Tax Credits

Employee Retention Credit Supply Chain Disruption (2023)

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Disruptions in the supply chain can pose significant challenges and have far-reaching consequences for businesses. As experienced during the COVID-19 pandemic, businesses must find effective solutions to maintain operations, minimize financial losses, and retain their skilled workforce. One such solution is the Employee Retention Credit, which offers welcome support for businesses facing supply chain disruptions.

The purpose of this article is to illustrate examples of government orders, which resulted in supply chain disruptions, that businesses have successfully used for claiming the Employee Retention Credit (ERC).

Supply Chain Disruptions during the COVID-19 Pandemic

The COVID-19 pandemic, which emerged in late 2019, has had a profound impact on global supply chains. Governments implemented lockdowns, travel restrictions, and social distancing measures to contain the spread of the virus, resulting in significant disruptions to global trade and supply chains.

Taxpayers are gaining a better understanding of the partial shutdowns their businesses endured during 2020 and 2021 as a result of supply chain disruptions linked to COVID-19 restrictions imposed by governments. However, due to the complex nature of multiple overlapping orders issued by different governing bodies, employers face challenges in identifying specific supply chain disruptions directly related to government-mandated limitations.

Causes of Disruptions

1. Factory closures and reduced production: Many factories and manufacturing facilities were forced to shut down or operate at reduced capacity due to government restrictions and labor shortages. This led to delays in production and reduced supply of goods.

2. Transportation constraints: Travel restrictions, reduced airline capacity, and disruptions in freight transportation networks made it difficult to move goods across borders. Ports, airports, and logistics hubs experienced delays and congestion.

3. Raw material shortages: Disruptions in the global supply of raw materials, components, and intermediate goods affected the production capabilities of industries reliant on these inputs.

4. Shifts in consumer demand: The pandemic caused significant shifts in consumer behavior and demand patterns. Some industries, such as healthcare and essential goods, experienced a surge in demand, while others, such as tourism and hospitality, faced a drastic decline.

Examples of Supply Chain Disruptions during the Pandemic

1. Personal protective equipment (PPE): The global demand for PPE, including masks, gloves, and medical gowns, surged during the pandemic. However, supply chain disruptions hindered the production, distribution, and availability of these essential items, causing shortages in healthcare settings.

2. Retail and e-commerce: With increased online shopping during lockdowns, retailers and e-commerce businesses faced supply chain challenges. Delays in sourcing products, shipping, and last-mile logistics impacted inventory management and customer satisfaction.

3. Automotive industry: Automakers faced significant disruptions due to factory closures and shortages of critical components. Reduced consumer demand and challenges in the availability of semiconductor chips disrupted the production and delivery of vehicles.

The Employee Retention Credit: An Overview

The Employee Retention Credit is a tax incentive introduced by the U.S. government to provide financial relief to eligible businesses that faced significant disruptions due to the COVID-19 pandemic. The credit was created as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020 and has since been expanded and extended by subsequent legislation (see ERTC Reinstatement Act).

The Employee Retention Credit has specific provisions that make it relevant for businesses facing supply chain disruptions:

1. Partial or full suspension of operations: Eligible businesses can claim the credit if they experienced a partial or full suspension of operations due to government orders or significant disruptions in their supply chain. This provision recognizes the impact of supply chain disruptions on a business’s ability to operate effectively.

2. Significant decline in gross receipts: Businesses can also claim the credit if they experienced a significant decline in gross receipts compared to a previous period. This provision acknowledges the financial strain businesses face when demand and revenue are affected by supply chain disruptions.

To qualify, businesses need to meet specific eligibility criteria, including:

1. Size of the business: The credit is available to businesses of all sizes, including tax-exempt organizations and governmental entities, but with certain limitations for larger businesses.

2. Impact of the pandemic: Businesses must demonstrate that they experienced either a suspension of operations due to government orders or a significant decline in gross receipts.

3. Retention of employees: Eligible businesses must retain employees and continue to pay wages during the period covered by the credit.

The ERC provides a valuable opportunity for businesses to alleviate the financial burden of supply chain disruptions. By taking advantage of this credit, businesses can offset a portion of their employment costs, retain their skilled workforce, and improve their overall financial resilience.

