Impact of Tax Reform on Commercial Loan Documents: Adjustments to Financial and Other Covenants

Description

Tax reform has varying effects on commercial borrowers. The lower corporate tax rate will improve the after-tax return of many businesses, but they will likely also see a reduction in deductible items, including interest. Business interest deductions are capped at 30% of “adjusted taxable income,” which is based on EBITDA from 2018 to 2021 and on EBIT after that. The new pass-through business deduction will benefit certain partnerships, but may impact the calculation of tax distributions for pass-through entities.

Tax reform also fundamentally altered the U.S. international tax regime for U.S. taxpayers. The repatriation of cash currently held abroad will increase the domestic cash flow of many companies. Importantly, recent regulations under Section 956 would substantially eliminate the impact of Section 956 on financings to corporate borrowers, which traditionally has limited the ability of foreign subsidiaries of U.S. borrowers to guarantee, or pledge assets to secure, those borrowers’ loans.

Commercial finance counsel must review and revise documents to address these changes. The parties may desire specific "fixes" for these and other issues relating to tax reform, including provisions relating to the pledge of stock in and assets of foreign subsidiaries. Carefully structured financial and other covenants will provide lenders with their intended protection and remedies and borrowers with continued flexibility to operate their businesses.

Listen as our authoritative Mayer Brown panel discusses the impact of tax reform on commercial loan documents and how financial and other covenants might be revised to the satisfaction of borrowers and lenders.