The Tax Times: TCJA Favors Corporations With Outbound Tax Planning

On January 26, 2018 we posted TCJA Favors Corporations With Outbound Tax Planning where we

discussed that The Tax Cuts and Jobs Act (“TCJA”) imposed international tax law changes which relate directly to U.S. corporations doing business outside the United States.

Despite these shifts toward partial territoriality, the new law retains the Subpart F rules that apply to tax currently certain income earned by CFCs (i.e., foreign corporations that are more than 50% owned by 10% U.S. shareholders (under the new law, both the 10% and 50% standards are measured by reference to either vote or value), as well as introducing a new category of income puzzlingly called “global intangible low-taxed income” (GILTI), though it has almost nothing to do with income from intangibles.

GILTI will include nearly all income of a CFC other than ECI, Subpart F income (including Subpart F income that is excludible under the Section 954 (b)(4) high-tax exception), or income of taxpayers with very significant tangible depreciable property used in a trade or business.The GILTI tax, imposed under Section 951A, applies to U.S. shareholders (both corporate and individual) of CFCs at ordinary income tax rates.

U.S. C corporations that are shareholders of CFCs, on the other hand, are entitled under new Section 250 to deduct 50% of the GILTI inclusion, resulting in a 10.5% effective tax rate on such income.

Additionally, such corporate shareholders are permitted to claim foreign tax credits for 80% of the foreign taxes paid by the CFC that are attributable to the relevant GILTI inclusion. Accounting for the 50% deduction and foreign tax credits, if any, a corporate U.S. shareholder’s GILTI inclusion that is subject to a rate of foreign income tax of at least 13.125% should result in no further U.S. federal income tax being due.

In addition to the above GILTI provisions, Section 250 also permits U.S. corporations to deduct 37.5% of “foreign-derived intangible income” (FDII), resulting in an effective U.S. federal income tax rate of 13.125% on such income. FDII is the portion of the U.S. corporation’s net income (other than GILTI and certain other income) that exceeds a 10% rate of return on the U.S. corporation’s tangible depreciable business assets and is attributable to certain sales of property (including leases and licenses) to foreign persons or to the provision of certain services to any person located outside the United States.

Now as reported by Reuters, the corporate tax cut enacted in the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017) was in part designed to help dissuade U.S. companies from moving profits overseas, but may instead make the practice a lot more rewarding. Take 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 U.S. tax, the U.S. drugmaker expects its tax rate to fall to 9% this year from around 22% in recent years.

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, Humira, in Bermuda, a country that has a zero tax rate on corporate profits.

Despite Recording over Half Its $28.2 Billion in 2017 Sales in the US 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 $10.4 billion on international revenue of only $9.97 billion.

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.

“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.

“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 U.S. 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.

Congress attached such a provision to the TCJA. 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 U.S. However, the effective tax rate that will apply is half the U.S. corporate tax rate of 21%, or 10.5%. And if a company reports a loss in the U.S., this can reduce the tax liability further.

The exact mechanisms AbbVie uses to report such a low a tax rate are 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 U.S., at a high price, with the U.S. distribution arm getting a sales margin as low as 5%.

Sometimes the U.S. distribution profit is not enough to cover group costs incurred in the U.S. For example, many of AbbVie’s biggest costs, including $1 billion a year in interest charges and over $50 million in compensation for its top 5 executives, are covered by AbbVie’s U.S. entities, contributing to the U.S. loss, filings show.

That is why AbbVie can forecast a tax rate below the 10.5% GILTI rate, which some commentators have described as a new minimum tax rate.

Need International Tax Help?