Energy Industry Accounting and Tax Update July 2013

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

Dodd-Frank Section 1504 and 1502
July 16, 2013

Agenda for Today
Today we will be covering current developments
related to:
The Disclosure of Payments by Resource Extraction
Issuers (to governments) (Section 1504)
and
Conflict Mineral Disclosures (Section 1502)
© 2013 Hein & Associates, LLP. All rights reserved.

Answer to the first question you have…..
Does the law require disclosure of payments made to
the US Government?
Yes

What are the Objectives of 1502 and 1504
- Increase transparency and accountability
- 1504- Highlights payments to governments. With that
information Congress believes that public can then hold
governments accountable for the use of those funds.
- 1502- The law’s purpose is to indirectly discourage the use
of minerals that are being mined in areas controlled by
armed groups in the Democratic Republic of the Congo
region.
- 1502, 1503, and 1504 will allow investors to make more
socially responsible investing decisions.

Current developments
-Dodd-Frank was signed into law in July 2010.
- On August 22, 2012 the SEC adopted rules to implement
Sections 1504 and 1502 of Dodd-Frank.
- Created a new SEC form called Form SD
- In 2012 litigation against the SEC commences on both the
1504 and 1502 rules.
- On July 2, 2013, a judge vacates the SEC rules on section
1504.
- Oral arguments in July 2013 on 1502…Judge expects to
make a quick decision.

1504 and Form SD
• Only the SEC’s rules in implementing 1504 were
vacated…not the underlying Dodd-Frank section
1504, which is still the law.
• Court order was based on the conclusion that the
process/deliberations used by the SEC to develop
the rules to implement 1504 were flawed.
• It is possible that the SEC re-deliberates,
incorporating the concerns from court, and reaches
the substantially the same conclusions.

1504 and Form SD
• The EU has also adopted similar rules in April and
June of 2013, albeit for larger enterprises.
• NGO’s, governments and industry players have
proposed similar disclosure rules through an
organization called the “Extractive Industries
Transparency Initiative” or “EITI.”

1504 and Form SD
Disclosure of payments to Governments is….
NOT GOING AWAY.

1504…Who does this apply to? (per Dodd-Frank
Act)
Applies to any Company that:
1. Files a annual report with the SEC, and
2. Engages in the commercial development of oil,
natural gas, or minerals.
(note: includes exploration)

1504…Who does this apply to? (per Dodd-Frank
Act)
Also applies to any entity under the control of an
extraction company.
SEC estimates that 1,100 US Companies are subject
to the rule. Cost to comply was estimated by the SEC
at $1 Billion.
(note: no exemption for small filers)

1504…What types of payments need to be
disclosed (per Dodd-Frank Act)
• Taxes (except VAT and Sales Taxes)
• Royalties
• Fees
• Production Entitlements
• Bonuses (such as a lease bonus)
• Infrastructure Improvement fees

1504…What types of payments need to be
disclosed (per Dodd-Frank Act)
• Must be done on Edgar and must use XBRL
• Consistent with the EITI
• Not de Minimis
– (defined by the SEC and any series of payments over
$100,000)

1504…What Information must be disclosed for
the payments
Per Dodd-Frank:
• Type and total amount for each “project”
• Type and total amount paid to each government
• Totals amount of payments by category
• Currency used
• Financial period
• Business Segment
• The name of the government that received the payment
and the country in which that government is located
• The “project” to which the payment relates

1504…Definition of Foreign Government and
Federal Government
Foreign Government includes payments made to
companies owned by foreign governments.

1504…Definition of Foreign Government and
Federal Government
- (SEC) Foreign Governments include
subnational governments…i.e. a province, county,
district, territory etc.
- (SEC) Federal Government means the United
States and not subnational U.S. governments (i.e.
does not include states or municipalities in the U.S.)

Form SD and timing….(per SEC)
• Form was to be due 150 days after year-end.
Note: Q1 will be due shortly before SD will be due
• Payments are disclosed on a CASH basis.
• Disclose method used to translate into reporting currency.
• Form SD is FILED with the SEC not furnished to it
(section 18 liability)
Note: SEC says late filing will not preclude S-3 use.

