Until recently, the concept of permanent immediate deductibility of capital expenditures was relatively unheard of.  But just like butter and coffee, some things we might not envision in combination can indeed go together – and may offer a unique set of benefits.  It may seem surprising to hear that an aspect of proposed tax reform has garnered some modicum of unified support. Yet, an immediate deduction for capital expenditures is a common objective on the Republican side, whereas other proposals (e.g. border adjustments) have become mired in disagreement among the Republicans.

 

Currently, the cost of capital expenditures may only be recovered for tax purposes over extended periods of time. But many Republicans, including the President, believe that immediate and full deductions for capital expenditures can stimulate the economy by lowering the cost of capital for expansion, thereby encouraging new job-creating investments. The exact parameters (including potential limitations, if any) around immediate expensing have yet to be fleshed out – with the House Republican Blueprint proposing immediate expensing for all, while the Trump plan proposes an election to either deduct interest or to immediately deduct capital expenditures.

 

So, what might happen when you dip the proverbial fries in the Frosty and encounter the pleasantly unexpected? Perhaps the most pronounced effects of this proposed new unity will be in M&A transactions, with the entire value of the target business (or much larger portions thereof that in the past) being currently deductible in an asset deal; or even in a stock deal if a 338 election is made (perhaps increasing the attraction of the 338 election).  

 

Even outside the M&A context, the effects of this proposal should touch on any capital expenditures, even if not part of the acquisition of an entire business.   But regardless of the context, there are likely to be many situations where the amount of the deductions for capital expenditures will greatly exceed the company’s taxable income, giving rise to large NOLs for which future benefits may be uncertain.   At the other end of the spectrum, businesses that are not capital intensive would experience little or no stimulus from this proposal (outside of the M&A context).   

 

The prospect of little benefit for some companies and excessive benefits for others may lead the Republicans to reconsider something they tried several decades ago: i.e., a mechanism to allow taxpayers to effectively sell excess tax benefits to others who can use them.   In the first of President Reagan’s tax reform measures (the Economic Recovery Tax Act of 1981), the Republicans created what became known as “safe harbor leasing.” A safe harbor lease was a “paper transaction” whereby the real owner/user of a capital asset could transfer nominal/legal ownership of the asset (with all the attendant tax benefits of true ownership), for a price, to someone who could use the tax benefits.  

 

Safe harbor leasing was a short-lived phenomenon, as Congress quickly realized the magnitude of what they had done.  Thus, those in Congress with longer memories may shy away from this sort of proposal; or they may try to temper it, or at least give it a different name and transaction vehicle.    

 

The prospect of capital expenditures meeting immediate deductibility is like When Harry Met Sally (and perhaps also the 1981 Tax Act) all over again. 

 

 

Authors: Rebecca Lara and Brendan Sinnott