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Tax reform: Telcos see lower taxes enabling greater fixed investment

President Donald Trump is turning his attention toward tax reform, an issue that stands to have a substantial impact on the communications industry. Prior to the election, Trump pledged to cut the corporate tax rate to 15%, down from the current statutory rate of 35%. An alternative proposal put forward by House Republican leadership called for a 20% corporate tax rate. An analysis of the 15 largest U.S.-based publicly traded communications companies, as ranked by market cap, shows nearly half of them will pay a 2016 effective tax rate above 30%, money that some CEOs believe would be better spent elsewhere.

Executives at communications giant AT&T Inc. often argue that every dollar spent on taxes is a dollar that could have been spent on infrastructure and expansion.

"When you just look at the U.S. economy for the last decade, one thing has been woefully absent and that is significant business fixed investment," AT&T CFO John Stephens said at a March event, before attributing those low numbers to the country's 35% federal statutory tax rate.

"You can put it somewhere else and pay 20% in taxes or you can put it in the United States and pay 40% when you take into account most of our state tax rates. That differential makes us noncompetitive," Stephens said.

Companies report their effective tax rate as a calculated figure that includes federal, state, local and foreign taxes. In some cases, it can be higher than the 35% federal statutory rate, as state taxes will typically add a few percentage points, while lower foreign tax rates can drive the overall figure down.

Stephens said the impact of a lower corporate tax rate in the U.S. would be far greater than just a smaller tax bill. Instead, he said as new factories and offices are built, they will need internet, phone and wireless services, which will lead to more revenue.

According to the independent tax policy think tank Tax Foundation, the worldwide average top corporate income tax rate across 188 countries and tax jurisdictions is 22.5%. After weighting by each jurisdiction's GDP, the average rate is 29.5%, giving the U.S. one of the highest corporate tax rates in the world.

Unlike certain U.S. new media companies that have cultivated a reputation for lowering their effective tax rate by keeping cash overseas, many of the country's largest communications companies pay an effective tax rate close to the federal statutory rate.

AT&T, for instance, reported an effective tax rate of 32.7% for 2016, while Verizon Communications Inc. and Comcast Corp. reported rates of 35.2% and 37.0%, respectively.

Verizon CFO Matt Ellis said in February the company is "a supporter of tax reform," believing such reform is necessary to maintain the U.S. as a competitive place for companies to invest. He did, however, acknowledge that there also could be some "negative" effects from a proposed plan on tax reform.

The "A Better Way" blueprint — backed by House Speaker Paul Ryan, R-Wis., and House Ways and Means Committee Chairman Rep. Kevin Brady, R-Texas — has been criticized for its inclusion of a border adjustment tax, which would apply to goods manufactured overseas. Opponents of the border tax warn that it could distort supply and demand, ultimately raising prices for U.S. consumers. Additionally, it may violate a World Trade Organization "national treatment" clause that prohibits favoring domestically produced goods over imports.

While many of the largest communications network operators have continued to pay effective tax rates at or around 35%, there are other companies that have found a way to significantly lower their tax rates.

Tower companies American Tower Corp., Crown Castle International Corp. and SBA Communications Corp., for example, reported effective tax rates for 2016 of 13.8%, 4.5% and 12.7%, respectively.

All of these tower companies were converted into real estate investment trusts, or REITs, in recent years. A REIT is a corporation that qualifies for special treatment for U.S. federal income tax purposes because, among other things, it derives most of its income from real estate-based sources.

A few years ago, there was a relative boom in REIT conversions as companies, including cell-tower operators and billboard advertisers in the media and communications space, took the expensive and time-consuming steps to convert from an operating entity to a REIT. Following Trump's election, however, professional services firm PricewaterhouseCoopers LLP suggested there may be fewer REIT conversions going forward.

"The benefit of a corporation considering a REIT conversion may be lessened if the corporate tax rate is reduced," the firm said, adding that real estate funds and other investors who are deciding whether to invest in a regular corporation or a REIT "might come to a different conclusion" if the corporate tax rate is dramatically reduced.

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