How businesses plan to use cash from tax cuts for M&A

High asset valuations, regulatory issues and trade risks make boards and businesses cautious.

Many businesses know what they want to do with the extra cash generated by the US Tax Cuts and Jobs Act (TCJA): spend it on strategic mergers and acquisitions.

According to our survey of 500 US C-level executives released in March 2018, 42% of respondents plan to use their savings to pursue M&A transactions. Mid-cap companies are the most acquisitive, with 82% planning to accelerate their M&A strategies compared with 72% of large-cap companies and 69% of small-cap companies.

Yet businesses aren’t rushing out to do deals. Observers agree that asset valuations are high, making boards reluctant to commit to large acquisitions, according to a Reuters report. Increasing regulatory and trade risks are also making businesses cautious. The US introduced tariffs on imported aluminum and steel goods, solar panels and washing machines this year, and then followed up by announcing another US$50 billion in additional tariffs on goods produced by Chinese firms.

China has responded in kind with tariffs on 128 US products including wine, apples and almonds. In March 2018, US President Donald Trump issued an executive order that blocked Singapore-based Broadcom Ltd.’s hostile takeover of Qualcomm Inc., citing US national security.

As for reactions to US tax reform, which was signed into law on December 22, 2017, corporate development strategies and M&A markets remain in the evaluation phase. Beyond the headline rate reductions, taxpayers are still sorting through all the nuances and implications of the new tax law, and its impact will continue to affect markets going forward.

Businesses must also assess how they will fund transactions. The decline in corporate tax rates reduces the prior law benefits associated with debt, making high levels of leverage less appealing, according to our report, How can finance executives walk the tax reform tightrope? Making capital allocation decisions in light of US tax reform. Businesses should review their entire global financing structures post-TCJA, according to the report.

Finally, businesses need to consider M&A transactions from two perspectives, that of a US buyer or seller vs. that of a non-US buyer or seller. These different viewpoints have implications on everything from valuations to deal structure, according to Auri Weitz, EY Americas Transaction Tax Market Leader.

“It is complicated legislation, but what we’re starting to see is how certain aspects of the legislation can have different impacts to US and non-US buyers and sellers,” says Weitz. “I think we will see a gradual shift over time in the marketplace as US taxpayers begin to understand how to maximize these differences.”

Built to last?

A key concern raised by corporate dealmakers is the longevity of such reforms. The impact of the TCJA could be reduced if other jurisdictions follow suit and reduce their corporate income tax rates.

There’s also a chance that aspects of the TCJA could be modified by future US Congresses. Any legislation that clears the legislature would have to be signed by President Trump, making it unlikely that there could be major changes to the TCJA.

Even if such a change in congressional control occurs, Greene is quick to add that there is a strong case to be made that US tax rates are now, finally, at parity with other developed countries and that there’s not much room for further maneuvering. Thus, “there will still be considerable resistance to undoing what took so long and so much work to accomplish —at least for the foreseeable future,” says Greene.

Key action points

• Revisit fundamental strategies. With the stroke of a pen, the US is no longer a (relatively) high-tax jurisdiction. This should have profound implications for all aspects of corporate development, including M&A.
• Delve in to the details. The TCJA is a complex set of rules. There is much to consider, and businesses should carefully analyze the implications before making a strategic move.
• “Dual-track” your divestitures. Sellers should examine how their asset might look different to a non-US vs. a US buyer. Changes to the deal structure based on buyer domicile can greatly impact tax effectiveness and valuation.

This article was originally published in Tax Insights on 31 May 2018.