Supply Chain Disruptions, Government Orders, and the Employee Retention Credit
Businesses Impacted by Supply Chain Disruptions Could Qualify for the Employee Retention Credit
With the benefit of hindsight, many taxpayers are now beginning to understand the partial shutdowns that their businesses endured in 2020 and 2021 due to supply chain disruptions associated with government-issued COVID-19 orders. Due to the overlap of multiple orders issued by various governments, it is difficult for an employer to trace which of its supply chain disruptions were associated with government-mandated limitations. The intention of this article is to highlight examples of government orders that businesses have used to establish themselves as Eligible Employers for purposes of the Employee Retention Credit (ERC).
The Employee Retention Credit
The ERC, originally issued under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, later expanded and enhanced, is a payroll tax refund available to Eligible Employers that experienced either:
- A significant decline in gross receipts in any calendar quarter of 2020 or the first three quarters of 2021 (as compared to the same calendar quarters in 2019) (the Gross Receipts Test); or
- A partial shut-down of operations due to a direct impact of COVID-19 orders limiting commerce, travel or group meetings on a more than nominal portion of the trade or business (the Government Order Test).
There are four separately calculated ERCs, which can provide a gross benefit of up to $26,000 per employee over the course of 2020 and first three quarters of 2021:
- 2020: ERC = 50% of Qualifying Wages (the first $10,000 of Employee Wages + Health Plan Costs)
- 2021 Q1: ERC = 70% of Qualifying Wages (the first $10,000 of Employee Wages + Health Plan Costs)
- 2021 Q2: ERC = 70% of Qualifying Wages (the first $10,000 of Employee Wages + Health Plan Costs)
- 2021 Q3: ERC = 70% of Qualifying Wages (the first $10,000 of Employee Wages + Health Plan Costs)
Government Order Test
Many employers have been approached by tax consultants who may indicate that these employers qualify for the Employee Retention Credit (ERC) even if they were essential businesses (i.e., unaffected by COVID-19-specific government orders) because they experienced supply chain disruptions. While this may be true, the identification of general supply chain disruptions is not enough to establish a taxpayer as an Eligible Employer. From the perspective of the IRS, the language from Notice 2020-21 is informative:
Question 12: If a governmental order causes the suppliers to a business to suspend their operations, is the business considered to have a suspension of operations due to a governmental order?
Answer 12: An employer may be considered to have a full or partial suspension of operations due to a governmental order if, under the facts and circumstances, the business’s suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations. If the facts and circumstances indicate that the business’s operations are fully or partially suspended as a result of the inability to obtain critical goods or materials from its suppliers because they were required to suspend operations, then the business would be considered an eligible employer for calendar quarters during which its operations are fully or partially suspended and may be eligible to receive the employee retention credit.
Example: Employer A operates an auto parts manufacturing business. Employer A’s supplier of raw materials is required to fully suspend its operations due to a governmental order. Employer A is unable to procure these raw materials from an alternate supplier. As a consequence of the suspension of Employer A’s supplier, Employer A is not able to perform its operations for a period of time. Under these facts and circumstances, Employer A would be considered an eligible employer during this period because its operations have been suspended due to the governmental order that suspended operations of its supplier.
As evidenced from the above IRS guidance, it is imperative to not only identify a supply chain disruption, but also to document:
- The name of the supplier
- The location of the supplier
- The specific government orders imposing a disruption / partial shut-down on the supplier
- The duration of the supply chain disruption
- Evidence that no other suppliers could fill the Eligible Employer’s needs
- A detailed description of the supply disruption on the Eligible Employer
General Supply Chain Disruption Considerations
To investigate whether supply chain delays can cause a taxpayer to become an Eligible Employer, it is appropriate to investigate government orders issued by both domestic and foreign governmental entities. Below is a summary of the points in a supply chain to investigate for disruptions and some specific examples of disruptions that taxpayers have identified to support the position that they are Eligible Employers for purposes of the ERC. Any or all points in a company’s supply chain may have been impacted by a government issued COVID-19 order, which in turn impacted the company itself by limiting its commerce, travel or group meetings.
- Sourcing Point: A manufacturer produces the goods.
- Storage Point: The goods are stored locally, waiting to be shipped.
- Transfer Point: The goods are loaded onto cargo containers at a dock or similar area.
- Transfer/Storage Point: A dockyard acts as both a transfer point and storage point for shipping, as cargo containers are unloaded from ships, trucks, and trains and must wait for their next shipping vessel.
- Shipping (land): A truck or train delivers the cargo containers to the next point of transfer, which can be other storage points or transfer points, until the goods end up at a shipyard dock.
- Shipping (sea): The goods, loaded on a cargo ship, make the journey to the next port of call, which is not necessarily the destination port.
- Shipping (land): The process continues in reverse as the cargo container is transported via truck and/or rail.
- Destination Point: The goods finally reach their destination, which can be to the end user or to the next point of manufacture.
Specific Supply Chain Disruptions
Following are a few examples of government orders leading to disruptions at points along the supply chain discussed above. Did one of these examples impact your business?
LA Port Congestion: 2020 – 2021
- Starting in January of 2020, the port at Los Angeles and Long Beach started to experience increased wait times and an increased number of ships at anchor. In addition to logistical issues, such as a trucker shortage and the inability to dispense with empty containers, the ports were also subject to local mandates that imposed limitations on employee work and interactions.
- The Los Angeles County Mayor issued a series of executive orders, describing the hazard levels on a color-coded basis and requiring various precautions across all industries, which included warehouse and dock workers. These mandates included social distancing and self-quarantine when COVID-19 symptoms were detected.
