Multinational companies including Apple, Pfizer and Ford MotorCo. would face a new tax on payments they make to offshoreaffiliates under the House Republicans' tax bill—a surpriseprovision that has stunned tax experts.

The new 20% tax is “the atomic bomb in the draft” legislation,said Ray Beeman, co-leader of Ernst & Young's WashingtonCouncil advisory services group. “We're trying to get our armsaround the implications.”

So far, many big U.S. companies have kept quiet on the proposal.But already, House Ways and Means Chairman Kevin Brady has tweakedthe provision to lessen its impact, part of a package of changesthe tax-writing panel adopted Monday night. The committee willcontinue debating the bill Tuesday.

House tax writers say the proposed excise tax is aimed atpreventing U.S. companies from shifting their earnings offshore tosubsidiaries in tax shelters—and it moved into the spotlight thisweek amid a series of global investigative reports on corporate taxavoidance. But tax practitioners say the provision has far largerimplications for consumer prices on a range of goods.

“It's a very big gorilla in the living room,” said GaryFriedman, a tax partner at Debevoise & Plimpton. Techcompanies, pharmaceutical makers, automakers and reinsurers are thecompanies most likely to be concerned, he said.

A Pfizer spokeswoman said it was premature to comment, and anApple spokesman declined to comment. Ford did not respond torequests for comments.

The tax would apply to billions of dollars inintellectual-property royalties that technology and pharmaceuticalfirms make to their overseas affiliates each year—payments oftenlinked to tax-avoidance strategies. But it would also hit U.S.companies' imports of generic drugs, cars and other products fromtheir affiliates. Global insurers would incur the levy on the costof “reinsurance” they buy from foreign affiliates.

The provision, which is estimated to raise $154 billion over adecade, “could trigger a trade war,” Friedman said—stirring othercountries to tax their companies' imports from U.S. units.

For investors, the impact would appear as higher overallexpenses in corporate financial statements across a range ofindustries, potentially depressing earnings, said Robert Willens,an independent tax and accounting expert.

For consumers, the result might be higher prices for importedgoods and insurance premiums, and that's a message that variouslobbying groups have been eager to share with House taxwriters.

“We expected significant feedback there, and it's exactly whatwe got,” Brady told reporters Monday. He added: “Insurance is anindustry where I think there are some unintended consequences fromthe first draft. I am re-examining those provisions to make sure wegot it right.”

The Coalition for Competitive Insurance Rates, a lobbying groupthat includes the U.S. arms of Zurich Re, Allianz Re and Swiss Re,came out swinging after the bill appeared.

Insurers' Complaints

In the wake of recent hurricanes that ravaged Puerto Rico, Texasand Florida, “it is unfathomable” that the bill proposes “a measurethat will shrink competition in the insurance marketplace andincrease the cost of insurance for consumers,” it said in a Nov. 2statement. Large global insurers, not smaller U.S.-only ones thatwouldn't face the tax, typically insure against most majordisasters.

House tax writers envisioned the 20% tax as a way to shore upthe U.S. corporate tax base, which has been eroded for years bycompanies sending their earnings overseas. As part of a taxoverhaul that would cut the U.S. corporate tax rate to 20%—downfrom 35%—the House bill would also remake the U.S. approach tointernational business taxation.

Unlike most other developed economies, the U.S. taxes companieson their global earnings, but it allows them to defer paying taxeson overseas earnings until they're returned to the U.S. As aresult, companies have stockpiled an estimated $3.1 trillionoffshore, beyond the reach of U.S. corporate taxes.

The House bill would end that practice, apply a cut-rate tax tothe stockpiled earnings and use the new excise tax to try to keepmore U.S. income at home in the first place.

'Border-Adjusted' Redux

The excise tax would apply to many payments that U.S. basedcompanies make to foreign affiliates, be they subsidiaries, sistercompanies or parent companies. That would include royalties, butalso payments for inventory later sold to consumers—essentially,any payment to a foreign affiliate on which the U.S. company couldtake a tax deduction immediately or over time.

The tax wouldn't apply to payments between two U.S. affiliatesof the same U.S. company. And it wouldn't apply to interestpayments, another method companies use to send profit overseas thatwould be curbed under a separate bill proposal.

Because the tax would apply to payments for inventory, some havecompared it to the controversial “border-adjusted tax,” or BAT,that House Speaker Paul Ryan proposed last year. That proposalwould have placed a 20% tax on companies' domestic sales andimports, while exempting their exports. Ryan gave up on the ideaafter retailers and others argued that it would raise consumerprices.

“Our concern is that the tax ends up getting passed on toconsumers and winds up being a consumption tax, similar to theborder-adjustment tax,” said Levi Russell, a spokesman forAmericans for Prosperity, a group backed by billionaireindustrialists Charles and David Koch that also opposed theBAT.

International Automakers

Here for America, a lobbying coalition of internationalautomakers including Honda, Toyota and Volvo, all withmanufacturing, R&D and sales operations throughout the U.S.,said in a Nov. 5 statement that the tax was “discriminatory”against global companies. The current tax bill, it said, “is flawedand disadvantages companies that are a backbone of Americanmanufacturing and job creation.”

The bill does contain an escape hatch, of sorts—a way forcompanies to cut the amounts they'd pay under the excise tax.

Companies can either pay the 20% excise tax on the payments theymake to an overseas affiliate—or they can make the affiliate itselfsubject to a tax on its net profit.

Choosing the second option might be more beneficial for mostcompanies, tax experts said, because most U.S. companies pay theirforeign affiliates a premium, a price that includes profit.

Consider a case in which the U.S. company pays its foreignaffiliate $100 for a particular good. If it chooses to pay theexcise tax on the payment, that's a tax bill of $20.

But let's say it costs the affiliate $60 to produce the good inquestion. Its profit would be $40, and its tax would be just $8.The company could cut its potential tax bill in half—but there'd bea different kind of price to pay: It would have to disclose more toinvestors, and therefore, perhaps, to competitors, about itsprofits on particular product lines.

Currently, companies tend to make such disclosures on broadsegments of the products they offer, not particular lines. “Thisbill allows the IRS to define what a product line is,” said SethGreen, a principal in KPMG's Washington National Tax practice.

Choosing the extra disclosure and the lower tax bill is thebetter option, said Michael Mundaca, co-director of Ernst &Young's National Tax practice—even if it does subject foreignaffiliates to more scrutiny from the IRS.

“Neither choice is good,” he said, “but the second one isbetter, even with increased reporting.”

From: Bloomberg News

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