On Tuesday President Obama signed into law H.R. 1, The
American Recovery and Reinvestment Act of 2009 (the
"Act"). At an estimated cost of US$787 billion, the law
is focused on tax relief for individuals and job creation. It also
includes some significant tax relief for businesses. The final
version of the law includes draconian restrictions on salary and
bonuses for senior executives of companies that receive funds under
the troubled assets relief program ("TARP"). Also
included is the troubling "Buy American" provision for
iron, steel and manufactured goods used in construction projects
funded by the Act.
The summary below describes some of the provisions of the Act of
most importance to the business community.
1. Infrastructure spending
The Act authorizes spending $120 billion on infrastructure,
which is less than was called for by many members of Congress. Much
of the spending will be done by the states with federal dollars.
The largest allocation, $28 billion, is for highway and bridge
construction. In a surprise move, the amount allocated for
high-speed rail is $8 billion, four times the amount previously
proposed. Other spending priorities include: modernization of the
electric grid; expanding broadband access, especially in rural
areas; construction and repair of military housing and other
facilities; improving the energy efficiency of federal buildings;
and repairing public housing. The Buy American provision prohibits
the use of funds appropriated under the Act to construct or repair
public buildings or public works unless only American-made iron,
steel and manufactured goods are used. Exceptions are permitted if
the exclusive use of American-made goods would be too expensive or
otherwise not in the public interest. The impact of the provision
is further blunted by a requirement that it be applied in a manner
consistent with U.S. obligations under international
agreements.
2. Renewable energy and business development
incentives
The Act expands and extends tax credits for investment in
renewable and alternative energy and creates other incentives for
businesses to invest in renewable energy and to use energy
efficient products.
The Act includes several incentives intended to promote business
development, which are generally focused on small businesses.
Certain rules that accelerate depreciation and permit small
businesses to deduct currently the cost of assets have been
extended through December 31, 2010. In addition, gain recognition
rules have been relaxed for small companies. For example, certain
individuals that own stock in small businesses are permitted to
exclude from income 75% of the gain realized from the sale of such
stock. Also, the rules requiring S corporations to pay tax on
dispositions of assets with built-in gain have been significantly
limited.
3. Tax provisions that target business
restructurings
(i) Net operating loss carryback extensionWith respect to net operating losses ("NOLs") for any
one tax year that begins or ends in 2008, the Act permits an
eligible small business to elect to increase the carryback period
from the usual two years to up to five years. The final version of
the provision is a significant limitation of the election proposed
in earlier bills, which would have been available to all taxpayers
other than those that had benefited from a recent government
bailout and would have included both 2008 and 2009 NOLs. An
eligible small business is a taxpayer that satisfies a $15,000,000
gross-receipts test.
(ii) Cancellation of indebtedness income
deferral
In general, under U.S. tax rules, if a debtor's obligation is
forgiven in whole or in part by the lender, the debtor realizes
taxable income in the amount of the forgiveness in the tax year in
which the forgiveness occurred. The Act permits a taxpayer to elect
to defer inclusion of cancellation of indebtedness
("COD") income that results from the reacquisition in
2009 or 2010 by the taxpayer or a related person of a debt
instrument issued by a C corporation or in connection with a trade
or business. Deferred income is generally included in taxable
income ratably over the tax year beginning or ending in 2014 and
the following four years. Contrary to the Senate proposal, which
would have permitted deferral only for acquisitions made for cash,
the election appears to be available with respect to acquisitions
made in any manner, including those made (a) for cash, (b) in an
exchange for a newly issued debt instrument (including an exchange
resulting from the modification of a debt instrument), (c) for
corporate stock or a partnership interest, (d) upon a contribution
to capital of the issuer, or (e) upon complete forgiveness of the
debt by the holder. The provision includes special matching rules
that (a) prevent partners from realizing phantom gain as the result
of a decrease in a partner's share of partnership liabilities
and (b) defer deductions for certain original issue discount
accrued on newly issued debt instruments until the taxpayer begins
recognizing deferred COD income.
(iii) Built-in loss rule change
On October 1, 2008, the Internal Revenue Service issued a
controversial notice that exempted U.S. banks from some of the
loss-limitation rules of § 382 of the Internal Revenue Code
(the "Code"). Prior to the notice, losses on loans or bad
debts realized by banks that had undergone a change in ownership
could have been deemed under Code § 382 to be attributable to
the period before the ownership change, which would have sharply
limited the ability of the bank to use the losses as a deduction
against income. Notice 2008-83i provided that losses realized by
U.S. banks after an ownership change generally would not be treated
as attributable to periods before the change. The loss-limitation
rules would therefore not apply to those losses. The Act provides
that the Treasury does not have the authority to provide exemptions
from the loss-limitation rules to particular industries or classes
of taxpayers. Stating that taxpayers should be able to rely on
guidance issued by the Treasury, the Act provides that Notice
2008-83 will have the effect of law for changes of ownership that
occurred on or before January 16, 2009 or those that occur pursuant
to written agreements that were entered into on or before that
date. For later changes in ownership, Notice 2008-83 will not be
effective. While the Act generally repeals Notice 2008-83, it
enacts a new exception to Code § 382 that applies in the case
of certain ownership changes occurring pursuant to a restructuring
plan required under a loan agreement or commitment for a line of
credit entered into with the Treasury under the Emergency Economic
Stabilization Act of 2008.
(iv) Applicable high yield discount obligation rule
suspension
The applicable high yield discount obligation ("AHYDO")
rules generally deny corporate issuers of certain high-yield debt a
deduction for a portion of the original issue discount that accrues
on their notes. The Act temporarily suspends the AHYDO rules for
high-yield obligations issued or deemed issued in exchange for debt
instruments that were not AHYDOs. The suspension protects issuers
who are forced to borrow at a higher rate of interest from also
being penalized by the AHYDO rules.
4. Executive compensation provisions
The restrictions on salary and bonuses for senior executives of
companies that benefit from TARP funds are far more expansive than
previously proposed and were apparently included over the
objections of the Obama administration. The Act requires TARP
recipients to meet appropriate standards for executive compensation
and corporate governance, including refraining from structuring
executive compensation to encourage "unnecessary and excessive
risks". Also included are expansions of the prohibition on
golden parachutes and the requirement to recover bonuses that are
based on statements of earnings, revenue, or gains later found to
be materially inaccurate. Bonuses to certain executives may be paid
by TARP recipients only in long-term restricted stock while
obligations under the TARP are outstanding. These restricted stock
bonuses cannot have a value greater than one-third of the
executive's cash compensation, creating an odd incentive for
companies to raise base salaries of affected executives. The reach
of the restriction on bonuses depends upon the amount of assistance
a company has received. The Act requires companies receiving TARP
funds to create policies governing luxury expenditures such as
entertainment, office renovations and transportation services. The
Treasury Secretary is given the authority to review compensation
paid to senior executive officers and the next twenty most highly
paid employees. If the compensation is found to be excessive, the
Act authorizes the Secretary to seek reimbursement of excessive
amounts to the federal government. The Treasury is specifically
authorized to issue regulations to implement the executive
compensation rules. Given the significance of these provisions to
the finance community, early action is likely.
In compliance with U.S. Treasury Department Circular 230, you are hereby notified that any discussion of U.S. federal tax issues contained herein is not intended nor written to be relied upon, and cannot be relied upon, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.