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  • US Interest Expense Limitation – Time to Optimize Your Working Capital

11/27/2018

US Interest Expense Limitation – Time to Optimize Your Working Capital

Insights

The major overhaul of the U.S. tax code with the Tax Cuts and Jobs Act in 2017 has had significant financial implications for corporations, including a revision to rules around the deductibility of interest payments. The new Section 163(j) rules restrict companies to deducting interest payments up to 30 percent of their adjusted income plus floor plan financing interest. Previously, companies could generally deduct corporate interest payments without a firm limit.  

While the new Section 163(j) currently limits the deductibility level to earnings before interest, taxes, depreciation and amortization, or EBITDA, starting January 1, 2022, depreciation and amortization costs will be included in the calculation. As a result, profit and the amount of interest expense that is deductible will be reduced.

Effects of the New Section 163(j)

Capital-intensive or highly leveraged companies will likely be some of the most affected by these new limits. Though the Tax Cuts and Jobs Act helped many companies make gains by reducing the corporate tax rate from 35 percent to 21 percent, the updates to Section 163(j) could eliminate much of those savings, potentially leaving companies with bigger financial concerns than before the Act was passed.

Unlocking Cash with Supply Chain Financing

With the new interest deduction limit, many companies are exploring options and solutions to keep their interest payments below the 30 percent marker. Supply chain financing (SCF) is one solution companies can utilize to minimize the impact of the revised Section 163(j). Rather than paying interest on debt, companies taking advantage of SCF can unlock cash that is trapped in their supply chain.  

With the help of SCF, buyers have a tool to optimize their working capital by negotiating extended payment terms with their suppliers, allowing them to plan for longer terms from the start and have access to their cash for longer. SCF also enables suppliers to get paid early by selling their buyer-approved receivables to banks like CIT prior to maturity at a small discount. This is a win-win opportunity for buyers and suppliers that can also minimize risk across the supply chain. Through this arrangement, buyers don’t need to borrow as much and will pay less interest, helping keep their interest payments below the 30 percent cap mandated by the new Section 163(j). At the same time, the buyer’s DPO (days payable outstanding) and the supplier’s DSO (days sales outstanding) could improve if both parties take full advantage of the SCF solution. 

Technology’s Expanding Role in SCF 

SCF can also increase transparency between buyers and their suppliers thanks to recent developments in digital technology. With CIT, buyers can upload approved invoices to an online platform where suppliers can view all approved invoices and select at their discretion invoices for early payment. The buyer will then pay CIT on the invoice due date based on the agreed-upon supplier terms. Not only can this technology be efficient for advancing financial flows, it could improve relationships between buyers and their suppliers by providing visibility into payment terms and expected cash flow while possibly decreasing opportunities for miscommunication. 

SCF Workflow

After buyer and supplier have agreed on the new extended payment terms, the SCF process follows a few simple steps with banks like CIT: 

  1. Supplier ships the goods and invoice to the buyer
  2. Buyer uploads an approved invoice for payment 
  3. CIT notifies the supplier of the buyer’s invoice approval
  4. Supplier sells the invoice to CIT at a discount in exchange for immediate payment
  5. Buyer pays CIT the invoice amount on the due date of the new extended payment terms

Planning for 2018 Taxes and Years Ahead

As companies look ahead to the coming tax season, it may be helpful to consider SCF as a solution to the new Section 163(j) 30 percent interest deduction limit. Taking advantage of the working capital trapped in the buyer-supplier relationship can allow companies to avoid borrowing and keep their interest levels comfortably below the limit. Learn more about how SCF from CIT can help your business optimize working capital by contacting Joerg Obermueller, managing director of supply chain finance, CIT's commercial services business, at 212-461-5299 or via joerg.obermueller@cit.com

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