Until Enacted or Withdrawn, Proposed U.S. Tax Reform Continues to Have an Effect on M&A and Private Equity Transactions
Since early 2021, Congress has been working on legislation that would alter the U.S. tax laws and potentially have a significant impact on M&A and private equity transactions. Although, in the aggregate, more a tremor than an earthquake when compared to the 2017 tax reform under the Trump administration, the proposed changes under the Build Back Better Act ("BBBA") (or whatever legislation may ultimately reach President Biden's desk) may have a profound effect on the global deal market. The uncertainty surrounding if and when the proposals will be enacted and what actually finds its way into law continues to impact deal structures. As businesses and investors alike attempt to avoid signing and executing transactions that may be in the cross-hairs of one or more of these proposals (possibly with retroactive effect), careful consideration should be paid to "safer" alternatives. In our summary discussion of these proposed changes, we have limited our focus to those provisions that, in our view, have the broadest applicability coupled with the greatest impact on M&A and private equity transactions.
Rate Increases and Related Provisions
The Biden administration's proposals to increase the corporate tax rate from 21% to 28% and the individual capital gains rate from 20% to 39.6% have been abandoned—the current iteration of the BBBA maintains a rate of 21% and 20% respectively. The BBBA likewise leaves untouched the tax provision providing for a 20% deduction on "qualified business income" for income earned through pass-through entities and the regime affording favorable capital gain treatment on carried interest.
However, the BBBA does provide for an increase in individual income tax rates whereby income in excess of $10 million and $25 million would be taxed, respectively, at rates of 44.6% and 47.6%. The BBBA would expand the application of the 3.8% "net investment income" tax to all trade or business income of individuals—including income from the sale of a limited partnership or S corporation—meeting certain thresholds except to the extent already subject to self-employment tax. Further, the BBBA would reduce the 100% gain exclusion for sales of qualified small business stock occurring after September 13, 2021, to 50% (unless a binding contract was entered into as of that date and subsequently materially modified).
We also note that in an effort to align the United States with global efforts to discourage multinationals from shifting profits and tax revenues to low-tax countries, the BBBA would increase a U.S. multinational's tax on the sale of active business assets from a quasi-effective rate of 13.25% to 15%.
M&A and Private Equity-Specific Proposals
In addition to rate increases, the BBBA would increase the cost of certain M&A transactions.
New Excise Tax on Certain Stock Repurchases. The BBBA would impose a new 1% excise tax on "repurchases" of stock by certain publicly traded corporations. The term "repurchase" is defined quite broadly and, in addition to traditional stock buy-back programs, would likely extend to a host of other common acquisition structures such as leveraged buyouts of a publicly traded corporation.
Further Limitations on the Deductibility of Interest Expense. The BBBA contains additional provisions that would further limit a business's ability to deduct interest expense. One of those provisions would limit a business's interest expense deduction when its U.S. operations are overleveraged compared to its foreign operations. This new provision may encourage U.S. multinationals to "push down" debt to their foreign subsidiaries—a process that may be feasible only under local law in connection with a third-party acquisition.
Spin-Off Transactions. With respect to "spin-off" transactions, it is common to reallocate the capital structure of the legacy corporation and the spun-off corporation ("Spinco") to better align the debt load of their respective businesses. Under the BBBA, this realignment would be more challenging as it places significant limitations on the ability to increase Spinco's debt without incurring tax at the legacy corporation level. The effective date of this provision is January 1, 2022; however, if the transaction was publicly announced by a publicly traded company before that date, it may not be subject to the new leverage limitations.
Investment in Foreign Businesses. The most recent Senate tax bill includes a proposal that would expand the scope of the anti-inversion rules—potentially implicating run-of-the-mill structures that historically never would have raised an eyebrow. This proposal, for example, could render a newly formed foreign joint venture vehicle a U.S. corporation for U.S. tax purposes when the vehicle was formed solely with cash from U.S. or foreign private equity funds.
Read the full 2021 Transactional Year in Review and 2022 Forecast.
