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Discussions over the benefits of EBIT and EBITDA can be found at home on Reddit threads or on business school seminars. However, the gap between these two measures in corporate revenue has recently become an important issue in US tax policy.
In 2017, during his first term as President Donald Trump, he signed a reform law that would limit the amount of interest payments that could be deducted from a company’s profits before calculating tax bills. Initially it was set at 30% of the company’s revenue before interest, tax, depreciation and amortization, but was often considered a close representation of cash flow.
The law stated by 2022 that the reference diagram will switch from EBITDA to profit before interest and tax or EBIT. This small number deducts depreciation and amortization costs, which represent the depletion of the value of a long-term asset, rather than actual cash expenses.
According to Bloomberg News, it’s no surprise that private equity and manufacturing lobbies want to bring the law back to EBITDA standards, as interest rates are still rising. As far as they are concerned, the more interest they can offset on the tax, the better. Congress must change the original law to make it.
Using either measure to capping the interest tax deduction amount may sound arbitrary. The logic is that companies partially offset distortions in their own way of raising funds. Taxes are calculated after interest is paid, but it effectively means that borrowings are subsidized at the company level before dividends, but there is no fairness. Trump’s restrictions will bring more equality between the two.
For many companies, EBIT and EBITDA choices are quite important. Charter Communications, a debt-rich, capital-intensive US communications group. Last year, its interest expense was $5 billion and its EBITDA using statutory accounting standards was $21 billion. However, EBIT is only $13 billion, and if that alternative ceiling is prioritized, 30% is not enough to completely offset interest payments on taxes.
There is a greater debate as to whether debt should be tax-backed over equities. It’s probably for future administrations. For now, correct measurements depend on the desired outcome. If the goal is to raise the maximum tax revenue or discourage a company from taking on excessive debt loads, then using EBIT makes the most sense.
However, if the goal is to ensure that businesses continue to grow and invest, and if the Trump administration certainly makes the impression, maintaining the appeal of relatively inexpensive debt is a priority. So Ebitda might be the winner for now. Of course, it could produce other results that would please the White House too. For example, more profits are led to dividends and buybacks, and the thanks of the Private Equity Baron.
sujeet.indap@ft.com
