Trump’s overhaul fails to kill off corporate tax dodge
US corporations have largely abandoned the contentious deals that allowed them to shift addresses abroad for a lower tax rate. Yet a key part of the strategy is continuing quietly, even after President Donald Trump’s tax overhaul.
The president’s 2017 tax law was designed to stop “inversions” – which had invited scrutiny and negative publicity for companies moving their headquarters overseas – as well as to halt the flow of intellectual property (IP) to low tax countries. For companies that invert, the address change is generally the final step so they can more easily access cash generated after years of shifting IP overseas.
Most firms are continuing with business as usual when it comes to IP since the law’s provisions aren’t enticing enough for them to keep it at home, according to interviews with eight tax experts who advise large public corporations. They disclosed the details of the conversations they’re having with companies whilst declining to identify clients.
The problem: IP moves of this nature mean other countries ultimately get to collect the billions of dollars of tax revenue generated by many US-made innovations, including life-saving drugs, the algorithms that power social media networks, and the software running computers and smartphones.
“It’s not changed the kinds of tax planning we’ve talked about for 20 or 30 years,” says Linda Pfatteicher, managing partner of law firm Squire Patton Boggs’ San Francisco and Palo Alto offices. “The changes just tweak around the edges.”
That’s a blow to Republicans who had intended the law’s corporate tax rate cut and overhaul of international tax rules to remove incentives to shift IP abroad and invert. The US now has a corporate rate of 21 per cent, lower than the previous 35 per cent, but still pretty average compared to other developed economies. And it is high relative to the 12.5 per cent rate in Ireland, a popular destination for “inverters”.
For years, US companies – especially in the technology and pharmaceutical industries – have shifted patents and software to subsidiaries in low tax or tax-free countries, and paid their foreign firms licensing fees to use the assets. Those franchise fees and royalty payments were booked as income offshore and taxed at the other country’s lower rate. A change in headquarters was the choice for the most tax-averse companies. Last year’s US tax law was supposed to change all that.
The law attempts to deter profit shifting and ensure companies are paying a minimum amount of tax in the countries where they store IP. If the offshore tax rate is at least 13.125 per cent, the company isn’t supposed to owe anything to the US Internal Revenue Service. If it’s below that rate, in most cases the company will only owe a couple of additional percentage points – in what is called the Gilti tax – to the US. That is a figure still below the 21 per cent a company would pay if the assets were in the US.
For example, US corporations in Ireland would pay around an additional half a per cent to the IRS.
Other countries with lower corporate rates have an additional source of tax revenue, such as VAT, so they can afford to keep rates low – the US doesn’t
“The raw math is still beneficial to move that out of the US,” says Albert Liguori, a managing director with consulting firm Alvarez & Marsal. “There’s a concern that once you come into the US, you can’t get it out.”
Shifting IP – rather than headquarters – is also a strategic political move, says Robert Willens, an independent tax consultant. A true inversion entails merging with a foreign firm – and generally requires disclosures – but shifting IP doesn’t involve the same scrutiny and can happen quietly, shielded from finger-wagging by US lawmakers or the president.
Both parties have railed against inversions, and ending the practice is probably one of the few things Mr Trump and his predecessor Barack Obama agree on. Obama called the moves “unpatriotic”, and Trump has said he’s “disgusted” with them.
Many other countries with lower corporate rates have an additional source of tax revenue, such as a value added tax, so they can afford to keep rates low. The US doesn’t have VAT, and probably won’t as long as Republicans control congress, because it’s viewed as a tax increase.
Unless tax writers can get the US corporate rate into the mid-to-low teens – which would require finding additional revenue or adding trillions more dollars to the budget deficit – companies will continue to shift easiest-to-move assets such as IP to countries where it’s less expensive to keep them, tax experts have said.
Researchers at the US Commerce Department’s Bureau of Economic Analysis appear to agree. “Although the ultimate effects of the 2017 changes to US tax law remain to be seen, there is reason to believe that the incentives for this behaviour have not disappeared,” said the authors of a report published in August that referred to moving IP overseas.
Less than 1 per cent of Facebook and Nike’s profits were tied to a specific jurisdiction in their public disclosures
It’s hard to know just how much intellectual property US-based companies hold overseas. Corporate filings show few details about where such property is located, and companies are hesitant to disclose the information for public relations reasons.
For example, Apple’s filings show where about 3.6 per cent of its profits are earned, according to analysis by researchers at the University of Copenhagen and University of California, Berkeley. For Alphabet parent company Google, the location of about 1.4 per cent of profits is visible, the data show. And less than 1 per cent of Facebook and Nike’s profits were tied to a specific jurisdiction in their public disclosures.
Apple and Google have said in recent filings any change in Ireland’s tax rates could be material to their financial statements, a sign they intend to maintain employees and assets there. Apple, Alphabet, Facebook and Nike have declined to comment further.
Ireland’s National Treasury Management Agency said its own IP numbers have been distorted in recent years because of “onshoring” by US companies. About 65 per cent of the value of the technology produced in Ireland in 2015 was from US-owned companies, a figure Ireland said it expects to continue to expand even in the wake of last year’s tax law.
Corporate inversions, like those conducted by Burger King, Johnson Controls International and Medtronic, were a driving force behind the tax overhaul. Under Obama, the US Treasury Department issued rules to deter inversions, and the tax law was intended to be the final blow for switching headquarters and IP shifting.
The tax law has certainly changed the calculus for some corporations. Drug maker Amgen said in April it would build a manufacturing plant in Rhode Island instead of Puerto Rico. Those are mostly one-offs, though, and tax experts say it’s unlikely to see a homecoming of software and patents already parked overseas.
Tax advisers say they were inundated earlier this year with requests from multinationals about whether some of the US tax law changes – such as the Gilti tax and the minimum tax on offshore payments – should prompt them to restructure their businesses and bring IP home.
Most companies decided they didn’t want to upend their tax planning because of uncertainty about how the various provisions of the law would interact and whether a future, Democratic-controlled congress would roll back selected provisions of Mr Trump’s overhaul.
There’s more confidence lower-tax jurisdictions such as Ireland will maintain their corporate tax regimes, according to Tom Zollo, a principal specialising in international tax at accounting firm KPMG.
“After doing some modelling, many have decided to stay put for a while,” Mr Zollo said. Bloomberg