Question

The 2017 tax cut and job act greatly reduced the tax burden for many businesses. Given the opening case with Apple, please evaluate the benefits and costs of the legislation now that enough time has passed since its implementation. Please use any additional research material you need in addition to the textbook, to answer this question.

Answer 1

Outline:

The Tax Cuts and Jobs Act of 2017 lowered the corporate tax rate, but not all of its provisions reduced the effective corporate tax burden. Under the new Internal Revenue Code section 965, U.S. multinational entities must pay a one-time mandatory repatriation tax on undistributed and deferred post-1986 foreign income. Companies were permitted to estimate provisional amounts of repatriation tax within 12 months of the new regulation, and have begun disclosing actual amounts with their 2018 financials.

Forreign Taxes before TCJA

Before the TCJA, U.S. taxpayers who were shareholders in foreign corporations were generally not taxed on the earnings of said foreign corporations until the earnings were distributed (repatriated) to them. If the foreign corporation did not distribute earnings back to the United States, shareholders could postpone paying taxes on such foreign income indefinitely.

Upon repatriation of earnings from a foreign subsidiary, U.S. corporate shareholders’ earnings were treated as dividends that were included in the parent corporation’s income and were subject to U.S. taxation at a rate of up to 35%, with a foreign tax credit based on foreign taxes paid. As a result, U.S.–headquartered MNEs could incorporate in tax havens and allocate as much taxable income as possible to these low-tax jurisdictions in order to minimize corporate income tax. For example, in a recent high-profile tax case, the European Commission demanded that Apple pay Ireland 13.1 billion euros in underpaid taxes because Ireland granted state aid to the company (Padraic Halpin, “Ireland Collects Disputed Apple Taxes in Full ahead of Appeal,” Reuters, Sept. 18, 2018, https://reut.rs/38wQSLQ). Apple, a U.S.–headquartered MNE, had been offshoring its profits to Ireland, where the corporate tax rate is 12.5%. Thus, one of the primary goals of the TCJA was to remove potential tax benefits from offshoring income, thus deterring such activity.

Before the TCJA, U.S. taxpayers who were shareholders in foreign corporations were generally not taxed on the earnings of said foreign corporations until the earnings were distributed (repatriated) to them. If the foreign corporation did not distribute earnings back to the United States, shareholders could postpone paying taxes on such foreign income indefinitely.

Upon repatriation of earnings from a foreign subsidiary, U.S. corporate shareholders’ earnings were treated as dividends that were included in the parent corporation’s income and were subject to U.S. taxation at a rate of up to 35%, with a foreign tax credit based on foreign taxes paid. As a result, U.S.–headquartered MNEs could incorporate in tax havens and allocate as much taxable income as possible to these low-tax jurisdictions in order to minimize corporate income tax. For example, in a recent high-profile tax case, the European Commission demanded that Apple pay Ireland 13.1 billion euros in underpaid taxes because Ireland granted state aid to the company (Padraic Halpin, “Ireland Collects Disputed Apple Taxes in Full ahead of Appeal,” Reuters, Sept. 18, 2018, https://reut.rs/38wQSLQ). Apple, a U.S.–headquartered MNE, had been offshoring its profits to Ireland, where the corporate tax rate is 12.5%. Thus, one of the primary goals of the TCJA was to remove potential tax benefits from offshoring income, thus deterring such activity.

Apple Case

Apple had the largest amounts of cash and marketable securities held overseas, and it faced the largest repatriation tax bill as a result (Laurie Meisler, “The 50 Largest Stashes of Cash Companies Keep Overseas,” Bloomberg, June 13, 2017, https://bloom.bg/2kUQiU1; Allyson Versprille and Alison Bennett, “Early Numbers Show Repatriation Tax Haul Likely to Miss Estimates,” Bloomberg Tax, May 31, 2018, http://bit.ly/2YRP6AF). Apple’s 2018 Form 10-K did not specifically disclose the net impact of the TCJA; instead, it said that the company’s repatriation tax payable of $37.3 billion was a provisional estimate that may change as the company continues to analyze the impact of additional implementation guidance. In its 2017 disclosure, Apple estimated a deferred tax liability of $36.4 billion based on the cumulative post-1986 deferred foreign income, and it replaced $36.1 billion of its deferred tax liability with a deemed repatriation tax payable of $37.3 billion in 2018. The figures in the Exhibit were adjusted accordingly to reflect the impact of the repatriation tax.

Apple disclosed that it elected to pay the repatriation tax in installments. The company’s effective tax rate decreased significantly from 24.6% in 2017 to 18.3% in 2018, primarily due to the lower TCJA tax rates and $1.7 billion of unrecognized tax benefits resulting from the repatriation tax.

Negative effect on Nike

Nike had a nearly $2 billion adjusted net tax charge as a result of the TCJA, including the transition tax and increase in deferred tax liability. Nike elected to pay the tax under an eight-year installment plan. Nike stated that it had $12.2 billion worth of previously untaxed foreign earnings subject to the TCJA transition tax; this caused its effective tax rate to increase by 42.1% in the year of application, to 55.3%. Furthermore, its earnings declined by 54% from 2017 to 2018, in major part due to the tax effects. This is not surprising, given that the majority of Nike’s total revenue (nearly 58%) comes from overseas operations.

Ending notes

Conversely, the repatriation tax was immaterial for some companies, with the TCJA having little effect on their tax liability. For example, Walmart’s repatriation tax charge was only 0.4% of sales.

It is evident that the TCJA, and specifically the repatriation tax, affected MNEs’ financial statements in 2017 and 2018. The effects do not, however, seem to be uniform across companies and industries. For some companies, such as Cisco and Nike, the repatriation tax resulted in a material cost in the first year of remittance (to 99.2% and 55.3% effective tax rates, respectively). For others, the TCJA had a lesser or even positive effect, such as with Walmart and ExxonMobil. Overall, it appears that the cost of the repatriation tax to MNEs may not be as high as expected, and the variation of its effects could be related to the extent of the companies’ international business and their ability to offset this tax expense with related tax benefits (Versprille and Bennett 2018).

The repatriation tax was implemented quickly amid much uncertainty. The regulations allowed companies to make reasonable estimates and complete their accounting of the repatriation tax’s effect within 12 months. For the most part, the MNEs discussed above were able to make reasonable estimates and complete the accounting within the 12-month deadline.