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Abu Dhabi, UAETuesday 13 November 2018

US tech tax Gilti could bite Wall Street and banks

Peculiarities in the way the new international tax is calculated mean it will probably hit big lenders with offshore operations

New York Stock Exchange. Markets and US lenders could be hit by Gilti levy if not adjusted. AP
New York Stock Exchange. Markets and US lenders could be hit by Gilti levy if not adjusted. AP

A new international tax that was supposed to deter US 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 probably 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 policymakers who wrote the legislation.

The effect of the Gilti levy on banks is an example of how the biggest US tax rewrite in a generation has lead to unintended consequences. The Republican law slashed the corporate tax rate to 21 per cent from 35 per cent, and shifted the US 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.

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Financial services firms are particularly affected, because they tend to borrow more than other industries and have high interest expenses, factors that can minimise the value of the foreign taxes they pay to offset their US 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.

Tax writers had intended for the Gilti levy to target companies like Apple Inc. and Pfizer, which for decades have routed income from royalties, trademarks and patents through tax havens. They created the tax, which effectively sets a 10.5 per cent 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 per cent, or 16.4 per cent after 2025. In practice, tax practitioners say that’s not what will happen for US banks with operations in countries like the UK, Germany or France, where they can end up owing Gilti even though they’ve paid foreign taxes at 19 per cent (the UK), about 30 per cent (Germany) and 33 per cent (France).

Part of the issue has to do with new limits established for foreign tax credits that companies use to reduce their US 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.

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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.

Those expenses end up shrinking the foreign income pile on which the company owes US tax, in turn diminishing the value of credits for foreign taxes they’ve already paid on those units. The result for companies with large expenses can be a higher Gilti bill.

Every dollar of expense allocation may cause an incremental 21 cents of US tax, according to estimates included in a memo called “A Gilti Trap Waiting to Spring” by management consultants Alvarez & Marsal Inc.

Companies can now use only 80 per cent of foreign tax credits when calculating Gilti, a major shift from nearly a century of law during which the credits were a dollar-for-dollar reduction in taxes. And companies can’t carry forward credits or “cross credit” them to other pots of income, like active earnings by foreign branches, that aren’t caught up by Gilti.

“It’s ‘Oh my gosh, I paid all this foreign tax, but I don’t get to use all these credits,’” Mr Sites said.

The US Chamber of Commerce has requested “regulatory relief in this space because Congressional intent was to limit US tax liability when the foreign tax rate is 13.125 per cent or higher,” said Caroline Harris, the group’s chief tax policy counsel.

The Securities Industry and Financial Markets Association, a trade and lobbying group, has also comment to Treasury on behalf of its members to ensure the regulations reflect Congress’s intent, said Payson Peabody, a managing director and tax counsel for federal government relations at Sifma.

A Treasury Department official said Treasury’s working on regulations that will clarify how expenses are to be allocated for purposes of the Gilti calculation.

Meanwhile, banks and investors are left with uncertainty.

“Your effective tax rate depends on your foreign taxes and the extent to which you can claim credits for foreign taxes paid against US tax,” said Manal Corwin, KPMG’s principal-in-charge of Washington national tax - international tax policy, and a former Treasury official.

Bank of America said in its first-quarter earnings report that its savings from the corporate tax cut were “somewhat offset by an increase in US taxes related to our non-US operations,” while Citigroup said in its 2017 year-end report that it was still trying to assess Gilti’s effects.

“Gilti is one area where the larger banks have not done much disclosure whatsoever,” said Todd Castagno, an equity strategist and accounting analyst at Morgan Stanley. “We don’t have a good gauge of how material it will ultimately be.”