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Risk Management

US Tax Reform: Challenges, Opportunities and Solutions for MNCs and Corporate Treasury

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February 27, 2018

The sweeping US tax reform law passed in 2017 has major implications for how global MNCs allocate capital across the globe, putting treasury and tax departments—and the technology systems they rely on—in the spotlight as senior executives evaluate how to spend or invest the cash windfall some companies expect to enjoy in the years ahead. 

President Donald Trump's signing of the Tax Cuts and Jobs Act (TCJA) in the waning days of 2017 set off a mad scramble at multinational corporations (MNCs) based in the US (and foreign companies that do business here), ruining the Christmas vacations of many a tax professional. Year-end financial statements had to be quickly adjusted to reflect the new law's various, often complex changes to tax rates, deductions and credits. The same day the president signed the bill, the Securities and Exchange Commission said it recognized that companies "may face challenges in accounting for one of the most comprehensive changes to the US federal tax code since 1986."

Indeed, the biggest overhaul of the US tax code in 30 years will have "a huge impact across the board for taxation," says Roman Scheller, principal consultant for back office and accounting solutions at Openlink, a provider of trading, treasury, accounting and risk management systems and software. "I think there's going to be more need for informed decisions, internal controls and decisions around taxation," he says. And Mr. Scheller argues that integrated technology systems will provide an advantage for corporations contemplating changes to their balance sheets and capital structures in the wake of tax reform.

Eric Cohen, principal at PwC's Advisory Corporate Treasury Solutions Practice, agrees and says the tax overhaul creates a chance for treasury departments to shine. "Treasury can play really big here," he says. "It is an opportunity for treasurers to step up and be involved in some very strategic decisions that could potentially give their organizations a competitive advantage and potentially increase shareholder value."

Here's a look at some key issues facing corporate treasury and tax departments.

What's Changing

The new year brought with it plenty of headlines that made clear the immediate and varied impact the TCJA would have on fourth-quarter earnings and the future financial health of MNCs. Reviewing a few of those headlines and earnings reports provides a useful recap of some of the changes that received the most attention from investors following the act's passage.

JPMorgan's Profit Hurt by Tax Law (WSJ)

Net income at the nation's largest bank fell 37% from a year earlier, reflecting the impact of a $2.4 billion hit to earnings resulting from the TCJA. That one-time charge stemmed largely from the act's imposing a tax on the foreign profits of US companies held overseas that were "trapped" because repatriating that money would have cost 35% in tax under the old code. Now those profits are subject to a one-time tax of 15.5% for liquid assets like cash and 8% for illiquid assets. (Don't forget Apple's announcement that it will pay an estimated $38 billion in repatriation taxes.) And it's important to note that companies do not have to bring those taxed foreign earnings home. In fact, JPMorgan's presentation to investors said: "No significant remittance of cash expected—we have capital and liquidity requirements in foreign entities—it is a deemed repatriation."

James Dimon: The Tax Law Means More Profit for JPMorgan (WSJ)

JPMorgan's CEO, despite the hit to fourth-quarter earnings, said the TCJA is "a big, significant positive and much of it will fall to our bottom line in 2018 and beyond." One major reason: the drop in the corporate income tax rate from 35% to 21%. JPMorgan expects its effective tax rate to drop to 19%, down from more than 28% in 2016. By contrast, IBM expects its full-year tax rate to rise to about 16% in 2018, up from 12% in 2017.

Verizon Expects $4 Billion Boost From Tax Cuts (Bloomberg)

Another effect of lower corporate tax rates: Verizon booked an enormous $16.8 billion, one-time, after-tax increase to earnings, mostly from the reduced cost of the company's net deferred tax liabilities at the new rate. (Verizon also expects $3.5 to $4 billion in extra cash flow as a result of tax reform.) The flip side of this is that companies with significant deferred tax assets will take an accounting hit because those assets are now worth less. For example, Caterpillar said $596 million of the $2.37 billion charge it took because of the TCJA came from a write-down of deferred tax assets. (It also said it would take a $1.77 billion charge for the taxes on overseas profits.)

In addition, the TCJA gives companies the right to fully expense tangible property, plants and equipment immediately (including any equipment purchased after Sept. 27, 2017). That's great news for some businesses. What's not good for most firms, though, is the act's limits on the amount of interest corporates can deduct. Going forward, deductions for net interest expense are limited to 30% of adjusted taxable income, which PwC says is defined similarly to EBITDA (earnings before interest, taxes, depreciation, and amortization). Finally, the law imposes minimum taxes on foreign income. That could hurt companies with the lowest effective tax rates, including tech giants, that have parked lots of foreign profits overseas.

Tax & Accounting

Whatever their tax rate, companies are now grappling with the complexity of applying the new tax code to their individual financial circumstances. Mr. Scheller of Openlink says that means they need to have a complete picture of their finances. "The challenge for clients is to know what the taxation basis is. This whole problem becomes a valuation problem: assets and liabilities or income or expenses within multinational corporations. A company needs to be able to have those values available, categorize them accordingly and then apply the new taxation on them in order to know how does that change the impact on my P&L."

