A new international tax that was supposed to deter U.S. technology and pharmaceutical companies from shifting their profits offshore could instead catch Wall Street banks in its crosshairs.
The levy on international profits -- called Gilti -- is only supposed to kick in if a company is paying an especially low tax rate in foreign countries. But quirks in the way the tax is calculated mean it will likely hit big banks with offshore operations, even when they already pay effective foreign tax rates above the threshold.
Bank lobbyists are now urging the Treasury Department to come up with a fix for last year’s tax overhaul that would lessen the pain from Gilti, saying an adjustment is needed to make the tax consistent with the intent of Republican lawmakers who wrote the legislation.
The effect of the Gilti levy on banks is an example of how the biggest U.S. tax rewrite in a generation has lead to unintended consequences. The Republican law slashed the corporate tax rate to 21 percent from 35 percent, and shifted the U.S. to a system of taxing its companies on their domestic profits only. Those changes required guardrails -- like the Gilti tax -- to ensure that multinationals pay at least something on their overseas profits. But much of the implementation of Gilti is governed by old tax regulations still on the books.
Financial services firms are particularly affected, because they tend to borrow more than other industries and have high interest expenses, factors that can minimize the value of the foreign taxes they pay to offset their U.S. tax liabilities. They also lost a loophole that previously allowed them to postpone paying taxes on certain overseas income, like dividends and interest. Now that income is subject to Gilti.
“Gilti is very unforgiving,” said David Sites, a partner for international tax services at Grant Thornton LLP.
Tax writers had intended for the Gilti levy to target companies like Apple Inc. and Pfizer Inc., which for decades have routed income from royalties, trademarks and patents through tax havens. They created the tax, which effectively sets a 10.5 percent rate, to apply to a company’s “excess” profits earned overseas through some of their foreign subsidiaries. Gilti is an acronym for “global intangible low tax income,” but applies to tangible assets as well.
The law says companies can avoid Gilti if they pay rates in foreign countries of at least 13.125 percent, or 16.4 percent after 2025. In practice, tax practitioners say that’s not what will happen for U.S. banks with operations in countries like the U.K., Germany or France, where they can end up owing Gilti even though they’ve paid foreign taxes at 19 percent (the U.K.), about 30 percent (Germany) and 33 percent (France).
Extra 21 Cents
Part of the issue has to do with new limits established for foreign tax credits that companies use to reduce their U.S. taxes. But at the same time, the old conventions of how companies are directed to divvy up their expenses between domestic companies and foreign subsidiaries are still in place.
When calculating Gilti, a company has to allocate some of its domestic expenses for administration, research, and interest payments to the scores of foreign corporations through which they do business. The tax is hitting the banks’ foreign entities where they channel investments.