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Capital Markets

Repurchases Get the Nod

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July 27, 2018

By Julie Zawacki-Lucci

Treasury and tax have a “spaghetti bowl” of tax issues to untangle, but most of the money will go toward share repurchases and paying down debt. 

The new tax rules made into law at the end of 2017 promise to keep tax and treasury departments busy over the next few years. That's because guidance on how to apply the hastily produced law will arrive only in incremental fashion. The unprecedented pace of the process has resulted in a law creating interpretative uncertainties and potentially unintended consequences. But what's for certain, according to NeuGroup peer research, is that most of the cash is going to buying back stock.

Although the idea of tax reform has been discussed for years, the Republican-led Congress produced the major legislative package—called the Tax Cuts and Jobs Act—in a speedy seven weeks, with President Trump signing it into law on Dec. 22. Tax experts at one NeuGroup meeting described the new law as a "spaghetti bowl" of tax issues that must be unraveled before US companies can be certain on how best to repatriate the cash and reorganize funding and flow-of-funds structures in the wake of the reform.

There are drafting issues in the hastily written legislation, plus intended and unintended consequences in terms of how the new tax rules interact with preexisting international tax rules. The branch, hybrids, Subpart F, CFC and FTC regimes now interact with global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), base erosion and anti-abuse tax (BEAT) and other new measures. "It's new IRS code on top of old," said one tax expert.

From a tax planning perspective, the right answers to many lingering questions, starting with whether to fund from the US or not, will depend on the facts and circumstances of individual companies. Expect a lot of friendly dialogue with your tax department going forward on how to get a handle on the new rules. That said, members are focused primarily on share repurchases (47%), debt paydown (40%) and M&A (34%) as expected uses of proceeds from tax-reform repatriation flows. Capex and dividends were much lower, at 26% and 24%, respectively.

Still, despite three notices from the IRS about mandatory repatriation, one on withholding on partnership interest sales and a recent notice on a new cap interest deductions, treasurers are still awaiting consistent guidance. And it can't come soon enough as substantial amounts of money plan on coming back to the US.

According to respondents to NeuGroup Treasurers' Group of Mega-Caps' (tMega) pre-meeting survey, a total of 43% say they are expecting to repatriate over a billion dollars thanks to tax reform (with 38% within the $1 billion-$9 billion range.) At the meeting, which was held at BlackRock, the company's Chairman and CEO, Larry Fink, urged members to tie the use of proceeds to long-term value that ultimately should be linked to their stated long-term purpose as a company. If the business generates capital well in excess of what is needed to fulfill a well-articulated, long-term purpose, then by all means return it to shareholders, he said.

In this vein, US companies must determine and communicate their use of proceeds so the company's credit rating does not change and activists don't pounce. Activists might be expecting a plain vanilla approach to using the repatriated cash—i.e., a little bit of debt tender, share repurchases, a dividend increase and M&A, and perhaps a small capex increase—but if it's too vanilla, they might get activated. Rating agencies will then fill in the blanks in what issuers disclose with overly conservative estimates and haircuts to incent greater disclosure. Collectively, 55% of NeuGroup peer group survey respondents have or plan to communicate plans to deploy repatriated cash.

US Tax Reform Expected Use of Proceeds

What About ALM and THE Fixed-Floating Mix?

In anticipation of tax reform, one tMega member said he has stopped swapping as much floating to fixed and matched off the lower duration in his cash portfolio. Now there is an opportunity to fix more and extend duration on the liability side (especially as cash gets returned to shareholders). New hedge accounting rules make this easier and offer more flexibility: You can now fix any time period of the debt cash flows vs. the whole term of the debt. The question is when to enter into the swaps. This same thinking prompts paying down outstanding commercial paper, which 48% of those paying down debt are planning to do with their repatriated cash.

Another upcoming trend is that more corporates are planning to move debt financing overseas. One peer group sponsor bank noted that the BEAT provisions of US tax reform—along with GILTI provisions—weigh on MNCs' thinking about intercompany funding and the location of entities arranging that funding (say, a centralized treasury center or IHB in Europe). Accordingly, some MNCs may choose to issue more non-US-domiciled debt, particularly for non-US acquisitions.

While corporates and tax experts alike are keeping a close eye on the US Treasury and IRS, and remain uncertain, they are fairly confident it will all be clear by some time in 2019. One tax expert said he "knows that they are working hard to get other TCJA guidance out. That is [the IRS and Treasury's] top priority."

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