster occurs.
What types of situations can impede normal business operations? How can a business protect itself from these events, which may include power outages, burst water pipes, server failures, data hacks, fires, floods or acts of nature? How can a business mitigate its losses following a disastrous event? What does the business need to do to recover in a timely manner, if recovery is even possible?
Answering these questions in advance of a potential threat can help businesses be better prepared to act quickly and reduce their risks of interruptions in normal business operations. Following are a few critical factors businesses should consider when preparing a business continuity and disaster-recovery plan.
Employees. How will a business communicate with its workers and their family members during and after a disastrous event? Which business functions and staff members will be required during the preparation and recovery periods?
Businesses should maintain up-to-date contact information for all of their employees and put into place a system for sharing information with them. In the wake of recent disasters involving power outages and overloaded telephone networks, text messaging has proven to be an effective communication tool. In addition, businesses should ensure that critical employees know their roles and responsibilities to carry out the business’s emergency plan. Similarly, the business should be prepared to assign backup staff to cover for those workers who may be unreachable or unable to return to work following a perilous event.
Customers. Businesses that cannot respond to customers’ immediate needs are likely to lose those customers. To build trust and loyalty, businesses should communicate their emergency plans to customers before disasters strike and have in place a plan for communicating with them and providing them with alternative arrangements in the wake of a disaster.
Suppliers and Vendors. Interruptions in the supply chain can cripple a business when its vendors or suppliers are unable to deliver required services, products and materials. As a result, businesses should first consider whether or not their existing suppliers have business-continuity plans in place and whether such plans should be a requirement of their working relationships. In addition, businesses should have at the ready a backup list of pre-vetted suppliers who can step in to fulfill their orders in a timely manner.
Critical Business Functions. What activities are vital to a business’s survival? Critical business functions include those assets that are required to resume operations and those activities whose interruption will result in a loss of revenue and noncompliance with industry and governmental regulations. Businesses must prepare contingency plans in the event a disaster debilitates these functions.
Documents and Data. All businesses should have backup systems in place to retrieve and restore data in order to resume normal operations. This may include keeping duplicates of important records off-site, downloading them onto portable storage devices, such as external hard drives, or saving them to cloud-based applications. Similarly, businesses should regularly update their accounting and operational data, including records of inventory and sales as well as forecasts of future performance, in order to quantify and substantiate incurred losses.
Insurance. Property insurance typically covers costs to repair physical damage. Companies located in regions that are prone to hurricanes, earthquakes, tornadoes or floods should also consider investing in business-interruption insurance to cover the potential loss in income due to an inability to continue normal operations in the aftermath of a covered catastrophe. In fact, in today’s environment of frequent cyberattacks and data breaches, weather conditions and natural disasters are far from the only factors that can impede business operations and lead to monetary and reputational losses. Business interruption insurance helps organizations mitigate these losses and quantify and substantiate claims of lost earnings.
The professionals with Berkowitz Pollack Brant’s Forensic Accounting and Business Insurance Claims practice have more than three decades of experience helping organizations of all sizes and in all industries prepare for and maximize financial recovery from insured perils.
About the Author: Daniel S. Hughes, CPA/CFF, CGMA, is a director in Berkowitz Pollack Brant’s Forensics and Business Valuation Services practice, where he helps companies of all sizes assess economic damages, lost profits and the quantification of business interruption insurance claims. He can be reached in the CPA firm’s Miami office at (305) 379-7000 or via e-mail at firstname.lastname@example.org.
Financial experts are often utilized by attorneys in commercial litigation cases. The goal is to make the injured party whole; in other words, to return the plaintiff to the financial condition the business would have been in but for the alleged acts of the defendant. Economic damage claims can be calculated by analyzing the affected business from two different perspectives – lost profits or lost business value, depending on the facts and circumstances of each case. The decision of which approach is appropriate should be decided by the damages expert and counsel early in the case, being aware that a business cannot typically recover both lost business value and lost profits.