Technology and systems play a critical role in how MNCs approach the challenges posed by tax and reporting requirements. And Mr. Cohen at PwC says companies that are "behind on the technology maturity curve" will find the analytical exercises necessary to comply with the TJCA cumbersome and costly. "The more technology you can use in supporting the reform requirements, the greater the advantage you will have and the less burdensome it will be on resources," he says.

The ideal technology solutions, Mr. Scheller says, are integrated treasury and risk management systems like those offered by Openlink. "Having an integrated system and specifically an accounting solution that captures all those values and attributes allows a company to get those breakdowns to better assess the impact of those taxation changes."

The reality, though, is that many companies are unable or unwilling to make the investment in an integrated system that allows them to connect most treasury processes on one platform. "You'd be surprised how many companies on a global level still operate in spreadsheets," says Mr. Scheller. "They have an extremely complex and often disconnected systems landscape with a lot of manual effort in terms of aggregating values, providing breakdowns."

Treasury

Enrico Camerinelli, senior analyst at Aite Group, a research and advisory firm, agrees that a "multitude of companies" are still relying on Excel or "some very basic treasury system."

That's far from ideal, given the spotlight treasurers will now find themselves in because of the crucial decisions many companies will face about how to deploy excess cash in the months and years ahead. "If treasurers are smart at taking advantage of this, it could certainly help them to put back the attention on their role … and reinforce their position in the company," Mr. Camerinelli says.

Other experts agree that the stakes and the challenges for treasurers from tax reform are high. "The repatriation requirement and the limitation on interest expense are going to have a profound effect on treasury," says Mr. Cohen. "Specifically, on how the company manages its global cash, how capital is allocated, how funding decisions are made."

Where are You on Your Repatriation Checklist 

Recent NeuGroup Peer Research suggests that most treasuries are still in the initial stages of figuring out what to with some of the estimated $2.6 trillion in profits they have parked offshore. The chart shows that a month after the TCJA became law, two-thirds of survey respondents said they were still exploring strategies for previously trapped cash they can now repatriate.

All that money represents both an opportunity and a risk, says Vincent Menna, principal product manager in financial services at Openlink. "Treasury has to manage their risk going forward. The risk could be excess liquidity. Do they pay down debt, what investments do they make with the excess cash, do they buy back stock?" Making those decisions, he says, is easier when you have a solution that shows you all your risk exposures. "As a treasurer you want a system to be able to manage all these different risks, whether it be cross currency, cross commodity, cross interest rate," he says.

Another survey from NeuGroup Peer Research, as well as other data, suggests the answer to the share buyback question is "yes." As the chart below shows, fully half the respondents in the fall of 2017 ranked share repurchases among their top expected uses of repatriated cash flows. That may be no surprise, given pressure from shareholder activists and other institutional investors.

Lawmakers who voted for the TCJA may have high hopes about companies using new cash, including funds repatriated from overseas, to build plants and buy equipment in the US, creating American jobs. But that's not what some treasury consultants, including Anthony Carfang of Treasury Strategies, were hearing a month or so after the bill became law.

"Many of our clients are now seeing this as an opportunity to figure out where in the world they want to place this cash. So it's not simply one direction back to the US," Mr. Carfang says, adding, "What this is causing a lot of companies to do is step back and ask what their balance sheet should look like."

In the Event Tax Reform is Passed What is Your Primary Use of Proceeds for Repatriation FlowsIndeed, Verizon said it will use most of its extra cash flow to strengthen its balance sheet by paying down some of the company's $117 billion in debt. It will also donate to its charity and give employees company stock.

And even though IBM will now pay a higher tax rate, Martin Schroeter, senior vice president of IBM Global Markets, told CNBC that IBM supports the TCJA. "Over the long term, it's going to free up our capital [and] it gives us a territorial system so we can invest on par with our competitors," he said. Under a territorial tax regime, US MNCs are taxed only on earnings generated by their US operations.

Of course, it's not just the risks and opportunities raised by the tax law that treasurers and their bosses have to worry about in the year ahead. There's also the likelihood of rising interest rates, the unwinding of the Federal Reserve's balance sheet, those activist shareholders and changing regulatory rules to keep them up at night. Oh, and playing a greater strategic role while staying on top of the digital technology that's making some treasury jobs obsolete.

All the more reason, says Openlink's Mr. Menna, for treasurers to tap into the power of an integrated technology system. "It gives you an overview of what your situation is going to look like now and in the future … you can do what-if scenarios if the Fed raises rates more than expected. You want to have a system that will enable you to forecast that event risk and help you decide what to do in those different scenarios."

Whatever the scenario, Mr. Camerinelli boils down what treasurers need from technology to tackle tax reform or any of their myriad responsibilities: "Visibility and integration—these are the major needs of a corporate treasurer," he says. "Having something that aggregates the data, normalizes it, harmonizes it so you have a holistic view is the No. 1 need of treasurers."

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