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By Sony Kassam
Chevron Corp.'s tax team has been spending a lot of time understanding the consequences of the new U.S. tax code’s base erosion and anti-abuse tax—a “draconian provision,” according to the company’s tax head.
“The BEAT is a disaster,” said Charles N. (Sandy) Macfarlane, vice president and general tax counsel at the San Ramon, Calif.-based company.
“If you have NOLs, if you have ODLs, if you have foreign branch income covered by foreign tax credits, if you have GILTI that’s covered by foreign tax credits, you could be put in a situation where you have all that income subject to 10 percent tax,” he said.
Macfarlane referred to net operating losses, overall domestic losses, and “global intangible low-taxed income,” an income category created by the new tax law.
The BEAT is an additional tax on corporations with average annual gross receipts for the last three years of more than $500 million that make “base-eroding payments to related foreign persons” of 3 percent or more of their deductible expenses, or 2 percent for certain banks and securities dealers.
“We don’t want to be in a position where we’re over the three percent rate,” Macfarlane said Feb. 22 at a Houston conference organized by the U.S. branch of the International Fiscal Association.
If a company reaches the 3 percent, or 2 percent, threshold, “it isn’t the initial dollar BEAT payment that’s subject to tax, it’s the whole thing that’s subject to tax,” he said.
The BEAT also produces unpredictability because many foreign related-party payments aren’t base erosion payments, David P. Lewis, vice president of global taxes at Eli Lilly and Co. in Indianapolis, said.
The intent of the provision might have been “have those activities, for what you’re paying, in the U.S. rather than outside the United States,” Lewis said, speaking on a lunch program with Macfarlane.
But for a company like Lilly, where clinical trials are conducted all over the world, “it’s hard to conduct a clinical trial for a Japanese population group in the United States,” he said.
The company’s local affiliates coordinate the trials instead by hiring vendors who are then reimbursed by Lilly on a cost-plus basis. “That’s now a BEAT payment,” Lewis said.
The medical company will have to restructure that practice by having direct contracts even though there’s no base erosion going on, according to Lewis. This restructuring might introduce value-added taxes, he said.
Then there are other payments to consider. “Unfortunately, if your IP is held in the U.S., and you are doing work outside the U.S., you have to reimburse related parties,” Lewis said. “It’s not advantageous to hold it in the U.S., and I don’t think that was the intent in the legislation.”
Although the new tax law gave the U.S. biopharmaceutical industry a lower rate, access to foreign cash, retention of the R&D credit, and something of level playing field, it left uncertainty embedded in the tax code, Lewis said.
“It’s because we still have to play the game,” he said. “We still have to be on the Hill. We still have to be working on sustaining tax reform in a manner that keeps U.S. companies competitive.”
Still, the new law did level the playing field somewhat, Lewis said.
Before, U.S. companies had effective tax rates in the low 20s, while foreign competitors had effective rates in the low teens.
Foreign competitors “had access to their cash, we didn’t,” Lewis said. “And so they had more money to spend, and they could use it around the world more easily.”
But with the new tax code, “all of us have reported for 2018 lower forecasted effective tax rates than what we otherwise were predicting under the old system, and they are more in line with the effective tax rates reported by foreign competition,” Lewis said. “So I would say check on the level playing field.”
The complexities of the new tax law have also propelled companies to rethink their internal operations and change old ways of tax planning.
“All of the instincts that you have built up over your career about ‘what do I want to do about this, what do I want to do about that,’ we’re at the pitfalls,” Macfarlane said. “You’ve gotta rethink all that, and so you’re really kind of retraining your brain.”
Macfarlane and Lewis said their tax teams spent countless hours before the new year trying to understand the implications and rules of the new law.
Chevron recognized that it will have to focus on collecting all of its financial data and information—a time-consuming task.
“Your financial systems are not always so flexible that you can, you know, you just hit F6 and the GILTI comes up on your computer screen,” Macfarlane said to audience laughter. “You have to figure this all out. So that’s something we’re working on for the first quarter, and obviously it will continue for the rest of the year and as long as we have the law in place.”
Meanwhile, Lilly has designated experts on its teams for specific provisions. Focal points include the BEAT, GILTI, and expense interest deductions. This way, it’s easier to get management, clients, and team members up to speed on the new law, Lewis said.
State reaction to the new tax system is important to consider, Lewis said.
With a new 21 percent corporate tax rate, he said, if he were a state leader he “would be asking how do I distinguish my state versus the 50 states, because the U.S. will now be looked at more for investment by both foreign-owned companies and domestic companies.”
Further, California’s legislature has a bill to raise the franchise tax rate by 10 percentage points, Macfarlane said, “on the theory that, ‘You have a big federal tax cut, you can afford it.’ So we could see more of this sort of thing.”
Overall, Lewis said, the “three buckets” to watch for in tax are: the need for technical guidance and correction; how midterm election outcomes or the built-in changes in the code affect substantive issues; and whether consumption taxes are next.
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