On November 16, 2020, the IRS issued taxpayer-favorable FAQs clarifying the interaction of the employee retention credit (the "ERC") and Paycheck Protection Program ("PPP") loans in M&A transactions. A taxpayer (including all affiliates that are treated as members of a single employer under aggregation rules) cannot claim the ERC if any member of the aggregated group has taken a PPP loan. This rule raised significant concerns in M&A transactions where the target company took a PPP loan and the buyer claimed the ERC. FAQ 81a clarifies that a taxpayer (the "Acquiring Employer") that acquires the stock or other equity interests of an entity (the "Target Employer") in a transaction that results in the Target Employer becoming a member of an aggregated group with the Acquiring Employer that is treated as a single employer under the aggregation rules (the "Aggregated Employer Group") is still eligible to claim the ERC. Similarly, FAQ 81b clarifies that an Acquiring Employer that acquires the assets and liabilities of a Target Employer is still eligible to claim the ERC as long as the Acquiring Employer does not assume the Target Employer's obligation for the PPP Loan. Although the FAQs cannot be relied upon as a legal authority, they provide welcome confirmation that the Acquiring Employer in an M&A transaction will not have to recapture or forego the ERC.
Taxpayers Who Receive a PPP Loan Generally are Not Eligible to Claim the ERC
Under the CARES Act, if a taxpayer has taken a PPP loan, the taxpayer and all of the members of the taxpayer's Aggregated Employer Group are ineligible for the ERC. In addition, if a taxpayer utilizes the ERC and subsequently obtains a PPP loan, the taxpayer must recapture the ERC. These rules raised significant concerns in M&A transactions that a buyer or its affiliates acquiring the stock or assets of a target that received a PPP loan would be ineligible for the ERC and would be required to recapture any previously claimed benefit.
Buyer Eligibility for the ERC Following Stock or Other Equity Purchase
If, prior to the transaction closing date, the Target Employer, in compliance with procedures established by the Small Business Administration (SBA), either (i) fully satisfies the PPP loan, or (ii) submits an application for forgiveness of the PPP loan and establishes an interest-bearing escrow account (which will be used to repay the PPP loan), the Acquiring Employer and the members of its Aggregated Employer Group (including the Target Employer) remain eligible to claim the ERC after the closing date. In addition, the Acquiring Employer and the members of its Aggregated Employer Group and are not required to recapture any previously claimed ERCs.
If the PPP loan is not fully satisfied or the escrow account is not established prior to the transaction closing date, then the buyer and its Aggregated Employer Group will still generally be eligible to claim the ERC. Further any ERC claimed by the buyer or its Aggregated Employer Group prior to the transaction will not be subject to recapture. The newly acquired Target Employer, however, would continue to be ineligible for the ERC with regard to any wages paid to its employees before or after the closing date.
Buyer Eligibility for the ERC Following Asset Acquisitions
If a buyer acquires assets of a Target Employer with a PPP loan, the buyer will not be treated as receiving a PPP loan for ERC eligibility purposes, provided that the buyer does not assume the Target Employer's obligations under the PPP loan. Thus, the buyer will be eligible for the ERC following the closing date and is not required to recapture ERCs it utilized prior to the closing date.
Even if the buyer assumes the Target Employer's obligation for the PPP loan, the buyer will not be treated as receiving a PPP loan for ERC eligibility purposes. Thus, any ERC claimed before the closing date will not be subject to recapture. Any wages paid by the buyer to employees who were employed by the Target Employer on the closing date, however, will not be treated as qualified wages for ERC purposes. As a result, the buyer will not be eligible to claim the ERC for wages paid to any continuing employees from the Target Employer.
The FAQs do not address all open issues with respect to the ERC and PPP Loans. The FAQs do not address whether the ERC must be recaptured if a buyer with a PPP loan acquires a target that utilized the ERC prior to the transaction closing date, nor do the FAQs contemplate any transaction in which the buyer has a PPP loan. The FAQs also do not explicitly address the treatment of stock purchases treated as asset acquisitions under Section 338 or Section 336(e). In the case of a Section 338(g) election, new target, rather than the buyer, will be deemed to have assumed the obligations of old target for tax purposes. In the case of a Section 338(h)(10) election, buyer will be deemed to have assumed the obligations of the PPP loan for tax purposes, but not for commercial law purposes. In the case of a Section 336(e) election, which can be made without the buyer's consent, the buyer will be treated as having purchased assets of the target.
Implications for M&A Transactions
While the FAQs may not be legal authority, they provide welcome confirmation that the Acquiring Employer in an M&A transaction will not have to recapture or forego the ERC.
Parties should verify early in the due diligence process whether the purchaser, the target, or both have claimed the ERC or received a PPP loan. This will enable the parties to develop a transaction structure and strategies for dealing with situations where one of the parties to the transaction has claimed the ERC and the other has claimed a PPP loan. It will also be important to determine whether the party who received the PPP loan has paid, or will have paid prior to closing, sufficient qualifying expenses to obtain complete forgiveness of the PPP loan in full. Purchasers should keep in mind that, if they assume PPP loans, qualifying expenditures will not be deductible if the loan is forgiven. Our analysis of recent guidance on deductibility of expenses paid with PPP loan proceeds can be found here. Issues relating to PPP loans may require adjustments to purchase price, escrows, representations, and indemnity provisions in purchase agreements as well.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.