By Richard Rubin
WASHINGTON -- A new tax aimed at overseas income earned by U.S.
technology and pharmaceutical firms is hitting unexpected places,
including Kansas City Southern, a U.S. railroad company.
The new minimum tax on foreign earnings will cost Kansas City
Southern $25 million a year, according to the company, which warns
the measure also encourages it to borrow money outside the U.S.
Kansas City Southern's predicament is an example of the shifts
in international taxation emanating from last year's rewrite of the
U.S. tax code, and of the potential unintended consequences that
companies are starting to see. Congress lowered the corporate tax
rate to 21% from 35% and tried to change the way the U.S. taxes
profits abroad, in an effort to boost domestic investment and help
U.S. firms compete globally.
In the past, the U.S. taxed corporate profits earned overseas at
the domestic rate of 35%. Companies could avoid that tax by booking
their income overseas and keeping it there. The new system in
theory aims to lighten the overseas tax burden and target it more
carefully.
Congress set a minimum tax known as GILTI, for Global Intangible
Low-Taxed Income, of roughly 10.5% on a portion of corporate income
earned overseas. GILTI is directed at trademarks and patents of
technology and pharmaceutical firms, which are easy to transfer to
low-tax foreign countries. It was supposed to create a floor on
taxing those highly mobile profits, an assurance that companies
would pay something while stopping short of the full U.S. tax rate.
Without it, lawmakers worried, U.S. companies could have an even
larger incentive to move intangible assets and profits
offshore.
Kansas City Southern, based in Kansas City, Mo., doesn't seem to
fit the profile of companies the tax was aimed at. Its assets are
railcars, not patents, and its only substantial foreign operation
is in Mexico, where it pays a relatively high 30% tax rate.
But it could get hit with the GILTI tax anyway.
"We should have been exempt from these provisions," Mike
Upchurch, Kansas City Southern's chief financial officer, said in
an interview. The company had projected that the new tax law would
drop its 34% tax rate to 29% or 30%, but it has since revised that
projection upward by 1 to 1.5 percentage points, Mr. Upchurch
said.
GILTI is hitting Kansas City Southern and other companies like
it because of the way the new tax interacts with other provisions
in the tax code, specifically the treatment of foreign tax credits
that are supposed to prevent two countries from taxing the same
income. When companies calculate the credits they receive for
paying taxes overseas, the law typically requires them to assign
some of their domestic expenses to foreign jurisdictions. The
result for some companies is that, for U.S. tax purposes, their
foreign income and foreign taxes look smaller than they actually
are, shrinking their credits. That, in turn, could force them to
pay the new minimum tax on top of their foreign tax bills.
The quirk particularly affects companies with overseas
operations and significant domestic expenses for interest,
administrative costs and research. It hits companies with
operations in high-tax countries like Mexico, Germany and
Japan.
"It's already hit a third of companies that we deal with, and
the other two-thirds are going to have a harsh reality to face in
the coming weeks, " said Albert Liguori of tax advisory firm
Alvarez & Marsal Taxand LLC.
Congressional aides are aware of the issue, which could be
addressed in legislation or Treasury Department regulations later
this year. Part of the challenge, however, is that loosening the
rules for some companies could open tax-avoidance strategies for
others.
The U.S. Chamber of Commerce included this issue in its list of
regulatory priorities for Treasury, arguing that Congress intended
to limit GILTI when foreign taxes exceed 13.125%. That is the
simple case outlined in the House-Senate conference report -- but
lawmakers didn't make changes to other tax rules, such as
accounting for foreign tax credits, that make the goal
achievable.
Euronet Worldwide Inc., which runs automated teller machines
around the world, also expects to pay GILTI. It gets 75% of its
revenue from outside the U.S. Despite the cut in the U.S. corporate
tax rate, the company's effective tax rate will increase from 22%
to 25% or 26% because of the GILTI provision, said Rick Weller, the
company's chief financial officer.
"What we think was a tax provision targeted at covering the
intangible assets in low-tax jurisdictions ended up being a tax
against all foreign business or income that you generate from
foreign sources," he said.
The system creates odd incentives. Some companies will be better
off moving domestic expenses such as interest costs to foreign
countries, where they can get deductions against the higher rates
and mitigate the GILTI impact. Kansas City Southern could benefit
if it borrowed money in Mexico instead of the U.S. Euronet could
gain if it hired administrative staff outside the U.S. instead of
at its Leawood, Kan., headquarters.
"All that would do is to encourage us to shift our jobs out of
the United States," Mr. Weller said. "It seems to be
illogical."
The system also could encourage U.S. companies to find low-tax
foreign countries, rather than operating in high-tax countries and
paying GILTI on top of that, said Ed Kleinbard, a tax law professor
at the University of Southern California.
"It's a great example of what happens when legislation is
rushed," he said. "There's a great deal of anxiety about this
issue, enormous anxiety."
Write to Richard Rubin at richard.rubin@wsj.com
(END) Dow Jones Newswires
March 26, 2018 05:44 ET (09:44 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
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