The amount of damages under both approaches could be similar if all else is held constant. However, in reality, the damages may be significantly different due to the inherent differences in both approaches, which are discussed below.
On June 6, 2014, the Florida Supreme Court approved jury instructions for contract and business litigation that concisely presents the concepts of contract damages. Instruction 504.3, Lost Profits, explains that to recover lost profits, a claimant must prove the defendant caused the claimant’s lost profits and the amount of lost profits must be established “with reasonable certainty.” Instruction 504.4, Damages for Complete Destruction of Business, is only given in the case of a “complete destruction” of the claimant’s business. The jury is instructed that the claimant’s damages are based on the market value of the business; anything less than “complete destruction” would be compensated via the “lost profits” instruction. (Source: In re Standard Jury Instructions – Contract and Business Cases, Instruction 504.3-504.4, 116 So. 3d 284 (Fla. 2013)).
In many valuations (under the fair market value standard), the parties are the hypothetical willing buyer and willing seller as discussed in IRS Revenue Ruling 59-60; in lost profits analyses, the parties are not considered to be either hypothetical or willing. Another of the differences between a compliance-related valuation (i.e., those for tax and financial reporting purposes) and a valuation related to economic damages is that the business value in a compliance-related valuation is as of one specific date in time, whereas in a damage claim for diminution in business value, the value of the business is determined both before and after the causative act as of the dates decided by the court.
In a loss of business value calculation, only the facts known or knowable as of the valuation date are generally considered. The courts in some cases have allowed hindsight, even where there has been a loss of business value, such as when, if hindsight were not allowed, it would result in either a windfall gain or an unfair penalization of the plaintiff.
An early case, frequently cited even today, allowed hindsight and is referred to as the “Book of Wisdom” based on a 1933 U.S. Supreme Court decision in the case of Sinclair Refining Co. v. Jenkins Petroleum Process Co., 289 US 689 (1933). The decision in this case advocated the use of actual results to determine what the value of a patent should have been on the valuation date by proving the “elements of value that were there from the beginning”. The decision in Sinclair Refining effectively allowed for a valuation based on actual results after the valuation date that would supplant market value (based on forecasted data) estimated as of the valuation date since that assessment failed to accurately determine value for the undeveloped patent.
However, in a lost profits calculation, facts and events occurring after the alleged harmful actions of the defendant are considered. If the business lost earnings for a finite period of time, damages can be determined by using a lost profits approach and then adjusted for any mitigation of those damages by the plaintiff.
In the analysis of lost business value under an income approach, the discount rate utilized would typically be either the injured entity’s equity rate of return or its weighted average cost of capital (WACC), calculated using either a build-up method or the capital asset pricing model (CAPM). However, the discount rate utilized in a lost profits calculation could be one of those or others such as the plaintiff’s cost of debt, or its internal rate of return. Another option allowed by some courts is that the projected cash flows can be adjusted to account for the risk associated with them and a risk-free (or risk reduced) rate can be used.
Lost business value calculations consider all costs needed to generate the entity’s revenues and profits as compared to lost profits analyses, which typically place greater emphasis on costs associated with the lost revenues.
As is evident from the discussion above, the calculation of damages under either the lost profits approach or the loss of business value approach is complex and dependent on the facts and circumstances unique to each case, making it very important to utilize experienced, credentialed damage experts that will provide optimum assistance to counsel.
About the Author: Sharon Foote, ASA, CFE, is a member of Berkowitz Pollack Brant’s Forensic and Business Valuation Services practice. She can be reached in the firm’s Miami office at 305-379-7000 or by email at email@example.com.
As Hurricane Matthew churned along South Florida’s coastline, residents and businesses dodged a potentially devastating bullet. Yet, the storm serves as an important reminder about how businesses must prepare for and respond to natural disasters in order to minimize losses and ensure their long-term viability. The actions a business takes during the first few days following a loss can often determine the success of its recovery and settlement of insurance claims for property damages and lost profits.
