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Four industries—technology, pharmaceutical, manufacturing, and banking and financial services—are among those that could lose foreign credits and other tax benefits under a new tax on income from intangible assets, like patents and trademarks, and other kinds of assets overseas.
The tax on global intangible low-taxed income (GILTI) is one of several provisions in the 2017 tax act (Pub. L. No. 115-97) intended to prevent revenue from draining out of the U.S. The provision hits companies with lots of overseas assets—and shareholders of those companies—with taxes on a broad range of assets, in both high- and low-tax jurisdictions.
And that’s the rub across these four industries, practitioners and groups told Bloomberg Tax: The law’s definition of assets subject to the GILTI provision is so wide that it affects far more than only technology and pharmaceutical companies, which historically have large amounts of intangible assets in jurisdictions where they don’t pay much tax.
The tax law can also take away the benefits of some types of corporate planning that manufacturing and financial services companies were able to use to lower their taxes in high-tax jurisdictions.
GILTI of a U.S. shareholder of a controlled foreign corporation (CFC) is generally the U.S. shareholder’s net income from all CFCs, less a 10 percent deemed return on tangible property. If GILTI isn’t already taxed at a rate of at least 13-1/8 percent overseas, it faces a 10.5 minimum tax.
Technology and pharmaceutical companies would be the most obvious ones to fit the bill of having assets in low-tax jurisdictions, according to John Bates, a partner at Baker & Hostetler LLP in Washington, but other industries with complicated overseas dealings are likely to feel the pinch too.
A major worry across the spectrum is the potential loss of foreign tax credits that can be used to offset GILTI taxes, and the way that expenses will be allocated in calculating those credits. Treasury officials have said at recent events they are aware of foreign tax credit issues raised by the new international tax regime, but didn’t specifically mention GILTI.
Here’s how GILTI creates concerns about higher taxes and fewer foreign credits across four industries, practitioners and industry representatives told Bloomberg Tax.
U.S.-based global manufacturer Illinois Tool Works Inc., a Fortune 500 company, wrote to the Internal Revenue Service asking that some types of indirect expenses not be pulled into the definition of GILTI.
One of those expenses is the cost of stewardship—the job of supervising or taking care of something, such as an organization or property—the company said in a letter the IRS released April 10 under the Freedom of Information Act. That’s a key cost in the manufacturing industry.
The industry is talking with the Treasury Department about foreign tax credit and expense allocation issues in potential regulations to implement the statute, a tax specialist in the manufacturing industry told Bloomberg Tax. The source requested anonymity because of those ongoing discussions .
According to Gregory Kidder, a partner with Steptoe & Johnson LLP in Washington, one overseas planning structure that could raise issues in the manufacturing world involves companies set up to manage international supply chains.
Those companies are set up to facilitate worldwide production of tangible assets in lower-tax jurisdictions. The assets could be pulled into the definition of GILTI by the broad reach of the statute, and if companies generate “high-value returns” from those assets, GILTI taxes could arise.
John Kinsella, vice president of tax policy for the American Bankers Association in Washington, said financial institutions—which have “way, way more intangible assets than a lot of other companies"—are moving cautiously and carefully running numbers.
While not all financial institutions would see the same impacts from GILTI, large international banks could end up paying a lot, he said. “This could be a big deal for some of our members.”
Banks’ intangible assets include credit card customer relationships and computer software.
Kinsella raised an example of a U.S. multinational bank that has significant foreign activities leading to foreign income. Under the new post-reform tax regime, the income would be subject to GILTI. The new tax takes away the benefit of U.S. “tax attributes"— such as significant tax credits or losses—that once could have been used to offset that income and lower the bank’s effective tax rate.
Morgan Stanley, one of the biggest U.S. multinational financial services companies, said in its most recent financial filing that it was concerned about potential adverse impacts from GILTI, along with other tax base erosion provisions in the 2017 tax act.
A tax specialist in the securities sector said GILTI is hard on U.S.-headquartered financial services companies that, by their nature, must do business in high-tax foreign jurisdictions and pay lots of foreign tax already. The companies need to have bank capital in place in these jurisdictions, he said. Historically, they get a tax break for activity outside the U.S. that requires such capital, but the way the GILTI statute is worded, that tax break goes away.
The source requested anonymity because of the securities industry’s ongoing discussions with the Treasury Department on regulations to implement the law.
Technology sector winners and losers aren’t yet clear. Microsoft Corp. said in an April 26 filing that it recorded an estimated $454 million benefit in the second quarter of fiscal year 2018 related to GILTI, but Apple Inc. and Hewlett Packard Enterprise Co. didn’t mention GILTI in their most recent filings.
The sector is monitoring GILTI closely, said Alex Burgos, vice president of federal policy, government relations, and communications for TechNet, one of the largest industry groups.
“GILTI is very important to the tech industry as a whole, some companies more than others, depending on what kind of intangible assets they have offshore,” Burgos said in an interview. “The challenge for us and the industry is to make sure that any rulemaking properly implements the statute. This is something our companies are trying to work through.”
Burgos said companies that are calendar-year taxpayers “are farther along in trying to address this.”
Dentons partner John Harrington, chairman of the Bloomberg Tax International Advisory Board, said technology companies have often been able to structure their operations to avoid a “Subpart F” tax on foreign income and negotiate tax holidays and other incentives for locating in a foreign country— planning put in jeopardy under GILTI.
Because GILTI has such a broad reach across so many types of foreign income, it can negate the types of planning taxpayers once did to avoid tax on that income. GILTI is imposed regardless of what incentives may be offered by other countries, making attempts to structure around the new tax via international tax help difficult.
U.S. multinational companies have generally been able to defer taxes on their foreign income until that income is brought back to the U.S. in the form of dividends. Subpart F, part of the tax code for years, establishes what’s known as an “anti-deferral” regime for certain categories of foreign income.
GILTI is expected to have an especially tough impact on the pharmaceutical industry, where U.S. multinational companies rely heavily on the use of intellectual property in manufacturing and selling their products, Harrington said.
Certain IP, such as patents, trademarks, and trade names, can be transferred to and held by an IP holding company that licenses the IP to members of the group that need it.
This approach can reduce the group’s overall tax liability if the IP holding company is in a low-tax jurisdiction while the companies using the IP are in high-tax jurisdictions.
The structure works because the group is able to deduct what it pays for the licenses in the high-tax jurisdictions where the operating companies are located, Harrington said. At the same time, it increases income in the low-taxed jurisdiction where the IP holding company is located.
Although it isn’t easy, Harrington said, until the new tax law created GILTI, companies could set up these structures without subjecting the income of the low-taxed IP holding company to Subpart F tax. “Now, that low-taxed income will be subject to GILTI, and so the U.S. tax costs of the structure just went up,” he said.
That could hit drug companies hard, he said.
In a May 1 filing, Johnson & Johnson said GILTI increased its worldwide effective tax rate by 2.6 percent in the first quarter of 2018.
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