U.S. companies that make billions of dollars from patents and other intellectual property held offshore would be eligible for a special 12.5 percent tax rate on those earnings under the Senate tax plan.
That’s a potential “gold mine” for some multinationals, said Michael Mundaca, co-director of Ernst & Young’s National Tax Practice—especially compared to international tax provisions in the House bill that generally would apply a top rate of 20 percent.
But it’s unclear which chamber’s vision will prevail—and some companies that now pay even lower rates on such income may oppose the measure regardless.
Republican lawmakers in the House and Senate are rushing to rewrite complicated laws of international taxation on a tight, self-imposed deadline, part of their effort to overhaul the U.S. tax code by year’s end. The bills contain prizes for corporate America—including a corporate tax cut to 20 percent from 35 percent—but also potential surprises.
“That the two proposals contain dueling provisions covering fundamental tax issues—and the legislative process has been rushed and chaotic—creates uncertainty for the markets and for deal makers,” said Gary Friedman, an international tax partner at Debevoise & Plimpton.
Bill writers in both chambers want to end America’s quirky, globalist approach to taxation, while preventing companies from sending their earnings offshore to tax havens. How they reconcile their proposals—both of which are still subject to change—carries multibillion-dollar implications for IP-reliant companies, including Apple Inc.
The bills “upend decades of U.S. tax policy,” Friedman said. “They so radically change the landscape that almost every multinational corporation will have to rethink its tax strategy.”
With regard to the 12.5 percent Senate proposal for IP, experts say it appears to be designed to compete with countries like Ireland, which has a 12.5 percent corporate tax rate. But—as may be fitting for a rewrite of the byzantine rules of international taxation—the rate is impossible to find in the actual Senate plan.
To unearth it, tax lawyers have had to assess two provisions. First, the Senate plan would require that any “global intangible low taxed income” received by a company’s offshore unit would be immediately taxable in the U.S. at the new 20 percent corporate rate. But then a second provision would allow companies to deduct 37.5 percent of their “foreign derived” income from such intangibles that comes from trade or business in the U.S.
That deduction would leave them paying 20 percent on 62.5 percent of that income—the functional equivalent of a 12.5 percent tax.
“There is nothing that explicitly says the rate is 12.5 percent, but the math gets you there,” said Debevoise’s Friedman.
The combination of the immediate taxation of that income—and the generous deduction—led Congress’s official tax scorekeeper to estimate the provisions would raise about $29.1 billion over 10 years, said Bret Wells, an international tax professor at the University of Houston. Setting the rate at 12.5 percent is no accident, Wells said.
“It’s clearly aimed at Apple and Ireland,” he said.
A spokesman for Apple didn’t immediately respond to a request for comment. The company’s tax arrangements with Ireland have drawn scrutiny on both sides of the Atlantic. Last year, the European Commission ordered Ireland to collect 13 billion euros ($15.2 billion) in back taxes from Apple.
Apple Chief Financial Officer Luca Maestri said in an interview earlier this month that the company is waiting to see what legislation gets enacted. “We’ve always been a very strong advocate for comprehensive corporate tax reform,” he said.
The tax overhaul that Republicans hope to deliver would change international taxation in profound ways. Currently, the U.S. applies its 35 percent corporate income tax to its companies’ global earnings—unlike other developed countries, which focus only on their companies’ domestic activities.
But the U.S. system also allows companies to defer paying tax on foreign income until they decide to return that income to the U.S. parent. As a result of that quirk, companies have left large stockpiles of unreturned earnings sitting offshore for years. Those accumulated earnings may total $3.1 trillion, according to a Goldman Sachs research estimate.
Now, congressional tax writers propose to cut the corporate tax rate, end the global system, impose a one-time tax rate on the stockpiled earnings and keep companies from shifting their future profit offshore in search of still-lower rates.
One widely used technique involves transferring intellectual property, like patents, to offshore subsidiaries in tax havens, including Ireland, Bermuda and the Cayman Islands, and then paying royalties to those units. The Senate bill would aim to stem the practice with its 12.5 percent rate on income from IP—which would apply whether the property in question is held offshore or not.
“They’re basically saying, ‘Please don’t move your science from the west coast to a foreign country, because we’ll give you the 12.5 percent rate,”’ Wells said.
The House’s approach would levy a 20 percent excise tax on certain payments that U.S. companies make to their foreign affiliates—including royalties, but also for other costs, including imported inventory. Ray Beeman, co-leader of Ernst and Young’s Washington Council advisory services group, labeled that provision “the atomic bomb” in the original House bill; it’s since been softened.
The House Ways and Means Committee amended the provision last week, to “significantly water it down,” Wells said. By week’s end, the measure included an escape hatch that would let companies choose to pay tax on their foreign affiliates’ profits—not on the gross payments made to them—under certain conditions. Another change boosted the amount of credits companies could take for foreign taxes paid by such units to 80 percent from 50 percent.
As a result, the provision went from raising an estimated $154.5 billion over 10 years in its original drafting to raising just $87.6 billion, according to Congress’s Joint Committee on Taxation.
The House and Senate will have to iron out the differences between their bills. House leaders hope to have a floor vote on their bill as soon as Thursday. In the Senate, where actual legislative text has yet to be revealed, leaders say they want to vote during the week of Nov. 27.
After that—assuming the approved versions still differ—a conference committee from the two chambers would have to reach agreement.
The Senate bill includes a few other proposals aimed at keeping U.S. companies’ earnings in the U.S. for tax purposes—or combating the corporate profit shifting that tax experts call “base erosion.”
One of them is a 10 percent “base erosion and anti-abuse tax,” or BEAT, on companies that make deductible payments to foreign affiliates—including for payments on loans between units in different countries. The 10 percent rate would function as a kind of “alternative minimum tax,” Mundaca said.
That’s because under the Senate plan, companies would generally pay either the 12.5 percent rate on their intangible property income or the 10 percent rate on a larger income base that includes “excess income” and other items.
Whichever tax results in the larger bill would be the one that applied, according to Mundaca. But Itai Grinberg, a tax law professor at Georgetown University and a former top Treasury tax official, said the Senate language on this was “unclear.”
The 10 percent BEAT tax would raise $123.5 billion over a decade, according to the official congressional estimate.
The Senate plan also contains a harsh new rule for new corporate inversions—transactions in which U.S. companies merge with offshore firms to shift their tax addresses offshore. It would hold that any company engaging in an inversion within 10 years after enactment would be taxed at 35 percent—not any lower rates.