By Julie Zawacki-Lucci
Even as controversy continues to swirl around the Trump administration, tax planning is paramount for treasury.
Planning and modeling for the prospect of tax reform and its impact on capital structure, capital and cash forecasting is consuming large chunks of time for many NeuGroup peer group members lately. The uncertainty surrounding the content and timing of any type of tax reform requires treasury to develop scenarios and propose actions for various outcomes.
Indeed, this has caused some CFOs to maintain a wait-and-see approach on reform-oriented planning. Still, congressional Republicans need to show legislative success before the midterm elections after their failure on health care reform may boost the odds of some kind of tax legislation passing. And although many details remain undefined, being proactive with no-regrets planning trumps being purely reactive.
Despite this, the political dysfunction in Washington points to a low chance of a broad, well-thought-out reform of the US tax code. On the positive side for corporates, elimination of interest deductibility is considered unlikely, as is the adoption of a border adjustment tax (“Hallelujah!” said one member). Policymakers are also still uncertain about the possibility of a split rate for repatriated cash (8.75% in the House “Better Way” Blueprint) and non-cash assets (3.75%). Staying liquid may be important because activist pressure means “time will be ticking really fast” to make good use of untrapped cash, experts warned, especially for companies that lack credibility with activist investors.
NeuGroup Peer Research surveyed treasurer and assistant treasurer groups during the first half of 2017 on what preparation has occurred at their companies regarding potential tax reform and the repatriation of funds. The aggregated results from approximately 100 company responses and key takeaways from discussions with these NeuGroup members are summarized below.
Despite the questions about timing and content, planning for US tax reform is one of the top two priorities being addressed by members in 2017 H1, and scenario planning has (wisely) begun. Over half (52%) of members have prepared various scenarios for senior management regarding repatriation or tax reform, quantified after-tax proceeds with the tax group (36%), or mapped out potential uses of proceeds (36%). Only a small minority have changed their forecasting process or prepared scenarios for ratings agencies. Opportunities, members say, may include shifting more debt offshore (while having less onshore, with no impact to overall leverage), and using the additional liquidity in the US to accelerate tax-deductible uses of funds.
It’s time to put your tax playbook together
Although it may seem premature given the lack of clarity on when and how tax reform will take place, lively meeting discussions throughout the first half led most members to conclude playbooks should be developed now—in collaboration with tax groups—for a wide range of scenarios. Treasurers should also lobby for senior level buy-in as soon as possible so action can be taken without unnecessary delay when the tax code changes. Much of the planning is opportunistic, or focused on what can be done if x happens or what value creation may be exercised regardless of whether x happens or not or if y happens instead.
Tax advisors presenting to members at one meeting encouraged “no-regrets” planning: taking actions to review or revise tax structures that will bring benefits no matter what form tax reform takes, or even if it does not come to pass at all. For example, this would include shifting out of offshore cash positions and making efforts to minimize existing profits subject to a transitional deemed repatriation tax by shifting liquidity to subs without earnings, harvesting foreign tax credits (FTCs) from subs in high-tax pools in case the FTCs are derailed by repatriation, or planning to accelerate interest deductions while you can.
The degree of planning and sophistication of the modeling may depend on the tax department’s connection with the CFO. “Our CFO was previously the tax guy,” one member noted, “so there has been a lot of debate about what we expect to happen and how to model the implications for shareholders.” It may also depend upon the board. As another member said: “Even though we know nothing, we have been modeling and continue to model, because the board wants to see what all the possibilities are.” It pays to make it a joint effort: “Our planning is a joint effort between treasury, tax, IR, FP&A and the business CFOs.” Some have been planning for a while: “Our tax group has been saying we will get tax reform in 2018 for five or six years, so we’ve been planning over that period for either getting tax reform in 2018 or changing how we view our capital structure anyway in 2018.”
Cap restructuring and M&A opps?
In the event of tax reform, members see a sizable opportunity to rationalize the amount of debt on the balance sheet as well as increase capital return programs and boost inorganic or organic investments. Although Republicans and Democrats alike anticipate companies steering mandatory repatriated cash under tax reform to capex and new manufacturing jobs, a common expectation has been that much of the cash will go to share repurchases and dividends, with M&A a close third. A bank presenter at one peer group meeting suspects that “five years down the road, when companies no longer have trapped cash and can use overseas profits in their calculations to allocate resources, they’ll be able to think about their growth plans more holistically.”
Nevertheless, “the boon will be the accessibility of the cash,” said a treasurer whose company’s effective tax rate is already in the low 20% range. The company also may pay down debt with repatriation proceeds, using the “opportunity to have a meaningful impact on our balance sheet.” Another member said it would be impossible for his company not to pay a dividend if tax reform passes. A treasurer whose company has been adding debt to the balance sheet in recent years said tax reform was “causing us to take a step back and figure out where we want to land.” The treasurer of another large global company, one he described as a “huge taxpayer,” was unequivocal about the sizable windfall tax reform will bring: “It should be a huge win for us.”
Repatriation in some form is likely
If repatriation is enacted, activists won’t delay gunning for the return of repatriated cash to shareholders. They may, however, give you a shorter or longer window depending on what you say you might do with proceeds, and if they believe in the positive outcome of those plans. Members were advised to be sure to develop a coherent message for investors, and perhaps highlight significant points with a portion of the investor base. Messaging should provide confidence that (1) you have done due diligence on capital structure ratios that underpin your credit rating and (2) you have a coherent plan to mitigate the impact of repatriated earnings.
For years, the Republicans have been calling for fundamental tax reform, especially for corporate taxes. Their wish list took shape a year ago, when Speaker of the House Paul Ryan and House Ways and Means Chairman Kevin Brady published the blueprint. One meeting presenter explained that the blueprint rests at one end of the spectrum in terms of fundamental reform, while the middle—seemingly the direction of President Trump’s page-long proposal—could include a rate reduction coupled with eliminating some deductions, referred to as “broadening the base.” The other extreme would be simply “tinkering around the edges,” potentially including some form of cash repatriation, using part of the proceeds to invest in infrastructure, and perhaps shifting to a territorial tax system.
The lack of an ACA repeal presents a hurdle to tax reform and other Republican initiatives. It is unlikely there will be any major reform this year. And if a bill fails to get the president’s signature by the end of the first quarter of 2018, congressmen will be too busy campaigning for midterm elections to pass major legislation. The most likely scenario is a signing ceremony in early 2018 but the package will likely be less transformative than hoped for; nor will it level the playing field for US MNCs vis-à-vis their non-US peers.