During the Senate Finance Committee's May 11 hearing on "Cross-border Rx: Pharmaceutical Manufacturers and U.S. International Tax Policy," Democratic members and some witnesses criticized perceived profit shifting by the pharmaceutical industry even after enactment of the 2017 TCJA's guardrails, while Republican members expressed concern about the effect of the OECD-led Pillar Two global minimum tax on US MNCs, particularly the undertaxed profits rule (UTPR) and treatment of US tax credits including the R&D tax credit.

In effect, it was the tale of two hearings. The SFC Democratic majority released a report ahead of today's hearing finding that large pharmaceutical companies report a collective 75% of taxable income in foreign subsidiaries, including for some drugs that are household names in the US. Republicans, meanwhile, used the hearing to focus on Pillar Two and the UTPR. The UTPR allows a country to increase taxes on a multinational company if that company has a taxable presence in the UTPR country and another subsidiary or branch of the parent company pays less than the global minimum tax of 15% in another jurisdiction. The UTPR "backstop" rule has been a particular target of Congressional Republicans in recent hearings, including during the March 16 Finance hearing with Secretary Yellen, arguing that the UTPR could have the impact of diminishing the value of US tax incentives like the R&D tax credit.

Near the close of the hearing, Chairman Ron Wyden (D-OR) noted the differing takes and priorities between the parties on the international tax issues, remarking that Republicans must be participating in a different hearing given their lack of stated concern about pharmaceutical company profit shifting.

Witnesses at the hearing were:

• Brad Setser, Council on Foreign Relations
• Daniel Bunn, Tax Foundation
• Diane Ring, Boston College Law School
• William Morris, PwC

In testimony and Q&A, Setser said the pharmaceutical industry by and large keeps its intellectual property offshore, structures their businesses to shift the profit from their US sales to their offshore subsidiaries and, by extension, shifts production and jobs to other jurisdictions.

Under questioning from Chairman Wyden about increasingly low post-TCJA effective tax rates for corporations, Ring said that results from a combination of the global intangibles low tax income (GILTI) tax rate being lower than the US corporate tax rate, a provision of the GILTI regime that provides an exception for income related to tangible property in a country, and the fact that GILTI applies on a global averaging basis rather than a country-by-country (CbC) calculation. Some Democrats have sought to address all of those aspects in proposed legislation that doesn't appear poised to move in a divided Congress.

Ranking Member Mike Crapo (R-ID) countered that the discussion by Democrats of the 2017 law doesn't take into effect the fact that the TCJA broadened the tax base. He focused more so on Pillar Two's disparate treatment of investment incentives and questioned why the R&D and other US tax credits receive punitive treatment compared to subsidies employed by other countries. Senator Crapo further questioned OECD administrative guidance providing that a country imposing a qualified domestic minimum tax up tax (QDMTT) has priority over US GILTI, saying the OECD sanctioned a pathway for a 15% minimum tax and Treasury agreed to give this priority over GILTI. Bunn said guidance has been a moving target since the original rules came out in December 2021, the most recent guidance clarified the Pillar Two ordering rules allows a country with a QDMTT to impose the QDMTT top up tax even if a US company suffers GILTI on that same income, and he claimed the effect will be a reduction in GILTI revenues.

Senator Debbie Stabenow (D-MI) lamented that drug prices have increased faster than inflation. She asked how lawmakers can build upon the 15% corporate alternative minimum tax (CAMT) enacted as part of the 2022 Inflation Reduction Act (IRA). Ring responded that the US already has GILTI and could move to shore it up through a higher tax rate and CbC calculation. She said the CAMT as written will apply to no more than 150 companies and it is not applied on a CbC basis, so the same concerns resurface there as well.

Senator Chuck Grassley (R-IA), a former Finance Chairman who serves as Budget Committee Ranking Member as the committee holds hearings on tax fairness, said the US originally entered the OECD negotiations as a response to other nations' digital services taxes (DSTs). He said foreign countries continue to threaten DSTs and the OECD-led agreement provides them an invitation to tax the US profits of US companies under the UTPR. He asked how the UTPR runs afoul of bilateral tax treaties. Morris said, on the UTPR, that a number of lawyers and academics have expressed the view that it runs contrary to US tax treaties. His testimony said, "Contrary to longstanding international tax treaty practice, it also gives countries the right to tax income not earned in their jurisdiction based on calculations not necessarily agreed to by the home country. The compatibility of the UTPR with tax treaties seems likely to be litigated."

Senator James Lankford (R-OK) said he is amazed that Treasury has been negotiating with other countries such that other nations' subsidies for R&D, etc., are not penalized through the Pillar Two rules but US credits do not receive this favorable treatment. Senator Todd Young (R-IN) also asserted that the OECD Pillar Two rules confirmed that the US R&D tax credit will receive less-favorable treatment than other foreign countries' subsidies.

Senator Bob Casey (D-PA) said that unlike the average family, corporations have the raw power to design and implement legal maneuvers to lower taxes. Profit shifting in the pharmaceutical industry is emblematic of a wider problem, he said, as the IRS has reported that American companies book billions in the Cayman Islands. Asked whether GILTI was a success, Setser said no, American companies are still reporting significant profits in tax havens and only a fraction in other nations. He said some companies have repatriated IP and have a more US-based tax system, but other companies have not, including most of the large pharmaceutical companies. Senator Sheldon Whitehouse (D-RI), the Budget Committee Chairman who is bringing a renewed focus on tax fairness to that committee, invoked the memory of former Senator Kent Conrad (D-ND), who during speeches would display a poster of Ugland House, the modest building in the Caymans that served as the on-paper home of thousands of corporations.

Senator Mark Warner (D-VA) asked if Pillar Two is indeed going forward. Ring said just this week Australia outlined its timetable and we need to appreciate the seriousness of Pillar Two implementation. Asked whether there is any indication that other nations are willing to reopen the full negotiation, Ring said no, and that instead the OECD continues to produce implementation rules and details that are being incorporated into foreign law. Senator Warner observed that even some of the biggest backers of the 2017 law acknowledge they didn't get it completely right on GILTI. However, he added that some in the business community are burying their head in the sand and pretending Pillar Two is not happening. "The world is moving forward on Pillar Two," he said, adding that there are ways it can be implemented that don't penalize US MNCs and implored companies to coordinate with lawmakers on the issue.

Materials from the hearing are available here.

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