In an era of heightened risk and uncertainty, remote workforces, and complex technologies, having effective policies and procedures that are easy-to-understand and accurate has become critical to keeping pace in the developing global regulatory landscape. 

Data Privacy and Protection – Why Is It Important?

Data privacy is the set of strategies and processes that focus on how personal data is collected, processed, stored, shared, retained, and destroyed, while data protection focuses on securing the availability and integrity of data and protecting assets from unauthorized access. A data privacy and protection strategy are crucial for any organization because it aims to provide individuals with transparency, control over their data and how it is used, and to protect personal data from unintended access and use. Without a data privacy and protection strategy, your organization may be more vulnerable to consumer complaints, regulatory investigations and fines, and fraudulent activities like identity theft, phishing, and hacking.

Source: https://www.bdo.com/services/business-financial-advisory/governance,-risk-compliance/data-privacy

Components of a Data Privacy and Protection Strategy

When developing a strategy, you need to understand:

The Business

Understanding the business is key to a data privacy and protection program. The more you know about the business, the more you’ll understand about the types of data it processes and the level of protection required, and so on.

The Data

Many organizations collect personal data from both internal and external sources. For example, a bank collects financial information from customers. A healthcare organization collects health information. All organizations collect and process personal data of their employees. It’s important to identify the categories of personal data as this will inform various privacy notices, policies, and procedures.

The Purpose

It’s one thing to identify data, but to understand what the data is and how it serves a purpose in your organization is an entirely different task. This is important when building a data privacy and protection strategy because it helps you populate your personal data inventories and records of processing (where applicable or legally required), identify opportunities for data minimization, confirm that the data collected is proportional to the purpose, and implement appropriate safeguards.

Data Privacy and Protection—5 Steps to Get Started

Identifying data, how that data is used, classifying the data, and outlining what actions to take with each type of data is key to data privacy. Here are five things all organizations can do to begin or enhance their data privacy strategy:

1. Identify where your data is located

It can be a challenging task but identifying where your data is should be the first step in protecting it. Where does all your data live and where does it go? What types of data exist? Where is it physically hosted? Discovering your data is a foundational task because it informs the rest of your data privacy and protection strategy.

2. Identify what your data is

You cannot protect your data without first understanding what you have. After identifying where the data is, the next step is to create a personal data inventory and record what you do with that data. At this stage you may also tag the data by classification. Data classification helps to organize the data into groups – most often according to level of sensitivity – to enable efficient data protection.

It’s also important to note that data protection and e-discovery have certain functional overlap and that we see a rise in privacy programs leveraging e-discovery solutions as part of their privacy strategy and toolsets. Data investigation is also less burdensome when your data is classified; therefore, the two can be interdependent.

3. Determine who has access to the data

Who currently has access to each type of data? This includes internal stakeholders, as well as third-party recipients, such as service providers or partners. Knowing who is receiving or accessing the data and where they are located affects the rules you’re placing around the data and transfers. Certain privacy laws may also require data localization or additional technical, organization, and contractual safeguards to transfer data cross-border.

4. Define how you will implement privacy controls

Once you understand your data, you can better customize privacy policies and procedures. For example, you can use your personal data inventory to guide where and how to execute a data subject/consumer rights request. Understanding your business, technologies, and risk profile can also help you create a customized privacy by design program and methodology that embeds privacy controls during the early stages of a project or development lifecycle.

5. Implement technical and organizational controls

A data privacy strategy relies upon the implementation of strong security controls. This includes organizational or programmatic controls such as policies, training and awareness, incident response plans, and password policies, as well as technical controls such as encryption, anonymization, logging, multi-factor authentication, and vulnerability detection. One important safeguard for data protection is Data loss prevention (DLP) which prevents unauthorized leakage of data outside of the organization. Once data is classified, the technical implementation of DLP can establish policies for each layer of classification to prevent unwanted sharing. Once implemented, continuously monitor and maintain the policies to stay up to date with business needs and regulatory requirements.

Data privacy can be a tricky concept if you haven’t yet addressed it within your organization. The data privacy specialists at Urish Popeck can help you understand the risks and maturity of your current business environment and discover whether your program meets applicable regulatory requirements and leading practices. To learn more, contact us today.

Written By Taryn Crane, Mark Antalik and Steve Combs. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com

The post Data Privacy In 2022: What You Need To Know appeared first on Urish Popeck.

Evolving roles and responsibilities

Compensation committees are navigating a variety of challenges from traditional roles and responsibilities in addition to taking on emerging areas of focus. Core required responsibilities, including C-suite compensation recommendations and performance evaluations, now require more time and effort than they may have in the past. As compensation considerations become more complicated, a higher level of commitment, responsibility, time and expertise is expected. Leading directors are pursuing continuing education to ensure they can properly carry out their duties.
 
Compensation committees are also being tasked with board-level oversight of broader human capital responsibilities. While traditionally focused on executive team compensation arrangements and exercising fiduciary duties in applying the business judgment rule and duties of care and loyalty, the topics of people and performance are broadening in compensation committee discussions to cover a more expansive employee population.
 
As ESG issues come to the forefront, compensation committees are concentrating on the “S,” collaborating with corporate HR departments and expanding their charters to focus on human capital management (HCM), diversity, equity and inclusion (DEI) and other social concerns. Succession and leadership pipeline planning, talent development, employee health and safety and oversight of DEI metrics are all on the agenda as boards look to ensure their organizations have the right talent mix—and incentives to draw in and retain top performers—that will set the organization up for long-term success.
 
Creating a baseline is key to successfully guiding the human capital conversation. For companies just starting the conversation, it can be helpful to take a step back and define what HCM means for the organization and help the board understand what management is already doing—and not doing—in this area. Considering an array of HCM strategies to align operational, functional and board oversight responsibilities is a good starting point. It is also important to recognize that each company is unique, and the HCM conversations and strategies may vary from one company to another.
 
DEI metrics and practices most often fall under the HCM responsibilities. Many companies made DEI commitments in the past 18 months, and employees and other stakeholders are keeping a careful eye to ensure that promises made by executives are kept. Diversity in the board and C-suite have long been under the microscope, but employees are now looking to commitments made about recruiting a diverse pool of candidates for rank-and-file positions. Pay equity is also top of mind, both among various identity groups but also between employees and senior leadership. Compensation committees should carefully consider the metrics they are putting in place to track executive action in these areas. On top of that, there are disclosure approaches to consider. Currently, the majority of DEI disclosure is voluntary, but employees increasingly require transparent executive action to feel confident that leadership is making good on promises
 
As responsibilities expand, so does the scope of stakeholders the board is beholden to. The Business Roundtable has provided impetus for a focused and prioritized plan that outlines how to satisfy the needs of various stakeholder groups. Institutional investors’ growing focus on ESG is reverberating through incentive discussions as companies evaluate the use of ESG goals or metrics in their annual bonus and performance share unit plans. This comes alongside continued external stakeholder focus on executive compensation, pressuring the compensation committee to consider these sometimes conflicting priorities. Outside parties such as proxy advisory firms ISS and Glass Lewis will provide their own analyses of stakeholder priorities, but it is critical that the company takes control of the narrative and informs stakeholders of the risks and opportunities directly.
 
