Pfizer and Apple's effective tax rates misleading fictions
Pfizer and Apple's published US effective tax rates are fictions which give a false impression of the tax payments that they make to the US Internal Revenue Service (IRS).
These fictions give Republican Party consiglieri in the US Congress and outside advocates of a tax amnesty and lower corporate rates for big business, an apparently compelling argument that US firms are forced to pay much higher taxes than their foreign competitors.
Neither companies generally or the IRS disclose the amounts that they actually pay each year in taxes, which is typically lower for US companies with international operations than they report annually as effective tax rates in their Form 10-K filing with the US Securities and Exchange Commission (SEC) — the effective rate is the ratio of the provision for income taxes (corporate taxes outside US) to the income total before taxes in the Statement of Operations / Profit and Loss Account.
Pfizer, founded by German immigrants in Brooklyn, New York in 1849, is in the news this week after its announcement Monday that Allergan, a smaller nominally Irish company but in reality American, would purchase the drugs giant — this was also a fiction to enable Pfizer to become an Irish company and avail of Ireland's lower tax rate. It is known as a tax inversion in the US.
Ian Read, the Scottish chartered accountant who is CEO of Pfizer, was unsuccessful in making the company British, when the takeover attempt of AstraZeneca failed in 2014.
Last July on a conference call with analysts, Read called on the US Congress to implement corporate tax reform that would allow it to repatriate cash trapped overseas to the US, and give it a tax rate that would enable it to better compete with rivals in Europe — the term "trapped" is also a fiction and even though most of Apple's end September cash hoard of $205.7bn is in the names of Apple companies with addresses at what the Guardian newspaper has called "the edge of Knocknaheeny, a run-down northern suburb of Cork" Ireland, the money is in US bank accounts and securities, and is managed from Reno, Nevada.
I do think I am heartened by the conversations that are occurring and the acknowledgment in Washington that something has to be done to allow global US corporations to become competitive given the nature of the US tax system.
The dysfunctional US corporate tax system was last overhauled in 1986 but Read is disingenuous when he suggests that Pfizer is disadvantaged compared with rivals in Europe.
According to Reuters, non-US units account for over 80% of Pfizer's US sales — Read isn't promising to open new US plants or R&D centers — and when the headline corporate tax rate was cut from 35% to 5.25% in 2004 to promote repatriation of overseas profits, Pfizer had the single largest share of the repatriated profits, bringing home $35.5bn in foreign earnings, while also cutting 11,748 US jobs between 2004 and 2007 according to a 2011 report by the Democratic staff of the Senate Permanent Subcommittee on Investigations.
Pfizer has reported losses on its US business in each of the past five years. The sales of imports generate margins of around 40% for Pfizer's overseas arm.
According to the 2014 annual report (Page 78) the US accounted for about 40% of revenues 60% came from foreign sales while Pfizer had $17bn in pretax income from overseas, and nearly a $5n pretax loss in the United States despite a market with the highest prices in the world for prescription drugs!!
Pfizer has $137bn in accumulated foreign earnings that becoming Irish will remove any tax liability to the US. It can also write back a provision of $21bn — good short-term opportunities compared with finding teh next miracle drug.
Most of $16bn of US taxes Pfizer has paid since 2009 reflects payments in relation to such remitting of profits from overseas subsidiaries, a Reuters analysis of group filings shows.
Reuters adds that even including this tax on remitted earnings, the amount of cash Pfizer pays in overall corporate taxes as a share of its profits is lower than rivals like Britain's GlaxoSmithKline, Denmark's Novo Nordisk and Paris-based Sanofi.
Most multinational firms in the United States are entitled to a production activities deduction, which reduces the US statutory tax rate by 9%, from 35% to 31.85%.
A 2014 Congressional Research Service report says:
Although the US statutory tax rate is higher, the average effective rate [compared with other OECD] is about the same, and the marginal rate on new investment is only slightly higher. The statutory rate differential is relevant for international profit shifting; effective rates are more relevant for firms’ investment levels.
