The Trump plan to overhaul the US tax code has moved very close to finally becoming law, with a final vote expected next week and the couple of senate Republican holdouts looking like they’ll now back the measure, giving it just about enough votes to pass. While the political back and forth has been interesting to follow, it’s less important to us in the finance section than the fact that it is about to come into effect.
But what exactly is it that we’re looking at that will pass and what impact is it likely to have on tech company finances? There are a few headline provisions which will have a big effect on corporate finances, including on our favourite companies to follow in this section, places such as Intel (NASDAQ:INTC), NVIDIA (NASDAQ:NVDA), AMD (NASDAQ:AMD), Facebook (NASDAQ:FB), Google (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN) and others.
Foreign Earnings Repatriation Tax Holiday at 15.5% and 8%
As we’ve reported in the past. The current regime of US taxing for multinational corporations foreign earnings is somewhat nonsensical. Corporation tax in the US is of course ridiculously high as things stand today, ringing in at an eye-watering 35%. Luckily for many large companies which operate across borders, they also effectively have an out on paying this rate due to the fact that they don’t have to actually write a cheque to the Treasury until they actually bring the cash back into the US proper.
Loopholes aside (such as the one where they calculate this as part of their global effective tax rate, even though it isn’t physically paid), what this means is that US corporations are holding an estimated $2tn to $3tn in foreign offshore tax havens such as Ireland and the Netherlands among others. Ultimately this is an inefficiency from a purely capitalist perspective because what it means is that rather than attempting to generate more wealth and economic activity via some form of investment, this money just runs around the world trying to escape tax jurisdictions such as the US and the EU.
Well, the tax holiday for foreign earnings is approaching. In current form, the bill does ratchet it up from what was originally hoped for, settling in on a final rate of 15.5% for cash and equivalents, dropping to 8% for illiquid assets (such as factories, plant machinery etc). The higher rate was a side effect of the fact that the bill itself is going to be nowhere near fiscally neutral and is estimated to pile at least an extra $1tn on to the US national debt over the next decade. The original senate version of the bill had passed at 14.5% and 7.5%, but the increase brings about an extra $40bn into government coffers.
The important point to note here is that it is not optional, as the current 35% rate is, meaning that the money itself will become due and the corporations will have to actually pay the US government tax on this money.
Corporation Tax Rate Cut from 35% to 21%
Corporation tax in the US is at a staggeringly high 35% as things stand today. A rate which puts it out of step with much of the developed world with the nearest major economies being Japan at 32%, Germany at 29%, China at 25% and the UK at 19%. A cut to 21% would align it much more closely with other countries (the OECD average is about 25%) and the Republicans are hoping that this sparks a flame under industry to ignite economic growth. Independent economics and even Fed Chair Janet Yellen however have downplayed such speculation with Yellen predicting only “some modest uplift” in US economic growth as a result of the tax cut.
Again however, what we have here is an effort to not just tax US activity less, but also an incentive for companies to start looking at their money in a more traditionally capitalist manner. By which I mean moving it to where they can get the best return on investment. Something which current tax law doesn’t really facilitate because companies keep cash in low yielding territories to avoid paying a massive tax bill if they bring it back to the US. Under the new rates, the objective of course is that if they generate a lot of profit in another major economy and pay the tax there, they won’t have to pay any tax to the US if they paid 21% or more where the profit was generated.
What this also does however is drop the tax bill for any company which has US operations and here again, we have a significant technology company benefit with a Cowen analysis of Google (NASDAQ:GOOGL), Facebook (NASDAQ:FB) and Amazon (NASDAQ:AMZN) predicting a large earnings per share boost for each of the companies, Amazon being the biggest winner at a 24% increase saving $723 million, Google and Facebook with an 8% bump each saving $2.3bn and $1.6bn respectively.
What to Watch for Next?
Well, there is the small step of the vote to pass next week, but expectations are high that it will pass in its current form. Once that has passed, there are a few things to watch out for.
Multinational corporations will try to sink as much of their foreign cash holdings into the 8% bracket as possible, prior to bringing back anything that remains to the US. This could mean a spending bonanza for overseas operations but is also likely to produce some accounting manoeuvring as well.
Once this has been done, there is effectively no barrier to these companies bringing this money back to the US from the low tax jurisdictions which they currently reside in. At that stage, there are several potential routes for the money to go including bringing forward large capex projects, R&D expenditure and an increase in M&A activity as well as venture capital fund arms of the corporations as they look for the next big thing so the number of tech startups in the US getting funded should increase too.
It’s going to be an interesting 2018! I’ll be seeing the New Year in from Mauritius. I hope you all have a great Christmas and New Year and a prosperous year of investing in 2018.