By Joseph Neu
For most US MNC treasurers, capital planning is now about tax-change contingencies.
Even before the Trump presidential win the twin issues of a tax break on repatriation as well as the prospect of meaningful structural tax changes weighed on US MNCs’ capital planning. Some were simply waiting out the Obama years to see whether a new administration, be it Clinton or Trump, would offer tax reform to alter the fundamental capital calculus for the majority of large US MNCs. That is, borrow against growing offshore deferred taxable earnings to fund share buybacks and dividends, keep up with domestic CAPEX and R&D, all while maintaining debt capacity for a strategic acquisition if needed. Plan B was perhaps engineering a foreign acquisition.
EXPLORING THE TAX CONTINGENCIES
At one NeuGroup meeting session in late 2016, US MNC treasurers discussed tax-driven capital planning contingencies. Two basic scenarios presented themselves: (1) tax reform or another tax holiday happens, allowing companies to repatriate trapped cash; or (2) hope for tax change fades so that a few leading companies start to pay the tax on deferred earnings and bring back their cash, which would pressure peers to do the same. The consensus was that 2018 was a critical milestone year. If a tax holiday, with or without more structural tax reform, did not come about by then, contingencies based on scenario two were more likely to kick into place; namely, repatriate the funds and pay the tax. No MNC would want to be the first to fold on paying the tax to repatriate their cash, but the consensus was that as soon as a significant company went down that road, it would be very hard not to follow.
But Trump as president now makes the first scenario much more likely (though there was significant optimism even if Clinton had won). And the first scenario makes these questions most relevant:
- What to do with the cash? Depending on the sector, most firms will look at strategic acquisitions and then share repurchase and dividends. Depending on the state of their leverage and rating outlook, some may also retire debt, but given the current rate outlook and recent low-rate opportunistic funding, there will likely be few taking this route. Meanwhile, strategic M&A might get bid up so much in anticipation of repatriated offshore cash that it will become less appealing. This leaves shareholder distribution as the most probable use of cash.
Given the likelihood for incentives to invest some of the repatriated cash, the consensus at the fall meeting was that tax relief on cash repatriation would indeed also help bolster some investment in manufacturing and R&D domestically, at least in some sectors, which is the policy intent. Accordingly, one aspect of the “what to do with the cash” question will be driven by the tax rules Trump and the Republicans are able to pass; for example, what percentage of the repatriated funds must be invested in infrastructure bonds (or something like that)?
At the end of the day, since much of the cash is invested in the US now—namely, in financial securities in the name of foreign affiliates—the main advantage of international tax reform is making more cash available for more uses—in other words, flexibility. Seen in macro terms, even cash returned to shareholders via buybacks will end up somewhere and with a possibility that it will get invested to fund US economic growth.
- Will you have to sell financial assets to repatriate? One of the questions that asset managers and their tax and legal experts will be helping treasurers answer is if they will need to sell financial assets in order to repatriate the funds. As noted above, a lot of offshore cash is held in the name of foreign entities in the US. Thus, as a practical matter it would be economically more efficient to simply transfer these assets to US entities rather than force the sale and repurchase of assets in order to transfer them. With the last tax holiday, the sale was needed, but this time around taxable repatriation may not be voluntary and all offshore cash may be deemed to be repatriated.
- What’s your new perspective on minimum cash? If offshore cash is unrestricted going forward, then this will change the analysis on the minimum cash needed to run the company for many firms. Accordingly, at least one member at the fall meeting said he will redo this analysis based on total cash and not just domestic cash to determine how this might change his thinking in the future.
- How will your global trading, capital allocation and flow-of-funds models change? Since many US MNCs have adapted their trading, capital allocation and flow-of-funds models to optimize their effective tax rates under the current US rules, a structural change eliminating the deferral of offshore earnings would bring about the opportunity for structural change in how US MNCs operate. These fundamental changes will not happen overnight, but planning for them will need to happen as soon as new tax rules take shape.
- Will there be a new balance of power with tax? Could treasury get a leg up? Given the structural changes that will take place with international tax reform, the balance of power between treasury and tax considerations will be altered substantially. Maximizing the availability of funds may trump minimizing the effective tax rate in far more circumstances, especially if a major reduction in the US corporate tax rate is made.
MORE CLARITY SOON
While the level of optimism for international tax reform in the US is higher than it’s ever been, many MNC treasurers are reluctant to get too optimistic. However, optimism for a one-time repatriation provision is generally higher than for full-blown tax reform. Movement on either will need to happen quickly to have a high probability of success, according to the consensus view. “My tax department is telling me we should know in the first 120 days of the Trump Administration what tax reform is going to look like,” noted one treasurer recently. Considering the growing competition for untaxed corporate income amongst foreign jurisdictions, and the advantages foreign MNCs operating in the US enjoy, if the Trump administration and Congress are not persuaded to act on US international tax reform early, it may be too late. Thus, 2017 (and even Q1 2017) is a critical period.
US MNC treasurers and their tax colleagues will probably be pressured by a useit-or-lose-it calculus to repatriate eventually. Therefore, the key capital-planning question is whether tax changes this year can make repatriation less costly for companies, level the playing field with non-US-based MNCs and jump-start a higher US growth trajectory in the process. Capital allocation would then take on much more of a US focus too.