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

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

1504
Any questions on 1504 before we move onto 1502?

1502 Conflict Minerals
“Conflict Mineral” is a defined term in Dodd-Frank Act.
Conflict Minerals are
– Gold
– Columbite-Tantalie (Coltan)
– Cassiterite
– Wolframite
– Any derivative of the above.

1502 Conflict Minerals
- ANY of these minerals from ANY area or country are
“Conflict Minerals”
- If your product has gold in it, you are using a Conflict
Mineral and are subject to the requirements on 1502. Gold
is a “Conflict Mineral”
- Depending on where the gold in your product comes from,
you will be subject to various levels of reporting.
- SEC estimates that 6,000 issuers will be impacted, with
initial compliance cost of $3B to $4B.

1502 Really Simplified
Step 1:
Do you manufacture (or contract to manufacture) a product that must
contain gold, solder, tungsten (or other components made from a
Conflict Mineral) ? If not, stop.
Step 2
Perform a “Reasonable Country of Origin Inquiry” or RCOI. After this
inquiry, did the gold (etc.) possibly come from the Congo (DRC)
region? If not, FILE A FORM SD, then stop. If yes, continue.
Step 3
Preform Due Diligence. File a FORM SD, obtain and audit, and
disclose products that are not DRC conflict free, or (during a
transition period), disclose DRC conflict undeterminable.

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

1502 RCOI
Steps needed for “Reasonable Country of
Origin Inquiry” are not defined.
- Must be reasonably designed
- Must be performed in good faith

1502 RCOI
If you must move on to the Third Step, then
you must perform Due Diligence.
- Must use a nationally or internationally recognized framework.
- A framework for Due Diligence has been designed by the
Organization for Economic Co-operation and Development
(OECD Framework .)
- Audit is to ensure compliance with OECD criteria…not to
determine if minerals are from a Conflict Area. (Similar to the
objective of a 404(b) audit)

1502 Mining Companies
In a change from the proposed rules, mining
companies will not have to make disclosures
unless they also manufacture.
– FAQ clarifies that standard mining activities are not
manufacturing

1502 Mining Companies
• Question: Instruction 1 to Item 1.01 of Form SD states that an issuer
that mines conflict minerals would not be considered to be
manufacturing those minerals for purposes of the rule. Does this
Instruction exclude all of the activities customarily associated with
mining from the rule? For example, gold mining of lower grade ore
often involves, in addition to mining the ore, transporting the mined
ore to a processing facility; crushing and milling the ore; mixing
crushed/milled ore with cyanide solution; floating cyanide mixture
through a leaching circuit; extracting gold from a leached circuit;
melting leached gold, which is often referred to as smelting, into
ingots or bars, which are often referred to as doré gold; and
transporting the doré gold to refinery for refining process.
• Answer: Yes. An issuer that only engages in those activities
customarily associated with mining, including gold mining of lower
grade ore, is not considered to be manufacturing those minerals.

THANK YOU
Please call with any other questions for comments:
Jake Vossen, National Director of Audit and Accounting
Hein & Associates LLP
jvossen@heincpa.com
303-298-9600
From SEC's small business guide to Conflict Minerals

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

Significance to the Energy Industry
• Raising capital from foreigners
• Payments to foreign vendors and service
providers
• Acquisitions and divestitures with foreign parties

Foreign Withholding - Exposure
• The U.S. mechanism for taxing foreign persons.
• The responsibility for foreign withholding lies with the
U.S. person who is considered the “withholding
agent”.
• Potential civil and criminal penalties can apply.

Penalties
The exposure associated with non-compliance may
include any under withheld tax, interest, and the
following civil penalties:
Penalty IRC § Amount
Failure to file correct information return 6721 $100/ea
Failure to provide correct payee statement 6722 $100/ea
Failure to File (e.g., Form 1042) 6651(a)(1) 5%/month
Failure to Pay 6651(a)(2) 0.5%/month
Failure to Deposit 6656 10%
Accuracy related penalties 6662 20%

Classification of Payee
The payee should provide you with one of the following
forms prior to payment:
• Form W-9 – With an EIN/SSN declaring they are a US
resident
• Form W-8ECI – With an EIN declaring they are a foreign
company doing business and paying taxes in the U.S.
• Form W-8BEN – This form indicates that they may be
eligible for a reduction of withholding under the treaty if
properly completed.

