Moody’s Research Underscores Negative Impact Of Eliminating Interest Deductibility

Last week, Moody’s Investors Service published a new report, “Debt And Taxes: Credit Implications Of New Tax Reform Proposals,” showing how the House GOP Blueprint’s proposal to eliminate interest deductibility would lead to an increase in cash taxes for most business.

The loss of interest deductibility would be particularly punitive for speculative-grade rated companies, even with a lower corporate rate. Unlike non-financial investment-grade companies, speculative-grade rated companies have a lower ratio of operating profits to interest payments. Add in the fact that they typically have a higher interest rate on their debt and it is clear eliminating ID would result in a major squeeze on their cash flow.

Moody’s also notes that the costs of lost tax deductibility accelerate as interest coverage declines. Key findings from the report include:

· If the corporate rate is 20%, Moody’s says companies will pay more taxes if they have an interest coverage ratio of 2.33x or less.

· When the corporate rate is 15%, the report shows that companies will pay more taxes if they have an interest coverage ratio of 1.75x or less.

Below are other relevant excerpts from the report:

The Loss Of Interest Deductibility Will Be More Credit Negative For Speculative Grade Companies Given Their Higher Leverage. “The baseline data presented in this report (see Exhibit 2, page 2) indicates that the credit effects are likely to be more favorable for investment-grade companies. To put this in context, the credit benefits from a lower tax rate, full investment deductibility, and exempting profits on exports and foreign sales from taxes are generally greater for investment-grade companies. This is because a higher percentage of such companies pay taxes and have more global operations. The credit implications of losing interest deductibility will be more negative for speculative-grade companies since they are more highly leveraged, which means the lack of interest deductibility for tax purposes would be a significant burden on cash flow.”

Losing ID Would Increase Cash Taxes For Companies. “The loss of interest deductibility would increase cash taxes. This would be less credit negative for investment-grade companies because their relative interest burden is lower along with their leverage. These companies also have higher interest income owing to their tendency to hold higher cash and liquid investment positions to support larger and more global operations. In the House Republican tax proposal, interest expense is deductible against any interest income.”

For Companies With An Interest Coverage Ratio Of 2.33x Or Less, The Negative Impact Of The Loss Of ID Exceeds The Benefits Of A Lower Tax Rate. “The combination of a lower corporate tax rate (20% or 15%) and the lack of interest deductibility will be a negative for many speculative-grade companies. The credit impact from the combination of a tax rate reduction and loss of interest deductibility for companies with pre-tax reform EBIT-to-interest coverage of less than roughly 2.33x will be negative assuming a shift to a 20% tax rate. Below this interest coverage cutoff point, the negative impact of the elimination of interest deductibility would more than offset the benefit from a reduction in the corporate tax rate from 35%. If we adjust the assumed tax rate to 15%, the cash savings increases from the 20% case and the cutoff point at which the loss of interest deductibility exceeds the benefits of the lower tax rate declines to pre-tax reform EBIT-to-interest coverage of less than 1.75x.”

The Costs Of A Loss Of ID Accelerate As Interest Coverage Declines. “We also note that the costs of lost tax deductibility accelerate as interest coverage declines. Companies with significant EBIT coverage of Interest Expense (i.e., companies which populate the right-hand side of Exhibit 4, page 7), lose only a small deduction when calculating EBT from an EBIT starting point. By contrast, companies with weaker EBIT coverage of interest expense (i.e., companies at the left-hand side of Exhibit 4), lose progressively more from interest deductibility being eliminated than the cash savings from a lower tax rate. This dynamic accelerates as EBIT-to-interest decreases.”

The BUILD Coalition believes that effective tax reform should not be punitive or negatively impact one particular group. Rather, the goal is to provide support for faster economic growth.

By | 2017-03-22T17:17:10+00:00 March 22nd, 2017|Blog, Issue Briefs, News|