[ed. See also: Pfizer takeover: what is a tax inversion deal and why are they so controversial?]
Pfizer’s proposed merger with Allergan is a blockbuster deal in the pharmaceutical industry. History may remember the deal instead for finally killing off the United States’ outdated approach to taxing multinational corporations.
Pfizer will shed its identity as a United States corporation in the deal, notwithstanding the fact that it, not Allergan, is the larger merger partner. Allergan itself is an expatriate; it is nominally based in Ireland, but the bulk of its operations are still in Parsippany, N.J.
Our tax system is premised on taxing United States-based multinational corporations on 35 percent of worldwide income, with a credit for foreign taxes paid. This “worldwide” approach is often identified as anachronistic; most of our global trading partners have adopted some form of a “territorial” approach.
In theory, there’s not anything wrong with taxing American corporations on their worldwide income. The most vexing problem of international tax — trying to figure out the source of income within a multinational operation — would only be exacerbated by a territorial approach.
In practice, our approach has been a failure. One problem is that we allow the deferral of foreign-source income: the profits of foreign subsidiaries are not generally subject to United States tax until “repatriated” in the form of a dividend. Thus, to minimize taxes, multinationals use transfer pricing, cost sharing and other tax planning techniques to shift as much income as possible overseas.
Pfizer mastered this game early on, and its expertise in tax-shifting continues today. For example, Pfizer takes in about 40 percent of its revenue from sales in the United States and 60 percent from foreign sales. Yet, according to its 2014 annual report, Pfizer had about $17 billion in pretax income from overseas, and almost a $5 billion pretax loss here in the United States. By shifting profits overseas, Pfizer pays relatively low cash taxes compared with the nominal United States tax rate of 35 percent. Instead, much of its American tax liability is illusory, taking the form of an obligation to pay taxes in the future if it repatriates cash to the United States.
As of the end of 2014, Pfizer had $74 billion of foreign earnings “indefinitely reinvested” overseas, and another $63 billion in foreign earnings that have not been indefinitely reinvested. Repatriating $137 billion in earnings would generate a United States tax liability of about $48 billion.
Pfizer’s deal means that the United States will never see that $48 billion in tax revenue.
This isn’t Pfizer’s first visit to the circus. In 2004, Pfizer successfully lobbied Congress for a tax holiday. The American Jobs Creation Act of 2004 temporarily allowed companies to bring back foreign earnings at a tax rate of only about 5 percent instead of the usual 35 percent. Pfizer brought back $37 billion, paying less than $2 billion in taxes.
Just 11 years after cleaning out its overseas coffers, Pfizer now finds itself with $137 billion of new earnings “trapped” overseas.
Pfizer’s proposed merger with Allergan is a blockbuster deal in the pharmaceutical industry. History may remember the deal instead for finally killing off the United States’ outdated approach to taxing multinational corporations.
Pfizer will shed its identity as a United States corporation in the deal, notwithstanding the fact that it, not Allergan, is the larger merger partner. Allergan itself is an expatriate; it is nominally based in Ireland, but the bulk of its operations are still in Parsippany, N.J.Our tax system is premised on taxing United States-based multinational corporations on 35 percent of worldwide income, with a credit for foreign taxes paid. This “worldwide” approach is often identified as anachronistic; most of our global trading partners have adopted some form of a “territorial” approach.
In theory, there’s not anything wrong with taxing American corporations on their worldwide income. The most vexing problem of international tax — trying to figure out the source of income within a multinational operation — would only be exacerbated by a territorial approach.
In practice, our approach has been a failure. One problem is that we allow the deferral of foreign-source income: the profits of foreign subsidiaries are not generally subject to United States tax until “repatriated” in the form of a dividend. Thus, to minimize taxes, multinationals use transfer pricing, cost sharing and other tax planning techniques to shift as much income as possible overseas.
Pfizer mastered this game early on, and its expertise in tax-shifting continues today. For example, Pfizer takes in about 40 percent of its revenue from sales in the United States and 60 percent from foreign sales. Yet, according to its 2014 annual report, Pfizer had about $17 billion in pretax income from overseas, and almost a $5 billion pretax loss here in the United States. By shifting profits overseas, Pfizer pays relatively low cash taxes compared with the nominal United States tax rate of 35 percent. Instead, much of its American tax liability is illusory, taking the form of an obligation to pay taxes in the future if it repatriates cash to the United States.
As of the end of 2014, Pfizer had $74 billion of foreign earnings “indefinitely reinvested” overseas, and another $63 billion in foreign earnings that have not been indefinitely reinvested. Repatriating $137 billion in earnings would generate a United States tax liability of about $48 billion.
Pfizer’s deal means that the United States will never see that $48 billion in tax revenue.
This isn’t Pfizer’s first visit to the circus. In 2004, Pfizer successfully lobbied Congress for a tax holiday. The American Jobs Creation Act of 2004 temporarily allowed companies to bring back foreign earnings at a tax rate of only about 5 percent instead of the usual 35 percent. Pfizer brought back $37 billion, paying less than $2 billion in taxes.
Just 11 years after cleaning out its overseas coffers, Pfizer now finds itself with $137 billion of new earnings “trapped” overseas.
by Victor Fleischer, NY Times/Dealbook | Read more:
Image: Mark Lennihan, Richmond Times-Dispatch
