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March 31, 2020
2020-0786

CARES Act has implications for the energy industry

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted in response to the COVID-19 pandemic, contains roughly $2 trillion in economic relief to eligible businesses and individuals impacted by the novel coronavirus outbreak. The CARES Act, which includes, in part, modifications to the Internal Revenue Code (IRC), will affect nearly every aspect of the US economy, including the US energy industry.

The CARES Act has several key business tax relief measures that may present potential cash benefits and/or refund opportunities for energy companies, including, in part, the following:

  • Five-year net operating loss (NOL) carrybacks with no taxable income limitation
  • Temporary relaxation of the limitations on interest deductions
  • Acceleration of alternative minimum tax (AMT) credits
  • Modification of the excess business loss rules
  • Qualified improvement property (QIP) eligible for bonus depreciation
  • Employee retention tax credits and deferral of payroll tax

Additionally, IRC Section 139 provides a benefit for qualifying disaster-relief payments, which may be available following President Trump's emergency declaration on March 13, 2020.

For more details regarding the relevant provisions of the CARES Act, see Tax Alerts 2020-0586, 2020-9011, and 2020-9012.

Energy companies will need to carefully consider the interaction of the various amended IRC provisions and may need to engage in financial and tax modeling to determine the best use of tax attributes, such as NOLs, during the limited periods in which the changes are effective. In addition, energy companies should consider evaluating restructuring opportunities that may permit them greater utilization of certain tax attributes. The remainder of this Alert will discuss certain amendments to the IRC made by the CARES Act, including the implications of each provision to the energy industry.

Key business provisions

NOL and NOL carrybacks

Under the CARES Act, NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2021 (i.e., NOLs incurred in 2018, 2019, or 2020 by a calendar-year taxpayer), may be carried back to each of the five tax years preceding the tax year of such loss. After enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), NOLs generally could not be carried back but could be carried forward indefinitely. Further, the TCJA limited NOL absorption to 80% of taxable income. The CARES Act temporarily removes the 80% limitation, reinstating it for tax years beginning after 2020.

As a result of changes under the CARES Act, taxpayers with eligible NOLs may now be able to claim a refund for tax returns from prior tax years. As the CARES Act did not modify IRC Section 172(b)(3), a taxpayer, when advantageous, can still waive the carryback and elect to carry NOLs forward to subsequent tax years.

Many taxpayers — particularly multinational energy companies that own controlled foreign corporations — will need to carefully consider the interaction of an NOL carryback with other IRC provisions. For example, an energy company that elects to apply an NOL carryback to a tax year in which the IRC Section 965 transition tax was imposed will generally be precluded from taking its IRC Section 965 inclusion when determining the amount of taxable income that may be offset by NOL carrybacks. The CARES Act does not, however, generally prohibit taxpayers from using an NOL from a tax year with a lower corporate tax rate (e.g., 2020) to offset taxable income that was subject to a higher corporate tax rate in an earlier tax year (e.g., 2017).

Moreover, before claiming an NOL carryback to a prior tax year, energy companies may also want to consider how other tax attributes (e.g., foreign tax credits) that were absorbed in a prior year may now be displaced as a result of the carryback, as well as any base erosion anti-abuse tax (BEAT) liability implication.

Business interest deductions

The CARES Act modifies IRC Section 163(j), which affects many types of energy companies, and was substantially modified by the TCJA in 2017. IRC Section 163(j) limits the amount of business interest that may be deducted in a tax year to the sum of (1) the taxpayer's business interest income for the year; (2) 30% of the taxpayer's adjusted taxable income (ATI) for the year; and (3) the taxpayer's floor plan financing interest expense for the year. For the years in question, ATI roughly equates to the financial concept of earnings before interest, taxes, depreciation, and amortization (EBITDA), not reflected in cost of goods sold. For most taxpayers, the CARES Act changes the ATI limitation, increasing it from 30% to 50%, but only for tax years that begin in 2019 or 2020, with certain additional elections potentially available.

Under the CARES Act, partnerships continue to apply the 30% ATI limitation (and cannot apply the 50% limitation) for their 2019 tax years (although the percentage increases to 50% of ATI for the 2020 tax year for partnerships). In the 2020 tax year, to the extent a partner was allocated excess business interest expense (EBIE) from a partnership in the 2019 tax year, the partner may treat the interest as paid or accrued by the partner in the partner's 2020 tax year. As a result, that amount ought not to be subject to further limitation under IRC Section 163(j) (i.e., the partner can deduct that 50% portion regardless of the partner's ATI). The remaining 50% of such EBIE ought to be subject to the "normal" testing rules for EBIE at the partner level (i.e., the partner needs to receive an allocation of excess taxable income from that same partnership in future years to potentially free up those amounts).

