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 extension

With 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.

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