Government Orders & Supply Chain Disruption Considerations

Tax consultants have approached employers to suggest that they may be eligible for the Employee Retention Credit even if they were classified as essential businesses and were unaffected by COVID-19-related government orders. However, it is important to note that the mere identification of general supply chain disruptions is insufficient to establish a taxpayer as an Eligible Employer. The IRS provides valuable insights on this matter, as highlighted in Notice 2020-21.

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 such, it’s important to document the following details of any supply chain disruption the business endured:

  1. The supplier’s name
  2. The supplier’s location
  3. The specific government orders that affected the supplier
  4. The duration of the disruption
  5. Evidence that no other supplier could fill the business’s needs
  6. A detailed description of the supply disruption on the business

It’s also necessary to investigate both domestic and foreign government orders. Eligible employers should look into all points in the supply chain to identify those that might have been impacted by COVID-19 orders, such as the following:

  1. Sourcing point
  2. Storage point
  3. Transfer point
  4. Shipping (via land and sea)
  5. Destination point

Examples of Disruptions from Government Orders

Here are some government orders that resulted in supply chain disruptions during the pandemic:

LA Port Orders

In the first quarter of 2021, an outbreak of COVID-19 among dockworkers in Los Angeles had a significant impact on supply chains. Over 700 workers were infected, leading Los Angeles County to enforce a requirement for infected personnel to stay at home and undergo self-quarantine. This measure was implemented despite the essential nature of the work performed by these individuals. The COVID-19 outbreaks and the subsequent mandated self-quarantine periods had a nominal impact on the supply chains of numerous taxpayers, both in Los Angeles and at other ports.

COVID related shortages and shutdowns delayed the flow of goods through the LA port through the rest of the year despite the county mayor easing restrictions in June. Crewing issues in particular impacted efficient loading and unloading during this time.

Mexico Orders

The government of Mexico shut down all manufacturing from March to June 2020 unless it was related to healthcare, transportation or owned by US companies, which also had to follow similar restrictions. There were cases in which restrictions had to be enforced and some locations were even shut down. From June to September that year, the government implemented color coded designations (green, yellow, orange, red) that denoted the level of safety guidelines that manufacturers had to adhere to, such as social distancing and PPE use.

China Orders

In efforts to contain the COVID-19 outbreak, China suffered significant disruptions and port closures during much of 2020 and 2021, which affected overseas supply chains. Several large ports, such as the Yantian Port and Shanghai Port, which are among the country’s major distribution centers and shipping hubs, experienced total closures for several weeks, impacting movement of goods around the world.

India Orders

In early 2021, the government of India enforced social distancing and self-quarantine to contain the spread of the COVID-19 Delta variant. International travel was also limited, and cargo movement was slowed down as workers had to comply with numerous health and safety regulations. Visakhapatnam Port and Karaikal Port had to invoke force majeure during May 2021 as their operations were severely impacted by the pandemic and the international maritime orders sent to contain it.

Japan Orders

In the fourth quarter of 2020, Japan required new crew to take COVID-19 tests at least 72 hours before departure and upon arrival at Japanese ports. Workers were required to board ships at the earliest schedule and had to make sure that their ships did not call any foreign ports within 14 days of arriving at a port in the country. As such, many ports denied entry to ships that were entering solely for crew changes. Later that year, incoming airline flights were halted due to the spread of the Omicron variant. Seafarers flying in to the country and leaving their vessels in Japanese ports were also ordered to stop.

Verdict

Throughout the COVID-19 pandemic, businesses in various industries have faced unprecedented challenges. The examples of supply chain disruptions, such as the outbreak among Los Angeles dockworkers, demonstrate the far-reaching impact of these disruptions and the importance of addressing them effectively.

The Employee Retention Credit provides businesses with an opportunity to alleviate the financial burden of supply chain disruptions and retain their valuable workforce. By leveraging this credit, businesses can stabilize their operations, preserve jobs, and strengthen their resilience in the face of future disruptions.

It’s highly recommended to contact ERC experts if you have yet to claim maximum benefits for qualifying employees in 2020 and 2021.