In December, 2017, the Tax Cut and Jobs Act (“TCJA”) was passed by the US Congress, and it was expected to have meaningful effects on both US and internationally based M&A activity. Several features of the new tax system were meant to encourage US-parented multinational corporations to keep or otherwise relocate their headquarters and/or substantial portions of their business activities to the US. One of the more significant features of the TCJA was the reduction of the US federal corporate tax rate from 35 percent to 21 percent, with a tax of 15.5 percent established for the onetime repatriation of cash from profits kept overseas. This brought the US statutory corporate tax rate, which had been relatively high, closer to that of most other countries in the Organization for Economic Cooperation and Development (“OECD”).
Regarding the effect of this change on US multinational corporations, President Trump himself even commented in August, 2018, that he expected over $4 trillion to be returned into the US tax system as a consequence of the TCJA. However, these substantial cuts in the US corporate tax rate have seemingly failed to produce, at least in magnitude, some of the effects that the TCJA’s proponents claimed that it would deliver. In fact, as of September, 2018, only about one-sixth of the estimated profits parked overseas by US corporations had been repatriated. Many corporations have remained silent as to their plans to bring their overseas profits back into the US tax system. Nevertheless, since global M&A activity had been surging in 2017 (exceeding $3 trillion in deals), the outlook for 2018 and beyond was still decidedly very much healthy.
The Effects of the TCJA on the US Tax System and Economy
Regardless of the amount that would ultimately be repatriated, the money brought back into the US tax system through the TCJA was predicted to have positive effects for the US economy, including encouraging investment in the US and discouraging profit shifting to lower-tax jurisdictions overseas. Yet, while the total effect of tax law changes may in the long run produce net positive gains in GDP, the anticipated effect of the TCJA on workers and investments has so far not been observed. This is because, prior to the passage of the bill, US corporations had generally been flush with cash and have access to low-cost financing opportunities. This means that an influx of cash repatriated from overseas profits would be unlikely to change the investment behavior of US corporations. In fact, investment activity in the third quarter of 2018 actually slumped. Instead of increasing investment or paying more to workers, US corporations have been buying back stock from shareholders, and at a record volume.
The TCJA and Global M&A Activity
So then, how did the TCJA affect global M&A activity? For one, the decrease in the US corporate tax rate should give firms more cash to spend on M&A, along with more liquidity to fund foreign transactions. Additionally, the valuations of US-domiciled businesses may increase due to the reduction of the US corporate tax rate, making them more attractive potential targets for M&A activity. Additionally, certain provisions of the TCJA were designed to deter inversion transactions, meaning transactions in which a US corporation is folded into a foreign one, and has its business headquarters relocated to the foreign corporation’s country for the purpose of shifting profits to a jurisdiction with a lower tax rate.
Thus far, there have been indications that the TCJA has led to increased M&A activity, at least in geographical proximity to the US. The average size of proposed, pending, or withdrawn M&A deals for North American businesses increased by 9 percent during the first three months of 2018, compared to the same period a year before. US corporate acquisitions made up a substantial amount of North American M&A activity (over 80 percent) in the first quarter of 2018, and acquisitions announced by US acquirers in the first two months of 2018 was at the highest dollar volume since the first two months of 2000. However, the decrease in the corporate tax rate may also correspondingly decrease incentives for US corporations to structure M&A deals in ways that previously aimed to unlock the benefits of relocating businesses to jurisdictions with lower tax rates.
Other Factors May Push 2019 M&A Activity Downwards
While the TCJA may continue to boost overall global M&A activity this year, there are reasons to believe that the record growth may, in fact, cool in the future. New developments in the political and regulatory realms may push M&A activity in a different direction, or provide uncertainty in determining how the global level of cross-border M&A activity will change in 2019, compared to 2018. While M&A activity in the first half of 2018 surged to highs not seen since before the 2008 financial crisis, the amount of US-foreign cross border deals seen in 2019 may cool because of an increasing trend toward protectionism and global political uncertainty. The impacts of trade wars loom as well, though their effects may differ on an industry-by-industry basis because of the impacts that tariffs have on the cost of inputs, for example, in the manufacturing industry.
From a regulatory standpoint, political turmoil in the international arena has brought regulatory challenges for firms seeking cross-border merger approval. In particular, US and EU antitrust enforcers have been particularly active as of late. Additionally, some analysts have predicted increased US scrutiny of foreign M&A and investment, particularly from Chinese companies. The Committee on Foreign Investment in the United States (“CFIUS”) has recently seen its transaction approval process updated after President Trump’s signing of the Foreign Investment Risk Review Modernization Act (“FIRRMA”) in August, 2018. FIRMMA is expected to increase the level of scrutiny faced by foreign investment into the US. On a similar front, the EU Commission has been working to reach an agreement on new legislation regarding the screening of foreign direct investment before the EU Parliament elections in May, 2019. The pending legislation, though it would not provide a blocking power to the EU Commission, proposes requirements for such controls if EU-countries choose to put them in place. By contrast, certain large Asian economies, such as China and Japan, have been taking steps to open themselves up more to foreign direct investment and cross-border transactional activity.
Overall, there is confidence that firms, buoyed by the effects of the tax law overhaul, will be able to navigate the difficulties that arise from changes in trade policy and regulation. Thus, while there are a number of competing variables that will affect the overall amount of M&A activity in 2019, a significant amount of capital and increased access to liquidity due to the TCJA should still contribute to a robust year for M&A activity around the world.