We are just weeks away from knowing more of the details of the much-vaunted United States tax reform package, a central pillar of the Republican Party’s legislative program for President Trump’s first term in office.
The potential move to territoriality, as currently envisaged by the Trump administration, presents an opportunity for US businesses to return cash, currently offshore, back to the US at a lower tax rate, which in turn could fuel renewed M&A activity.
This, in particular, might be a kicker for activity in the technology and pharmaceutical arenas, both of which have powered global M&A activity in recent years, with many such businesses having significant cash pools offshore. A potential issue for these sectors, however, is the proposed global minimum tax on intangibles income of 15 per cent.
While replenished war chests and eliminating the US tax on repatriated foreign subsidiary income might fuel domestic and outbound US M&A activity, the reforms would mean that some US businesses are made more attractive and ultimately vulnerable to non-US takeover.
A lower effective tax rate reduces the cost of locating income generating assets in the US and, all other things being equal, makes US corporations more attractive for acquirers. A potential loss of interest deductions would likely serve to stymie highly leveraged deals – the takeover weapon of choice for acquisitive private equity and hedge fund groups.
The financial services industry could lose out on the potential benefits of territoriality, given that so many businesses in the sector operate overseas on a branch basis. Meanwhile the retail market in the US will be a major beneficiary of the slashing of the corporate income tax rate to 25 per cent, or less.
For the energy sector, the proposed package is likely to offer up a mixed bag. The sector is likely to be hurt by the limit on interest deductibility, with infrastructure projects highly leveraged. But other aspects would be beneficial, albeit large existing tax losses may mean there is less immediate benefit.
The proposed package could also prompt changes to the way businesses structure acquisitions in the future. Territoriality will be a further nail in the coffin of controversial inversion-led deal making. Bonus depreciation or possibly lifetime expensing for capital assets, including intangibles, could incentivise US buyers to acquire these assets directly, rather than through stock deals. Private equity funds would likely change their structures if carried interests lose their capital gains tax preference, as proposed by some.
Given the plethora of potential changes to the US tax regime likely to be tabled in September, it is easy to understand why standing on the sidelines has become the M&A strategy of choice for some chief executives this summer.
But as execs return from their vacations, the scale and ambition of the programme the Republicans are expected to put forward is becoming clearer, meaning a holding pattern will soon cease to be the appropriate option. Understanding the implications of the likely tax reforms will be a key priority for chief executives considering M&A activity in the weeks, months, and years ahead.