The U.S. tax reform is predicted to have an overall positive impact on brokers domiciled in the country, with the lower corporate tax rate boosting net profits. However, for highly leveraged private brokers the reforms could reduce earnings due to higher taxable income from limits on the deductibility of interest expense, according to Moody’s.
Moody’s analysts said some private brokers are likely to reduce financial leverage over time to protect earnings and perhaps shift their funding for acquisitions to more equity and less debt.
From 2018 to 2021 interest deductions are capped at 30% of EBITDA and 30% of EBIT thereafter, resulting in higher taxable income for affected brokers.
In some cases the increase in taxable income will outweigh the impact of the lower tax rate, resulting in higher cash tax payments and lower operating cash flows, at least in some years, and Moody’s believes this could leave some brokers more vulnerable to business and market disruptions.
However, as highly leveraged brokers adjust by reducing interest expense and thus becoming more profitable, the new tax law would become a net benefit, with the impact of the lower tax rate outweighing the interest deductibility limit.
Moody’s explained that “many private brokers have significant net operating losses (NOLs) which will limit or postpone their future tax payments.
“Existing NOLs reflect historical deductions for interest expense and for goodwill related to acquisitions, and such NOLs can be carried forward for defined periods.”
An additional change under the new tax law is the deductibility of net operating losses (NOLs) being limited to 80% of taxable income in the carry forward year, although newly generated NOLs can be carried forward indefinitely.
Along with a shift to a territorial tax system, global brokers will now have to pay taxes in the jurisdictions where they generate profits, with no further tax upon repatriation of profits to the U.S.
There is also a one-time transition tax on previously deferred foreign income, explained Moody’s.
“Brokers with foreign operations can now repatriate all accumulated foreign earnings at a tax rate of 15.5% for liquid assets and 8% for certain illiquid assets, payable in instalments over eight years,” said Moody’s.
The new tax law also allows for more favourable treatment of capital expenditures, although analysts don’t expect this change to have a significant impact given that insurance brokers have relatively low capital requirements.
In conclusion, Moody’s said that the new U.S. tax laws will positively impact global brokers with improved earnings, although leveraged private brokers with high levels of interest expense that have until now been deducted from payable taxes, are likely to be negatively impacted by new limits on these deductions.
However, highly leveraged private brokers are expected to respond to the changes by reducing interest expense which would mean that over the long-term, they also stand to benefit from the new U.S. tax regime, according to Moody’s.
