University of Amsterdam
Advanced L.L.M.
International Tax Law and Policy
An Urgent Response to the Crippling Effects of Corporate
Inversions and the Avoidance of Repatriating Foreign Income
Date:
Table of Contents
Chapter 1: Introduction ...3
1.A) – United States Domestic Attributes ...4
1.B) – What is a Corporate Inversion? ...6
1.B.1. – Three General Types of Corporate Inversions ...7
1.B.2. – 26 U.S.C. § 7874 ...8
1.C) – Why the United States? ...9
1.C.1. – Post Inversion Financial Planning Techniques ...10
1.C.2. – United States Defensive Measures to Financial Planning ...12
1.C.3. – Home is Where the Money is ...13
1.D) – The Manufacturer and the Retailer ...16
1.D.1. – The Manufacturer – Pfizer ...16
1.D.2. – The Retailer – Walgreens ...21
Chapter 2: Proposals ...23
2.A) – Author Proposals ...23
2.A.1. – 30% Standard Corporate Income Tax on Foreign Sourced Profits ...23
2.A.2. – Global Formulary Apportionment ...25
2.A.3. – Exit Tax ...26
2.A.4. – Place of Effective Management ...26
2.B) Government Proposals ...27
2.B.1. – Obama Administration FY2016 ...27
2.B.2. – Repatriation Holiday ...30
2.B.3. – Common Consolidated Corporate Tax Base ...35
2.B.4. – Deemed Repatriation ...35
Chapter 3: Conclusion ...36
Appendix: ...38
CHAPTER #1 – INTRODUCTION
It is imperative to know where we have been in order to know where we are going. The basis of this thesis is to examine what an inversion is and the legislation invoked by the U.S. that is used to identify whether an inverted MNE should continue to be subject to U.S. taxation on its worldwide income. The thesis elaborates upon the inversion process generally, while highlighting the financial planning techniques that inverted MNEs use and the corresponding devastation that they cause to American tax base.
The thesis also examines the potential inversions of the pharmaceutical
manufacturer named Pfizer and a pharmaceutical retailer named Walgreens that would have significantly hindered the U.S. tax base. Moreover, Pfizer’s situation is analyzed more deeply due to their never-ending attempts to relocate their tax residence outside of the United States and the regulatory actions taken by the United States Treasury
Department to halt the exodus of Pfizer. As discussed below, Pfizer’s ‘endless deferral dilemma’ has provided them with two options: i) repatriate the profits back to the United States at the 35% statutory rate, or ii) relocate their tax residence to a country with a more favorable statutory rate. The Pfizer situation is compared to that of Walgreens because it is a comparative example that highlights the relative impact of an inversion on the local and global populations.
The U.S. regulations aimed at inversions and halting the financial planning
techniques have been used as a tool to distance MNEs from their foreign sourced income. As an alternative to the current trend of encouraging MNEs to invert, an independent proposal is presented by the author that provides MNEs with the option to voluntarily repatriate profits back to the United States at a 30% statutory rate during the 5-year period after acquisition. Moreover, recent academic are put forth to exemplify the urgent need for evolution in the area of repatriating foreign sourced profits.
Lastly, the thesis examines governmental proposals, as well as the American Jobs Act of 2004 to emphasize the complexities that are inherent in the repatriation of foreign sourced profits. The recent FY2016 administrative proposals from the Obama
Administration are discussed to show the political nature of motivating MNEs to
from the author, whereby MNEs would be subject to a 1% annual increase for the minimum tax on foreign income proposal.
1.A) – United States Domestic Attributes
The United States was founded upon three things: 1) Taxes, 2) War, and 3) Agriculture. The U.S. started the war for independence, which was premised upon
‘taxation without representation’, and the U.S. relied on agriculture in order to survive the war. Today, the United States of America is one of the largest and most exploitable commercial markets in the world. The geographical composition of the U.S. is almost two and a half times the size of the European Union, which forces the U.S. to maintain strict regulations within the field of taxation. Comprising Alaska and Hawaii, the U.S. is 9,161,923 km2, while Europe is 3,788,027 km2.1 Generally, a corporation is treated as a domestic corporation and a U.S. resident taxpayer if it is created or organized under the laws of the United States, any State, or the District of Columbia.2 The U.S. utilizes the place of incorporation rule because it provides certainty. When a corporation qualifies as a resident for tax purposes, than the corporation is thereby subject to the United States domestic corporate tax rates with a maximum federal progressive rate of 35%.3
Due to the aforementioned characteristics, the United States utilizes a system founded upon capital export neutrality where a corporate resident is subject to worldwide taxation on all income earned domestically and abroad. The United States exemplifies the theoretical notions of credit export neutrality by employing a foreign credit system where the taxes paid abroad are proportionally credited against the taxes owed on the worldwide income in the United States. Nevertheless, the system is premised upon the notion of ‘endless deferral’ because a considerable amount of active income, which is derived from sources outside of the U.S., will not be taxable until it is repatriated back into the United
1 ielanguages.com/esl/usvseurope.doc
2 OECD, “United States - Information on residency for tax purposes, Section II”.
https://www.oecd.org/tax/automatic-exchange/crs-implementation-and-assistance/tax-residency/United-States-Tax-Residency.pdf
States. Accordingly, a U.S. MNE is able to accumulate substantial sums of income in a more favorable foreign jurisdiction by exploiting the loophole of endless deferral.4
“The U.S. tax rules for deferring U.S. tax on active earnings of CFC subsidiaries generally are conditioned on not using the assets of the foreign subsidiary, directly or indirectly, for the benefit of the U.S. parent. Thus, U.S. rules generally cause foreign subsidiary loans to the U.S. parent, use of foreign subsidiary assets to secure U.S. parent debt, or even foreign subsidiary guarantees of U.S. parent debt as deemed distributions of the untaxed earnings. The policy behind these rules is that CFC earnings that have not been subject to U.S. taxation should not be allowed to be used on a pretax basis for the benefit of the U.S. parent or its U.S. affiliates.”5
A U.S. based MNE with a foreign subsidiary is only taxed to the extent that the income of the foreign subsidiary is paid onto the U.S. parent and the MNE will not be taxed on the active income held in a foreign jurisdiction when it is labeled as
‘permanently reinvested earnings’ (PRE). The designation of foreign income as PRE under ASC 7406 permits U.S. MNEs to delay recognition of the tax liability that is coupled with repatriating the income back to the United States.7
Nevertheless, objective evidence suggests it is unlikely that the permanently reinvested funds will be used to advance actual investment in the foreign jurisdictions. The Senate Permanent Subcommittee on Investigations surveyed 27 corporations, including the 15 that repatriated the most funds during the 2004 repatriation holiday, to find that at least 46 percent of their offshore ‘permanently reinvested earnings’ were actually invested in U.S. assets like Treasury bonds, U.S. stocks, and U.S. bank deposits by the American corporations’ controlled foreign subsidiaries.8
4 Donald J. Marples, and Jane G. Gravelle. "Corporate expatriation, inversions, and mergers: Tax issues." (2014).
5 Stephen E. Shay, "Mr. Secretary, Take the Tax Juice Out of Corporate Expatriations." (July 28, 2014). Tax Notes 144.473 (2014). (Page #476)
6 Accounting Standard Codification section 740
7 Alexander Edwards, Todd Kravet, and Ryan Wilson. "Permanently reinvested earnings and the profitability of foreign cash acquisitions." Rotman School of Management Working Paper. 1983292. (2012)
8 Citizens for Tax Justice. “$2.1 Trillion in Corporate Profits Held Offshore: A Comparison of International Tax Proposals.” (July 14, 2015).
