New US Tax Rules Are a Gift to Europe

The effects of the Trump administration corporate tax reform on U.S. multinationals that were, as of the end of last year, holding some $1.4 trillion in cash overseas, are largely beneficial: Now these companies finally know how much of that money the U.S. wants — and there’s also some long-awaited clarity on how foreign profits will be taxed going forward. What’s less clear is how the changes will affect European plans to tax U.S. companies’ profits where they’re made. So far, it looks as though the new U.S. rules are a gift to European nations that they should hurry up and use.

Up front, the U.S. government is taxing the accumulated foreign cash at 15.5% to treat it as repatriated. That’s something of a relief to the biggest cash holders. Apple, whose foreign subsidiaries held $252.3 billion in cash and equivalents as of the end of September 2017, had been making provisions for U.S. federal taxes on its foreign profits. At the end of September, the company had on its books a deferred tax liability of $36.4 billion related to foreign subsidiaries’ earnings. That’s about 14.4% of the cash pile, meaning Apple will pay only slightly more than it has budgeted for the formal repatriation of the money (in reality, much of it was already invested in U.S. assets, anyway).

Microsoft, with $127.9 billion of overseas cash as of June 30, 2017, the end of its financial year, reported an unrecognized deferred tax liability of $45 billion on some $142 billion of foreign income. Unlike at Apple, the new taxes will have a negative effect on the bottom line, but Microsoft will still pay only about half as much as it expected.

No longer having to guess about the U.S. government’s claims frees up the companies to invest the cash more productively than by purchasing marketable securities. Expect some bold acquisitions from the U.S. tech and pharma giants, which hold most of the cash. But it’ll be even more interesting to see how the companies change their tax schemes in response to other parts of the U.S. reform, meant to tackle profit shifting. 

Starting this year, the U.S. taxes foreign income above 10% of revenue — deemed to be the normal rate of return on tangible assets — at 10.5%. This rate will go up to 13.125% in 2026. Companies will only get an 80% credit for foreign taxes paid. A 13.125% tax effective tax rate applies to income from licensing U.S. parents and other intellectual property to foreign companies. These measures are specifically meant to eliminate tech companies’ favorite scheme: booking all the non-U.S. revenues in a low-tax country such as Ireland, with its 12.5% corporate tax rate, and then paying almost all the profit to a company in, say, the Cayman Islands, as royalties for the use of intellectual property. Some companies — Google is one example — ended up paying almost no tax on their non-U.S. profits thanks to the scheme.