Multinational companies including Apple, Pfizer and Ford Motor Co. would face a new tax on payments they make to offshore affiliates under the House Republicans' tax bill—a surprise provision 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 Washington Council advisory services group. “We're trying to get our arms around 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 tweaked the provision to lessen its impact, part of a package of changes the tax-writing panel adopted Monday night. The committee will continue debating the bill Tuesday.

House tax writers say the proposed excise tax is aimed at preventing U.S. companies from shifting their earnings offshore to subsidiaries in tax shelters—and it moved into the spotlight this week amid a series of global investigative reports on corporate tax avoidance. But tax practitioners say the provision has far larger implications for consumer prices on a range of goods.

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

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

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

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

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

For consumers, the result might be higher prices for imported goods and insurance premiums, and that's a message that various lobbying groups have been eager to share with House tax writers.

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

The Coalition for Competitive Insurance Rates, a lobbying group that 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, Texas and Florida, “it is unfathomable” that the bill proposes “a measure that will shrink competition in the insurance marketplace and increase the cost of insurance for consumers,” it said in a Nov. 2 statement. Large global insurers, not smaller U.S.-only ones that wouldn't face the tax, typically insure against most major disasters.

House tax writers envisioned the 20% tax as a way to shore up the U.S. corporate tax base, which has been eroded for years by companies sending their earnings overseas. As part of a tax overhaul that would cut the U.S. corporate tax rate to 20%—down from 35%—the House bill would also remake the U.S. approach to international business taxation.

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

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

'Border-Adjusted' Redux

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

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

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

“Our concern is that the tax ends up getting passed on to consumers and winds up being a consumption tax, similar to the border-adjustment tax,” said Levi Russell, a spokesman for Americans for Prosperity, a group backed by billionaire industrialists Charles and David Koch that also opposed the BAT.

International Automakers

Here for America, a lobbying coalition of international automakers including Honda, Toyota and Volvo, all with manufacturing, 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 flawed and disadvantages companies that are a backbone of American manufacturing and job creation.”

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

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

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

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

But let's say it costs the affiliate $60 to produce the good in question. 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 be a different kind of price to pay: It would have to disclose more to investors, and therefore, perhaps, to competitors, about its profits on particular product lines.

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

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

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

From: Bloomberg News

Instant Insights /

Multinationals Unhappy with Proposed Excise Tax

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