Unlike the endless deferral of active income, most passive income (including interest, dividends, annuities, rents, and royalties) that is attributable to a subsidiary of a US parent is includable in a U.S. corporations tax base as Subpart F income for the year in which it is attained. However, the caveat for the inclusion of Subpart F income is that the shareholders must be able to influence locational decisions at the corporate level.9 Subsidiaries that are subject to the Subpart F inclusion rules are also known as controlled foreign corporations (CFC).
In a worldwide (or residential) tax system, corporate residents are taxed on their worldwide income, regardless of the source. At the other end of the spectrum is a
territorial tax system, where corporate income taxes are only collected on income earned within the country’s jurisdictional boundaries. The U.S. has a hybrid of these two systems because taxes are collected on income earned domestically and, in theory, the income corporations earn abroad. However, corporations can defer paying taxes on foreign income until they “repatriate” the funds (i.e., pay to the U.S. parent company as dividends). Additionally, the U.S. tax system provides an indirect foreign tax credit on repatriated income, which is a dollar-for-dollar reduction in U.S. tax liability to offset any taxes paid to foreign governments (limited to the total U.S. tax that would be due in cases where the foreign tax rate is higher than the U.S. rate).10
1.B) – What is a Corporate Inversion?
A ‘corporate inversion’ is a phrase that is broadly used to describe when a United States parent corporation reorganizes itself within a multinational group to become a subsidiary of a foreign corporation, afterwards the new foreign corporation becomes the parent of the multinational group and retains the tax residency.11 A writer for the Wall Street Journal identified an inversion as a process where “the foreign minnow swallows the domestic whale.”12
9 These stockholders are defined as owning at least 10% of a subsidiary’s stock and only subsidiaries that are at least 50% owned by 10% U.S. stockholders. See 26 U.S.C. § 951(b).
10 Citizens for Tax Justice. “$2.1 Trillion in Corporate Profits Held Offshore: A Comparison of International Tax Proposals.” (July 14, 2015).
11 IBFD Online Glossary, “Corporate Inversion”. (2016)
12 See Edward D. Kleinbard, “Tax Inversions Must Be Stopped Now.” Wall Street Journal, July 21, 2014.
1.B.1. – Three Types of Inversions
Corporate inversions can occur in a multitude of ways, but a corporate inversion generally arises in three different scenarios: i) the substantial activity test, ii) a merger between a U.S. parent with a larger foreign MNE, or iii) a merger between a U.S. parent with a smaller foreign MNE.13
The first type of inversion is characterized as the Substantial Business Activity or the Presence Test (also known as “Naked Inversions”). A U.S. MNE with substantial business activity in a foreign jurisdiction establishes a new foreign subsidiary in that jurisdiction. Subsequently, the U.S. MNE and the new foreign subsidiary swap stock thereby resulting in each entity owning some of the other’s stock. After the stock exchange, the foreign subsidiary converts into a foreign parent corporation with a U.S. subsidiary. This form of inversion is dubbed as a ‘naked inversion’ because the effective control of the corporation is not altered and the place of effective management continues to be located in the United States.14
The second general type of inversion is the least ideal because a U.S. MNE loses majority control over the final parent corporation. This inversion is exemplified when a U.S. corporation is acquired by or merged with a larger foreign corporation. As a result of the acquisition or merger the U.S. shareholders end up owning a minority share of the new merged company. Consequently, the tax residence of the corporation, as well as the place of effective management and control, is located outside the United States. This form of inversion is naturally connected with the desires of a U.S. corporation to bolster its foreign operations and lower the taxes owed in the U.S on foreign sourced income held in a foreign jurisdiction.15
The third and most prevalent type of inversion is executed when a U.S. corporation acquires a smaller foreign corporation. As a result of the merger or
acquisition, the U.S. shareholders end up owning a majority share of the new company. The tax residence of the corporation is thereby moved to a different jurisdiction whilst the
13 Donald J. Marples, and Jane G. Gravelle. "Corporate expatriation, inversions, and mergers: Tax issues." (2014).
14 Id. at page 4. 15 Id.
place of effective management and control of the new company stays with the previous shareholders of the U.S. corporation.16
The objective of undertaking the corporate inversion process is to expatriate the tax residence of the U.S. based MNE from the United States to a low tax jurisdiction in order to reduce the tax burden on certain types of income earned and held abroad by Controlled Foreign Corporations (CFC’s).
1.B.2. – 26 U.S.C. § 7874
26 U.S.C. § 7874 and the corresponding Treasury regulations were developed to maintain taxing jurisdiction over U.S. MNEs that seek to artificially expatriate their tax residence to a foreign jurisdiction. As discussed above, an inversion transaction could potentially arise when a foreign corporation exchanges its stock for a substantial part of a U.S. entity’s assets. Section 7874 provides that a non-U.S. corporation will be treated as a U.S. corporation for federal income tax purposes when the following three elements of ‘the ownership test’ are established: i) the non-U.S. corporation acquires, directly or indirectly, substantially all of the assets held by a U.S. corporation; ii) after acquiring the U.S. corporation, the ‘expanded affiliated group’ of the non-U.S. corporation does not have ‘substantial business activities’ in its country of origin when compared with the worldwide activities; and iii) the former U.S. entity shareholders own 80% or more of the acquiring non-U.S. corporation.17 The threshold to qualify for ‘substantial business activities’18 is premised upon maintaining at least 25% of total group employees, group assets, and group income in the relevant foreign jurisdiction.
Moreover, a non-U.S. corporation will be treated as a ‘surrogate foreign corporation’19 when the acquired former U.S. entity shareholders own 60%-80%.20 Surrogate foreign corporations lose the ability to use certain losses and other tax attributes for a 10-year period.
16 Id.
17 See Coca-Cola Enterprises, Inc. Form DEFM14A filed on 04/11/2016. 18 26 CFR § 1.7874-3T
19 26 U.S.C. § 7874 (a)(2)(B)(ii)
20 Andrew Kreisberg, Narissa Lyngen, John Sasopoulos “Treasury Department Issues Temporary and Proposed Regulations to Curb Inversions and Earnings Stripping.” White & Case LLP, April (2016).
1.C) – Why the United States?
