US companies count costs and benefits of Trump tax law
As John Gerspach, Citigroup’s chief financial officer, announced the bank’s first-quarter earnings this month, he told Wall Street analysts “the best is yet to come” from the overhaul of US corporate taxes that passed the Republican-controlled Congress in December.
A Financial Times analysis of how the Tax Cuts and Jobs Act (TCJA) has affected the accounts of the US’s 100 largest listed companies shows the truth of that sentiment, for Citigroup and most of its big business peers.
While investors and commentators have focused on the long-term boost to business from the act’s steep cut to headline corporate tax rates, most of America’s biggest corporations have first had to record one-off charges — and the question of what happens next is not straightforward.
In all, the FT analysis shows, 61 of the top 100 quoted companies have reported an initial net income tax expense, amounting to a combined $168bn. The remaining 39 have reported one-off net tax benefits worth a total of $150bn, meaning that the biggest overhaul of the tax code for a generation has cut $18bn from the current book value of its leading public companies.
That net figure seems likely to change: the Securities and Exchange Commission has given companies a year to finalise the accounting adjustments, as they work through the implications of a complex and ambiguous new law.
Meanwhile, the first effects of the reforms on actual tax bills are starting to emerge in the quarterly earnings season that has just got under way.
$240m
Drop in JPMorgan Chase’s first-quarter tax bill
Citigroup saw the biggest accounting hit in the FT’s analysis because the tax reforms reduced the value of the huge losses it recorded during the financial crisis, which it is able to offset against future profits.
However, the bank’s effective tax rate dropped from 31 per cent to 24 per cent in the first quarter, sharply increasing its earnings. Tax reform is “the boost the US economy needs”, Mr Gerspach said.
JPMorgan Chase similarly lowered its first-quarter tax bill by $240m even as its taxable income grew by $2bn. Bank of America’s tax outlay fell by a quarter and Omnicom’s effective tax rate fell from 29.2 per cent to 24.3 per cent. “As much as we’re all eager to see the benefits … I think we have to recognise that tax reform is still in the early phases,” JPMorgan’s chief financial officer Marianne Lake noted.
The far-reaching legislation was rushed through in December after heavy lobbying from corporate America.
The act bundled several important changes with the cut to the headline corporate rate from 35 per cent to 21 per cent. One reform that could increase tax bills for some companies is the new levy on global intangible low-taxed income, the so-called GILTI tax, which is likely to increase the rate paid by companies with high foreign earnings in low-tax jurisdictions.
There is also a one-off levy on past profits held offshore, which hits many multinationals with large cash pools abroad. The one-off accounting charges recorded so far and tallied by the FT include the cost of that tax, although companies can spread payments over the next eight years.
The charges differ widely from company to company, depending on the tax provisions they had made before the reforms. The most significant adjustments reflect a revaluation of deferred tax balances under the new, lower headline rate. A company that had deferred taxes on past profits would record a gain because it will now pay the new lower rate; conversely, a group carrying forward previous losses to offset against future tax bills would book a hit to its value.
Sandra Peters of the CFA Institute said that apparently non-cash accounting adjustments reflected real implications of the reforms. “These write-offs are true reductions in the value of the enterprise in book value and economic value,” she said. The companies “expected to get a deduction on their [future] tax returns, and they are still going to get it but it’s not worth as much”.
Pfizer shows how the adjustments made so far reflect the balance of different factors. The drugmaker reported a net tax benefit from the TCJA — an unexpected outcome because it held nearly $200bn in earnings offshore in 2016. While it forecast a $15bn tax bill on that offshore cash, that cost was swamped by a $24bn benefit from paying its deferred taxes at the new lower rate.
The biggest one-off benefit of $28bn was to Berkshire Hathaway, Warren Buffett’s holding company, which will pay the lower tax rate on decades of unrealised capital gains — if he ever sells his investments. While the accounting gains “did not come from anything we accomplished at Berkshire”, they were nonetheless real, Mr Buffett assured shareholders.
Citigroup’s net accounting expense of $22.6bn was roughly equivalent to its operating profit before taxes last year, but bank executives urged investors to look past the mostly non-cash charge. Analysts said the market was not giving the bank full credit for its deferred tax asset anyway, because it was unclear it would be able to use it all.
The list of companies with the largest tax expenses is dominated by companies with big offshore cash piles. Big tech and pharma companies, in particular, have been accused of aggressively cutting tax bills by keeping profits overseas and several face a significant levy on past profits. Microsoft expects an $18bn bill; Google’s parent Alphabet forecast a $10bn hit.
Apple reported a relatively modest net $2.6bn expense, despite being the company with the largest offshore cash hoard. Unlike some companies subject to the levy, the iPhone maker had already recorded — but did not pay — US tax on about half of its overseas earnings.
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For now, attention has turned to how the new law will affect tax bills this year and beyond, and to the wider questions of what companies will do with their higher post-tax earnings and how the stimulus from the tax cut might boost business. Mr Trump has billed tax reform as the biggest economic achievement of his presidency so far.
UBS analysts cautioned in January that the reforms could see effective tax rates reset at “materially different” — but not necessarily lower — levels for different companies. Overall, however, lower headline corporate tax rates are expected to boost future profits for most companies and eclipse the accounting adjustments made so far.
The effective US corporate tax rate is set to fall to as low as 9 per cent this year, according to Penn-Wharton tax model estimates. The TCJA includes a provision to encourage business investment by allowing companies to expense capital expenditure more quickly, something which cuts their taxable income in the near-term and contributes to the significant initial fall in tax rates.
The effective tax rate across the wide swath of corporate America measured by the Penn-Wharton model, will rise again to 18 per cent by 2027 as some of the incentives expire, it estimates.
Investors may have to focus on the accounting adjustments again later in the year, if they change significantly from the estimates recorded so far.
General Electric, the industrial conglomerate, has amended its initial estimate. It told investors this month it was adding an extra $1.2bn tax charge to the $3.5bn hit it booked after the TCJA passed, to reflect a new accounting rule it was adopting.
Meanwhile, there are continuing ambiguities to be ironed out by the US Internal Revenue Service. Tax experts have predicted a “rocky” year for the IRS as the overloaded agency struggles to provide clearer guidance to companies.
The Association of International Certified Public Accountants this month called on the IRS to clarify the treatment of certain overpayments and the reporting requirements for some foreign corporations.
A Treasury report last week estimated that implementing the TCJA would cost the IRS about $397m as the agency revised 450 publications, modified 140 technology systems and responded to an additional 4m calls and queries from business and individual taxpayers.
https://www.ft.com/content/01a3d5b8-4417-11e8-803a-295c97e6fd0b
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