Though compensation committees have increasingly taken on these additional roles, at the end of the day, they serve as advisors to the full board on determining matters of compensation. Communication with the full board, management and stakeholders, together with clear documentation of roles and responsibilities within the charter, are imperative to long-term success and accountability.
 

Understanding the impact of organizational culture and wellness

As part of the board’s role in mitigating organizational risk and providing strategic oversight of management, it must consider the implications that corporate culture has on an organization’s agility and ability to sustainably scale.

To be successful, especially in the long term, culture must be foundational and driven from the top down. When employees see that leadership advocates for an organization’s purpose, values and vision, they are more likely to feel connected to their work and less likely to leave for other opportunities.

Onboarding and recruiting are expensive—currently where companies are seeing employees exit for a whole host of reasons, the need to understand the specific triggers to enable the creation of an environment that allows employees to thrive becomes increasingly important. This includes conducting and being responsive to periodic employee pulse surveys and ensuring meaningful organization-wide participation that may impact decisions ranging from compensation/financial/health and wellness benefits to equity and inclusion, flexibility and other supportive means impactful to employees. It further includes carefully crafted, robust talent and skill development programs, transparent growth opportunities along with continual succession plans to ensure leadership at all levels are prepared to execute on longer term strategies of the business.

Amid the “Great Resignation” being experienced globally, employers are challenged to rethink traditional workplace norms and levels of transparency with both internal and external stakeholders. Many companies are reconsidering strategies for an optimal work life balance, opening opportunities for employees to pursue individual interests, be creative with how they craft their job role and career path, and even offering perks like sabbaticals to allow employees to pursue passions outside of everyday work.

The increased transparency required in external reporting may also influence corporate culture. Compensation ratios reported under the Dodd-Frank Act have been under fire in recent years, and COVID-19 increased scrutiny of excess pay, amplifying existing compensa­tion issues and creating urgency for change from proxy advisory firms and other stakeholders. The CEO pay ratio for companies in the S&P 500 was up to 264:1 in 2019 and increased to 299:1 in 2020; while pay levels increased by 12.1% for CEOs and 10.1% for CFOs between April 2020 and March 2021. This increase is the largest of the last five years.

These metrics will continue to be scrutinized, not only by stakeholders outside the company, but by those within and disparity will likely not support a unified culture. If leadership is seen as putting their compensation over the well-being of employees, confidence in management is bound to dry up rapidly and turnover will likely increase.

The compensation committee should consider whether corporate culture benchmarks should be included in their compensation packages. Focusing on hitting tangible metrics in areas such as staff retention, upskilling programs and DEI can help incentivize executives to focus on these areas as they focus on culture and the impact on long-term company performance. That said, any DEI metrics in an incentive plan should support the organization’s overarching DEI or ESG strategy. Absent a defined plan and communications strategy, DEI metrics risk being counterproductive or viewed as disingenuous by stakeholders.
 

Aligning compensation with evolving strategic business priorities

As priorities and strategies evolve, aligning performance goals with business strategy becomes more complicated for compensation committees. BDO’s most recent Board Pulse Survey found that boards are aiming to take specific action to align executive compensation with business objectives and evolving stakeholder expectations. Their main focus areas are pay for performance and ESG. Tying compensation to value-driving goals can help compensation committees keep executives accountable and drive long-term benefits.

In the area of pay for performance, 63% of directors surveyed are aligning performance goals (thresholds/maximums) with the probability of achieving them. On top of that, 37% are shifting incentive compensation from a periodic bonus structure to longer-term equity grants, likely with the goal of pushing executives to think about business success long-term rather than simply making decisions to maximize their next bonus. COVID-19 caused some adjustments to be made to short-term executive compensation due to changes in annual cash flow, but most long-term incentives were not significantly impacted. Given the increased transparency and stakeholder interest in executive compensation, compensation committees should be considering what success metrics they are putting in place for the C-suite and how hitting those goals will further the organization’s strategic vision and benefit shareholders.

When it comes to ESG success metrics, some boards have already begun weaving them into compensation agreements, even if a central framework on ESG disclosures has yet to be agreed upon. Based on a recent BDO study of 600 middle market public companies, about 14% mention using specific ESG metrics in their short-term incentive plans. BDO further found that 19% of public board members indicate that they are increasingly tying annual and/or long-term incentives to ESG metrics, 35% are enhancing communication and disclosures to key stakeholders about compensation and 33% are expanding the oversight role of the compensation committee. Ultimately, the end goal for most leadership is for ESG to become a natural fit within corporate strategy, though most companies are still working toward this. However, organizations shouldn’t jump to using ESG metrics to gauge performance and evaluate compensation payouts until an organizational ESG strategy has been developed.

When designing an incentive plan that incorporates ESG factors, it is crucial to lay out the following strategic execution considerations:

• What are you trying to measure? Agree on specific metrics and goals that align with your organization’s values and vision. Without clear KPIs from the outset, measuring success over time will be more difficult in the long-term.
• Should it be over a long or short term? Consider how long it will take to show improvement for that area of focus. Some areas may be tackled quickly, while others are best measured over a longer time frame to truly capture the impact.
• How much of an incentive should it be? Consider the importance of each factor and take that into account when building the plan. Will you weigh the performance measures based on priority level? Does a modifier make sense to include? This step requires that the ranking of priorities has already been determined.

With a still uncertain economy, compensation plans also need to be structured to ensure they are responsive to economic shifts, keeping executives accountable for long-term value creation without punishing them for unforeseeable circumstances that arise. These compensation committee challenges may be mitigated by strategies such as:

• engaging with shareholders and other key stakeholders (e.g., employees, customers, etc.),
• reviewing peer group data and making adjustments to ensure continued alignment with evolving business needs,
• implementing relative performance measures if well-defined peers exist, and
• expanding performance ranges or lengthening stock holding periods  

Any change, particularly actions that stand out relative to market expectations, should be well documented and disclosed so stakeholders understand how the compensation programs align with the company’s needs. Overall, there is no one-size-fits-all solution to creating the perfect compensation package, and committee members need to consume available market data along with internal data in proposing compensation strategies and plans reflective of the business needs.
 

Mastering M&A: Considering Compensation Strategy

As merger and acquisition (M&A) transactions continue to trend higher, there are many considerations for the board to take into account. The most recent BDO Board Pulse Survey found that appetite for acquisition is high—50% of directors are seeking or expanding an acquisition strategy. No matter the goal(s) for an acquisition—growth, gaining new market share, increasing innovation—contemplating compensation is a key step in the process both from the perspective of your existing employees and from integration of talent that will be acquired.

Whether engaging in a traditional acquisition or executing a SPAC transaction, there are a number of compensation considerations to keep in mind:

• Defining talent strategy. The company will need to establish a talent philosophy that inventories current skills, defines corporate needs, and creates a plan to address the gaps therein. The compensation committee should work collaboratively with the nominating and governance committee as necessary to execute the strategy.
• Aligning compensation plans. Evaluate the plans already in place on each end of the deal and consider the best way to ensure they are aligned. This may require going back to the drawing board and reevaluating organizational goals and priorities of the newly merged entity. Consider the historical incentives that have been offered—are they still relevant? This can be a delicate process so ensure the compensation team works closely with the broader board to consider all the potential complications.
• Aligning human capital departments and policies. Integration is a key step in any M&A process. When it comes to compensation planning, smoothly integrating the human capital aspects of the merging organizations is critical. Policies and procedures are important to examine, as are the less tangible aspects like culture and employee morale. Once again, carefully consider the goals for the company post-deal and ensure that you have plans in place to align your new human capital policies with those goals.

