With the passage of the 2017 tax reform reconciliation act in December, it’s time for private equity firms to take a fresh look at their tax positions. Here are some of the high-level issues to consider.
Deal financing: The new tax rules significantly limit the deductibility of interest for US entities. As a result, the after-tax cost of debt for acquisitions may rise. Firms should reconsider the location of borrowing (US versus international) and potentially rethink/remodel their capital structures.
Pass-through vs. corporate income: Tax reform has led to a significant change in rules about pass-through versus corporate income. This will require PE firms to refresh their analyses of how to structure deals. The suitability of various ownership structures (e.g., corporation versus partnership) will have to be examined in light of the new rules.
Toll charge: When considering deals, PE firms will have to determine the amount of the toll charge, (including how the target calculated and planned for the charge) and quantify the future impact (e.g., if the target elected payments over eight years).
Toll charge: Portfolio companies will also have to determine the amount and impact of the toll charge. Now is the time for planning to move cash to discharge the tax obligation and redeploy cash and offshore earnings.
Valuations: The changes brought by reform require companies to reassess the impact of the new tax law on their financial statements. That includes revisiting deferred tax assets and liabilities as well as the projected cash flows of portfolio companies, as these will impact company valuations.
Value chain: The lowering of corporate tax rates, move to a territorial tax system, and new rules and approaches to taxing the value chain of companies across sectors may require companies to restructure. These changes could also drive decisions about future investments as well as the locations of intangibles and the workforce.
Individual tax: Higher effective tax rates for individuals will require managers and principals to reconsider where they personally reside and where the management company is doing business.
Entity choice: Given that PE firms and asset and wealth management (AWM) managers are not eligible for the pass-through special rate, they may need to reevaluate how they are organized (e.g., as a corporation, limited partnerships, or S corporation) to optimize their tax status.
Impact from portfolio companies: Under the new tax rules, the co-investment vehicles and control of portfolio companies through the general partner could result in increased reporting and income pick-up at the management company level, even before investment returns are distributed.
Valuations: Evaluating the impact of tax reform on portfolio companies or targets is important to determine impact on cash flow and other key indicators that drive value.
Consistency: Taking a standardized approach ensures proper controls for data and methodology used for modeling.
Opportunities: Help identify areas impacted and allows prioritizing impact that is short term versus long term. This can be helpful in determining if there are opportunities or pitfalls that are simply timing related.
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Private Equity Tax Leader, PwC US