Sec. 385 reprieve and Trump’s election bring a new outlook for treasury in 2017.
The Treasurers’ Group of Thirty for the first time divided its meeting between two locations on two separate dates. By the second meeting in November, the Section 385 rule was approved and no longer threatened most cash pooling arrangements, and Donald Trump unexpectedly won the presidential election, increasing the prospect of friendlier cash repatriation rules and lower corporate rates. A pervasive theme throughout was how business transformation now dominates treasury activities. Against this backdrop, T30 members delved further into these and other topics, concluding that:
1) Big Section 385 Relief, But Not Out of the Woods. Documentation and funding rules of the 385 regulation, though less burdensome than expected, will still require significant compliance efforts.
2) Tax Reform a Priority. Donald Trump’s proposals would lower the tax rate to 15% and eliminate the AMT. He has proposed a 10% repatriation tax.
3) Advanced Hedging to Make it Worth the Trouble and Cost. Chatham Financial says more corporate clients are thinking of hedging only a majority of their exposure versus all exposure, to lower costs.
The Liquidity Maze— Adapting to New Regulations
The new rule under Section 385 of the US tax code, finalized faster than expected, more specifically targets US companies’ pursuit of inversions, where they buy a foreign company in a low tax jurisdiction and the US subsidiary deducts interest payments to the foreign parent. For the most part, US MNCs have dodged a bullet, with requirements being less onerous than anticipated. However, treasury must apply additional efforts and bandwidth, especially with regard to intercompany loan documentation. Some companies will have to restructure at least a portion of their intercompany lending or pooling arrangements.
Compensation and Budgeting: How Do You Stack Up?
Total compensation levels for NeuGroup members were higher than anticipated, according to the recent NeuGroup Peer Research FTE and Compensation Survey of 40 executives, perhaps in part due to the sample bias of professionals from top companies, several of which are growth companies. Companies averaged 21 full-time employees (FTEs) in headquarters and 28 globally, although those numbers varied significantly by company size.
Treasurer compensation varies widely. Total compensation for treasurers averaged $844,795, with the minimum at $213,600 and the maximum at $1,770,000. On average, $317,379 was the base/cash salary, $236,865 was equity vesting in four years, $163,217 cash bonus, and $280,280 performance-based equity. Assistant treasurers’ total compensation averaged $436,296, with the minimum at $122,000 and the maximum at $770,000.
Members are granting equity awards down to the manager level. Those rewards make up a significant portion of total compensation—28% for treasurers and 26% for ATs—and vest over three to four years.
The main areas where treasurers report increased budgets for the coming fiscal year are personnel and technology.
Key Takeaways
1) Big relief, but not out of the woods. While quite broad when it was published in April, the Section 385 proposal has been pared back significantly. Major changes include:
- The “bifurcation” rule, requiring intercompany funding to be reclassified partially as equity and the rest debt, has been eliminated.
- The transaction rules’ exceptions were expanded, providing treasury with much more flexibility in terms of intercompany funding.
- The transaction rules no longer apply to foreign-issued debt nor debt issued by S Corporations, RICs and REITs.
2) More breathing room. Effective dates have generally been extended in the final rule:
- The documentation effective date has been delayed from the date the rule was finalized to debt issued on or after Jan. 1, 2018, and the due date is now the US tax return filing date, with extensions.
- The transaction rules apply to debt issued after April 4, 2016, but the debt wasn’t subject to recharacterization until immediately after Jan. 21, 2017.
3) Still lots of work to be done. The documentation and funding rules of the 385 regulation are less burdensome in their final form but will still require significant compliance efforts.
- The funding rule applies to three intercompany transaction types, but exceptions have been granted if:
– The covered debt instrument is a demand deposit received by a qualified cash pool header in a cash management arrangement.
– It is a short-term lending arrangement, based on current assets on the financial statement or having a term of 270 days or less.
– The debt is issued in the ordinary course of business and is expected to be settled within 120 days.
- The documentation requirements remain largely the same, but intercompany transactions can be documented once a year under an omnibus agreement rather than transaction by transaction.
Next Steps for Foreign MNCs & Best Practices for US MNCs
- Coordinate Tax, Treasury, M&A and Legal on new, standardized terms for intercompany debt, protocols for borrowings and restructuring transactions.
- Assessment and Tracking.
• Identify grandfathered debt.
• Identify sources of intercompany debt (Treasury-to-Opcos; Opcos-to-Opcos).
• Track US group distributions and debt. - Tax attribute studies (earnings & profits, tax basis)—the opportunities that exist under the new rules will require high degree of certainty on these numbers.
- Implement controls to prevent foot faults on administration of loans and unintended tax consequences.
- Establish and maintain centralized documentation repository, including loan agreements, amendments, corporate governance and underwriting documentation.
Outlook
Whether the 385 regulations last under a Trump administration is an open question. Tax reform significantly reducing the corporate income tax rate could eliminate the benefits to inversions. In the meantime, the Treasury Department under Trump could simply rewrite the regulation to make it invalid.
Systems and Satisfaction
Discussing the pluses and minuses of treasury management systems (TMSs), and whether running them in-house or via software-as-a-service (SaaS) is preferable, attendees agreed that all TMSs have hiccups, some more than others. SunGard’s Quantum was largely viewed as a dinosaur, but the vendor’s “more off-the-shelf” Integrity TMS received kudos. Kyriba’s TMS, another SaaS offering, also received high marks despite hiccups. At least a few attendees said SAP’s treasury module was unappealing to engage and difficult to use outside the SAP enterprise risk planning (ERP) environment, but one said it worked well for his high-volume treasury, and that implementation was key.
