The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, dramatically changed the tax landscape. One of the most significant changes is the overall effect of the new international provisions, which reflect a shift from the worldwide system of taxation to a modified territorial system. Coupled with the corporate tax cut enacted in the TCJA, the shift to a territorial system was, according to some, "in part designed to help dissuade U.S. companies from moving profits overseas, [but it] may instead make the practice a lot more rewarding" (Erman and Bergin, "How U.S. Tax Reform Rewards Companies That Shift Profit to Tax Havens," Reuters (June 18, 2018).
Generally, U.S. citizens, resident individuals, and domestic corporations are taxed on all income, whether earned in the United States or abroad, under pre-TCJA law. This method is called a worldwide system of taxation. Foreign income earned by a foreign subsidiary of a U.S. corporation generally was not subject to U.S. tax until the income was distributed as a dividend to the U.S. corporation.
The TCJA adopted a new territorial system of taxation, which is also known as a participation exemption system. Under the new law, the U.S. taxes on income earned outside the United States by U.S. C corporations are eliminated or reduced. If a C corporation owns 10% or more of a foreign corporation that pays a dividend, then the C corporation receives a 100% dividends-received deduction for the foreign-source portion of the dividend income (Sec. 245A).
Furthermore, a U.S. shareholder of any controlled foreign corporation must include in its gross income for a tax year its global intangible low-taxed income (GILTI) in a manner generally similar to inclusions of Subpart F income (Sec. 951A(b)). Under the new GILTI provision, if a company generates untaxed profits in a tax haven, it will be liable to have that profit taxed as though it arose in the United States. The GILTI U.S. effective tax rate in 2018 is 10.5%. As such, the U.S. tax imposed on the dividends is eliminated or reduced.
Case and analysis
A U.S. corporation previously had to pay U.S. taxes on the profits from overseas at the rate of 35% when the profits were distributed to the U.S. corporation. Under the new law, the taxes on dividends from the foreign corporation may be eliminated or reduced. In addition, the overall corporate tax rate was reduced to 21% effective Jan. 1, 2018. It seems that the new law should provide an incentive for U.S. corporations to keep profits in the United States.
As reported by Reuters, AbbVie Inc.'s CEO Richard Gonzalez told investors earlier this year that the U.S. drugmaker expects its overall effective tax rate to drop from 22% in recent years to 9% this year. The reason is that only profits reported by domestic subsidiaries are subject to U.S. taxes.
AbbVie is a research-based pharmaceutical manufacturing company based in the United States. Based on Reuters research, AbbVie assigned the majority of the company's patents to its Bermuda subsidiary, AbbVie Biotechnology Ltd. (Bermuda does not tax corporate profits.) According to the Reuters article, AbbVie has the subsidiary hold the patents to protect the corporation's intellectual property. Most of those patents were developed by teams of researchers entirely or somewhat based in the United States, according to details in patent filings. As such, AbbVie pays its subsidiary AbbVie Biotechnology Ltd. royalty fees for the right to use the patents. This is how AbbVie uses patents to shift profits overseas.
Regarding its U.S. operations, AbbVie has a substantial amount of operating expenses, including $1 billion a year in interest charges, over $50 million in compensation for its top five executives, and research and development costs. In 2017, over half of the U.S. operation's sales of $28.2 billion were in the United States. However, it has never reported net income in its home country based on its annual reports. According to Reuters, AbbVie "took the profits reported by foreign subsidiaries" to the United States "to help cover expenses from its U.S. operations."
AbbVie is not the only U.S. company with relatively little income in the United States but with big operations in the United States. Based on Reuters's article, Pfizer Inc., Expedia Group Inc., Boston Scientific Corp., Synopsys Inc., and Microsoft Corp. follow the same tax strategy.
To move the United States toward a modified territorial system, Congress attached the GILTI provision to the TCJA. However, the effective tax rate of GILTI is only 10.5% in 2018. In addition, if a company reports a net loss, this can reduce its tax liability. As a result, a company probably has more tax benefits if it keeps its profits overseas.
The authors of the tax legislation said that the TCJA would discourage the shifting of profits earned in the United States, according to the Reuters article. But the principal anti-tax-avoidance measures introduced still allow companies to benefit from profit shifting. There might be more patents kept in foreign counties as long as the country of choice has a low enough tax rate.
Mark G. Cook, CPA, CGMA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or firstname.lastname@example.org.
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