The views reflected in this article are those of the authors, and do not necessarily reflect the views of the American Investment Council. PwC is an AIC Silver Level Associate Member.
By Puneet Arora, US Private Equity Tax Leader at PwC
After the initial euphoria around US Tax Reform, we can see that the impact of US Tax Reform on the private equity (PE) industry is both larger and smaller than expected.
Rather than a complete overhaul of existing US tax law, the legislation contains an assortment of new rules as well as modifications to existing rules. Although much of the excitement surrounding tax reform was due in part to the transition to a territorial tax system, the participation exemption is somewhat limited and the new rules build extensively on existing anti-deferral mechanisms.
The impact of many of these rules remains to be seen. Ambiguities abound, and although we understand guidance from the IRS and Treasury to be forthcoming, dealing with the realities of pending deals, compliance obligations, and financial statements in the meantime can be daunting.
For PE funds invested abroad, estimated payments for toll charge liabilities must be paid sooner rather than later. Finding the information required to identify impacted US shareholders and compute the toll charge liability may prove difficult for some companies that historically have not tracked their earnings under US principles. Minority shareholders in foreign companies subject to the toll charge may also face obstacles in gaining access to this information at all.
Due diligence on potential targets may also need to be modified going forward. PE firms may need to be on the lookout for a target’s historical toll charge liabilities, including how the target calculated and planned for the charge and if the target elected to pay the tax in installments over eight years.
Portfolio companies may need to reassess the impact of the new tax law on their financial statements. That includes revisiting deferred tax assets and liabilities as well as the projected cash flows of portfolio companies (including toll charge commitments as mentioned above), as these will impact company valuations. A useful guide to financial statement impact can be found in a recent PwC In depth report.
Operating models and value chains should be evaluated from a new tax reform lens. The rules have changed the approach to taxing the value chain of companies across sectors which may present companies with an opportunity to restructure the locations of intangibles and their workforce. For example, holding intellectual property in the US may be more palatable for businesses in light of new rules that are aimed at eliminating the benefit of holding intellectual property offshore. At PwC, we have a team that solely focuses on helping private equity clients assess their operating models & value chain should you have any questions on this front.
Although the true impact of US Tax Reform on the PE industry will only be known with the passage of time, the time to start evaluating its impact is now. Everything from due diligence, deal modeling, and financial statements to key performance indicators such as internal rates of return and compensation planning for senior management may change as a result of US Tax Reform. Staying current in this dynamic environment and engaged with the guidance to be issued to implement these new rules should prove to be a competitive edge in our industry.
For more information on how tax reform impacts private equity, visit our PE tax resource center on pwc.com and watch our recent Implications of tax reform on private equity webcast.