An acquisition also often brings a new range of stakeholders who need to be taken into consideration when evaluating compensation impact. For example:

• How may this impact corporate tax – e.g., deductions for highly compensated executives?
• Will the share price be affected, and if so, do we have a plan to communicate this to those whose compensation is tied to share price?
• If considering or already implementing a remote workforce post-deal, what are the tax and legal implications in the long-term and do we need to rethink our long-term incentive plans?

Ensure you have plans to address questions like these during the M&A process.

Looking beyond traditional compensation tools to attract and retain talent

When it comes to attracting and retaining talent, employees want more. While executive pay levels have been rising in recent years, companies and compensation committees need to look beyond pay to attract and retain talent.
 
In 2022, top talent will likely still be hard to come by and competition for qualified professionals will remain fierce. Sourcing labor is among directors’ top three impediments to economic and operational success, as cited by 16% of directors.

To mitigate labor challenges, businesses are attracting and retaining talent by using some of the following strategies:

• 55% are re-imagining flexibility and remote work
• 51% are emphasizing DEI initiatives
• 46% are upskilling the workforce
• 37% are enhancing employee benefits
• 32% are focusing on corporate social responsibility/philanthropy

Compensation committees are urged to consider broader labor strategies when crafting incentive plans as long as they are reflective of strategic shifts toward a more resilient and agile business model to sustain the organization’s future.

BDO is also seeing new benefit trends emerge as organizations look to retain talent in a recovering environment. These may include monetary retention awards in addition to reviewing compensation philosophy and structure to remain competitive. Beyond salary we expect to see more compensation packages include flexibility, mobility, improved benefits and the facilitation of growth and leadership opportunities.

Engaging with employees – whether through town halls or pulse surveys – can provide companies with real time feedback as to what employees value and what changes may be appropriate. Striking the right mix of cash, equity, benefits, growth opportunities and more will be a process unique to each organization and each candidate.
 

Grappling with increased disclosure and reporting demands

Boards are dealing with ever-increasing disclosure and reporting demands as regulatory agencies reconsider what information is necessary for shareholders to make informed investment decisions. In late 2020, the SEC issued new HCM disclosure rules but left them largely principles-based, requiring reporting companies to include human capital measures that are “material to an understanding of the registrant’s business.”  Although the SEC broadly identified the issues of attracting, developing, and retaining talent as examples considered important to stakeholders, it did not mandate the disclosure of these matters. Instead, the SEC recommended that each company disclose such details specific to its own business and circumstances. However, there is anticipation of additional and potentially more prescriptive HCM reporting requirements from the SEC expected in early 2022.

In August 2021, SEC Chairman Gary Gensler tweeted: “Investors want to better understand one of the most critical assets of a company: its people. I’ve asked staff to propose recommendations for the Commission’s consideration on human capital disclosure….This could include a number of metrics, such as workforce turnover, skills and development training, compensation, benefits, workforce demographics including diversity, and health and safety.”

Compensation committees must ask if their organization has the information and systems to collect such information readily available to address the potential additional disclosure requirements, as well as begin to understand what the disclosures will mean and how they might be interpreted by stakeholders. Directors should collaborate with the audit committee on reporting requirements, ensuring proper data controls are in place and disclosures are reviewed before filing.

The SEC also approved NASDAQ’s board diversity compliance and disclosure rules. While compliance of such rules may fall under the purview of the nomination/governance committees, the compensation committee will need to work collaboratively with the board to support any enhanced recruiting and retention efforts that may result.

Though compliance is crucial, compensation committees must be mindful of where and how information is being disclosed to ensure there is a consistent and cohesive narrative for shareholders. An official disclosure in the 10-K or within the Compensation Discussion and Analysis (CD&A) is different than a disclosure in a standalone ESG report. While the new HCM disclosure requirements are specific to the 10-K, HCM disclosures in the proxy statement are also gaining popularity given the placement of the CD&A. The board needs to ensure that the company has appropriate mechanisms and controls in place to ensure information is reviewed and compared for consistency and accuracy, as these sources of information are being used by key stakeholders, including investors and regulators. 

The increasing trend for companies to report on non-financial metrics has added complexities due to the subjectivity of the underlying qualitative and quantitative data. This causes difficulty when making a materiality assessment or trying to link to a trackable KPI. For example, boards have a range of plans to address ESG issues in the months and years ahead, with nearly three-quarters of directors (73%) focused on keeping up with evolving regulatory and reporting guidance for ESG in the near term. Board members also recognize this growing need for action and transparency, as the most important priorities coming out of shareholder meetings held during the 2021 proxy season included accountability for ESG/sustainability (13%) and DEI efforts (13%). Though ESG reporting remains largely voluntary in the U.S., we anticipate this to change significantly.

Controls are also critical to reporting and tracking comparatively over time; particularly as new non-financial metrics increase in frequency and prominence. The SEC has signaled that it is focusing heavily on comparability of data year over year. Any irregularities will be noted, and businesses will want to ensure controls are in place to explain variances and irregularities appropriately. Compensation committees should have a good understanding of the effectiveness of controls impacting compensation disclosures.

Overall, scrutiny continues to increase from a wide range of stakeholders and boards are being held to even higher standards. Any significant choices/changes made related to compensation are sure to be examined and dissected and committee members should take steps to ensure they feel comfortable responding to questions. Transparency is key, and carefully making and explaining strategic moves that drive long-term value will set organizations and board members up for success.

Next steps

We encourage compensation committees to remain up to date on evolving compensation trends and work with your advisors on continuing education plans.
 

Compensation and Proxy Advisor Focus in 2022

 Annually, proxy advisors Glass Lewis and ISS issue updates to their voting policies and guidelines. In 2021, ISS has further indicated within its FAQs that the “surprise” element of the COVID-19 pandemic is no longer applicable. Accordingly, ISS has indicated, “as in pre-pandemic years, any mid-year changes to metrics, performance targets and/or measurement periods, or programs that heavily emphasize discretionary or subjective criteria will generally be viewed negatively. This will be of particular focus for companies that exhibit a quantitative pay-for-performance misalignment.” Companies who decided to make such changes need to be prepared to disclose their specific reasoning to aid investors in their evaluation of such changes.

Written by Jason Brooks, Amy Rojik and Phillip Austin. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com

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As 2022 kicks off and tax legislation continues to be stalled in Congress, the amendment to Internal Revenue Code (IRC) Section 174 originally introduced by the 2017 tax reform legislation, the Tax Cuts and Jobs Act (TCJA), is now in effect.

TCJA’s amendment to Section 174 requires U.S.-based and non-U.S-based research and experimental (R&E) expenditures to be capitalized and amortized over a period of five or 15 years, respectively, for amounts paid in tax years starting after December 31, 2021. Additionally, software development costs are specifically included as R&E expenditures under Section 174(c)(3) and, therefore, will be subject to the same mandatory amortization period of five or 15 years.

