How boards can capitalize on the bonanza, avoid the traps.
By Maureen Milford
The sweeping rewrite of the tax code in late 2017 is set to bestow a bonanza on U.S. corporations.
Part of the gift basket from Uncle Sam is the biggest cut in the top corporate tax rate in U.S. history, slashed from 35% to 21%. Other significant highlights of the bill provide for full write-offs on qualifying capital expenditures, a reduced rate to repatriate deferred profits earned overseas and a break on future profits earned abroad.
Because the more-than-1,000-page Tax Cuts and Jobs Act (TCJA) barreled through Congress like a high-speed train, more time is needed to fully understand the ramifications for corporations.
But it’s clear, directors and top managers will have to respond to the bill and take actions that will shape the future direction of their organizations. It could make for a challenging year as directors and top leaders attempt to seize opportunities and avoid any traps.
Edward P. Garden, a director of Bank of New York Mellon Corp., says his company intends to plow most of its windfall to the employees and the business.
“After it was announced the stock went down 5%,” Garden adds. “But we think it’s the right thing to do.”
To navigate the changes, advises Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, “there are major decisions that need to be made on the structuring of business operations, the location of operations, capital structure and compensation of executives.”
Five months before tax reform was introduced, only 30% of boards that responded to the National Association of Corporate Director’s annual public governance survey foresaw tax reform as among the top five trends that would have the greatest effect on their company over the next year, according to the 2017-2018 survey.
Now, TCJA has changed the landscape and become “a game-change” for corporations, stresses A. Gilchrist Sparks III, past chairman of the corporate laws committee of the American Bar Association’s business law section.”
“This is an exciting time for boards and management as they look at the opportunities,” Sparks says. “You want to make sure you take full advantage of it.”
Still sorting it out
The previous rewrite of the tax system — the Tax Reform Act of 1986 — took two grueling years of rewrites, hearings, political horse-trading and a few brushes with death because of a lack of votes during the process.
By the time it was signed into law, tax professionals had a pretty good idea of what the bill contained, Rosenthal says. This time around, the bill flew through Congress. Now, three months after passage, tax professionals are still trying to figure out TCJA, which is astounding compared to previous overhauls, he adds.
Although the legislation has been touted as tax simplification, it is extremely complicated. And there are inconsistencies, gaps and mistakes.
“A massive bill like this — enacted in 50 days, affecting almost $10 trillion gross (roughly $5.5 trillion in tax cuts and more than $4 trillion in tax increases), rewriting almost the entire U.S. tax system — is clearly going to have provisions that need correction or clarification from the IRS and Treasury and some things that need to be fixed,” says Jeffrey C. LeSage, Americas vice chairman of tax services at KPMG.
The ultimate impact of tax reform on corporations could take years and will vary by industry and the individual company. For example, the ramifications for a strictly domestic business will be different from a multi-national corporation.
“At this point I’m seeing boards reluctant to make significant changes to their organizations until they fully understand the implications,” says Matthew Becker, head of the National Tax Office of BDO USA, an accounting and financial advisory firm.
Alex Raskolnikov, a professor of tax law at Columbia Law School concurs: “Companies are treading gingerly.”
Still, the immediate effect of the bill will be cash in the wallets of U.S. businesses as a result of repatriation of overseas cash and a decline in the tax rate.
Apple Inc., for example, is reported to have $252 billion in overseas earnings that had been kept off-shore because of the previous system’s high U.S. tax rate. Under the new tax regime, that cash can be repatriated at a far lower tax rate.
The big tax policy questions, notes Rosenthal, include:
• What will they do with the cash?
• Will they return the extra cash to shareholders in the form of dividend and stock buybacks?
• Will they keep extra profits and invest in workers and plants and equipment?
Options for using the windfall include investment in research and development, new factories, employee training, new job creation, higher wages, repayment of debt, employee bonuses, product improvements, rate or fee reductions for customers, stock repurchases and dividends to shareholders.
The allocation of any windfall has become something of a spectator sport with organizations and political groups attempting to compile data on what companies are doing.
A report compiled by JUST Capital, a non-political data organization, found that of the 117 companies that had announced their intentions by mid-March the majority appear to be allocating their tax savings to investors in the form of buybacks or direct distributions.
Buyback volume jumped to $223 billion from January to mid-March, just shy of the previous record of $226 billion in the fourth quarter of 2007, according to Winston Chua, spokesman for TrimTabs, an independent research firm focusing on equity market liquidity. Of the $153 billion in buybacks announced in February, 67% was from just 10 companies, including Alphabet Inc., Cisco Systems Inc. and Amgen Inc. Bank of America Corp. has told investors most of tax savings will go to shareholders.
Another 19% of those who have revealed plans say they have committed to job creation, according to JUST Capital, whose mission is to build a marketplace that reflects the priorities of the American people.
Apple announced it would invest more than $30 billion in U.S. capital expenditures over the next five years and create more than 20,000 jobs.
Six percent of companies tracked by JUST Capital report their windfall will go to workers in the form of bonuses, wage increases, expanded benefits, employee training or other services.
The Walt Disney Co. announced an initial $50 million investment in employee education programs.
Another 6% of companies announced they’ll allocate money to improving product benefits or quality, while 5% reported their tax savings are earmarked for customers through such things as rate and fee reductions and improvements in customer experience, according to JUST Capital.
Looking ahead, directors will need to lean on their tax and finance leaders.
These professionals will have to dissect TCJA so board members understand how it will affect their company, counsels David Katz, a partner at Wachtell, Lipton, Rosen & Katz.
Boards, adds KPMG’s LeSage, should consider adding regular tax discussions to their agenda. The company should be running models to see if the corporation comes out a net winner or a net loser.
“Directors should expect clear explanations of their exposures and liabilities and how they are being reported and addressed,” LeSage advises. “They should be comfortable with their organizations’ efforts to come to a reasonable interpretation of the law.”
When it comes to asset allocation, board members should also be mindful that the world is watching and evaluating decisions. Glenn Booraem, investment stewardship officer at The Vanguard Group Inc., advises directors to look at what’s best for their companies from the standpoint of long-term value creation.
Next, shareholders should get a prompt and comprehensive statement about how tax reform will affect corporate strategy, says Nell Minow, vice chair of ValueEdge Advisors.
“Directors have the opportunity to reflect on what kind of company they want to build and what creates value,” says Martin Whittaker, CEO of JUST Capital.
It’s a process some directors are enthusiastic about.
“It’s always exciting when companies need to navigate and manage change,” maintains Margaret M. Foran, a director of Occidental Petroleum Corp.
Maureen Milford is a Delaware business writer focused on corporation law and corporate governance matters.