Leveraging the net Interest deductibility tax change.
Debt just got a lot more expensive. The 2017 tax law disadvantages debt financing by significantly reducing the deductibility of net interest expense, impacting all but the smallest companies.
While companies with revenues below $25 million can still deduct their net interest expense, that deduction is limited to larger companies and gets more restricted beginning in 2022. CFOs and Corporate Treasurers accustomed to financing corporate activities with debt need to put their thinking caps on and consider how to take advantage of this new provision.
Fortunately, many large corporates are in a favorable position to take advantage of this new debt paradigm because they are under-leveraged and have benefitted from a decade of historically low interest rates. Large corporate financial executives should consider how the tax provision might benefit them to reduce supply chain risk, improve supplier relationships, and use arbitrage to pay down debt.
Like many other provisions of the new tax law, this one phases-in the change. Initially, companies with revenue in excess of $25 million can only deduct their net interest costs up to 30 percent of their earnings before interest, taxes, depreciation, and amortization, otherwise known as EBITDA. However, beginning in 2022, those companies must recalculate their net interest expense through a stricter lens, that of earnings before interest and taxes but after depreciation and amortization expenses, or EBIT.
Impact for your larger suppliers
There’s a huge difference between a company with revenues of $25 million and another with revenues of $25 billion. But not as far as this tax provision goes. There are two aspects to this change that impact suppliers with revenues in excess of $25 million:
1. The deduction is less valuable: under the former tax law, the deduction was worth 35 percent, or the tax rate your company paid. Under the new law, the deduction is worth 21 percent, which is the new tax rate. A company’s net interest expense tax deduction of $100,000 was worth $35,000 under the old tax law. This year, under the new law, that same deduction is worth $21,000, which is a $14,000 or 40 percent reduction.
2. The deduction is limited: using the example above, if the $100,000 net interest expense deduction exceeded 30 percent of the company’s EBITDA, some of that deduction would be disallowed. This further reduces the value of that deduction in a way that many suppliers can’t afford.
This represents a challenge for CFOs and treasurers of these companies, who already have less access to the traditional loan market than larger corporates. Many of these companies are growing as the economy improves and experiencing increased demand from their large corporate customers. They need to find a way to grow their sales while maintaining appropriate and affordable levels of cash flow and financing yet decrease reliance on debt for these activities.
In this environment, their options include:
Investigating alternative financing options: many low-cost, favorable alternative financing options exist, including supply chain financing, invoice discounting, factoring, private funding, and peer-to-peer lending.
Select the best alternative option: amid all the options, the alternatives that are the most flexible, affordable and liquid stand out. Choose the ones that align best with your organizational needs.
Align with creative partners: businesses that work with partners who can help them with ongoing, affordable financing needs position themselves for success. Large corporate customers who offer invoice discounting in return for faster payment make attractive long-term partners for suppliers in need of cash flow.
Opportunity for Corporates
Alternative financing arrangements make sense for large corporate CFOs and treasurers because they have the potential to raise revenue, decrease their own debt burdens and offer assistance to their suppliers. Options include:
Employ arbitrage: large corporates who are a key supplier can leverage a dynamic discounting platform to accelerate payments and use this cash flow to fund early payments to their own suppliers at an attractive rate. CFOs can generate revenue and manage balance sheets proactively.
Lower supply chain risk: Providing suppliers with access to early payment helps protect the corporate supply chain from financial risk.
Build improved relationships: Suppliers favor corporate customers that offer supplier-friendly early payment options. Such improved relationships can result in improved productivity and higher profitability for both suppliers and their large corporate customers.
Capitalize on opportunity
In today’s new corporate financing environment, alternative financing has much to recommend itself. CFOs who capitalize on opportunities such as dynamic discounting stand to reap many rewards, including increasing income to pay down debt, reducing supply chain risk, and improving relationships with your suppliers.