Pfizer Inc. (PFE)’s Tax Dodging Rx: Stash Profits Offshore by Americans For Tax Fairness
Author: Frank Clemente, Executive Director, Americans for Tax Fairness
Research and Graphics: Nick Trokel, Researcher, Americans for Tax Fairness Americans
Modern Day Asset Management
ValueWalk's Raul Panganiban interviews Ross Klein, CFA, and Vince Lorusso. Ross is founder and CIO at Changebridge Capital and Vince is Partner and Portfolio Manager at Changebridge Capital where they manage the CBLS, Changebridge Capital Long/ Short Equity ETF and CBSE, Changebridge Sustainable Equity ETF. The following transcript is computer generated and may contain some Read More
Pfizer, one of the world’s largest pharmaceutical companies,1 has announced that it has entered into preliminary discussions with the Irish corporation Allergan to effect a business combination, which most observers assume would be structured as an “inversion” transaction. An inversion would allow Pfizer to renounce its U.S. tax citizenship while retaining its current U.S. headquarters, management structure and facilities.
Pfizer executives have made no effort to hide that their latest inversion attempt is intended to dramatically cut its U.S. tax bill. The company’s leaders say they believe that Pfizer’s worldwide effective tax rate—which was reported as 25.5% in 2014—could be sharply reduced if the corporation’s legal address is shifted to Ireland through an inversion with Allergan.
This report finds that Pfizer appears to be dramatically overstating its corporate tax rate, and that the company may be paying taxes on its worldwide profits that are effectively tax-haven rates. Thus, Pfizer does not appear to be at a competitive disadvantage operating under the U.S. tax system—if anything it is highly advantaged. An inversion would lock in these current advantages and extend them further.
With an inversion, Pfizer essentially would continue to enjoy all the benefits of being an American corporation but just not pay the taxes required for that privilege. Pfizer would not pay its fair share for its educated workforce; use of our transportation systems; the protections provided by our strong judicial, banking and regulatory systems; and so much more that makes America one of the top countries in the world in which to do business, ranking number three according to the World Economic Forum.
Key findings in this report include:
- ATF estimates that Pfizer’s effective (i.e., economic) tax rate on its worldwide income was just 7.5% in 2014, compared with the 25.5% rate the company reported in its Securities and Exchange Commission (SEC) filings. (This finding was also reported in The Wall Street Journal on Nov. 8, 2015) Moreover, ATF estimates that Pfizer’s effective tax rate on its worldwide income from 2010 to 2014 averaged just 6.4% when the company’s filings reported a 24% tax rate. Therefore, up to 75% of Pfizer’s reported taxes may be an accounting fiction. The reason for the discrepancy in estimates is that Pfizer’s numbers include very large provisions (reserves) for U.S. tax that will never actually be paid, unless Pfizer elects unilaterally in the future to incur the tax bill, which seems remote.
- Pfizer had as much as $148 billion in profits parked offshore at the end of 2014, on which it has paid no U.S. income taxes. Pfizer alone controls whether, when and how much of its foreign earnings might actually be repatriated and therefore taxed. This enormous sum is comprised of two piles of profits:
- $74 billion in foreign “Permanently Reinvested Earnings” that Pfizer reports to the SEC –foreign profits on which Pfizer has neither paid U.S. tax nor provided a financial accounting liability for any ultimate U.S. tax due; and
- Up to another $74 billion in “stealth” foreign profits (ATF estimate) on which Pfizer has not actually paid any U.S. tax, but has in its SEC reports created a tax reserve against any U.S. tax that would ultimately be due only if Pfizer should unilaterally choose to “repatriate” those earnings to the U.S., which appears to be unlikely.
- The offshore stash of profits known as Permanently Reinvested Earnings alone has grown nearly three-fold since a repatriation tax holiday in 2004—from $27 billion in 2005 to $74 billion in 2014. When the U.S. government gave companies the tax holiday, charging them just a 5.25% tax rate on offshore profits if they voluntarily brought them home and invested in job creation, Pfizer repatriated $37 billion (the most of any company), took $10 billion in tax savings and promptly laid off 10,000 American workers within two years. Pfizer is looking for a similar tax break on its current offshore profits.
- Pfizer reported losing more than $16 billion in the United States from 2010 through 2014, while it earned $78 billion offshore. This is a major feat that is likely attributable to profit shifting to tax havens, as the company had 38% of its sales and 48% of its assets in the U.S. in 2014. Pfizer has 151 subsidiaries in 10 tax havens. The engine of Pfizer’s profits—development of new drugs—is heavily concentrated in America, as are its patents.
