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With revenues plunging, scores of capital-intensive companies have announced plans to rein in capital spending. While such cuts sound prudent giving the current economic downturn, the urge to curb could actually result in sizeable tax liabilities for these companies. Why? Because of their substantial deferred tax liabilities.
In fact, a new study conducted by the Georgia Tech Financial Analysis Lab found that Anadarko Petroleum, Marten Transport, Hunt (J.B.) Transport Services, NStar, GATX Corp., D&E Communications, Werner Enterprises, Sprint Nextel, Weyerhaeuser, Embarq and Dominion Resources all face big hits to cash flow from taxes because they are reducing capital expenditures while carrying deferred liabilities.
The deferred liabilities equaled at least 11% of each of the businesses’ total assets in 2007.
Energy company Anadarko topped the list of companies which can expect a big bill from the IRS. The oil producer’s deferred tax liabilities equate to 21% of its assets, said Georgia Tech.
Marten Transport was close behind on the list. That company's deferred tax liabilities equal 17% of its assets. Hunt and NStar both have deferred tax bills that add up to 16% of their corporate assets.
The companies face the prospect of required tax payments because of those deferred tax liabilities, which represent the amount of tax deferred as a result of accelerated depreciation that is reflected on tax returns but not on cash flow statements. "They're tax on the difference," explained Charles Mulford, an accounting professor at Georgia Tech who directs the financial analysis lab.
As those deferred liabilities decline, tax payments postponed from prior years come due. Such payments can be deferred indefinitely—but only if companies continue to increase their capex. Reason: Lower taxable income in early years due to higher tax-related depreciation charges is replaced with higher future taxable income as depreciation charges decline. In the process, income taxes deferred in the early going become due and payable later.
Even capital-intensive companies that didn’t reduce capex in 2007 may face increased payments as they succumb to pressure to do so as a result of the economic downturn, noted Mr. Mulford.
He added that the higher tax payments may surprise investors, since the downturn would otherwise reduce their liabilities as a result of falling income.
“Investors may not be expecting such high tax payments, especially during a recession.”
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