Many companies may seek to alter their business structures by divesting certain business units or expanding through acquisitions. For example, businesses will need to reassess their optimal level of debt (pdf) in light of US tax reform. The restriction on the amount of tax deductions for interest expense on debt, combined with a lower tax effect with the decline in the corporate US tax rate will make high leverage levels less appealing going forward. An EY report, Making capital allocation decisions in light of US tax reform, predicts the amount of debt held by public companies could decline by up to 25%.
Businesses will also have to adjust the way they evaluate potential acquisition targets (pdf) as the tax rate cuts will affect income, cash flow and the discount rate. The benefits stemming from these rate cuts will differ from business to business and sector to sector.
“Companies should aim to deploy their capital in a way that creates sustainable value across the business,” says Torsdon Poon, EY Americas Transaction Tax Leader. “Those who simply increase spending across the board could be left with value-destructive projects.”
Poon notes that businesses may face conflicting spending agendas as shareholders push for dividend increases and share buybacks, while leadership pursues plans to expand the business through capex investments or acquisitions. The key here is communication, he says.
“Companies need to demonstrate to shareholders that they have examined all the tax-related nuances and that their decision will deliver value creation in the end,” says Poon.
Companies should aim to deploy their capital in a way that creates sustainable value across the business. Those who simply increase spending across the board could be left with value-destructive projects.
Down to the details
The new US tax law ushers in numerous changes (pdf) that will affect financial reporting — each with its own effective date, transition and phase-in rules. Companies should not underestimate the complexity of this task. Businesses and their advisors will need to implement these modifications and technical details (pdf) in an environment where many points remain unclear.
Additional guidance from the Internal Revenue Service (IRS), the US tax administration, should help provide clarity, both in terms of preparing financial statements and understanding the broader tax implications that will affect the business in the future.
“The company’s finance, treasury and tax departments need to work together to execute a plan that responds to the different items,” says Frank Mahoney, EY Americas Vice Chair – Assurance. “This could include the new corporate tax rate, the one-time transition tax, a write-off of certain assets, or any adjustments to existing tax attributes or internal controls that may be necessary.”
For example, businesses may need more time to evaluate the new tax law’s provisions and account for these effects. If a business has not yet finished this analysis, it should make robust disclosures about where its accounting is not yet complete and therefore subject to change.
The tax law, for instance, contains new provisions targeting both US- and foreign-based multinational enterprises. These provisions create a new minimum tax on global intangible low-taxed income (GILTI) and a new base erosion anti-abuse tax (BEAT) through which certain payments made by a US company to a foreign-related business will be subject to an alternative tax computation.
Businesses subject to the new GILTI and BEAT provisions will need to evaluate how they may affect a company’s future tax obligations, effective tax rates and financial reporting.
For public companies, the law places new limits on deductions for compensation paid to certain covered employees. The tax law increases the number of employees’ subject to these provisions and eliminates the exemption for performance-based compensation. Businesses will need to pay close attention to these provisions to understand whether existing compensation plans can be grandfathered under the new law or if they need to be reevaluated.
There are also critical issues to address regarding the financial statement implications of the one-time repatriation tax. The complexities of understanding the amount subject to tax and the application of different tax rates will require additional effort and analysis.
Prepare for more change ahead
The US won’t be the last jurisdiction to cut corporate tax rates; the trend toward lower corporate income tax rates and a broader tax base will continue in 2018, according to EY’s Global tax policy outlook for 2018. Tax reform in another large economy could again be a game changer, forcing businesses once again to rethink their strategy.
But it will be important to look beyond a jurisdiction’s headline tax rate. As competition for investment and job creation continues, businesses will have to continuously evaluate tax as part of the overall landscape for business decisions. This includes understanding and managing an increasingly contradictory world of tax.
On one hand, many jurisdictions are competing for investment by reducing corporate income tax rates and revamping incentives to attract businesses and grow the economy. At the same time, we are seeing tax administrations increasing resources to drive up tax collections through digitalization and transparency initiatives while proposing sweeping changes to the taxation of the digital economy.
The world of tax and the impact of tax reform is about much more than taxes. Make sure you understand what it means for your business as a whole.
Summary
Tax reform in the US is forcing businesses once again to rethink their tax strategy, and re-evaluate tax as part of the overall landscape for business decisions.