In 2013, Senator Baucus called upon the aid of society to help update a decrepit tax system. Particularly, he sought to achieve four main goals: 1) Make the U.S. more attractive and competitive, which will encourage multinationals to invest domestically and create more jobs; 2) Reduce the incentives for U.S. based companies to move jobs or the entire company overseas; 3) End the trapped cash problem of endless deferral by allowing foreign profits to be repatriated back to the U.S.; and 4) Make it harder for MNEs to shift profits to tax havens, which reduce the capacity to invest in U.S. infrastructure, education, and other vital initiatives.21
Although Senator Baucus has the best intentions in mind, an exponentially large United States MNE is faced with strategic decisions on a daily basis. MNEs are forced to identify the most efficient way to grow the underlying business, maximize synergies, and pursue other commercial benefits.22 Nevertheless, all business decisions are influenced by government regulations.
A corporate inversion is an intriguing business strategy for companies that have a significant portion of their income derived from foreign sources. For companies engaging in an inversion, two characteristics make a country an attractive destination: 1) a low corporate tax rate, and 2) a territorial tax system that does not tax foreign source
income.23 Attractive destinations with a relatively low corporate income tax rate include countries like: the Bahamas (0%), Cayman Islands (0%), and Bermuda (0%).24 However, corporations have recently found more suitable destinations, such as: Ireland, the United Kingdom, and Malaysia.
Currently, U.S. MNEs have substantial sums of money in subsidiaries and holding companies located outside the jurisdictional grasp of the United States tax system. For example, “the Netherlands, Ireland, Luxembourg, Bermuda, Switzerland, Singapore, and the Cayman Islands account for 5% of U.S. multinationals foreign employees, but 50% of
21 Senate Finance Committee Chairman Max Baucus (D-Mont.) (2013) 22 U.S. Department of the Treasury Press Release and Fact Sheet (4/4/2016)
23 Donald J. Marples, and Jane G. Gravelle. "Corporate expatriation, inversions, and mergers: Tax issues." (2014).
their foreign profits.”25 Over the past 45 years, intellectual property has become much more important in the world economy and the United States has been at the forefront of most technological innovations. During that 45-year period, the number of foreign subsidiaries owned by U.S. corporations has grown from less than 20,000 to more than 80,000.26 Moreover, U.S. investment overseas has grown from $52 billion to $4.2 trillion and investments in so called tax haven jurisdictions has grown significantly from about $3 billion to roughly $1.7 trillion.27 Additionally, U.S. MNEs offshore cash holdings nearly doubled between 2008 and 2013 to more than $2.1 trillion.28
Therefore, MNEs with substantial offshore profitable operations have two options: 1) repatriate the profits back to the United States whilst incurring the maximum progressive corporate income tax rate of 35%, or 2) invert the U.S. parent, which thereby expatriates the tax residence of the MNE to a new tax jurisdiction. As discussed later, many pharmaceutical manufacturers and retailers have been seeking to change their corporate domicile to avoid the 35% U.S. corporate income tax rate.
To effectuate the expatriation, the subsidiaries and assets of the former U.S. parent must be transferred to the new foreign parent corporation. Inherent to the inversion process is the principal objective of the MNE to change its tax residence and remove untaxed foreign earnings from the taxing jurisdiction of the former U.S. parent corporation. Nevertheless, corporate inversions may also be used to remove domestic U.S. earnings from the U.S. taxing jurisdiction through financial planning techniques.
1.C.1. – Post Inversion Financial Planning Techniques
After a MNE expatriates their tax residence, they can engage in financial planning to further strip the United States tax base of profits that are attributable to the profit making activities in the U.S. Consequently, Base Erosion and Profit Shifting techniques by U.S. MNEs reduce tax revenues by more than $100 billion each year.29
25 Kimberly A. Clausing, “Profit Shifting and U.S. Corporate Tax Policy Reform.” (2016) 26 Chairman Max Baucus of the U.S. Senate Committee on Finance: International
Business Tax Reform Discussion Draft (November 19th, 2013). 27 Id.
28 Citizens for Tax Justice, “$2.1 Trillion in Corporate Profits Held Offshore: A Comparison of International Tax Proposals.” (July 14th, 2015).
29 Kimberly A. Clausing, “Profit Shifting and U.S. Corporate Tax Policy Reform,” at page 6.
The two most prominent tactics to Base Erode and Profit Shift from the U.S. are: 1) Earnings Stripping and 2) Hopscotch loans.
Earnings Stripping
After a MNE successfully concludes an inversion, it is no longer subject to the tax burden of 35% on its global income. Instead, the MNE only becomes liable to pay taxes on income that is effectively connected with the business operations in the United States.30 Nevertheless, companies often engage in earnings stripping to lower their overall tax burden in the United States. Earnings stripping is a phrase used to describe when there is “excessive extraction of corporate profits by way of tax-deductible payments (typically interest) generally to related third parties who may be tax exempt with respect to the interest or subject to a lower rate of tax.”31 The U.S. initially invoked the thin-cap rules in 26 U.S.C. § 163 as a means to combat earnings stripping. Under section 163(j), interest deductions are deferrable when the borrower has excess interest expenses after taking into account the debt to equity ratio when determining if the interest payments rise to the level of excessiveness.32
The thin-cap rules proved to be largely ineffective against earning striping techniques because the thin capitalization rules apply to corporations having excessive related party debt-to-equity, whereas the earnings stripping involve cases where a
corporation has excessive related party interest-to-income. Accordingly, the United States invoked legislation to combat corporate abuse of interest deductions by authorizing the Secretary to reclassify deductible debt as non-deductible equity. Specifically, the
Secretary is empowered to invoke “… regulations as may be necessary or appropriate to determine whether an interest in a corporation is to be treated as stock or indebtedness (or as in part stock and in part indebtedness).”33
30Americans for Tax Fairness, “Walgreen’s: Offshoring America’s Drugstore.” (June 2014)
31International Bureau of Fiscal Documentation Online Glossary, “Earnings Stripping”. (2016)
32 Andrew Kreisberg, Narissa Lyngen, John Sasopoulos “Treasury Department Issues Temporary and Proposed Regulations to Curb Inversions and Earnings Stripping.” White & Case LLP. (April 2016).
The subsequent regulations were implemented under 26 U.S.C. § 385 and are used to reclassify interest bearing financial instruments between related parties as non-deductible equity. Also, the regulations under section 385 have been developed to supplement judicial rules established under thin-cap litigation.
Hop-Scotch Loans
A hopscotch loan utilizes a foreign subsidiary of a U.S. MNE that has deferred taxable income maintained in a foreign jurisdiction. After the U.S. MNE inverts, the foreign subsidiary purchases debt and/or equity of the new foreign parent with funds that were previously subject to U.S. deferred taxation. When the foreign subsidiary loans funds to the new foreign parent, the loan hopscotches over the U.S. taxing jurisdiction without incurring U.S. tax liability. The new foreign parent is capable of using the funds in any manner, such as: distributing dividends to shareholders, engaging in stock buy backs, providing debt and/or equity to U.S. subsidiaries.34
“Hopscotch (loans) don't trigger tax for the U.S. corporation because purchasing securities in the U.S. parent triggers a deemed dividend, but purchasing securities of a foreign corporation, even a related corporation, hasn't been defined as a deemed dividend.”35 Therefore, the U.S. must be vigilant when refining the definitions that pertain to financial planning techniques.
