The dust is settling on December's tax reform bill - the most sweeping overhaul of the US tax system in more than three decades - and the market has now had some time to analyse its implications.
On the surface, it seems slashing corporate tax from 35% to 21%,
as well as installing lower taxes on overseas profits, would be a
boon for businesses operating in the US. Indeed, this falls
directly in line with the "America first" attitude we
have seen from the current administration.
However, as always, things are not that straightforward. There are
three main topics of discussion we are hearing in the industry
right now, both from clients and from our partners in the advisory
space: the simplification of the tax code and the reduction in the
federal base rate; repatriation of foreign-held earnings; and the
move to a territorial system of taxation. Let's look at these
in turn and explore the way they will affect US companies.
Less tax does not equal higher gross earnings
The US tax code has been very complicated for a long time, so
the reduction in the base tax rate is not necessarily as
straightforward as people think. For many years companies have been
able to take advantage of various deductions to compensate for the
35% corporate tax rate, and the simplification of the tax code
means that many of these will disappear. Therefore, it is not
correct to say simply that taxes are less; there are some firms
that will end up paying a lot less, and there are some firms that
also now have to disentangle themselves from various historical
deductions, and who may find that the overall effect is a lot less
positive.
So, as ever, there are winners and losers, with many companies now
paying "extra" wages, gratifications, and so on, while
others indicate they will need to write down on NOLs and
carry-forwards. A lot of firms are getting tax advice and trying to
work out where they stand, how best to position themselves for a
potential upside, and what to do with those tax windfalls if indeed
realised. They want to know where any potential savings are best
spent - is it to invest in R&D? Is it to invest in
international expansion? They really need to make sure the lasting
benefit of the short-term impacts is felt.
Bringing money back onshore might not bring the windfall you expect
The capital markets in the US continue to be bullish. The Dow
did have a couple of rough days earlier this year, but that was
mostly down to inflationary expectations and the likelihood of
higher interest rates. Some even now say it was driven by
robotisation of trading platforms - algorithms making odd decisions
and overheating of the system - but whatever the reason for that
slip, it was temporary and markets rallied.
Our partners and clients in structured finance, private equity and
real estate maintain the positive outlook they had held in
anticipation of this tax reform. We have not yet seen a roll-back
of some of the regulations around Sarbanes Oxley and Dodd-Frank,
which the market was also hoping for, but the financial markets
feel they are in a business-friendly environment and are expecting
there to be a lot of transactions over the next 12 months.
The likelihood is that many companies are going to take advantage
of the tax break to bring foreign-held earnings back into the US.
But beware the "toll charge": for the US to transition
from a worldwide tax system to a territorial one - meaning that US
companies are taxed only on US earnings - they're imposing a
one-time mandatory repatriation tax imposed at a rate of 15.5% for
earnings held in cash and cash equivalents, and 8% for non-cash
earnings. The goal of this transition tax is to flush out all
historic or deferred earnings and subject them to tax, allowing the
new system to start fresh with earnings generated after the
transition.
Post-transition, foreign-source dividends (that are not subpart F)
should be eligible for a 100% dividends-received-deduction. This
effectively makes a zero rate of tax in the US on repatriated
foreign earnings, post-transition, so long as it doesn't fall
into any anti-deferral rules (such as Subpart F or GILTI).
Repatriating earnings means companies will have many more
investment options, even though they're still likely to pay
more tax on repatriated money than the tax they're paying today
on their offshore holdings. As the most active market in the world,
there is great opportunity in the US for firms to broaden their
investment strategies and optimise returns on their capital.
Venture capital firms on the West Coast are expecting fundraising
to be easier, and we are seeing a lot of interest in alternative
investments as people explore for options for once the money has
been brought home.
It's worth noting, too, that bringing these reserves back to US
soil may also lead to restructuring or refinancing efforts.
Alternatively, companies may decide to pass the benefit to
different groups of stakeholders, including creditors, investors
and staff. It is thought this will stimulate corporate investments
or create higher consumption – that is, it will bring renewed
confidence, leading to economic growth that should in turn result
in higher tax receipts. The hope is that these effects will offset
the net reduction in the flat rate and result in the scheme paying
for itself, but only time will tell.
When it comes to corporate structuring, the rules have changed
Of course, as the US moves into a territorial system of taxation
and as the tax rate lowers, many firms are restructuring or looking
into how to restructure their operations. The tax advisors we work
with are doing a lot of that at the moment, and we are seeing
companies coming out the back end feeling dizzy. They have been
given a lot of advice, but don't really know what to do
next.
A specific clause that will make a large impact is the limitation
on US interest deductibility and the impact this will have on US
acquisitions – this means that it will be more difficult to
thinly capitalise domestic purchases. It seems this will drive an
increase in foreign M&A – that is, US firms purchasing
internationally in order to access easier financing. This is a
continuation of a recent trend, whereby US firms look abroad to
broaden their operations, expand into new markets and find the best
strategic opportunities.
We expect to see a lot of existing structures dissolved and then
new holdings set up, as businesses reorganise themselves to
optimise the recognition of revenue, and profits meet the demands
imposed by the new US and international tax frameworks. Certainly,
that is what we have seen over the first two months of 2018, and
expect to more of as the changes really take hold.
Of course, it may not only be the corporate, tax and financial
structures that need to be reviewed – the IP structure should
also be considered, and it is advisable for companies to review
their governance and value chain. It's not just the new US tax
plan that will affect US companies, as the global environment
induced by BEPS will also make an impact.
Changes are coming from all sides while exchange of information is
increasing. Tax revenues tend to be looking at enforcement and
dispute tax positions much more as they try to get the biggest
share of a company's tax pie. This requires secure, consistent
and coherent documentation, decision-making and reporting. The
choice, then, is to ramp up internal support departments, or to
look to professionals offering economies of scale, best practices
and continuity.
These changes in the US mean you must look differently at foreign
taxes. There is a lot of change and a lot of concepts that require
redefinition. Companies need to create flexibility and agility in
order to be able to respond to these changes, and also respond to
the evolution of the underlying concepts that are there. Every
guidance note issued by the OECD, or the UK, US or EU tax
authorities, and so on, could affect a company, so they need to
stay on their toes. It is almost like corporate kung fu: you must
be super agile, you need to be able to both defend and attack
aggressively in order to keep standing on your feet.
We all need to learn to play a new game
Businesses operating in the US are trying to understand how the
lower base rate is going to affect them, what deductions have been
taken away and what they can do with the money that they are
hopefully going to have left over. Once you have advice from the
architect - from the tax advisor - you need to find someone to do
the building. We all know that if you don't disentangle
yourself properly, then five to 10 years down the line you could
suddenly find there is a tax exposure or even a legal exposure that
you thought you had disengaged from but is actually still looming
over your head.
With this tax reform and code simplification, the US government has
effectively changed the rules and regulations around building codes
and specifications - so companies that used to have structures in
A, B or C location need to change to X, Y and Z. Companies who had
bridged in a certain way to be thinly capitalised now need to
re-evaluate those loans. All of this results in a plan, a
blueprint, and each of the companies we speak to are trying to
understand how to take that blueprint and create the reality, to
reconstruct their house. What these companies must then decide is
who their builder will be.
If everything is held domestically, those companies are usually
well serviced by local or even internal legal and financial teams.
However, companies with even a slight level of foreign exposure
will need to consider builders with international credentials to
ensure everything remains compliant with issues such as BEPS, BEAT
and GILTI. It means they'll get a much simpler, much broader
view of how to deliver that design which the tax advisors have put
forward.
To hear how TMF Group can help build your restructuring blueprint, get in touch with our US-based experts.
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