You did it. You’ve reached the third and final installment of our series on the “state of COVID-19 disclosure.” Previous episodes focused on language concerning debt covenants and going concern opinions. Today, we’re going to see what public companies are disclosing about relief they received under the CARES Act.
This trilogy of posts started, you’ll recall, after the SEC issued guidance at the end of June directing public companies to get real with investors about those three subjects. The SEC even listed specific questions about each for companies to address. Unsurprisingly, the CARES Act section included questions regarding the federal loan program that has consumed great public attention. But the SEC also zeroed in on a tax issue affecting a much greater portion of public companies. Specifically, it asked them to answer:
“Are you taking advantage of any recent tax relief, and if so, how does that relief impact your short- and long-term liquidity? Do you expect a material tax refund for prior periods?”
This is a timely subject. The CARES Act came with a big basket of tax relief, and disclosure around it is mandated not just by the SEC’s June guidance, but also ASC 740. That accounting standard requires the impact of tax changes “on deferred tax balances to be recognized in the period in which new legislation is enacted.” For the CARES Act, that’s March 27, 2020.
Accordingly, we see disclosures like this one from Capri Holdings Ltd. in its second-quarter filing: “We realized a slight favorable cash flow impact in Fiscal 2020 as a result of the deferral of income tax payments under the CARES Act and other local government relief initiatives.”
In the midst of the pandemic, accountants are encouraging issuers to “double down on their forecasting efforts” (as opposed to throwing up their hands, a more natural reaction to the state of the world), which has a big impact on the realizability of deferred tax assets. Capri Holdings, for one, seems to have gotten the message on that front. Its 10-K goes on to say: “We also considered the significant adverse impact of COVID-19 on our business in assessing the realizability of our deferred tax assets. Based on this assessment, we determined that valuation allowances of approximately $65 million were needed against a portion of our non-US deferred tax assets. We will continue to monitor the impacts of COVID-19 on our ability to realize our deferred tax assets and on the tax provision.”
Here are some of the specific, big-ticket tax goodies in the CARES Act, and what a few issuers are saying about them:
- Net operating losses: The CARES Act lifts the limit on NOL that a company can deduct in a single tax year, and also allows NOL incurred in 2018, 2019, and 2020 to be carried back to any of the five preceding tax years to get a retroactive refund on an old tax bill. Nurix Therapeutics leapt on the opportunity: “In the second fiscal quarter of 2020, we filed a refund claim of $15.7 million to carryback NOLs generated in the fiscal year ended November 30, 2018, and we intend to file an additional refund claim to carryback NOLs generated in the fiscal year ended November 30, 2019 to recover an additional $3.9 million of income tax.”
- AMT: The CARES Act accelerates the payment of alternative minimum tax credit refunds to corporations. Along these lines, KB Home in a recent 10-Q disclosed that it “filed a superseding 2019 federal income tax return claiming an additional refund of $39.3 million of AMT credits and reclassified this amount form deferred tax assets to receivables.”
- Business interest: The Act makes three significant changes to the limits on business interest deductions found in section 163(j) of the tax code. As an example, Enviva Partners recently noted in an S-3 filing that “For purposes of determining our 50% adjusted taxable income limitation, we may elect to substitute our 2020 adjusted taxable income with our 2019 adjusted taxable income, which may result in a greater business interest expense deduction.”
- QIP: The CARES Act also “makes a technical correction to the 2017 U.S. tax reform to provide a 15-year recovery period for qualified improvement property (QIP).” That explanation comes from the 10-K of DXC Technology, which elaborated on the correction and its own action like so: “This correction makes QIP eligible for bonus depreciation and is effective as if enacted as part of the 2017 U.S. tax reform. Accordingly, [DXC] has applied bonus depreciation to certain QIP.”
The CARES Act even waives the federal excise tax on distilled spirits used to make hand sanitizer. When it comes to tax relief, they really thought of everything. The question now is whether issuers, in turn, are disclosing it all.