The recent US tax overhaul continues to have wide-reaching implications.
The limit on interest deductibility is impacting the way that firms finance domestic mergers and acquisitions which is fueling the existing trend for US companies to pursue foreign M&A.
Why invest in foreign companies?
Growing a business internationally has always been attractive to US companies. Businesses are still structuring for tax purposes, however the main reasons for going abroad are now; the desire to find new markets with more customers, access fresh talent and technology and optimize international supply chains. Foreign markets can be an attractive destination for leading US brands given that if you can succeed in the world’s most competitive consumer market you may find you thrive in less developed economies.
With the recent tax reforms in the US, there have been some changes in the way deductions can be applied affecting the financing of domestic mergers and acquisitions. Often mergers are at least partially funded with debt which would be paid off in the form of a dividend. The dividend would be deductible making it a tax efficient way of financing the acquisition.
This deduction has been reduced greatly in the 2018 US tax reform. Companies were previously unrestricted in the amount of interest they could deduct before tax, but now there is a cap deduction of 30% of their 12-month earnings before interest, taxes, depreciation, and amortization (EBITDA). After 2021, the limitation becomes even more constraining by switching to 30% of EBIT only - that is, the deductions for depreciation and amortization are removed from the calculation, lowering the cap even further.
The deduction applies only when acquiring domestically, so not when buying a foreign company. You can still get the full deduction on dividends for a foreign owned corporation. Based on the current interpretation of the legislation, if you are looking to finance via debt, buying a foreign company will still allow you to benefit from this type of funding mechanism.
Why foreign M&A is more attractive
Other elements of the tax reform are also likely to drive further M&A and make it more likely that US firms look abroad for these acquisitions:
The tax reform was structured to incentivise businesses to bring money back to the US if they are holding historic earnings off-shore. This windfall of foreign held monies will enable some companies to invest more, with a portion of this spending likely to fuel M&A.
Related incentives to bring money back to the US have also reduced the tax on repatriation of future foreign earnings. Meaning that the return of investment for these foreign assets is improved.
What we are hearing from our clients is that US companies will continue to look to the global market as a way of leveraging faster growth and diversifying their business.
TMF USA are experts when it comes to M&A and international expansion, supported by a strong global presence in more than 80 countries worldwide. While there are always challenges when it comes to foreign investment the recent tax reform has introduced a whole new set of considerations. Please get in touch to find out how we can support your business achieve its global ambitions.
Jason Gerlis, Managing Director, TMF Group USA
Jason is responsible for TMF Group client delivery in the USA, Canada and the Caribbean. His teams support businesses expanding, or investing into the region. He is an experienced Corporate Director who regularly advises USA and Canadian businesses looking to expand abroad, as well as foreign companies and individuals coming to North America & Caribbean. Jason has been with TMF Group for five years, first based in London, but relocated to Miami, Florida in November 2014. Previously he worked at Deloitte Consulting LLP and Tesco PLC specializing in strategy, change management and Operating Model Development. Jason is a graduate of the University of Oxford and a Black Belt in Lean Six Sigma.
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