WASHINGTON, DC – The National Venture Capital Association (NVCA) was pleased to see that the “American Innovation Act of 2018” includes a proposal to protect the net operating losses (NOLs) of startups. The proposal would allow startups to carry forward their losses and R&D tax credits accrued in the company’s first three years of existence without regard to Section 382 of the tax code, which currently can create an unintentional tax penalty for startups. Startups often accumulate NOLs when using investment capital to try and build a successful company. These NOLs most often are related to research and development and hiring, activities that public policy separately seeks to encourage. However, the Section 382 rules often do not allow startups to carry forward their NOLs, essentially penalizing startups for investing in innovation since they serve as assets on a company’s balance sheet.
“We are thrilled to see that NOL reform for startups is becoming a higher priority issue in Washington,” said Bobby Franklin, NVCA President and CEO. “We are thankful for the inclusion of this provision and we look forward to working with policymakers and stakeholders to create an effective NOL safe harbor for startups investing in innovation.”
The current NOL rules are a major challenge for capital-intensive U.S. startups and can undermine pro-innovation tax policy such as the R&D credit and the deduction for R&D expenditures. The rules, in Section 382 of the tax code, were written in the mid-1980s with the intent of preventing loss trafficking, or the strategy of companies acquiring failing firms with enormous losses on their books for the sole purpose of using the tax losses to offset other unrelated income. But because growth companies can go through multiple ownership change events such as fundraising rounds, initial public offerings and acquisitions, and they are generally in a loss position while they take investment capital to grow their businesses, Section 382 is frequently triggered by VC-backed companies for doing nothing more than continuing along their growth paths. Further, the rules have their most detrimental impact on companies that are more capital-intensive, thus unwittingly discouraging investment in innovation.
NVCA supports the creation of a safe harbor from Section 382 NOL limitations (and related Section 383 R&D credit limitations) for startups less than 12 years old going through viable fundraising rounds and ownership changes. NVCA’s full safe harbor proposal can be viewed here.