Published on Sunday, May 8, 2005 by the New York Times
Tax Break Gives Huge Benefits to Drugmakers
New law allows corporations to pay 5.25% instead of 35% on foreign profits that are returned to US
by Alex Berenson
WASHINGTON - A new tax break for corporations is allowing the biggest American drugmakers to return as much as $75 billion in profits from international havens to the United States while paying a fraction of the normal tax rate.
The break is part of the American Jobs Creation Act, signed into law by President Bush in October, which allows companies a one-year window to return foreign profits to the United States at a 5.25 percent tax rate, compared with the standard 35 percent rate.
Any company with profits in other countries can take advantage of the law, but the drugmakers have been the biggest beneficiaries because they can move profits overseas relatively easily, independent analysts say.
The money the companies are bringing home has come from many years of using legal loopholes in the tax law to aggressively shelter their profits from U.S. taxes, tax lawyers say. While the companies' tax returns are private, fragmentary information about their tax payments is buried inside their annual financial statements.
Those figures show that the drugmakers have told the Internal Revenue Service for years that their profits come mainly from international sales, even though prescription drug prices are far higher in the United States than elsewhere and almost 60 percent of their sales take place in America.
Representatives of most of the big drug companies declined to comment beyond their annual reports, but in a statement Eli Lilly noted that several factors depressed its United States profits, while Pfizer said it was following the intent of the law.
Though the companies stand behind their accounting, financial analysts and tax lawyers say that the drugmakers' claims defy reality and that their profits come mostly from sales in the United States. But the IRS lacks the resources to challenge the companies effectively, the analysts and lawyers say. As a result, the six major companies -- Pfizer, Johnson & Johnson, Merck, Bristol-Myers Squibb, Wyeth and Lilly -- collectively pay a federal tax rate of less than 15 percent on their worldwide profits, and some companies pay much less.
Already, four of the six drugmakers have collectively announced plans to return $56 billion in profits to the United States. Two others say they are still considering but could repatriate an additional $18 billion. Had the six companies faced standard federal taxes on those profits, they would have paid $26 billion to the United States. Instead, they will pay less than $4 billion. Chris Senyek, an accounting analyst at Bear Stearns, said drug companies would probably make up about half of all the money repatriated by publicly traded companies.
During this window, returning money to the United States is to the advantage of the companies because they can spend the cash here rather than having to use it overseas as tax laws generally require. Lawmakers have said their main intention for the law is to encourage U.S. companies to build new operations and hire workers. Congress passed the law in response to pressure from the European Union to resolve a long-running trade dispute.
Although the act is intended to create jobs, Pfizer said last month that it would cut its annual costs by $4 billion over the next three years. Pfizer, which will repatriate at least $28 billion under the act, did not say how many jobs it planned to eliminate, but analysts expect the company to shrink its workforce by thousands of people. Senyek said the law would create an insignificant number of jobs because companies can easily work around provisions in the law meant to stop them from using the money for dividends to shareholders rather than new hiring.
After the break expires, companies will probably go back to stockpiling profits overseas as they wait for another tax holiday in a few years, tax lawyers say.
The major drugmakers use a variety of complex but legal tactics to move profits from the United States to low-tax countries like Ireland and Singapore where they have large manufacturing operations, said H. David Rosenbloom, director for the international tax program at New York University Law School.
"The law is complicated, but what's going on is perhaps less complicated, " he said. "They're doing everything they can to maximize their profit in Ireland and minimize the profit in the countries where the sales occur."
The government can challenge the way the companies allocate their profits internally. But the companies have usually been able to defeat the IRS, Rosenbloom said.
"There's a limit to what they can do, because these cases are huge. They're very expensive," Rosenbloom said of the IRS.
The companies declined to discuss the specific strategies they use to minimize taxes. But the result of their efforts can be seen in a remarkable set of figures inside their annual financial reports.
Pfizer, the world's largest drug company, said that in 2004 it had only $4.4 billion in pretax profits in the United States, compared with $9.6 billion internationally, though most of its sales came in the United States. The company says that its profit margins on international sales were almost three times as high as on U.S. sales.
Other companies reported similar trends. The biggest imbalance occurred at Eli Lilly, which reported that it had about $200 million in profits from U. S. sales in 2004, compared with $2.8 billion in profits from sales everywhere else.
Collectively, the six drugmakers paid about $6 billion in federal and state taxes, a fraction of their pretax worldwide profits of $43 billion.
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