Borrower Good Faith Certification and Other Sources of Liquidity; Employee Count for PPP Loan Eligibility; and Loan Forgiveness May Be Taxable
Borrower’s Good Faith Certification – Other Sources of Liquidity
All applicants on the Borrower’s application must certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Because of the economic uncertainty created for all Americans as a result of the COVID-19 global pandemic, at first, this certification seems easily made by all borrowers. However, on April 23, 2020, in the Frequently Asked Question (“FAQ”) No. 31, the Small Business Administration (“SBA”) stated that 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. We note that the SBA does not define “other sources of liquidity” or “not significantly detrimental to the business”, so we are unsure how broad those terms are meant to be (for instance, do liquidity sources include cash? Lines of credit or other debt? Additional capital from owners?).
This analysis regarding the need for a loan under the Paycheck Protection Program (“PPP”) is retroactive, meaning that borrowers that received funds prior to April 24, 2020, must analyze their business with this new guidance in mind to determine if the PPP loan proceeds were necessary to support ongoing operations. The SBA also created a safe harbor for any borrower that applied for PPP loans prior to April 24, 2020, which states that a borrower will be deemed to have made the above certification in good faith if it returns PPP loan proceeds by May 14, 2020.
This has created confusion for many borrowers for many reasons, and unfortunately, we don’t have many answers at this time; however, the SBA has said that it will provide additional guidance on how it will review the above certification prior to May 14, 2020.
Eligibility for a PPP Loan: Count Both Foreign and Domestic Employees
The first Interim Final Rule on the PPP published in early April stated several times that a business is generally is eligible for a PPP loan if it, combined with its foreign and domestic affiliates, has “500 or fewer employees whose principal place of residence is in the United States.” Our interpretation of this in early April was that employees of a borrower or any affiliate of a borrower living outside of the United States are not counted for eligibility purposes.
On May 5, 2020, the SBA published FAQ No. 44, which asks “How do SBA’s affiliation rules at 13 C.F.R. 121.301(f) apply with regard to counting the employees of foreign and U.S. affiliates?” The answer says “For purposes of the PPP’s 500 or fewer employee size standard, an applicant must count all of its employees and the employees of its US and foreign affiliates, absent a waiver of or an exception to the affiliation rules.” This FAQ question and answer calls into question our previous interpretation because the new FAQ specifically says that without a waiver of the SBA affiliation rules or other exception, all employees of the borrower and the affiliates of a borrower are counted for eligibility purposes without distinguishing between those that reside in the United State and those that do not. We note that this question and answer appears to directly contradict the language of the first Interim Final Rule referred to above.
We reached out to the SBA directly to ask about the contradictory language in the Interim Final Rule and FAQs published by the SBA related to counting foreign employees for purposes of eligibility for a PPP loan and received a response from Mr. Jesus Gomez, a Lender Relations Specialist. He indicated that our original interpretation was incorrect and that all employees (both foreign and domestic) of a borrower and employees of a borrower’s affiliates (both foreign and domestic) are to be counted when analyzing eligibility for a PPP loan. In other words, if the number of employees of a borrower and its affiliates (both foreign and domestic) is more than 500, absent a waiver of affiliation rules or other exceptions under the CARES Act, such borrower will not be eligible for a PPP loan. The distinction between employees residing in the US versus abroad is still applicable, however, for purposes of determining (i) the average monthly payroll costs of a borrower, (ii) the amount of a PPP loan that a borrower is eligible for, and (iii) which employees may be paid using PPP loan proceeds, which remains only employees that reside in the US.
While an email from an SBA Representative is not definitive, and we feel the Interim Final Rule and FAQs published by the SBA on this issue are still contradictory, it may be in an applicant’s best interest to follow the interpretation of the SBA representative.
Notice 2020-32 from the IRS – No Deduction For Expenses Paid with Forgiven Loan Proceeds
The CARES Act established that forgiven amounts of a PPP loan will not be included in the gross income of a borrower; however, it made no mention of the deductibility of expenses paid using PPP loan proceeds if such PPP loan, or part thereof, is ultimately forgiven. Recently, the IRS addressed this issue in Notice 2020-32, which indicates that no deduction is allowed for any expenses paid from the proceeds of a PPP Loan to the extent that the PPP loan is forgiven and excluded from taxable income. This issue may not be settled, as many lawmakers have expressed that this notice by the IRS may have been improper and against the spirit of the CARES Act. However, for right now, deductions are not allowed for expenses paid with forgiven PPP loan proceeds.