Tax News

What PPP Borrowers Need To Know

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For small and midsize businesses struggling because of the coronavirus, the Paycheck Protection Program (PPP), included as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, provided much-needed funding to cover necessary expenses. One of the chief benefits of the loans made through this program is the potential for the loans to be completely forgiven if borrowers meet certain criteria.

The Paycheck Protection Plan Flexibility Act of 2020, enacted on June 5, further enhances the opportunity for loan forgiveness by expanding requirements on how the loans are spent and extending the period to use the funds to 24 weeks, with the ability to elect the 8-week period if funds were received prior to June 5, 2020.

Borrowers of PPP loans should consider taking the following steps to maximize the amount and accelerate the timing of loan forgiveness:
 

1. Decide how much time you need to spend the funds

One of the key provisions in the Paycheck Protection Program Flexibility Act is more time to use PPP funds. In the CARES Act, employers were limited to only an 8-week period to use the funds, but now they have up to 24 weeks, provided the covered period does not extend beyond Dec. 31, 2020. When choosing the covered period for the loan, borrowers should consider the changes that apply to both the 8- and 24- week periods and the benefits of each:

  • The extended 24-week period will allow businesses to incur more eligible payroll costs. Many businesses were struggling to meet this minimum during the 8-week period, typically because of reduced staffing levels.
  • Additionally, more funds spent on non-payroll costs are now eligible for forgiveness under both the 8- and 24-week period. Only 60% of the loan must be spent on payroll costs to achieve the maximum forgiveness, (lowered from the original 75% minimum). This change alone will allow many borrowers to achieve 100% forgiveness in the allowable 8-week period.  
  • The ability to count more weeks of payroll costs will reduce the need to spend funds on non-payroll costs and ultimately reduce the documentation borrowers need to provide to their banks.
  • Businesses that choose the 8-week period will likely want to apply for forgiveness as soon as possible so they can make business decisions, such as any necessary payroll or staffing cuts, without impacting loan forgiveness.


2. Talk to your lenders

Regardless of the covered period a borrower chooses, it is critical to begin conversations about loan forgiveness procedures with lenders as soon as possible, particularly since lenders will be making the initial review before it goes to the Small Business Administration (SBA) for final approval. Borrowers should get clarity from their lender on the forgiveness process, including:

  • Will applications be accepted on the SBA’s paper forms or will an online submission be required? 
  • Is the lender requiring borrowers to submit documentation via email, an online portal, or in some other way?  
  • What formats are acceptable when submitting supporting documentation?
  • Will the lender provide a calculator that borrowers can use to analyze their expenditures and project the expected forgiveness amount?

3. Get your FTE counts and salary reduction amounts in order

Borrowers of PPP funds need to compile several counts of their full-time equivalent (FTEs) employees. This includes historical FTE counts that are not dependent on the covered period of the loan, and can thus be calculated and documented at any time, including before a loan is awarded. These historical FTE counts will be compared to a borrower’s average FTE count for the covered period.
 
Businesses will need to wait until their covered period ends to finalize their FTE determination for that time. Projection of the average number of FTEs for the covered period is useful for analysis purposes, but may be a difficult task for businesses like restaurants that are likely uncertain about when they can put employees back to work. However, a new safe harbor has been added that will take into account situations where compliance with COVID-19 precautions prevented business from reaching their average pre-COVID FTE count. Additionally, employers now have more time to reduce or eliminate their calculated FTE reduction by re-hiring laid off employees by the earlier of the loan forgiveness application date or December 31, 2020, instead of June 30, 2020.
 
If borrowers reduced employees’ hourly rates or annual salaries during the covered period, they must document that the reduction did not exceed 25% of the wages/salary of the quarter preceding the loan date. If borrowers did not reduce the rate of pay, they do not need to perform this calculation, even if payments to employees decreased due to reduced hours.  Reductions in wage payments due to reduced hours are not a part of this calculation because the reduced hours generate a reduction in the number of FTEs.
 
Any reduction in pay rates or salaries that exceeds 25% will be treated as a decrease of the amount spent on expenses eligible for forgiveness. However, the 24-week covered period allows more time to recover from temporary wage or salary reductions. For example, if a full-time employee’s hourly rate was reduced from $20/hour in Q1 to $10/hour for an 8-week covered period, the reduction at the end of the 8 weeks in excess of 25% would be $5/hour, which for a typical 40-hour work week would equate to $1,600. But, if the business restores the wage rate to $20/hour for weeks 9-24, the new average rate for the covered period is over $15/hour, meaning the pay reduction does not exceed 25%, preventing any adjustment on account of wage and salary reduction.  
 

