Tax Changes Hit Overseas Profits of Some U.S. Companies

Date: Tuesday, April 2, 2019
Source: The Wall Street Journal

New tax called GILTI entangles P&G, Otis Elevator

WASHINGTON—When Republicans rewrote the international tax system in 2017, they were trying to help U.S. companies like Procter & Gamble Co. compete in foreign markets and create domestic jobs. Fifteen months later, the Ohio-based consumer products maker and other U.S.-based multinationals warn the new law could instead put them at a disadvantage globally and reduce their incentive to invest at home.

P&G pays about 18% to 19% of its non-U.S. income in foreign taxes. That is high enough that executives thought they would avoid paying a new U.S. minimum tax designed to prevent companies from shifting profits to low-tax countries.

Instead, P&G now expects to pay the U.S. $100 million annually because of that minimum tax, raising its tax rate on foreign profits to 21%. Some non-U.S. competitors, such as Unilever PLC, generally don’t pay home-country taxes on global earnings.

P&G executives say the tax rules could hurt the company’s ability to compete for acquisitions. And, paradoxically, the easiest way for P&G to respond would be by shifting some research and headquarters expenses out of the U.S.

“It’s kind of dawning on everybody at about the same time that this is going to be an issue,” Jon Moeller, P&G ’s chief financial officer, said in an interview. “On the margin, it disincents local job creation.”

P&G is part of the Alliance for Competitive Taxation, a 40-company coalition that advocated international tax changes in 2017 and cheered the tax law’s passage. Now, the coalition is highlighting what it sees as flaws of the law’s minimum tax—using the same arguments about unlevel playing fields and disadvantages that companies once used to describe the old tax system.

According to a survey of alliance members, at least 60% have foreign tax rates above 13.125%, the level many of them thought would exempt them from U.S. taxes on foreign earnings. More than one-quarter have foreign tax rates at or above the new U.S. tax rate of 21%. Yet nearly all are paying the minimum tax, known as the Global Intangible Low-Taxed Income tax, or GILTI.

The new system’s incentives, while perhaps not favoring foreign investment as sharply as the old rules did, could encourage companies to put factories, research jobs and headquarters outside the U.S. That’s partly because arcane rules that Congress didn’t change in 2017 force some companies to count some domestic U.S. expenses toward foreign operations. These expense allocations shrink foreign tax credits that could otherwise be used to offset GILTI. To lower the tax, they could move the expenses out of the U.S.

Treasury officials have expressed openness to adjustments as they implement the law. They have already proposed some regulations that soften the law by limiting how much interest expenses get allocated to foreign income.

“That helped, but it didn’t kill the issue. The high-tax people are still somewhat screwed,” said Patrick Driessen, a former economist at the Joint Committee on Taxation.

To be sure, most U.S. multinational companies pay significantly lower overall taxes than they did under the old law. The new law’s centerpiece— cutting the corporate tax rate to 21% from 35%—put the U.S. closer to the middle of the pack internationally, reducing the benefits of shifting income to low-tax countries abroad.

But a core promise of 2017—the U.S. won’t impose its own taxes on top of substantial foreign taxes—has proven elusive.

Under the old system, U.S. companies owed the full 35% rate on world-wide earnings. They got tax credits for payments to foreign countries and didn’t pay the residual U.S. tax until they repatriated profits.

Those rules encouraged companies to push profits into low-tax countries and park them there, a strategy that was especially attractive for companies with profits from patents and trademarks that were easily shifted to low-tax countries. The old system also created incentives for inversions, deals where U.S. companies took foreign addresses and escaped some U.S. tax restrictions.

The new system was supposed to realign those incentives. Lawmakers wanted to exempt foreign income from U.S. taxes—but not all of it. The idea: If U.S. companies didn’t pay substantial foreign taxes and instead packed profits into low-tax jurisdictions like Bermuda or Ireland, they would face a backstop in a new minimum U.S. tax: GILTI.

Under GILTI, companies calculate their tangible foreign assets and don’t have to pay taxes on 10% of that total. Above that allowance, GILTI creates a 10.5% floor on what U.S. companies pay in foreign taxes and lets them get some foreign tax credits. If a company paid just 2.5% in foreign taxes, GILTI would effectively push its total to about 10.5%, creating a rough cap at half of the U.S. domestic tax rate.

“They’re continuing to get a very sweet deal,” Mr. Driessen said.

For companies with higher foreign tax rates, those operating in Europe and Asia with less mobile profits, the story is different. At the simplest level, companies paying at least 13.125% in foreign taxes theoretically shouldn’t pay GILTI at all.

But there is a wrinkle: When U.S. companies calculate their foreign tax credits, they have to follow rules designed to match the location of income and expenses. They must assign some domestic costs—such as research and development or interest on debt—to foreign income.

When domestic expenses are allocated abroad, a company’s foreign tax credits get limited. In the eyes of the U.S. tax system, that effectively pushes companies’ foreign tax rates below the 13.125% threshold, triggering GILTI taxes.

Consider a company with a 25% foreign tax rate, $10 million of foreign income and $1 million of domestic expenses that must be allocated to calculate the foreign tax credit. That company faces $210,000 in GILTI, beyond its $2.5 million in foreign taxes, according to an example being circulated by the Alliance for Competitive Taxation.

Congress left the expense allocation provisions in the law in part because eliminating them would have made the tax overhaul more expensive, pushing it above the $1.5 trillion tax-cut limit Republicans set. Companies point to a conference committee report suggesting no GILTI for companies with foreign rates above 13.125%, but that was a simplified example that ignored expense allocation. In effect, this tax was there all along.

United Technologies Corp. pays foreign taxes above 21%. With GILTI and those expense allocation rules intact, it faces a $120 million annual bill above that, said Akhil Johri, the CFO of the company, which is splitting into three parts. The Otis elevator business doesn’t get much benefit from the 10% allowance for tangible assets because it makes much of its money providing services. Otis operates in high-tax foreign countries, such as France and Japan. Because of GILTI, it could be more profitable if owned by a non-U.S. company.

“I would be jumping up and down with my CEO and saying we are not operating on a level playing field,” said Mr. Johri, describing what he would do if he were finance chief of Otis after the split is complete. “It would definitely make it a little easier for a foreign entity to make a play for a prized U.S. entity like Otis.”

Republicans such as Sen. Rob Portman (R., Ohio) are sympathetic to companies’ complaints and are working with the Treasury, but it is unlikely Congress will change anything in the law related to foreign income. That is in part because Democrats complain that the playing field is tilted the other way and that the foreign tax provisions keep corporate overseas taxes too low.

Sen. Sherrod Brown (D., Ohio) describes the 10.5% rate in GILTI as a huge discount from the 21% U.S. rate and an incentive for companies to earn profits outside the U.S. Rep. Lloyd Doggett (D., Texas) and Sen. Sheldon Whitehouse (D., R.I.) have introduced a bill to tax foreign and domestic income at the same rates.

“We’re definitely better off [after the tax law.] That is definitely true,” says P&G’s Mr. Moeller. “But remember. Everyone else is better off, too, including our foreign competitors. What matters in the long term is that relative position.”


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