- During the first quarter of 2021, the Los Angeles dockworkers suffered an outbreak of COVID-19. More than 700 workers were infected. Regardless of their essential nature, Los Angeles County required infected personnel to remain home and self-quarantine. The outbreaks of COVID-19 in Los Angeles and at other ports, and the mandated self-quarantine periods, had a more than nominal impact on the supply chains of many taxpayers.
- Despite easing these restrictions on June 15, 2021, as Los Angeles County Mayor announced that the county was moving into a yellow designation. Accordingly, COVID-19 related shutdowns and labor shortages continued to delay the flow of goods into and from the Los Angeles port.
- Crew issues, continuing through the year due to a Federal Entry Ban, disrupted the efforts to conduct loading and unloading efficiently. This congestion continued through September 2021.
Asian Port Closures 2021 Q2 & Q3
In the journey from Asia to ports of call in Europe and North America, container ships generally stop at intermediary ports, each of which have additional procedures, protocols and crew requirements due to COVID-19. Ships from India often stop at ports in Southeast Asia and Indonesia. Ships from China often stop at ports in South Korea and Japan. In addition to delays due to local COVID-19 restrictions and protocols, several ports in China and India experienced full closures in the attempt to contain COVID-19 outbreaks. These COVID-19 restrictions and closures are listed below:
- October 23, 2020: On-signers (new crew) were required to take a COVID-19 test 72 hours before departure and another COVID-19 test upon arrival at a Japanese port.
- Crew were required to join the ship with the earliest schedule. Off-signers needed to check a port call list and ensure the ship did not call any foreign ports within 14 days before arrival at a Japanese port.
- December 2, 2020: Due to the rising concerns of the Omicron variant, the Japan government required direct airlines to halt reservations for incoming flights to Japan for one month (until January 2, 2021) amid fears over the Omicron variant. This ban also applied to seafarers flying into Japan and leaving on vessels in the Japan sea port.
- Due to these limitations, most ports would not accept ships whose sole purpose of entering was for crew change purposes.
- February 17, 2021: The Indian Government limited international travel and enforced self-isolation and social distancing due to the increased spread of the Delta variant. This mandate directly impacted cargo supplies as many boat workers needed to be changed to comply with international maritime safety, health and welfare regulations.
- Cargo movement at the Visakhapatnam Port was affected after the local traders’ body announced force majeure in the port area until May 19, 2021.
- The Karaikal Port in southern India invoked force majeure until May 24, 2021, after operations were “severely affected” from the pandemic.
- Starting in May 2020, China faced severe supply chain disruptions and port closures that affected the ability to send supplies overseas. These delays lasted throughout 2020 and were still in effect through October 2021.
- On May 25, 2021, China closed the Yantian Port, one of the country’s largest shipping hubs, until June 24, 2021.
- On August 13, 2021, China closed its port in Shanghai, a major distribution point for manufacturing supplies. The port re-opened on August 24, 2021.
- February 2, 2021: All seagoing vessels were required to submit the Maritime Declaration of Health (MDH) by email to the local Port Health Authority. The MDH needed to be signed 24 hours prior to submission, and it had to be sent at least six hours prior to arrival at Pilot Station.
- Business travelers (including seafarers) had to be in possession of a Note Verbale issued by a Dutch embassy or consulate articulating an exemption from the entry ban for business travelers.
- March 17, 2020: The Italian Government released the “Decreto Rilancio,” which provided for the possibility for Port Authorities to temporarily change the designated use of port areas and quays.
- October 7, 2020: The Italian Government extended the National Healthcare Emergency until January 29, 2021.
- January 14, 2021: The Italian Government extended the State of Emergency until April 30, 2021. The changes affected travel by extending the restrictions on movements within Italy and for individuals coming to Italy.
- Until March 5, 2021: Those who transited through or stayed in in any non-EU countries during the prior 14-day period had to undergo self-isolation and health surveillance for an additional 14 days. In some cases, a negative swab test was necessary and local health-care authorities needed to be informed in advance.
Mexican Manufacturing Shutdowns 2020 Q2 – 2021 Q3
- March 31, 2020 – June 2020: The Mexican government issued the AGREEMENT Establishing Extraordinary Actions to Attend to the Health Emergency. All manufacturing was shutdown unless it was related to healthcare, transportation or maquiladora activities.
- Maquiladoras are U.S.-owned companies that operate across the U.S.-Mexico border in Mexican states. The Maquiladoras could only continue operations during the early part of the pandemic if they followed the same restrictions that healthcare and transportation manufacturers followed. Often the Mexican government stepped in to enforce restrictions or even shut down locations.
- June 2020 through September 2021: Modified orders from the Mexican government implemented the traffic light system. Under this system, each Mexican State received a color-coded designation of red, orange, yellow or green, with specific restrictions placed on businesses in accordance with the color.
- Red and Orange: Manufacturers were required to adhere to safety guidelines including social distancing of at least five feet between workers.
- Green and Yellow: Manufacturers were able to resume work with some health restrictions in place if it was yellow.
Cherry Bekaert is Here to Help You Determine ERC Eligibility Due to Supply Chain Disruptions
The specific government orders highlighted above are not all inclusive. These orders, or others like these, may have impacted your business in 2020 or 2021 creating a partial shutdown of operations. These consequential situations are covered by the Government Order Test for Eligible Employers and required documentation as outlined by Notice 2020-21.
If you have not already claimed the maximum ERC available for each of your qualifying employees in 2020 and 2021, we encourage you to contact our Employee Retention Credit (ERC) team at Cherry Bekaert. Our team can assist you in reviewing your supply chain and researching worldwide COVID-19 government orders to determine the impact of these orders on your business.