The profit-shifters boosted by US tax reform
Multinational companies’ practice of booking profits in low-tax jurisdictions like Bermuda to avoid high corporate taxes elsewhere may become more lucrative as a result of the US tax reform.
That was the finding of a Reuters report that highlighted pharmaceutical giant AbbVie’s use of Bermuda as home for most of the patents for its bestselling drug, Humira.
Before the US reform, backed by Republicans including President Donald Trump and enacted at the end of last year, companies like AbbVie had to pay 35 per cent on profits they brought home from abroad.
Under the new rules, the overall corporate tax rate has been slashed to 21 per cent, and income from overseas is taxed at a much lower rate, as low as 10 per cent.
The change to a territorial tax system means that only profits of US subsidiaries are subject to US tax at the full rate.
Richard Gonzalez, AbbVie’s chief executive officer, told investors earlier this year that the Lake Bluff, Illinois-based drugmaker expected its tax rate to fall to 9 per cent from around 22 per cent in recent years.
Many other companies who use this similar profit-shifting strategy, known as transfer pricing, will benefit similarly — despite the stated intention of the authors of the Tax Cuts and Jobs Act to dissuade companies from shifting profits from US sales overseas.
Transfer pricing is particularly popular with drugmakers. Typically it involves patents for drugs being owned by a subsidiary in a low-tax or no-tax domicile. Then royalty fees are paid to the subsidiary from other divisions of the company generating sales elsewhere.
Among companies that have been highlighted in international media for using Bermuda in a similar fashion are Google, Forest Laboratories and Nike.
While the island’s international reputation is damaged by this type of tax avoidance, Bermuda gains no taxes from it and usually the subsidiaries based here employ no one.
Bob Richards, the former finance minister, in his February 2017 budget, singled out international companies without a physical presence for a hefty permit fee increase — from $1,995 to $25,000 — and signalled that the island did not place a high value on them.
As MPs backed the legislation in the House of Assembly, Mr Richards said it was expected that some companies would “pack up and leave”. He added: “Those that really want to be here are going to have to pay. Those that don’t — see you later.”
Reuters said its analysed 88 of the patents for Humira, a drug used for the treatment of rheumatoid arthritis, and found that two-thirds of those patents were assigned to the Bermuda subsidiary, AbbVie Biotechnology Ltd, which was incorporated in 2001 and whose registered address is Clarendon House in Church Street, Hamilton.
Most of those patents were developed by teams of researchers entirely or somewhat based in the US, according to details in patent filings.
Reuven Avi-Yonah, director of the International Tax at the University of Michigan Law School, told Reuters: “This is the blueprint. The illusion that you would see more patents kept in the US [under the new tax law] is unreal as long as there are places you can keep them offshore where you pay zero.”
Despite recording more than half its $28.2 billion in 2017 sales in the US and basing most of its research facilities there, the company has never reported a profit in its home country.
In 2017, AbbVie reported foreign earnings before income tax of $10.4 billion on international revenue of only $9.97 billion. Yet, between 2013 and 2016 AbbVie had to pay around $1 billion a year of taxes in the US, when it took the profits reported by foreign subsidiaries home to help cover expenses from its US operations.
Democrats in the US Congress are looking at how the new tax law actually encourages companies to use patents to shift profits overseas. Ron Wyden, an Oregon senator, plans to publish a report later in the summer that will partly refer to this issue.
“The US shouldn’t get suckered into a race to the bottom with a bunch of no-tax, resort-lined islands to please the tax avoidance industry and their lobbyists,” Sen Wyden, who is the Senate Finance Committee Ranking Member, said.
Other US companies likely to benefit from the territorial tax system include Pfizer, Expedia Group, Boston Scientific, Synopsys and Microsoft.
Reuters reported that Microsoft and Synopsys have both experienced eight-year runs of reporting around half their sales in the US but less than a quarter of their profits there.
The Tax Cuts and Jobs Act did include anti-tax avoidance measures. For example, the new Global Intangible Low Tax Income provision, if a company generates untaxed profits in a low-tax jurisdiction, it will be liable to have that profit taxed as though it arose in the US.
However, the effective tax rate that will apply is half the US tax rate of 21 per cent, or 10.5 per cent. And if a company reports a loss in the US, this can be set against the Gilti provision, potentially reducing the tax liability further.