Prior to the TCJA amendment, Section 174 allowed taxpayers to either immediately deduct R&E expenditures in the year paid or incurred, or elect to capitalize and amortize R&E expenditures over a period of at least 60 months. Additionally, taxpayers were able to make an election under Section 59(e) to amortize R&E expenditures over 10 years. Similar options existed for the treatment of software development costs under Rev. Proc. 2000-50, which provided taxpayers the option to currently expense costs as incurred, amortize over 36 months from the date the software was placed in service, or amortize over not less than 60 months from the date the development was completed.

The statute specifies that amortization will begin with the midpoint of the taxable year in which expenses are paid or incurred, creating a significant year 1 impact. For example, assume a calendar-year taxpayer incurs $5 million of R&E expenditures in 2022. Prior to the TCJA, the taxpayer would have immediately expensed all $5 million on its 2022 tax return, assuming it did not make an election under Section 174(b) or Section 59(e) to capitalize the amounts. Under the new rule, the taxpayer will be entitled to amortization expense of $500,000 in 2022, calculated by dividing $5 million by five years, and then applying the midpoint convention in the first year of amortization to haircut the annual amortization amount in half.

In the House version of the Build Back Better Act passed in November 2021, the effective date for the amendment made by the TCJA to Section 174 was delayed until tax years beginning after December 31, 2025. While this specific provision of the bill enjoyed broad bipartisan support, comments made by Senator Joe Manchin (D-W.V.) in late December indicating his opposition to the bill effectively stalled progress on the Build Back Better Act, making the path forward on legislation unclear. Accordingly, as of the date of this publication, the original effective date (i.e., years beginning after December 31, 2021) for the mandatory capitalization of R&E expenditures remains in place.

Immediate Considerations for Taxpayers with R&E Expenditures

Due to the new capitalization requirements, taxpayers should ensure that R&E expenditures incurred are properly identified. Some taxpayers may be able to leverage from existing systems/tracking to identify R&E. For instance, companies may already be identifying certain types of research costs for financial reporting purposes under ASC 730, and/or calculating qualifying research expenditures for purposes of the research credit under Section 41. By definition, any costs included in the research credit calculation would need to be recovered under the five-year recovery period. As such, taxpayers with an existing methodology in place to calculate the research credit will likely be able to use such computations as a helpful starting point for determining R&E expenditures under Section 174.

However, it is important to note that the type of expenses eligible for deduction under Section 174 are generally broader than the type of expenses eligible for the credit under Section 41. While Section 41 only allows wages, supplies and contract research to be included in the computation of the credit, Section 174 expenses can include items such as utilities, depreciation, attorneys’ fees and other costs incident to the development or improvement of a product. Accordingly, even taxpayers that undertake a robust Section 41 analysis will likely need to examine additional costs outside of the amounts included in the credit calculation to determine whether other expenses meet the definition of R&E expenditures under Section 174.

Other taxpayers that are not currently identifying R&E expenditures in any fashion will need to consider what steps are necessary to assess the amount of expenditures subject to Section 174. For instance, taxpayers that include all of their salaries and wages in a single trial balance account should consider what mechanisms are readily available to them to allocate the single account balance between Section 174 and non-Section 174 amounts. In certain instances, it may be prudent to begin segregating R&E expenditure amounts in their own trial balance accounts (e.g., to have a separate trial balance account for R&E expenditure wages versus non-R&E wages), or employ the use of a departmental or cost-center based trial balance to capture R&E expenditure amounts. The determination of which specific costs should be included in the relevant R&E expenditure trial balance accounts or R&E expenditure cost centers/departments will likely involve interviews with a taxpayer’s operations and financial accounting personnel, in addition to the development of reasonable allocation methodologies to the extent that a particular expense (e.g., rent) relates to both R&E expenditure and non-R&E expenditure activities.

After identifying these costs, taxpayers will have to track amortization and make any necessary book/tax adjustments, as many of the costs that are required to be capitalized under Section 174 will likely continue to be expensed as incurred for book purposes. As such, companies should expect there to be a difference in the total cost basis of the property between their depreciation books maintained for financial reporting purposes versus tax reporting purposes. This may result in additional reconciliations that must be performed year after year.

From a procedural standpoint, the statutory language in TCJA indicates that while the amendment to section 174 is to be treated as a change in method of accounting, the new rule applies on a cut-off basis, meaning that any costs incurred in years before 2022 will remain as-is, with the capitalization requirement applying prospectively to costs incurred going forward. It is currently unclear whether taxpayers that previously were expensing the R&E expenditures will need to file an Application for Change in Method of Accounting (Form 3115) to begin capitalizing and amortizing these expenditures. We expect the IRS to release guidance specifically addressing how taxpayers must comply with the new rule for the 2022 tax year, presuming the effective date of the provision is not delayed by Congress. Taxpayers should, therefore, continue monitoring releases from the IRS and Treasury before filing their 2022 tax returns to ensure compliance with the latest guidance.

Other Effects of the New Section 174 Rule

While the most obvious impact of the new Section 174 is a temporary increase to taxable income (or temporary decrease to taxable loss) that will ultimately reverse in future years, there are other tax provisions for which the treatment of R&E expenditures and/or the determination of taxable income are relevant that could also be affected by the change. In certain instances, the difference could result in a permanent difference to a taxpayer’s lifetime taxable income, resulting in a difference to its effective tax rate. With the new capitalization requirement in place, some areas taxpayers should pay attention to as they begin to consider tax provision and taxable income projection implications for 2022 includes:

• Section 250 Foreign Derived Intangible Income (FDII) deduction: FDII benefits may increase due to increased taxable income (and therefore deduction-eligible income and foreign-derived deduction-eligible income) as a result of capitalized R&E expenditures.
• Section 163(j): Increased taxable income resulting from the capitalization of R&E expenditures may reduce disallowed business interest expense under Section 163(j) in a given year.
• Section 250 Global Intangible Low-Taxed Income (GILTI) calculation: The requirement to capitalize and amortize foreign R&E expenses over 15 years may have a significant impact on the amount of tested income. 
• Section 861 allocations: Provisions involving the allocation of R&E expenditures, including FDII, GILTI and the foreign tax credit, should ensure that all costs identified as Section 174 amounts are allocated in accordance with the rules provided under Treas. Reg. §1.861-17.

As noted above, some of the ancillary effects of amended Section 174 may be taxpayer favorable in certain instances. Another potentially favorable development involves taxpayers that were previously capitalizing R&E expenditures under old Section 174(b). Under the new rule, taxpayers will start amortizing their capitalized R&E expenditures beginning with the midpoint of the taxable year in which the amounts were incurred, instead of having to wait until the first month in which they realize a benefit from the R&E expenditures, as was required under old Section 174(b). This may allow certain taxpayers with multi-year Section 174 projects to begin recovering their costs at an earlier point in time.

While the discussion above highlights many of the important issues that taxpayers should begin considering now, many questions linger as we await further guidance from the government. Several notable areas of uncertainty include:

• How broad is the application of Section 174 to software development costs? For instance, does the new rule apply only to software development costs that also happen to meet the definition of Section 174, or does it include all costs associated with software development?
• How should amortization expense related to capitalized R&E expenditures be treated under Section 263A (UNICAP)?
• How are domestic and foreign research activities distinguished?
• What procedures are necessary to implement the method change to required capitalization?
• How should research expenses that are ultimately reimbursed by another party (e.g., under a cost-plus arrangement) be treated under Section 174?

