Replies to post #19810 on Biotech Values

[DewDiligence]

Re: This Merck restructuring really pisses me off

I hadn’t made a connection between the AJCA tax break and MRK’s restructuring because they strike me as disparate issues.

Because money is fungible, I’ve always considered the AJCA a scam, but I’m not complaining because biotech investors figure to be among the beneficiaries.

The bigger issue is the transfer-price scheme you touched on in your post. This is the source of perennial—and in some instances titanic—battles between the IRS and Big Pharma. We can grumble about the unfairness of it all, but closing these tax loopholes is a political matter and I don’t see how complaining about it on this board accomplishes much.

As the Forbes article depicted, MRK—and much of the rest of Big Pharma—need to fundamentally “restructure,” regardless of the tax rate they pay. If these companies do not drastically cut marketing expenses, the tax rate may be almost academic within a decade because there won’t be enough pre-tax income for taxes to be consequential.

What’s needed is what I called the Fallacy of Composition in Reverse (FoCiR). In the ordinary Fallacy of Composition we learned in Economics 101, what’s good for an individual company if they are the only one to take action—e.g. raising marketing expenses to gain market share—backfires if other companies do the same thing. With FoCiR, what’s bad for an individual company if they are the only one to take action—e.g. lowering marketing expenses and incurring a drop in market share—works out well if other companies follow suit.

It looked as though the virtuous cycle of FoCiR had begun within the past year but, alas, it turned out to be a mirage. I still think it’s coming, although I’m not sure that MRK’s “restructuring” signifies that MRK will be on the leading edge. Regards, Dew

[DewDiligence]

21% tax rate for LLY:
Don’t let it bother you, BI; 21% is
more than a lot of companies pay...

http://yahoo.reuters.com/financeQuoteCompanyNewsArticle.jhtml?duid=mtfh55899_2005-12-09_15-40-10_n09...

>>
Lilly sees favorable taxes for at least two years

NEW YORK, Dec 9 (Reuters) - Drugmaker Eli Lilly and Co. ( LLY ) on Friday said it expects its taxes to remain at a favorable 21 percent rate for at least another two years, helping financial results.

The Indianapolis drugmaker earlier on Friday said it expects 2006 earnings to be above Wall Street forecasts, in part because its tax rate recently dropped to 21 percent from 22 percent. Company officials said the tax-rate drop had been somewhat unexpected, but should persist for the foreseeable future.
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[DewDiligence]

IRS, Treasury Propose Tightening
Tax Rules for Multinational Firms

[This change could be a big (negative) deal for Big Pharma and such midsized companies as FRX and GILD. It’s astonishing that the rules governing these issues have not been changed in almost 40 years.]

http://online.wsj.com/article/SB115448422311124220.html

>>
By ROBERT GUY MATTHEWS
August 2, 2006

WASHINGTON -- Multinational companies operating in the U.S. will likely face stricter tax-compliance rules and bigger tax bites as a result of proposed changes designed to close loopholes that for decades have allowed the companies to shift tax liabilities into lower-tax jurisdictions.

The Internal Revenue Service and the Treasury Department yesterday issued proposed regulations revamping how companies account for the transfer of services and intellectual property to their affiliates in and outside of the U.S. The rules are likely to take effect Jan. 1.

With increased globalization, companies routinely transfer intellectual property, profit-making patents, legal services and payroll functions, for example, to related affiliates. Companies do that to lower their costs and share information and services that eliminate the need for duplicate operations and thus increase profits.

But tax authorities have struggled with how to assess a tax on services and know-how that ultimately lead to higher profits at related affiliates. Currently, if a company makes a product in the U.S. and then ships it to its foreign operations to be sold, the profit from the product comes back to the U.S. headquarters and can be taxed accordingly.

That process is murkier when a company develops intellectual property, or even a patent, and ships that information to a related foreign company. If the foreign affiliate tweaks the idea making it more valuable, tax authorities have been trying to figure out how much of the profit should be attributed to the U.S. company so it can be taxed.

Determining the tax liability has been a tedious process that often pits country against country and leaves multinationals bewildered, said Sean Kevelighan, spokesman for economic and tax policy for the Treasury Department.

The proposed rules, while not exhaustive, attempt to simplify and stop companies from classifying the profits from intellectual property to the country with the mildest tax bite. The proposal also aims to clarify how companies classified certain taxable income from their affiliates.

The regulations would spell out various scenarios, such as accounting, auditing and staffing, that the IRS would automatically accept so the company wouldn't have to show the tax income breakdown. The regulations also spell out the aspects of business -- research and development, construction and exploration of natural resources, for which a company would have to detail the effect on the parent company's profits.

The IRS regulations hadn't been changed since 1968.
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[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.‹

[DewDiligence]

Stalled Healthcare Bill Leaves Big Pharma in Limbo

[The proposed FY2011 federal budget contains a tax change with serious adverse consequences for the pharma industry.]

http://www.nytimes.com/2010/02/05/business/05pharma.html

›February 5, 2010
By DUFF WILSON

With the possible demise of health care legislation, getting back to business as usual may not be the best thing for the nation’s drug makers.

