Biotech Values

[DewDiligence]

Big Pharma Vows Overseas-Tax Fight

[The Obama administration’s planned full repeal of the deferral of US tax liability on ex-US profits of US-based multinationals is DoA, IMO, because implementation would induce some large companies to re-incorporate in a foreign country. What’s fairly likely, however, is some kind of change that increases the US income taxes paid by such companies. Please see #msg-12393413 for a related article.]

http://online.wsj.com/article/SB124035794000941117.html

›APRIL 22, 2009
By JESSE DRUCKER

The Obama administration's nascent proposals to tax offshore profits may have a sizable impact on the likes of Pfizer Inc., Cisco Systems Inc., Coca-Cola Co. and Hewlett-Packard Co., which shelter tens of billions in income offshore annually.

Under current law, U.S. companies can defer taxes indefinitely on the profits they say they have earned overseas until they "repatriate" that money back to the U.S. The administration has proposed changing this law, and has already baked in the new tax receipts into its budget figures for 2011.

The Wall Street Journal examined securities filings of more than two dozen big companies to see who has the most at stake. Just 10 of the largest companies accumulated nearly $58 billion in such earnings during 2008, representing about $20 billion in potential tax revenue. Total U.S. corporate tax receipts last year were around $304 billion.

The likelihood of some change to the current law is generating intense opposition from companies that generate big earnings offshore. Two hundred companies organized by the Business Roundtable wrote to congressional leaders last month to oppose the proposal.

"It's probably the top issue right now for the tech community," said Ralph Hellmann, the lead lobbyist for the Information Technology Industry Council. "This one hits the bottom line of companies more than any other issue right now. We have to defeat it."

A Treasury Department spokeswoman said the administration "is committed to reforming deferral to improve the overall efficiency and equity of the tax code by reducing incentives to divert investment from the U.S. in order to avoid taxation."

The controversy over taxing foreign profits has grown in recent years, as industries with highly "portable" profits -- such as the pharmaceutical and technology sector -- take an increasing role in the world economy. These firms' profits rely on patents that are easy to move overseas. That means taxable profits can easily "port" overseas, too.

Lawmakers have grappled with how to tax the U.S.'s fair share of these profits, without unintentionally creating new incentives for companies to shift more operations abroad. In the process, tax-enforcement authorities have struggled to navigate the complex system of inter-company tax accounting known as "transfer pricing."

By law, companies often don't owe taxes on income they say they have earned outside the U.S. Those taxes are deferred until the companies "repatriate" that money back to the U.S. In reality, the earnings often sit in U.S. bank accounts, but there are restrictions on how the money can be used. Companies also get an added earnings benefit from these arrangements, because unlike most deferred taxes, the foreign-earnings deferral aren't counted against net income, said Michelle Hanlon, an accounting professor at the University of Michigan.

The Journal's findings are similar to research in prior years: Tax economist Martin Sullivan and tax attorney Lee Sheppard calculated that 40 big U.S. companies generated $122 billion in indefinitely reinvested earnings offshore during 2007, according to an article published in the trade journal Tax Notes.

The pharmaceutical industry is one of the biggest beneficiaries of the current law. At Pfizer, for example, overseas tax deferrals cut the company's effective rate by 20.2 percentage points during 2008, making it the single biggest factor in its effective tax rate of 17%. Merck & Co. cut its effective tax rate by 11.7 percentage points because of its $4.8 billion in such overseas profits last year, according to its annual report. And Johnson & Johnson's effective tax rate was 12.4 percentage points lower because of its $4 billion it said was earned and reinvested overseas, primarily in Puerto Rico and Ireland.

In the technology sector, Hewlett-Packard and Cisco cut their effective tax rates by 16.9 percentage points and 16.1 percentage points respectively during 2008 due to earning foreign income taxed at lower rates abroad, securities filings show. Google Inc. generated $3.8 billion such earnings last year, which cut $1 billion off of a tax bill that wound up being roughly $1.6 billion.

General Electric Co. generated $13 billion in such earnings last year, and had a cumulative total of $75 billion as of the end of 2008. The tax treatment of its overseas activity as well as favorable tax treatment of exports lowered GE's tax rate by 26.9 percentage points during 2008, driving the company's effective tax rate down to 5.5%.

Coca-Cola shaved 14.3 percentage points of its effective tax rate during 2008 because of "earnings in jurisdictions taxed at rates different from the statutory U.S. federal rate." Chief Financial Officer Gary Fayard addressed this issue on Tuesday in a company conference call with investors. "I know that current U.S. budget proposal to substantially increase the taxation of income earned outside of the U.S. is top of mind for many of you," he said.

The companies with large earnings overseas either declined to comment or said that a proposal increasing taxes on those earning would put companies at a competitive disadvantage to foreign competitors.

The tax-law changes stand to be significant, as the White House is counting on the change, along with better international enforcement and other reforms, to generate $210 billion in new tax revenue between 2011 and 2019.

But, so far, the Obama proposal has taken the form of just two words on page 122 of the preliminary budget released in February: "Reform deferral."

A full repeal of the deferral rules is considered unlikely. One potential blueprint is the proposal made by Rep. Charles Rangel (D., N.Y.), chairman of the tax-writing House Ways and Means Committee, in a tax overhaul bill introduced in 2007 that would disallow certain deductions. Currently, companies can get deductions in the U.S., even though the spending may generate overseas income on which they never pay U.S. taxes.

The lack of detail in the Obama proposal has opened up a new debate on what the tax reform should look like. Critics abound on both sides: Some argue that the laws encourage companies to manipulate their books to aggressively shift taxable income to low-tax countries overseas, such as Ireland and Singapore.

Some corporate tax directors say the rules unfairly "trap" cash overseas, forcing companies to borrow domestically to get cash and propose that the U.S. only tax earnings generated within the U.S. That would be similar to the systems of other countries, a so-called territorial approach.

In reality, many U.S. companies actually oppose such a switch, because the systems of other countries often don't include several of the biggest exemptions currently offered by the U.S.

In 2004, Congress granted companies a one-time tax holiday, allowing them to bring home these overseas earnings and pay tax at an effective rate of 5.25%.

While successful in bringing home cash, its track record at creating new jobs and investment was viewed as mixed, say tax experts.‹