WASHINGTON, DC – The National Venture Capital Association (NVCA) was excited to see continued progress on net operating loss (NOL) reform with passage of the “American Innovation Act of 2018” in the House of Representatives. H.R. 6756 passed by a vote of 260-156. The bill includes a proposal to protect the NOLs of startups by allowing startups to carry forward their losses and R&D tax credits accrued in the company’s first three years without regard to Section 382 of the tax code, which currently can create an unintentional tax penalty for startups.
“We are thrilled to see growing momentum on the critical issue of NOL reform for startups,” said Bobby Franklin, NVCA President and CEO. “Reforming NOLs will allow for more investment into capital-intensive startups, will attract investment into non-coastal communities, and will level the playing field between startups and larger incumbent companies. We appreciate the hard work and leadership of those who championed this issue in the House, especially Chairman Kevin Brady and Rep. Erik Paulsen, and we look forward to continuing to work with policymakers and stakeholders in the Senate so that we can ultimately create an effective NOL safe harbor for startups investing in innovation.”
Startups often accumulate NOLs when using investment capital on 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.
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.