The partnership tax changes are important in the natural resources space (both in the oil and gas and the mining and metals industries) because many of these companies are formed and operate as pass-through businesses. In the power and utilities space, partnerships are commonplace for renewable energy companies and certain independent power producers (IPPs). In addition, IRC Section 163(j) is an important concept for tax-equity partnerships, which are common in the wind and solar renewable energy space. Debt is a major financing tool of many tax equity arrangements, with interest expense entering into internal rates of return on projects. IRC Section 163(j), however, is much less relevant for regulated utility companies (i.e., those regulated by the Federal Energy Regulatory Commission and/or Public Utility Commissions).

Thus, certain energy companies that otherwise would have disallowed business interest expense (the amount in excess of 30% of ATI, up to 50%) may be able to deduct more business interest expense in 2019 and 2020. Further, many energy companies may have greater ATI in 2019 than in 2020, so the ability to elect to use 2019 ATI when determining the allowable deduction in 2020 may enable those companies to deduct more interest in 2020 than might otherwise be allowed. The additional interest expense that may be deducted may also give rise to, or increase, an NOL, which may now be carried back to offset the taxable income of five prior tax years.

For oil and gas, mining and metals, and other natural resource companies, the CARES Act did not modify, change or otherwise provide clarity on the issue of whether a taxpayer can add depletion and depreciation (each which is subject to IRC Section 263A) to ATI for tax years beginning before January 1, 2022. Rather, any clarification or guidance on that matter is still expected to be addressed through Treasury regulations. Further, the CARES Act does not remove or defer the change from EBITDA to EBIT (in determining ATI) that will take place for tax years beginning on or after January 1, 2022.

Acceleration of the AMT credit

Under the TCJA, the corporate AMT was repealed, allowing corporate energy companies to fully offset regular tax liability with their AMT credits. Any remaining AMT credit amount became refundable incrementally from 2018 through 2021. The CARES Act accelerates the refund schedule, permitting corporate taxpayers to claim the refund in full in either 2018 or 2019 (instead of recovering the credit through refunds over several years).

Many oil and gas, mining and metals, and other natural resource companies had refundable AMT credits. Consequently, the acceleration of the AMT credit refunds should be well received by those affected energy companies.

For the few power and utility companies with AMT credits, this will be a welcome cash-acceleration benefit. Historically, however, the majority of these companies have not had large carryforwards.

Modification of the excess business loss rules

The CARES Act temporarily suspends the IRC Section 461(l) limitation on excess business losses for pass-through businesses and sole proprietorships for the 2018, 2019, and 2020 tax years. Thus, NOL relief is effectively extended to partnerships and sole proprietors by allowing excess business losses under IRC Section 461 for tax years before 2021. Further, the CARES Act makes certain technical corrections to IRC Section 461(l), including a change to IRC Section 461(l)(2), which allows carryover losses into subsequent tax years.

QIP eligible for bonus depreciation

Under the CARES Act, taxpayers with eligible QIP (e.g., real estate, leasehold improvements, facilities) may deduct those costs immediately. The CARES Act adopts a technical correction to the TCJA, which had previously excluded QIP from eligibility for bonus depreciation for tax years after 2017. This technical correction is effective as of the date of the TCJA's enactment, allowing taxpayers to amend returns to claim refunds for costs that were being depreciated. The CARES Act does not, however, remove the 20% annual scale back of bonus depreciation that is slated to commence in 2023.

The technical correction may be viewed as a welcome clarification for natural resource-related companies to the extent such companies have QIP that may now be eligible for bonus depreciation. For regulated power and utility companies, the application (and thus, the impact of the technical correction) is not relevant; however, this technical correction is relevant for independent power producers and renewable energy companies.

Employee retention tax credits and deferral of payroll tax

The CARES Act creates an employee retention credit for "eligible employers" subject to closure or significant sales disruption due to the COVID-19 pandemic. Eligible employers will receive a 50% credit on qualified wages against their employment taxes for each quarter (up to $10,000 in qualified wages), with any excess credits eligible for refunds. An eligible employer is one with operations suspended by orders issued in response to the pandemic or that has suffered a significant decline (more than 50% decrease year-over-year) in gross receipts during the quarters that begin with the quarter in which gross receipts declined by more than 50% and ending with the quarter in which gross receipts have recovered by more than 80%. To be eligible for the credits, recipients cannot also receive loans under the small business loan program in the CARES Act. Qualified wages are computed differently for companies with more than 100 employees.