After all, in return for the prospect of tens of millions of newly insured customers and a large degree of regulatory certainty, the pharmaceutical industry had agreed to pay a relatively small price: $8 billion a year in discounts and fees. It was a modest compromise for an industry with $246 billion in prescription drug sales last year.

But now, with the health care overhaul on a back burner in Washington and possibly dead for this year, drug makers are getting a sinking sense of how a piecemeal public policy future might look for them.

President Obama’s proposed budget this week, for example, includes a plan he alluded to in last week’s State of the Union address: a new tax on profits from some patents and other intangible assets parked in overseas tax havens by American companies.

For drug makers, which are among those most likely to be affected by such a tax, the president’s proposal “pretty much came out of the blue,” said Martin A. Sullivan, an economist formerly with the Treasury Department and Joint Committee on Taxation.

Another expert agreed. “Pharma’s one that would really get hit,” said Erik Gordon, a professor at the Ross School of Business at the University of Michigan. “That’s a biggie.”

The industry giant Pfizer, for example, which has said that 88 percent of its $56 billion in income from 2004 through 2008 originated overseas, could be subject to the corporate 35 percent tax rate on at least some of its foreign profit in the future if the president’s proposal goes through. [PFE already has the highest tax rate in the industry due to the repatriation of ex-US profits in order to pay for the cash portion of the Wyeth acquisition.]

Although the tax idea faced a cool reception from Democratic and Republican leaders of the Senate Finance Committee, it highlighted the risks to the drug industry of unpredictable election-year politics. It is a time when bolt-from-the-blue challenges may await drug makers, compared with the carefully mapped future they had worked out with the White House and the Senate under the health care legislation.

…Just last month, before the Republican candidate Scott Brown’s victory in a special election in Massachusetts upended the Democrats’ supermajority in the Senate, Pfizer’s chief executive, Jeffrey B. Kindler, told analysts that the Senate health care bill was “largely consistent with the principles” that were important to his industry.

The drug industry had forecast lower revenue in the early years of its cost-savings deal, in which it agreed to pay $80 billion in rebates and fees over a decade. But its revenue and profit were expected to more than make up the difference later in that period as more than 30 million uninsured people began receiving health and drug coverage.

And just as important, the industry had received assurances from the Obama administration and some critical Congressional Democrats that long-feared proposals that might have popular appeal — including government negotiation of Medicare drug prices and allowing the import of cheaper drugs from Canada — would be tabled in return for drug makers’ support of the rest of the health care overhaul. And some industry experts say any notions of an offshore tax had also been taken off the table.

As part of the deal, the drug industry had also pledged and spent more than $100 million on TV advertising in support of the overhaul effort.

It is unlikely that the drug industry will run ads promoting President Obama’s offshore tax proposal. Drug makers are fighting it through a Washington-based business coalition called Promote America’s Competitive Edge, which includes many other multinationals.

The group argues that lower foreign tax rates create a level playing field for American companies and international competitors and, ultimately, save jobs in the United States.

Mr. Sullivan, the former Treasury economist who now writes about tax issues, said that all the big drug makers engage in offshore tax sheltering of one sort or another. And the portion of overseas profit and revenue has been growing in recent years.

“Typically when a pharmaceutical company develops a new drug, it transfers it to a holding company in a tax haven like Bermuda or the Cayman Islands, usually on very favorable terms,” he said. “There’s a tremendous amount of income taken out of the U.S. and put into the tax haven. This proposal seems targeted to just that type of situation.” [No kidding.]

Pfizer has reported that 58 percent of its revenue came from overseas in 2008, compared with 39 percent a decade earlier. For other drug markets, overseas revenue in 2008 amounted to 46 percent for Lilly, 44 percent for Merck and 42 percent for Bristol-Myers.

Professor Gordon of the University of Michigan, who studies pharmaceutical companies, said the president’s new plan to tax “excessive” offshore profits had surprised the industry and revealed the risks of a piecemeal health policy.

“The industry thought that it got some uncertainty off the table,” Professor Gordon said. “They’re not thrilled about what happened in Massachusetts. It’s not working to their advantage.”

Some analysts, meanwhile, say parts of the $80 billion, 10-year deal could come back to bite the drug industry — if it is held to some of the cost pledges without receiving the offsetting political protection. The pact, for instance, committed the industry to support an increase in the rebate the government receives on Medicaid drugs — to 23 percent, up from 15 percent currently.

In the current deficit-cutting environment, that discount may still look attractive to lawmakers. And it could conceivably be enacted by Congress at any time without being part of an industry quid pro quo. “No question that’s alive,” said Seamus Fernandez, pharmaceutical industry analyst for the health care investment bank Leerink Swann.

But the overall health care reform package, he added, is “either dead or severely hobbled.”‹