Conserving cash may be vital to corporate survival these days, but a briar patch of regulations could entangle companies that don’t contemplate tax compliance as they set new strategy.
Vance
Businesses are increasingly studying their tax liabilities, to see where they might be able to wring out some new savings that could enhance cash flow. They might also renew efforts to settle audits with the Internal Revenue Service or other tax authorities more quickly. But both steps carry tax consequences, warns Scott Vance, a tax principal with KPMG.
“Companies clearly are interested in cash flow and tax savings as they attempt to preserve cash to weather the economic storm,” Vance said in a recent KPMG Webcast. “But they’re also very attentive to tax risk from a compliance and planning perspective.”
Hoffenberg
Many companies, for example, are restructuring business units as a result of the downturn, said Mark Hoffenberg, a corporate tax specialist at KPMG. That typically includes shuffling assets among business unit, but it presents “a huge trap for the unwary,” he said.
For example, companies may have significant stock basis built up in subsidiary units. That basis is important to know for tax purposes— either for calculating a capital gain tax or for calculating the loss on the investment—before dismantling the entity.
Many companies see assets depreciate sharply during a recession, “and typically those assets have tax basis only in the form of stock basis,” Hoffenberg said. “People make the mistake of totally foregoing that stock basis. If you move assets out of the company and liquidate, the basis is gone. Taxpayers have unwittingly liquidated the company even while not going through the steps of formally liquidating the company.”
“[Y]ou want to be careful when transferring assets that you don’t trigger a tax liability.”
— Dean Schuckman,
Partner,
PricewaterhouseCoopers
Schuckman
Dean Schuckman, a partner with PricewaterhouseCoopers, says companies undertaking liquidations or restructurings should bring the tax team into the conversation before any action is taken, to assure the tax implications have been considered. “You want to make sure you’re paying attention to this hidden trap and not losing any excess basis in the stock of the subsidiary,” he says. “And you want to be careful when transferring assets that you don’t trigger a tax liability.”
The implications vary depending on whether or not assets targeted for liquidation or transfer reside in the United States, and whether they will remain at home or abroad after the transaction—and then there are state taxes to consider, Schuckman adds. “That’s a minefield.”
Debt & Recovery Act
Simon
Companies also are restructuring debt, and that has tax consequences as well, says Raymond Simon, a partner with law firm White & Case. Normally, any reduction in liability associated with a debt restructuring (outside of bankruptcy) is regarded as taxable income, or “cancellation of indebtedness” income. The recently passed American Recovery and Reinvestment Act does allow companies taking that route to defer some of the income associated with that event for up to five years.
Jarvis Bomar, director of tax operations for Jefferson Wells, says the provision may help companies conserve cash currently, but it doesn’t wipe out the tax bill entirely. Instead, the Recovery Act allows companies to defer the tax five years and then pay it over the course of five years, he explains. “It’s a tax deferral—not an elimination of the tax liability.”
MISCELLANEOUS TAX PROVISIONS
The following excerpt from White & Case details some of the tax provisions under the Recovery Act:
Ownership Changes Pursuant to the Emergency
Economic Stabilization Act of 2008
The Act creates a narrow exception to the current law
restrictions on the use of NOLs and built-in losses following
an ownership change of a loss corporation. Generally under
the Act, if an ownership change of a loss corporation occurs
pursuant to a restructuring plan required by an agreement
with the Department of the Treasury under the Emergency
Economic Stabilization Act of 2008, the loss corporation will
not be subject to the restrictions that otherwise would apply
to the carryforward of its NOLs or its use of built-in losses
following the ownership change provided that no person
(other than certain VEBA plans) owns 50 percent or more
of the new loss corporation following the ownership change.
Extension of Bonus Depreciation for Newly
Acquired Property
The Act extends the additional first-year depreciation
deduction introduced in the Foreclosure Prevention Act
of 2008 (which allows taxpayers to take an additional
first-year depreciation deduction of 50 percent of the adjusted
basis of certain qualified property (“bonus depreciation”))
to certain property placed in service during 2009 or 2010.
