With vaccines rolling out across the US and a full year after the beginning of a global pandemic, the first quarter of 2021 brings with it a sense that, as vaccinations pick up, the economy will also receive an injection to return to pre-pandemic levels. With cautious optimism, companies are now beginning to contemplate what might be in store for the rest of 2021. The following sections highlight a few accounting for income tax considerations for companies as they prepare first quarter provisions.
CARES Act, one year later
In response to the pandemic, Congress has passed several packages over the last year designed to support businesses and stimulate the economy. The first, passed at the very end of first quarter of 2021, was the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act provided several significant changes for corporate taxpayers, including a temporary suspension of the limitation on NOLs, an ability to carry back NOLs, and an increased ability to deduct interest expense, as summarized the alert from last year: Accounting for the tax provisions of the CARES Act.
As companies prepare their 2021 income tax provisions, it is important to remember that most of the provisions under the CARES Act were temporary. This means that for 2021, a company’s interest deductions are once again limited to 30% of adjusted taxable income (ATI), NOLs generated in the current year can only be carried forward, and if a company is planning on utilizing NOLs, to the extent they were generated in years beginning after Jan. 1, 2018, utilization is once again limited to 80%. Note that NOLs generated in years beginning prior to Jan. 1, 2018 continue to be available to offset 100% of current year income. The CARES Act also codified the computation of the 80% taxable income limitation in situations where a company may utilize NOLs subject to both a 100% limitation and the 80% limitation. In that fact pattern, the 80% limitation is computed based on taxable income after applying pre-Jan. 1, 2018 NOLs.
Accounting for forgiveness of Paycheck Protection Program loans
One of the most successful programs under the CARES Act, was the Paycheck Protection Program which granted forgivable loans to companies impacted by the pandemic. The program has continued to receive extensions and expansions under more recent relief packages. While the program generated a lot of uncertainty throughout 2020 in terms of how loan forgiveness worked and the resulting tax consequences, on Dec. 27, 2020, the Consolidated Appropriations Act, 2021 (the CAA) was signed into law providing clarity on the tax consequences.
Under the initial CARES Act, while the proceeds from PPP loan forgiveness were not taxable, the loan forgiveness resulted in the loss of deductions for expenses paid from the loan proceeds. The CAA ensured that income from the forgiveness of PPP loans remains exempt from federal tax and allowed companies a deduction for the related expenses.
For book purposes, companies that receive loan forgiveness will recognize book income. As this income is not taxable for federal purposes under the CAA, companies that have recognized book income, or expect to recognize book income once forgiveness is achieved, will have a favorable permanent adjustment to reverse the book income recognized upon forgiveness. Companies recognizing book income in 2021 should give careful consideration as to how this impact should be reflected in interim provisions. Either including the income from the loan forgiveness in the annual forecast and the related permanent item in the calculation of the estimate AETR or including the effects of the forgiveness, as a discrete item in the period in which forgiveness occurs may be permissible approaches, depending on the particular facts for a business.
Given the unusual and infrequent nature of the PPP loans companies may prefer to treat the loan forgiveness income as a discrete item in the quarter in which loan forgiveness is achieved. This approach would be particularly acceptable in situations where the amount of loan forgiveness is large in relation to forecasted income.
Paycheck Protection Program loans and state conformity
While the treatment of PPP loan forgiveness has been resolved for federal income tax purposes, as with any federal tax law change, it takes time for states to adopt conforming legislation resulting in continued uncertainty surrounding the tax treatment at the state level. With states’ revenue streams hard hit by the pandemic, some states remain on track to tax the PPP loan forgiveness income by either treating forgiven loans as taxable income, denying the deduction for expenses paid for using forgiven loans, or both. Accordingly, while companies may have a favorable permanent adjustment for federal income tax purposes, state treatment may vary.
Companies should continue to monitor state legislation, reviewing the general conformity rules regarding debt forgiveness, the treatment of eligible expenses, and the state’s response to the CARES Act and reflecting any changes in tax law as they are enacted.
Meals and entertainment deductions
As part of the Consolidated Appropriations Act, 2021, companies are temporarily able to deduct 100% (rather than 50%) of the cost of food or beverages provided by a restaurant if paid or incurred during the 2021 and 2022 calendar years as long as the costs are otherwise deductible under section 274(n)(2).