Following are six tasks that well-prepared businesses incorporate in their continuity plans. If such a plan does not already exist, a business should still consider adopting these best practices to make the recovery process smoother and improve their chances of a complete and satisfactory recovery.
Step 1: Assess Damages. As soon as the danger has passed, business owners should conduct the following activities:
- Identify the cause and origin of the loss
- Assess structural components of the remaining facilities
- Determine the scope of physical damage
- Reach a consensus with an insurance representative on the scope of the damages
- Conduct a count of damaged and/or destroyed inventory
It is recommend that business owners record the damages they incurred via videotape as soon as possible after incurring a loss. A narrated video provides an inexpensive ounce of prevention if there are future disputes with insurers about specific damage.
Step 2: Protect and Secure the Site. Boarding up broken windows, making temporary roof repairs, covering machinery to protect against the elements and disconnecting utility services are examples of activities businesses should engage in to protect their property from further damage. In addition, consideration should be given to securing the damaged area with temporary fencing or security personnel to ensure it remains intact for subsequent investigation and calculation of losses. Retail establishments should take extra care to avoid looting. Securing the site and protecting property is typically an insurance policy requirement. Plus, it will help to expedite the business’s return to its normal operations.
Step 3: Form a Recovery Task Force. Business owners looking to get their operations up and running quickly must act fast to reestablish revenue streams from customers. The best way to accomplish this is to have a solid recovery plan carried out by a company task force made up the following key constituents:
- Employees representing the business’s damaged operations, such as an operations manager, head of manufacturing, etc.
- Personnel responsible for rebuilding, such as a facilities manager, project manager, etc.
- A representative with the construction contractor
- A risk manager or other staff member in charge of corporate insurance policies
- Key staff members who interact regularly with customers, such as sales directors or customer relations representatives
- A corporate finance or accounting liaison, who will serve as the gatekeeper to gather, track, and record the repair costs as well as distribute the necessary information to other appropriate parties
- Other consultants retained to assist in the recovery, including engineers, reconstruction experts and outside accountants and consultants
Step 4: Be Involved in Estimations of Losses. When an insured business has a covered loss, the insurance carrier will typically send out one of its adjuster to establish a “reserve”, which is an initial estimate of the loss. Rather than leaving this initial loss estimation solely in the hands of insurance adjusters or other outside consultants, business owners should involve themselves in the process. No one knows a business better than its owner(s), who have unique knowledge about the business’s operations and facilities as well as the cost of replacement equipment, building materials or temporary locations. Moreover, a business interruption estimate prepared in cooperation with a business owner is less likely to overlook important factors that might affect the ultimate amount of covered losses, such as recently awarded contracts, new customers, new products, recently implemented or soon to be implemented cost savings or efficiencies, which may affect the ultimate amount of the loss.
Step 5: Establish a Loss Accounting System. There are many ways for businesses to account for a loss, but the best method is to use a simple system that follows their normal day-to-day activities. Examples can include creating a set of charge codes related to the loss, establishing separate costs centers for each repair expense category or creating a project work order, as if the repair was a normal project. The goals should be to separate repair costs from normal operating expenses and keep them organized and easy to access.
Step 6: Run Expenses and Invoices through a Corporate Gatekeeper. Invoices for loss-related expenses should be routed to an individual in the business’s accounting department (e.g.; controller, chief accountant, etc.), who can review them for accuracy, appropriate detail and relevance to a claimed loss. The job of the Gatekeeper is to ensure that all invoices meet an insurance company’s reimbursement requirements before a business pays an invoice. If further detail is required from the vendor, it is often much easier to get the information before the invoice is paid rather than after.