Subject to certain exceptions, qualified property means
property to which the modified accelerated cost recovery
system applies with a recovery period of 20 years or less,
certain computer software, water utility property or qualified
leasehold improvement property, which is purchased and
placed into service within the applicable time period.
The Act allows taxpayers to also take the bonus depreciation
for qualified property acquired and placed in service in
calendar year 2009 (or 2010 for certain property with
longer production periods and transportation property).
Extension of Election to Accelerate Accumulated
AMT and R&D Credits In Lieu of Bonus Depreciation
The Act extends the current law provision that allows
a taxpayer to elect to increase the cap on its use of research
and development (“R&D”) and/or alternative minimum tax
(“AMT”) credits, in lieu of taking the bonus depreciation
(as described above). The cap on R&D and AMT credits
can be increased by up to 20 percent of the bonus depreciation
the taxpayer could have claimed on property that would
qualify for bonus depreciation. Prior to the Act, taxpayers
could make this election only with respect to property
acquired and placed in service between March 31, 2008
and January 1, 2009. The Act extends the benefit by one-year
to also apply to property acquired and placed in service before
January 1, 2010 (or January 1, 2011 for certain property with
longer production periods and transportation property).
Further, the Act also provides taxpayers with increased flexibility
when deciding whether to elect-out of the bonus depreciation
available for qualified property in exchange for the increased
cap on historic R&D and AMT credits. Specifically, taxpayers
that elected out of the bonus depreciation in the first taxable
year ending after March 31, 2008 may elect to take the bonus
depreciation for assets acquired in calendar year 2009.
Conversely, taxpayers that did not elect out of bonus depreciation
in the first taxable year ending after March 31, 2008 may elect
out of the bonus depreciation for assets acquired in calendar year
2009 for its first taxable year ending after December 31, 2008.
Source
White & Case Alert on Recovery Act Tax Implications (February 2009).
Vance said companies might even prefer to claim the income and pay the tax currently, depending on their overall income situation. For example, companies with net operating losses that can be carried forward might consider claiming the income now so they won’t lose any permanent benefits associated with the carryforward, he said.
Price
KPMG Principal Mark Price said companies also should be careful when securing new debt from foreign countries. Borrowing from countries such as China or United Arab Emirates, for example, may result in greater withholding tax risks than borrowing from the United Kingdom.
Transfer Perils
Businesses should also mind the tax consequences of transferring funds among business units, another common survival tactic during recessions.
Companies “may not be as willing to leave $1 million parked in [a subsidiary] as they were five years ago,” Price said. “Some thought needs to be put into how to get that cash back.” Depending on the nature of the transfer, it could be seen as either a short-term loan or a dividend—events that trigger different tax issues.
Foley
Transfer pricing (the amounts related business units charge each other as they move assets across foreign jurisdictions) may also need more attention in a down economy, KPMG tax principal Sean Foley said.
Transfer pricing is typically established so that more income is recognized in lower-tax rate jurisdictions, and it’s a structure that works well when entities are actually earning income, he said. In a down economy, however, companies could end up trapping losses in those jurisdictions and while taxable income remains in higher-tax-rate jurisdictions.
“You could have a situation where you’re paying tax on a worldwide basis, but suffering a worldwide loss,” Foley said. Companies can consider unwinding transfer-pricing structures to address the problem, but Foley said that decision should hinge on an analysis of the implications for prior periods and the projections for a recovery.
Another provision of the Recovery Act that may appeal to some companies is a change in the bonus depreciation allowances, meant to stimulate capital investments, says Marc Gerson, a tax lawyer at the firm Miller & Chevalier. The law allows companies to take an additional depreciation deduction of 50 percent of the adjusted basis of qualified property put into service in 2009 and 2010. “It lets businesses recover their costs quicker, and it will help cash flow,” Gerson said.
Sassano
And lastly, Paul Sassano, tax global practice leader for Jefferson Wells, says companies also are—or should be—looking for ways to settle audits with tax authorities more quickly. Many states, for example, offer amnesty programs, where it’s “easier to confess your sins,” he said. “In a down economy, it gets a little easier to settle. States are strapped for cash as well.”
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