Private equity and the five-year NOL carryback: Who owns the benefit?

Apr 01, 2020
Apr 01, 2020
0 min. read

M&A transaction agreements may provide unintended results

The Coronavirus Aid, Relief and Economic Security Act (the CARES Act or the Act) is a comprehensive plan that will affect the vast majority of US businesses. A significant tax provision of the Act creates a five-year net operating loss (NOL) carryback opportunity that provides private equity fund (PE or fund) portfolio companies an opportunity to raise cash through NOL carryback claims. 

The Act also accelerates refunds of alternative minimum tax (AMT) credits added to the law in 2017. Under the Act, the remaining refundable AMT credit amount will be available for a corporation’s first taxable year beginning in 2019. Alternatively, a corporation may elect to obtain 100% of its AMT credits in the first taxable year beginning in 2018. 

This analysis focuses on certain federal income tax issues regarding these carryback opportunity to corporate portfolio companies. These same issues are not applicable to portfolio companies taxed as a partnership for federal tax purposes. 

The issue

An interesting issue and potential complication is created by the new five-year carryback period for 2018 and 2019 NOLs. For portfolio companies involved in an M&A transaction in 2018 or 2019, the new ownership group may have the ability to carry back an NOL both from and to a year prior to their ownership of the company. The complication arises because negotiations relating to those 2018 and 2019 M&A transactions occurred when NOL carrybacks did not exist under federal tax law. The agreements thus may include provisions that give an unexpected result as to the beneficial owner of the refund. Similarly, M&A transaction occurring in years prior to 2018 likely contemplated only a two-year carryback, and did not contemplate refunds from years as far back as 2013. 

A quirk in the law regarding the alternative minimum tax (AMT) and corresponding refund opportunity further complicates the refund issue. Because of the mechanics within the tax law, many corporations will receive their largest refund through the refundable AMT credit and not through the actual NOL carryback. The refundable AMT credit is available for a tax year beginning in 2018, 2019 or both, and is subject to a separate claim filing. 

In addition, a carve-out acquisition of a portfolio company from a consolidated tax group adds a myriad of potential issues. Carrying an NOL back in that case would require the selling group to agree to carry the loss back into their previous consolidated tax return and provide the refund to the company. In addition, if the selling consolidated group carries an NOL back into a year in which the portfolio company was a member, it could actually increase the NOL acquired in the acquisition. 

It is fair to say that every PE was both a buyer and seller during the carryback periods; as such, each PE will need to address these issues when claiming a refund.  

M&A agreement mechanics for refunds

In many PE transactions, the seller offers limited indemnities to the buyer, wishing to take the sales proceeds and distribute those to the fund holders without holdbacks for the unknown. In these transactions, the buyer may assume liabilities for taxes (pre- and post-close) of the acquired portfolio company, and the seller walks away with its proceeds. In this case, the purchase agreement likely states that any refund for taxes received post-close relating to a pre-close period belongs to the buyer. To the extent this is the case, the fund should examine the possibility of carrying back losses to a period pre-transaction and reaping the benefits of the refund. 

However, it is also common to find transactions where the seller offers an indemnity to the buyer for pre-close tax liabilities, and the seller retains the rights to any refunds relating to a pre-closing tax period. Generally, in transactions structured this way, the parties should revisit the purchase agreement to confirm who has the rights to any refunds, and whether the buyer is obligated to carry back losses if available. For transactions that took place in 2018 and 2019, the agreements may be silent as to carrybacks since they did not exist under tax law at the time. In this case, the seller could reap the windfall of an unexpected benefit, although the situation could unfortunately lead to legal wrangling and negotiation over the refund. In addition, as is noted above, where carrying back NOLs after a carve-out, it may require the parties to agree to carryback to the consolidated tax return of the seller, if the fund even has a legal claim to the refund. 

Because a large portion of the available refund may become available through the refundable AMT credit, the choice of the tax year to claim the refund is another issue to consider. For a portfolio company acquired in 2018 with an agreement to pay 2018 tax year refunds to the seller, the new owner may decide to wait until the 2019 tax year to claim the remaining. The reverse would apply where the fund was the seller in 2018, but in either case the M&A agreements may address who controls the decision. 


The CARES Act provides a great opportunity for PE funds to obtain much needed liquidity to their portfolio companies. The five-year carryback is no exception. However, before filing for a refund it is important to understand how the relevant M&A transaction agreements addressed the benefits of income tax refunds. Correspondingly, we recommend that PE funds review the relevant M&A transaction agreements relating to portfolio companies that PE funds acquired or disposed of during the carryback years to understand their rights to refunds under the CARES Act.

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