1.C.2. – United States Defensive Measures to Financial Planning Techniques Notice 2014-52
In 2014, the Treasury Department instituted Action 2014-52 as a means to rein in corporate tax inversions. The 2014 Notice had four particular goals: 1) Prevent inverted companies from accessing a foreign subsidiary’s earnings while deferring U.S. tax through the use of creative loans, which are known as “hopscotch” loans; 2) Prevent inverted companies from restructuring a foreign subsidiary in order to access the
subsidiary’s earnings tax-free; 3) Close a loophole to prevent an inverted company from transferring cash or property from a CFC to the new parent to completely avoid U.S. tax; 4) Make it more difficult for U.S. entities to invert by strengthening the requirement that
34 Stuart Weichsel. "Corporate Inversions and Hopscotch Loans: The Remaining Loopholes Outnumber the Restrictions." Bloomberg BNA. (November 2014). 35 Id. at Page 3. Also, See 26 U.S.C. § 956.
the former owners of the U.S. entity own less than 80 percent of the new combined entity.36
The regulations associated with “hopscotch” loans were the most imperative for the treasury department because of the base erosion that was taking place by former U.S. tax resident MNEs after inverting. IRS Notice 2014-52 allows the reclassification of a loan made by a CFC as a hopscotch loan, which deems the loan as U.S. property and thereby taxes the loan in the same way as if it were made directly to the former U.S. parent. The regulations in Notice 2014-52 were substantiated by the authority established in 26 U.S.C. § 956(e), which allows the secretary to proscribe regulations associated with deemed dividends.
The Citizens for Tax Justice strongly urged the Secretary of Treasury, Jack Lew, to expand the scope of the Notice 2014-52 by applying it to all MNEs and not just the expatriated entities.37 The CTJ suggested expanding the scope of the 2014 Notice by not limiting the regulatory actions to MNEs covered by Section 7874, but applying the limitation to all foreign ownership cases under authority of section 956 and section 7701.
Notice 2015 – 79, also known as the 2015 Notice, strengthened the 25%
‘substantial business activities’ exception in section 7874 by limiting the applicability of the exception to situations where the new foreign parent is a tax resident of its host country. Also, notice 2015-79 limited the tax benefits associated with the property leaving the CFC of a recently inverted U.S. entity.38
1.C.3. – Home is Where the Money is.
Currently, a U.S. MNE is motivated to indefinitely keep foreign sourced profits abroad rather than to repatriate them back to the United States. In a complex and rapidly developing world, the U.S. must remain competitive in the commercial market by
adapting its current tax system to provide U.S. MNEs with incentives to repatriate profits at a competitive level. Providing U.S. MNEs with incentives to repatriate profits
36 United States Department of the Treasury, “Fact Sheet: Treasury Actions to Rein in Corporate Tax Inversions.” (September 2014).
37 Robert S. McIntyre, Citizens for Tax Justice, “Letter to Jacob Lew.” (March 23, 2016). 38 Andrew Kreisberg, Narissa Lyngen, John Sasopoulos, “Treasury Department Issues Temporary and Proposed Regulations to Curb Inversions and Earnings Stripping.” White & Case LLP. (April 2016).
correspondingly encourages the MNEs to remain U.S. tax residents. Tax residency is significant for companies like Pfizer because a change in corporate domicile would provide Pfizer with the capabilities to access offshore profits at a lower tax rate while continuing to exploit the United States market, workforce, and general demand for prescription medications.
President Obama has been quite critical of companies that seek to avoid corporate income tax by exploiting loopholes in the U.S. tax code because domestic investment provides opportunities for unparalleled growth. “When companies exploit loopholes, it
makes it harder to invest in the things that will keep America strong for future
generations…Many of those loopholes come at the expense of middle class families – because that lost revenue could have been used to invest in our schools, make college more affordable, put people back to work building our roads, and create more
opportunities for our children.” – Barrack Obama, The President of the United States.39
As expressed above, the United States has invoked congressional legislation as well as treasury regulations to curb the use of inversions and their related tax base
stripping techniques.40 Nevertheless, the legislation and regulations have been invoked to the detriment of the MNEs seeking to repatriate profits from abroad. Unlike the broad powers of Congress, the Treasury Department has limited regulatory authority to deter MNEs from inverting so as to avoid the U.S. domestic taxation of foreign sourced profits.
In this author’s perspective, Congress and the Treasury Department must use their regulatory powers to further encourage MNEs to repatriate their foreign sourced profits and use those profits for domestic investment. Only the shareholders of a U.S. MNE benefit from a change in their tax residence, whereas the employee or consumer is sincerely hindered by the change. Therefore, it is imperative for the United States to present a strong unified front with regards to tackling inversions and spurring domestic investment because, as president Obama highlighted, losing any MNE as a tax resident drastically affects people’s livelihood.
39 The White House, “The Corporate Inversions Tax Loophole: What You Need to Know.” (April 8th, 2016)
40 The White House, “You Don't Get to Pick Your Tax Rate. Neither Should Corporations.” (September 26th, 2014)
41
As the graph indicates, the Treasury Department has deterred MNEs from repatriating profits by invoking regulations that further distance the U.S. tax residents from their foreign sourced profits. The foundation of this thesis is to analyze how the legislation and regulations could be used to incentivize MNEs to voluntarily repatriate profits back into the United States.
41 Id.
1.D) – The Manufacturer and the Retailer 1.D.1. – The Manufacturer: Pfizer
Corporate inversions will cost the U.S. Treasury as much as $40 billion over the next ten years, according to Congress’s Joint Committee on Taxation.42 Why would a MNE engage in the inversion process if it will negatively affect the United States? The answer lies in the economic choices that companies encounter. For instance, “A recent study by Citizens for Tax Justice found that U.S. companies likely owe as much as $695 billion on the $2.4 trillion in earnings they hold offshore.”43
The most profound examples of companies that could do the most devastation through an inversion are noticeably in the pharmaceutical industry where a slight advantage could separate a company from its competitors. In fact, Citizens for Tax
Justice estimated that Pfizer alone could expatriate their tax residence to a more favorable jurisdiction and simply avoid paying the United States roughly $40 billion in taxes on the almost $195 billion that the company has in untaxed offshore earnings.44 Unlike smaller companies, Pfizer enjoys substantial benefits from the citizens of the United States that allow the company to attain its profitability standards, such as: research and development subsidies, a publicly educated workforce, reliable infrastructure, enforceable patent jurisprudence, and federal contracts.45
Pfizer received more than $590 million in tax breaks over a five-year span as research and experimentation credits or domestic manufacturing deductions.46 Moreover, Pfizer got $5 billion in federal contracts over the same five-year span that accounted for roughly 5% of Pfizer’s total U.S. sales. From 2010 to 2014, Pfizer reported losing $16.3 billion in the United States whilst earning $78.1 billion outside the United States.47 Furthermore, Pfizer exploited the United States as the largest prescription consuming country in the world when they extracted 43% to 38.4% (respectively) of total sales and
42Jeffrey Zients and Seth Hanlon, “The Corporate Inversions Tax Loophole: What You Need to Know.” The White House Blog. (April 8th, 2016)
