January 10, 2018

Tax Reform: Implications for M&A Deals

This Sullivan & Cromwell memo  highlights some of the key ways that M&A transactions are likely to be impacted by the recently enacted U.S. tax reform legislation.  Here’s an excerpt addressing some of the implications for tax-free and taxable transactions:

Increased Available Cash. There should be significantly more cash available for acquisitions of U.S. companies and assets due to the mandatory deemed repatriation of offshore earnings and profits, combined with the 100% dividends received deduction from a U.S. corporation’s foreign subsidiaries. (As a technical matter, this “participation exemption” applies to the foreign-source portion of dividends distributed from a controlled foreign corporation to a “10% shareholder.” For this purpose, a 10% shareholder is a shareholder that owns 10% or more of the vote or value of any foreign corporation, and a controlled foreign corporation is a foreign corporation more than 50%-owned by 10% shareholders.)

–  Effect of Immediate Expensing of Capital Expenditures. Although the immediate expensing of capital expenditures makes taxable transactions more attractive, we do not expect to see a significant shift away from the paradigm wherein sellers favor tax-free transactions and buyers favor taxable transactions. The immediate 100% deduction mostly applies to property that was already subject to an immediate 50% deduction under prior law (mostly machinery and tangible goods), and not to property like real property, intellectual property, and goodwill. As a result, a taxable transaction is still a trade-off between immediate ax to the seller and a future benefit to the buyer. Moreover, there may be limited financial statement benefit (other than timing) to the accelerated depreciation of properties otherwise entitled to bonus depreciation.

Reduced Benefit of Tax-Free Spinoffs. The benefit of tax-free spinoffs is significantly reduced. As a result, there are likely to be more taxable separations (including spinoffs electing to be treated like sales under Section 336(e)). Splitoffs and debt-for-stock exchanges in the context of spinoffs may also appear incrementally less attractive relative to taxable separations (e.g., a sale) in the lower tax rate environment.

Tax Due Diligence. M&A tax due diligence procedures should be reviewed in light of the changes in the Act. For example, until balance sheets and income statements catch up to the changes in the Act, acquirors should carefully examine the current and deferred tax accounts on a target’s financial statements.

The consensus of most commenters appears to be that tax reform will have an overall positive effect on the M&A environment, due to the repatriation of significant amounts of cash into the U.S., and lower corporate tax rates that will help juice buyers’ returns & give them more room in pricing discussions with potential sellers. We’re posting memos in our “Tax” Practice Area.

John Jenkins