The Small Business Administration (SBA), the U.S. Department of the Treasury (“Treasury”), and the Internal Revenue Service (“IRS”) continue to provide guidance regarding how they will administer, oversee, and treat loans issued in connection with the Paycheck Protection Program (PPP), some of which appear to contradict the intention of the CARES Act, which created the PPP loan program.
Eligibility for a PPP Loan Now Requires That You Not Have Access to Other Sources of Liquidity
The CARES Act contains a provision which waives the ordinary requirement for SBA loans that the Borrower has to certify that it is unable to obtain credit elsewhere, meaning the borrower was not required to certify whether it had access to credit from non-federal sources when applying for a PPP loan. Based on this provision and the other borrower requirements set forth in the CARES Act, it was fair to assume that having other sources of liquidity would not be a bar to obtaining a PPP loan. However, recently issued guidance from the Treasury changes this assumption.
In the guidance released on April 29, 2020, the SBA and the Treasury posed the following FAQ 37: Do businesses owned by private companies with adequate sources of liquidity to support the business’ ongoing operations qualify for a PPP loan?
The answer is that businesses that are either seeking to obtain a PPP loan or that have already obtained a PPP loan must assess their economic need for a PPP loan. In the loan application, borrowers are asked to represent that the “current economic uncertainty makes this loan request necessary to support the ongoing operations of the business.” The SBA and the Treasury have now indicated that in order for a borrower to be considered to have made this certification in good faith, the borrower must take into account its current business activity, and its ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to their business. If a business has substantial market value and access to capital markets, the SBA and the Treasury explain that it is unlikely the business can make this certification in good faith, and should be prepared to demonstrate why it required the loan.
It is still unclear how the SBA will measure what it means for a business to be considered to have “adequate sources of liquidity” that would preclude the business from making the certification in good faith.
The Treasury advises that businesses that made this certification prior to the issuance of FAQ 37 and repays the loan in full by May 7, 2020 will be deemed to have made the certification in good faith and will not be penalized.
Risk of Sanctions for Keeping a PPP Loan When Borrower Had “Adequate Sources of Liquidity”
If a borrower has applied for, or has already received a PPP loan, and has made the certificate of need knowing it to be false for the purpose of obtaining a PPP loan, the borrower could be subject to penalties. According to the Treasury, the borrower would have made the certificate of need knowing to be false if the borrower submitted an application for a PPP loan even though it had “adequate sources of liquidity.” Since this guidance was released after many borrowers had already applied for or received a PPP loan, the Treasury has offered borrowers the opportunity to return their PPP loans by May 7, 2020 without risk of penalty. If a borrower with “adequate sources of liquidity” does not return the PPP loan, and is later subject to an audit by the SBA, the borrower may be deemed to have made the certificate of need in bad faith, which in turn can result in a fine of not more than $5,000 and/or imprisonment for not more than two years.
Expenses You Use To Justify Forgiveness of Your PPP Loan Are Not Deductible
The CARES Act provides that to the extent that a PPP Loan is forgiven, the borrower would not be subject to cancellation of indebtedness income on the amount forgiven. However, the IRS, in recently released Notice 2020-32, advises that expenses used to justify forgiveness of PPP loans will not be deductible. The CARES Act provides that a borrower’s PPP loan may be eligible for forgiveness if used to cover the following expenses: (1) payroll costs; (2) payment of interest on any covered mortgage obligation; (3) any payment on any covered rent obligation; and (4) any covered utility payment. When the borrower applies for loan forgiveness, the amount forgiven will not be treated as taxable income to the borrower.
Since the CARES Act did not address whether deductions for ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business are still available if the expenses were paid for using the forgiven PPP loan, the IRS has released this guidance to fill in the gaps.
Pursuant to the guidance, no deduction is allowed for an expense that is otherwise deductible in a taxpayer’s trade or business if the payment of the expense results in forgiveness of a PPP loan.
The IRS reasoned that deductions are not allowed to a taxpayer for amounts otherwise allowable as a deduction if the amount of income is exempt under the tax code. This is to avoid a double tax benefit. Therefore, to the extent that the CARES Act operates to exclude from income the amount of the PPP loan that is forgiven, the forgivable portion of the PPP loan results in a class of exempt income that may not be taken as a deduction.
This information has been prepared by Tydings for informational purposes only and does not constitute legal advice.