Pharma-friendly tax reform is a tall order

The group of people happiest about the prospect of a major rewrite of US tax laws might be deal bankers. A shift to a “territorial” system of taxation could allow cheap repatriation of $130bn in overseas profits at US-based big pharma companies, giving them new funds for acquisitions.

Dropping the statutory corporate rate to 20%, meanwhile, could result in a number of big pharma groups falling to single-digit effective tax rates. This is no easy bill to pass, however – and with a host of pressing matters such as a budget for next year facing legislators, the chances that tax reform is pushed into a congressional election season in 2018 are high.

Single digits?

President Donald Trump yesterday unveiled the tax plan, which was negotiated between his administration and congressional Republican allies. The administration had earlier released a vague proposal that called for a 15% corporate tax rate, but the current proposal is still a 15-point drop below the current statutory levy of 35%.

Few corporations pay the 35% rate, though, and thanks to such things as R&D tax credits the average effective big pharma tax rate is 19% (How low can you go? US pharma already shoulders light tax burden, April 27, 2017). It is conceivable that with a 15-point drop companies like Pfizer, Amgen, Celgene and Merck & Co, with effective rates in the mid-teens, could fall into the single-digit range.

Equally important would be the proposed shift to “territorial” taxation – that is, applying taxes only on income from US-based activity. This would permit repatriation of current ex-US cash derived from profits at overseas subsidiaries to be returned to the US-based parent at a low rate, and allow future profits to be repatriated at the same low rate.

Evercore ISI analyst Umer Raffat wrote earlier this week that the eight big-cap companies he covers had more than $130bn in overseas cash that could be brought home.

Indeed, big pharma would be one of the sectors benefiting most from a territorial system and low repatriation taxes; the liberal-leaning Center for Budget and Policy Priorities notes that in the last “repatriation holiday” in 2004 the pharmaceutical sector accounted for 32% of the cash returned to the US. The pharma and technology sectors accounted for $140bn in repatriated cash.

Creating jobs or enriching shareholders?

What pharma companies will use the cash for is unclear. A congressional report on the 2004 holiday suggested that there was an acceleration in share buybacks, but not in R&D spending.This will not dissuade the deal bankers, who will see opportunities for newly flush pharma groups.

And indeed even Pfizer's chief executive, Ian Read, has said his company will wait for a resolution to the tax reform question before making any major strategic decisions – although he said the uncertainty was more about valuation than about tax reform making deals more likely. 

Should a “territorial” tax scheme be successfully implemented it could conceivably make international takeouts by US pharma companies less complicated and thus more lucrative – and would certainly provide less incentive for companies to “invert” to an overseas domicile, as Pfizer sought to do twice. As it is, US buyouts of EU groups have been uncommon of late (Few M&A teams venture beyond domestic borders, August 24, 2016).

Having the White House and congressional leadership aligned on tax reform is just one step on the path to enactment. In particular, getting through the almost evenly divided Senate will prove difficult.

If the debate stretches well into the 2018 election season some members might grow nervous about voting for a far-reaching bill that includes corporate tax cuts – and is particularly beneficial for the unpopular pharma sector – compared with a smaller package that benefits middle-class individuals. Building a coalition that can pass this will prove much more demanding than drafting a plan that Republican leaders can agree to.

To contact the writer of this story email Jonathan Gardner in Virginia at jonathang-us@epvantage.com or follow @ByJonGardner on Twitter

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