Next Steps

Legislative action is required to change the treatment of R&E expenditures for tax years beginning after December 31, 2021 and thereafter. As mentioned above, the delay of the effective date to capitalize R&E expenditures has broad bipartisan support, and taxpayers remain hopeful that Congress will be able to enact a bill that will allow for uninterrupted expensing treatment of Section 174 costs, at least for the next few taxable years. In the meantime, taxpayers should start considering the implications of the Section 174 rule as currently enacted, and assess the impact of the changes to their 2022 taxable income for financial reporting and estimated tax payment purposes.

Written by Connie Cunningham and Chris Armstrong. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com

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Background

On October 15, 2021, the Office of Chief Counsel released Chief Counsel Advice Memorandum 20214101F releases its revised policy regarding research credit claims. The CCA mandates that taxpayers include certain information along with a research credit refund claim filed under Internal Revenue Code (IRC) Section 41 on or after January 10, 2022, or risk having such claims deemed “deficient” and, thus, rejected without further IRS inquiry. The IRS stated that the CCA is intended to improve tax administration by:

• Providing clear instructions for eligible taxpayers to claim the Section 41 credit; and
• Reducing the number of disputes over such claims.

The interim guidance regarding the application of the CCA sets out specific procedures. These procedures must be followed to determine if a claim is “valid,” including requiring a taxpayer to provide detailed information to the IRS on the grounds and facts upon which a research credit refund claim is based. The IRS will assess the validity of each claim filed after January 10, 2022. However, the interim guidance reflects other procedural exceptions the IRS may apply during its evaluation of the validity of a claim. The IRS has committed to make determinations on such claims within six months of receipt.

Determining the Validity of Refund Claims that Include a Claim for Credit for Increasing Research Activities

Existing Treas. Reg. § 301.6402-2(b)(1) requires taxpayers that are filing a tax refund claim to apprise the IRS of the basis for the claim. According to the CCA and the January 5 FAQs, taxpayers filing an amended research credit refund claim will also be required to provide, at a minimum, five essential pieces of information:

1. All business components that form the factual basis of the Section 41 research credit claim for the claim year;
2. A description of all research activities performed, by business component;
3. The first and last names or title/positions of all individuals who engaged in the research activity, by business component;
4. The information each individual sought to discover, by business component; and
5. The total qualified employee wage expenses, supply expenses and contract research expenses.

The above list is the minimum criteria that must be submitted. In addition, each taxpayer submitting an amended research credit refund claim must submit a declaration. This declaration must be signed under penalty of perjury verifying that the facts provided are accurate. For most taxpayers, the signature on Forms 1040X or 1120X serves this function.

The interim guidance also clarifies that taxpayers submitting a research credit claim begin explaining the information that each individual sought to discover by business component. Specifically, this information, included under criterion 4, may be submitted as a list, table or narrative. This is beneficial for taxpayers that may have anticipated challenges in reporting this information.

Transition Period and Time to Perfect

For amended research credit refund claims filed during the period January 10, 2022 through January 9, 2023 (“transition period”), taxpayers will be given 45 days to perfect a timely filed claim that is deemed deficient because it failed to provide the five minimum criteria listed above. Notably, this is an extension of the period previously mandated under the CCA, which originally granted only 30 days to perfect such a claim. 

Taxpayers that fail to provide the required five minimum criteria will be notified via Letter 6428, Claim for Credit for Increasing Research Credit Activities – Additional Information Required. The 45-day perfection period will begin on the date Letter 6428 is issued. If a taxpayer does not submit sufficient information to perfect the claim pursuant to the process set forth in the letter, the claim will be considered deficient, and the taxpayer will be issued Letter 6430, No Consideration, Section 41 Claim. If the IRS does not receive a taxpayer’s information or the missing information is insufficient following the 45-day perfection period, the IRS will reject the research credit claim without further consideration.

Claims Filed After the Transition Period Ends

Taxpayers that file a research credit claim after the transition period will be subject to general rules of Section 6511(a). Then, will not have the opportunity to perfect a claim that is deemed deficient. The IRS will evaluate each research credit claim based on the same five minimum criteria outlined above and verify that each claim was signed under penalty of perjury. If a claim is determined to be deficient, examiners will issue Letter 6430, No Consideration, Section 41 Claim, to the taxpayer, and reject the research credit claim without further consideration.

Next Steps for Companies

The IRS’s revised administrative policy impacts many U.S. taxpayers that engage in research and development (R&D) activities. As a result, the American Institute of Certified Public Accountants (AICPA), American Bar Association (ABA), National Association of Manufacturers (NAM) and many others have commented on the need for the IRS to delay implementation and resolve potential uncertainty for taxpayers. However, taxpayers submitting amended research credit refund claims must be prepared to set forth the following in detail:

• Each ground upon which a credit or refund is claimed; and
• Facts sufficient to support the basis for the claim in accordance with the IRS’s new five minimum criteria.
• A written declaration verifying such facts under the penalty of perjury.

While it is expected that taxpayers will continue to be able to uphold the validity of research credit claims that have previously been filed, taxpayers should consider the IRS’s five minimum criteria for future research credit claims and the potential need to perfect claims the IRS may deem as deficient for failure to meet these criteria.

We Can Help

We understand the challenges that companies face. Whether you’re a startup or an established company, we offer a breadth of integrated services tailored to your individual needs. We also have extensive experience assisting taxpayers of all industries and sizes. We help with evaluating their qualified R&D expenses, calculating their credit claim amount for filing and, when necessary, defending the position with the IRS. To ensure companies continue to efficiently and effectively file claims, we can provide comprehensive support in assisting companies with planning and complying with the IRS’s new administrative policy.

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Insights 

• Stay tuned for a more detailed analysis of Michigan’s new elective PTE tax law, along with the guidance expected to be released by the Department of Treasury.
• Based on informal discussions with Treasury, a notice is in progress and expected to be released by December 27, 2021 that will provide guidance as to how to make Michigan’s election for 2021 before year end. For at least the 2021 tax year, it appears that a form will not be available to make the election by December 31, 2021. Rather, Treasury indicated that payment of the tax for 2021 will constitute making the election. Payments must be made electronically through Michigan Treasury Online, which is expected to be open for payments the week of December 27.
• Because the election is binding for the year of election and two subsequent tax years, it should not be entered into lightly. Taxpayers contemplating making the PTE election should perform a detailed analysis and modeling to determine whether the election is beneficial to the entity, its resident owners and – most importantly – its nonresident owners.

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The model rules fill in the details regarding Pillar Two of the agreement announced on October 8 to address the tax challenges of the digitalization of the economy. Pillar Two set out in broad strokes the parameters of the Global Anti-Base Erosion (GloBE) rules, which establish a “top-up tax” to be applied to profits in any jurisdiction if the effective tax rate is below the minimum 15% rate in that jurisdiction.

The rules, originally expected to be release in late November, represent the next step in a process that ultimately would reform the global tax system.

The Details

The 70-page model rules are organized into 10 chapters that deal with the scope of the rules, the computation of GloBE income or loss and the top-up tax, corporate restructurings and holding structures, administration and transition rules. The OECD explained that the model rules have been designed to accommodate a broad range of tax systems and business structures, and therefore many of the specific provisions may not apply to all jurisdictions or in-scope MNEs.

