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Tax reform for telecom companies
Flashpoint 23: What's the impact of US tax reform on telecom?
By this point, most executives are well aware of how tax reform will impact their companies. And for the telecommunications sector, which has one of the highest tax rates of any industry, there is definitely a lot to consider. How will tax cuts right now impact telecom companies’ strategy in the future?
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- M&A strategies may need to change
- States are still working things out
- Fringe benefits just got complicated
- Take one last look in that rearview mirror
Responding to tax reform
By now the bill formerly known as the Tax Cuts and Jobs Act has received plenty of airtime. There’s certainly much to evaluate for the telecommunications sector: With one of the highest effective tax rates of any industry, companies are seeing their effective rate slashed and the disappearance of alternative minimum tax as we have known it. The immediate expensing of tangible assets will likely be another boon for the sector, whose capital-intensive projects range from laying cable to constructing cell towers to
In the short-term, the limit on interest deductions to 30 percent of adjusted taxable income plus interest income may have a minor impact on telecom companies that have relied primarily on debt to finance investments and acquisitions. However, companies should consider planning for the expanded definition of adjusted taxable income that starts in 2022. This may influence future investment strategies, prompting more companies to consider equity-based financing.
Many of these changes are probably already well known to telecom executives charged with getting their arms around the implications of tax reform. What’s now incumbent on leaders is to look ahead and begin to think more broadly about how tax reform will affect their business—and what they should be doing about it. This can include determining what technology and data-driven tools and systems need updating, as well as forging a closer collaboration with the internal budget and forecasting units.
M&A strategies may need to change
The telecom sector has witnessed a high level of M&A activity in recent years, from acquisitions of smaller players to mergers of equals to vertical integrations. If anything, tax reform may step up M&A transactions—but companies may want to rethink how they structure deals. From a cash flow perspective, the ability to write something off immediately can have a huge impact.
M&A models that worked in 2017 likely need to be updated for tax reform. Prior to tax reform, if a transaction was structured as an asset deal, the buyer could not take the immediate expense—they were only able to depreciate it on an accelerated basis. Under the new law, previously owned assets would now qualify for immediate expensing. As a result, companies may want to reevaluate the benefits of a stock versus an asset deal.
There is one caveat, however: Certain interest expense limitations could temporarily disallow the expense incurred in acquisition planning, and due diligence in connection with targets that have international operations may need further investigation.
A new approach to M&A
Consider a target company with $1M in fixed assets that it has depreciated to be worth $200k. The buyer values the target at $1M based on five times the value of the assets. After purchase, rather than expensing the asset over the course of 3 to 15 years, the buyer can take a deduction for the full $1M under an asset deal. The deduction for depreciation goes against the target company for the year. At the 21 percent tax rate, the company is paying $210k less in taxes in the year of purchase.
States are still working things out
With tax reform hot off the presses at the federal level, states are now considering what adjustments they may want to make, weighing the trade-offs between reduced tax revenues and attracting corporate players to their jurisdictions. There are no guarantees that every state will adopt every provision of the code. For example, some states will continue to decouple on immediate expensing of purchased assets and how they apply the interest expense limitations. In addition, the evaluation of foreign tax provisions will likely vary widely based on each state’s laws and regulations.
For telecoms, many of which operate in multiple—if not all—states, staying on top of evolving state and local tax rules can be critical. To do this, they likely need strong modeling capabilities. It’s also likely important to engage with M&A and business development teams to make sure they’re aware of these state-level changes.
No state’s response to tax reform is a foregone conclusion. There’s still an opportunity for the telecom industry to potentially shape policy at the state level.
Fringe benefits just got complicated
Large telecom companies typically aren’t only asset-intensive, but they generally have a high number of employees. They’ll likely have to pay careful attention to the new rules pertaining to deductibility of various benefits because many of these expenses will no longer be 100-percent deductible. As a result, companies may need to consider increasing their tracking and recordkeeping capabilities.
For example, entertainment is now 100-percent nondeductible, while meals remain 50-percent deductible. This means companies may need to be especially careful about how employees are coding expenses and may need to develop additional training modules to ensure compliance. Statistical sampling and data analytics can help companies catch errors and minimize any disallowances that they may now be
Other benefits are also on the chopping block. For example, the tax-free benefit for transportation valued by many employees who use public transit to commute to work is no longer deductible by corporations.
These new rules also create a new employer credit for paid family and medical leave in section 45S that permits eligible employers (employers that allow all qualifying full-time employees at least two weeks of annual paid family and medical leave and allow part-time employees a commensurate amount of leave on a pro rata basis) to claim a business credit for 12.5 percent of the wages paid to qualifying employees during any period in which such employees are on family and medical leave if the payment rate under the program is 50 percent of the wages normally paid to an employee.
Ultimately, companies should consider reexamining their policies covering fringe benefits, ensuring they’re able to take advantage of any deduction they’re entitled to while looking for creative ways to compensate their employees that are still tax effective.
Taking one last look in that rearview mirror
Finally, it’s important to remember that 2017 isn’t completely in the bag from a tax standpoint. And the old adage holds true: Accelerate deductions and defer revenue.
Companies generally rely on the prior year to avoid underpayment penalties. But given the fact that the 2017 rate is 14 percentage points higher than the 2018 rate, there are a number of opportunities to potentially take advantage of all the rules associated with automatic accounting method changes and the funding mechanism for some employee benefit plans.
For example, if you’re considering funding your 2017 pension obligations in 2018, you may be able to deduct the amount on the 2017 return. In terms of estimated tax planning, companies should now budget for cash taxes under the reduced rate and applicable impact to permanent and temporary differences. They should also consider scrutinizing all tax accounting methods to determine if alternative methods are available (uniform capitalization requirements, comp and benefit items, review of fixed asset class life, etc.).
There’s little doubt that digesting the new tax policies will take some time. The provisions are complex, and the implications for telecom companies are far-reaching. But Deloitte’s tax professionals are a step ahead. We’ve already dug in and examined the Act in minute detail. We understand the changes and can help guide you through the twists and turns. Let’s talk about what tax reform can mean to you.
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