4. Gather your documentation to submit to your lender

In addition to FTE counts, borrowers will need to supply supporting documentation for any other expenses that are being submitted on the loan forgiveness application. This includes payroll registers and payroll tax reports that provide cash payroll paid during the covered period and the first payroll paid after the covered period, if this includes pay for days worked during the covered period.  Your payroll vendor may have reports designed specifically to document PPP loan forgiveness amounts.

If additional payroll costs are needed to achieve 100% forgiveness, borrowers must include the receipts showing payment of health insurance premiums or claims paid for self-insured plans. If the entire loan proceeds are not accounted for with these documented payroll costs, then borrows should submit documentation showing the payment of non-payroll costs. Larger expenses like rent and interest on mortgages might achieve total forgiveness, eliminating the need for any additional documentation. If there are remaining funds that have not yet been documented as forgivable, then borrowers should continue to submit utility payments.

To minimize the back and forth with lenders, borrows should confirm if they need document submitted in a specific format.
 

5. Don’t forget about documents you need to maintain, but not submit to the lender

In addition to the documents that must be submitted with the application for forgiveness to the bank, borrowers must maintain certain additional documentation for six years after the date the loan is forgiven or repaid in full. This is required should the SBA chose to audit the loan forgiveness. These documents include:

  • PPP Schedule A Worksheet or its equivalent and documentation supporting:
    1. The listing of cash paid to each employee who worked during the covered period, including the “Salary/Hourly Wage Reduction” calculation, if necessary.
    2. Which employees received compensation at an annualized rate of more than $100,000 during any single pay period in 2019.
    3. FTE calculations for each employee including written offers of reemployments, firings for cause, voluntary resignations, and written requests by any employee for reductions in work schedule.
    4. FTE Reduction Safe Harbor calculations if applied to cure an FTE shortfall.
    5. Written explanation regarding the inability to return to pre-COVID-19 operation levels due to compliance with COVID-19 guidelines.
  • Identity of owner-employees and self-employed owners and how their maximum loan forgiveness was determined.
  • Copies of all records relating to the borrower’s PPP loan, including:
    1. Documentation submitted with the PPP loan application and documentation supporting the borrower’s certification as to the necessity of the loan request and its eligibility for a PPP loan.
    2. Documentation necessary to support the borrower’s loan forgiveness application, and documentation demonstrating the borrower’s compliance with PPP loan requirements.

PPP loans provide many businesses with a critical influx of cash needed to survive the ongoing pandemic, and recent changes to the loan program have increased flexibility for borrowers. However, loan forgiveness is a key element in maximizing the benefit of this loan program. Approved borrowers should act quickly to ensure their ability to have these loans forgiven. 

PPP Loan Forgiveness and Payroll Tax Deferral Has More Flexibility

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The Paycheck Protection Program Flexibility Act of 2020 (H.R. 7010) (PPP Flexibility Act), enacted on June 5, 2020, makes welcome changes to the forgiveness rules for Paycheck Protection Program (PPP) loans made to small businesses in response to the novel coronavirus global pandemic (COVID-19). The PPP Flexibility Act greatly increases the likelihood that a large percentage of a borrower’s PPP loan will be forgiven. PPP loans (and related forgiveness) were created by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Public Law 116-136), which was enacted on March 27, 2020. The PPP Flexibility Act also eliminates a provision that made recipients of PPP loan forgiveness ineligible to defer certain payroll tax deposits.

Insight:

The PPP Flexibility Act does not address whether employers can deduct the expenses underlying their PPP loan forgiveness. In Notice 2020-32, the IRS announced that employers could not deduct such expenses, but congressional leaders vowed to reverse the IRS’s position in future legislation. On June 3, Chairman of the House Ways and Means Committee, Richard Neal (D-MA), said that in the next COVID-19 stimulus bill he intends to clarify that the loan forgiveness expenses are tax deductible. But negotiations on that bill are still in the early stages.

PPP Loan Forgiveness Expanded

The PPP Flexibility Act makes the following changes:

1. Extends the “covered period” for PPP loan forgiveness from eight weeks after loan origination to the earlier of (i) 24 weeks after loan origination or (ii) December 31, 2020. Borrowers who received their loans before this change can elect to use their original or alternative payroll eight-week covered period.

Insight:

In connection with passing the PPP Flexibility Act, a Statement for the Record was issued by several Democrats and Republicans in the House and Senate, clarifying that the Small Business Administration (SBA) will not accept applications for PPP loans after June 30, 2020. The statement says: “Our intent and understanding of the law is that, consistent with the CARES Act as amended by H.R. 7010, when the authorization of funds to guarantee new PPP loans expires on June 30, 2020, the SBA and participating lenders will stop accepting and approving applications for PPP loans, regardless of whether the commitment level enacted by the Paycheck Protection Program and Health Care Enhancement Act has been reached.” Given this affirmation, very few loans will have fewer than 24 weeks as a covered period.

