Impact of tax reform on M&A activity
So the most important consequence of the Tax Cuts and Jobs Act of 2017 was to remove the cloud of uncertainty that was hanging over the market. In terms of the positive aspects, I think there are primarily three.
The first one is the 21% corporate tax rate, significantly lower than the 35% corporate tax. The second one was the one-time deemed repatriation of trapped offshore earnings. US multinationals now have access to all of their offshore earnings. The third benefit is a pseudo-territorial system going forward, where US corporations with lots of foreign subsidiaries can access the earnings of those foreign subsidiaries after paying tax in the local jurisdictions without any additional repatriation tax.
So, how has that impacted M&A activity?
More cash on the balance sheet is a good thing. That plus the removal of the uncertainty has caused US companies to be more constructive about M&A in 2018. And indeed, we've seen the first half volume numbers up significantly.
Tax considerations driving M&A transaction structures
The 21% tax rate has caused companies to look again at their portfolio of businesses and try to assess which businesses are core and which businesses are non-core. Non-core business that haven't been really saleable, because the return on an after-tax basis hasn't been very attractive, are more saleable now at a 21% tax rate than they were at a 35% tax rate. So 21% is better than 35, zero is better than 21.
What we have seen this year so far is a tremendous focus on tax-free deals. So far this year 15 tax-free spinoffs have been announced. That includes four Reverse Morris Trust transactions. The other type of complex transaction that we've seen more of this year than we're used to are taxable spinoffs. And the second thing is mergers with a spinoff to be done later.
M&A outlook for the remainder of 2018
Although the M&A volume in the first half of the year was extremely positive, in the last couple of months we've seen a little bit of a drop off. So, as we look at sectors this year that have performed strongly TMT is up, Healthcare is up, Power and Utilities are up. All three of those sectors have been very strong in terms of global announced volume relative to the ten year trend.
The hope for the rest of the year in terms of tax clarification is that some of these complexities will be clarified. So far we've seen a lot of commentary on a number of questions relating to base erosion, interest deductibility, the various complexities associated with the the territorial concept. We're hoping to see some additional guidance before the end of the year, and that will certainly cement some of the positions that companies have been taking, particularly in M&A transactions.
So I think we can hope to see continued pick up in activity. But it's going to be a little bit more muted than it was in the first half.