June 18, 2019 - The Tax Cuts and Jobs Act enacted at the end of 2017 has impacted businesses and individuals and alike. After its passage, the LSTA hosted Latham & Watkins for a webcast on the projected impact of tax reform on financings. While predictions could be made then, much of the detail was left to implementing guidance and was then unknown. Last week, roughly 18 months later, Jiyeon Lee- Lim, Elena Romanova and Jane Summers, partners at Latham & Watkins, returned to give an update now that some of those details have been filled in.
As a refresher, generally speaking, the post-tax reform landscape for financings includes: 1) the new corporate tax rate of 21% (significantly lower than the top individual tax rate which may have implications for the drafting of restricted payment baskets), 2) limited interest expense deductibility, 3) under the new partial territorial regime, US corporations are now taxed on worldwide income (above certain tangible assets), but most dividends are received tax free, 4) increased ability to give foreign credit support in US borrowings, and 5) immediate expensing of US capital expenditures and post-2017 NOLs can be carried forward indefinitely but can offset only 80% of income. The two most important pieces of guidance relevant to leveraged finance are the proposed regulations under Section 163(j) (limitation on net business interest expense deductions) and the final regulations under Section 956. The former, which are expected to be finalized later this year, are still in flux and market participants should watch this space as it will impact how a borrower projects its cash flows. The latter was published in May and means that foreign credit support of US borrowings may now be tax free under certain conditions. With respect to foreign credit support, however, where it may be possible from a tax perspective, it may still not be possible or desirable for borrowers for other reasons, such as local law limitations and the high expense associated with taking collateral in some jurisdictions. We will see how the market evolves here.
In conclusion, overall the market is adjusting and the impact on leveraged finance transactions has been less pronounced than expected despite tax reform having implications for the place of borrowing or ability to obtain foreign credit support. This may change, however, as more IRS guidance is finalized. Further, certain provisions are scheduled to “sunrise” or “sunset”, such as the transition from EBITDA to EBIT for purposes of the 30% interest expense cap computation, immediate expensing phaseout and a higher tax rate applicable to GILTI, which could all also affect financings in the next few years as borrowers bear higher cash tax burdens in 2022.
The presentation and webcast replay are available here.