Offshore cash

A common trait among multinationals known for avoiding US taxes, is that they hold large amounts of cash overseas. By doing so, they are able to defer tax payments until they repatriate these earnings. The time horizon of deferral, however, is oftentimes undefined, which means that such funds could in practice be held offshore indefinitely. In this subchapter, we estimate Pfizer’s total offshore cash reserve, and examine how this has developed historically.

6.4.1 Reported permanently reinvested earnings

Companies are required to report the amount of permanently reinvested earnings (PRE) held offshore in their annual 10-K SEC filing. By assessing the historical filings of Pfizer, we retrieve the development of Pfizer’s reported PRE in the period 1995 to 2016. This is illustrated in Figure 6.3, which shows the increasing trend of Pfizer’s reported earnings that are intended to be indefinitely reinvested overseas. Starting with $3.3 billion in reported PRE in 1995, the amount has increased dramatically over the 21-year period. In their latest SEC filings as of December 31, 2016, Pfizer reports $86 billion of unremitted earnings from their international subsidiaries. Also noticeable from figure 6.3, is the two significant dips in reported PRE in 2005 and 2009.

Figure 6.3: Reported PRE 1995-2016

The first dip represents the US repatriation tax holiday which became effective in October of 2004. The tax break was included in the larger legislation of The American Jobs Creating Act of 2004, with the intention of incentivizing multinational companies to repatriate offshore profits, in order to increase US investments and spur job growth. During the tax holiday, multinational companies could repatriate offshore earnings at a tax rate of 5.25%, rather than the 35% existing corporate tax rate (Sullivan, 2011). Pfizer, along with many other US multinationals, took advantage of this opportunity and repatriated $37 billion of foreign earnings (NY Times, 2008).

After having been given a strong incentive to repatriate offshore profits in late 2004, Pfizer’s reported PRE increased steadily until the next dip in 2009, where Pfizer repatriated $34 billion of foreign earnings to finance the acquisition of Wyeth, a $68 billion deal (Sullivan, 2013).

Even though the repatriation of foreign earnings triggered a deferred tax liability of $25 billion and a $10 billion tax obligation, Pfizer managed to limit the tax payment’s impact on its publicly reported profits. This was done using a legal accounting quirk that allowed Pfizer to draw down $10 billion of its new deferred liability through its income statement, which would offset the tax obligation (Bloomberg, 2010). Since then, Pfizer’s reported PRE have more than doubled.

6.4.2 Adjusted permanently reinvested earnings

Pfizer also reports a deferred tax liability named unremitted earnings in their 10-K SEC filings.

This balance sheet item reflects a deferred US tax liability on offshore profits that Pfizer would eventually pay upon repatriation of the foreign profits not defined as PRE. In effect, Pfizer has a second PRE account, that we call the “Stealth PRE”. As of December 31, 2016, Pfizer has accumulated $23.108 billion in deferred US tax liability on the Stealth PRE, but has yet to pay any actual US taxes on the foreign earnings. Figure 6.4 shows the development of the deferred US taxes on unremitted earnings in the 1995-2016 period.

Figure 6.4: Deferred US taxes on unremitted earnings 1995-2016

Knowing that the cumulated deferred US tax liability on offshore profits is a liability for US taxes having to be paid upon repatriation, we can estimate the second Stealth PRE account.

Since: 𝑆𝑡𝑒𝑎𝑙𝑡ℎ 𝑃𝑅𝐸 ∗ 𝑇𝑎𝑥 𝑢𝑝𝑜𝑛 𝑟𝑒𝑝𝑎𝑡𝑟𝑖𝑎𝑡𝑖𝑜𝑛 = 𝐷𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑈𝑆 𝑡𝑎𝑥𝑒𝑠 𝑜𝑛 𝑢𝑛𝑟𝑒𝑚𝑖𝑡𝑡𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠, we know that 𝑆𝑡𝑒𝑎𝑙𝑡ℎ 𝑃𝑅𝐸 =𝐷𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑈𝑆 𝑡𝑎𝑥𝑒𝑠 𝑜𝑛 𝑢𝑛𝑟𝑒𝑚𝑖𝑡𝑡𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠

