An earlier post linked to today’s FT piece on inversions and other tax strategies. The following is an amended comment to that post.
Ebay’s 8-K SEC filing made yesterday for Q1 2014 has some interesting outcomes that are related to some of the issues covered by the FT. The form is available here but all you really need is:
Non-GAAP earnings increased 11%, to $899 million or $0.70 per diluted share, over the prior year, driven by strong top line growth. A first quarter GAAP loss of ($2.3) billion or ($1.82) per diluted share, was due to a discrete tax charge of approximately $3.0 billion.
From the income statement it can be seen that Ebay’s effective tax rate for Q1 2014 was:
($3,199mn/$873mn) x 100 = 366%
The $3 billion discrete tax charge was primarily because Ebay now intends to repatriate to the US around $9 billion of profits that were previously held ‘offshore’. EBay probably used versions of the ‘double-irish’ tax strategy to trigger a deferral of the US corporate income tax liability using subsidiaries in Luxembourg and/or Switzerland.
Tax payments such as this $3 billion will never appear in US BEA data on direct investment abroad by US MNCs as the tax payment is made by the US parent not the foreign subsidiary. The US BEA data only gives the corporate income tax paid by the subsidiaries outside the US. Under the current international tax regime most of the corporate income tax owed by these companies is owed on risks, assets and functions that are in the US (though the US offers extensive deferral provisions). Effective tax rates based on this BEA data are a poor indicator of the actual tax rates as the US tax liability is not included.
This Ebay example is what is supposed to happen with tax deferral provisions such as the ’same-country exemption’ (which allows ‘double-irish’ type structures to work). Ebay could invest the money abroad free of making a US tax payment. Alternatively it could choose to repatriate the profits to the US and the US corporate income tax payment up to the 35 per cent federal rate becomes due. This seems to be a case of this happening.
Apple with around $150 billion of retained earnings are going to return money to shareholders through a massive share buy-back but instead of repatriating offshore profits to do it are going to issue bonds to borrow the funds. If Apple does this outside the US it can ‘invest’ its retained earnings by repaying the bonds and the deferred US tax will not be paid.
Pfizer with $70 billion of retained earnings are going to use the money to buy AstraZeneca. This is fine from a US perspective and is what the deferral provisions are designed for – giving US companies interest-free loans to allow them to increase their non-US presence. The inversion to the UK that will come with the acquisition is not what the US wants and completely removes not only the retained earnings but the entire company from the US system.
The FT piece somewhat conflates the impact of inversions and the use of ‘double-irish’ type tax structures. If a company inverts and re-headquarters to Ireland or the UK or any country it no can longer avail of the key benefits of a ‘double-irish’ scheme. It can have the same corporate structure but the purpose of the ‘double-irish’ is to defer US corporate income tax by utilising the “same-country exemption” in Subpart F of the US tax code. Under the “same-country exemption” passive income payments between two companies in the same country are not subject to the general anti-deferral provisions of Subpart F.
If a US company re-headquarters it is no longer a US company and therefore no longer subject to US corporate income tax on its global profits. The “same-country exemption” becomes irrelevant as it only applies to US companies.
The piece says the ‘double-irish’ “allows royalties paid by the Irish manufacturing subsidiary to end up in a company that is not taxable under either Irish or US rules.” That is not correct. The royalties are taxable under US rules but the ‘double-irish’ creates a deferral of the actual payment using US tax provisions until the profit is repatriated to the US. In the case of Ebay we can see this repatriation and the triggering of the tax payment happening.
The US is more likely to act against the inversions than the deferral provisions. But even getting consensus on that may be difficult as Republicans will argue the inversions highlight problems with the US tax code and that it is the overall code which should be changed not the addition of roadblocks against inversions – the biggest of which seem to be to the UK not Ireland.
Finally, whatever is left of Pfizer’s retained earnings of $70 billion after the AstraZeneca acquisition will likely have a large once-off impact on UK GNP if the inversion does go ahead.