- Pfizer pocketed $5.3 billion in federal contracts between 2010 and 2014, while benefitting from low effective tax rates those years. About 5% of Pfizer’s $20 billion annual U.S. revenue is from the federal government. Yet, Pfizer does not come close to paying its fair share, and it may desert America for a tax haven through an inversion.
- Pfizer’s R&D spending since 2002 has increased while its offshore stash of untaxed profits has skyrocketed, suggesting that the increase in Pfizer’s offshore profits and the U.S. corporate tax rate are not stifling new drug investments. Pfizer’s R&D spending has climbed 1 percentage point since 2002, from 16% of revenue to 16.9% in 2014–while its offshore profits have nearly tripled, rising from $29 billion in 2002 to $74 billion in 2014. One would expect R&D to have plummeted during that time if these offshore profits were critical to financing new drug development.
- The pay packages of Pfizer’s top five executives doubled between 2004 and 2006, the time period when the repatriation tax holiday kicked in. A major criticism of the 2004 tax holiday is that much of the money was spent to buy back corporate stock to boost share prices, which provided a windfall for corporate executives, but did little in terms of creating new jobs. The same is likely to happen if Congress provides future tax breaks on repatriated profits, as it has considered doing.
- Congress can pass legislation that would prevent Pfizer from doing an inversion with Allergan in order to take advantage of the low tax rates in the tax haven of Ireland. Two remedies will take away the tax advantages of an inversion:
- Close the earnings stripping loophole: This would eliminate the ability of Allergan (Pfizer’s new foreign parent under an inversion) to load up its new U.S. subsidiary (Pfizer) with excessive debt that would be owed to Allergan, debt that Pfizer could claim a hefty U.S. tax deduction on thereby reducing its U.S. tax bill and shifting taxable profits to Allergan in low-tax Ireland.
- Enact the Stop Corporate Inversions Act (S. 198 and H.R. 415): These bills would make it very difficult for corporations to desert America for a tax haven, and they would raise $33.6 billion over 10 years, according to the Joint Economic Committee. The bills would not allow for an inversion unless the new foreign parent company acquiring the U.S. company comprised more than 50% of the shareholders. Moreover, the new smaller foreign parent and its U.S. subsidiary would have to pay U.S. taxes if its headquarters remains here and it is managed and controlled from U.S. soil.
Up to 75% of Taxes “Paid” by Pfizer May be Accounting Fiction
Pfizer executives have made no effort to hide that their latest attempt at an inversion, this time with Allergan, is to dramatically cut the company’s U.S. tax bill. The company’s leaders say they believe that Pfizer’s worldwide effective tax rate—which was reported as 25.5% in 2014–could be sharply reduced if the corporation’s legal address is shifted to Ireland through an inversion (or through some other type of merger) with Allergan.
It is difficult to assess the validity of that claim as Pfizer’s financial filings are very murky given the apparently large amount of income shifting the company does from the United States to its 151 subsidiaries in 10 tax havens across the globe.
ATF, with the assistance of tax experts, has analyzed Pfizer’s Securities and Exchange Commission (SEC) filings. A fair reading of those filings is that the company’s reported income tax rates are largely an accounting fiction. Specifically, ATF estimates that Pfizer’s worldwide tax rate was as low as 7.5% in 2014, rather than the 25.5% tax rate Pfizer reported to the SEC. Moreover, Pfizer’s five-year tax rate between 2010 and 2014 averaged just 6.4%, as opposed to the 24% reported to the SEC. [Figure 1] That means the company’s effective tax rate was about 75% lower than it has claimed.
Why do we suggest that Pfizer’s true global tax rate was closer to 7.5% in 2014 and to 6.4% over the last five years? The answers require a deep dive into the arcana of financial accounting for taxes—in particular, deferred tax liabilities. A brief explanation is provided immediately below, with a fuller explanation after that.
As Figure 1 shows, in 2014 Pfizer reported $12.2 billion in worldwide pretax income, and a worldwide income tax provision of $3.1 billion. This computes to the 25.5% tax rate claimed by Pfizer. At the same time Pfizer reported in a tax footnote that the $3.1 billion tax liability in 2014 included $2.2 billion in “deferred” taxes to the U.S. These are taxes the company says it will pay sometime in the future, attributable to foreign profits it plans to repatriate to America. But it did not pay them in 2014 and there is no reason to believe that it will happen in the future.
Subtracting the $2.2 billion from reported worldwide taxes of $3.1 billion leaves about $920 million in actual taxes paid in 2014, which is 7.5% of the $12.2 billion in worldwide income. Figure 1 makes a comparable calculation for the full five-year period of 2010 to 2014.
