By Alex M. Parker

Law360 (July 17, 2020, 8:56 PM EDT ) Former Vice President Joe Biden's recent proposal to secure medical supply chains in the wake of the COVID-19 pandemic includes tweaks to the 2017 federal tax overhaul, reigniting the debate about whether its international provisions are pushing manufacturing facilities offshore.

The provisions of the Tax Cuts and Jobs Act , such as the tax on global intangible low-taxed income, don't single out any sector in particular. But because those anti-abuse rules target profits from intangible assets, they are likeliest to affect companies reliant on intellectual property — such as the pharmaceutical giants.

In a campaign plan released July 7, Biden vowed to "eliminate Trump administration tax incentives for offshoring" and "pursue other tax code changes that will encourage pharmaceutical production in the U.S."

But many question whether the TCJA, one of President Donald Trump's signature initiatives, has truly led to an exodus of production, or whether onshoring the manufacturing of critical prescription drugs is a feasible goal in today's globalized, interdependent economy.

Broadly speaking, the TCJA exempted most foreign income from taxation as part of a shift toward a more territorial tax system, similar to those used in Europe and much of the world. But it also enacted new provisions, including the GILTI tax and the base erosion and anti-abuse tax, which lawmakers said would block companies from shifting U.S. income abroad.

Many of the structures for tax avoidance that have drawn public scrutiny and outrage over the past decade have involved intangibles, which are relatively easy to move from jurisdiction to jurisdiction to chase the lowest tax rate. But the very attribute that makes them difficult to tax also makes them difficult to define. Rather than attempt to pinpoint the intangibles themselves, the TCJA instead targets unusually high returns on tangible assets.

Under the GILTI provision, the total foreign income of a U.S. company, beyond a 10% return on its offshore depreciable tangible assets, is taxed at 10.5%. That rate is half of the overall corporate rate of 21%.

As the bill was passed by Congress in 2017, Democrats and outside critics quickly noted that the GILTI tax could encourage companies to shift investments in tangible assets abroad. Because the GILTI tax kicks in only at a 10% return on foreign tangible property, the more valuable that property is, the smaller the ultimate GILTI tax bill will be.

Even further, because GILTI is calculated at the global level, in most cases it would not matter where new tangible assets were located; as long as they were offshore, they would decrease the GILTI tax. A reduced rate on foreign-derived intangible income, or domestic income defined through a formula similar to GILTI, also creates a similar incentive, critics contend. If a company has tangible assets at home, it will have less income defined as FDII, and less of the tax benefit. 

Brad Setser, a senior fellow at the Council on Foreign Relations and the former deputy assistant secretary for international economic analysis at the U.S. Treasury Department, has blamed the provision for a 20% increase in pharmaceutical imports since 2018.

"The rise in pharmaceutical imports is likely, in part, a reaction to the incentives to offshore pharmaceutical production that were included in the Tax Cuts and Jobs Act," Setser said Feb. 5 in testimony to the U.S. House Ways and Means Health Subcommittee.

Biden has yet to release a formal tax plan, but in campaign materials and on the stump the presumptive Democratic nominee has vowed to eliminate tax incentives for offshoring.

In this most recent news release, Biden said he would nix those provisions as part of his plan to "build long-term supply chain resilience for pharmaceuticals" following the pandemic crisis, and included a link to Setser's writing on the topic.

But defenders of the law, and some other experts, question whether the GILTI incentive is strong enough to affect location decisions on manufacturing. They also say that too little time has passed since 2017 for the law to have dramatically tilted the balance of global trade.

"I think the migration of supply chains has had a long history and that blaming GILTI for it loses sight of that history," said Mark Mazur, director of the Tax Policy Center, a Washington, D.C., research group, and the assistant treasury secretary for tax policy from 2012 to 2017. "Given that making large international investments requires substantial amounts of time, I doubt that the Tax Cuts and Jobs Act has been around long enough to cause a lot of investment abroad that would not have otherwise occurred."

While a tax structure for profit shifting doesn't require much more than low-tax jurisdiction and a mailbox, corporate decision makers need to consider a country's infrastructure, workforce, legal system and other aspects before deciding whether to place a real manufacturing facility there. While tax competition is an undeniable dynamic in the global economy, business leaders have long insisted that real investment decisions are less sensitive to income tax concerns than other considerations.

Furthermore, the TCJA included new incentives for domestic activity, such as companies' ability to deduct many new investments immediately. By locating facilities offshore, a company would lose out on tax benefits for expensing and depreciation.

"I don't know if messing around with a few components of GILTI is going to change the reality of what our medical supply chains will look like," said Kyle Pomerleau, a resident fellow at the American Enterprise Institute, a right-leaning economic research group in Washington, D.C.

Setser said the trade numbers seem to indicate the TCJA is driving pharmaceutical imports, as well as low tax rates reported by pharmaceutical companies and announcements from Ireland about new pharmaceutical facilities.

"Right now, I think the numbers speak for themselves — there has been a steady rise in pharmaceutical imports and a big increase in the trade deficit in pharmaceuticals subsequent to the passage of the Tax Cuts and Jobs Act," Setser said in an email to Law360.

The debate over GILTI overlaps with a larger debate about whether the U.S. should try to tax the foreign income of its taxpayers, or focus on income from domestic economic activity. It also reflects a constant tension in international tax policy between the writing of rules that connect taxable income to economic activity, and the impulse to use the tax system to encourage economic results.

Indeed, the idea of using tangible property as a basis to tax intangible income has a long history. The version in the TCJA has its roots in the 2011 and 2014 draft proposals from former Rep. Dave Camp, R-Mich., who was then chairman of the Ways and Means Committee. And in 2015, the administration of President Barack Obama proposed a 19% global minimum tax with an exemption for returns from "active assets," which generate profits other than rents, royalties, interest and other passive forms of income. Obama's proposal would have applied country by country, a basis that Democrats contend would be a tighter system allowing for less abuse and manipulation.

Experts within the health field say the recent uptick in pharmaceutical imports is part of a long-term trend toward globalization of the supply chains and the use of low-cost labor, not tax policy changes.

"It's certainly not the driving force," said Fred Abbott, a professor of international law at Florida State University and a former adviser to the United Nations on health law issues. "There may have been a marginal role."

And in an age when prescription drugs are created through a complex, multistage supply chain that can span the globe, trying to ensure that they can be fully produced at home may be an impossible task.

"Like a lot of products, pharmaceuticals aren't made in one spot, soup-to-nuts anymore," said Chad Bown, a senior fellow at the Peterson Institute for International Economics. "There are ingredients that you have to put together to have the final products, and those ingredients can be made in lots of places across the world. We've become very interdependent."

Lee Branstetter, a professor of economics at Carnegie Mellon University, said onshoring pharmaceutical production is an ill-considered public policy goal for disease preparedness or job creation.

"Pharmaceutical manufacturing, especially chemistry-based and small-molecule drugs, is a fairly low-tech and low-margin business," Branstetter said. "And it actually doesn't generate that many jobs. It's a fairly capital-intensive undertaking, but it's not a very labor-intensive undertaking."

--Editing by John Oudens and Neil Cohen. 

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