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Tax Overhaul May Be Boon to M&A Despite House, Senate Conflicts

As House and Senate Republicans race to bridge differences in sweeping tax-overhaul bills, experts say the plans could be a boon to mergers and acquisitions, while their impact on leveraged buyouts wouldn’t be as painful as private equity investors feared. Yet the latest drafts of the bills differ in key ways.
Rise In M&A

"There could be a major spike in deal making” if either of the bills took effect, said Andrew Kreisberg, a partner at White & Case LLP specializing in domestic and international tax law.

That’s because two provisions in the bills may set the stage for a wave of acquisitions, he and others said. First, they would slash the levy that companies pay on repatriated foreign earnings. The current tax on income brought home -- 35 percent -- has encouraged U.S. companies to stash an estimated $2.6 trillion abroad. The House bill would set a one-time 14 percent tax on cash assets, designed to halt the practice and bring much of the money back to the U.S. The House previously had proposed 12 percent.

The Senate plan, released Thursday, would impose a one-time 10 percent charge on returned cash.

The repatriated mother lode could trigger a buying spree by U.S. companies. And not just domestically. Because the bills additionally would eliminate tax on U.S. companies’ future foreign earnings not held abroad, they could spur cross-border M&A by making it easier to repatriate cash.

"Making it simpler to bring cash back could encourage investments outside the U.S.” Kreisberg said.
Private Equity

For leveraged buyouts, there’s good and bad news. Private equity sponsors caught a break on interest deductions, a pivotal matter. Buyout firms currently can saddle companies they buy with debt and then deduct 100 percent of the interest cost from the companies’ taxed earnings. The deduction is crucial to the returns that sponsors reap.

House Speaker Paul Ryan had pressed to abolish corporate interest deductions -- a move that would make buyouts unworkable. House tax writers settled on a less severe rollback that would cap the deduction at 30 percent of a company’s earnings before interest, taxes, depreciation and amortization, or Ebitda.

The cap in the Senate bill is stingier: Just 30 percent of a company’s earnings before interest and taxes. That’s a big difference, since depreciation and amortization are major components of Ebitda.

In addition, resolving another disparity in the plans will have an impact. While both bills would cut the federal corporate tax rate to 20 percent from 35 percent, the Senate bill delays the reduction taking effect by one year.

Healthy companies with high Ebitda-to-interest would come out ahead in the House bill. In 2016, National Vision Holdings Inc., controlled by buyout firm KKR & Co., would have paid about 35 percent less in federal tax under the House bill, according to an analysis by Bloomberg.

Under the Senate plan, the company would have paid about 13 percent more in year one. In year two, assuming a 20 percent rate, its 2016 federal tax would have been nearly unchanged.
Modest Rise

National Vision is unusual, since most private equity-backed businesses have lower Ebitda-to-interest ratios. Under the House bill, a typical privately owned company, according to a Nov. 9 Morgan Stanley report, would see its effective after-tax cost of debt rise modestly, by less than half a percentage point.

Ailing, debt-laden companies that currently pay no federal tax may owe money they can ill afford.

The House plan would allow companies that can’t use the full interest deduction permitted in a given year the ability to carry forward the unused amount for five years. The Senate’s has no time limit for roll forwards.

"Even though your interest deduction is limited, you can carry it forward,” said Ernst & Young LLP tax principal Gerald Whelan. "If you use your cash flow to pay down debt, maybe your rate won’t be 20, but it won’t be that far off. You can still do better than with the current 35 percent rate.”
Expensing Tangible Assets

Perhaps the biggest difference in the bills related to M&A is this: The House’s bill would give buyers a massive gift by letting them immediately deduct the entire value of the tangible assets -- equipment, buildings, land, inventory -- of businesses they acquire. Now such deductions must be spaced out over five or more years.

There’s a catch. Buyers must structure the deal as a purchase of a target’s assets and not of its stock, as with many current buyouts and acquisitions. While stock purchases often are easier to structure, asset purchases are a way to maximize a deal’s cost basis and boost deductions.

If a buyer later sells the business and reinvests the proceeds in another acquisition within a year -- also structured as an asset purchase -- it could then use the up-front deduction from the second acquisition to offset capital-gains taxes incurred in the sale.

Peter Furci, co-chair of Debevoise & Plimpton LLP’s global tax practice, compared the proposed break to the "like-kind” tax deferrals that home buyers are allowed.

"This certainly could spur M&A activity because people will want to buy to take advantage of it,” he said. "It would incentivize people to accelerate purchases.”

While the Senate bill includes a provision to speed such deductions, its scope is far narrower than the House’s, applying only to assets recently put into service.

Under both bills, the swifter deductions would end after 2022.

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