2. Replaces the June 30, 2020, date for the rehire safe harbor with December 31, 2020. 

Insight:

Additional guidance is needed to determine if a borrower who elects their original or alternative payroll eight-week covered period would also retain the June 30, 2020, date for the rehire safe harbor.

3. Expands the rehire exception based on the non-availability of former employees and applies that exception when the need for workers is reduced to comply with COVID-19 standards. Specifically, PPP loan forgiveness would not be reduced due to a lower number of full-time equivalent (FTE) employees if:

  • The employer is unable to rehire individuals who were employed by the employer on February 15, 2020, and the employer shows the inability to hire similarly qualified employees for unfilled positions on or before December 31, 2020, or
  • The employer documents its inability to return to the same level of business activity as it had before February 15, 2020, due to having to comply new COVID-19 standards for sanitation, social distancing or other safety requirements during the period of March 1 through December 31, 2020.


4. Allows up to 40% of the loan proceeds to be used on mortgage interest, rent or utilities (previously such expenses were capped at 25% of the loan proceeds), while at least 60% of the PPP funds must be used for payroll costs (down from the 75% that was noted in SBA guidance). This applies even if the borrower elects to use the eight-week covered or alternative payroll covered period. If the borrower does not use at least 60% of the loan on payroll costs, then it appears that no forgiveness would be available (i.e., the 60% would be a “cliff,” even though it was previously unclear whether the 75% limit would allow for partial loan forgiveness for payroll costs of less than 75% of loan proceeds).

Insight:

Some members of Congress are considering a “technical correction” that would provide that the new 60% limit is not a “cliff” (thereby allowing partial loan forgiveness if less than 60% of PPP loan proceeds are used for payroll costs).

5. Provides a five-year term for all new PPP loans disbursed after June 5, 2020. Loans disbursed before that date would retain their original two-year term unless the lender and borrower renegotiate the loan into a five-year term.

6. Changes the six-month deferral period for loan repayments and interest accrual so that payments on any unforgiven amounts will begin on either (i) the date on which loan forgiveness is determined or (ii) 10 months after the end of the borrower’s covered period if forgiveness is not requested.

Insight:

Although the PPP Flexibility Act doesn’t clearly say as much, it appears that the $100,000 maximum on cash compensation paid to any one employee that is eligible for PPP loan forgiveness would continue to apply, such that the $15,385 cap (for eight weeks) would now be $46,153 (for 24 weeks).

The PPP Flexibility Act does not address whether the loan forgiveness cap for “owner-employees” (i.e., 8/52 of their 2019 compensation) would change to 24/52 of their 2019 compensation.

Notwithstanding some commentary that has been released, the statute does not appear to allow borrowers to request PPP loan forgiveness as soon as they spend all of their PPP funds in the ninth to 24th weeks following receipt of their PPP funds. That is because the CARES Act has been amended to substitute “24 weeks” for “eight weeks,” so absent additional guidance, it seems that borrowers must wait until the end of the 24-week period to request PPP loan forgiveness, unless they elect to use the original eight-week period (regular or alternative payroll covered period).

These changes garnered nearly unanimous, bipartisan support in both the House and Senate because the CARES Act assumed that most businesses would be up and running in a matter of weeks. But more time is needed to incur forgivable costs, because many businesses are at or near the end of their initial eight-week loan forgiveness period, yet they remain partially or fully suspended by governmental orders.
 

Payroll Tax Deferral Expanded

In addition to PPP loan changes, the bill allows all employers, even those with forgiven PPP loans, to defer the payment of 2020 employer’s Social Security taxes, with 50% of the deferred amount being payable by December 31, 2021, and the balance due by December 31, 2022. Previously, the CARES Act prohibited such payroll tax deferral after a borrower’s PPP loan was forgiven. 

Transfer Pricing & Trade Duties Review For U.S. – China Supply Chain

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China’s National Bureau of Statistics reported in April that China’s GDP shrank 6.8% from the prior year in the first quarter of 2020.  Based on a poll conducted by Reuters, analysts expect China’s economic growth to slow sharply from 6.1% in 2019 to 2.5% for 2020.

As the world is going through an unprecedented novel coronavirus (COVID-19) crisis, multinational corporations (MNCs) with cross-border trade or transactions are facing challenges to maintain cash flow, improve liquidity, control profit decline and mitigate losses caused by demand and/or supply shocks.  
 

Review Current Transfer Pricing Policy

MNCs with operations in China have traditionally employed a classical supply chain model involving a contract manufacturer (CM), toll manufacturer (TM), or limited risk distributor (LRD) in China, depending on the type of their Chinese operations.  

