All industries have been forced to face the health and economic challenges from the global pandemic but the O&G industry is also facing lower demand and weak commodity prices while needing to increase revenue to survive. Plunging oil prices are a direct result of production declines in the wake of the Russia-OPEC price war and reduced demand for oil from measures to mitigate the spread of COVID-19.
As companies try to overcome this dual challenge, they can consider several business developments as well as tax implications that may help them mitigate the negative impacts this sector is facing. Certain planning strategies for the utilization of tax attributes and cash repatriations can be considered if depressed commodity prices and decreased demand continue for an extended period. Below are a few recommendations for companies in this sector to consider.
CARES Act Provisions
Among the many favorable CARES Act provisions, the updated rules regarding net operating losses (NOL) carryback, as well as interest expense deduction, may benefit many O&G businesses. Taxpayers can carry back NOLs in the tax years beginning after 2017 and before 2021 for five years. Taxpayers may also offset ordinary income of capital gains for this period that were previously taxed at a much higher rate. Additionally, companies may temporarily increase the interest expense deduction limitation under I.R.C section 163(j) from 30% to 50% of the taxpayer’s adjusted taxable income for the tax years beginning 2019 and 2020.
Firms are taking the benefits of the newly enacted provisions by accelerating alternative minimum tax credits, delaying self-employment and employer payroll taxes, postponing certain tax filings, and of course payments, to July 15, 2020, and taking advantage of the employee retention payroll tax credit to increase cash flow for their day-to-day operations.
As companies anticipate debt risks, a potential opportunity may be to diversify their line of business, dispose of an existing operation or contemplate mergers or acquisitions in which tax attributes and consequences should also be considered.
Many companies are considering refinancing debt in efforts to increase their cash flow. However, it is important to look at the tax consequences along the way and evaluate the net effect of the term modifications. A reduction of the amount of principal in a debt instrument may be considered a cancellation of indebtedness income (CODI) which could generate ordinary income, regardless of its character. It is important to keep in mind that as many alternative investments are structured as pass-through entities, it is the ultimate owners who would take these tax burdens themselves.
Furthermore, as we approach another quarterly filing, it is expected that many corporations will book impairments of O&G properties, other long-lived assets, and goodwill for financial reporting purposes when addressing the impact of COVID-19 on liquidity. It is anticipated that there will be an increase in valuation allowances on deferred tax assets during the Q2 filings.
Supply Chain Impairments
Businesses all around the globe are potentially experiencing a weakened link in their supply chain. This may create supply chain bottlenecks that may be mitigated if timely identified. As such, companies should evaluate the need for alternative providers and maintain close communication with their vendors during these challenging times to recognize their suppliers’ operational or financial struggles.
The energy section has proven its resistance over time. By working together, we can help ensure the industry makes a stronger recovery. Contact us to help you navigate through this pandemic and check out our COVID-19 Resources page for more information.