Step 7: Get Help. The recovery from a loss is a traumatic and potentially significant event. For some companies, major losses threaten their very existence and a full recovery determines survival or extinction. Getting help from a professional accountant, lawyer and/or engineer who specialize in financial recovery from losses and keeps your best interests in mind can make the process less complicated. They will work with your company, insurance broker and the insurer’s representatives in the time consuming task of preparing complete and fully documented claims, allowing your personnel to concentrate on the task of serving customers, repairing facilities and returning to normal operations. In addition, their fees may be covered by an insurance policy with a “professional fee” or “claim preparation cost” endorsement.
The Forensic Accounting and Business Insurance Claims practices of Berkowitz Pollack Brant has more than three decades of experience helping Florida businesses prepare for and maximize financial recovery from insured perils.
About the Author: Daniel S. Hughes, CPA/CFF, CGMA, CVA, is a director in the Forensics and Business Valuation Services practice at Berkowitz Pollack Brant, where he works with businesses of all sizes on matters involving valuations, economic damages, lost profits and the quantification of business interruption insurance claims. He can be reached in the CPA firm’s Miami office at (305) 379-7000 or via e-mail at firstname.lastname@example.org.
The IRS this month issued temporary regulations that will give taxpayers who incurred losses from a federal disaster area an additional six months to claim those losses on their federal tax income tax returns.
Under Section 165 of the Internal Revenue Code, taxpayers may elect to deduct losses incurred from a federally declared disaster area. These casualty losses are typically deductible only for the taxable year in which the disaster and resulting damages occur or for the taxable year immediately before the year in which the disaster occurred, as long as the election is made by filing a return, an amended return, or a claim for refund on or before the later of (1) the due date of the taxpayer’s income tax return (determined “without” regards to any extensions) for the taxable year in which the disaster actually occurred, or (2) the due date of the taxpayer’s income tax return (determined “with” regards to any extensions) for the taxable year immediately preceding the taxable year in which the disaster actually occurred.
Effective immediately, a taxpayer will have six months after his or her original federal tax return due date of the year following a disaster to make a 165(i) election. That means that a taxpayer whose 2016 federal income tax filing deadline is April 15, 2017, will have until October 15, 2017, to deduct casualty losses incurred in 2016.
The taxpayer does not need to request an extension of time to file a federal tax return for the disaster year in order to benefit from the extended due date. In addition, under the newly issued Revenue Procedure 2016-53, taxpayers will receive an additional 90 days after the April federal tax deadline to revoke a 196(i) election for the previous year. According to the IRS, these filing extensions will provide taxpayers affected by storms, flooding, fires or other natural disasters more time to recover and decide whether they choose to make the election, without waiting for the IRS to respond to federal disaster declarations and extend filing deadlines.
Taxpayers who experiences losses due to a disaster should reach out to their accountants to understand their tax filing rights and responsibilities, to quantify damages to property and interruption of business operations losses and to identify opportunities to qualify for a casualty loss deduction.
About the Author: Angie Adames, CPA, is an associate director in the Tax Services practice of Berkowitz Pollack Brant, where she provides tax and consulting services to real estate companies, manufacturers and closely held business. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at email@example.com.
In April 2016, the Department of the Treasury and IRS issued its third package of regulations in as many years to curtail the practice of corporate inversions in which U.S. companies change their tax residence overseas in order to reduce or avoid paying corporate U.S. taxes. To be sure, businesses that pursue inversions, often through a merger or the establishment and restructuring of a foreign subsidiary, tout the strategic benefits and competitive advantages these transactions will yield to their operations and their stakeholders. However, the tax savings they may reap by re-domiciling in a low-tax foreign country is substantial enough that the U.S. government has taken notice.
While corporate inversions are legal, the government is seeking to make these transactions “less economically beneficial” by closing tax loopholes that allow abuses to occur. The most recent set of regulations focuses on limiting serial inversions and addresses intercompany transactions and earnings stripping.
