January 18, 2018

On Thursday, the markets had what seems to be a rare down day.

The S&P 500 index was down 0.2% and Toronto was down 0.3%.

Our biggest gainer was Constellation Software, up another 1.6%.

A number of large U.S. financial companies have reported big write-offs due to Trump’s income tax reductions. That’s rather counter intuitive but it happens for two reasons:

  1. When a corporation has past losses, that have not yet ever been claimed on its tax returns and that it expects to carry forward to reduce future cash income taxes, it must book this as a deferred tax asset. When income tax rates drop, the value ability to carry forward past losses declines. In this case each $1.00 of unclaimed past losses could formerly be used to reduce future taxes by 35 cents at some point. But now, it will be just 21 cents.
  2. Some corporations have earned money in other countries at low tax rates. The former rules were that if the cash was repatriated to the U.S. income tax was payable representing the difference between the foreign tax rate and 35%. Trump’s changes included capping the repatriation tax rate at 15.5%. to the extent that this encourages companies to repatriate cash that they formerly had no intention of repatriating, this causes a one-time income tax hit. In many cases large corporations were using accounting maneuvers to basically legally pretend that profits were earned largely in tax havens. If the foreign tax was zero then upon repatriation they will now pay 15.5% whereas previously they were refusing to repatriate the cash due to a 35% tax. Paradoxically, the new rules could encourage corporations to book even more of their profits in offshore tax havens and then repatriate it. Why pay 21% in the U.S. when you can transfer the profit to a tax haven through “transfer charges” and then bring the money back at a 15.5% tax rate?