Chapter 1 of the model rules delineates the scope of the GloBE rules, which will apply to constituent entities that are members of an MNE group with annual revenue of EUR 750 million or more in at least two of the four fiscal years immediately preceding the tested fiscal year.

Specific types of entities are excluded from application of the rules, in addition to those that fall below the monetary threshold of EUR 750 million. These include government entities, international organizations and nonprofit organizations, as well as entities that meet the definition of a pension, investment or real estate fund.

Chapters 2 to 5 comprise the heart of the model rules. Chapter 2 sets out the charging provisions whereby the amount of top-up tax payable is determined, Chapter 3 provides rules for calculating the income (or loss) on a jurisdictional basis, Chapter 4 for determining the tax attributable to that income, and under Chapter 5 the top-up tax of each low-taxed constituent entity is determined.

In essence, the model rules establish a five-step process to determine an MNE’s top-up tax liability:

1. As a first step, MNEs must determine whether they fall within the scope of the GloBE rules and must identify all constituent entities in the group and their locations.
2. Step 2 is to determine the income of each of the MNE’s constituent entities.
3. Under Step 3, the MNE would determine the pre-GloBE tax attributable to each constituent entity’s income.
4. The results of steps 2 and 3 would allow the MNE to determine the effective tax rate of each of its constituent entities; if the effective tax rate of all constituent entities located in the same jurisdiction is below 15%, then the top-up tax would be applied to income in that jurisdiction.
5. Finally, Step 5 would impose the top-up tax on the member of the MNE group that is determined to be liable for the tax in accordance with an agreed-upon rule order.

The determination of an MNE’s income or loss relies on financial accounts, after some adjustments to align those accounts with tax purposes. For example, dividends and equity gains are removed, as are expenses disallowed for tax purposes. For MNE groups that have international shipping income, the model rules exclude that income from the computation of GloBE income.

To determine the income taxes attributable to an MNE’s constituent entities, the rules provide that the calculation includes income taxes but does not include non-income-based taxes such as indirect taxes, payroll and property taxes. The rules also allocate income taxes charged as a withholding tax or following the application of a controlled foreign corporation (CFC) regime.

The model rules recognize that temporary differences that arise when income or loss is recognized in different years for accounting and tax purposes must be addressed. The rules adopt deferred tax accounting as the primary mechanism for addressing these timing differences; as a result, timing differences generally will not result in top-up tax. However, this is subject to a recapture mechanism in respect of certain deferred tax liabilities that do not unwind within five years. Therefore, even businesses that operate only in “high tax” jurisdictions will need to carefully follow how the model rules are translated into local legislation in the jurisdictions in which they operate to determine if top-up tax may be likely to arise in those jurisdictions.

Once the effective tax rate is calculated — the calculated tax divided by the income and aggregated on a per jurisdiction basis, the rate of tax owed is the difference between the 15% minimum rate and the effective tax rate in that jurisdiction. That top-up tax percentage is then applied to the GloBE income in the jurisdiction, after deducting a substance-based income exclusion. This substance-based carveout has two components: the payroll carveout and the tangible asset carveout, and serves to exclude income equal to 5% of the carrying value of tangible assets and payroll. For purposes of the carveout, tangible assets include property, equipment and natural resources located in the jurisdiction, as well as a lease on rights to use tangible assets.

The final step of the process to determine an MNE’s top-up tax liability is to pinpoint which entity in the group is liable for the tax. The rules provide that the top-up tax is first imposed under the “Income Inclusion Rules” or IIR on a parent entity with an ownership interest in the lowtaxed constituent entity. If any residual amount of top-up tax remains unallocated after the IIR applies, the undertaxed payments rule (UTPR) allocation mechanism comes into play, so that liability for residual top-up tax will land in the UTPR jurisdictions through a UTPR adjustment.

The model rules also address the administrative aspects of Pillar Two implementation and impose an obligation on MNEs to file a standardized information return in each jurisdiction that has introduced the GloBE rules to provide information on the MNE’s tax calculations.

Next Steps

The OECD expects to release a Commentary on the model rules in early 2022, and will address the issue of the rules’ coexistence with the U.S. global intangible low-taxed income (GILTI) rules at that time. The OECD then plans to issue an implementation framework dedicated to administrative, compliance and coordination issues regarding Pillar Two. Although the OECD did not specify a date for the expected release of the implementation framework, it did state that it intends to hold a public consultation on the framework in February 2022.

The OECD is also working on model rules for the “Subject to Tax” rule, the second prong of Pillar Two, as well as on a multilateral instrument for its implementation. Another public consultation event on the Subject to Tax model rules and multilateral instrument will be held in March 2022.

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Generally, if the stock is a capital asset and becomes wholly worthless during the taxable year, the investor may recognize a capital loss. The amount of the capital loss is the adjusted basis of the stock at the time of worthlessness.

However, a special rule applies to the worthlessness of stock in qualifying subsidiary corporations. Under this exception, it may be possible for the parent company to claim an ordinary loss on the worthlessness of a subsidiary company if certain requirements are met.

Deduction for worthless subsidiary stock

The complete worthlessness of stock in a subsidiary may generate an ordinary loss deduction equal to the basis of the stock of the subsidiary in the hands of its immediate corporate parent, as determined under the consolidated return basis adjustment rules. It should be noted that in certain cases, the otherwise allowable loss may be reduced or eliminated pursuant to other consolidated return rules.

The amount of deduction attributable to stock in a worthless foreign subsidiary is generally the investment made to acquire and fund the foreign subsidiary (with certain adjustments) and is unaffected by the consolidated return adjustment rules.

In addition to establishing worthlessness (see below), the subsidiary must meet the following tests as well as certain other requirements to qualify for the ordinary loss deduction:

• Affiliation test: The taxpayer must directly own stock constituting 80% of the voting power and 80% of the value of non-voting stock but excluding certain limited preferred stock.
• Gross receipts test: More than 90% of the aggregate gross receipts of the affiliated subsidiary corporation for all taxable years during which it has been in existence must be from sources other than royalties, rent (except rent from property rented to employees of the corporation in the ordinary course of its operating business), dividends, interest (except interest from the deferred purchase price of operating assets sold by the corporation), annuities and gains from the sale of stock or securities.

Establishing worthlessness

In addition to meeting the affiliation and gross receipts tests, the taxpayer must establish that the subsidiary stock is wholly worthless (meaning the stock has no liquidating or potential future value). Stock has no liquidating value when the fair market value of the business’ assets is less than its liabilities, which for this purpose includes intercompany liabilities owed to the immediate parent. All assets— including tangible assets such as machinery and equipment, as well as intangibles such as goodwill, going concern value, workforce in place, supplier-based intangibles, customer-based intangibles, trademarks, tradenames, etc.—must be considered in determining the value of the gross assets.

Once stock is deemed worthless, there must be an “identifiable event” to trigger the loss deduction for income tax purposes. Examples of an identifiable event include:

• A legal dissolution of the subsidiary.
• A formal or informal subsidiary liquidation.
• A “check-the-box” election, or entity classification election, to treat a foreign subsidiary as a disregarded entity.
• A state law formless conversion of the subsidiary from a corporation to an entity classified as a disregarded entity (i.e., a single-member LLC).

