Tax Considerations for Tech: The Tax Cuts and Jobs Act saw the most changes to U.S Tax policy in recent history. Tax matters are a driving force of mergers and acquisitions (M&A) when determining the value of the transaction. In order for Technology (Tech) companies engaged in M&A to assess the impact of the TCJA, they must take into consideration the changes in the rules for 1) Net Operating Losses (NOLs), 2) Research and Experiment tax deduction, 3) fringe benefits, 4) the Global Intangible Low Tax Income (GILTI), and 5) the new limitations interest deductions.
Tax Considerations for Tech: What to Expect
Deferred tax benefits such as NOLs add value to the transaction. This is because it allows the acquiring company to benefit from the target’s prior losses. Prior to the TCJL NOLs were allowed to be carried back provision where the taxpayer could apply its NOLS to previous years. The TCJL eliminates the ability to carry back NOLs. Tech companies with volatile cash and operating capital may use NOLs as an incentive to facilitate the sale. The new restrictions on NOLs may decrease the purchase price.
Tech companies are heavily invested in research and experimentation (RE) activities by nature. Expenses incurred from these activities are deductible. Under the TCJA these expenses will eventually no longer be allowed to be deducted immediately and will only be allowed to be capitalized and amortized between 5 and 15 years. This will have a high impact on the tax position of Tech companies with significant capital invested in RE activities.
Due to the TCJA, tech companies can no longer deduct the fringe benefits or perks they provide to employees. These activities, such as entertainment, amusement, recreation, and transportation benefits, are now considered non-deductible. However, in the current employee-friendly climate, many tech companies prioritize offering work-friendly environments and employee amenities. Therefore, tech companies must now decide whether to stop providing these benefits or to accept the added tax cost associated with them
Provisions introduced by the GILTI
The Global Intangible Low Tax Income (GILTI) is an entirely new provision. This provision requires shareholders of Controlled Foreign Corporations to include GILTI in their gross income. The provision allows for 80% foreign tax credits and an incremental GILTI tax levy on corporations whose taxes are below a certain threshold. U.S. Tech companies routinely establish foreign-owned subsidiaries in counties with no taxes on income. As such they are subject to GILTI tax provisions which can frustrate the tax implications of a transaction.
Section 163(J) places a cap on the deduction of interest expenses to interest income plus 30% if adjusted taxable income. The limitation is without regard to allowable deductions for depreciation amortization and depletion. The TCJA revises and expands section 163 (j) to apply to all businesses including partnerships. These new limitations decrease the amount of cash flow a Tech company has to include in the valuation of the transaction. [1]
[1] Unless otherwise indicated, all IRC section references are to the Internal Revenue Code.