Detailed Explanation Of Pfizer’s Effective Tax Rate
Most U.S. multinationals elect to designate all of their offshore business profits as indefinitely reinvested outside the United States, which are known as Permanently Reinvested Earnings, or PRE. Under financial accounting rules, if a U.S. firm declares that its offshore profits will be indefinitely reinvested outside the United States (i.e., PRE) then financial accounting treats the foreign income taxes paid as the final taxes on that income. As a result, a company making the PRE designation is not required to create any U.S. deferred tax liability at all with respect to those offshore earnings, because the presumption is that the earnings will not be repatriated as cash to the United States, and therefore will never become subject to U.S. tax.
Pfizer has done just this—it has designated $74 billion in accumulated foreign profits as PRE (see next section).Unlike many other companies, however, Pfizer has not made the PRE designation with respect to many billions of dollars of additional foreign income each year. As a result, Pfizer must provide a financial deferred tax liability (a tax reserve) for the U.S. corporate income tax that theoretically might one day be paid on those offshore profits not designated as PRE.
This is reflected in Pfizer’s 2014 financials, for example, by the disclosure deep in the tax footnotes that Pfizer’s $3.1 billion tax liability in 2014 for financial accounting purposes includes $2.2 billion in “deferred taxes”—taxes the company says it will pay sometime in the future–attributable to foreign profits it plans to repatriate to the United States at some later date.
Normal deferred tax liabilities simply record differences in timing between financial and tax accounting: the deferred tax liability will ripen into a cash tax liability with the simple passage of time. However, when a deferred tax liability is attributable to foreign profits that are not actually subject to current U.S. tax, that deferred tax liability is purely speculative and may very well never be paid. While Pfizer said in its annual report for 2014 that someday it will pay $2.2 billion when the foreign profits are repatriated, there is no reason to believe that will happen. The event that would actually trigger the Pfizer tax bill would be Pfizer’s unilateral decision to repatriate offshore cash, over which Pfizer exercises complete control—in contrast to the ordinary deferred tax liability, which will ripen into a cash tax bill without the firm’s ability to control it.
The company has made a very similar statement in each of the last five years. Since 2010, Pfizer has claimed that it would eventually pay a total of $11.3 billion in U.S. taxes on foreign profits when these profits are eventually repatriated. During this period, the company’s cumulative deferred tax liability for unrepatriated foreign earnings has increased from $9.5 billion to $21.2 billion [Figure 1 and Appendix 1]. Pfizer has not paid any actual U.S. tax on this $21.2 cumulative liability, and need not do so in the future.
In effect, Pfizer created a second “stealth” PRE account that amounts to a pure accounting reserve for U.S. taxes that may never be paid. By our estimate, this second stealth PRE account is roughly as large as Pfizer’s explicit designation of permanently reinvested earnings–i.e., another $74 billion as explained below.
That means up to $148 billion in profits are parked offshore on which Pfizer has not paid and may never pay any U.S. taxes.
This second stealth PRE account is estimated as follows:
- Pfizer has $21.2 billion in cumulative deferred U.S. tax liability on offshore profits, which is a liability for U.S. taxes that might be paid in the future. [Figure 1 and Appendix 1: Cumulative Deferred Tax Liability for Unrepatriated Foreign Earnings] Pfizer has not elected to designate these profits as Permanently Reinvested Earnings.
- Divide that $21.2 billion by the difference between the statutory U.S. tax rate of 35% and Pfizer’s 2010-14 effective tax rate of 6.4%, which excludes this accounting tax charge for offshore earnings that might never be paid to the IRS. This yields a U.S. tax rate of 28.6% (after claiming a tax credit for foreign taxes paid at the assumed rate of 6.4%).
- $21.2 billion in taxes is about 28.6% of $74 billion in profits.
In sum, Pfizer has $74 billion of acknowledged Permanently Reinvested Earnings, which are profits Pfizer is reporting are never coming back. It has another $74 billion or so of “stealth” PRE–profits Pfizer is pretending it will bring back and pay taxes on to make the corporation look respectable to tax authorities, lawmakers and the financial industry. There is no real meaningful difference between these two piles of profits even though they are reported much differently.
Why would Pfizer make this odd decision to provide a U.S. tax charge for repatriating such a large amount of offshore earnings, and then not follow through on it by actually bringing the cash back to the U.S. parent?
One possible reason is that this choice makes it appear that the company is paying a substantial tax rate when it is not. If we take Pfizer’s word that it will eventually pay these taxes, then its effective worldwide tax rate over the past five years seems respectable: on $60.2 billion of pretax income, it has claimed a tax bill of $14.4 billion, for a 24% worldwide tax rate. But if the apparently-fictional deferred taxes on foreign profits are subtracted, Pfizer’s remaining tax bill for these five years is just $3.9 billion, for a 6.4% five-year effective tax rate.
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