The continuance of a subsidiary’s business following a worthless stock deduction for any purpose other than winding down the business operations must be done in a manner that separates the circumstances supporting the deduction from subsequent events that allow the business to continue.

Coordination with NOL and disaster loss rules

A worthless stock deduction that is treated as an ordinary loss in the current year could create or increase a net operating loss (NOL) that can be carried forward or, in limited cases, carried back. The CARES Act temporarily reinstated the NOL carryback provisions by extending the carryback period to five taxable years for losses originating in 2018, 2019, or 2020. By carrying a loss back to taxable years prior to 2018, taxpayers may have the opportunity to receive a refund for taxes paid at tax rates as high as 35%, creating a permanent benefit as compared to otherwise carrying the loss forward to reduce taxes paid at a 21% rate. In some cases, a carryback can generate a refund sooner than would otherwise be available with the use of an NOL carryforward.

While most 2020 returns have already been prepared, certain losses attributable to COVID-19 in 2021 may be eligible for an election under Section 165(i) to be claimed on the preceding taxable year’s return. The determination of whether a taxpayer is eligible to make this election for a worthless stock loss should be made on a case-by-case basis.

Statute of limitations

Determining the timing as to when a corporation’s stock becomes worthless can be a very difficult task. In recognition of this challenge, the tax law provides a seven-year statute of limitations for deductions with respect to the worthlessness of a security.

How we can help

Worthless stock deductions can provide significant tax benefits and should be carefully considered given the economic harm caused to many businesses by the COVID-19 pandemic.

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A tax control framework (TCF) provides the building blocks as to how tax operates within the company. Among other things, an effective TCF will foster a tax risk communication mechanism and clearly defined processes and controls to identify and manage operational tax risk. Key benefits of an effective TCF include:

• Provides clarity, confidence and transparency in an organization’s tax operations;
• Allows for an optimized tax delivery model through better use of people, processes and technology; and
• Provides a clear vision and mandate in meeting current and future tax requirements.

Essential components of an effective TCF are:

1. Establishment of a tax strategy – clearly documented vision of the tax function that sets out guiding principles.
2. Comprehensive application – implementation across all transactions and all tax matters in a consistent and predictable manner and embedded into the day-to-day actions and culture of the tax department.
3. Assignment of responsibility – availability of adequate resources and clear assignment of responsibilities.
4. Documentation of governance – mechanism in place for rules and reporting and understanding the consequences of noncompliance.
5. Testing – compliance with the policies is monitored and tested.
6. Assurance – assurance to internal and external stakeholders that the TCF is executed in a manner consistent with the organization’s “risk appetite.”

Why Should Controlling Tax Risk Matter?

There is no denying that the global tax landscape has become highly technical and complex in recent years. Rapidly proliferating changes to tax rules (both domestic and international), regulations and guidance, as well as heightened tax authority scrutiny driven by more effective information exchanges, are intensifying the pressure on tax departments. Concrete examples of recent initiatives that are requiring tax departments to revisit and rethink their approaches include the OECD’s BEPS project and the ambitious initiative that addresses the challenges of taxation of the digitalized economy, with a reallocation of profits to market countries and the introduction of a global minimum tax. Moreover, keeping current on legislative and regulatory requirements—combined with the pressure for the tax department to add value through planning opportunities—is no simple task. The costs of noncompliance can be severe—investigations, audits, tax assessments/adjustments, penalties, controversies, damage to corporate reputation, etc.

These types of challenges can potentially create heightened levels of operational tax risk within a company’s tax function. These risks associated with tax can be addressed by taking a holistic view of the tax function and adopting a total tax approach, which includes an effective TCF.

Tax risk management is not a new concept, but it has evolved over the years. Many companies have risk management policies in place, some in the form of TCFs. The OECD has previously outlined the features of a TCF and has provided guidance for businesses to design and implement a TCF tailored to their particular circumstances.

A TCF — as envisioned by the OECD — is a way for taxpayers, stakeholders and tax authorities to work cooperatively to ensure that an organization has proper controls in place to effectively comply with tax laws and regulations. While the U.S. does not mandate that companies implement a TCF or publish a formal tax policy or risk statement, other countries have trended in this direction. (However, there have been advances in tax risk management in the U.S. in more focused areas, such as internal controls for public companies, expanded disclosure requirements under U.S. GAAP and local tax regulations, etc.).

How Do I Know if My Organization Needs a TCF?

Organizations are realizing it may be time to implement a TCF. Anticipation of tax risk management and tax governance being fully embedded in their organization in two years’ time was identified by 52% of respondents to the BDO Regional Tax Outlook 2020, Americas Report.

The key starting point in determining whether a TCF is needed is understanding the current state of the tax function. Factors that may indicate your organization needs a TCF include:

• Significant or unexpected tax examination findings.
• High tax department turnover, leading to loss of institutional knowledge.
• Findings from auditors indicating internal controls around the tax provision may break down or fail.
• Rapid growth, either organically or through acquisition.
• Increasing board or stakeholder inquiries related to tax.
• Effective tax rate out of line with peer companies.
• Organizational transformation such as an initial public offering, process overhaul/efficiency initiatives, C-suite turnover or ERP system change.
• Changes to business operating model, supply chain or other significant business factors.

By creating or making enhancements to a TCF, a company can immediately minimize the potential that any of these would adversely impact the company.

Insight

An organization’s ability to demonstrate a clearly defined strategy for early and proactive tax risk management and how that strategy aligns with the risk approach of the organization overall can instill confidence in board members, senior management, tax authorities, regulators and other stakeholders.

It will also help ensure a culture of no surprises and will provide assurance to corporate stakeholders that a resilient and effective TCF exists within the company.

Written by Michael Williams. Copyright © 2021 BDO USA, LLP. All rights reserved. www.bdo.com

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• Third-country concerns;
• Cooperation in regional and multilateral trade arenas;
• Labor- and environment-related priorities;
• Supportive digital ecosystems; and
• Trade facilitation.

 The first series of meetings under the U.S.-Japan Partnership on Trade are expected to occur in early 2022. Thereafter, periodic meetings will be held on a regular basis to advance a shared agenda of cooperation across a broad range of issue areas, as well as to address bilateral trade areas of concern.
 
Although USTR Katherine Tai provided no specifics with regard to what actions may be taken by the U.S. or Japan as a result of this initiative, she did state “[o]ur close collaboration will support the Biden-Harris administration’s economic framework for the Indo-Pacific and help create sustainable, resilient, inclusive, and competitive trade policies that lift up our people and economies.” Whether this may ultimately lead to additional trade sanctions or other actions against China due to its market-distorting practices, forced labor concerns, required technology transfers and other trade related issues is an open question.
 
It is also significant to note that USTR and the trade ministers of Japan and the European Union issued a joint statement also on November 17 announcing their agreement to “renew” their partnership to deal with the “global challenges posed by non-market policies and practices of third countries.” This may signal the start of a multilateral effort to curb the market disruptions believed to be caused by China’s non-commercial practices. How sustained these collaborative efforts may be and whether they will have any immediate or long-term impact on China’s behavior remain to be seen. However, the fact that various countries are entering into such agreements primarily due to the impact of Chinese trade policies should, at a minimum, alert China that its trade practices are of growing concern globally.
 