Under such supply chain model, the Chinese CM, TM or LRD normally maintains a fixed (albeit limited) profit level coupled with limited risks.  The offshore principal often reaps greater rewards or bears losses commensurate with the greater economic risks borne. 

Since China started a nationwide shutdown in early February as part of its COVID-19 containment measures, its manufacturing output dropped significantly, as evidenced by the sharp decline in the Purchasing Managers’ Index (PMI) of China in February.  As China’s economic activities have resumed recently, other countries around the world are taking an economic hit, causing a reduction in consumer demand.  MNC’s sales have significantly shrunk in the past months and certainly are at great risk of further decline with the global pandemic. Meanwhile, the effort of Chinese enterprises to resume production has been slow due to continued virus containment requirements and shortages of workers and supplies.

The combined effects of a two-month shutdown, sluggish resumption of production capacity, and suppressed global demand could severely impact the overall profitability of MNCs, which may now need management to review the limited-risk supply chain model for the Chinese CM, CM or LRD.  

For a CM or a TM that is typically guaranteed a fixed cost plus mark-up, the cost plus compensation may no longer be considered reasonable and sustainable, since the arrangement may overburden the principal.  In the current situation, these structures should be reviewed to determine how declines in profit (or losses) should be shared between the CM, TM and principal.

Similarly, for an LRD that is typically guaranteed a fixed profit margin while the principal absorbs the gains and losses from changes in the business or economic climate, it may also be necessary to review the current structures and determine how declines in profit (or losses) could be shared between the LRD and the principal in the current economic environment.

MNCs should consult their transfer pricing advisors to assess whether and how to maintain and adjust their current transfer pricing systems, taking into account the current economic climate, tax consequences, and risks in both countries while balancing the impact on the group’s overall tax liability. In addition, considering that the Chinese tax authorities have required stable profit margins for CM, TM and LRD, which is stipulated in the prevailing China transfer pricing rules, an adjustment to an MNC’s transfer pricing policy to reduce the profit allocated to China faces uncertainty. It is suggested that MNCs seek proactive communications with Chinese tax authorities or engage professional tax advisors to assist with such communications if the MNCs would like to implement transfer pricing policy adjustments.  
 

Review Import and Export Duties and Taxes

Since 2018, the U.S. and China have respectively increased import tariffs on goods imported from the other country.  Most notably, the U.S. has imposed tariffs on more than $360 billion of Chinese goods, and China has retaliated with tariffs on more than $110 billion of U.S. products.  These tariffs have increased the cost for businesses in both countries to engage in cross-border trade. 

On January 15, 2020, the U.S. and China signed the “phase one” trade deal under which the U.S. agreed not to impose tariffs on $160 billion of Chinese imports (including popular consumer items such as cellphones and laptops) and reduced the tariff rate on another $120 billion worth of goods from 15% to 7.5%.  In return, China’s retaliatory tariffs, including a 25% tariff on U.S.-made autos, have also been suspended, among other concessions made by China.  After signing the phase one trade agreement, the trade negotiation of phase two agreement was put on hold under the global outbreak of COVID-19 crisis.

Meanwhile, in response to the COVID-19 pandemic, the U.S. has temporarily exempted a range of Chinese health and medical products, including sanitary wipes, medical gloves, face masks, surgical gowns, and other items from Section 301 duties.  Notably, these medical exclusions are retroactive to the imposition of the tariffs, with the starting date varying based upon the applicable list at issue. This opens up the opportunity of seeking refunds of these Section 301 duties back to the original imposition of the duties, providing a potential source of liquidity for businesses.  Moreover, the U.S. Trade Representative (USTR) likely will continue to grant numerous medical exclusions.   

Businesses in the impacted sectors should regularly monitor the USTR website for potential future exclusion developments.  As the USTR generally issues exclusions on a rolling basis, early submission of requests can result in earlier duty savings and better cash flow.

The Chinese customs and tax authorities have also taken measures to provide certain tax relief in response to COVID-19.  Based on the most recent customs duty relief announced in China, qualified goods imported from the U.S. during the period from February 28, 2020, to February 27, 2021, are added to the exclusion list for the additional retaliatory tariffs against the U.S. Section 301 duties.  In addition, donations used for epidemic prevention and control are exempted from import duties, import VAT, and consumption tax.

Last but not least, U.S. companies that import goods from Chinese related parties should also consider how the aforementioned transfer pricing adjustments to prices may affect the import duties.  It is important to take action before importation to align the income tax and customs approach to mitigate the impact of any transfer pricing adjustment.

U.S. companies with Chinese operations should carefully review the continuing development of COVID-19 relief measures in both countries to identify how it will impact them. Please contact your client service professionals for the latest COVID-19 updates and discuss the appropriate course of action to manage the business impacts of COVID-19.