Gap in IRS’s Coronavirus Relief Guidance Creates M&A Uncertainty

Companies that want to merge or buy other companies are facing new risks because of uncertainty about how the IRS will deal with the coronavirus relief the businesses may have received.

The IRS and the Treasury Department are working overtime to issue guidance on measures created by Congress to boost the liquidity of struggling businesses. But questions remain in the mergers and acquisitions space about implications of two major relief programs: the Paycheck Protection Program, which provides forgivable loans to small businesses, and the employee retention tax credit, designed to help employers keep workers on their payroll.

Businesses aren’t allowed to take advantage of both, which has led to some head-scratching over whether that limitation applies in cases where one business acquires another.

It’s unclear whether a company that’s claiming the employee retention credit can acquire a company with an outstanding PPP loan without jeopardizing its tax credit, said Robert Delgado, a principal in the compensation and benefits group at KPMG LLP’s Washington National Tax practice.

The uncertainty adds a wrinkle to potential deals, at a time when M&A activity has already stalled because of the pandemic. The combined volume of announced global M&A for April and May was about $100 billion—the lowest two-month period in 22 years, according to a Bloomberg Intelligence report.

Daniel Pinto, co-president and chief operating officer of JPMorgan Chase & Co., said in late May that companies with strong balance sheets were starting to talk about potential smaller deals and acquisitions.

Activity is likely to pick up over the next six to nine months, with many businesses eager for cash after the easing of nationwide lockdown orders and fearing a possible second surge of the virus, said Russell Pinilis, a partner in Willkie Farr & Gallagher LLP’s Tax Department.

“For the first time that I’ve ever seen, essentially everyone should be for sale in one way or another to shore up their balance sheets, to get cash on their balance sheets, to make sure that they can get through the next six, eight, 12 months until the coronavirus is a thing of the past,” said Pinilis, who has represented private equity firms for 25 years.

The restrictions on the loan and tax relief programs, according to Delgado, are forcing some companies to think twice about transactions they were planning to close this summer. They “are having to delay that, or offset that, or now are taking on an additional risk,” he said.

Weighing Risk

This issue has been raised in M&A deals involving small businesses—for example, a corporate buyer seeking smaller acquisitions, said Jason Spann, an M&A tax partner at Deloitte Tax LLP. It hasn’t necessarily prevented deals from happening but it has led to discussion about how to circumvent the problem, Spann said.

Some businesses are considering delaying the close of a deal until Jan. 1, 2021, to avoid the issue altogether, he said. The employee retention credit can only be claimed for wages paid before that date.

Alternatively, Delgado said, potential buyers may decide not to buy businesses with outstanding PPP loans until their loans are repaid or forgiven.

Another possible option is for a buyer to purchase a company’s assets rather than the company itself, Spann said. “That could be a way around,” he said. But “we’re not certain how the IRS would interpret that,” he said.

Businesses facing this issue are weighing the risk of losing all or some of their credits and how big that loss would be against the benefits of the deal, Spann said. “Most people have tried to put their arms around the amounts and take some sort of risk-adjusted view, or just bake it into the potential economics of the deal.”

Counter-Arguments

Pinilis said he “would not advise someone to forego a business transaction that they wanted to do as a consequence of this potential risk.”

If the IRS were to challenge companies choosing to move forward with their transactions, it would face strong counter-arguments—from both a policy and a technical perspective, he said.

The reason businesses don’t get to claim the employee retention credit and the PPP loan at the same time is that they would essentially get a double benefit, he said. But that argument “completely falls away” in the case of an acquisition because the price the buyer pays for a target company reflects benefits, like those gained from PPP loans, he said.

From a technical standpoint, the law generally says members of a consolidated group can’t take employee retention credits if one member gets a PPP loan, but there isn’t explicit language applying that logic to new company purchases, Pinilis said.

Guidance Sought

All of the practitioners said they would like to see the IRS issue guidance to address the M&A issue. The agency didn’t respond to requests for comment.

Guidance could remove the potential hurdle for transactions—some of which could benefit businesses struggling to stay afloat during the pandemic, Delgado said.

The law, as written, doesn’t seem to contemplate fact patterns and scenarios that arise from M&A, Spann said.

It does, however, instruct Treasury to draft recapture guidance covering situations where the government can reclaim employee retention credits if a business has received a PPP loan. Some of the M&A questions, which aren’t addressed in frequently asked questions posted to the IRS website, could be addressed in the recapture rules, Spann said.

“Until you get it, there’s uncertainty,” he said of the lack of guidance.