Two new(ish) worries for firms to ponder.
First, The Economist newspaper of last week has a leader and several pages of article advocating the ending of tax deductions for interest payments.
This has been advocated by a number of academics for many years. And it received a boost when excessive leverage – more interest, and so more tax deductions – was seen as contributing to the financial crisis of 2007-8 and the separate euro-crisis since 2009. Politicians everywhere, trying to balance budgets, are likely to be very tempted by a new way of reducing “tax expenditures” – tax exemptions/deductions. The Economist, however, suggests that tax rates be reduced to keep overall tax take constant despite the change. (Of course, I’m sure that finance ministers everywhere would see it that way…)
Let ignore the arguments for or against. And I’ll ignore that interest is a huge expense for many financial services firms and just look at non-financial corporates. And assume The Economist’s aim of making firms’ tax neutral between debt and equity.
But, while tax is the headline subject – all those elementary financial economics calculations of the “value of tax shield” of debt – there are other differences between debt and equity. Investors see different risks and different rewards. Different durations. And, perhaps, different tax treatment in the recipient’s hands between dividends and interest - and different capital gains potentials with their tax consequences. And for existing shareholders the difference in ownership dilution.
So, for treasurers, it is possible to see the new judgement types to be made. And tax structures will still need to respect the need to recognise tax treatment in the investor’s hands.
One thing to think about, though, are the knock on effects. For example, companies are companies’ biggest creditors – trade credit. What are the implications for that? Why borrow to fund sales?
And what about the transition process – the disruptions could be material. And will all tax authorities, everywhere, make the change in a similar way, with the same transition arrangements, over the same time schedule?
One to watch. Alongside the OECD projects on Base Erosion and Profit Shifting that will probably override tax treaties on treatment of intra-group interest, if they are implemented2.
Authorities around the world are expressing concerns about diminishing liquidity in financial markets3. And a common suggestion for “improving” liquidity in secondary corporate bond markets is “standardisation” (even “standardization”). The Bank of England’s response to the European Commission’s Building a Capital Markets Union green paper speaks favourably of this – while noting corporate treasurers’ reservations. Bond standardisation featured in the UK authorities’ Fair and Effective Markets Review in which the Bank is, of course, a major player.
Something else for treasurers to worry about.
Among sessions I will be facilitating at #ATAC15 are two sessions on aspects of strategy for treasurers. It will be interesting to see what is on treasurers’ minds.
References
1For a discussion of equity duration, see: A new measure of equity duration: The duration-based explanation of the value premium revisited, David Schroder and Florian Esterer 2012, available at http://tiny.cc/v4hvxx
2See article at foot of May ACT news update: http://tiny.cc/xddvxx
3E.g.: Financial Market Volatility and Liquidity – a cautionary note, Chris Salmon, Executive Director, Markets, Bank of England, speech given at the National Asset Liability Management Europe Symposium, London, 13 March 2015 http://tiny.cc/wx6cyx and
Financial Markets: identifying risks and appropriate responses, Andrew Bailey, Deputy Governor, Prudential Regulation, Bank of England and Chief Executive Officer, Prudential Regulation Authority, speech at
Hughes Hall, Cambridge University, 15 May 2015 http://tiny.cc/yi6cyx
4http://tiny.cc/s86cyx , 12 May 2015
