5 key tax considerations for industrial M&A deals

1. Cost segregation and bonus depreciation

For industrial businesses, accelerating cost deductions through cost segregation studies and bonus depreciation is key. Starting in 2023, the 100% bonus depreciation limit now decreases each year until it is phased out by 2027. For 2023, eligible property qualifies for 80% bonus depreciation in the first year.

Companies will need to understand the implications of this change as the reduction in accelerated deductions may have a significant impact on taxable income and the related tax liability. Buyers should ensure that targets are properly depreciating property put in service. 

2.  Interest expense limitation under IRC section 163(j) and section 266

For tax years 2022 and 2023, interest deductions are limited to 30% of adjusted taxable income subject to certain adjustments. Interest expense capitalization under IRC section 266 may help industrial businesses maximize interest deductions. Under section 266, a taxpayer may elect to capitalize interest and other expenses into property. This may allow an opportunity to capitalize interest to shorter-lived property and accelerate tax deductions.

Companies should continue to monitor limitations on the utilization of their interest deductions. From an M&A perspective, it is important for buyers to review targets’ historical interest deductions, including determining if the deductions may have been subject to any limitations.    

3. Global minimum tax

The Organisation for Economic Co-operation and Development (OECD) introduced the Pillar Two Model Rules, which provide for a global minimum effective tax (GMT) where multinational enterprises with consolidated revenue over €750 million are subject to a minimum effective tax rate of 15%. Over 135 jurisdictions have joined the Pillar 2 proposal, with many aspects in effect for tax years beginning in January 2024, and certain remaining impacts to be effective in 2025. Country-specific implementation, however, is subject to local legislation.

Given this OECD pillar, manufacturers and other industrial companies will need to consider their global operations, including possible opportunities to reimagine global supply chains.

4. Superfund excise tax

The Superfund excise tax on chemicals and imported taxable substances took effect July 1, 2022, with a 10-year effective period through Jan. 1, 2032. IRC section 4671 imposes tax on taxable substances sold or used by an importer. Given the recent guidance that has come out regarding the tax, energy and manufacturing companies in the chemicals sector or related areas, industrials should continue to stay current with the law to ensure potential compliance obligations are met.

5. Research and experimentation capitalization and amortization

For tax years beginning after Dec. 31, 2021, companies are required to capitalize and amortize IRC section 174 R&E expenditures over a five-year period if the R&E activities are performed in the United States and over a 15-year period if the activities are performed outside of the United States.

From an M&A perspective, it is important for buyers to review the R&E expenses of potential targets and understand the tax implications of the new section 174 rules, which will require ultimately capitalizing these expenses going forward.