Trump on Treasury
16 December 2016
Political upsets in the US and Europe, on top of the ongoing digital revolution, make this the most uncertain operating environment for corporates for 30 years. In the US in particular, the opacity of president-elect Donald Trump’s economic programme makes planning especially difficult. It’s not simply the case that corporate taxes will fall. So what are the possible short- and medium-term Trump policies that will affect corporate treasurers?
Cash pile repatriation
According to Morgan Stanley, S&P 500 companies have around $1 trillion in cash or equivalents offshore. Trump’s proposal would impose a one-time transition tax of up to 10 percent on existing unrepatriated foreign income of US companies, payable over 10 years. This would effectively emulate the last tax holiday (2004) and make it worthwhile for companies to bring this money back onshore. Aside from the need to study the tax implications of any deal, treasurers will need to start thinking about what to do with the money when it returns.
With the banks leery of large deposits and money market funds unattractive because of regulatory reforms and low yields, stock markets have priced in a huge share buyback programme. Goldman Sachs predicts that S&P 500 companies will bring back about $200bn, and spend $150bn of this on buybacks, making a total for 2017 of $780bn.
The proposal also look to tax the future profits of foreign subsidiaries of US companies each year as the profits were earned, ending the current law’s deferral of tax on these profits until they are repatriated. This potentially removes one treasury headache, but has implications for working capital, liquidity management structures and balance sheet management.
Corporate tax rate slashed
The headline Trump proposal is to reduce the corporate income tax rate from 35 percent to 15 percent and repeal the corporate alternative minimum tax (AMT). The plan would also eliminate most business tax subsidies.
As the Tax Policy Center at the Brooking’s Institute points out, “Large reductions in the corporate rate and the repeal of deferral would reduce the incentive for firms to recharacterize their domestic income as foreign-source to avoid US tax. The lower corporate tax rate would also decrease the incentive for a US corporation to move its tax residence overseas (a so-called corporate inversion). However, ending deferral would increase the incentive for corporate inversions, offsetting some of the effects of the rate cut.”
Again, treasurers, CFOs and tax face a new environment in which their old assumptions and structures will need to be updated.
One significant update will be needed if another Trump pledge comes into law. While his proposals see lower corporate taxes across the board, they also include a 35% tax for "any business that leaves our country for another country, fires its employees, [or] builds a new factory or plant in the other country, and ... sell[s] its product back into the U.S."
Trump argued that those companies deserve "retribution." He said businesses that want to offshore jobs have been "forewarned."
The implications of this proposal are profound, particularly if they are in any way retrospective (as most offshoring has already taken place). Does this mean a 35% tax on all the US revenues of a business regardless of the scale of offshoring? Does it mean that profits on only those goods shipped back via such offshoring would be hit with this tax? Will companies therefore have to track the profitability of each different product line offshored? Clarification is needed, but this is one for treasury – and businesses as a whole – to watch closely.
Trump’s proposals also cap the top rate on pass-through businesses such as partnerships at 15 percent. This is 10 percentage points below the top rate on wages. On the face of it, it would create a strong incentive for employees to become independent contractors, who would be taxed at the preferential pass-through business rates. The scale of any change would depend on the additional rules put in place to limit changes in worker status, but a widespread change in the status of workforces would have significant financial and operational implications for business., particularly at a time of relatively full employment.
Debt versus equity: all change?
Trump’s plan contains changes in minimum effective tax rates on new investment (METRs). METRs for equity-financed corporate investments would decline from 32.5 to 18.9 percent, while the METR on debt-financed corporate investment would rise from -6.2 to 4.8 percent (mainly owing to the reduced value of interest deductibility with a lower corporate tax rate). The proposal would also significantly reduce the variation in METRs across assets and industries. In theory, these changes allow for a more creative debt/equity mix in new investments as well as a less-tax driven investment choice process. That said, Trump has also alluded to the introduction of new industry-specific shelter provisions which could re-complicate this new picture. Watch this space.
Until Trump assumes the presidency and Congressional Republicans agree a new tax programme, this is all so much speculation. But the key message is that it is unlikely that normal service will be resumed any time soon, so treasurers need to be on their toes.