An Intro to Inversions
It is said that the U.S. has the highest corporate tax rate of all industrialized nations. When combining the federal rate of 35 percent with state taxes, a U.S.-based company can expect to pay as much as 40 percent in corporate taxes. However, the federal tax system allows these companies to take advantage of tax credits and expense deductions, which essentially reduce their corporate tax liabilities.
In order to shift some of their profits to lower-taxed countries and reduce the amount of income subject to domestic taxes, U.S. companies may consider an inversion. One commonly employed strategy involves a domestic business merging with a foreign company and moving its legal tax address overseas. By making the foreign country the tax domicile of the parent company, these companies avoid paying U.S. taxes on profits by repatriating the cash, but not the earnings, back to the United States.
Reigning In Serial Inversions
Under its most recent guidance, the U.S. government has focused its aim on what it refers to as “serial invertors” or large companies created through multiple mergers with, or acquisitions of, U.S. companies. The new regulations exclude from the calculation of a company’s ownership the stock attributable to assets acquired from a U.S. company within three years prior to the signing date of a current acquisition. By disregarding the assets of recently acquired U.S. companies, a foreign entity will appear significantly smaller and may fail to meet the 20 percent foreign ownership threshold that would allow a U.S. company to be treated as a foreign corporation exempt from U.S. corporate taxes. When foreign entities own at least 40 percent of the combined firm, they may still be considered foreign-owned for U.S. tax purposes, but restrictions on tax benefits will apply. However, the new regulations attempt to prohibit entirely the practice of establishing third-party holding companies to serve as the “acquirer” of any inversions in which U.S. shareholders own at least 60 percent of the inverted entity.
Restricting Earnings Stripping
Historically, inversions have allowed participating companies to reduce their U.S. corporate tax rate through the practice of earnings stripping, which involves intercompany transactions that effectively shift taxable earnings outside the U.S. to the parent company’s lower foreign tax rate. In these related-party transactions, the foreign parent company may lend money to its U.S. subsidiaries, loading them up on debt. The U.S. subsidiary will make interest payments to its foreign parent company and deduct the amount from its U.S. earnings subject to U.S. taxes. As a result, the interest payments will be taxable to the foreign parent company, often at much lower foreign tax rates.
Newly proposed debt-equity regulations address these practices of eroding U.S. corporate tax liabilities by re-characterizing the treatment of certain debt issued between related companies as equity. More specifically, the regulations would require businesses to treat as stock dividend distributions, interest payments and principal repayments on debt in which a U.S. subsidiary borrows cash from a related company and makes a purported “interest repayment and principal repayment” to its foreign parent. Additionally, debt instruments would be treated as stock if they are “issued by a U.S. subsidiary to its foreign parent in a shareholder dividend distribution, or issued in connection with certain acquisitions of stock or assets from related corporations in transactions that are economically similar to a dividend distribution.” The only exception to this rule and treatment of debt as stock is related-party debt incurred to fund actual business investments, such as the building or equipping of a factory.
In an effort to ensure compliance with the new regulations, the IRS will require inverted companies to conduct due diligence and document, up front, that a financial instrument is indeed debt. This includes documenting binding obligations for issuers to repay the amount borrowed, a reasonable expectation of repayment, rights of creditors and other evidence of an ongoing debtor-creditor relationship.
With the announcement of these anti-inversion rules, U.S.-based Pfizer and Ireland-based Allergan were prompted to call off their merger-in-the-making, which was being touted as the largest inversion in history. Additional fallout from the regulations remains to be seen. In the meantime, businesses considering inversions should seek the advice of experienced accountants to weigh the remaining tax benefits of cross-border mergers and acquisitions against the backdrop of further regulations that may be applied retroactively in the future.
About the Author: James W. Spencer, CPA, is a director with Berkowitz Pollack Brant’s International Tax Services practice, where he focuses on a wide range of pre-immigration, IC-DISC, transfer pricing and international tax consulting issues for individuals and businesses. He can be reached at the CPA firm’s Miami office at 305-379-7000 or via email at firstname.lastname@example.org.