Classification of Income
• Effectively Connected Income (ECI)
• Dispositions of U.S. Real Property - Foreign
Investment in Real Property Tax Act (FIRPTA)
• Fixed or Determinable Annual or Periodical Income
(FDAP)

Effectively Connected Income (ECI)

Effectively Connected Income (ECI)
• U.S. Source income as defined by §861-863, 865
– “Asset-Use Test” - Income derived from assets used/held
for use in a U.S. trade or business.
– “Business-Activities Test” – The activities of the U.S. trade
or business are a material factor in the realization of the
income.
• Withholding rates: 39.6% ordinary, 20% capital
(under §1446)
– Election under Reg §1.1446-7

Withholding Forms to file:
• Annual return for Partnership Withholding Tax - Form
8804, 8805
– Filing deadline: April 15th, Form 7004 extends to October
15th
• Required quarterly tax deposits using Form 8813
• Distribute Form 8805 to recipients

Foreign Investment
in Real Property Tax Act
(FIRPTA)

FIRPTA
• Withholding tax imposed on sales or exchanges of any US
real property interest (USRPI) by foreign party.
• What is a USRPI?
– Land, land improvements
– Buildings
– Mines
– Wells
– Other natural deposits
– Stock in a US Real Property
Holding Corporation
“USRPHC”
– Some US Partnership
interests
• Withholding obligation lies with U.S.
purchaser/transferee.
• Withholding is on 10% of the gross amount or fair market
value of the USRPI.

FIRPTA (Continued)
• What is a US Real Property Holding Corporation
(USRPHC)?
US Corporation is considered a USRPHC if:
FMV USRPI . ≥ 50%
FMV USRPI + Foreign Real property + trade/business assets
IRC §897(c)(2)
Under the alternate valuation test a US Corporation is NOT considered a
USRPHC if:
NBV USRPI . < 25%
NBV USRPI + Foreign Real property + trade/business assets
IRC Regulation §1.897-2(b)(2)

U.S. Real Property Holding Corporation Example
Resident of
Canada
U.S.
Corporation
North Dakota
Working Interest
FMV = $3M
Canadian
Royalty Interest
FMV = $2M
15%
USRPI = $3M = 60% = USRPHC
$5M
Resident of
Canada
U.S.
Corporation
North Dakota
Working Interest
FMV = $3M
Debt Secured by ND
Property = $2M
Canadian
Royalty Interest
FMV = $2M
15%
USRPI = $3M - $2M = 33.3% ≠ USRPHC
$3M

FIRPTA Exceptions
Exceptions to the general rule to withhold are:
• Public company exception for a USRPHC –
• Stock is regularly traded on an established securities market, and
• The foreign shareholder owns less than 5% on acquisition date.
• Personal residence sold for less than $300K.
• Withholding certificate - The amount required to be withheld cannot
exceed the transferor's maximum tax liability with respect to the transfer
of a USRPI as determined by IRS. File Form 8288-B on or before the
date of the transfer.

FIRPTA Forms to file:
• U.S. Withholding Tax Return for Dispositions by
Foreign Persons of U.S. Real Property Interests- Form
8288, 8288-A
– File within 20 days of the transfer
• Application for Withholding Certificate – Form 8288-B
– File on or before the day of transfer - IRS will respond by the
90th day after receipt

Fixed or Determinable
Annual or Periodical Income
(FDAP)

Fixed or Determinable Annual or Periodical Income
(FDAP)
• All other income from a U.S. Payer – some examples
(§861,871,881):
– Dividends
– Interest
– Compensation for Personal Services
– Director Fees
– Rental income
– Royalties
• Withholding rate 30% (under §1441)

FDAP - Treaty Reduction of rates
• Many times, the rate of withholding can be reduced
or eliminated under treaty.
• Treaty rates listed in IRS Publication 515, updated
annually.
• Documentation required: properly completed Form
W-8BEN, or Form 8233.
• There is no reduced rate for natural resource
royalties.