43 Robert S. McIntyre, Citizens for Tax Justice, “Letter to Jacob Lew.” (March 23, 2016). 44 Id.
45 William Rice. "Pfizer: Price Gouger, Tax Dodger." (2015) 46 Id.
47 Frank Clemente, Americans for Tax Fairness, “Pfizer’s Tax Dodging Rx: Stash Profits Offshore.” (2015). See Appendix 2, page 14.
maintained roughly 48% of their assets in the United States.48 Thus, there is a conundrum between the worldwide profits made by Pfizer and the United States losses that it claims to have incurred. Pfizer’s financial and asset capacity allows them to utilize more than 150 subsidiaries to its advantage by engaging in financial planning techniques that manipulate their worldwide profits and losses.
Pfizer has in the past and will continue in the future to exploit the American consumers of their prescription drugs by charging Americans higher prices for the same drugs sold on foreign markets. For example, the average U.S. price for Celebrex on June 1, 2015 was $6.51 per pill while the average respective price in Ireland was $0.58 per pill.49 Pfizer has the capability to significantly damage the U.S. market without any adverse effects coming back on the company by expatriating their tax residency to a different tax jurisdiction whilst maintaining corporate control in the United States,
Congress has been motivated to protect the U.S. tax base from the abusive practices of corporate inversions, but congressional cohesiveness is seemingly
improbable. Nevertheless, the “No Federal Contracts for Corporate Deserters Act”50 was introduced in April of 2015. The Act applies the ban of federal contracts to companies that retain 50% or more U.S. shareholders after inverting and applies the ban to companies that subcontract with inverted MNEs. If the proposed legislation became a law, than Pfizer would cease to obtain the $1 billion per year from Medicaid, Medicare, or other federal contracts after expatriating.51 However, Congress should contrive the legislation to encourage Pfizer to stay in the U.S., rather than discouraging them from leaving the U.S.
Pfizer – Astrazeneca (2014)
Pfizer has sought to expatriate their tax residency from the United States to Europe on numerous occasions. In November 2013, Pfizer unsuccessfully sought a merger with United Kingdom based pharmaceutical manufacturer Astrazeneca. In January 2014, Pfizer again tried to merge with Astrazeneca by offering $100 billion in
48 Id.
49 William Rice. "Pfizer: Price Gouger, Tax Dodger.” (2015) at page 11.
50 H.R. 1809: “No Federal Contracts for Corporate Deserters Act of 2015.” Sponsor: Rosa DeLauro, Co-Sponsors: Lloyd Doggett and Sander Levin.
70% stock and 30% cash that led to another unsuccessful merger.52 In April 2014, Pfizer approached Astrazeneca again with a deal that proposed a new U.K. incorporated holding company with management in both countries, head offices in New York, and a listing on the New York Stock Exchange.53 Ultimately, the merger between Pfizer and Astrazeneca never got past the negotiating table.
Pfizer vigorously pursued the merger with Astrazeneca because as Pfizer CEO Ian Read stated, “…this transaction will make us a stronger company and give us greater ability to invest. Investment goes to places that have great science and really
well-educated work forces, so I don’t believe it should be any concern to the U.S. government that we’re becoming a stronger company and more competitive on a global scale.”54 Seemingly, Mr. Read would like to have his cake and eat it too because he also stated, “It would have been very detrimental to the deal to bring AstraZeneca profits, which are taxed differently from the U.S., into the U.S. tax jurisdiction, which is why we opted for a domicile in the U.K.”55
In 2014, Pfizer sought to alleviate three major complications: i) the 24% effective corporate tax rate, ii) an accumulation of billions in foreign sourced income, and iii) a faltering pipeline of new drugs.56 Pfizer’s problems have persisted because the attempted merger(s) with Astrazeneca never fully materialized due in large part to the
aforementioned Notice 2014-52. Nevertheless, Pfizer will continuously seek to expatriate their tax residence until Congress or the Treasury develops a strong incentive that is capable of persuading Pfizer to remain a U.S. tax resident.
Pfizer – Allergan (2016)
On November 23, 2015 Pfizer informed the Securities and Exchange Commission that they were seeking a merger with Allergan, an Irish pharmaceutical manufacturer based in Dublin, which would relocate Pfizer’s worldwide tax residence to Ireland.57 The
52Ann M. Thayer. “Pfizer Pursues AstraZeneca.” Chemical and Engineering News (2014) 53 Id.
54 Id. 55 Id.
56Andrew Ward and David Crow, “Pfizer and AstraZeneca: one year after deal that never was.” Financial Times. (2015).
57 Pfizer and Allergan filing pursuant to Rule 425 under the Securities Act of 1933. (November 23rd, 2015).
transfer of Pfizer’s tax residence to Ireland would be a calculated tactical maneuver by Pfizer to dodge U.S. deferred tax on income located outside the U.S. taxing jurisdiction because the new Irish parent company will still be primarily owned be Pfizer’s current shareholders and will continue to be directed/managed in Manhattan, New York.58
In 2014, Pfizer claimed that they were subject to an effective corporate income tax rate of approximately 25.5%. However, Pfizer’s actual effective corporate income tax rate in 2014 was 7.5% due to the fact that Pfizer did not properly report and/or
mischaracterized the income earned from non-U.S. sources.59 Pfizer has been playing the game of endless deferral with their foreign sourced income to avoid paying the maximum U.S. corporate income tax rate of 35%. Therefore, Pfizer has two options: 1) Repatriate the profits back to the United States at 35%, or 2) establish a new tax residence in a foreign jurisdiction to retrieve the profits at a lower corporate tax rate. The proposals provided in this thesis and the further proposals that are analyzed would provide Pfizer with a third option that allows the voluntary repatriation of foreign sourced profits at a lower rate, so long as the profits are repatriated within a five-year span.
In a study from 2015, William Rice identified how $13.9 billion of potential U.S. taxes would be dodged on the $74 billion that Pfizer holds in foreign jurisdictions labeled as ‘Permanently Reinvested Earnings’. Mr. Rice used the U.S. statutory corporate income tax rate of 35% and subtracted the average foreign corporate income tax rate of 16.3% to conclude that an 18.7% (or $13.9 billion) tax burden in the United States would disappear after a corporate inversion by Pfizer. By applying the 30% standard foreign sourced rate proposal in this thesis, Pfizer’s underlying tax burden would be 13.7% (or $10.14 billion) because 30% - 16.3%. Thus, Pfizer would enjoy a $3.76 billion discount under the proposal provided in this thesis, so long as the funds are repatriated within 5 years.