American Rescue Plan Act of 2021 – 162(m) Implications
In response to the economic concerns caused by the COVID-19 Pandemic, President Biden recently signed the American Rescue Plan Act of 2021 (H.R. 1319) (the Act) on March 11, 2021. While most of the provisions under the Act focused on providing funding to families, state and local governments, and others, the $1.9 trillion pandemic relief bill also includes a number of tax provisions, some of which will raise taxes on certain businesses and expand refundable credits. You can find a general summary of the Act in RSM’s alert: President Biden signs American Rescue Plan Act of 2021.
In order to pay for some of the current stimulus, the Act includes a future expansion to the number of employees covered by section 162(m), which limits the deductibility of compensation over $1 million for select employees of public companies. Effective for taxable years beginning after Dec. 31, 2026, publicly traded companies will be denied a deduction for compensation in excess of $1 million for the eight highest-paid employees, plus the CEO or CFO. Previously, the deduction was only denied for the three highest-paid officers, plus the CEO or CFO. Because of the delayed effective date, companies may have difficulty in identifying who those highest paid persons might be in 2027. However, to the extent the company has options or deferred compensation that may vest in that period, the company should evaluate the realizability of its deferred tax assets.
ASU 2019-12, adoption time is now for public business entities
As we move into 2021, the time has come for public business entities to adopt the new guidance in ASU 2019-12, Simplifying the accounting for income taxes, which is effective for public business entities with fiscal years, and the related interim periods, beginning after Dec. 15, 2020. Non-public entities still have some time, with required adoption effective for fiscal years beginning after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022. For more information on the update and the eight simplifications to ASC 740, please refer to the following alert: ASU 2019-12 Simplifying the accounting for income taxes. While the method of adoption for much of the new guidance in ASU 2019-12 is on a prospective basis, companies with past changes in ownership of foreign entities and companies that file returns in jurisdictions with both capital and income based measures will need to spend some time evaluating the impact of the new guidance on prior periods. Companies should include disclosures in their financial statements regarding the adoption of ASU 2019-12 and its material impacts.
Updates from the Financial Accounting Standards Board
FASB issued two accounting standards updates during the first three months of the year, however, neither of these relate directly to ASC 740. FASB is still deliberating over the much anticipated accounting standards update regarding enhanced income tax provision disclosure requirements.
State and local tax
For a roundup of state and local tax changes, see the alert: State tax law changes for the first quarter of 2021
As countries continue to look for ways to aid an economy beleaguered by the effects of the pandemic, several countries have announced or enacted changes in tax laws. A few of the changes from around the globe are included below with assistance from RSM’s international global network.
The Australian Federal Court has recently held that a payment made by an employer to cancel employees’ entitlements under an Employee Option Plan was not ordinarily deductible. The amount may however be eligible for deduction over five years on a straight line basis. This case is currently on appeal.
Find more insights about Australia’s tax incentives in response to COVID-19 in the tax alert: Australian tax incentives: Significant savings for U.S. multinationals
Hong Kong-Serbia tax treaty in force
On Dec. 30, 2020, the Comprehensive Avoidance of Double Taxation Agreement (CDTA) with Serbia signed in August of 2020 came into force after the completion of the relevant ratification procedures. The CDTA will have effect with respect to Hong Kong tax for any year of assessment beginning on or after April 1, 2021.
Netherlands enacts tax law changes
The Netherlands enacted several changes to corporate income tax as follows:
- As from Jan. 1, 2021, the corporate tax rates for 2021 are 15% (reduced from 16.5%) on the first EUR 245,000 (lower bracket increased from 200,000) of taxable profits and 25% on taxable profits exceeding EUR 245,000. The previously announced tax rate reduction of the standard rate from 25% to 21.7% has been cancelled. The standard rate therefore remains 25% during 2021. Further increase of the lower bracket to EUR 395,000 will take place as from 2022, with the tax rates expected to remain at 15% for the lower bracket and 25% for the excess.
- In addition, the effective tax rate of the innovation box that applies to profits from self-developed qualifying IP will be increased from 7% to 9% as of Jan. 1, 2021.
