Mergers and acquisitions announced in the first two months of 2018 are at the highest dollar volume since the first two months of 2000. However, certain provisions of the Act may impact transactions.
- Selling assets may become less costly
Prior to the Act, the tax cost for a corporation to sell a business or business assets was 35 percent of the gain recognized (plus any state and local taxes). Therefore, many corporations preferred tax-free transactions, such as spin-offs, to achieve their goal of separating business lines. The Act reduced the corporate tax rate to 21 percent, which may encourage businesses to sell unwanted businesses and raise cash, rather than spin off an unwanted line of business.
- Capex expensing—accelerated tax deductions
The Act allows a corporation to currently deduct, rather than depreciate over time, the cost of tangible personal property that would otherwise have a depreciable life of less than 20 years, which generally includes most machines, automobiles, trucks, and airplanes. The ability to expense applies to new assets and also to assets that were previously owned, if they are newly acquired by the taxpayer. This can significantly increase the tax benefit of purchasing certain equipment for use in a trade or business.
- Limitations on the deductibility of interest
The Act limits the ability of a borrower to deduct net interest expense in excess of 30 percent of “adjusted taxable income.” Adjusted taxable income is based on taxable income, not GAAP or book income, and therefore for this purpose EBITDA and EBIT are tax, not GAAP, numbers. Understanding the limitation on the deductibility of interest under the Act is an important part of modeling the cash flows of a target company. The deduction for interest (as well as depreciation for capital expenses) can be very different for GAAP and tax purposes under the Act, and should be modeled accordingly.
The new international tax regime created by the Act taxes historical tax-deferred offshore earnings at reduced rates and allows future offshore earnings to be repatriated tax free. This should generally increase the amount of corporate cash available for M&A transactions.
- Participation exemption
Future earnings of foreign subsidiaries can be repatriated as dividends to U.S. corporate shareholders free from U.S. tax. The Act also included various other complex international provisions. These international provisions may cause companies to re-evaluate their overseas holdings, supply chain arrangements, and arrangements with foreign affiliates. As part of this strategic evaluation, companies may decide not only to reorganize parts of their businesses, but also to consider acquisitions to improve their global competitiveness.