ACG keeps wary eye on proposals to eliminate interest payment deduction

Speaking this Tuesday during the public policy session held at the Association for Corporate Growth’s Intergrowth conference in Orlando, Fla., Gary LaBranche, president and CEO of ACG, said that the association has on its radar proposals floating in Congress to eliminate the deductibility of interest payments. “Will that change your world? Yeah. So, that’s the kind of thing we’re engaged in through ACG’s public policy efforts,” LaBranche said.

Matthew Morris, a partner in the Dallas office of RGL Forensics, a company that provides valuation services and conducts financial investigations, said during the same session that enthusiasm in Washington for eliminating or reducing the deductibility of interest on taxes has waxed and waned over the years. But, he added, “It’s waxing right now in a pretty big way.” Morris predicted that a number of candidates for president would propose this year or next tax reform as part of their campaign platforms.

At least two kinds of proposals have already been made, according to Morris. The one most talked about, and supported by Republican presidential candidate Marco Rubio, a senator from Florida, would eliminate or “dramatically curtail” the deductibility of interest expenses, Morris said. It would then use the savings to fund a cut in overall corporate tax rates to get them closer to the 25 percent rate that would presumably be more competitive with that of other countries. The other, championed by Devin Nunes, Republican representative from California, would let corporations expense the cost of the item being financed up front, but not let them deduct interest payments. 

And why have the proposals to eliminate deductibility of interest payments been gaining traction? First, according to Morris, many people believe that companies taking on too much leverage played a role in provoking the financial crisis of 2008. Second, the deductibility of interest payments is seen by some as encouraging companies to take on unhealthy levels of debt. And third, many people are simply hostile to financial sponsors, investment banks and other financial institutions. It has all added up to sentiment that makes it easier for politicians to target the deductibility of interest payments as part of comprehensive tax reform.

In its simplest formulation, the value of a company is determined by cash flow divided by the difference between the cost of capital and growth. Proponents of eliminating the deductibility of interest payments often call their plans “revenue-neutral,” with the implication that cash flow would not be affected. Even so, the proposals would raise the cost of capital for companies, causing a “permanent impairment” of value, Morris said. 

RGL Forensics, a sponsor of ACG, has an agreement with the organization to conduct research on the subject in return for having its name associated with the results. It has undertaken two projects to determine the cost of the proposals to middle-market companies, and whether they would have “unintended consequences,” Morris said.

In the first project, RGL Forensics is looking at the impact the proposals would have on the equity values of hundreds of public companies. Once that is determined, the impact would be “extrapolated” to mid-market private companies, Morris said. Preliminary results suggest an average 15 percent reduction in equity valuations, assuming no change in growth rate at companies.

RGL Forensics also plans to survey private companies (excluding insurance companies, banks and other financial firms) to find out how the proposals would affect their capital budgeting, as well as their appetite for growth projects.

Morris said the firm aims to present the results of the two projects in a white paper to be published by mid-August. “We’re going to let the numbers tell the story, and just take the political aspect as much as possible out of it,” he said.

Sidebar: Looking to get involved?

A number of companies and organizations with an interest in maintaining the deductibility of interest payments have formed a lobbying organization in Washington.

While supporting comprehensive tax reform, the BUILD Coalition (Businesses United for Interest and Loan Deductibility) describes its mission as preserving “100 percent interest deductibility, a core component of the tax code for 100 years.” Among members of the coalition is industry trade group Private Equity Growth Capital Council.

“Virtually every business in America uses debt to finance fundamental business activities, like meeting payroll, buying raw materials, or making critical capital investments,” the coalition states on its website.

For more information contact Sabrina Siddiqui at ssiddiqui@buildcoalition.org or 202-822-1205