This is going to be a long post on my experience with the recent tax reform.
I work in finance for a small global company and needed to understand how the tax reform legislation would affect us. I read the all high status financial press, but the information provided was very low quality for my needs. I found that one big 4 firm and two law firms had good quality material online that gave me the information I needed to have productive discussions with our accounting firm and make informed decisions for our company.
Between my research online and the need to explain things to the boss, owners and other stakeholders, I began to see one of the biggest impacts of the tax reform was the destruction of tax shelters used by many US tech companies. Now, here is a claim I am less certain about: some firms have been and will be net losers by their use of creative tax strategies in the past. I expected to see this idea expressed more widely or at least investigated. (...)
This is not about whether the tax reform was good or bad. It’s about what it means to a good chunk of the corporate world, mainly, but not entirely tech companies.
Imagine a thousand tall towers all collapsing simultaneously. Imagine the noise, the pain, the horror of incomprehension, seeing dimly through the dust, ears ringing. That’s what was felt by a subset of tax lawyers, CFOs, CEOs and accounting firms all around the world. The US tax reform did have an impact on individuals, sure, but It was also about blowing up an enormous edifice of tax avoidance. There may not be many of us, but I feel this has been largely overlooked in the media.
For many years, companies have been placing their IP, booking their sales and paying themselves transfer prices to low tax jurisdictions to avoid US taxes. And yet all this was and is illegal unless:
1) There was a real underlying business purpose to it.
2) The business purpose was not merely to reduce taxes.
Sometimes only the thinnest veneer of business purpose was invoked. Then you would get a law firm to write an Opinion Letter which said what you were doing was legal because reasons and you could rely on this Opinion Letter to stay out of jail. Nevertheless, setting up the correct legal framework to avoid taxes was expensive. (A few years ago someone quoted me a price of about $2million to set up something like that for where I worked. I never did it though.)
And now none of this tax strategy works. It’s all over.
US corporate tax at 35% was among the highest in the world, even though effective rates were lower due to tax strategies. The high rate encouraged tax avoidance strategies, that for many companies was borderline (ref. the trouble Caterpillar is in now), and also had significant costs. This incentivized spending that had no real productive purpose. And it encouraged inversions, i.e. moving corporate headquarters out of the US into another tax jurisdiction.
The US also had a weird worldwide system where all a company’s income was taxed together. However, if a foreign subsidiary of a US company kept their profits, those profits were not taxed. The rules here were complex. To highly simplify, if a company kept their foreign profits overseas they would not pay US tax on those profits. The dominant tax avoidance strategy used by US companies involved creating profits in foreign subsidiaries, creatively.
The thing is, these shelters often don’t last forever. Major tax reforms don’t happen often, but they do clear out many abusive shelters.
As a historical example, do you recall seeing video of buildings in Grand Cayman where there are literally thousands of companies registered there? That was the great tax evasion effort of a couple generations ago. Then the application of the rules 1) & 2) destroyed that tax strategy. Corporations could not point to an underlying business reason to have their investment portfolios domiciled in Grand Cayman as opposed to anywhere else. There have been many other geographically based tax avoidance strategies that were eventually blown up by European or US regulators, e.g. Jersey Islands, Malta, Cyprus. And others.
Caterpillar put a formal sales office in Geneva. Many others created profits in Ireland where they had a 12% tax to domicile their IP. Other countries were used as well. These countries had a lower tax rate than the US 35% and as long as they didn’t repatriate profits technically, they had no US tax, even though the US was, in theory taxing all profits worldwide at 35%. These companies’ foreign subsidiaries creatively created foreign profits could then be deposited in a US bank, which could be used as collateral for the parent company. Eventually, this tax avoidance strategy started to become embarrassing to US authorities. (...)
Back to US corporate tax. A lot of companies were able to get their effective tax rates down into the low teens. Using the embarrassing strategy I described. The CBO estimated the average marginal rate was 18.6%, others have estimated more like 27%, the truth is nobody really knows.
With the recent tax reform the corporate rate was reduced to 21% from 35%. Kinda average for the developed world, but fabulous for domestic companies that didn’t have good tax strategies available to them.
With the recent tax reform companies have to pay tax, 15.5% on all the profits they previously sheltered from US tax (8% if you invested in real property). That’s why you see stories of companies like Apple paying $38 billion dollars in tax from prior profits of foreign subsidiaries.
And the expensive tax shelters they set up have to keep running. They can’t just shut them down because of 1) and 2) above. If they did just shut them down, it would be close to an admission of guilt for tax fraud. I find this both weird and sort of beautiful.
There has been some bad journalism about this, even in the high status financial press.
Several stories about corporate quarterly earnings calls have featured CEOs explaining that their effective tax rates are going UP, even though the tax rate was lowered, because specific shelters don’t work anymore. Then a journalist asks something like, “so will you shut down the operation in Ireland?” The CEO responds, “No, Ireland is an important part of our business.” The stories never note that the CEO has to say that or the CEO would be almost admitting to fraud.
