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Treasury & Taxation

With US Tax Reform Companies Look for Leaks

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June 26, 2018

By Wendy Chan

Tax reform will have many MNC treasuries reexamining their tax structures to minimize the small leaks that can add up. 

US tax reform policies can affect a multinational's subsidiary and debt structure, capex, optimal cash level, cash distribution to shareholders—the treasury laundry list seems endless. Corporate tax teams must now contemplate redesigning the company's legal entity and business structure in light of the new regs. And what was learned at a recent NeuGroup Asia Treasurers' Peer Group meeting was that while regional MNC treasurers in Asia must help HQ treasury do that, they also have to keep supporting business activities in Asia—including looking at new opportunities to fund them.

One takeaway from the meeting was that while US tax reform enables more "frictionless" intercompany transactions, beware of "leakage." Leakage "is additional tax cost that is in a way uneconomic or unexpected," said Peter Connors, a tax law partner with Orrick Herrington & Sutcliffe LLP in New York. "It tends to be small—hence the term 'leakage' rather than a term indicating a larger magnitude—but these can add up."

With US tax reform in place, corporations are expected to repatriate significant dividends to the US. Boundaries between US and international cash pools will erode, and corporates may end up managing just one cash pool. But new tax provisions, such as interest expense deductibility limits, global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII) and the base erosion and anti-abuse tax (BEAT), can cause "tax leakage" on intercompany transactions. Tax and legal teams are now likely to review the legal entity structures of all subsidiaries to maximize the benefits of US tax reform changes.

"The leakage is the foreign tax credit," Mr. Connors said. "There are very restrictive foreign tax credit rules under the GILTI regime." This means "there are no carryovers and no cross-crediting." In addition, he said, "the long-standing interest expense rules apply to GILTI income, which results in residual US tax, above the nominal 13.125% rate."

As for BEAT, Mr. Connors said, "in a sense, it is a minimum tax that mostly attacks intercompany transactions. Among other things, foreign tax credits are disallowed in the calculation of the BEAT. That alone will create tax leakage." As a result, he added, companies are structuring to address both issues.

Base Erosion Anti-Abuse Tax Global Intangible Low-Taxed Income

FUTURE STATE

AsiaTPG members also discussed how treasury centers will operate in the future. In a future state, regional treasury center roles may focus on corporate finance and capital markets. As rates rise in the US and tax leverage rules change behaviors, companies will be motivated to borrow outside the US, especially where interest rates are low or negative, as in Japan. As US MNCs consider raising funds in Asia, regional treasury teams may need to build their capital markets skills. Raising capital to take advantage of Asia's growth may arise as an in-region activity.

Expect higher US interest rates and a strong US dollar. US tax reform policies are meant to spur investment and boost employment and consumer spending. This investment and consumption will raise inflation expectations. Fed rate hikes and sizable repatriation flows are likely to drive USD appreciation.

WORKING CAPITAL EFFICIENCY NEEDED

Treasurers at the meeting also speculated that more working capital efficiency will be needed to manage liquidity requirements to support business growth. With excess cash balances being sucked out of the regions amid ongoing business growth, efficient working capital cycles will ensure that cash liquidity needs are met. Expect bank and third-party supply chain, customer, distributor and general trade financing solutions to gain popularity.

Treasury's priorities in the wake of cash moving back to the US include FX hedging for dividend payments, meeting local business funding requirements and achieving working capital management efficiencies to unlock cash from the financial supply chain. Also, regional treasurers need to be kept in the loop on corporate plans and what decisions are reached in conjunction with the tax department.

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