Candice M. Turner Northeast Service Line Leader M&A Tax Grant Thornton Christine Watson Partner – Insurance Tax Deals Leader PricewaterhouseCoopers
September 17, 2019
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1 Tax Cuts and Jobs Act of 2017 Overview
2 State Law Issues
4 Questions
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Summary
• 21% flat federal tax rate. • Corporate AMT repealed. Prior year AMT credits refunded over 2018-2021. • Blended rate applies for fiscal year taxpayers.
Practical considerations
• Acquisition Structures - Asset vs Stock Deals. • Deal Model -
- Model US with lower corporate tax rate - Present value of certain tax benefits reduced in light of lower corporate tax rate
environment: Deferred tax assets (e.g., NOLs, depreciation and amortization, etc.). • Life/Nonlife consolidated return enhanced scrutiny • BEAT, particularly on reinsurance • GILTI
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• The new tax rules significantly limit the deductibility of interest for US corporate and pass-through entities. - Interest expense deductibility limited to 30% of a business’s ‘adjusted taxable
income’ (i.e., EBITDA until tax year 2021 and EBIT beginning after 2021). - Disallowed interest carried forward indefinitely.
• Notice 2018-28 - - Application of Section 163(j) limitation at the consolidated tax return filing
level. - Allowing the carryforward of a taxpayer’s disallowed disqualified interest that
arose under Section 163(j) prior to its amendment. - Allowing a partner to take into account its share of the partnership's net
interest income
Deal Financing
Summary
• NOLs arising in taxable years beginning after 12/31/2017 limited to 80% of taxable income. Pre-2018 NOLs are not impacted.
• Unlimited carryforward, no carryback. Practical considerations
• FMV of NOL - Present value of NOLs reduced in lower corporate tax rate environment.
• Limitation/Timing - 80% limit will slow the ability to use NOL carryforwards in post- closing years, potentially affecting overall deal value.
• Purchase Agreement - Considerations/restrictions on ability to carryback pre-2018 NOLs to pre 2018.
• Elimination of carryback may reduce tax value of transaction expenses (e.g., banker fees, compensatory payments, debt payoff costs, etc.) as NOLs would not be utilized until the company generates sufficient post-acquisition taxable income.
• Limitation may affect highly-leveraged companies with significant interest expense, particularly when the debt is paid off / revenues increase.
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Structure: Flow-through v. Corporate Structure
• Corporate - The overall corporate marginal rate (combining the corporate tax rate and the top 20% individual rate on dividend income) is reduced from 48% to 36.8%, a 21.5% increase in after-tax cash.
• Pass through - The overall pass-through marginal rate (assuming full benefit of the new 20% pass-through deduction) is reduced from 39.6% to 29.6%, a 16.6% increase in after-tax cash.
• Double tax disadvantage shrinks - The relative tax inefficiency of the corporate form (measured in terms of after- tax cash) is somewhat reduced (a corporation can pay out dividends at a lower overall cash tax rate), so a wave of conversions from corporate to partnership form is unlikely. The “gross up” on asset vs stock deals shrinks, thereby making asset deals more attractive.
• Accumulated earnings tax - Partnerships may instead contemplate conversion to corporations to take advantage of the lower-taxed compounding of earnings inside a corporation, but such conversions must consider the impact of the accumulated earnings tax (a 20% tax on earnings that accumulate “beyond the reasonable needs of the business”).
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Reduced double tax on asset sales (combined 36.8% v. 48%)
Immediate expensing of a target's intangible assets Reduced tax exposure for taxable spin-offs 21% v. 35%)
Benefit of tax attributes are reduced (e.g., "stepped-up" basis and target's NOLs)
More complex tax due diligence process (toll charge, GILTI, FDII, BEAT, etc.)
Post-2017 NOLs are limited to offsetting 80% of taxlable income (with indefinite carryforward)
Interest deductions are limited to 30% of adjusted taxable income (EBITDA; starting 2022 EBIT)
Tax reform changes for M&A
Impact on M&A activity
• Additional after-tax income may boost company valuations, raising prices and sense of urgency to initiate deals.
• Higher after-tax margins can lead to future stronger earnings and opportunities for return on investment.
• Foreign-based parents will be attracted to lower tax rates in the modified US tax system
• Expectations of US economy expansion my increase, boosting inbound business outlook
• Foreign source dividend changes put US multinationals in new tax-favorable position
• Emerging markets could offer access to new customer base and more premium
• Review M&A objectives and determine if they will change as a result of tax reform
• Consider the strategic timing of M&A, including short-term goals and longer-term horizon objectives
• Review geographic footprint and evaluate target domiciles to include in strategic objectives
• Evaluate global operations and identify new opportunities (supply chain, IP, etc.)
• Evaluate business line, geographic, and pricing strategy for net tax effect as a result of tax reform
– Capital planning management strategy and pricing for new business
– After-tax earnings prospects and risk profile of pre and post tax reform balance sheets
• Assess and evaluate valuation modifications to further consider tax reform for in flight targets
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A lower US corporate tax rate, the discontinuance of higher US tax on foreign profits, and the repatriation of cash into the US could boost M&A activity. Themes that may impact M&A Actions for corporate development
Valuations may rise, but so will expected after-
tax earnings
M&A activity
expansion
What happened in Wayfair?
Historically, under Quill and National Bellas Hess, some form of physical presence was necessary for states to require companies to register for, charge, collect, and remit sales tax South Dakota law • Direct legislative challenge to physical presence rule adopted in Quill • Imposed tax collection obligations on certain remote sellers that sell tangible personal
property or services for delivery to South Dakota customers • Specifically, economic nexus rules apply to remote sellers/marketplace providers if one
of two thresholds are met in either the current or previous calendar year: • Gross revenue for such sales exceeds $100,000; or • Seller engages in 200 or more separate in-state transactions
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What happened in Wayfair?
