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Manufacturers and tax reform: Seize the opportunities

11 May, 2018

John Livingstone
Industrial Products Tax Leader, PwC US

The new tax bill is a game changer for manufacturers. For years, they have focused on cost containment to maintain profitability. But with lower tax rates, easier access to foreign cash, and favorable expensing provisions for buyers, manufacturers can think more about how to grow their business and prepare for the future. Manufacturers of capital equipment are twice-blessed because the expensing provision will stimulate demand for their products, especially during the next five years when companies can deduct 100% of the purchase price.

Manufacturing executives have some important decisions to consider, including these key ones:

Investment and growth opportunities

With more cash on hand, manufacturers have the opportunity to modernize their plants and processes. They can buy state-of-the-art equipment, boost IT infrastructure, and expand digitization of manufacturing facilities and supply chains. They also can rethink how they want to allocate capital and grow the business. With so many possible options, companies shouldn’t rush the pace of decision-making, but weigh pros and cons in light of a long-term strategic vision.

Supply chain complications

Three new provisions in the tax bill — GILTI, FDII, and BEAT — complicate manufacturers’ supply chain decisions, and may result in onerous cash tax costs this year. GILTI, intended to tax certain global intangible low-taxed income, does not apply only to ‘intangible’ or low-taxed’ income and may discourage US companies from moving future assets offshore. FDII (foreign derived intangible income) provides a tax benefit to exporters, such as aerospace and defense companies. BEAT (base erosion and anti-avoidance tax) taxes many non-US companies with operations in the US and US-headquartered companies with foreign affiliates, reducing the ability of large multinationals to shift income to lower-tax countries. Multinationals also have to consider the customs implications of the new tax provisions related to cross-border operations.

Deals/capital structure changes

The tax bill is likely to increase deal activity. More cash on hand and liberal expensing rules make it easier for manufacturers to acquire assets. And lower tax rates make it less burdensome to divest non-core assets. If tax reform provides an economic boost, it also will incent companies with high valuations to use their stock as currency in deal-making.

The new provision that limits the business debt interest deduction may result in more non-US borrowing to finance transactions. Some companies may borrow offshore and repatriate the cash to the US to pay for US loans.

I expect fewer companies will choose tax inversions as the revised US tax structure makes relocation generally less attractive. Also, inverted companies will incur GILTI and BEAT taxes.

Human resource considerations

The tax reform bill provides a one-time opportunity to accelerate deductions into higher-rate years and defer income into lower-rate tax years. Companies can take advantage of this situation to enhance the benefits of certain deductions, such as expanding pension plans to fund retiree medical expenses. This also is an opportune time to use repatriated offshore cash to fund any partially unfunded pension plans.

One controversial provision in the tax bill makes performance-based compensation subject to a deduction cap of $1 million and adds the CFO to the list of executives included in the cap. This cap may discourage compensation based on performance, causing pushback from shareholders who consider it part of a good governance strategy. We are awaiting guidance from the IRS and Treasury on this and other new rules. In the meantime, employers should prepare themselves for dealing with the potential impact on their HR policies.

Preparing for change

Manufacturers need to be prepared to deal with the ramifications of tax reform. Even during this time of uncertainty, companies should start to model the impact of new provisions before they begin planning discussions. Below are four critical decision areas along with several alternative choices:

  1. Where to deploy additional cash: invest in manufacturing capacity, digitize manufacturing plants, improve back-office processes, upgrade IT, invest in CRM capabilities
  2. How to grow: current business vs. new market opportunities, organic vs. inorganic growth, return capital to shareholders
  3. How to prepare for a demand increase: change sales/marketing messaging, adjust production levels, consider supply chain efficiencies and adjustments
  4. Whether to change the capital structure: borrow in the US or abroad, establish a global treasury function