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Tech industry girds for tax battle

An Obama administration proposal to change deferral rules riles US multinational tech companies.

By Tam Harbert, Contributing Editor -- Electronic Business, 6/30/2009

The Obama administration hopes to raise some $210 billion over the next 10 years by changing the rules governing how foreign earnings of United States multinational companies are taxed. Although the details are technical, complex, and arcane, the potential impact is big enough to make top technology executives sit up and take notice.

“CEOs and CFOs are paying attention to these potential changes,” said Paul J Sallomi, partner and US tax industry leader, technology, with Deloitte Tax LLP. “Usually it’s just the corporate tax department that’s tuned in to stuff like this.”

In general, the changes would increase taxes on US multinationals. For technology companies -- many of which earn the majority of their revenue outside the United States -- that increase could be substantial.

The administration characterizes the changes, which are included as revenue raisers in Obama’s budget, as removing tax incentives that shift jobs overseas. But tech industry leaders say these tax increases would hurt, rather than help, the US economy. Rather than stimulate domestic investment, the changes would reduce the amount of money technology companies have available to spend on domestic R&D, manufacturing, and expansion, they claim.

Foreign sales “expand our R&D base and our capital expenditures domestically,” according to Peter Cleveland, VP of global public policy at Intel Corp. “We spend $10 billion on those two categories annually,” he said. “If we're doing well overseas, where 95% of the consumers are in this world, then that helps expands our US investment, which expands jobs.”

Obama is offering an olive branch to the industry by proposing to make the R&D tax credit permanent. This would provide a tax cut of $74.5 billion over 10 years to companies that invest in the United States, according to the White House. While making the R&D credit permanent has been a major goal of the tech industry for more than two decades, the offer doesn’t seem to be blunting industry opposition to the overall package. Intel is pleased by the prospect of a permanent credit, said Cleveland. On the other hand, Obama’s not really giving the industry any more than it was already getting, even though the industry has had to lobby for its renewal year after year. “It's very smart on [Obama’s] part to state that he’s going to make it permanent, because that doesn’t affect the fiscal bottom line,” he said. “We were already anticipating receiving it and he was already anticipating us getting it.”

Here are the parts of Obama’s proposal that are causing the most concern for the technology industry:

Limiting deductions for overseas investment: Under current rules, US companies can deduct some of the expenses associated with their foreign activities. Under Obama’s plan, such deductions would be deferred until the foreign earnings from those operations are brought back to the United States. The administration estimates this would raise $60.1 billion in tax revenue from 2011 to 2019. Obama would specifically exempt R&D investments overseas, so companies could still continue to deduct those expenses. That exemption has less impact on the US semiconductor industry, however, which focuses 75% of its R&D spending within the United States, according to the Semiconductor Industry Association.

Changing the US tax credit for foreign taxes paid: Today, US companies can claim a US tax credit for foreign taxes paid on repatriated dividends. The amount of the credit depends on the amount of tax paid in the specific country where the profits were earned. Thus, repatriated earnings from a high-tax country receive a larger credit than repatriated earnings from a low-tax country. Obama wants to change how these credits are calculated, the net effect of which would reduce their value to US companies. The administration estimates this would raise $43 billion from 2011 to 2019.

Changing the check-the-box rules: Companies currently are allowed to determine how certain foreign entities are classified. Obama’s changes would require some foreign subsidiaries to be considered separate corporations for US tax purposes. The White House estimates this would raise $86.5 billion from 2011 to 2019.

Overall, the administration is suggesting “pretty sweeping changes to well-established rules,” said Sallomi. If Congress approves the provisions, companies will have to conduct a comprehensive review of their global activities, said Sallomi. “They’ll have to consider the impact on their ability to move cash in order to make appropriate business investments and the cost of doing that,” he said. “They will have to revisit their entire supply chain to determine whether modifications would need to be made in the way they do business, and they'll have to assess the impact it'll have on their US cash tax obligations.”

In June, the SIA’s board of directors met with administration officials, laying out its arguments against the changes, according to Patrick Wilson, director of government affairs for the semiconductor industry group. The executives pointed out that such an increase in taxes would reduce profits and thus make it harder for them to invest in domestic operations. In addition, they could create some unintended consequences, making small, innovative American chip companies more attractive acquisitions for foreign multinationals because of the tax savings that would materialize once these companies were foreign-owned, noted Wilson. “The tax increases proposed, whatever their so-called targeting, will not create the revenue projected precisely because they will further incent innovation to move elsewhere,” he said.

Intel will continue talking with the Administration over the summer months, “trying to find a positive way forward,” said Cleveland. Specifically, the tech industry is exploring ways to make changes “that will allow the administration to raise the money it needs without disproportionately impacting technology companies.” One idea, said Cleveland, is to delay the changes for a year, when the Bush tax cuts are scheduled to expire.

Indeed, Sallomi said he thinks it would be more appropriate to review such major changes within the context of broad tax reform, rather than in the narrow context of raising revenue.

However, given the pressure to raise revenue, observers say there’s a good chance that Congress will move quickly on the measure.

White House May 4 announcement

General Accountability Office report on tax havens