How US tax reform rewards companies that shift profit to tax havens
THE corporate tax cut passed by US President Donald Trump and fellow Republicans that was in part designed to help dissuade US companies from moving profits overseas may instead make the practice a lot more rewarding.
That is because companies which shifted profits linked to US sales, research or production previously had to pay US taxes on the money at the rate of 35 per cent when they brought those profits home.
The new tax bill cuts the overall corporate tax rate to 21 per cent, and allows income from overseas to be taxed at about half that rate – to as low as 10 per cent.
AbbVie Inc is a case in point. Its Chief Executive Richard Gonzalez told investors earlier this year that because of the change to a territorial system, whereby only profits reported by domestic subsidiaries face US tax, the US drugmaker expects its tax rate to fall to nine per cent this year from around 22 per cent in recent years.
That ranks among the lowest of the companies in the S& P 500 that have announced estimates for their tax rate, which average around 22 percent, according to Credit Suisse.
The company has historically reported its income in lower tax jurisdictions, which is possible in part because AbbVie parks the majority of the patents for its top- selling drug in Bermuda – a country that has a zero tax rate on corporate profits, according to a Reuters analysis of 88 Humira patents.
Despite recording over half its US$ 28.2 billion in 2017 sales in the United States and basing most of its research facilities there, the suburban Chicago company has never reported a profit in its home country, its annual reports show.
In 2017, AbbVie reported foreign earnings before income tax of US$10.4 billion on international revenue of only US$ 9.97 billion.
Yet, between 2013 and 2016 AbbVie had to pay around US$1 billion a year of taxes in the United States, when it took the profits reported by foreign subsidiaries home to help cover expenses from its US operations.
In the future, it will not have to pay such taxes under the Tax Cuts and Jobs Act.
The authors of the tax legislation, including Senator John Thune of the Senate Finance Committee, said their bill would discourage the shifting of profits earned in the United States.
But the principal anti-tax avoidance measures introduced still allow companies to benefit strongly from profit shifting.
AbbVie does not address the patent locations on earnings conference calls or in its SEC filings, and declined to discuss its accounting practices or its annual U.S. losses – which are widely accepted among investors who have scooped up its shares over the 5-year life of the company.
The main driver for AbbVie, a rheumatoid arthritis treatment called Humira, generated more than US$ 12 billion in sales in 2017 from patients in the United States, where the most common dose has a list price of about US$ 60,000 a year.
If the guardrails in the new territorial system were meant to prevent companies from avoiding all taxes, AbbVie’s (tax rate) is a pretty clear signal that these guardrails may not be effective. Matthew Gardner, Institute of Taxation and Economic Policy senior fellow
“If the guardrails in the new territorial system were meant to prevent companies from avoiding all taxes, AbbVie’s (tax rate) is a pretty clear signal that these guardrails may not be effective,” said Matthew Gardner, senior fellow with the Institute of Taxation and Economic Policy.
AbbVie is not the only US company with big operations at home but which reports relatively few profits. Pfizer Inc, Expedia Group Inc, Boston Scientific Corp, Synopsys Inc and Microsoft Corp also do the same and are set to be big winners from the shift in territorial system, executives have said and earnings for the most recent quarter show.
Microsoft and Synopsys declined to say if their eight-year runs of reporting around half their sales in the United States but less than a quarter of their profits domestically reflected a tax reduction strategy.
Expedia and Boston Scientific did not respond to requests for comment.
Pfizer said its 10 years of US losses reflected operational matters rather than tax planning.
“Because of our US domicile, we have significant domestic funding needs, such as paying for R& D, corporate functions, interest on our debt, to name a few. As a result, our US operations can be less profitable than other jurisdictions,” the company said in a statement.
Democrats in Congress are examining how the new tax law incentivises companies to use patents to shift profits overseas, and Oregon Senator Ron Wyden plans to issue a report dealing in part with the issue later this summer.
“The US shouldn’t get suckered into a race to the bottom with a bunch of no-tax, resort-lined islands to please the tax avoidance industry and their lobbyists,” said Wyden, the Senate Finance Committee Ranking Member.
The US move away from worldwide taxation represents an adoption of modern tax orthodoxy. All the biggest western economies operate a territorial tax system but, conscious of the risk of profit shifting, they also have rules to tackle this.
Typically, these rules allow governments to tax income reported in tax havens as though it arose in the home country.
Congress attached such a provision to the Tax Cuts and Jobs Act approved at the end of 2017. Under the new Global Intangible Low Tax Income (GILTI) provision, if a company generates untaxed profits in a tax haven, it will be liable to have that profit taxed as though it arose in the United States.
However, the effective tax rate that will apply is half the US tax rate of 21 per cent, or 10.5 per cent. And if a company reports a loss in the United States, this can be set against the GILTI provision, or deemed US income. This can reduce the tax liability further.
Senate Finance Committee spokeswoman Julia Lawless did not respond to a question about whether the panel’s Republican members would consider raising the GILTI rate.
But she said current discussions around the new law centered on its implementation rather than redrafting the Act.
“The international title of the tax overhaul included significant anti-base erosion provisions,” she said.
“The blueprint”
Reuters reviewed close to 90 patents on Humira, most of which were cited by AbbVie in lawsuits as protecting intellectual property. Around two-thirds of those patents were assigned to the Bermuda subsidiary, AbbVie Biotechnology Ltd. Most of those patents were developed by teams of researchers entirely or somewhat based in the US, according to details in patent filings.
“This is the blueprint,” said Reuven Avi-Yonah, director of the International Tax at the University of Michigan Law School.
“The illusion that you would see more patents kept in the US (under the new tax law) is unreal as long as there are places you can keep them off shore where you pay 0.”
The exact mechanisms AbbVie uses to report such a low a tax rate is not public.
However, analysts and academics say corporate filings often show that drug companies frequently reduce their taxes by parking patents in a low-tax haven, as AbbVie does, and then have their affiliates – which manufacture or market the drug – pay the tax haven subsidiary royalty fees for the right to use the patent.
This arrangement sees a drug sold into a target market, like the United States, at a high price, with the US distribution arm getting a sales margin as low as five per cent.
Sometimes the US distribution profit is not enough to cover group costs incurred in the United States.
For example, many of AbbVie’s biggest costs – including US$ 1 billion a year in interest charges and over US$ 50 million in compensation for its top five executives – are covered by AbbVie’s US entities, contributing to the US loss, filings show.
That is why AbbVie can forecast a tax rate below the 10.5 per cent GILTI rate, which some commentators have described as a new minimum tax rate.
“There is an incentive to profit-shift,” said Daniel Shaviro, a Professor of tax law at New York University. — Reuters