- It has been announced that the carry forward loss relief rules will be amended effective Jan. 1, 2022, when an indefinite loss carry-forward will apply instead of the current six-year period. The carry-back period remains one year. However, losses (both carry-forward and carry back) can annually only be used to compensate an amount of EUR 1 million in taxable profit plus 50% of the taxable profits exceeding EUR 1 million. These limitations ensure a more gradual compensation of losses over future profit years.
- As from Jan. 1, 2021, additional substance requirements will apply to Financial Service Companies (FSC). An FSC is a Dutch taxpayer whose activities, for more than 70%, consist of back-to-back intragroup financing, licensing, renting or leasing activities. In addition to the already existing substance requirements, the two additional substance requirements for FSC’s are: i) EUR 100,000 of payroll expenses and ii) existence of an office space at the disposal of the company for at least 24 months. Failure to meet those requirements will have to be disclosed in the annual corporate income tax return of the FSC and will result in the exchange of information between the countries involved in the payment flows. As a consequence, the source state could deny treaty benefits.
- Beginning on Jan. 1, 2021, interest and royalty payments to affiliated entities in designated low-tax jurisdictions are subject to an interest/royalty withholding tax. The same applies to tax abuse situations (e.g. where payments are artificially diverted). The withholding tax will be levied at a rate equal to the standard corporate income tax rate.
- As part of the coronavirus relief measures and to encourage investments and employment, an investment incentive (BIK) has been introduced as of Jan. 1, 2021. With retroactive effect to Oct. 1, 2020, companies with personnel can apply for an investment allowance which can be deducted from payroll taxes due. Investments in new fixed assets that are taken into use by the company within six months after acquisition are eligible for the investment allowance. Up to and including investments of EUR 5,000,000 an investment allowance of 3.9% of the investment amount can be obtained. For larger investments in excess of EUR 5,000,000, an investment allowance of 1.8% can be obtained for the investment amount in excess of EUR 5,000,000.
For additional information, see the whitepaper: Netherlands Budget Day 2021 and other tax developments
United Kingdom announces increasing tax rates
In the United Kingdom, the Chancellor of the Exchequer released a proposed budget indicating that beginning in April 2023, the 19% United Kingdom corporate tax rate will rise to 25% for large businesses. It is important to note that the rate change is neither enacted, as required under US GAAP, or substantially enacted, as required under IFRS. Accordingly, the following changes should not yet be reflected in a company’s provision for income taxes.
The 25% tax rate will only apply to corporations with profits in excess of £250,000, while those under £50,000 in profits will remain at the 19% tax rate. Businesses with profits less the £250,000 will be granted relief so they are able to pay less than the headline rate of 25%. In addition, as an incentive to deter corporations from diverting profits out of the U.K., the 25% U.K. diverted profits tax will also increase in April 2023, to 31%. Also announced as part of the budget is a ‘super deduction’ for companies making capital expenditures in the near term, allowing for a deduction of 130%. Companies preparing foreign provisions should consider the effects of this rate change when valuing its deferred items.
Other recent global tax changes
Canada: For insights as to how Canada has responded in support of businesses during the pandemic, see the tax alert: Canadian COVID-19 support programs for U.S. multinationals
France: For more information about a recent court case in France that expands the notion of permanent establishment, see the tax alert: French court case expands notion of permanent establishment
Germany: For recent guidance on withholding tax on IP transactions, see the tax alert: New German guidance on withholding tax arising from IP transactions
Mexico: For an overview of the 2021 Mexican tax reform act, see the whitepaper: Mexican tax reform may have substantial impact on taxpayers
Spain: For recent changes to the tax law in Spain, see the tax alert: Corporate tax rates increase for Spanish entities by 1.25%
While preparing first quarter provisions, companies may need to give additional consideration to the impact of ASU 2019-12, the shifting rules on NOLs and interest deductions, and the tax consequences of PPP loan forgiveness. Looking back to the first quarter of 2020 and the uncertainty created by the early weeks of the pandemic, it seems as the first quarter of 2021 comes to a close there is reason to be hopeful while looking forward that the remainder of 2021 will bring more stable economic conditions and a return to days that feel a bit more normal.