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Tax Reform Will Affect Corporate Deal Pricing, Practitioner Says

Posted on June 16, 2017 by Emily L. Foster

House Republicans’ tax reform proposal will affect the nature and price of corporate acquisitions and require practitioners to rethink how deals are done under subchapter C, a practitioner said June 15.

A substantially lower corporate tax rate will affect corporate acquisitions, said Eric Solomon of EY, speaking at the Texas Federal Tax Institute in San Antonio. For example, “if the target corporation is to pay less tax after an acquisition because of a lower tax rate, that’s going to increase the purchase price of deals,” he said. But on the other hand, it depends on which pay-fors Congress decides to use because of the lower tax rate, Solomon added.

The destination-based cash flow tax proposal in House Republicans' “A Better Way” tax reform blueprint would reduce the corporate tax rate from 35 percent to 20 percent and shift from a corporate income tax to a system that includes immediate expensing of investments in tangible and intangible property, excluding land. The blueprint also calls for the elimination of net interest expense deductions and for net operating losses to be carried forward indefinitely.

If net interest expense is not deductible in corporate acquisitions, then corporations would presumably use less leverage and more equity in those transactions, Solomon suggested.

With full expensing, if a corporation is considering an asset sale, or a stock sale with a section 338(h)(10) election that is treated as an asset sale, there would be different consequences for the seller and the buyer, Solomon said. The seller would have immediate gain on the sale because with full expensing the basis in the assets is zero, while the buyer would immediately write off the basis of the asset purchased, he said.

Transition rules are important in addressing net interest deductibility on old debt, and with full expensing, whether a taxpayer that places an asset in service before the effective date will still be able to amortize it, Solomon said.

Any tax reform legislation is expected to have deemed repatriation of earnings at a tax rate of less than 10 percent, Solomon said. The blueprint provides that accumulated foreign earnings in the form of cash or cash equivalents would be taxed at 8.75 percent, and any remaining earnings would be taxed at 3.5 percent. Solomon noted that corporations might consider plans to reduce their offshore earnings that would be the basis for the deemed repatriation.

Under the blueprint’s border-adjustable tax, an exporter would generally have net operating losses — no income from tax-free offshore sales with all the deductions, Solomon said. An importer would have “greatly increased income” because it’s not allowed the deductions, he said, adding that “presumably, there would be an incentive to merge” with an exporter. So under tax reform, would we still have sections 382383, and 384? Solomon asked. He also wondered whether an importer would have incentive to purchase property for the expense deduction and then lease it to an exporter.

In an effort to retain the controversial border-adjustable tax provision and address challenges companies could face, House Ways and Means Committee Chair Kevin Brady, R-Texas, suggested a five-year phase-in period. However, that may not be enough to make the provision palatable, given the resistance it faces from the White House and the Senate.