Mr. Rice further contends that there is an additional $74 billion in unreported foreign sourced income that Pfizer has yet to declare, which he equates to a $21.2 billion tax burden in the United States because the income likely will not be subject to taxation
http://www.sec.gov/Archives/edgar/data/78003/000119312515384517/d94498d425.htm
58 William Rice. "Pfizer: Price Gouger, Tax Dodger.” (2015).
59 Richard Rubin, “Pfizer Piles Profits Abroad: Drug giant’s accounting method leads to higher effective tax rate in U.S.” The Wall Street Journal. (Nov. 8th, 2015).
in another jurisdiction.60 However, the proposal in this thesis would limit that tax burden to roughly $15 billion.
Pfizer’s attempted merger with Astrazeneca in 2014 was halted by the treasury department’s 2014 Notice as mentioned above. Nevertheless, Pfizer attempted to merge with Allergan in 2015 because the Treasury department did not address a substantial loophole in the 2014 Notice when they failed to accurately define an inversion. Mr. Rice stated, “a principal way inversions are different from regular mergers and acquisitions— what’s ‘inverted’ about them—is that the supposedly ‘acquired’ U.S. company winds up with a bigger ownership stake in the merged entity than the allegedly ‘acquiring’ foreign company. Logic indicates that a merger resulting in the ‘acquired’ U.S. corporation owning anything more than 50% of the new foreign company should qualify as an inversion. But the Treasury rule sets the threshold at 60%.” Therefore, Mr. Rice alleges that Pfizer was seeking to exploit the 50%-59.9% loophole, whereby a company will not be subject to the restrictions in 26 U.S.C. § 7874 when they retain less than 60% of the stock in the new parent company after the inversion process. The attempted merger between Pfizer and Allergan would have given Pfizer 56% of the inverted company, which would be enough to keep them just underneath the U.S. regulatory threshold of 60% for a ‘surrogate foreign corporation’ under 26 U.S.C. § 7874.
Treasury Notice 4/4/2016
On April 4, 2016 the Treasury Department derailed Pfizer’s attempted merger with Allergan by instituting regulatory action that disregards the foreign parent stock that is attributable to recent inversions or acquisitions of U.S. companies. The objective was to “prevent foreign companies that acquire multiple American companies in stock-based transactions from using the resulting increase in size to avoid the current inversion thresholds for a subsequent U.S. acquisition.”61 Specifically, companies were seeking to avoid the application of 26 U.S.C. § 7874 and the corresponding inversion regulations by acquiring multiple American companies over a short period of time. Thus, the regulations make it so the foreign acquirer’s size does not grow substantially after the acquisition
60 William Rice. "Pfizer: Price Gouger, Tax Dodger.” (2015).
61 U.S. Department of the Treasury: “Treasury Announces Additional Action to Curb Inversions, Address Earnings Stripping.” (April 4th, 2016)
period and most of the growth that is attributable to the assets of recently acquired American companies is disregarded. Nevertheless, the 2016 Notice only excludes the amount of stock a foreign company possesses that is attributable to assets acquired from an American company within three years before the latest acquisition.62 Therefore, it is consistent with the objectives in section 7874 to regulate Pfizer’s situation and other comparable situations when a company increases in size with the objective of artificially avoiding the inversion threshold.
1.D.2. – The Retailer: Walgreens
Pfizer is one of the largest pharmaceutical manufacturers in the world, but Pfizer also requires a comparably large distributor to disperse their products in the United States. The largest pharmaceutical retailer in the United States is Walgreens Co. with more than 8,173 stores in all 50 states as of August 31, 2015.63
In June 2012, Walgreens announced that they had begun merger procedures with one of Europe’s largest pharmaceutical retailers named Alliance Boots (AB) after purchasing 45% of AB for $6.7 billion. In December 2014, Walgreens purchased the remaining 55% of AB for $4.8 billion and 144,300,000 shares of the new parent company Walgreens Boots Alliance (WBA).64 As expressed earlier, a MNE successfully completes an inversion when the U.S. domestic owners retain less than 80% of outstanding stock after the inversion, or if the MNE has ‘substantial business activities’ (at least 25%) in another country.65
The formation of WBA allowed Walgreens to reorganize itself into three segments: Retail Pharmacy USA, Retail Pharmacy International, and Pharmaceutical Wholesale. In fiscal 2015, Retail Pharmacy USA accounted for 78.3% of WBA’s total sales and 83.2% of operating income. Pharmaceutical Wholesale accounted for 13.4% of WBA’s total sales and 8% of its operating income. Retail Pharmacy International
accounted for 8.4% of sales and approximately 8.5% of operating income.
62 Id.
63 Walgreens, “Store Count by State”.
http://news.walgreens.com/fact-sheets/store-count-by-state.htm
64 Sonya Bells, “Walgreens Boots Alliance: Merger of Walgreens and Alliance Boots”. Market Realist. (January 20th, 2016)
The formation of Walgreens Boots Alliance also allowed Walgreens to become a subsidiary of WBA, which thereby relocated Walgreens worldwide tax residence to Switzerland. Similar to Pfizer’s aspirations, Walgreens was not intending to move its headquarters, employees or supply chains to Switzerland. The move was projected to cost U.S. taxpayers more than $4 billion in lost tax revenue over a five-year span and cut Walgreens U.S. domestic tax rate from 30% to 20%.66 Unfortunately, the tax revenue that would be lost “is enough to pay for one-and-a-half years of prescriptions for the entire veterans population at the V.A., or pay for health coverage for 3.5 million children for a year.”67 Additionally, WBA has the capacity and capability to engage in financial planning techniques, like those discussed above, to artificially shift profits between the three different supply chains and allocate of Alliance Boots’ $8.5 billion debt to Walgreens Co. 68
The merger between Alliance Boots and Walgreens not only affected the international market, but it also influenced the U.S. domestic market and local state markets. For example, “Walgreens average U.S. tax rate was 31% from 2008 to 2012. Its chief competitor, CVS Caremark, paid a higher tax rate of 34% over those same years, but it has made no move to reincorporate offshore.” WBA has begun to slowly
monopolize the pharmaceutical distribution industry because they do not face the same hardships as their smaller competitors that cannot relocate their tax residence. Moreover, WBA is hindering the United States tax base because about 23% or $16.7 billion of Walgreens sales in 2013 came directly from the federally sponsored programs like Medicare and Medicaid.69
Walgreens and Pfizer both benefit from operating in the United States by utilizing a publicly educated workforce, a strong and stable infrastructure, public spending on health care, and legal certainty/security. Senate Finance Committee Chairman Senator Ron Wyden (D-OR) recently wrote in The Wall Street Journal, “…while their
shareholders may secure a temporary win, workers, taxpayers and this country all lose. America's tax base erodes at a cost of hundreds of millions of dollars in revenue,
66 Americans for Tax Fairness, “Offshoring America’s Drugstore”. (June 2014). 67 Id.
68 Id. 69 Id.
increasing the burden on other companies and individuals.” Senator Charles Grassley (R-IA), a senior member of the Senate Finance Committee, has said: “These corporate expatriations aren’t illegal. But they’re sure immoral.” American citizens and elected officials have become nervous about the economic decisions that are being made by MNEs. Thus, the following proposals were developed as a means to encourage shareholders and MNEs to invest in domestic endeavors, which benefit the American population, by allowing the repatriation of foreign sourced income at a lower rate.