With cybersecurity top of mind, one member said SaaS “scared the life out of our CFO,” so the company implemented its TMS software within its own firewalls. Another noted, however, that nobody is safe from cyber attacks today, adding that cybersecurity is a core competency of SaaS service providers. One of the biggest advantages to delivering software via SaaS is the inability to tailor it, another member said, noting no more custom reports requested by top management.
Republicans Aim for Tax Reform Trifecta Under Trump
With Republican control of the presidency and both branches of Congress, the time appears ripe to tackle individual and corporate tax rates as well as taxes on corporate overseas earnings. A Big Four rep said word on Capitol Hill is that Republicans would prefer drawing some Democrats onboard to capture a filibuster-proof majority, perhaps by channeling tax proceeds from a one-time repatriation tax on corporates’ more than $2 trillion in overseas cash toward projects the opposition party can support.
Key Takeaways
1) Tax reform a priority. Trump had modified some of his campaign planks to resemble the House’s tax reform blueprint, published last June. Trump’s campaign proposal aimed to lower the tax rate to 15% for all businesses that want to retain the profits within the business, compared to the blueprint’s 20%, and apply a special 25% rate for business income earned by pass-through entities. Trump would allow manufacturers in the US to elect to expense capital investment and lose the deductibility of corporate interest expense, while the House plan would allow businesses to fully deduct and immediately expense the cost of investment in tangible property, but not land. Corporate AMT would disappear.
2) Planning to repatriate cash? As an independent issue, repatriation-tax legislation may be first to approach Capitol Hill. Trump proposed a 10% repatriation tax, compared to the House blueprint’s 8.7% tax for cash or cash equivalents and 3.5% for illiquid assets payable in installments over eight years.
3) Out with income, in with consumption. Corporates would be subject to a consumption tax, where the taxing jurisdiction for business income would be determined based on the location of consumption of products and services and not the location of their production. US importers would be taxed on income earned from their imports and US exporters would not be taxed on export income.
Outlook
Tax reform benefitting the wealthy that contributes to greater deficit spending may be hard to sell. However, the reconciliation process, requiring only a majority vote, requires bills to be revenue neutral, an even bigger challenge, so Republicans will likely seek enough Democratic support to overcome a filibuster. A one-time repatriation tax to infrastructure projects may be one solution.
Treasury’s Impact on Key Corporate Initiatives
In both meetings, it was striking how many members were involved in projects related to business transformation. Whether an acquisition, spin-off, geographical expansion or new strategic alliance, treasury has important value to bring to the discussion. But how is that message effectively conveyed to the C-Suite?
One member said one of the best things to happen to treasury was the financial crisis, because until then senior management had overlooked the importance of shoring up FX and stabilizing the company’s capital structure. Treasury stepped in to lend its expertise to the business units and the M&A department to determine whether acquisitions made long-term, strategic sense.
The disconnect between management’s strategic planning and real-world numbers highlights the importance of treasury taking on a strategic role, another member said. FP&A’s rosy forecasts were tempered by treasury’s realism, stemming from actual company results and provided senior management with a warning bell. With one exception, members complained that despite treasury’s increasingly strategic and expanding role, treasury department resources at best remained the same.
Advanced Hedging Concepts
FX risk management is a perennial hot topic, and tumult across the globe will ensure it remains so. Executives at Chatham Financial, a provider of FX risk management and advisory services, presented the firm’s views on markets, hot spots and approaches to effective FX philosophy and strategy.
Key Takeaways
1) MNCs exempt from margin but not from self-disclosures. Corporate end users escaped margin and clearing regulatory requirements, but by March 1, 2017, margin rules spurred by the Basel Committee will require all their hedging entities to complete self-disclosure letters, to continue trading swaps. Information to be included in the letters includes: general biographical information; entity classifications/status in the US; same for the EU; other sections to be completed by jurisdiction, as requested by bank counterparties.
2) Pumping up hedge-accounting capacity. A Chatham executive described techniques to hedge beyond corporate entities’ direct exposures. By looking for FX exposures its affiliates globally have in common, a company may be able to hedge one entity’s exposure indirectly via another entity, and exposures can also be divided among multiple swap legs. Another strategy is to extend the forecast period from one month to a rolling three months, providing greater assurance hedging transaction will occur over the longer time period and encouraging companies to take greater advantage of hedge accounting treatment.
3) Is it worth the trouble and cost? Chatham said more corporate clients are re-evaluating the cost of hedging in jurisdictions where hedging costs are high. One member described cost as a good issue to promote discussion of companies’ hedging programs, and after a lengthy discussion members concluded hedges ultimately only buy time to deal with external factors.
Outlook
Global economic fragility and the likelihood of a stronger USD will prompt members to reevaluate their hedge programs. Some may want to consider more advanced approaches to hedging, including improvements to forecasting, categorizing exposures based on certainty, and better aligning hedge ratios with hedge objectives. For many advanced hedgers, this will entail a more holistic approach to risk management that considers the magnitude, direction and correlation of exposures to make hedging more efficient.