Deals are an opportunity often pursued by firms because businesses continuously need to grow. By acquiring a business as a subsidiary or its assets, the acquiring company can extend its roots into a foreign industry or obtain deeper market penetration in its operations. Deals are a strategy.
2018 is a vibrant year for M&A. The Tax Cuts and Jobs Act Bill (TCJA), approved last November, brought changes in ways that motivate deals. Observing the recent upswing of M&A, the cause is found attributable to the TCJA.
Business combination typically takes place for expanding a business, improving efficiency, or reducing market competition. In the language of business, acquisition serves the purpose of “increasing shareholder value”.
Companies acquire foreign, unrelated companies to diversify. By obtaining deeper market penetration, firms can expand customer base and market share. Some businesses buy their competitor’s business, which is known as a horizontal merger. A horizontal merger allows more time- and cost-efficiency than having to produce separately. Some firms acquire their suppliers because intercompany transfer pricing (agreeing on a cost, between divisions under the same company, that is lower than that of purchasing externally) can be cost-efficient. Buying a supplier is referred to as a vertical merger. From the perspective of the company being acquired, selling itself to a larger company may seem ideal for network growth and better productivity. Being acquired may also serve as an honorable exit for firms that do not quite meet their goals. All of the above are actions businesses take to increase shareholder value.
With the enactment of TCJA, it may be an ideal time to opt into M&A. Under TCJA, acquired qualifying assets can be 100% expensed under the updated Section 179 depreciation deduction rules. The cap amount of business expense doubled to $1M. The corporate tax rate dropped from 35 to 21 percent, making the U.S. firms more attractive for inbound deals. The reduced tax costs on an asset transaction could lead to lower demands for tax “gross-up” payments (when the buyer or employer is liable for paying the additional amount of tax withheld). The lower tax on operating income reduces the amortization deductions in an asset acquisition. In addition to the layer of Section 179 deduction, a second layer, of 100% first-year bonus depreciation, will be an option for companies to claim until 2022. Buyers would be attracted to asset purchases because they can immediately deduct equipment costs and depreciable assets. This deduction now applies to both new and used property. The full, 100% bonus depreciation also increases the chances of acquiring part of assets with big allocations of purchase price to assets.
The fast-changing trend of M&A is creditable to the rising demand for deals and tax professionals in the economy today. Businesses react to changing tax regulations. It is what makes being in the accounting profession so interesting—helping businesses adapt to dynamics and capturing their shareholder values.
Amy Kwon/ Tax Advisors for Champaign Society (TACS)