Eventually, the tax strategies that are now an expensive waste, can be unwound. You have to let enough time go by to let them get “old and cold.” After a couple/three years a company can simply be assumed to be changing business strategy.
by mrjeremyfade, Commenter, Slate Star Codex | Read more:
I work in finance for a small global company and needed to understand how the tax reform legislation would affect us. I read the all high status financial press, but the information provided was very low quality for my needs. I found that one big 4 firm and two law firms had good quality material online that gave me the information I needed to have productive discussions with our accounting firm and make informed decisions for our company.
Between my research online and the need to explain things to the boss, owners and other stakeholders, I began to see one of the biggest impacts of the tax reform was the destruction of tax shelters used by many US tech companies. Now, here is a claim I am less certain about: some firms have been and will be net losers by their use of creative tax strategies in the past. I expected to see this idea expressed more widely or at least investigated. (...)
This is not about whether the tax reform was good or bad. It’s about what it means to a good chunk of the corporate world, mainly, but not entirely tech companies.
Imagine a thousand tall towers all collapsing simultaneously. Imagine the noise, the pain, the horror of incomprehension, seeing dimly through the dust, ears ringing. That’s what was felt by a subset of tax lawyers, CFOs, CEOs and accounting firms all around the world. The US tax reform did have an impact on individuals, sure, but It was also about blowing up an enormous edifice of tax avoidance. There may not be many of us, but I feel this has been largely overlooked in the media.
For many years, companies have been placing their IP, booking their sales and paying themselves transfer prices to low tax jurisdictions to avoid US taxes. And yet all this was and is illegal unless:
1) There was a real underlying business purpose to it.
2) The business purpose was not merely to reduce taxes.
Sometimes only the thinnest veneer of business purpose was invoked. Then you would get a law firm to write an Opinion Letter which said what you were doing was legal because reasons and you could rely on this Opinion Letter to stay out of jail. Nevertheless, setting up the correct legal framework to avoid taxes was expensive. (A few years ago someone quoted me a price of about $2million to set up something like that for where I worked. I never did it though.)
And now none of this tax strategy works. It’s all over.
US corporate tax at 35% was among the highest in the world, even though effective rates were lower due to tax strategies. The high rate encouraged tax avoidance strategies, that for many companies was borderline (ref. the trouble Caterpillar is in now), and also had significant costs. This incentivized spending that had no real productive purpose. And it encouraged inversions, i.e. moving corporate headquarters out of the US into another tax jurisdiction.
The US also had a weird worldwide system where all a company’s income was taxed together. However, if a foreign subsidiary of a US company kept their profits, those profits were not taxed. The rules here were complex. To highly simplify, if a company kept their foreign profits overseas they would not pay US tax on those profits. The dominant tax avoidance strategy used by US companies involved creating profits in foreign subsidiaries, creatively.
The thing is, these shelters often don’t last forever. Major tax reforms don’t happen often, but they do clear out many abusive shelters.
As a historical example, do you recall seeing video of buildings in Grand Cayman where there are literally thousands of companies registered there? That was the great tax evasion effort of a couple generations ago. Then the application of the rules 1) & 2) destroyed that tax strategy. Corporations could not point to an underlying business reason to have their investment portfolios domiciled in Grand Cayman as opposed to anywhere else. There have been many other geographically based tax avoidance strategies that were eventually blown up by European or US regulators, e.g. Jersey Islands, Malta, Cyprus. And others.
Caterpillar put a formal sales office in Geneva. Many others created profits in Ireland where they had a 12% tax to domicile their IP. Other countries were used as well. These countries had a lower tax rate than the US 35% and as long as they didn’t repatriate profits technically, they had no US tax, even though the US was, in theory taxing all profits worldwide at 35%. These companies’ foreign subsidiaries creatively created foreign profits could then be deposited in a US bank, which could be used as collateral for the parent company. Eventually, this tax avoidance strategy started to become embarrassing to US authorities. (...)
Back to US corporate tax. A lot of companies were able to get their effective tax rates down into the low teens. Using the embarrassing strategy I described. The CBO estimated the average marginal rate was 18.6%, others have estimated more like 27%, the truth is nobody really knows.
With the recent tax reform the corporate rate was reduced to 21% from 35%. Kinda average for the developed world, but fabulous for domestic companies that didn’t have good tax strategies available to them.
With the recent tax reform companies have to pay tax, 15.5% on all the profits they previously sheltered from US tax (8% if you invested in real property). That’s why you see stories of companies like Apple paying $38 billion dollars in tax from prior profits of foreign subsidiaries.
And the expensive tax shelters they set up have to keep running. They can’t just shut them down because of 1) and 2) above. If they did just shut them down, it would be close to an admission of guilt for tax fraud. I find this both weird and sort of beautiful.
There has been some bad journalism about this, even in the high status financial press.
Several stories about corporate quarterly earnings calls have featured CEOs explaining that their effective tax rates are going UP, even though the tax rate was lowered, because specific shelters don’t work anymore. Then a journalist asks something like, “so will you shut down the operation in Ireland?” The CEO responds, “No, Ireland is an important part of our business.” The stories never note that the CEO has to say that or the CEO would be almost admitting to fraud.
Eventually, the tax strategies that are now an expensive waste, can be unwound. You have to let enough time go by to let them get “old and cold.” After a couple/three years a company can simply be assumed to be changing business strategy.