The U.S. and Japan also confirmed that they will work to resolve a dispute over additional U.S. tariffs on steel (25% ad valorem) and aluminum exports (10% ad valorem) to the U.S. imposed by the prior U.S. administration. Japan is seeking the normalization of trade in steel and aluminum similar to that recently resolved between the U.S. and the EU. Further, the U.S. and Japan will establish a new partnership to strengthen industrial competitiveness, supply chains for key components (including semiconductors and those linked to 5G networks) and economic security.

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Over time, some businesses began to realize that not only could work be done from anywhere, but that they and their employees could thrive in this virtual environment. Many of those same companies could also expand their talent pool by hiring a remote workforce, while saving money by shrinking their physical footprint. From an employee perspective, remote work opens up the opportunity pool in a way not previously available. Now, with a computer and a reliable internet connection, employees can potentially work for companies located anywhere around the globe.

This has also created a situation whereby many workers’ expectations regarding work are beginning to change, and some no longer want to be in the office from 9 to 5. While there are obvious exceptions for businesses where a physical presence is necessary (such as restaurants, medical centers, manufacturing plants, logistics and delivery warehouses), workers’ expectations are changing across industries and business situations.

Coupled with pent-up demand from employees hesitant to leave their jobs earlier in the pandemic, this dynamic has led to what is being dubbed the “Great Resignation.” Desiring more flexibility and better pay, and seeking more from work and opportunities that better align with their personal values, employees are pursuing new opportunities or deciding to leave the workforce for a variety of reasons, leaving employers concerned about retaining talent. Losing talent can be costly, and high-performing employees are difficult to replace.

So how can companies retain talent during the Great Resignation?

In our experience, employees rarely leave solely because of compensation issues. Yes, employees may leave if they are underpaid relative to the market and another employer will properly compensate them for their skills. But in general, employees leave for other reasons — new responsibilities, more advancement opportunities, more job flexibility, better work/life balance, or to become caregivers, for instance. As companies think about retaining talent, a holistic review of the employee value proposition that looks beyond compensation can be helpful.

The employee value proposition is a broad look at why employees come to work each day. It is the reason employees choose to work at a particular business vs. another. This typically includes traditional items such as compensation and employee benefits, as well as non-compensatory items such as job flexibility, mental health benefits, learning/development, advancement opportunities, vacation time, other perquisites, and corporate mission/purpose.

Below are seven potential actions for companies looking to retain talent, as well as some key considerations:

Provide Monetary Retention Awards

When thinking about retaining talent, cash and/or equity retention awards are often one of the first levers considered. While such awards can be an effective tool to keep employees engaged, unless additional actions are taken, they may simply delay resignation instead of preventing it.

Review Compensation Philosophy and Structure

While companies should review their compensation philosophy and structure periodically to ensure continued alignment with company strategy, periods of high talent demand/turnover and business disruption increase the importance of making sure employees are paid competitively for their services. A holistic review can analyze how companies pay, in addition to how much employees are paid, to determine whether employees are properly motivated and rewarded for the right behaviors given any business or strategy changes as a result of the pandemic and its ongoing impact on the economy. The shift from physical to online operations, addition of new product lines, etc. all have implications for business financials and strategy, and it is important for compensation structures to evolve with the business.

Corporate transactions are another major source of employee uncertainty. M&A activity of any type often leads employees to ask questions, such as whether roles will continue to exist post-transaction, what changes to compensation levels/structures are coming, and who will lead the company going forward. As leaders and owners navigate these decisions, monetary retention policies or temporarily enhanced severance programs can be particularly helpful in smoothing employee anxiety and limiting unwanted turnover leading up to and for a period of time after a transaction. As with non-transaction-related retention, any temporary program should be coupled with a holistic review of the employee value proposition going forward to increase the company’s ability to retain talent after payments are made.

Set Clear Working Expectations

One significant source of frustration for employees is uncertainty regarding work expectations (for example, working hours, working location, maintaining flexibility) going forward. Companies have taken varied approaches when it comes to announcing (or not!) clear work-from-home vs. work-in-office policies, and some employees are leaving to find employers that espouse approaches that match their preferred working style. While having an explicit policy may alienate some workers and create some regrettable turnover, setting clear working expectations can increase trust and minimize one area of uncertainty for workers.

Clarify the Mobility Policy

Many employees became mobile during the pandemic, whether out of necessity or simply because the opportunity presented itself. Some people needed to spend time caregiving, while others used the pandemic as an opportunity to give up the confines of a specific residence and instead traveled and worked throughout the country (and even the world). Regardless of the rationale behind this change, living and working in different locations potentially creates liabilities for both employees and employers that may not have been entirely understood or planned for in advance. Creating an explicit policy regarding where employees can work, and the potential consequences of changing physical work locations, can minimize frustration for all parties.

Mobility policies are rapidly evolving, and local governments (both domestic and global) are working hard to ensure they are not losing out on much-needed tax revenues. Because the burden of ensuring that all employment and tax obligations are observed falls on employers, a head-in-the-sand approach will not work. We expect this to become a significant issue for organizations that have not figured out a way to track where employees are working and accurately report this information.

Review Benefits Package

The pandemic has led many people to rethink their priorities and place a higher value on elements other than compensation. This includes items such as retirement benefits, mental health offerings, flextime, caregiver support, the opportunity for volunteering time off, and backup babysitting. Companies can use surveys to understand what their employees currently value and evaluate whether there is an opportunity to address employee needs.

Most people have read that COVID unequally impacts women who are leaving to be caregivers; however, many organizations have been slow to roll out official policies to support caregivers. Best-practice suggestions include listening to employees to understand what they need and reviewing current policies to meet those needs. Offering flexible or non-traditional working hours, role sharing, temporary part-time hours, unpaid time off, sabbaticals, backup childcare and other similar measures can go a long way to supporting caregivers.

Clarify Growth Opportunities

Employees often consider new roles because of the excitement of taking on a growth opportunity, such as a leadership opportunity, new responsibilities or a new focus area. At times, opportunities at a given employer may be limited given the employee’s role and the company structure, and there may be little the employer can do to retain a particular employee. Many times, however, the lack of intracompany mobility is due not necessarily to a lack of opportunities, but to employees’ lack of awareness that opportunities exist. Opportunities can come in many forms and include everything from educational courses, lateral movement or promotions. Having open dialogues, working with employees to create tailored plans, and then integrating those plans as part of the regular performance management process can go a long way to show employees that they are individually valued and that there are benefits in staying with their current organization.

Increase Access to Leadership

Perhaps more than ever before, employees are purpose driven. People want to feel that what they do matters, and they want to identify with their company and its leadership. Actively creating a mentoring culture and providing access to leaders is one way an organization can increase productivity and engagement that directly reduces turnover. Having leadership bring their authentic selves to work, while sharing situations they are navigating, can encourage cohesion. Inviting employees to share their experiences and perspectives with leadership on a range of issues from inclusion to workplace flexibility to health and wellness will help solidify company culture and community.

Every company’s situation is unique, and how companies address the Great Resignation should take into consideration both their business strategy and their talent needs. Companies can also use this opportunity to create a process for reviewing and updating related policies and procedures over time. Retaining talent is an ongoing process and what works now may need to evolve to work tomorrow.

Written by Jason Brooks and Liz Mack. Copyright © 2021 BDO USA, LLP. All rights reserved. www.bdo.com

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