South Dakota v. Wayfair, Inc. (June 21, 2018) • Ruling: In a 5-4 decision, the U.S. Supreme Court held that the South Dakota economic nexus
statute satisfied the substantial nexus standard • Expressly overruled Quill and National Bellas Hess decisions stating that the physical
presence rule is "unsound and incorrect" • The case was initially remanded back to the South Dakota Supreme Court • On September 12, 2018, the South Dakota Legislature passed a pair of bills enacting
enforcement dates for the economic nexus provisions on remote sellers (effective 11/1/18) and marketplace providers (effective 3/1/19)
• Fundamental change in constitutional sales tax nexus standard that has been applied for over 50 years
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Prior to Wayfair • For the past several years, states have found increasingly creative ways to expand sales tax nexus
requirements, including affiliate nexus, click-through nexus, cookie nexus, marketplace nexus, and economic nexus
• Several states enacted economic nexus legislation and/or issued guidance requiring remote sellers to register, collect and remit sales tax
• The effective dates and threshold amounts of the laws vary • As of the date of this presentation, not all the states have provided guidance on whether or
not their laws will be retroactively applied to their original effective dates
What are states doing in response?
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CAVEAT: This map provides a summary of those states that enacted economic nexus legislation or provided guidance as of June 21 2018, and where we anticipate laws to be passed in the future. Due to amount of activity by the states around economic nexus, it is important that company activities are reviewed on a state-by-state basis to determine the potential sales tax nexus implications as the rules are continually changing.
Economic nexus footprint as of 6/21/18
What are states doing in response?
Since Wayfair • Increasingly more states have enacted economic nexus provisions that have been relatively
consistent with South Dakota's statute, and we anticipate that all states that impose a sales tax will enact similar provisions within the next several months
• How are states doing this? • Legislation to the extent states are still in session • Regulations and guidance from state tax authorities
• Potential traps • Revenue threshold measurements (varying amounts, gross vs. taxable) • The “and” versus “or” test • Effective/enforcement dates
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17 © 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd
CAVEAT: This map provides a summary of those states that enacted economic nexus legislation or provided guidance as of August 21 2018, and where we anticipate laws to be passed in the future. Due to amount of activity by the states around economic nexus, it is important that company activities are reviewed on a state-by-state basis to determine the potential sales tax nexus implications as the rules are continually changing.
Economic nexus footprint as of 8/21/18
Does Wayfair apply to me?
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Wayfair doesn't impact my business . . . or does it? • The decision only applies to internet retailers • The decision doesn't apply to my business because I don’t sell taxable products or services • I perform services for customers in just one state, and I only need to be worried about the tax
implications in the state where the services are performed • The economic nexus thresholds only apply to taxable sales • The nexus rules only apply prospectively, and I don't need to be concerned about prior periods
Common misconceptions on Wayfair
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• I have treaty protections on my inbound sales • The decision only impacts sales tax • This decision does not have an impact on my financial statements • My staff, systems, and sales tax process are able to handle the increased compliance and
administrative burden
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• Sales of products or services to customers throughout the United States • Filing sales and use tax returns in a limited number of states • Historical reliance on physical presence for making nexus determinations (for both sales/use and
income/franchise tax) • Decentralized sales and use tax departments • Limited processes and procedures in place around sales and use tax • Limited processes and procedures around the collection, validation, and maintenance of
exemption certificate documentation • Limited tax automation systems in place to assist in the calculation and reporting of sales and
use tax
• Merger and acquisition activity • Impact of new or changing legislation:
• Economic nexus • Product taxability • Customer level exemptions
• State income/franchise tax implications
Be on the lookout
Wayfair Readiness Approach
What are the issues you identified resulting from the impact of Wayfair on your business?
What is your current process to assess risks and opportunities?
How are you engaging your current people, processes, and technology to address those risks?
How does Wayfair impact the future state of your business?
How will Wayfair impact your other state tax filings?
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Wayfair Readiness Approach
Where do I start? What do I potentially need to do?
Determination of state nexus and filing requirements - you will need to review the current activities of the Company, and continue to monitor those activities on a go-forward basis, to determine your nexus footprint and filing requirements from a sales/use and income/franchise tax perspective
State nexus study, voluntary disclosures
Determination of business impact - you will need to evaluate the impact from a business, customer, and competitive standpoint so all internal business partners are aware of the implications from a business perspective
Sales tax diagnostic, sales factor sourcing study, tax function outsourcing, refund studies, voluntary disclosures, loan staff
Determination of taxability of items and services - as your nexus footprint expands, you will need to evaluate the taxability of your sales in different jurisdictions
Sales/use taxability study, letter rulings, refund studies, voluntary disclosure
Sales tax system selection and implementation - as you expand into more states, you may need to update or implement a new sales tax engine to calculate, track and record sales tax for reporting purposes
Sales tax system and software automation
Sales and use tax compliance and registration - as the amount of states in which you are doing business increases, the compliance burden increases and you will need to consider how you can meet the increased compliance demands
State tax registration services, loan staff, sales tax compliance outsourcing
Managing documentation - keeping up with the lifecycle of all your documentation is complex and time consuming, and you will need to monitor compliance closely, including the collection, tracking, and maintenance of resale and exemption certificate documentation
Exemption documentation services, voluntary disclosures, audit assistance, merger and acquisition due diligence
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