Five accounting and tax challenges testing the sports industry
Revenue recognition, stadium contracts, and more
Sports industry accounting and tax professionals are feeling the pressure as new guidance put forth by the Financial Accounting Standards Board (FASB) for revenue recognition and leases takes a foothold. Stadium and arena deals and existing contracts with sponsors, media rights holders, and licensees could be significantly impacted. To help chart the course, Deloitte’s sports practice has identified five key tax and accounting topics to consider moving forward.
- New revenue recognition criteria
- Accounting for athlete contracts
- Apportioning revenue and expenses
- Active versus passive team ownership
- Stadium and arena leases
Explore the challenges
The professional sports industry is not immune to the unique challenges that come into play with the application of accounting principles and tax regulations. Teams and leagues have always struggled with accurately apportioning revenue, and optimizing franchise ownership structure. Accounting for player contracts and signing bonuses, especially when an athlete is traded or released, can also be a complex situation.
Accounting and tax decisions will become even more complicated over the next several years, as the FASB implements new guidance for revenue recognition and leases.
As the sports accounting playing field evolves, Deloitte’s sports practice has recognized five challenges that chief financial officers, finance and tax executives, and controllership functions in the sports industry should recognize and form a plan around before moving forward.
New revenue recognition criteria
Companies should be prepared to implement the FASB’s new revenue recognition model, which goes into effect for annual reporting periods beginning after December 15, 2017, for public entities, and after December 15, 2018, for non-public entities. While the standard’s new criteria for recognizing revenue applies to all industries, there are several unique considerations for sports properties, given their array of revenue streams such as sponsorships, media rights, and burgeoning digital opportunities.
Revenue recognition remains a key consideration for income tax purposes, given the number of potential revenue streams and the advance cash payments typically received. Deferred revenue balances in acquisitions and divestitures of sports franchises can be particularly challenging, as often the liability assumed is the cost to perform the obligation rather than the actual deferred revenue amount stated on the target company’s balance sheet before purchase accounting.
New revenue recognition standards could impact sponsorships, media rights, digital opportunities, performance bonuses, and more.
Accounting for athlete contracts
There are accounting and financial reporting implications of signing players to long-term, multimillion-dollar contracts. Like those of other employees, the salaries of athletes are expensed when incurred. Depending on the league in which they are a member, teams can offer additional consideration to players as part of their total compensation package. Properly accounting for player compensation helps teams determine the present value of long-term contracts, how to amortize up-front signing bonuses, and ensure financial statements appropriately reflect a team's long-term liabilities.
Income tax implications exist as well. Even if a player contract includes a signing bonus, if the bonus payments are deferred throughout the life of the contract, capitalization, and amortization does not occur until the payment is made. This tends to be more common in leagues where contract lengths are not limited, but is a concept all teams should be aware of. Additionally, player trades often result in an exchange being considered like-kind exchange for income tax purposes, which requires a rollover of the remaining basis in the contract and potential gain for cash boot received.
Additional consideration for athletes such as signing bonuses, performance clauses, or deferred compensation require special treatment on the balance sheet and income statement.
Apportioning revenue and expenses
Sports teams and leagues generate revenue all around the world. To do so, they incur millions of dollars in operating expenses staging events and transporting players from city to city for games.
In the same way athletes are subject to “jock taxes” in the jurisdictions in which they play games, teams, and leagues also are responsible for paying taxes in the municipalities where they generate income. This issue is not just limited to the US. Apportionment of revenue and expenses will present new challenges over the next several years as sports enterprises increasingly look to grow in international markets.
Over the last five years, regular season games for US-based sports leagues have been played in cities as diverse as London, Sydney, and Tokyo. As part of this growth strategy, leagues also are considering permanently placing a team overseas. The potential legal and tax structures of international operations are likely to play a role in limiting foreign income and non-income tax exposure. Effectively identifying where revenue is being generated and resources expended is critical in limiting income tax exposure and could play a key role in where and how sports stakeholders expand abroad.
Effectively identifying where revenue is being generated and resources expended is critical in limiting income tax exposure and could play a key role in where and how sports stakeholders expand abroad.
Active versus passive team ownership
An attractive way for sports team owners to defray the large capital investment necessary to buy a franchise is by bringing on limited partners. For these investors, holding a small stake in a team has its perks. Limited partners frequently can travel on the team plane, meet with players in exclusive settings, or receive an option to buy the franchise outright at a later date. However, since 2013, these minority owners have faced a new challenge with the Net Investment Income (NII) Tax, which imposes a 3.8 percent tax on certain passive activities.
Understanding the income tax complexities of active vs. passive participation is critical for both the managing and limited partners. By structuring partnership agreements to give investors certain responsibilities and opportunities and having the partners carefully manage and document time spent on franchise business affairs, managing partners, and their limited partners may be able to meet the “material participation” requirements necessary to reduce exposure to the 3.8 percent NII tax assessed on passive income.
Understanding the income tax complexities of active vs. passive team ownership is critical for both managing and limited partners.
Stadium and arena leases
As the FASB rolls out new guidance for lease accounting, teams should consider the impact the standard will have on their stadium rental agreements.
The new lease standard eliminates the requirements to perform bright-line tests for lease classification and introduces a lessee model that brings most leases onto the balance sheet. The impact will force teams and their lenders to reevaluate and more closely monitor league-level compliance requirements and third party debt covenants to ensure default has not occurred. Teams will also have to ensure that any resulting book and tax differences that arise through changes in lease treatment are accounted for.
Another key issue from an income tax perspective is that for stadiums financed with both public and private money, franchises may be permitted to “allocate” their contributions to the project to specific stadium assets. In this scenario, franchises typically want their contributions allocated to shorter-lived properties in order to take advantage of accelerated cost recovery. Therefore, it is important in planning and drafting the agreements to ensure that proper provisions are included to allow the franchise to utilize this allocation methodology.
Teams should consider the impact that new lease accounting standards will have on their stadium rental agreements.