MANAGING THE TAX IMPACT IN THE WAKE OF COVID-19

Many businesses especially corporate consultancy soon will be unable to meet their obligations. Not all businesses in distress are unsuccessful; sometimes, as in the economic circumstances arising from the coronavirus (COVID-19) and the governmental directives tailored to address the related public health issues, even successful businesses must confront closures and steep drops in demand that could not have been anticipated and may find it necessary or desirable to restructure their existing debt obligations.

Already, many corporate consultancy company are facing liquidity pressures and seeing their debt trade at a discount, or at steeper discounts than before the current crisis. Prudent managers of corporate consultancy looking ahead, examining ways to relieve these pressures and to maintain their financial footing. Many will consider making modest changes to existing debt obligations, and some will explore more significant amendments or restructuring of their obligations. Any adjustment of a debt obligation can have tax implications. Even an apparently innocuous change is tested under the tax law to determine whether it must be treated as a taxable exchange transaction in corporate consultancy. For tax objectives, the adjustment of corporate consultancy which may take the form of a simple measure be treated as though the issuer of the debt issued a new debt obligation in exchange for the pre-amended debt obligation.

A debt restructuring can take many forms in corporate consultancy such as an in-form replacement of existing debt for new debt, an exchange of debt for stock, a correction of the terms of a debt instrument or payment deferral thereunder, or using new money and repurchasing existing debt on the market. When a debtor company reacquires its existing debt in any of these ways the corporate consultancy company generally recognizes taxable cancellation of debt income. Often, a corporate company in this situation will have been incurring losses for a while and, therefore, would have net operating loss carryforwards that would wholly or significantly offset such otherwise taxable income.

There are various exceptions to the cancellation of debt resulting in taxable income that can apply depending on a company’s particular situation because of COVID 19. The two most prevalent exceptions in times of distress for corporate taxpayers at corporate consultancy are the bankruptcy and insolvency exceptions. Notably, the bankruptcy exception is available even in the case of a so-called pre-packaged or pre-negotiated plan of reorganization. These are plans of reorganization that have already been negotiated, and sometimes even voted on, prior to the actual bankruptcy filing such that their success is essentially assured. These types of plans have become quite common and can be negotiated and brought to completion relatively quickly. Under this exception, any exclusion from taxable income is limited to the amount of the corporation’s insolvency, as determined immediately prior to the transaction under applicable tax principles (in very general terms, the excess of its liabilities over the fair market value of its assets). The determination of a corporation’s insolvency is subject to certain special rules depending on the circumstances, which aren’t always intuitive and can result in a lesser insolvency exclusion amount than expected.

It is clear that the government is focused on taking steps to reduce the economic pain inflicted by the current crisis of COVID 19. It is, therefore, possible, as was the case in the 2008 financial crisis that one form of government assistance could be to relax the cancellation of indebtedness tax rules especially in corporate consultancy. In response to the 2008 financial crisis, debtors were granted an election to defer the inclusion of cancellation of indebtedness income over an extended period, as opposed to having a current income.