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As an experienced tax professional, the passing of the Tax Cuts and Jobs Act (“the Act”) into law on 22 December 2017, from an early November launch, was quite remarkable. Particularly taking account of the fact the Act revamped large elements of the existing US tax code.

It also resulted in many new tax acronyms to get to grips with e.g. FDII, BEAT, GILTI, the latter being somewhat appropriate given its potential penal nature.

Given how fundamental the changes were they quite rightly received a lot of press.  So much in fact, that colleagues outside of the tax team were taking a real interest!  The headline grabber was the reduction in the standard rate of Federal Income tax from 35% to 21%, placing the US rate on a par with the UK, lower than countries such as Germany and Japan but still higher than Ireland and Singapore.  The immediate reaction was that this can only be good news for portfolio assets which have a US interest. In addition, we were also thinking about the impact on valuations and M&A activity.

Bitter Sweet

The detail of changes is outside the scope of this Article however, below are some of the key changes and an assessment of their potential effect. The headline rate reduction is only one of several changes introduced to boost US competitiveness.  Other key changes include:

  • Immediate expensing of capital expenditure on property (other than real estate);
  • Retention of tax relief for research and development;
  • Indefinite carry forward of losses, however offset restricted to 80% of future profits;
  • Exemption for overseas dividends where you hold a minimum 10% shareholding;
  • A preferential tax rate for foreign derived intangible income (”FDII”) – essentially an export credit for US based companies [1] 

 This all sounds too good to be true.  To protect US fiscal interests there are some less welcoming changes:

  • Tax deductibility of interest on debt (third party and related) restricted to 30% of tax adjusted EBITDA;
  • One time deemed mandatory repatriation of profits of overseas subsidiaries (taxed at 15.5% or 8%).  Broadly applies to a US company’s proportionate share of net accumulated profits arising post 1986 to their tax year ending in 2017;
  • Potential tax liability on payments made by a US corporation to a related foreign person, known as the base erosion and anti-abuse tax (“BEAT”);
  • US tax obligation in relation to certain deemed foreign profits, arising where an overseas group company earns more than a 10% rate of return on their assets ‘GILTI’ – it is bad news, say no more!

Making Sense of it All

On balance, these changes appear to be good news for US domestic corporations, that are asset intensive and have low financial leverage e.g. heavy investment in US manufacturing facilities, IP held and developed in the US.

However for multinational groups, with a high financially leveraged US presence, significant related party cross-border activity and IP residing outside of the US, the changes will not be so appealing.

For the latter entities, they will no doubt be modelling the impact of US tax reform on their US and global effective tax rates.  Based on the analysis it could result in such groups looking to change their operating model to repatriate or shift activities to the US to take the benefit of the reduced Federal rate, immediate expensing of capital expenditure and export credit in the form of FDII.   Supply chain decisions are more likely to be focused on factors such as cost, labour skills, regulatory environment rather than tax being a material factor in future decisions. This is because the ‘tax cost’ of locating or maintaining an activity in a low tax offshore territory, taking into account the new GILTI and BEAT provisions, may now be comparable with undertaking similar activities in the US given the tax benefits referred to above.

What about Private Equity?

Private equity investors will need to re-assess how they finance US businesses.  The proposed reduction in tax relief for interest costs on debt could have a significant impact on valuations if there is limited EBITDA capacity in US based companies to absorb the interest cost.  Decisions will need to be taken whether to finance future investments with less debt and more equity, which could dilute returns, or alternatively we may see the introduction of more preferred equity structures.

The mandatory repatriation of overseas profits will result in an injection of cash for US based companies, which should increase liquidity for investment in capital assets or to finance acquisitions.   This additional liquidity could offer an advantage over buyers with a higher dependency on leverage to drive returns.

The headline reduction in the tax rate could have two further potential consequences that could well stimulate M&A activity:

  1. Divestments of non-core US assets that were previously prohibitive given the expected US tax cost, may now be viable;
  2. Targets with non-core US assets may become more attractive, on the basis that it will now be more tax efficient to on-sell these assets at a future point in time.

The restriction on the carry forward of losses is penal and could impact investment in turnaround businesses.  If a target business has just moved into losses, will you be able to secure value for these losses on a sale?  Previously you could carry back losses to a pre-completion period, but this is no longer an option.  Secondly, losses can only be offset against 80% of future profits, not 100%.  Both points will impact valuations and negotiations.

What is clear is that the changes are fundamental and anyone with US interests needs to carefully assess the impact of the changes and to decide whether they will present an additional opportunity or a cost, to their investment. 

It may be time to drop by your Tax Director’s office or meet with your external advisors for a catch-up.



[1]This change introduces a reduced rate of tax (13.125% increasing to 16.406%) on income, which applies when net export sales, services, rental and royalty income exceed a routine return (10%) on certain US based depreciable property.

For media enquiries please contact Tom Sutton, Head of Communications, Clyde Blowers Capital, / 07471228494 

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