Liquidity and Cash Management Opportunities
Under the previous law, U.S. companies were taxed on a worldwide basis and many corporates deferred taxes on certain foreign earnings by keeping them offshore, with funds only being taxed when brought back into the country. The U.S. Tax Cuts and Jobs Act (TCJA) changes this with its deemed repatriation provision, whereby accumulated foreign earnings from 1987 to 2018 are “deemed” to have been repatriated regardless of whether or not they have been physically moved to the U.S. Historical earnings invested in cash and cash equivalents are subject to a 15.5% tax, while illiquid investments will be taxed at a rate of 8%. Companies can choose to pay taxes all at once in 2018, or make interest free payments in increasing percentages over the next eight years. The new tax law is also moving from the worldwide system to a territorial model, meaning that most foreign dividends received by a U.S. company will be 100% exempt going forward.
Combined, these two provisions will create opportunities for U.S. companies, making it easier to move funds onshore. As a result, we may not see the same level of overseas cash accumulation as we have in the past. Deemed repatriation in particular may have a short-term impact on liquidity for companies who choose to mobilize cash to pay taxes off at once.
In the longer term, some corporates may need to reevaluate their approach to liquidity and cash management as it relates to foreign earnings and subsidiary funding strategies. Tax reform may provide an incentive for multinational companies to repatriate idle balances to a centralized treasury based in the U.S. This might create opportunities for those who currently maintain operating accounts in the various jurisdictions where they do business
In markets where U.S. corporates have full-fledged operations integrated with the local supply chain and use a wide variety of receivables, payables, credit and liquidity management solutions, it may make more sense to keep local in-country accounts. However, in markets where they only make ad-hoc payments to local suppliers, there may be an opportunity to rationalize account structure in the U.S. Rationalization is not only more cost effective, it simplifies account management. It can also lay the groundwork for centralizing treasury operations and setting up payment factories or shared service centers in the U.S. This enables the implementation of a global payment platform that delivers common disbursement capabilities across various markets, as well as a range of other benefits such as single window access, a consistent client experience and effective liquidity management.
International companies will also need to think about how cash coming back into the U.S. will impact the way they fund local subsidiaries overseas. In the past, foreign subsidiaries may have had easy access to sufficient liquidity to fund themselves. As a result, we expect many companies to keep some liquidity offshore for day-to-day operations. Others, however, may opt to repatriate cash and fund subsidiaries from the U.S. In this case, corporates may want to consider setting up liquidity arrangements that either automate the movement of cash surpluses from foreign subsidiaries to the U.S. or automate funding of foreign subsidiaries from the U.S.
Implications of the BEAT Tax and the Limit on Net Interest Expense Deductibility
While provisions like deemed repatriation and the move to a territorial tax system will result in opportunities for corporates, others will require more consideration. For instance, the Base Erosion Anti-Abuse Tax (BEAT) and the limit on net interest expense deductibility may have an impact on intercompany funding arrangements.
BEAT is a new tax that companies may be liable for depending on the amount of deductible payments they make from the U.S. to their foreign entities. The intent is to ensure that corporations making large deductible payments to these affiliates do not escape U.S. taxation.
This is likely to affect corporates using intercompany loans to borrow liquidity from their foreign affiliates – which includes cash pooling schemes – because the interest payments made on these types of lending are considered “BEAT-able.” As a result, it will be critical for U.S.-based corporates to have a great deal of control and visibility over payments being made to subsidiaries. Some banks have tools that will help with this, enabling corporates to set up parameters to limit intercompany borrowing and lending between participating entities within their cash pool. The full impact is still unknown, however, as companies are currently waiting for clarification from the IRS on a number of points around BEAT.
The limit on net interest expense deductibility is another provision that companies may need look at more closely. Previously, 100% of net interest expenses were deductible. Under the
TCJA, however, net deductions are limited to 30% of adjusted taxable income (ATI). This may make borrowing less efficient.
The TCJA is complex and needs to be looked at holistically as its provisions are intertwined. It’s important to gain a complete understanding of existing and planned arrangements, and work with your tax advisor to assess the specific impact the reform is likely to have on your company. For instance, with the reform and the interest rates currently rising – you are likely to have access to more cash and the opportunity to get higher returns, making it a good time to optimize your liquidity. That’s where your international banking partner can help, reviewing your existing liquidity and cash management strategies and discussing the tools and solutions that will help you make the most of your opportunities while also mitigating any potential risk.