U.S. Paycheck Protection Program:  Issues for Non-U.S. Companies with U.S. Subsidiaries

Overview

A U.S. subsidiary of a non-U.S. company may be eligible for a forgivable loan under the U.S. government's Paycheck Protection Program ("PPP") if (i) the U.S. subsidiary, combined with its affiliates, has 500 or fewer employees whose principal place of residence is in the United States, and (ii) the company is able to certify in good faith that the current economic uncertainty makes the PPP loan necessary to support its ongoing operations.

There has been an overwhelming demand for PPP loans and most of the funds authorized by Congress will soon be exhausted given the high volume of applications. Nonetheless, eligible companies that have not already applied for a PPP loan should consult with their relationship banks and their legal, tax and other advisors and consider submitting an application in case another round of funding becomes available.

At the same time, companies need to recognize that there is no bright-line test for making the self-certification as to economic need and that the PPP has become a political hot topic. In response to the public backlash against large, well-capitalized entities getting PPP funds instead of small businesses in dire straits, administration officials have recently issued further guidance on the factors to consider when making this certification and threatened criminal liability for false certifications. This new guidance, along with continued media exposure and a general state of uncertainty, has persuaded several companies that initially applied for a PPP loan to withdraw their applications or return the loan proceeds.

Background

The PPP is administered by the Small Business Administration in consultation with the Treasury Department and is part of the $2 trillion Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") which was signed into law on March 27, 2020. So far Congress has authorized two rounds of PPP loans, totalling nearly $660 billion.

The PPP provides loans of up to $10 million to eligible businesses hurt by the COVID-19 pandemic, with an aggregate limit of $20 million for loans to a single corporate group. The principal amount of a PPP loan and any accrued interest may qualify for loan forgiveness if used to pay employees, mortgage interest, rent or utilities.

While the PPP is intended to provide economic relief to small businesses adversely impacted by the pandemic, there are several exceptions which have allowed larger businesses, including public companies, to apply for PPP loans. For multinational corporate groups with U.S. subsidiaries, the most notable exception is that they do not need to qualify as a small business concern under section 3 of the Small Business Act if the U.S. subsidiary, combined with its affiliates, has 500 or fewer employees whose principal place of residence is in the United States.

Eligibility

In most cases, a borrower will be considered together with its affiliates for purposes of determining eligibility for the PPP. Under the SBA's affiliation rules, a company organized in the U.S. generally is eligible for the PPP if it, combined with its affiliates, has 500 or fewer employees whose principal place of residence is in the United States.

In addition to reviewing applicable affiliation rules to determine eligibility, a borrower must also consider whether it can certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” When making this certification, borrowers must take into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. As an example, the SBA has emphasized that it is unlikely that a business would be able to make this certification in good faith if it is owned by a public company with substantial market value and access to capital markets or if it is owned by a private company with adequate sources of liquidity.

To further ensure PPP loans are limited to eligible borrowers in need, the SBA also recently announced that all PPP loans in excess of $2 million will be reviewed when the borrower submits its loan forgiveness application. As mentioned in the overview, administration officials have also recently issued further guidance on the factors to consider when making the relevant certifications in PPP loan applications and threatened criminal liability for false certifications. In their application for a PPP loan, a company is required to certify that the information and all supporting documentation provided is true and accurate in all material respects and that they understand that knowingly making false statements is punishable by imprisonment or fines at varying thresholds per the U.S. Code. While criminal repercussions are not intended for unintended omissions and inaccuracies, it is clear that preserving the integrity of the PPP is a priority.

The SBA has offered a safe harbor for any borrower that applied for a PPP loan prior to the issuance of this recent guidance and repays the loan in full by May 7, 2020. Any borrower that repays its PPP loan by such date will be deemed by the SBA to have made the required certification in good faith.

Tax Considerations

Businesses interested in obtaining a PPP loan should consider the potential tax consequences of loan forgiveness and deductibility of business expenses. While the CARES Act expressly provides that amounts forgiven are excluded from gross income, the legislation does not address whether eligible expenses that otherwise would have been deductible would be allowed where the loan is forgiven. The question arises from a generally settled tax principle that taxpayers should not be entitled to a double tax benefit, in this case, resulting from the loan proceeds not being taxable and deduction for related expenses. Following weeks of discussion among the tax bar, the U.S. Internal Revenue Service ("IRS") issued guidance on April 30, 2020 on the issue. The IRS guidance cites to established legal authorities addressing deductibility of expenses allocable to tax exempt income and provides that taxpayers will not be permitted to deduct eligible expenses where the PPP loan is forgiven. The guidance notes that disallowance may also be supported under a separate legal principle that denies deductions for payments for which a taxpayer receives reimbursement. While providing clarity, the IRS's position was undoubtedly disappointing to many taxpayers who expected the IRS to take a different view given the extraordinary context and objective of the program.

There are signs of potential relief coming to taxpayers. The day after the IRS issued their guidance, the House's top taxwriter, House Ways and Means Committee Chair Richard E. Neal's office announced an intention to take legislative action to make expenses funded with PPP loans deductible. Senate Finance Committee Chair Chuck Grassley also expressed his view that the IRS guidance was contrary to Congressional intent, stating "[t]he intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible.” Recipients of PPP loans should be aware of further developments in the tax context.

This content is current as at April 30, 2020 but does not take into account any developments to the law or any guidance issued by the SBA after that date.

Authors: Sharon Kim (Partner), Michael Neary (Partner), Matthew Haist (Counsel), Nathan Huynh (Associate), Nirali Shah (Associate) and Ana Namaki (Law Clerk).