'Orwellian' offshore tax will hit some firms harder than others

The name given to a new, multibillion-dollar business levy implies that it targets foreign earnings from "intangible" intellectual property — hitting tech firms and drugmakers such as Apple and Pfizer.

But observers agree that the little-understood "global intangible low-taxed income" levy, or GILTI, will also apply to earnings that go far beyond patents, royalties and licensing, and could end up snaring many global firms that earn little such income. Private-equity partnerships that aren't publicly traded stand to pay rates three times as high as their corporate competitors', tax lawyers say. Law and advertising firms with overseas offices may also be hit — as will many U.S. companies that make "excess" profit from foreign plants, equipment and inventory.

"Orwellian" is how James Duncan, of the law firm Cleary Gottlieb Steen & Hamilton LLP, described the tax in a Dec. 20 webcast. "Its most significant effect is on income that is neither intangible nor low-taxed."

GILTI has been commonly viewed as a minimum tax on foreign earnings from intangible property, one that's meant to prod American technology and pharmaceutical companies into holding their valuable intellectual properties in the United States. Currently, many hold their patents in subsidiaries in Ireland or other low-tax countries.

Yet the tax "doesn't attempt to actually characterize income as tangible or intangible," said David Miller, a lawyer with Proskauer Rose LLP. It will apply to both, Miller and others said.

In writing the biggest tax overhaul in three decades, congressional Republicans made two major changes for corporate income taxes: They cut the rate to 21 percent from 35 percent, and they ended the tax's "global" reach.

For years, the American system has taxed corporations on their foreign profits, but allowed them to defer paying that tax until they brought their overseas earnings back to the U.S. The new system ends that deferral — and will require companies to pay a cut-rate tax on an estimated $3.1 trillion in income that they've stockpiled offshore.

At the same time, the legislation's drafters sought new ways to prevent companies from shifting profit offshore — to countries with tax rates even lower than the new 21 percent corporate rate. The GILTI is key to that effort; for corporations, the tax applies only in cases in which a company's cumulative overseas tax bill is below a minimum threshold.

The new tax applies to excess foreign profit, and it allows significant deductions that — for those eligible — take its effective rate to 10.5 percent through 2025. After that, the rate increases to a little more than 13 percent. Next year, corporations could take a 50 percent deduction and an 80 percent credit for foreign taxes they've paid. Together, the provisions mean that any corporation that pays foreign taxes at a rate of at least 13.125 percent could avoid the GILTI entirely before the rate rises in 2026.

But those low rates are available only for corporations. Partnerships and other so-called pass-through entities would face much higher rates on some foreign income. Pass-through entities don't pay taxes themselves, but pass their income to their owners, who pay tax at their ordinary rates. As of Jan. 1, the top individual income rate is 37 percent.

In effect, experts say, a corporation would pay no more than $10.50 on every $100 of income that's hit by the GILTI. A pass-through would pay as much as $37.

Three other tax experts — Proskauer Rose's Miller; David Sites of Grant Thornton LLP; and Robert Scarborough of Freshfields Bruckhaus Deringer LLP — agreed that global private-equity partnerships that are not publicly traded wouldn't be eligible for the GILTI deduction.

Moreover, a separate tax break for partnerships and other pass-throughs applies to domestic income only — not to the global earnings caught up by the GILTI. Scarborough said the tax will hurt such firms as Bain, TPG Holdings and Warburg Pincus, which are all private. By contrast, he said, Blackstone Group, Apollo Global Management, and Carlyle Group — all partnerships traded like corporations — would get the GILTI deduction.

Generally speaking, the GILTI will apply to many companies that might not seem to depend on intellectual property. Potential payers "will include lots of other businesses that don't depend on factories or turbines to make money," said Cleary Gottlieb's Duncan.

It is estimated the GILTI will raise $112.4 billion over a decade.