The Cash Investment Conundrum

Blog Post

The Cash Investment Conundrum

The Assistant Treasurers’ Leadership Group considers the likelihood of tax reform, methods for pricing intercompany notes and where to invest cash in recent meeting at Chatham Financial. 
 
Here is a summary of key takeaways from the meeting:
 
The early bird gets hedge-accounting treatment. FASB has addressed new hedge accounting guidance and plans to issue the final language toward the end of June. Chatham Financial anticipates many companies adopting the amended accounting standard early – at the start of a company’s fiscal year after Dec. 31, 2017 – because it facilitates achieving hedge accounting in several ways. For one, components of risk can be hedged if they are contractually specified. Corporates that had term loans in place during the last financial crisis at times saw the prime rate set lower than Libor. However, they could not switch to prime because it wasn’t a benchmark, and all-in cash flows had to be considered, increasing variability and ineffectiveness and prohibiting hedge accounting treatment. Under the new guidance, they’ll be able to if it is contractually specified. Commodity users may be the biggest beneficiaries. They will be able to contractually specify the key economic component to hedge, whereas today variable elements such as transportation and processing are included in the hedge, jeopardizing hedge accounting. Aaron Cowan, global leader of corporate accounting advisory services at Chatham, said corporates early on must adapt their hedging policies and align with auditors on what the accounting outcome will be. Mandatory compliance begins after Dec. 31, 2018.  
 
Don’t bet on radical tax reform. KPMG pegged the chances of radical tax reform at 30% before the ACA repeal-and-replace debacle earlier this year, and now chances are even less, said Kathleen Dale, principal at KPMG. To have a chance of enacting such reform before 2018 elections, it is imperative that the House introduces a bill by the start of August, but the outlook is grim. Radical reform encapsulated in a plan published by House of Representative leaders a year ago, referred to as the “blueprint,” would eliminate interest-expense deductibility and move to a destination-based and territorial corporate tax system to pay for a drop in the corporate rate, to 20% from 35%. The Trump Administration’s one-page summary proposes dropping the corporate rate to 15%, eliminating unspecified tax breaks for “special interests” and moving to a territorial tax system, but not much else on the corporate side. Desperate for a tax win before 2018 elections, Republicans may settle on bits and pieces, such as a lesser drop in the corporate rate and switching to a territorial system. Also likely is a mandatory repatriation tax, supported by both Democrats and Republicans, if for different reasons. 
 
Why BAT? The border adjustment tax (BAT) taxes imports and not exports and highly favors U.S. companies that source and produce their products and services domestically. It’s a key element not only to incent companies to create jobs in the U.S., but to provide a major source of tax revenue for the corporate rate drop. Without it, lowering the rate below 28% isn’t feasible, if tax reform is to remain revenue neutral and not sunset after 10 years. The Trump Administration makes no bones about its proposal failing to achieve revenue neutrality, saying the anticipated economic growth warrants the risk of being unable to renew the law. BAT is designed to mimic many aspects of the value added tax (VAT) prevalent in most developed countries, so it will not be considered an unfair trade subsidy by the WTO.
 
Cash investment conundrum continues. ATLG members exchanged ideas about where to invest cash in the low, even negative interest-rate environments.  Australian banks are paying favorable rates for three-month deposits of USD – one member cited 1.38%. Often the three-month tenor is based on a handshake deal: The bank will pay a decent, if slightly lower, rate for the generally sticky deposits, and in return, the corporate can withdraw the cash sooner if necessary. A few members spoke about dividing cash among short-term, medium-term and longer-term buckets, although less so in the latter these days given the likelihood of mandatory repatriation. “Given the cash we have to today, we would [normally] be allocating more to the longer-term bucket,” said one. “But in light of potential tax reform and repatriation, and since most cash is offshore, we wouldn’t want to add to the risk of having to repatriate.” 
 
Pricing intercompany notes. Noting audits by tax authorities of his company’s intercompany notes, one member solicited suggestions on how to price them. He noted one method involves determining a subsidiary’s stand-alone credit rating and from there deriving a credit spread, although such a rating may not be readily available. A bank recommended using revolving-credit pricing in the specific country as a proxy for the cost of funds there, he said. Another approach may be to strip away the underlying treasury-bond benchmark from the weighted average cost of the parent’s debt and replace it with a spread appropriate for the subsidiary, rated typically one or two notches lower. Another member pointed to an asset-based facility covering a number of subsidiaries that provides an approximation of the market rate, which can then be used for entities outside the facility.  
 
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