Foreign tax credits

This docs not include over 900 million foreign tax credits. Unlike other tax credits which are designed to stimulate certain types of behavior among taxpayers, foreign tax credits are simply a mechanism to prevent U S. firms from being taxed twice on income earned in another country. 

Among other tax credits of the Federal Tax Code, two provisions are of particular relevance to the pharmaceutical industry the foreign tax credit system and the possessions tax credit. While these credits do not represent direct subsidies to the firm s R D costs, there are at least two reasons to consider their importance for pharmaceutical R D. First, they indirectly affect the location and amount of R D. These credits affect the after-tax cost of doing business in political jurisdictions outside the United States. Second, they affect pharmaceutical firms returns to R D. 

All major U.S. pharmaceutical firms are multinational and are taxed under the U.S. tax code on the basis of their worldwide income.19 This creates the potential for double taxation of foreign source income. Because most other nations have mechanisms to prevent double taxation, the United States would beat a competitive disadvantage without a similar policy here as well. For this reason, the United States has adopted a foreign tax credit system allowing multinational corporations to credit tax payments they make to foreign treasuries against their domestic income tax obligations (26 U.S.C. 861). Because the credit is... 

A firm s excess foreign tax credits may be carried back to offset tax obligations for up to 2 prior years or carried forward to offset future tax obligations for up to 5 years. However, unused credits do not earn interest over time. 

For the pharmaceutical industry, however, the possessions tax credit may be more important than the foreign tax credit.27 More than half of the total credit was claimed by firms in the pharmaceutical industry, and, on average, it reduced each fro s tax liability by more than a third. The percentage deduction in tax liability was greater for smaller companies (those with assets 250 million) than for larger companies, which suggests size may not be a barrier to establishing a subsidiary in Puerto Rico. 

General business credits were claimed by firms of all sizes in this industry and reduced the taxes owed by the smallest companies (those with assets under 50 million) by almost 4 percent more than for larger fins. Although genera-1 business credits for drug companies cost the Treasury 17 times more than the orphan drug credit in 1987, it still totaled less than 10 percent of the foreign tax credit and only 6 percent of the possessions credit claimed by this industry. 

Table 8-4 presents estimates of tax credits claimed by firms in pharmaceutical firms (PAC 2830) in the 1984-87 period.30 Whereas all of the credits increased in the 1984-86 period, the possessions, orphan drug, and general business credits dropped between 1986 and 1987, the first year after tax reform. Of these three, only the general business credit registered a major decline (48 percent). It is likely that the dramatic decline between 1986 and 1987 in this set of credits is attributable to the elimination of the Investment Tax Credit in the 1986 Tax Reform Act (297). The foreign tax credit actually increased between 1986 and 1987. Despite the evident trends, the numbers indicate that the relative magnitude of these credits remained roughly steady between 1984 and 1987. 

Adding foreign tax credits raises this to 59 percent. 

For the startup firm, tax credits are not particularly useful since it usually does not pay income taxes. Such a firm is intent on identifying or moving a product or process to the point that investors may realize a return. To the extent that it can anticipate taxable income in the future, it can carry forward R D tax credits to subsequent years, but the value of these potential future credits is diminished because of the time value of money. While the possessions and foreign tax credits can also theoretically be carried forward, a firm can earn these credits only by generating income (either abroad or in a U.S. possession). 

In actual Federal dollars spent, Federal tax credits constitute one of the most substantial forms of government involvement in the operations of the pharmaceutical industry. In 1987, not including over 900,000 in foreign tax credits, the Federal Treasury made 1.4 billion in tax expenditures through credits to drug companies. Of this, only about 90 million was for credits whose specific policy purpose is to stimulate R D. The major part, 1.3 billion, of the lost tax revenue was due to the foreign and possessions tax credits. 

Overall, tax credits reduced the amount of taxes pharmaceutical firms would have otherwise owed the U.S. Government by 36 percent and equaled 15 percent of the industry s taxable U.S. income. Adding foreign tax credits raises these figures to 59 percent and 24 percent, respectively. 

It is important to recognize that short term measures, while essential, will not bring a total solution. While the Bush administration is supporting measures such as hybrid vehicle tax credits, ethanol production, and revisions in fuel efficiency standards, these interim strategies will not ultimately reverse our dependence on foreign oil or address environmental problems as hydrogen can. 

---