FAQ: Understanding the tax implications of the CARES Act on private equity

Plante Moran professionals recently hosted a webcast for the Association for Corporate Growth (ACG) focused on the impact of the Coronavirus Aid, Relief, and Economic Security (CARES) Act on private equity funds and the businesses that they own . What follows is a list of some of the most frequently asked questions from the attendees, along with answers from our experts.

 

1. How do I determine if my business is eligible for the Paycheck Protection Program (PPP)?

The PPP is based on the existing SBA 7(a) loan program, so the basic rules that govern eligibility for that program apply here. The initial criteria, such as size and affiliations, can be found in the Code of Federal Regulations. In addition to the regular 7(a) rules, the SBA has published guidance on certain qualification standards that will apply specifically for the PPP.

• Size standard — Employee count
  • Additional SBA guidance on PPP eligibility clarified that businesses with 500 or fewer employees whose principal place of residence is in the United States, as well as employers that meet SBA employee-based size standards for their industry’s North American Industry Classification System (NAICS) code, may qualify.
• Size standard — Net worth and income
  • An SBA Frequently Asked Questions document states that a business can qualify if it meets both tests of an SBA “alternative size standard” as of March 27, 2020. A business can qualify under this standard if it stays within these limits:
    • Its maximum tangible net worth doesn’t exceed $15 million.
    • Its average net income (not including losses carried over) for the two full fiscal years prior to the application date doesn’t exceed $5 million.

PM observation: The interplay of the basic 7(a) rules, the employee-count standard, and the alternative size standard create a significant potential for confusion in determining eligibility for the PPP. Interested applicants need to understand the interaction between these various standards, as well as the SBA’s affiliation rules. These provisions should all be carefully reviewed with legal counsel to determine eligibility.

2. What affiliation rules govern when determining eligibility for the PPP?

SBA guidance details four tests of control to apply when determining whether affiliation with another entity affects the size of an applicant to the PPP.

The SBA can determine to affiliate a business with a larger entity for purpose of PPP eligibility based on:

• Ownership
• Stock options, convertible securities, & agreements to merge
• Management
• Identity of interest

The SBA can find that an affiliation exists if another entity merely holds the power to control the applicant. The fact that an entity hasn’t exercised that power isn’t relevant. These provisions should be carefully reviewed with legal counsel to determine if they affect a business’ eligibility.

Comment: These complex affiliation rules necessitate a comprehensive review of organizational structure, bylaws, and other charter documents to identify eligibility, especially when it comes to affiliations with private equity, venture capital, and foreign investors. Of particular concern is the term “fewer employees whose principal place of residence” in the SBA guidance on the 500-employee standard. This has generated mixed interpretations and confusion from participating lenders. It’s important to review this with legal counsel and understand how your lender interprets the rules.

3. Are there any circumstances in which affiliation rules are waived?

The SBA’s affiliation rules are waived for:

• An employer with not more than 500 employees that, as of the date of loan disbursal, has a NAICS code that starts with 72.
• An employer operating as a franchisee that’s assigned a franchise identifier code by the SBA.
• An employer that receives financial assistance from a company licensed under Section 301 of the Small Business Investment Act of 1958 (15 U.S.C. 681).

PM observation: The waiver for businesses receiving SBIC investment has allowed some portfolio companies to revisit eligibility. The Act doesn’t specify if the financial assistance can be in debt or equity, nor does it set a minimum investment threshold for satisfying the provision. We encourage businesses to discuss eligibility with their SBIC capital partner.

4. Are there any alternatives to the PPP?

Main Street Lending Program

The Main Street Lending Program  (MSLP) offers debt financing to businesses with fewer than 15,000 employees and 2019 revenue below $5.0 billion. Unlike the PPP’s forgivable loans, principal will amortize over the term of these loans.

Businesses seeking Main Street loans apply through participating banks and other direct lenders. Eligible banks may originate new Main Street loans or use Main Street funding to increase the size of existing loans they have with businesses.

Guidance from the Federal Reserve states that the MSLP will be made up of three programs. The Main Street New Loan Facility (MSNLF) and Main Street Priority Loan Facility (MSPLF) will issue unsecured term loans up to $25 million. The Main Street Expanded Loan Facility (MSELF) will allow lenders to upsize existing facilities in tranches up to $200 million.

PM observation: The Federal Reserve has stated that businesses may be eligible for both the MSLP and PPP; however, it’s unclear how the programs will interact.

PM observation: The EBITDA leverage ratios will likely exclude many higher-levered companies in stress from obtaining access to the funds. In an open letter to the Federal Reserve, the Association for Corporate Growth outlined 10 challenges to the program and proposed solutions to address.

5. Is the deadline for filing Form 4466 Corporation Application for Quick Refund of Overpayment of Estimated Tax automatically extended along with other deadlines from this spring?

Yes. The IRS issued guidance that extended time-sensitive acts with deadlines between April 1 and July 15 to: July 15. One of the specific items included in this extension was the Form 4466 quick refund claim for corporations that overpaid their 2019 taxes. Please see COVID-19 tax return extension and payment relief guidance for additional information on this topic.

6. Can you explain the interaction between the deferral of employment taxes and loans forgiveness under the PPP?

Employers that have applied for or received proceeds from a PPP loan may continue to defer deposit and payment of the employer’s share of Social Security tax through the date the lender issues a decision to forgive the loan. The deferrals during this period will not be subject to a failure to deposit or payment penalty.

Once the lender forgives a loan, the employer may no longer defer the deposit and payment of the employer’s share of Social Security from that point forward. Any amounts that have been deferred must be repaid as required in the law, with 50% due by Dec. 31, 2021, and the remainder due by Dec. 31, 2022.

7. Do net operating loss carrybacks present an opportunity for PE funds to amend past returns and claim additional refunds?

The Tax Cuts and Jobs Act (TCJA) repealed all net operating loss (NOL) carrybacks for 2018 and later tax years. However, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in March 2020 and retroactively restored NOL carrybacks for 2018, 2019, and 2020 by permitting a carryback to the five previous tax years. The CARES Act also temporarily repealed, through 2020, the TCJA provision allowing no more than 80% of taxable income to be offset by NOLs. The new relief provision creates an opportunity for the taxpayer to file original or amended returns to carry back NOLs and generate cash refunds.

Purchase agreements from 2018 and 2019 should be reviewed to determine the appropriate recipient of any refunds generated from carrying back NOLs into those tax years. If a seller obtains the benefit from the carryback, it may subsequently change the economics of the purchase price if value had been assigned to NOLs being carried forward to buyer that have now been reduced by the carryback.

Carrying back an NOL is generally advantageous compared to carrying it forward since it can generate immediate cashflow and the benefit of any carryforward is dependent on future profits. The current five-year carryback extends back to years where tax rates were higher, which can result in an even greater benefit. Carrying NOLs back also preserves more income in subsequent years which maximizes the possibility of carrying back any future NOLs. Taxpayers are permitted to waive an NOL carryback, but this decision should be scrutinized closely before it is made.

Have more questions about how the CARES Act affects private equity-owned businesses? Give us a call.