BEAT Up? U.S. Tax Provision May Sting Foreign Firms

(The Wall Street Journal) -- Bill McDermott, chief executive of German enterprise-software giant SAP SE, last month praised the new U.S. tax code, publicly thanking President Donald Trump during a dinner in Davos, Switzerland, “for spurring on all this growth.”

But foreign firms like Mr. McDermott’s may want to hold their cheers. Executives around the world have embraced the overhaul’s big reduction in the federal corporate-tax rate—from 35% to 21%. Less-well-known provisions in the new code, however, could hurt some companies based outside the U.S. and doing business in the country.

One of the biggest potential threats is the base-erosion and anti-abuse tax. Dubbed BEAT, the levy could damp—or even completely offset—any gains that foreign multinationals such as SAP might otherwise expect from the reduction in the U.S. tax rate.

Here is how BEAT is designed to work: If a company generates more than $500 million in annual revenue in the U.S., and its American units make above a specified level of tax-deductible payments to related companies overseas, those units must pay a minimum tax on their U.S. profit after adding back in certain types of deductions. The minimum rate is 5% in 2018, but rises to 10% in 2019 and 12.5% in 2026.

Drafters of the tax law say the provision was meant to discourage companies from inappropriately channeling profit generated in the U.S. to lower-tax regimes.

While U.S.-based multinationals are also concerned about the provision, tax experts say among the harder hit could be non-U.S. companies in the technology, banking and pharmaceutical sectors. Companies in those businesses often pay themselves interest for intracompany loans or for the rights to sell their software or drugs in the U.S., cutting down on their taxable profit in the U.S., according to these experts.

Executives and tax experts are awaiting further guidance on the measure from U.S. Treasury authorities. Depending on how the law is interpreted, it could encourage big foreign companies to reshape their supply chains, entirely outsource some functions or manufacture more finished products outside the U.S. to minimize their taxes, tax experts say.

“It’s bad news for foreign-based multinationals,” said Edward Kleinbard, a former U.S. tax official who is now a tax professor at the University of Southern California’s Gould School of Law . “The bottom line is that this will be very expensive for some firms, and will incentivize them to undergo costly restructurings,” Mr. Kleinbard said.

Take SAP, Europe’s largest software company. It generates billions of dollars in revenue a year via U.S. subsidiaries that sell its enterprise software. It then pays license fees for some of that software to its headquarters in Germany. SAP says that some provisions of the new law “might have an impact” on it, and it is crunching numbers about what hit, if any, it will take from BEAT. “It is not clear yet,” said Luka Mucic, the company’s chief financial officer.

In December, Barclays PLC warned that BEAT “could significantly reduce the benefit of the reduction in the statutory U.S. federal rate.” Credit Suisse Group AG also said its intracompany interest and services payments would be taxed under the measure in 2018, “increasing our U.S. corporate tax liability.”

The new tax in some ways mirrors efforts in Europe to wring more tax from economic activity within its borders. The U.K. in 2015 passed a tax on profits that the tax authority said had been inappropriately shifted to low-tax regimes. The European Union is now weighing proposals to force companies to pay more tax where they do business, including a tax on turnover, rather than profit.

In response to those efforts, American firms and U.S. officials denounced what they called protectionism. Now some Europeans are lobbing the same charge.

“BEAT is a one-sided rule which disadvantages legitimate cross-border payments within companies,” said Karoline Kampermann, deputy head of tax at the BDI Federation of German Industries.

U.S. companies are holding more than $2.6 trillion in profits across the globe and they haven't paid U.S. taxes on it. Why is so much money offshore, and how could the tax code be changed to bring it back? WSJ's tax reporter Richard Rubin dives in. Photo: Heather Seidel/The Wall Street Journal

Steve Hare, chief financial officer for British enterprise-software firm Sage Group PLC, said on a call with financial analysts that provisions in the law acted like a “protectionist regime” that would offset some of the benefits of the U.S. tax cut for foreign companies.

BEAT doesn’t apply to overseas payments for the cost of materials, labor and other inputs for products made in the U.S. Danish drugmaker Novo Nordisk A/S, for instance, imports insulin crystals into the U.S. to fill cartridges that are packaged for sale at American factories. Its U.S. unit pays a manufacturing fee, which would likely be exempted as part of BEAT, rather than a royalty, which wouldn’t. There isn’t an equivalent exemption for services.

Some companies, including Siemens AG , say that BEAT will encourage them to raise capital in the U.S., rather than lending money internally to a U.S. unit as they do now, because their internal interest would incur the tax.

In the long run, BEAT might make it less attractive for some international companies to have a physical presence in the U.S., if that presence would mean large tax payments under BEAT, said Stef van Weeghel, global tax policy leader at PricewaterhouseCoopers LLP.

“There are a number of quite significant questions that international companies have to think about,” Mr. van Weeghel said.

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