Some CFOs Say Higher Corporate Taxes Could Lead to Lower Investments

If the tax increase happens, privately owned Donatos Pizzeria LLC, based in Columbus, Ohio, expects to scale back its investments in automation and store remodeling, Chief Financial Officer Doug Kourie said. “Any more taxes we pay is less invested back into the company,” he said. “It would have a real impact.”

Other companies, including network equipment maker Cisco Systems Inc. and water systems provider Core & Main Inc. are also reviewing the proposals and what they could mean for their business, with many of them worried about the prospect of a higher corporate tax rate.

“No one wants to see the tax rate go up” to 26.5%, said Scott Herren, chief financial officer at Cisco, adding that there shouldn’t be tax changes that make it less appealing for businesses to invest in the U.S.

House Democrats, in addition to the higher corporate tax rate, proposed increasing the base erosion and anti-abuse tax, the tax on global intangible low-tax income, or Gilti, and other levies, such as the tax on foreign-derived intangible income, while taking away certain deductions.

“What tax advisers are trying to do is a lot of modeling,” said Greg Engel, vice chair for U.S. tax at professional services firm KPMG LLP. “The modeling is very complicated. Some companies have gone deep into it, while others have kept it [more] high level,” Mr. Engel said.

St. Louis, Mo.-based Core & Main, which sells water pipes, drainage equipment, pumps and other products, is in the process of assessing the potential significance of the Democrats’ tax package on its finances, CFO Mark Witkowski said. “We are paying close attention to what the increase in the headline rate could mean for our cash flows,” Mr. Witkowski said. Core & Main reported net sales of $1.3 billion for the quarter ended Aug. 1, up 36% from a year earlier, while net income fell by nearly half to $9.5 million due to costs related to the company’s recent initial public offering.

The bill includes several tax increases on businesses organized as pass-throughs, such as Donatos. Unlike regular corporations, pass-through businesses’ net income flows directly to their owners’ personal return and is only taxed once, at the owners’ individual rates.

Donatos Pizzeria is reviewing several scenarios for its annual budget based on the potential level of tax rates, Mr. Kourie said. “You work on two or three different budget scenarios,” Mr. Kourie said. “If taxes are this, then here’s the priority list of your capital investments. And you just start at the top and do those,” he said, adding that certain projects—for example investing in research and development—would have to wait if the company had to spend more on paying its tax dues.

The House Democrats’ plan, which differs slightly from proposals made by the Biden administration, keeps many of the provisions of the Republican tax overhaul in place, but increases the rates associated with them to pay for higher spending, including an expanded child tax credit, a national paid-leave program and renewable-energy tax breaks. Democrats have also argued that the 2017 law, which was signed by then-President Donald Trump, went too far in terms of reducing the tax burden on companies.

The law lowered the statutory tax rate from 35% and introduced various stipulations meant to discourage profit shifting to low-tax jurisdictions and instead motivate companies to invest more in the U.S.

Cisco, which moved a large proportion of its intellectual property back to the U.S. following the passage of the 2017 tax law, said it welcomes maintaining the current framework around foreign-derived intangible income. The provision, which sets a 13.125% rate on domestic income generated from serving foreign markets, was meant to encourage companies to locate their IP back to the U.S. The Democrats’ plan envisages raising the rate on such income to 20.7%.

“We have been very active in helping shape policy along those lines,” Mr. Herren said. Cisco’s effective tax rate stood at 20.1% during the fiscal year ended July 31, up from 19.7% during the prior fiscal year and broadly in line with the 2019 fiscal year. It is lower than the statutory rate due to things like tax credits for research and development and deductions for foreign-derived intangible income, the company said in a filing with securities regulators.

Finance chiefs at U.S. businesses with large operations abroad also will be reviewing their interest expenses, said Remmelt Reigersman, a partner at law firm Mayer Brown and a member of its tax transactions and consulting practice.

House Democrats are proposing to limit companies’ ability to offset interest costs at the U.S. corporate tax rate depending on the proportion of income that is generated in the country, which could result in CFOs moving debt to foreign subsidiaries. “Debt can become very expensive if the interest isn’t deductible anymore,” Mr. Reigersman said.

Some businesses could benefit from a higher rate, at least temporarily. Coffee company Farmer Bros. Co. might see the value of certain tax offsets tied to the company’s net operating losses rise, finance chief Scott Drake said. The company hasn’t been profitable in recent years and can apply its historical losses against future income, Mr. Drake said.

Northlake, Texas-based Farmer Bros. hasn’t had to pay corporate taxes on its profits, due in part to costs stemming from the company’s 2017 acquisition of Boyd Coffee Co. and, more recently, the impact of the pandemic, according to Mr. Drake. Farmer Bros. reported a $41.7 million net loss during the fiscal year ended June 30, compared with a $37.1 million loss a year earlier.

Farmer Bros. expects to return to profitability once the impact of the pandemic on its commercial customers, which include restaurants and hotels, abates, Mr. Drake said. At that point, the company could use some of the tax offsets it has accumulated, he said. “It’s kind of one of the benefits of bad times, and then turning to good times,” he said.

Write to Nina Trentmann at [email protected], Mark Maurer at [email protected] and Kristin Broughton at [email protected]