The US corporate tax system has remained largely unchanged since 1986. However, on April 26, 2017, the Trump administration publically released its plan to significantly reduce corporate income tax rates by passing legislation for comprehensive tax reform. The proposed tax reform calls for a reduction in corporate income tax rate from the current 35% to as little as 15%.
Trump administration officials and congressional Republican leaders are in the process of negotiating the terms of a tax reform bill (the “Trump Plan”). However, to date, neither legislation nor detailed plans have been introduced, only a high-level tax reform proposal.
The proposed objective of the Trump Plan is to provide tax reform and simplification by imposing a lower corporate income tax rate. The Trump Plan proposes switching to a territorial international tax system for U.S. companies’ foreign earnings, in order to level the playing field for American companies and bring trillions of dollars from offshore to be invested in the U.S. Furthermore, Trump’s Plan also proposes a one-time tax on the repatriation of foreign earnings of U.S. companies at an unspecified rate and to eliminate tax breaks for special interests.
President Trump has called for a proposed corporate income tax rate of 15%, while the House Republicans have set a goal of 20%. A specific target rate has not yet been set, however we understand that some credit rating agencies have begun to include a 25% corporate tax rate assumption in their modeling in anticipation of the Trump Plan.
If enacted, the legislation could have significant income tax accounting implications for companies in the U.S., especially in the year the change is enacted. Companies should continue to monitor developments in this area and evaluate the potential future accounting effects, as it will require careful consideration and preparation. Additionally, depending on the timing of when the reform bill is signed by the President, companies may have limited time between the date of enactment and the end of their financial reporting period. Although the Trump administration has commented that it expects the bill to pass before 2017 year end, many consider this to be an aggressive timeline, with 2018 being more realistic.
A reduction in the corporate income tax rate could significantly impact regulated utility companies and their customers. Unlike other commercial enterprises, regulated utilities deal with the complexity of economic regulation and the ratemaking process.
Accounting Implications and Considerations
Under U.S. Generally Accepted Accounting Principles (“GAAP”), Accounting Standards Codification 740 (ASC 740), “Income Taxes,” a change in enacted tax law and/or tax rates is recognized in the period in which the new legislation is enacted. A reduction in the corporate income tax rate will affect current tax expense, current tax payable, as well as deferred tax expense and accumulated deferred income taxes (“ADIT”). The total effect of income tax law changes on deferred tax balances is recorded as a component to tax expense related to continuing operations for the period in which the law is enacted, even if the assets and liabilities relate to discontinued operations, a prior business combination or items of accumulated other comprehensive income.
Regulated utility companies operate as a monopoly, and as a result are regulated by either a state public utility commission or the Federal Energy Regulatory Commission (“FERC”). The regulators are tasked with ensuring the tariffs charged to the customer are fair. To accomplish this, the regulator requests rate case filings from utilities to present information about operating and capital costs incurred for a period of time. Regulators use the information to determine the proper rate a regulated utility company can charge its customers in recovery of operating costs plus a reasonable return on capital. The potential cut in corporate tax rates do not benefit the earnings of the company as income tax expense is passed through to ratepayers instead. The more important issue is the effect it has on the rate base.
Rate base primarily reflects the utilities’ investment in property, plant, and equipment (“PP&E”). When determining the rate base, utilities subtract from the value of their PP&E the value of deferred tax liabilities that arise from the differences in reporting depreciation for rate-setting purposes versus depreciation for tax purposes. A reduction in the corporate tax rate would reduce the disposition value of these liabilities by diminishing actual future tax liabilities. Also, the excess tax liabilities would be returned to ratepayers through lower rates.
However, utilities have taken advantage of accelerated depreciation for tax purposes as a means of financing capital expenditures. By reducing interest free ADIT, utilities will need to find new sources of capital, such as debt and equity, to fund their capital expenditure needs. Regardless of whether it is replaced by debt or equity, it will come at a higher cost, which will ultimately drive higher tariffs.
We do not currently know how tax reform will play out, however the current administration will certainly push forward on this initiative in the near term. It is smart for companies to consider how potential changes could impact their operations, budgeting, financing, and reporting so that they are prepared.