CHAPTER #2 – OTHER REPATRIATION PROPOSALS There have been a number of proposals in recent years aimed at allowing corporations to repatriate profits held outside of the United States. However,
Congressional approval has been sparse and the Treasury Department has been forced to adapt with limited powers. Consequently, it has become much more imperative to
provide MNEs with a positive incentive that encourages voluntary repatriation of foreign sourced income.
2.A) – Author Proposals
2.A.1. – 30% Standard Corporate Income Tax on Foreign Sourced Profits A United States Multi-National Enterprise (MNE) with substantial international operations will amass inconceivable amounts of money in tax friendly jurisdictions as a result of endlessly deferring the United States corporate tax that is owed on the foreign sourced income. A noteworthy amount of corporate inversions have been taking place at the expense of the American tax base and a significant reason for the occurrence of the inversion epidemic is the amount of deferred worldwide profit in holding companies located outside of the United States by U.S. resident companies. Moreover, a further catalyst is the U.S. corporate tax rate that is currently at 35%.
The basis of this thesis is to determine whether the corporate inversion movement in the United States can be slowed or stopped by providing companies with the option to repatriate profits back to the United States at a lower rate than the U.S. domestic
corporate income tax rate (35%).
The United States has a sovereign right to set the corporate tax rate for domestic source profits at whatever they feel is appropriate, thereby subjecting all profit making
activities in the U.S. to the domestic tax rate. Taxing the profit making activities in the U.S. at a higher rate is appropriate because companies exploit the U.S. market whilst receiving numerous advantages, such as: educated workforce, sustainable infrastructure, legal/physical protections, and a profound judicial system. However, income from abroad should be subject to minimal taxation because the income is not taking advantage of the U.S. market in the same way. Comparable profits should be exploitable and taxable in the same way.
All income empowers the beholder with the ability to choose the ultimate fate of that income. Nevertheless, foreign sourced income by its very nature is fundamentally different than income earned on the United States domestic market because the foreign sourced income is obtained under different legal and financial circumstances.
A reasonable solution to the ‘trapped cash problem’ is to allow a U.S. tax resident to repatriate the active and/or passive income derived from a foreign market at a lower rate. The United States should levy only an additional 5 – 10% from all foreign sourced income where the source country has at least 60% of the U.S. domestic tax rate (i.e., 21% or more). If the foreign source country subjects the income to less than 60% (i.e., 21%) than the US should levy an additional 10 – 15%.70
For example, the United Kingdom’s corporate income tax rate for 2016 is 20%, which is about 57% of the highest US domestic corporate rate. Consequently, the U.S. would levy an additional 10% thereby raising the total to 30%, rather than 35% under the U.S. domestic rate.
Comparatively, the Netherlands corporate income tax rate is 25%, which is about 71% of the US domestic corporate rate. Thus, the U.S. would levy an additional 5% thereby raising the total to 30%, rather than 35% under the US domestic rate.
As a corollary to the proposal, the foreign sourced income must be repatriated within the first 5 years of acquisition for the U.S. tax residents to take advantage of the lower corporate tax rate in this proposal. After 5 years, the funds must be either:
permanently reinvested in the foreign jurisdiction or they will be deemed as repatriated.
70 See, The United States Model Tax Convention for 2016 – Special Tax Regimes. Art. 3(1)(l)(iii)
The objective of this proposal is to provide for a lower worldwide corporate tax rate for U.S. tax residents on their foreign sourced profits. Therefore, the proposal is premised upon the United States maintaining a lower corporate income tax rate for foreign sourced income. In order to reduce the risks of erosion to corporate tax revenues, the beneficial standard statutory corporate tax rate for foreign sourced income should be set at 30%. The inspiration for the 30% favorable rate was drawn from the Ruding Report.71
2.A.2. – Global Formulary Apportionment
Currently, the U.S. government faces a yearly revenue loss that exceeds $100 billion due to Base Erosion and Profit Shifting.72 The U.S. should seek to harmonize a U.S. resident’s worldwide tax base by applying formulary apportionment to the domestic and foreign sourced income. Formulary apportionment would spur the mutual
cooperation between tax administrations, as well as providing the correct monetary value that is attributable to each party’s actions as they pertain to the transaction.
Under formulary apportionment, worldwide income is attributable to each country based on a formula that reflects the real substance of economic activities. The two
general approaches to deriving an adequate formula are based on: 1) sales, assets, and payroll; or 2) destination of sales.73
The key advantage expressed under formulary apportionment is that international income is not subject to the tax residence of the company involved. Also, the factors based upon sales, assets, and payrolls are real economic activities that are less mobile
71 Onno Ruding. “Report of the Committee of Independent Experts on company taxation. Executive summary.” (March 1992.) [EU Commission - Working Document]
Detailed Recommendation for Corporate Tax (Page 15):
“To reduce the risks of serious erosion of corporate tax revenues, the Committee recommends:
• That a draft directive be prepared by the Commission prescribing a minimum statutory corporation tax rate of 30% in Member States for all companies, regardless of whether profits are retained or distributed as dividends (Phase I); • Adoption by all Member States of a maximum statutory corporation tax rate of
40% (Phase II); …”
72 Kimberly A. Clausing, “Profits Shifting and U.S. Corporate Tax Policy Reform.” (May 10th 2016). See Footnote 12.
73 Kimberly A. Clausing, “Profits Shifting and U.S. Corporate Tax Policy Reform.” (May 10th 2016).
than financial activities. Therefore, formulary apportionment will alleviate competitiveness for tax residency and reduce base erosion practices.
2.A.3. – Corporate Exit Tax
In order to deter the expatriation of a MNEs tax residence, the United States should supplement 26 U.S.C. § 877 and § 877A with an ‘exit tax’ that is applicable to corporations. The ‘exit tax’ could derive precedent from Europe and the National Grid Indus case74 where a company must pay the capital gains associated with the
development of property within a jurisdiction. Prior to exiting the jurisdiction, the company must choose between immediate payment of the capital gains tax or deferral of the capital gains tax with interest. Generally, the company will not have sufficient capital to effectuate the immediate payment of the capital gains tax and must elect for deferred payment with interest/security. If there is a decrease in capital asset value, than it will not be taken into account for future tax payments by the exiting company.
