Wednesday, November 25, 2015

Sound arithmetic; shocking logic

The Irish Times yesterday featured a piece which said:

Pfizer reported international revenue last year of $28.5 billion and a group profit margin of 18.4 per cent. On that basis, its international profits were about $5.3 billion, translating to a tax bill of €620 million at the Irish corporation tax rate at the current euro/dollar exchange rate if it was all taxed here.

Yes, $28.5 billion multiplied by .184 is $5.24 billion and that multiplied by .125 is $0.65 billion which at the current €/$ exchange rate of 1.06 corresponds to €618 million.  Flawless arithmetic.

The problems with this are many.  Let’s go through the numbers using Pfizer’s most recent 10k SEC filing.

The $28.5 billion revenue figure is Pfizer’s non-US biopharmaceutical revenue.  Pfizer’s total non-US revenue was $30.5 billion so it would seem this is the appropriate revenue to use.  But why would the distinction between US and non-US revenue be important for determining Irish Corporation Tax.  So what if $30.5 billion of Pfizer’s $49.6 billion is earned outside the US.  What makes the $19.1 billion of US revenue earned by Pfizer irrelevant when Pfizer becomes an Irish company?

Pfizer Revenue

Next up is the profit margin used of 18.4%.  Firstly, this is the group profit margin so there is no way of knowing whether this applies to the $28.5 billion of revenue used in the calculation.  Next is the problem that it is the post-tax profit margin.  The objective seems to be to calculate some form of taxable income so it should be the margin before existing taxes are subtracted.  Pfizer’s 10K form shows that this was 24.7% for the group in 2014.

Pfizer Income Analysis

So maybe we should be multiplying €49.6 billion by .247 which gives us $12.24 billion.  The next step in the arithmetic was to multiply the taxable income figure by the Irish 12.5% tax rate to get the tax due.  Using the $12.24 billion we have a figure $1.53 billion.  Wouldn’t $1.5 billion of extra tax have made for an even better headline?

Of course, it is a nonsense calculation.  The easiest problem to see is that Pfizer already has operations in Ireland so is already paying our 12.5% Corporation Tax on a share of its profits. Just because they move the headquarters here doesn’t mean we can tax them twice on their Irish profits!

However, the most serious error is the assumption the piece makes the Ireland’s 12.5% Corporation Tax could be due on all of Pfizer’s profits (even if it makes the division between US and non-US profits which is irrelevant for Irish purposes).  The piece says:

In Ireland, it will pay our 12.5 per cent tax rate on any international income routed through the new Dublin operation.

It is true that Ireland levies the 12.5% rate on dividends received by Irish-resident companies from their trading subsidiaries in EU and treaty countries [It is 25% for non-treaty countries].  So when Pfizer becomes Irish-headquartered the dividends the parent receives from subsidiaries will be taxed at the 12.5% rate.

However, the crucial element is that the tax is applied at a net effective rate of 12.5%.  Companies get a tax credit for any foreign tax they have already paid on the profits and only have to pay additional tax to the extent that the tax already paid is below 12.5%.  The hints at this but seems to get the logic in reverse:

The precise benefit will depend on how much international revenue is channelled through the merged Irish business. Pfizer may choose to pay tax locally in countries with even lower tax rates.

This seems to suggest the tax paid in Ireland would be lower if Pfizer pays lower taxes in other countries.  The opposite is the case.  The less tax Pfizer pays in other countries the more tax will be payable here.

What countries does Pfizer operate in? Most of Pfizer’s R&D takes place in the U.S. Pfizer has major manufacturing facilities in Belgium, China, Germany, Ireland, Italy, Japan, Puerto Rico, Singapore and the U.S and operates multiple distribution facilities around the world.  It is likely that the tax paid in many of these countries will exceed our 12.5% rate.

The exceptions are maybe Puerto Rico and Singapore where the tax paid by the these subsidiaries might result in additional tax being due in Ireland to bring the tax on these profits up to an effective 12.5%.  However, Pfizer will be able to avail of “dividend pooling” so that the tax credits on all the foreign dividends received can be combined before they are offset against the Corporation Tax due in Ireland.

Even after the inversion Pfizer will earn a substantial portion of its profits in the U.S.  This will now be counted as a dividend from a subsidiary for the Irish HQ.  It is likely that Pfizer will get sufficient tax credits from its US tax to offset any additional tax liability from Ireland it might face.  And then there will be the credits from corporate income tax paid in Belgium, Germany, Japan and other countries.  It is very difficult to see how the inversion alone will result in Pfizer paying any additional Corporation Tax in Ireland even though dividends from its subsidiaries around the world will become liable to our 12.5% Corporation Tax rate.

The appropriate calculation is foreign dividends received multiplied by 0.125 minus double taxation relief equals nil.  But where would be the headline in that?

Pfizer have said that they expect their effective tax rate to go to around 17 per cent once the inversion has washed through.  If a large part of the company’s profits were going to be taxed in Ireland wouldn’t this be closer to our 12.5% headline rate?

Now, it is possible that Pfizer will pay more Corporation Tax in Ireland.  We simply do not know the full detail of what its new tax structure will look like.  Pfizer likely has a major tax restructuring that it wishes to implement of which the inversion is just one part.  But to suggest that Pfizer will be paying our 12.5% tax on its net non-US profits is misleading in the extreme.

So why is Pfizer engineering this inversion? The reason is in this table from its 10k filing.

Pfizer Tax Analysis

The reason is the deferred U.S. corporate income tax which was $725 million in 2014.  The table also shows that Pfizer pays lots of ‘international’ income taxes ($2,321 million in 2014) which doesn’t seem to leave much for our double-dip to bring them up to 12.5%.  The problem for Pfizer is that the US’s worldwide regime is applied at 35%.

The table also shows that a large part of Pfizer’s tax provision is not actually paid – it is deferred. The inversion will not really change the income tax Pfizer pays but it will change the corporate income tax it owes.  The cash tax paid of $2,100  million in 2014 (and $2,874 million for 2013) can be compared to the tax provisions in the above table.

Pfizer’s balance sheet shows that it has $25.0 billion of non-current deferred tax liabilities.  This is mainly the US corporate income tax due on its non-US profits that is has deferred using various provision in the US tax code.  This tax does not become payable until Pfizer repatriates the profits to the US.  Pfizer’s 10k statement also says that:

As of December 31, 2014, we have not made a U.S. tax provision on approximately $74.0 billion of unremitted earnings of our international subsidiaries. As these earnings are intended to be indefinitely reinvested overseas, the determination of a hypothetical unrecognized deferred tax liability as of December 31, 2014, is not practicable.

This is the issue the inversion is trying to address.  Pfizer wants greater flexibility to utilise its profits without running the risk of tripping a major US tax payment on profits which are earned outside the US.

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