Tax Reform Consensus: Lower Rates, Closed ‘Loopholes’

In the game of tax reform, one CFO’s “loophole” is another finance chief’s essential tax credit.
David KatzFebruary 4, 2015

With the Republicans in control of both the Senate and the House and Democrats and the Obama Administration willing to deal for breaks aimed at the middle class, tax reform has become hot again. And the consensus on corporate reform has been that it should be the product of a Grand Bargain: a big, across-the-board corporate tax cut paid for by the elimination of tax breaks for certain industries and kinds of business.

Joyce Ferris, CFO, Nextility

Joyce Ferris, CFO, Nextility

And though it may throw a monkey wrench into current budget negotiations, President Obama’s plan to finance fixing the nation’s roads and bridges with a 14% one-time tax on foreign-based corporate income deferred overseas doesn’t seem likely to affect the tax-cut-loophole consensus.

For one thing, some observers reportedly consider the proposal to be merely an opening gambit in negotiations involving tax reform for U.S. multinationals — a proposal that might disappear in the course of political bargaining. For another, in some quarters the Grand Bargain represents the bedrock of a comprehensive plan to remake the entire U.S. tax system, a reform effort partly aimed at eliminating the incentive to park money overseas to avoid taxes.

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If corporate federal taxes are cut from their current top marginal rate of 35% to, say, 25%, U.S. multinationals would be more motivated to invest their foreign earnings here, the reasoning goes.

But there’s a catch to corporate-tax cutting. “We live in a deficit-constrained environment. We’re just not going to see Congress cut the corporate rate and watch revenue decline as a result. It’s not possible,” says Jon Traub, managing principal of Deloitte’s national tax group in Washington.

Indeed there’s general agreement in Congress that corporate taxes can be cut only in a “revenue neutral” way — that is, by getting an equal amount of revenue from elsewhere in the tax system. “And the way to do that is to pull out — pick your euphemism — ‘loopholes,’ ‘base broadeners,’ ‘preference items’” from the tax code, says John Gimigliano, head of the tax legislative group at KPMG.

The problem then becomes: which deductions or tax credits should be reduced? And by no means is there any consensus on that. “This isn’t Lake Woebegon, where everybody’s above average. There has to be some winners. If you’re a relatively plain-vanilla company with not that many special deductions, you’ll do well with a rate reduction. If you’re a company that depends on deductions,” says Traub, “you may do better with the loopholes.”

Rate Reduction or Loophole?

Dell might be an example of the former kind of firm. Tom Sweet, CFO of the computer-technology giant, would take the elimination of various loopholes in exchange for a 25% top marginal rate. To be sure, the company takes advantage of the federal R&D tax credit, “which I think helps promote appropriate research and development. And whether you would consider that a loophole would be subject to interpretation by whomever you talk to,” he says.

“Other than that, we’re plain vanilla in terms of the tax implications and tax regimes for our business,” he adds.

In sharp contrast to Dell is Nextility, a five-year-old energy technology firm. “Reducing the corporate tax [would have] a negative impact on us” because the value the company derives from the 30% federal tax credit for solar-energy projects would drop proportionately, says Joyce Ferris, the firm’s CFO.

To construct the solar-energy rooftop systems, the firm amasses investors who finance the projects and are the taxpayers on the gains of the investment. “We have to find investors that can use the tax credit as part of the return on their investment in order for the numbers to work,” she says.

But an across-the-board tax cut could change all that. If tax reform is enacted and the investors’ tax rate decreases, the 30% credit would be calculated on the basis of a lower tax bill. Thus the ROI Nextility could offer investors would be slashed relative to electric utilities and other energy producers that don’t have the benefit of the solar tax credit.

That means that Nextility would have to charge its customers more for installing the systems in order to keep the ROI for investors competitive, Ferris noted.

“A 30% tax credit for our business is obviously really meaningful,” the finance chief says. “The interesting thing is that everybody’s got a different definition of a loophole, depending on whom it impacts.”