By Dwight Cass
Despite some encouraging signs, companies could still have a few sleepless nights.
Corporates began 2013 with some reasonably good news. The skin-of-your-teeth fiscal cliff deal, despite the weakness of its Congressional support and the strength of the tax hikers at the negotiating table, nonetheless contained some $46 billion of corporate tax breaks. Unfortunately, these sops to Nascar, rum makers, Goldman Sachs and Hollywood don’t help the overall drive for corporate tax reform.
Corporates also dodged bullets on high-profile issues such as dividend taxes and the taxation of their overseas cash hordes. However, these issues could come up again in the next round of negotiations, which will attempt to deal with the sequestration part of the Fiscal Cliff in February.
Wishful Thinking
Since Japan lowered its corporate income tax rate, the US has had the highest rate in the OECD, according to lobbying group Business Roundtable. The OECD average, the group says, is 25 percent. But corporate taxes are now equivalent to only one percent of US GDP—the lowest level in 30 years, according to the FY11 Federal Budget—in an environment where taxes overall are absorbing some 15 percent of GDP (and spending equals some 25 percent of GDP). So any net decline in corporate taxes, either through a rate cut or more generous loopholes, would leave the government almost entirely financed by individual taxpayers—a prospect that is hard to imagine in the current political climate.
After largely winning the battle to keep corporates’ tax burden from rising during the Fiscal Cliff negotiations, Republicans are saying that they will not consider any further tax increases, and insisting that the negotiations focus on spending cuts. Senate Republican boss Mitch McConnell said in early January that taxes are off the table.
But McConnell’s negotiating advantage, the debt ceiling deadline, could turn out to be ephemeral. If the Obama administration were to somehow defuse the debt ceiling issue with some clever means (the $1tn coin is now off the table, the White House says), McConnell’s corporate constituents could find themselves forced to pay more into government coffers.
Known Knowns
A number of tax changes have already kicked in this year. Most of these are increases linked to the Affordable Care Act, or specified in the 2010 budget compromise. For example, as of January 1, the following changes took effect:
- The expiration of full expensing, which allowed the immediate deduction of corporate capital purchases, rather than forcing corporates to abide by the depreciation schedule. President Obama allowed 100 percent capital expensing as part of the 2010 Bush tax cut extension. The Fiscal Cliff deal allows 50-percent expensing for another year as an “extender” to the original measure.
- The Affordable Care Act eliminates the corporate income tax deduction for expenses related to the Medicare Part D subsidy. Employers had been able to claim a deduction for the entire cost of providing a prescription drug coverage plan that is at least as valuable as Medicare Part D, even though a portion of the cost is offset by the subsidy they receive. Obamacare no longer permits that deduction.
- Limitation of the corporate income tax deduction for compensation that health insurance companies pay to their executives. This is another deduction eliminated by Obamacare.
Known Unknowns
Other tax-related issues that would have caused corporate treasurers major headaches have been postponed—but remain lurking on the horizon. Chief among these:
- FATCA, the law that gives the IRS new powers to pursue individual tax cheats that hide overseas investment income, is no longer going to be implemented in 2013. The complexity of the measure and the political sensitivity of the bilateral negotiations with foreign governments to implement it have forced the delay. The implementation will now be done in stages between January 1, 2014 and January 1, 2017.
Hopes that the law would be refined to make its reporting and withholding mechanisms less burdensome for corporates have faded as the US government has entered into implementation agreements with several major trading partners, and negotiations with over 50 other countries to enshrine the extraterritorial measure in international law.
- Overseas cash remains an unresolved issue. The 160 lobbyists hired by a group led by Apple, Google and Cisco to push for a 5.25 percent tax repatriation holiday in 2011, according to Bloomberg, have been unsuccessful. Giving corporates a tax holiday while raising payroll taxes on the middle class seems untenable in the current political environment. And corporates never had a strong case for a repeat of the 2004 tax holiday, since the savings were transferred to shareholders rather than used, as intended, for job creation.
Meanwhile, government inquiries into cash hordes held by large US multinationals are reportedly coming to an end. These stockpiles, especially Apple’s $121bn in overseas cash, have drawn official scrutiny of companies’ transfer pricing policies. If the government decides that these policies are designed to avoid taxation, the companies involved could face massive tax liabilities. For example, a recent article in Wired magazine put Apple’s potential tax hit at $28bn.
- The overseas cash issue would not be a problem if the US were to switch from a global taxation model to a regional one, as most corporates want. The Congressional Budget Office, in a new report, “Options for Taxing US Multinational Corporations,” estimates that moving to a territorial approach could garner the government an additional $76 billion in taxes over ten years (see chart below).
- Carried interest isn’t a topic normally considered a top corporate concern. But the government’s failure to resolve the issue by defining carried interest either as income or capital gains has had some unfortunate effects. If carried interest is defined as income, companies may find their private equity masters becoming more than usually rapacious. Investor pressure on private equity to reduce management fees is growing. If carried interest becomes less lucrative, corporates owned by private equity may find themselves ponying up more management fees and special dividends to their buyout bosses to make up the difference.
Unknown Unknowns
While corporate lobbyists continue to brass it out in Washington, political currents are not running their way. So far, there haven’t been any catastrophic changes in corporate tax policy. But the electorate resoundingly rejected the party that makes the traditional corporate arguments against higher taxes the last election.
Corporate America may find 2013 brings change—just not the kind it wants.