Democratic Presidential candidate and former Secretary of State, Hillary Clinton, plans to propose an exit tax for corporations that is similar to the provisions applicable to individuals because she “believes that if a company does give up its U.S. identity, it should pay taxes on the unrepatriated profits that it made as a U.S. company, benefiting from U.S. infrastructure, our investments in human capital, and the efforts that the government makes on behalf of U.S. corporations – from basic research to enforcing trade treaties.”75 Seemingly, Mrs. Clinton’s exit tax would be starkly different from the precedent in the National Grid Indus case. Any exit tax will have a strong deterrent affect on corporate decision-making, but companies like Pfizer need encouragement to remain U.S. tax residents and options to repatriate their foreign sourced income.
2.A.4. – Place of Effective Management
The U.S. should strive to become a tax friendly jurisdiction, whereby the tax system seeks to protect the companies established within its jurisdictional market and promotes the mutual cooperation with the government for the betterment of society. For a MNE, the United States bases tax residence on the place of incorporation. Comparatively,
74 National Grid Indus BV v. Inspecteur van de Belastingdienst Rijnmond/kantoor Rotterdam, C-371/10.
numerous other OECD countries use the Place of Effective Management/Control test in addition to the place of incorporation test. In those other countries, a company is tax resident when the company is effectively managed and controlled from within the jurisdiction. For example, a company Incorporated in the U.S. but effectively managed/controlled in the Netherlands will be a tax resident in both countries.
The U.S. would have a solid legal basis for being able to retain the tax residency of more MNEs by adding the ‘Place of Effective Management’ (POEM) principle to its qualification of tax residence. Consequently, MNEs that continue to be effectively controlled or operated from the United States would remain tax residents for federal income tax purposes. The Place of Effective Management principle would be a useful tool to characterize the tax residency of a corporate inverter because the principle attempts to establish tax residency on the substance of the decision making, rather than the place where the company was formed. Unfortunately, the POEM principle creates uncertainty and allows manipulation of tax residency, whereas the place of incorporation test is clear and undeniable. The complexities of corporate tax residency and the
application of the POEM principle are highlighted by the Apple structure in Ireland. 2.B) – Government Proposals
2.B.1. – Obama Administration FY2016 Budget Proposal76
President Obama’s FY2016 Revenue Proposals included two specific proposals targeting the repatriation of foreign sourced income: 1) Impose a 19% minimum tax on foreign income, and 2) as a transition, impose a 14% one-time tax on previously untaxed foreign income.
The 19% Minimum Tax on Foreign Income.
As part of the FY2016 Budget, the Obama administration proposed
supplementing the subpart F regime with a per-country minimum tax on the foreign earnings of C corporations (U.S. corporations) and their CFCs.77 The minimum tax would apply to a U.S. corporation as it operates in the capacity of a United States shareholder of a CFC, as well as the foreign earnings from a branch or from the performance of services
76 Department of the Treasury: “General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals.” (February 2015).
abroad.
“Under the proposal, the foreign earnings of a CFC or branch or from the performance of services would be subject to current U.S. taxation at a rate (not below zero) of 19 percent less 85 percent of the per-country foreign effective tax rate (the residual minimum tax rate). The foreign effective tax rate would be computed on an aggregate basis with respect to all foreign earnings and the associated foreign taxes assigned to a country for the 60-month period that ends on the date on which the domestic corporation’s current taxable year ends, or in the case of CFC earnings, that ends on the date on which the CFC’s current taxable year ends.”78
The problem with the 19% minimum tax is it does not take into account the market that was utilized for the creation of the income. Also, the 19% minimum tax on foreign income will encourage the continuation of endless deferral and corresponding tax planning by forcing MNEs to find the most attractive jurisdiction to avoid the 19% tax. AUTHOR’S ADAPTED 19% Minimum Tax on Foreign Income
The 19% minimum tax should be implemented as proposed in the FY2016 budget, so long as the Minimum tax is subject to a temporal scope in addition to the legislation’s substantive scope. The 19% minimum tax could be used to incentivize MNEs to repatriate their foreign sourced income at an earlier point in time if the
percentage were to increase by 1% progressively for the first ten years (up to 30%) after the income is received.
For example, if a corporation repatriates the foreign sourced income in the first year than it will be subject to 19%. However, if a corporation repatriates the foreign sourced income in the sixth year than it will be subject to 25%. Therefore, the corporation has the incentive to repatriate the income to avoid the 1% annual increase.
As an illustrative example, Pfizer has approximately $195 billion in untaxed offshore earnings.79 If Pfizer repatriated the entire $195 billion in year 1, than they would be subject to 19% (or $37.05 billion) as the Minimum tax on foreign income. However, if Pfizer repatriated the income in year 6, than they would be subject to 25% (or $48.75 billion). Thus, Pfizer has a $1.95 billion yearly incentive to repatriate their foreign
78 Id.
income by adding the 1% yearly increase as suggested.
14% One-Time Tax on Previously Untaxed Foreign Income.80
In order to effectuate a transition to the 19% minimum tax, the Obama
Administration proposed a one-time 14% tax on earnings that are currently accumulated in CFCs and not previously subject to U.S. tax. Furthermore, the United States would relieve double taxation by providing a credit for the amount of foreign taxes previously paid upon the respective foreign income. The Citizens for Tax Justice have been quite critical of the 14% one-time tax because, according to them, “Ten of the biggest offshore tax dodgers would receive a collective tax break of $82.4 billion.”81
“Apple Inc. currently holds $137 billion of its cash offshore. Under current rules, the company should pay $45 billion when these profits are repatriated. But the Obama plan would allow it to reduce its tax bill to $18 billion — a $26.9 billion tax break. Microsoft would see a $17.7 billion tax cut on its $92.9 billion in offshore profits under Obama’s proposal. Large financial companies with substantial offshore cash would benefit handsomely from the president’s proposal: Citigroup would enjoy a $7 billion tax cut, while JP Morgan Chase would get a $3.8 billion tax break. Bank of America and Goldman Sachs would receive tax breaks of $2.6 billion and $2.4 billion, respectively.”82
Seemingly, the one-time 14% transition tax would be beneficial because the amount of tax that is alleviated would allow the MNEs to freely use the capital for other purposes. The overarching question for U.S. reformers is whether they want the foreign sourced income left abroad or repatriated back to the United States for utilization in the business strategies? It has been expressed consistently throughout this thesis that the persistent dilemma MNEs have been facing is whether to repatriate the income or invert to go get the income. It is in the best interest of the United States to use incentives like the 14% transition tax to keep the MNEs as U.S. worldwide tax residents. Nevertheless, if the transition to the minimum foreign tax does not fully materialize, than MNEs will receive the benefit of the 14% transition tax without the corresponding 19% minimum
80 Id.
81 Citizens for Tax Justice: “Ten Corporations Would Save $82 Billion in Taxes Under Obama’s Proposed 14% Transition Tax.” (February 3rd, 2015)
