DealLawyers.com Blog

There’s a lot to chew on in the GOP’s tax reform legislation, but many dealmakers may choke on this morsel – in its current form, the legislation would limit the amount of interest that a business could deduct to 30% of its adjusted taxable income. This Bloomberg article discusses the potential consequences of that cap for M&A transactions.  Here’s an excerpt:

Private equity titans, beware: The tax bill House Republicans unveiled on Thursday could have seriously negative implications for buyout firms.

The legislation includes a provision that would cap interest deductibility at 30 percent of adjusted taxable income, a dramatic shift from the 100 percent allowed now. While the shift would be a concern for any company that issues loans and bonds, it would be particularly worrisome for private equity firms that rely on large levels of debt to finance their transactions. These borrowings — and the way they are treated for tax purposes — are crucial in helping firms achieve their targeted annual returns of 20 percent or more.

Many M&A professionals have anticipated that a reduction in corporate rates might prompt a boom in deals – but limiting the deductibility of interest on debt incurred to pay for those deals could dampen those expectations.

In the short term, the article notes that one potential consequence of the deductibility cap might be a shift in private equity investment toward more capital intensive businesses.  The proposed legislation would temporarily allow capital expenditures on machinery & equipment to be expensed immediately, instead of depreciated over time. That provision would be phased out after five years – but that coincides with many private equity funds’ typical investment horizon.

– John Jenkins