Effective tax rates
Pfizer reported an effective tax rate of 25.5% in 2014 but according to The Wall Street Journal, the gap between Pfizer’s tax rate and the 4.8% reported by Actavis PLC, the American company with an Irish tax address, before it changed its name to Allergan, "is somewhat illusory, an artifact of tax accounting rules and Pfizer’s decisions about how to show the information to shareholders."
The Journal says that the company could have cut that rate to 7.5% if it reported its foreign earnings the way most US corporations do. Absent deferred tax provisions the company’s tax rate would have been 12.8% in 2013 instead of 27.4%. In 2012, it would have been 0.2% instead of 19.8%.
In effect Pfizer is providing for US taxes on profits it says are permanently invested overseas.
“It seems awfully disingenuous to be wringing your hands about how awful the US tax system is,” said Ed Outslay, a tax accounting professor at Michigan State University who reviewed Pfizer’s filings for the Journal. “They don’t seem to be all that impacted by it.”
Pfizer has $74bn in indefinitely reinvested overseas earnings and it already has $21bn in deferred taxes provided in its accounts.
Apple's effective rate for fiscal year ended September 2015 was 26.5% but again like Pfizer it artificially boosts the figure.
The Financial Times said in 2013:
Apple would have paid a tax rate of about 15% last year, far below the 25.2% it reported, had it not used a form of reserve accounting that sets it apart from other big US technology companies.
As for other big US companies and the claims of being overburdened by taxes compared with foreign rivals, the evidence suggests that this is a fiction.
General Electric (GE), the American industrial conglomerate ex-the troubled GE Capital division, had an effective rates of 17 and 18.9% in 2014 and 2013.
Siemens of Germany, its chief global rival, had rates of 27% in 2014 and 28% in 2013%.
US business wants lower tax rates but they also want to keep their sectors' useful loopholes.
On Tuesday, in an op-ed in The New York Times, Giving Billions to the Rich, that appears to have blindsided the editors, the two authors who are front men for the Koch brothers — the energy billionaires who are the top funders of the Republican Party — rail against corporate loopholes that benefit the rich.
Vanessa Williamson of the Brookings Institution points out here that the authors forgot to mention the tax breaks for oil companies, worth an estimated $4bn a year!
Why become Irish for tax purposes
Pfizer said on Monday that it expects its move of its tax address to Ireland (management will remain in US) will see its tax rate cut to 17% or 18%, from its roughly 25% rate currently, because corporate taxes in Ireland are lower than in the US — as we noted above, the 25% rate is a fiction.
At the end of September, Pfizer had $37.6bn in cash and equivalents, most of it overseas — and Ian Read assured Americans on Mobnday that it would help to use cash "trapped overseas" to invest in the US but once the so-called tax inversion is completed, thousands of jobs will be cut.
A spokesman for Ireland's Department of Finance said the only “major concern” was that the merger would result in job losses. “We would be hoping that the merger would result in an increase in employment here rather than a decrease,” he said.
Tim Mullaney of MarketWatch recommends that the US government should tie purchases for Medicare and Medicaid to tax inversions.
Eaton, the US power management firm, had an effective rate of tax of 0% in 2010. However, it still saw advantage to become Irish in 2014 after acquiring a former Texas firm, which had earlier become Irish.
While the Irish headline tax rate of 12.5% is an attraction, Ireland hasn't the capacity to regulate these giant companies and removing SEC regulation while maintaining operations in the US must also be attractive.
Pfizer as Irish firm will swamp Ireland's national accounts — including Pfizer, 7 faux-Irish companies will have payrolls that exceed 700,000, one third of the domestic Irish workforce, and they will artificially boost GNP (gross national product) and create fake Balance of Payments surpluses.
At the WSJ Viewpoints Executive Breakfast Series on 29 Oct, Ian Read, Pfizer CEO Ian Read, discusses the burdensome US tax code, potential for the company to spin off a portion of its business and other topics.
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