What is the Safe Harbor for Working Capital?

Since coming into effect in January 2018, Subchapter Z of the U.S. Tax Code, also known as the Opportunity Zone provisions, has allowed investors to pour billions of dollars into a wide range of businesses. , from real estate development companies to tech startups. Investments in Qualified Opportunity Funds (QOF) offer a number of distinct tax advantages, not the least of which is the reduction in capital gains tax. But the rules governing these investments are novel, confusing and, in some cases, severely restrictive.

In this eighth of our Qualified Opportunity Fund (QOF) article series, we discuss the WC Safe Harbor that applies to Qualified Opportunity Zone (QOZB) businesses. ).

In our seventh article, we discussed the limitation of unqualified financial assets (QSLS) and the general exception to the limitation of QSLs for reasonable amounts of working capital held in cash, cash equivalents and debt. ” a maturity of 18 months or less (short term). term debt). The areas of interest in this article are the more technical aspects of the WC Safe Harbor rules for taxpayers who wish to avoid the uncertainties of the general rule regarding working capital.

As we mentioned in the previous article, a QOZB should limit the portion of its property that is NQFP to less than 5%, measured by the unadjusted aggregate base:

A taxpayer can exclude working capital assets from the numerator, however, neither Subchapter Z nor Treasury regulations under it give explicit guidance on what characterizes an asset as working capital and whether the amount of these assets is generally reasonable. Although we have drawn an analogy with other areas of tax law (for example, the tax on profits accrued under section 541 et seq.), in our experience, the overwhelming majority, if not all, of QOZBs choose to qualify their assets as working capital in accordance with WC’s narrower but safer safe harbor, where possible.

Main effect: exclusion from the NQFP

If the QOZB meets the technical requirements of the WC Safe Harbor with respect to a particular amount of cash, cash equivalents and / or short-term debt held by the QOZB, these amounts will automatically be treated as amounts. reasonable working capital. This last point is the key, because it is what allows the QOZB to exclude such assets from its NQFP.

The technical requirements

Primarily, the technical requirements of the WC Safe Harbor are three in number: the first two relate to when the putative working capital assets are acquired, or shortly thereafter, and the third applies on an ongoing basis. until those assets are spent.

First, the QOZB should prepare a written plan for the use of working capital assets in the trade or business within the QOZ. Second, in addition to or as part of the written plan, the QOZB should prepare a written schedule for the expenditure of the working capital assets which normally should not cover more than 31 months after receipt of the working capital assets and must be compatible with the ordinary start-up of a business or business. Third, the QOZB must effectively use and spend the working capital assets according to the written schedule.

In a subsequent injection of working capital assets, a QOZB may qualify this second (or later) amount as part of WC’s Safe Harbor plan. All the same technical requirements apply to this amount, including the need for a written plan and schedule and substantially consistent use therewith. In addition, however, the subsequent injection of working capital assets should have been considered in the original working capital plan, and the written schedule for the use of the new amounts should provide for the use of the working capital assets. rotation within 62 months. from the initial date of the first working capital plan.

Care should be taken and foresight should be used when preparing the written plan and schedule, as Treasury regulations generally do not allow a QOZB to modify, revoke, or in any way alter the plan. or the written schedule once in place. It’s a place where proper guidance and skillful writing can preserve future flexibility (and project value).

A narrow, but seemingly prescient, exception in the proposed regulations is that a QOZB would be allowed to modify or revoke its written plan in the event that the QOZ in which it operates is in a federally declared disaster area. In this case, the QOZB would have up to 120 days after the expiration of the declaration to change its written plan. Under current regulations, such a QOZB has an additional 24 months to use its working capital subject to the written plan and schedule. Apart from this, the QOZB is bound by its own written plan and must stick to its schedule, at least until the specificity of its plan and the standard of use of working capital substantially in line with the plan and the schedule. written calendar.

The trade-off that a QOZB must make for the certainty of the safe harbor of the WC is that each time the QOZB receives working capital assets, it must prepare a new written plan and schedule for each infusion separately. Otherwise, with regard to this infusion, the general rules, and as yet unwritten, apply. In the case of a large cash contribution from the training or loan proceeds that QOZB receives for a major expansion, this may not be a problem, but for more common cash inflows in the ordinary course of business. business, such as inventory sales, this requirement virtually prohibits the use of the WC Safe Harbor in relation to the day-to-day transactions of the QOZB.

Side effects: relax the qualification for QOZB start-ups

In addition to allowing a QOZB to exclude working capital assets from the definition of NQFP, the WC Safe Harbor goes further and makes it easier for a QOZB engaged in starting a business to meet general requirements. to qualify as a QOZB.

While a QOZB is engaged in starting a business and has working capital assets that meet the WC Safe Harbor, that QOZB is automatically considered to meet the tangible property test during the period (s) of 31 month working capital (plus any extensions). In addition, any tangible property acquired, leased or improved with these working capital assets and which is expected to be QOZB property due to anticipated expenses under the written plan will be treated as such for the purposes of testing the tangible property during any 31 month period. working capital period (s). Likewise, intangible assets acquired with such working capital assets are treated as used in the trade or business of QOZB, and any income generated by such tangible or intangible property is counted favorably towards the requirement that at least 50%. of the gross income of the QOZB is generated in a QOZ. However, no working capital asset is itself treated as real tangible property, intangible property or QOZB property for any purpose.