What the new tax plan means for you and your SME suppliers

The new debt paradigm: how to leverage the net Interest deductibility tax change.

As the celebrating dies down around one of the largest corporate tax cuts in history, corporate CFOs who read the fine print understand that it isn’t all good news. In fact, companies accustomed to funding business activities, acquisitions, shareholder benefits, and other endeavors with debt are in for a rude awakening.

That’s because the deduction on net interest expense has been trimmed for all but the smallest companies. Companies with revenues below $25 million can still deduct their net interest expense, but that deduction is limited to larger companies and gets more restricted beginning in 2022.

CFOs must embrace creativity and a new paradigm around debt. Large corporates can leverage this seemingly unfavorable tax change to position themselves more favorably to reduce supply chain risk by helping your suppliers access off balance sheet cash flow, improve supplier relationships, and use arbitrage to pay down debt.

Download the full white paper, including insights for your large suppliers and your own corporate financial strategy

Tax provision details

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. Beginning in 2022, companies must replace the EBITDA calculation with one based on the more restrictive calculation based on earnings before interest and taxes but after depreciation and amortization expenses, or EBIT.

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. Beginning in 2022, companies must replace the EBITDA calculation with one based on the more restrictive calculation based on earnings before interest and taxes but after depreciation and amortization expenses, or EBIT.

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Impact for your small and midsize (SME) suppliers

It may seem that small and midsize companies are completely unaffected by this tax change, but that isn’t the case. Think about it: the value of the tax deduction equals the tax rate. At a tax rate of 35 percent, the deduction was worth 35 percent. Now, instead of a deduction worth 35 percent, which was the previous tax rate, the deduction is worth 21 percent, the new tax rate. In essence, there has been a net reduction in the value of that particular deduction.The net effect of this is an increase in the cost of debt for SMEs. As a result, SMEs in your supply chain may welcome alternatives like early payment programs that offer no-debt access to cash flow.

For larger, more profitable companies, the benefit from the overall lower tax rate may mean this change isn’t significant. However, for the smallest SMEs, the impact is potentially significant. Many businesses struggle with profitability and cash flow as they grow, which means they don’t have as many profits to tax as do larger, more established companies.

These small SMEs need every deduction they can get. Even a change in the net value of this deduction could mean the difference between survival and failure for an SME on the edge. As the economy grows, SMEs are finally in the position of being able to grow their businesses as demand increases. But if their profitability and cash flow are at risk, growth is a two-edged sword. This increases supply chain risk for you.

Growth leads to another danger in this situation — companies that grow themselves into the restrictions on this deduction. For the Congress that passed the law and the president that signed it, there were meaningful distinctions between companies smaller than $25 million in revenue and companies with more than $25 million in revenue.

However, a CFO of a company that has revenue of $24.9 million in 2018 and grows to $25.1 million in 2019 isn’t in charge of the finances of a fundamentally different company. She’s in charge of the same company, the company which just saw their ability to deduct interest on their debt fall by 70 percent. That’s a significant hit.

That CFO could easily turn to alternative financing to gain some flexibility over cash flow and debt. In fact, SMEs are increasingly open to alternative financing, especially when it occurs in the context of invoice discounting in exchange for faster payment. Such an arrangement provides one of the most affordable sources of liquidity through a direct and transparent relationship with a customer instead of an opaque relationship with a financial intermediary.

Opportunity for Large Corporates

Large corporate CFOs and treasurers have the opportunity to consider alternative financing arrangements that can raise revenue to decrease their own debt burdens while offering help to their SME suppliers. Creative options include:

  • Use arbitrage: By taking advantage of name their own rate early payment discounting options, CFOs can manage balance sheets proactively and generate revenue.
  • Lower supply chain risk: Extending favorable payment terms to SME suppliers helps protect the corporate supply chain from risk around cash-strapped suppliers.
  • Build improved relationships: SMEs favor corporate customers that extend favorable terms. 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 gaining revenue to pay down debt, reducing supply chain risk and improving relationships with SME suppliers.

Download our white paper to learn:

  • How your supplier of all sizes may be impacted financially by the new plan — and what you can do to reduce financial supply chain risks
  • How to leverage the net interest deductibility change to your benefit
  • Why CFOs and treasurers must start now to assess their current and future debt loads and needs
  • Three strategies for CFOs to deploy capital in the new tax environment
  • How your SME suppliers can transform tax law challenges into opportunities