Earnings down on Trump tax cuts?

A few companies have come out recently talking about the effect of Trump tax cuts and flagging large losses/write-downs. From the FT:

in the short term, the cut in corporation tax to 21 per cent will lead to a revaluation of all BP’s US deferred tax assets and liabilities. On current estimates, the impact of this will be a one-off non-cash charge to the group’s income statement of around $1.5bn that will hit the oil company’s fourth quarter 2017 results. Details of the actual charge will be disclosed in BP’s fourth quarter 2017 results announcement, on February 6.

Last week, oil rival Shell and banking group Barclays said they were also likely to to benefit over time from the reduction in the US corporate tax rate, but incur hefty non-cash charges in their fourth-quarter results.

Shell said last Wednesday that it expected to take a $2bn-$2.5bn charge against the accounting value of its “deferred tax assets. Barclays said it expected to record a £1bn charge in its 2017 results that would dent its capital position and could damp shareholders’ hopes that the bank would soon announce a sizeable increase in its full-year dividend.

Just to unpack this for those who aren’t that interested in accounting:

  • The Trump tax changes will result in companies paying less “cash” tax
  • The Trump tax changes will result in companies reporting lower “accounting” tax after next year
  • Next year, companies that have deferred tax assets will have write-downs/losses in the value of those assets – and for some companies, the amount will be massive

So, for the next 12 months, we are going to see many companies reporting large write-downs that we can ignore for the purposes of valuation – these write-downs are non-cash and aren’t indicative of any loss of value.

Accounting aside

A deferred tax asset usually comes from one of two ways:

  1. Losses in subsidiaries: if a company lost $100 then it gets a future tax benefit – i.e. it can earn $100 the next year and not have to pay tax. When the tax rate was 35% this was worth $35. Now its only worth $21.
  2. Differences between reported income and taxable income: Companies prepare two sets of accounts, one for the tax department and then a different set for investors. The goal is to tell the tax department that earnings are as low as possible (to minimise profit) and to tell investors that earnings are as high as possible (to maximise the share price/management salaries). The difference between the two can lead to deferred tax assets.

While this might sound all a bit arcane, I do have a point.

The second type is one of my favourite measures when exploring company accounts for shenanigans – when the company is telling the tax department that it isn’t making any money but telling shareholders that it is making money you should think twice about which number you believe.  “I’m not lying to you, I’m lying to the other guy” is rarely a statement to inspire confidence.

Damien Klassen is Head of Investments at Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.