Director Fee Considerations
• Location services are performed
• Reimbursed expenses and accountable plan
requirements
• Method of payment (i.e. restricted stock, cash,
options)

Services
Performed Outside the
U.S.
Performed Inside the U.S.
Exempt
Regulation
1.1441.1(b)(4)(v)
Paid To Foreign
Corporation/Branch
NRA Individual
All Others
Engaged in U.S. Trade or
Business
Not Engaged in U.S.
Trade or Business
Not Engaged in U.S.
Trade or Business
Subject to
Withholding
Exempt Reg.
1.441-1(b)(t)(viii)
-4 (a)(1)
Subject to FDAP
Withholding
Reg. 1.1441-
4(a)(2)
Reduced or
Eliminated by
Form 8233
Provided By
NRA
Subject to
FDAP
Withholding
Obtain Form
W8-ECI
No Form
W8-ECI
Services Flowchart

IRS Audit Example - FDAP
In February of 2013 Form 1042 for 2010 is selected for
audit and the following is discovered:
• Payments of U.S. sourced income during 2010
totaled $300K. (Assume both were paid 12/31)
• $100K Dividends (for a 4% owner)
• $200K Royalty Payment (landowner)
• Canadian Undocumented recipients = 1
• Withholding = 0
• Forms 1042 and 1042-S filed = 0

IRS Audit Example – FDAP (Continued)
• Received Form W-8 from dividend recipient
• With treaty benefits claimed under Article X.
Dividend withholding = $15,000 ($100K x 15%)
Royalty withholding = $60,000 ($200K x 30%)
Total amount underreported and under-withheld = $75,000

IRS Audit Example – FDAP (Continued)
• On May 5,2013 you receive the final Form 4549 with the Income Tax
Examination Changes and your amount due is as follows.
Description Amount
Tax Liability $75,000
Interest $5,440
Failure to deposit §6656 $7,500
Failure to file §6651(a)(1) $16,875
Failure to pay §6651(a)(2) $9,750
Penalty Interest $1,770
Failure to file form 1042-S $100
Failure to provide payee statement $100
Total Liability $116,535

FDAP Forms to file:
• Annual Withholding Tax Return for U.S. Source Income of
Foreign Persons - Form 1042
– Filing deadline: March 15th, Form 7004 extends to
September 15th.
• Annual Summary and Transmittal of Forms 1042-S, 1042-
T, 1042-S
– Filing deadline: March 15th, Form 8809 extends 30 days
(automatic), 2nd extension for another 30 days (with
permission in extreme cases).
– Distribute Form 1042-S to recipients.
• Required tax deposits
– EFTPS, Frequency depends on amount due.

Foreign Account Tax Compliance Act
(FATCA)

FATCA
What is FATCA –
• Withholding under IRC §1471 on payments to certain foreign
financial institutions.
• Reporting specified foreign financial assets on Form 8938
• Intergovernmental agreements

§1471 Withholding
• Who is a withholding agent?
• What amounts are subject to withholding?
• Who is subject to withholding?
• What are the penalties for failure to withhold?

Form 8938
• Who is required to file: Individuals
– Entities – pending regulations
• Reporting period – specified person’s taxable year.
Reg. §1.6038D-2T(a)(9)
• Due date: return due date including extensions
• Penalties: Reg. § 1.6038D-8T
– $10,000 – there is a reasonable cause exception.
– Increase in penalties for continued failures to file after receiving
a notice: $10,000/month up to $50,000.
– If you do not report income related to these assets the §6662
penalties apply and there are criminal provisions under this
section.

Form 8938 Filing Thresholds
Filing Status Domicile
Value of foreign
financial assets on
the last day of the
year > :
OR at any time
during the tax
year is >:
Single US $ 50,000 $ 75,000
Married Filing Joint US $ 100,000 $ 150,000
Married Filing Separate US $ 50,000 $ 75,000
Single Abroad $ 200,000 $ 300,000
Married Filing Joint Abroad $ 400,000 $ 600,000
Married Filing Separate Abroad $ 200,000 $ 300,000

Intergovernmental agreements
Under the Model IGA:
• Foreign Financial Institutions (FFIs) will report
information on U.S. account holders to their national
tax authorities, which in turn will provide this
information into the U.S. under an automatic
exchange of information.
• In addition, the U.S. will reciprocate and provide
similar information related to foreigners with
accounts in the U.S.

Questions?
Mei Lin Kis, Tax Manager
mkis@heincpa.com
303-298-9600
Patrick Hanley, Tax Partner
phanley@heincpa.com
303-298-9600

Energy Industry Accounting and Tax Update July 2013

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