Why NOLs should be transferable

Dad stopped by the other day on his way back from a meeting and we were kicking around some ideas. One of the things that he brought up that I’d been toying around with as well was the notion of enabling companies to sell their NOLs. I think this is an outstanding idea – both at the state and the federal level. I don’t really want to get into it here, but you should assume a priori that I believe that NOLs should also be more transferable in acquisitions as well. That’s a related topic for sure but here I’d just like to address the ability of companies to literally sell their NOLs to the highest bidder.

Let my address this from the perspective of the three entities most affected by this idea:

- The selling company. The company selling its NOLs clearly benefits. It turns an asset that it can not currently make use of (and one that has a limited lifetime) into immediate cash to fund its current operations (and perhaps to generate more NOLs). Clearly this is a way for the selling company’s investors to double down their investment, to the extent to which their money is spent on things that give rise to expenses. Depending on how the market for NOLs develops and the company’s expected near to medium term prospects for generating taxable income it can plan with some accuracy to balance the generation of near-term benefit (cash) with expected later benefit (the tax shelter their NOLs would provide).

- The buying company. Different companies would derive different benefits from purchasing NOLs – companies have different tax rates, tax rates vary by domicile, companies have different expected needs for sheltering income, etc. Presumably a relatively perfect market would develop for the buying and selling of NOLs and these differences would work themselves out in the form of different prices companies would be willing to pay for $1 of NOL shelter. I don’t see much downside for buying companies if this idea were implemented – they’ll be able to do similar planning as the selling companies and determine the right balance of NOL need vs. price based on their individual outlook.

- The government. The government clearly ‘pays’ for all of this NOL transfer activity. In their best case scenario they’ve just lost the time value of money, if you assume that all of these NOLs would have been used anyway. In reality there will also be a real cost to a program such as this because under the current system there are lots of ways companies lose the ability to use their NOL balances (the NOLs run out; the company is purchased by another entity limiting the use of transfered NOLs; companies go out of business before they use their NOL balances; etc.). That said, there will also be some tangible benefits from businesses that stay in business longer and become more successful because they have access to additional investment capital. This will result in higher employment (and employment related taxes) and a more stable business climate (i.e., more profitable companies in a region and the resulting increased corporate tax base). I’m scaring myself because this sounds a lot like trickle down economics, but in this case I think society as a whole benefits. I’m not ready to argue that for government this will be a zero sum game (i.e., I think there will likely be a true hard dollar cost to government revenue if a plan like this were implemented), but I think there are real benefits to business that would ultimately make their way back to government coffers in the form of future business and personal tax revenue.

Clearly there would need to be some limits to a program like this – limits to the total NOLs that a company could buy or sell over a certain period; limits to the total income a company could shelter with purchased NOLs; etc. I did some searching around and found a few state level initiatives that are pushing a program like the one I’m describing (and at least one – in New Jersey of all places – that was already in place, allthough in a limited form). My dad told me that there’s a group working on this idea in Colorado (I couldn’t find any reference to it on-line) and that he’s been talking this idea up on some of his recent trips to Washington. I hope the right people are listening . . .

Let me know what you think.

Comments

[Craig]

Interesting idea. It looks like a few states have these provisions set up to keep capital flowing mainly into the life sciences. The concern I would have is that small businesses would be unable to participate due to unaudited financials representing too high of a risk. Or, the small business might have to endure higher accounting costs to ensure compliance. (All this might be alleviated through risk pooling, though.)

The other worry I would have is that the government, facing really uncertain income, would be forced to rely even more heavily on income taxes, a negative incentive for the marginal work product...or something like that.

[Dad]

The R&D tax credit (just like an NOL) benefits corporations that pay taxes. Startups usually don't for several years. Selling NOLs gives them an infusion of cash just when they need it (if they chose to do so); the R&D tax credit doesn't. The idea of selling NOLs is to limit it to small companies in the first few years of their existence (buyers could be any corporation).

[Dave Jilk]

The reason this sort of thing never flies politically is that it has exactly its intended effect: you have companies that don't pay any taxes even though they have income, because they've bought NOLs. The following year, pro-tax people come out with their list of companies that had profits but paid no taxes and that puts political pressure on for repeal.

Although I don't think it's the government's money in the first place, from a purely input/output point of view you could think of this as the government throwing good money after bad. In other words, companies that have lost a pile of money now have a bit more runway supplied (in effect) by the government. Or, another way to look at it would be as a subsidy for VCs, because in effect every investment would have a "kicker" equal to the value of the NOL benefit of the amount invested (so, for example, if a VC invests $10m, and the company spends all that, they can look forward to an additional $3m in NOL value, so really the company gets $13m for the VC's investment.

How about this for a better proposal: stop double-taxing corporations.