Companies Warn of Hits From Tax Cuts. Don’t Be Fooled.
Posted January 4, 2018 3:59 p.m. EST
It will sound like bad news.
Over the next few weeks, some of the world’s biggest companies, household names including Microsoft, Google and Johnson & Johnson, are likely to warn that their financial results will be severely dented, if not altogether wiped out, by huge tax bills that they have to pay to the Internal Revenue Service.
Don’t be fooled.
The big one-time losses are a prelude to even bigger profits — a paradox caused by the tax cuts that recently zoomed through Congress and that largely benefit corporations.
A couple of provisions in the tax package are prompting many companies — those based in the United States as well as some foreign corporations with big American presences — to pay the taxman while anticipating huge savings for decades to come.
The biggest factor, by far, is the requirement that American companies bring back money that they claimed to have earned via overseas subsidiaries, most of them in tax havens such as Luxembourg, Grand Cayman and Bermuda.
Until now, companies generally didn’t have to pay federal income taxes on such earnings, at least not immediately, as long as those profits stayed overseas. But if the companies brought the money back to the United States, they would face a 35 percent tax rate (minus whatever they had already paid tax collectors in other countries).
American companies currently attribute about $2.8 trillion to their overseas units. The new law requires them to bring the money back to the United States — or to “repatriate” it — but at reduced tax rates as low as 8 percent.
In the short term, that may appear painful. Companies collectively will have to pony up about $235 billion in taxes stemming from the repatriated profits, said David Zion, a tax accounting analyst. He estimates that five companies — Apple, Microsoft, Pfizer, Cisco and Oracle — account for one-third of that.
The phenomenon is likely to be on display in the next few weeks, as companies report financial results that look surprisingly weak because of the tax law.
Goldman Sachs Group said last week that it expected to suffer a $5 billion charge in the fourth quarter, mostly because of the forced repatriation of earnings. That threatened to obliterate the Wall Street bank’s normally robust quarterly profits. But investors shrugged, sending Goldman’s shares down slightly before quickly pushing them higher.
Why? Because the repatriation provision is part of a package likely to deliver vastly larger long-term savings for the world’s biggest multinationals. Zion estimates the benefit from the repatriation tax break alone could be worth $500 billion to companies compared with the old law — more than double what they’re paying upfront.
And so profit warnings that normally would leave investors shuddering are instead being taken in stride.
“Although hundreds of companies are going to report unfavorable charges, ultimately the legislation should be a big win for them,” said J. Richard Harvey, a Villanova University law professor and former IRS official. “Multinationals have been pursuing this sort of legislation for over a decade. We wouldn’t have the legislation if they didn’t want it.”
Indeed, companies have spent years lobbying for tax breaks on the profits they held in tax havens. In 2004, they succeeded when Congress passed the American Jobs Creation Act, which dangled a one-time tax break for companies that repatriated offshore profits. Companies brought home $312 billion at a rate of just 5.25 percent.
Despite the law’s name, studies showed that companies used the money to buy back their shares in order to lift their stock prices. Some of the same companies laid off thousands of workers.
Among the biggest potential winners from the new tax package’s repatriation provision is Apple. The company has $252 billion in cash offshore — and most likely even more in earnings, untaxed by the United States.
Apple might eventually fork over about $33 billion to the IRS when those earnings come back to the U.S., Zion said. But, in yet another oddity caused by the tax package, the company might actually record a one-time benefit to its profits.
That’s because, over the years, Apple has set aside money, at least in accounting terms, to cover the potential taxes it might owe on its offshore earnings. But the company was applying a theoretical tax rate that was higher than what was included in the Republican tax package. As a result, Apple is likely to pay about $3 billion less than what its accountants had told it to set aside, said Harvey, the Villanova professor.
Figuring out how to tally this quickly is giving finance chiefs heartburn. Regulators are offering some breathing room. Two days after Christmas, the Securities and Exchange Commission essentially gave companies an extension to report any expected tax-law-related losses or gains, if they could not come up with a “reasonable estimate” by the end of the year.
Going forward, the tax code will be more profitable for multinational companies based in the United States. The simplest change: The corporate income tax rate is dropping to 21 percent, from 35 percent. Overnight, the United States becomes one of the lowest-tax jurisdictions in the developed world. Under the previous tax regime, American companies owed federal income taxes on their worldwide profits, regardless of whether they were generated domestically or internationally. (They could indefinitely defer the taxes on profits earned abroad — as long as those profits stayed overseas.)
The new tax law changes that. Now companies have to pay full income taxes only on profits that they say were earned in the United States. Income earned abroad will be subject to federal income taxes at half that rate — 10.5 percent — and potentially even less. As a result, companies are likely to shift even more profits into tax havens — even if they want to use that money in the United States.
It is not only American companies bracing for short-term losses from the legislation.
In Europe, several companies said the new tax law would generate one-time hits to their profits. On Tuesday, BP said the law would lop $1.5 billion from profit in the fourth quarter of 2017. That’s because the lower corporate rate will reduce the value of future tax deductions that the British oil and gas company had been expecting to benefit from.
Credit Suisse said last month that it would take a $2.3 billion write-down because of the tax bill. Royal Dutch Shell said on Dec. 27 that it would subtract up to $2.5 billion from its quarterly profits.
Several companies said the tax overhaul would result in a one-time gain. They included the German automakers BMW and Daimler, which both said the law would provide a temporary benefit of more than $1 billion.