As discussions about corporate tax reform continue to take place on Capitol Hill and in the Treasury Department, the one thing that remains true after many months of talks is that the outcome remains highly uncertain.
Three key questions have emerged about the impact of reform on U.S.-based multinationals — questions that the CFOs of these companies should regularly ask their chief tax officers as scenarios in Washington continue to play out. Staying on top of these issues will help ensure the best possible outcome for the company in the midst of all the uncertainty.
And although corporate chief tax officers shouldn’t be held to unfair standards of clairvoyance, they should be closely watching the direction the winds are blowing and employ flexible models to readily play out various scenarios as those winds shift. The questions are:
1.Will a rate cut come with any unwanted surprises?
Both House Republicans and the Trump administration have proposed a cut to the corporate income tax rate, from its current 35% down to 20% (House GOP) and 15% (White House). Whatever else happens, a rate cut seems to be one area of common ground for all Republican tax reform proposals.
While a rate cut would certainly be welcome news to most taxpayers in the long run, in the short run it could cause some companies to have to write off certain assets on their balance sheets. Most deferred tax assets — tax credits or losses that are being carried forward to reduce taxes in later years — can only be carried forward for a set number of years. A rate cut makes it more likely that assets will expire before they can be used, thus resulting in a potential write-off of any remaining balance. The larger the cut, the more likely a write-off. Thus, any company with deferred U.S. tax assets should be keeping close track of the tax-rate proposals floating about in the reform debate so they can analyze the extent to which the proposal would affect those assets.
A well-resourced tax department should be able to use projections from the company’s financial planning team to develop a flexible model of future credit and loss usage that can be modified to reflect proposed (and probably shifting) rate changes as legislation works its way through Congress. A company may be able to employ certain strategies to mitigate negative effects — and maximize beneficial ones — but only if it’s aware of the impact sufficiently early.
2.How are we optimizing our sourcing of U.S. cash needs?
Another idea common to nearly every serious tax reform proposal floated over the last few years is a “deemed repatriation” provision that would take a snapshot of all overseas earnings of U.S.-headquartered corporate groups and tax them at a reduced rate immediately in the United States. Typically this measure has been floated as a way to transition from the current U.S. worldwide system of taxation to a territorial system in which most profits earned offshore are never taxed in the United States (or are only lightly taxed upon remittance home). It is likely to have staying power in a final reform bill because it’s expected to raise significant revenue that can offset the losses to the U.S. Treasury projected by a rate cut and a new territorial system.
The proposal, while likely to result in large up-front tax bills for many U.S. companies, isn’t entirely a bad thing. It’s potentially helpful in the sense that most versions call for the unremitted earnings to be taxed at a rate much lower than the regular corporate tax rate (or even than a new, reduced rate).
Proposals range from 3.5% (House GOP plan, earnings not held in cash or equivalents) to 10% (suggested by Trump administration). Thus it could be helpful for companies that are currently holding cash offshore to avoid the current U.S. tax hit on repatriation but are rapidly running out of alternative sources for their U.S. cash needs. Some of these companies may have eagerly taken advantage of the one-time repatriation holiday enacted in 2004 as part of the American Jobs Creation Act.
The downside is that, unlike the 2004 provision, none of the proposals for a repatriation charge are voluntary. In 2004, each company could determine for itself whether the rate reduction tipped the scale in favor of repatriating foreign cash. By contrast, in the deemed repatriation proposals, all offshore earnings would become immediately subject to tax, regardless of whether the parent ever wants or needs to remit them to the United States.
The position becomes even stickier for companies that have reinvested their offshore earnings and thus lack the cash to repatriate or even just to pay the U.S. tax bill. (Most proposals would impose the levy over time — 8 to 10 years. But few details are known about how the transition would work.)
During this time of uncertainty, CFOs should make sure that their corporate tax departments are staying aligned and sharing information on the current state of reform proposals with their colleagues in the corporate treasury department. Together they thus can determine the best and most agile plan for their long-term and short-term cash needs.
For example, if U.S. cash uses are outpacing U.S. cash sources, it may be better to fill gaps during this period of uncertainty by issuing debt, rather than by repatriating low-taxed offshore earnings. That said, House Republicans have proposed to eliminate the deduction for net interest expense. Without knowing more about a transition rule, there’s risk that the interest on that debt may one day be nondeductible.
Similarly, the fate of foreign tax credits in this brave new world is also uncertain. So companies holding pools of offshore earnings that have already been highly taxed in their source countries — such that little residual tax will be owed in the U.S. on repatriation —might want to consider paying dividends out of such pools to take advantage of those credits.
3.How should we be thinking about the timing of large capex investments? How about supply contracts?
House Republicans have proposed a measure that would allow businesses to eschew complex tax depreciation schedules and simply write off all business expenses immediately. A move to immediate expensing would represent a vast departure from current law (and a costly one for the U.S. Treasury).
It would remove the disincentive against large capital investments that many argue is inherent in the current system, which generally requires companies to recover those types of costs over a long time.Companies that enjoy some flexibility in planning for large capex projects may want to hold off for a while to see how this one plays out. While no legislative language has been floated yet, it’s possible that a transition rule could limit the measure’s price tag by rendering it inapplicable to costs incurred on projects that went under contract prior to enactment.
Supply contracts potentially implicate a different proposal, the so-called border adjustment tax, or “BAT,” a controversial measure that found its way into the House Republicans’ tax plan. The plan, which would exempt from tax income from exported property and deny deductions for imported property sold in the United States, was immediately met with vehement opposition from industries that rely on imports, such as mass-market retail and automotive.
A lack of strong support from the Trump administration seems to have sounded the death knell for the BAT, and most observers consider it to be on its last legs. Thus, any planning for the sole purpose of optimizing a company’s position vis-à-vis the BAT probably isn’t time well spent. But a wise chief tax officer will continue to watch this space, as the BAT still enjoys the support of some powerful House Republicans who may have another go at the idea with BAT version 2.0.
Heléna M. Klumpp is a partner in the Washington office of Ivins, Phillips & Barker,