This is a welcome cash benefit to power and utility companies and other energy companies (including oil and gas and mining and metals companies), as many have continued to pay their workforce through the pandemic even though some employees, such as crews, lines people, and other field personnel, are not able to perform their regular jobs.

The CARES Act also allows employers and self-employed individuals to defer payments of the employer share (6.2% of employee wages) of Social Security payroll taxes that would have otherwise been owed from March 27, 2020, through December 31, 2020. Any such deferred taxes must be paid over two years, with half to be paid by December 31, 2021, and the other half to be paid by December 31, 2022. Otherwise, required estimated tax payments during the deferral period would also exclude the payroll taxes that are being deferred.

As all energy companies navigate through the current economic environment (both from a COVID-19 economic perspective, as well as, in the oil and gas industry, a drastic low-commodity-price environment), the deferral of the applicable payroll taxes should be well received. The deferral effectively provides employers with some immediate and short-term liquidity.

Qualifying disaster relief payments

Separate from the CARES Act, but very relevant in the current environment in light of the COVID-19 pandemic, IRC Section 139(a) permits individuals to exclude a "qualifying disaster relief payment" from income. IRC Section 139 applies when, among other factors, the President declares a "disaster" within the meaning of IRC Section 165(i), which references a Presidentially declared disaster under the Stafford Act. On March 13, 2020, President Trump made the applicable emergency disaster declaration related to the COVID-19 pandemic, so IRC Section 139 applies. An employer that provides a qualifying disaster relief payment is not required to include those amounts as wages (or as self-employment earnings) under IRC Section 139(d), and, as a result, these amounts are tax-free for federal income tax purposes.

Although covered in more detail in Tax Alert 2020-0586,{link} payments (not wages) an employer makes to employees due to COVID-19 will be excludable from income if they are intended to cover reasonable and necessary personal, family, living, or funeral expenses occurred as a result of COVID-19. Relevant to many energy companies under the current work-from-home situation, if an employee is teleworking and must incur new expenses, such as childcare as a result of school closures, such expenses likely meet the qualifying disaster relief definition.

Implications

The CARES Act may have broad implications for energy companies, with the degree of impact dependent on their sub-sector, number of employees, pricing and revenue models, and tax footprint (domestic vs. multi-national). In many cases, the CARES Act could have a significant near-term impact on tax planning. For certain energy companies (other than regulated utilities) that are subject to IRC Section 163(j)'s interest limitation regime, the temporary expansion from 30% of ATI to 50% of ATI ought to be well received.

Energy companies should analyze the ability to take certain credits or refunds. The refund opportunities resulting from the NOL changes may, in many cases, be beneficial by providing access to liquidity. Additionally, energy companies of all kinds should thoroughly vet and review the CARES Act to determine what potential payroll tax deferrals or credits may apply, especially in light of the relatively limited window of opportunity within which to act (for certain provisions). As the more significant business tax changes are temporary (i.e., the NOL-related rules and the IRC Section 163(j) business interest rules), and certain elective mechanisms must be exercised within a relatively short window (e.g., within 120 days of the CARE Act's March 27, 2020, enactment date for certain measures), time is of the essence.

Even for Code provisions that the CARES Act did not directly alter or amend, the ripple effects of the CARES Act should be thoughtfully considered (and likely modeled). For example, although the CARES Act did not directly amend or change the international tax provisions, the changes to the NOL rules and the changes to the IRC Section 163(j) ATI limitation could affect multi-national energy companies. For example, the carryback or carryforward of an NOL may affect a multi-national energy company's: (1) allowable IRC Section 250 deduction (both against foreign-derived intangible income and global intangible low-taxed income); (2) allowable foreign tax credits; (3) BEAT liability, and (4) in some cases, the energy company's IRC Section 965 transition tax liability. Additionally, the additional IRC Section 163(j) deduction may yield negative tax consequences to another tax provision, such as IRC Section 59A (BEAT), with the result that certain multinational energy companies may decide not to elect to apply the increased IRC Section 163(j) limitation. For a more in-depth discussion of the CARES Act's international tax implications, see Tax Alert 2020-9011.

While the CARES Act is clearly designed to be taxpayer-favorable, and to increase short-term liquidity, the decision to pursue a refund through an NOL carryback ought to be carefully considered (and likely modeled) to understand the derivative impacts. As with any material tax legislative changes, most taxpayers will benefit from more thorough, nuanced, quantitative analytics to support decision-making. Overall, many energy companies will find the business tax changes made by the CARES Act to be helpful.

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Contact Information
For additional information concerning this Alert, please contact:
 
Americas Energy Tax Group
   • Greg Matlock (greg.matlock@ey.com)
   • Ginny Norton (ginny.norton@ey.com)
 

 


 

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