𝑇𝑎𝑥 𝑢𝑝𝑜𝑛 𝑅𝑒𝑝𝑎𝑡𝑟𝑖𝑎𝑡𝑖𝑜𝑛 . Tax upon repatriation is given by the difference between the statutory US tax rate of 35% and the tax rate already paid on the offshore profits. Thus, the actual size of the Stealth PRE depends on how much Pfizer has already paid in foreign taxes. We use a 5-year moving average on Pfizer’s ETR on international operations to estimate the tax rate paid on offshore profits. With a 5-year average ETR on international operations of 12.06% in 2016, Pfizer has an additional Stealth PRE of

$100.745 billion¹². Pfizer’s offshore cash therefore amounts to an adjusted PRE of $186.745 billion in 2016. The adjusted PRE is apportioned between a reported PRE of $86 billion, profits never to be repatriated back to the US, and $100.745 billion of Stealth PRE, profits Pfizer should repatriate back to the US. Figure 6.5 shows Pfizer’s adjusted PRE in the period 2010-2016, and how it is distributed between reported and Stealth PRE.

Figure 6.5: The composition of Adjusted PRE 2010-2016

The Offshore Shell Games report (2017) that assesses the use of tax havens by Fortune 500 companies, also estimates the profits held offshore by the Fortune 500 companies. In 2016, The Offshore Shell Games estimates Pfizer’s offshore profits to be $198.9 billion, the second highest amount held offshore, only beaten by Apple who holds an estimated $246 billion. Our estimate of Pfizer’s adjusted PRE is conservative compared to Offshore Shell Games, where the difference most likely stems from different assumptions made regarding the calculation of the tax upon repatriation. Nevertheless, Pfizer has huge amounts of foreign earnings being held offshore, effectively utilizing the accounting standard APB 23. Pfizer does not disclose information on how and where their offshore profits are invested. According to The Offshore Shell Games (2017) report, offshore profits are often housed in banks or invested in assets situated in the US through foreign subsidiaries. American corporations thus benefit from the stability of the US financial system, without paying taxes on their profits apparently invested offshore.

Increased R&D: A weak rationale for holding profits offshore

A company spokeswoman for Pfizer commented on their stashing of offshore profits by stating that their aim is to level the playing field with foreign competitors, and to have more resources to accomplish their purpose of bringing more innovative therapies to patients (Wall Street Journal, 2015). A critical component for a pharmaceutical company to be able to produce innovative therapies and discover new medicines, is research and development (R&D).

However, taking a look at the historical R&D expenses of Pfizer, there are no signs of Pfizer’s offshore earnings being invested in R&D. Evident from Figure 6.6 is the relatively flat R&D

spending measured in percentage of total revenue, compared to the dramatically increasing offshore earnings (only including the reported PRE).

Figure 6.6: R&D in % of sales vs. Reported PRE 1995-2016

Looking at Pfizer’s development of reported PRE, there are no indications of Pfizer being willing to repatriate their offshore profits, unless they are given incentives similar to the 2004 repatriation tax break and the 2009 acquisition of Wyeth.

Estimation of taxes owed on offshore profits

An accurate measure of Pfizer’s offshore profits is necessary in order to estimate the taxes owed on these earnings. We have already disclosed that Pfizer’s offshore profits is comprised of two parts; the publicly reported PRE, and the Stealth PRE obtained from Pfizer’s SEC filings. Table 6.7 presents an estimate of Pfizer’s total tax liability on offshore earnings. We use a 5-year average foreign tax rate to find the estimated repatriation tax rate of 22.9% in 2016. This yields $19.726 billion in US taxes owed on their reported PRE. In addition, Pfizer has already disclosed $23.108 billion in deferred tax on unremitted earnings. The total estimated tax owed on offshore profits is therefore $42.834 billion.

0 20 40 60 80 100

0%

4%

8%

12%

16%

20%

USDbn

Reported PRE R&D in % of sales

Table 6.7: An estimation of taxes owed by Pfizer on their offshore profits

Estimated Tax Owed on Offshore Profits

$ million

Reported PRE, 2016 86,000

5-year Average Foreign Tax Rate 12.1 %

US corporate tax rate 35.0 %

Repatriation tax 22.9 %

Estimated tax owed on PRE (22.9%) 19,726

Deferred tax on unremitted earnings 23,108

Total estimated tax owed on offshore profits 42,834