US Tax Reform YOUR QUESTIONS ANSWERED

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Irene Crawford
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1 US Tax Reform YOUR QUESTIONS ANSWERED

2 2 The changes to the tax code have driven many corporate entities to reexamine their tax strategies and the associated impacts.

3 Seizing the Tax Reform Opportunity Corporate treasurers are diligently working through the effects of the recently passed sweeping reforms to the US tax code and what it means for their businesses moving forward. The implications are numerous, but so too are the opportunities for cash managers who move adeptly to position their firms to take maximum advantage. The Tax Cuts and Jobs Act 2017 is the most substantial overhaul of the US tax code in more than 30 years. The bill reduces overall tax burdens for corporates while encouraging further investment in the United States. Not surprisingly, the changes to the tax code have driven many corporate entities to reexamine their tax strategies and the associated impacts on the location and utilization of resources for the efficient deployment of capital. In this guide we will discuss the following reforms: 1. Lower Federal Corporate Tax Rates 2. Limits on Interest Deductions 3. Foreign Income 4. How Will Repatriated and Additional Income be Allocated? 5. From Worldwide to Territorial Taxation 6. Moving from Passive to Active Management 7. Working with the Right Partners 3

4 1. Lower Federal Corporate Tax Rates 35% 21% For businesses, the reduction in the federal corporation tax rate from 35% to 21% may position them to generate additional income. Consequently, the reduction in headline rates creates the potential to earmark this income for items that were not previously included in budgets, such as employee pay raises, investments in capital expenditures and research and development. During January and February 2018, public announcements by several companies regarding how they intended to allocate this additional income provided markets with an early perspective on how corporations are beginning to align around the new tax rules. Offshore Tax Liability Payable by Year and Percentage 25% 20% 15% 10% 5% 0% YEAR YEAR YEAR YEAR YEAR YEAR YEAR YEAR Source: Tax Cuts & Jobs Act

5 2. Limits on Interest Deductions As well as presenting opportunities, there are also some obstacles in the new law for US firms to navigate. In order to discourage excessive debt and leverage, the legislation limits corporate tax deductions on interest payments to a maximum of 30% of EBITDA. These limitations will become more restrictive starting in 2022 with interest deductibility capped at 30% of EBIT providing treasurers a compelling reason to take advantage of the changes in the tax code with a sense of urgency. 5

6 3. Foreign Income Another key provision of the legislation taxes overseas earnings accrued since 1987 at 15.5% on earnings held in liquid investments, and at 8% otherwise. For companies, this changes what was once considered a tax asset into a tax liability. The increased tax liability may generally be paid over an eight-year period, without interest, according to the schedule in the chart on page 4. This tax treatment could see billions of dollars in assets being repatriated into the US. In early 2018, a number of US public companies announced such plans, where repatriation has begun by way of the movement of substantial dollar sums that are needed to cover tax liabilities. Other potential uses for these assets include M&A, buybacks, dividends, capital investments and the paying down of debt. All these avenues are certainly the subject of active discussions in board rooms and among shareholders, senior management, business lines and operations functions. TAX ASSET TAX LIABILITY 6

7 This tax treatment could see billions of dollars in assets being repatriated into the US. 7

8 4. How Will Repatriated and Additional Income be Allocated? Market analysts and observers have concluded that the majority of the supplementary income corporates may receive as a result of the new US tax laws will likely be allocated in four main activities: 1. Mergers & Acquisitions 2. Buybacks 3. Increased Dividends 4. Capital Investments 8

9 5. From Worldwide to Territorial Taxation The reformed tax code implements a change from worldwide to territorial taxation. Subsequently, the benefits of accumulating offshore earnings for tax purposes may become non-existent. Moreover, the distribution of earnings back to shareholders or the utilization of earnings for investments in corporate needs would likely become less burdensome under the new tax code. Although the tax liability noted earlier can be covered over a number of years, it s probable that companies may benefit from bringing back cash early on in the tax cycle to take advantage of a potentially rising rates environment and a lower tax rate levied on earnings in the US compared to other jurisdictions. From a macro perspective, it is generally anticipated that, given current inflation and unemployment levels, the Fed may raise rates a further two times in 2018 following its 25 basis point hike on March 21. However, alongside how firms think through their tax strategies from an interest rate perspective, they will likely also need to address the value of associated global legal entity structures, operating models and the related alignment of corporate treasury needs. Companies that have conventionally set up complex global legal entity structures and operating models in pursuit of tax savings may not necessarily need them for this purpose going forward, and in that regard may not see these as being core to business operations. In essence, simplifying these models and repatriating assets may in itself be of immediate value to companies. 9

10 6. Moving from Passive to Active Management The changes to the tax code may serve as an inflection point in how companies align their corporate treasury strategies. An inflow of cash from tax advantages and repatriation presents a unique opportunity for corporate treasurers. While management determines the best uses for assets and return on investments, treasurers need to move away from their historical predilection toward the passive management of assets with a primary focus on risk, to managing these assets actively and being nimble enough to balance a company s investment needs with risks and expectations for yield. For corporate treasurers and cash managers, paramount to operating in this new reality will be the need to have flexibility in managing deposits, short-term liquidity and strategic investments collectively, and in a cogent manner. 10

11 What Tools Will Cash Managers Need? Long-Term Bonds How can I best handle new balances? Money Market Funds Commercial Paper Cash Deposits Foreign Exchange 11

12 7. Working with the Right Partners Collaborating with bank partners especially with highly rated counterparties will be a key requirement. Having the capability to diversify across cash and short-term investments via money market funds and other high-quality securities will enable corporate treasurers to meet their company's current and future liquidity and investment requirements. While the importance of having a variety of cash management options and investment avenues is not necessarily a new concept, the constructs under which these need to be addressed, operating within an entirely new tax code, are new. Cash managers need to act now to position themselves for handling potentially the largest balances they have historically managed for their companies. Amid a broader set of requirements in how and when those balances may be utilized, flexibility, counterparty rating, breadth of investment options and timeliness in redemptions and managing liquidity are all critical considerations. Bank deposits and money market funds could be an ideal foundational choice but treasurers should ensure that they have the requisite banking relationships and necessary approvals to invest in such services. 12

13 The Time is Now In summary, changes to the tax code will have both short-term and lasting impacts not only in how a company addresses its tax strategies, but also in how it aligns any of its tax-driven legal entity structures, operating model and treasury needs. For the treasury function, managing corporate investment needs actively in a faster-paced environment with appropriate liquidity capabilities and aggregated data to drive decisions will be key. To ensure their company s success, cash managers and treasurers need to act quickly and smartly to implement deposit and investment options regardless of which moves their corporate entity will make. The time is now, so let us help you take advantage of this unique opportunity. 13

14 Contact For more information on these issues and BNY Mellon's solutions, please contact: Michael O Loughlin Michael.OLoughlin@bnymellon.com Kevin Ronan kevin.ronan@bnymellon.com 14

15 Cash managers and treasurers need to act quickly and smartly to implement deposit and investment options regardless of which moves their corporate entity will make. 15

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