By Douglas MacMillan, Richard Rubin and Jay Greene
While most U.S. businesses would pay lower taxes under
congressional Republicans' proposed tax overhaul, some of the
world's richest tech companies may actually see their rates
rise.
A window into how Microsoft Corp. currently pays a
disproportionately larger portion of its taxes overseas shows how
the legislation could offset the benefits of returning cash
home.
The software giant saves billions of dollars in taxes by holding
software licensing rights at facilities in Puerto Rico, Ireland and
Singapore, where it stockpiles profits and pays low foreign rates.
Puerto Rico, while a U.S. territory, is treated as a foreign
country under current tax law.
The proposed law lowers the corporate tax rate to 21% from 35%
but at the same time puts a minimum tax on profits overseas. That
set-up would likely force Microsoft to pay a minimum 10.5% tax on
future offshore profits, removing some of the benefit from its
offshore facilities, tax experts say. Yet, Microsoft and other tech
giants could still have an incentive to shift profits abroad.
Microsoft doesn't disclose its foreign tax rates. But it does
say it would owe about 32% if it repatriated all foreign profits.
The statutory tax rate, including state taxes, is between 35% and
39%, suggesting Microsoft has paid between 3% and 7% in tax on its
foreign profits.
Tech executives and industry groups largely support the tax
package, partly because it promises a one-time tax at a discounted
rate for the estimated $2.6 trillion in profits American businesses
have accumulated overseas -- a rate of 15.5% on liquid cash or 8%
on illiquid assets, including factories and equipment. Companies
currently pay up to 35% to bring back some of that cash to pump
into operations or return to investors.
But tech giants could be pinched by provisions in the new tax
code aimed at curbing the use of low-tax foreign jurisdictions.
"Those firms that have been the world leaders in avoiding taxes
will find their tax rates going up," said Edward D. Kleinbard, a
former U.S. tax official who is now a tax professor at the
University of Southern California law school.
Under current law, American companies owe the U.S. taxes of up
to 35% on world-wide income. They get tax credits for payments to
foreign countries, and don't owe the U.S. the remainder
immediately. But they face the residual U.S. tax if they repatriate
profits.
So companies book profits in low-tax countries, and leave them
there. This is easy for high-tech and pharmaceutical firms, which
put "intangible" assets, such as patents, in foreign countries and
book non-U.S. profits through there.
That is why most tech companies pay a much lower effective tax
rate than the standard 35% for American businesses. Tech firms paid
an average tax rate of 24% over the 10-year period to 2016, below
the 29% average tax rate for all companies in the S&P 500 for
that period and lower than any other industry, according to
analysis of corporate filings by Zion Research Group.
U.S. companies with the lowest tax rates include tech firms such
as eBay Inc., Cisco Systems Inc. and Alphabet Inc., whose effective
tax rates averaged under 20% over the past decade, filings for all
three companies show. Microsoft's average effective tax rate was
23% over the 10-year period through 2016.
Microsoft opened its first Puerto Rico facility in 1991 after
the U.S. established a tax break on new businesses there. The
island subsidiary buys the rights to Microsoft's intellectual
property, makes copies of its Windows and Office software and sells
that software to the company's North American distributors,
according to the findings of a U.S. Senate investigation into
corporate tax maneuvers in 2012.
"The structure is not designed to satisfy any specific
manufacturing or business need," the Senate investigators wrote.
"Rather, it is designed to minimize tax on sales of products sold
in the United States."
The Puerto Rico facility was previously used to produce physical
copies of software discs. In recent years, Microsoft's business
model has shifted to digital subscriptions, a change that could let
it shift more sales to the U.S., according to Bernstein
Research.
Under the existing tax regime, Microsoft can keep 47% of profits
in Puerto Rico, where it is taxed at a pre-negotiated rate of
2%.
The company also reduces its tax liability through similar
intellectual-property arrangements in Ireland and Singapore. Those
two countries, together with Puerto Rico, accounted for 64% of
Microsoft's income before taxes in the year ended June 30. In the
same period, about half of its revenue was in the U.S.
Microsoft could bring cash home after the tax law is passed
without much penalty beyond the initial one-time tax on accumulated
foreign profits. The company keeps 95% of its cash, or $132
billion, outside of the U.S., a larger offshore cash pile than any
company except Apple Inc., which holds 89% of its cash, or about
$240 billion, overseas. Microsoft has actively lobbied lawmakers on
tax-code changes, paying at least 18 lobbying firms to work on the
issue this year, according to Senate records.
What is less clear is whether the tax changes would give
Microsoft enough incentive to stop sending profits to places like
Puerto Rico. Representatives from the U.S. territory have voiced
concern that a tax-policy change could push companies out of Puerto
Rico and further hurt its economy as it recovers from hurricanes
and a debt crisis.
--Natalie Andrews and Theo Francis contributed to this
article.
Write to Douglas MacMillan at douglas.macmillan@wsj.com, Richard
Rubin at richard.rubin@wsj.com and Jay Greene at
Jay.Greene@wsj.com
(END) Dow Jones Newswires
December 18, 2017 11:25 ET (16:25 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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