Tax legislation passed in December 2017 by the US Congress—the Tax Cuts and Jobs Act (TCJA)—has implications for firms as well as litigants considering legal finance.
Legal finance not subject to restrictions on deducting interest expense
The TCJA imposes new restrictions on business’s ability to deduct interest expense. For law firms and clients alike, this would increase the cost of interest-bearing loans. Because Burford’s capital is typically provided on a non-recourse basis and is not a loan, it is not subject to these new restrictions.
As the impact of the US tax reform bill begins to be felt, clients and law firms may prefer funding products over traditional debt to avoid being subject to the limitations on deductibility of interest expense.
Corporate income is now subject to a lower federal income tax rate
Following the TCJA, income realized by US corporations is now subject to a 21% federal income tax rate rather than a 35% rate. Decreases, through smaller, were also enacted to individual rates. Even as firms and corporations welcome lower corporate and individual income tax rates, they may benefit from mechanisms to control the timing and flow of that income.
Legal finance provides a means to time cash flows from fees, settlements and awards more precisely—and from a balance sheet perspective, to record these as regular above-the-line income vs. extraordinary income (which is the usual treatment of monies generated by litigation).
Finally, even if a firm or company is not subject to the new interest deductibility restrictions, the reduction in the federal rate decreases the benefit of the deduction.
With elimination of net operating loss carry-backs, legal finance is even more attractive to companies under stress
Before TCJA, companies at risk of bankruptcy could get a cash infusion through a federal tax refund by carrying back current losses to prior tax years. With the elimination of net operating loss carry-backs, companies under duress no longer have access to this source of liquidity.
Legal finance can provide much-needed liquidity—enabling companies to monetize their litigation assets and turn them into cash.
As before, Burford can work with clients to offset cost and risk while they work to resolve contentious tax claims with government revenue authorities—thereby freeing up capital for other business purposes. We do not anticipate a significant increase in contentious tax disputes following the 2017 legislation, but there will likely be a period of adjustment with some concomitant ambiguities.
