CFOs understand the adage that the only constant is change. Taxes are no exception. Finance chiefs at companies of all sizes are fast realizing the need to allocate more resources to comply with efforts by policymakers and politicians to equalize worldwide tax rates and ensure that companies pay a minimum amount of taxes. CFOs will have to incorporate tax analysis as part of their strategic decision-making or find themselves dealing with unexpected financial and operational outcomes.
A spate of broad-reaching rules has CFOs rethinking their “finance first” approach to strategic decision-making to reflect the multi-disciplinary reality of tax compliance and reporting.
The Financial Accounting Standards Board (FASB) unanimously approved a mandate requiring private and public companies to report income taxes by jurisdiction and materiality last August, while in 2022 and 2023, the OECD released guidance about a minimum tax rate to apply to cross-border profits. Significant changes in the treatment of research and development expenses, part of the Tax Cuts and Jobs Act, are now in effect.
Hiring tax experts and upgrading technology to collect, analyze, and report data is easier said than done, especially for CFOs of small and mid-size businesses (SMBs). Here are the top three tax planning concerns CFOs should be ready for in 2024.
1. Going Public
Private companies, unlike their public counterparts, have fewer ways to raise capital. According to Bruce Lynn, a corporate treasury consultant and co-founder of the Financial Executives Networking Group, “A company such as a mid-size private firm may not have ready access to bank loans or private placements. If they do have access, that capital could end up costing a lot, especially now, as interest rates are rising.”
Companies going public via an initial public offering typically require a business to reform as a C corporation, which is taxed differently from a limited liability company — S corporation or partnership. Once a business goes public, the regulatory filing requirements multiply in frequency, quantity, and complexity.
Todd Horsager, a CPA and CFO at Compass Strategic Investments, cites a large number of private companies, especially mid-sized ones, that are organized as pass-through entities. The concern, however, is “they aren’t set up to meet public company reporting demands nor do they [generally] have the requisite internal controls in place to facilitate accurate and timely [financial statement] tax reporting,” Horsager said.
"Public company CFOs must ensure they are getting the right tax advice on an ongoing basis. Taxes become part of the CFO’s decision-making toolbox."
Gary Morrison
Tax Consultant, Translunar Consulting LLC
Tax consultant Gary Morrison agrees. “CFOs of private companies work with the CEO to build market share and manage budgets. They write a check to an outsourced firm and don’t worry a lot about tax strategies. Post-IPO, it’s a different situation altogether,” Morrison said.
Morrison adds, “Public company CFOs must ensure they are getting the right tax advice on an ongoing basis. Taxes become part of the CFO’s decision-making toolbox as opposed to being a point in time or single transaction influence.”
2. R&D Expenses
The passage of the Tax Cuts and Jobs Act in late 2017 removed the longstanding practice of allowing a company to fully deduct research and development (R&D) expenses in the year they were incurred. For tax years starting after December 31, 2021, companies must capitalize and amortize all R&D expenses. The number of amortization years depends on whether the activities are domestic or foreign. If R&D supports U.S.-based activities, the amortization period is five years. Otherwise, it is 15 years. The expected outcome of this change in tax treatment is a reduction in liquidity and potentially a need to borrow to pay what will turn out to be higher taxes.
“This capitalization of R&D puts a strain on a company’s cash flow. A company may no longer be able to deduct all their interest expenses under new interest deduction limits that no longer add back depreciation and amortization to determine the limit,” said Larry Smith, co-founder and CFO of Lifefront Corp. “This puts more pressure on cash flow. It could also mean banks won’t lend as much money to a company which in turn increases their cost of the funds needed to meet short-term expenses,” Smith said.
“This capitalization of R&D puts a strain on a company’s cash flow. A company may no longer be able to deduct all their interest expenses under new interest deduction limits that no longer add back depreciation and amortization to determine the limit.”
Larry Smith
Co-Founder, CFO of Lifefront
“The R&D changes caught more than a few companies off guard. Angel-backed companies, for example, don’t have a lot of idle cash. They frequently plow what they earn back into the company,” Horsager said.
“The same applies to older manufacturing companies that spend a lot on R&D. In a global marketplace, U.S. companies don’t fare as well in this area as companies situated in Canada and Belgium. Both countries have competitive R&D expenses and credit systems. China has been promoting competitive R&D incentives to encourage job creation.”
3. Global Tax Rate Standardization
Efforts to homogenize worldwide tax rates by the Organisation for Economic Co-operation and Development (OECD) and other supranational bodies directly impact U.S. companies with foreign subsidiaries or other types of foreign functional presence. More global tax rules are on the way, forcing CFOs to expand their geographic mindset if they aren’t already doing so.
Rono Ghosh, an international tax partner with BPM LLP, said CFOs will face significant challenges from new tax mandates from policymakers in the U.S. and overseas. One of them, introduced with the passage of the Tax Cuts and Jobs Act, focuses on Global Intangible Low-Taxed Income (GILTI).
“GILTI impacts the cash flow of corporations and, in many cases, increases their global tax rate,” Ghosh said. “This new regime requires income from foreign operations to be included in U.S. company taxable income at an effective tax rate of about 10.5% (rising to 13.125% by 2025), regardless of whether the income was distributed or fully available to the U.S. corporation.”
“GILTI impacts the cash flow of corporations and, in many cases, increases their global tax rate.”
Rono Ghosh
Tax Partner, BPM LLP
With the OECD’s introduction of model tax rules referred to as Pillar 2, both U.S. and non-U.S. companies could face a global minimum tax rate as early as 2024. Ghosh said the Pillar 2 tax would only apply to larger multinational corporations. The 15% minimum tax would apply to corporate groups with global revenues of over 750 million Euros, while the GILTI applies to all U.S. corporations.
Pillar 2, which is only applicable to the largest of corporate groups, shouldn’t have a significant impact on the economic health of most private mid-sized corporations. Most U.S.-based corporate groups will likely find Pillar 2 to be largely an added compliance exercise, but not a significant addition to their existing tax burden, said Ghosh.
This is the first article in a two-part series about how domestic and foreign tax rules influence strategic decisions made by CFOs. Part two can be found here.