The following updates our November 2, 2018 posting (read the post) regarding the use of the Opportunity Zone (OZ) provisions to invest in startup tech companies. While obstacles remain for now, there have been additional submissions that will result in some IRS/Treasury response on this topic.
The government shutdown has prevented further IRS OZ guidance from being issued, but activity should pick up again now that the government is open. The scheduled January 10 hearing on the October proposed regulations was postponed until at least two weeks after a new hearing notice is issued and a second round of IRS guidance has been delayed from the initial expected December issue date.
Since my November 2, 2018 submission to the IRS (read the submission) regarding obstacles preventing the use of OZ provisions to invest in the operations of startup tech companies, additional submissions and discussions have requested that OZ investments be expanded to better serve startup tech companies. The following summarizes the additional submissions and comments on the main points presented in my November 2 submission on this topic. The remaining points raised in the earlier submission should be resolved once these main points are addressed.
1. Organizations and bar associations repeated the comments stated in the November 2 comment letter, particularly with having the 31-month working capital safe harbor allow for cash investments to be used towards startup tech businesses’ operations, in addition to tangible property development. Note, however, a portion of the dollars must be used towards the purchase or development of tangible property in all events to meet the Opportunity Zone requirements. The necessary portion to be used toward new or substantially improving tangible property is determined based on the level of existing tangible property used by the existing entity. The approach requested is that once the purchase and development of tangible property requirements are met, the remaining cash balance (which could be substantial) can be retained and used toward operations (e.g., payment of license fees and compensation) within the same 31-month safe harbor working capital period.
We have not heard or seen any government feedback on this point, but it has received a lot of attention.
2. Members of Congress have advocated that it should not be required that revenue come primarily from sources within the Opportunity Zones and that the proposed regulations should be revised to clarify this point. The following is the favorable feedback we’ve seen on this point:
a. Following a meeting between Sen. Rob Portman (R‑Ohio) and Treasury representatives, Portman stated that the proposed regulations will be clarified to permit more than 50 percent of the revenue to come from revenue sources outside the OZ community. A December 14, 2018 Tax Notes Today news story quotes Sen. Portman:
“I’m glad they are clarifying that, because that requirement would keep a lot of investment from happening in Opportunity Zones.” For example, Portman said, a corporate headquarters moving to an Opportunity Zone might have businesses all over the United States or abroad and would find it restrictive to have 50 percent of its sales within the Opportunity Zone.
“If somebody wants to put a big business in an Opportunity Zone, they can do all of their sales there or they can do a small part, as long as they’re making the investment there,” Portman explained.
b. At a January 24, 2019, United States Conference of Mayors’ meeting, Treasury Secretary Steven Mnuchin is reported to have acknowledged that this point is being reviewed. Mnuchin said Treasury is “reviewing appropriate safe harbor rules for meeting the test based on where services are performed and where the tangible property is located to create additional opportunities.”
This point was also raised in a December 20, 2018 comment letter submitted to the IRS by the United States Conference of Mayors. (Read the mayors’ comment letter.)
c. A recent letter submitted by 16 members of Congress to Treasury Secretary Mnuchin requests that the proposed regulations be revised to remove the requirement that a specified portion of income be derived from the active conduct of the business “in the opportunity zone location.” (Read the comment letter from members of Congress.)
These requested revisions also apply to the requirement that a substantial portion of the intangible property of an opportunity zone business is used in the active conduct of a trade or business “in the qualified opportunity zone.”
3. An additional point raised in our December 28, 2018 and January 2, 2019 QOZ Alerts is the Joint Committee on Taxation statement of possible additional reporting and processing that a Qualified Opportunity Fund (QOF) might need to undertake. The recent letter submitted by 16 members of Congress to Treasury Secretary Mnuchin urges Treasury to implement “reasonable reporting requirements, including of Fund- and transaction-level information, in order to prevent against waste, fraud, and abuse, and to ensure that the incentive is delivering impact for communities (emphasis added).” (Read the comment letter from members of Congress.) This possible requirement for future reporting by the QOF would apply in all situations and not be limited to investments in startup tech companies through a QOF.
Absent another shutdown, additional guidance could be available in the next few months.