Pharma benefited from basing business overseas. An international tax effort could spur a rethink.

Pharma benefited from basing business overseas. An international tax effort could spur a rethink.

An overhaul of U.S. tax law six years ago saved big pharmaceutical companies billions of dollars and reshaped how they profit from lucrative drug patents held overseas. Policy changes now on the horizon could further shift how pharmas set up their international operations.

At the urging of economic policy groups, industrialized countries aim to impose a global minimum corporate tax rate of about 15%. They hope to end a “race to the bottom” that has allowed multinational corporations like Pfizer, AbbVie and Eli Lilly to pay single-digit or lower effective tax rates in recent years.

But the U.S. is lagging behind in instituting the new rules, which will start to take effect in January in some countries. A delay could cost the Treasury $39 billion over five years.

For drugmakers, the international agreement could disallow U.S. R&D tax credits from counting against the minimum, potentially raising their bills and forcing them to rethink where they base their laboratories.

“There’s this wide band of uncertain outcomes,” said Daniel Bunn, CEO of the Tax Foundation, a policy research group.

‘Territorial taxation’

The Tax Cut and Jobs Act of 2017 was the first major revision to U.S. tax law since 2001. Since it was put in place, the effective tax rates paid by major U.S. drugmakers have declined substantially. Actual tax payments also dipped for several years before returning to 2016 levels last year.

The law, known as TCJA for short, made several adjustments that reduced large corporations’ tax burden. The headline change was a lowering of the corporate tax rate from 35%, one of the highest in the world, to 21%. (President Joe Biden has repeatedly sought to raise the rate to 28%, but Congress has rebuffed him.)

Large pharma tax rates have fallen since TCJA law

Effective tax rates reported by companies before the TCJA’s passage and in years after.

The TCJA also changed how the U.S. taxes profits of overseas subsidiaries, offering reduced levies to incentivize the return of those profits to the U.S. Under the law, companies are also encouraged to bring some of their overseas activities back to the U.S.

Ultimately, the new tax structure attempted to transition the U.S. to a “territorial” taxation system, under which companies primarily pay taxes on profits in the countries where they are earned.

AbbVie, Pfizer and Regeneron Pharmaceuticals especially benefited from the law, reporting significant decreases in their tax burdens. For 2018 — the first full year under the TCJA — AbbVie and Pfizer received more in refunds than they paid in taxes, while Regeneron’s tax expense was slashed by nearly three-quarters.

The law’s encouragement of companies repatriating overseas profits spurred significant spending, too. For example, in January 2018, AbbVie announced a $2.5 billion capital project investment in the U.S., a onetime charitable donation of $350 million and accelerated pension funding of $750 million. Those announcements were followed weeks later by a much larger financial commitment to AbbVie shareholders in the form of a new $10 billion share buyback.

“With the TCJA, that low effective tax rate became even lower, with less paid to the U.S. Treasury and the amount of pharmaceuticals imported increased,” said Brad Setser, senior fellow at the Council on Foreign Relations.

Targeting tax arbitrage

The tax architecture set up by the TCJA could be undercut by the global effort to set an international minimum corporate rate of 15%.

Companies, particularly those whose profits rely on intellectual property, have in the past housed patents in subsidiaries located in low-tax countries. By reporting corporate profits in those low-tax areas, they were able to reduce their overall tax burdens. The practice can further minimize reported profits in the U.S. because the U.S. parent corporation will sometimes pay royalties, which are tax deductible, to their subsidiaries in low-tax countries. Industries like manufacturing, which rely heavily on capital investment that can’t easily be moved from country to country, were comparatively disadvantaged in this game of tax arbitrage

After years of work, the Organization for Economic Co-operation and Development, an intergovernmental organization of 38 high-income countries, in March 2022 unveiled a plan to address “base erosion and profit shifting.” In addition to seeking a 15% minimum tax rate, the OECD recommended a set of rules that would ensure rates don’t fall below that level in any country. The proposed mechanisms would allow nations to increase their taxes if others don’t maintain the minimum rate.

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