Tax reform has only just begun for healthcare companies

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The healthcare industry will begin to feel substantial effects of the 2017 Tax Cuts and Jobs Act in 2019. The law will create both new possibilities for companies looking to turn their tax savings into competitive advantages, and novel challenges for organizations facing new taxes. At the same time, emerging trade pressures may create uncertainties for companies hoping to maintain the status quo.

Portions of the healthcare industry are responding to tax reform’s known effects in different ways. For-profit companies generally are benefiting from tax reform because of lower tax rates on earnings (reduced from 35 percent to 21 percent beginning in 2018) and the ability to repatriate foreign cash at a favorable rate (15.5 percent for cash holdings as of Dec. 31, 2017 and zero US federal income tax for new foreign earnings starting in 2018). Some companies already have repatriated significant holdings, though the law doesn’t compel them to do so.

Many payers and providers don’t have foreign operations, so they won’t benefit from the repatriation provision, or they may not have positive taxable income to realize these benefits. In addition, other provisions of the law could negatively affect payers, providers and life sciences companies. For example, the global intangible low-taxed income (GILTI) provisions require a US shareholder to pay a minimum aggregate US and foreign tax on its share of the earnings of its controlled foreign corporations. And the base erosion and anti-abuse tax (BEAT) provisions impose an additional corporate tax liability on domestic and foreign companies operating in the United States that make certain deductible payments to foreign-related parties.

In 2019, healthcare organizations may find it necessary to restructure their businesses to accommodate new rules on unrelated business taxable income (UBTI); assess how taxes and refunds could affect their Medical Loss Ratios; determine how best to invest cash previously held outside the US; and restructure their supply chains to accommodate a new territorial tax system and emerging trade uncertainties, among other actions. 2019 also will mark the first calendar year in which most companies file a tax return reflecting a complete fiscal year under the new tax law.

 


Tax-exempt entities in some cases will have greater tax liabilities under the law’s rules that require such organizations—nonprofit hospitals, for example—to include the value of certain fringe benefits offered to employees, such as qualified transportation and parking benefits, as UBTI. The law also eliminated an incentive for some individuals to contribute to charitable organizations by almost doubling the standard deduction.

As with any major new law, the act didn’t change the tax system the moment it was signed.1 While many of the law’s provisions have gone into effect, the IRS and Treasury Department are still developing guidance on its numerous complex rules. The terms “Secretary shall” or “by the Secretary” appear 51 times, each indicating where the IRS or Treasury is required to release guidance or regulation. Beyond that, the IRS still must weigh in on dozens of smaller issues, including definitions and which entities a specific provision applies to. The pace of Treasury and IRS guidance may accelerate by the end of 2018. While organizations are grappling to understand tax reform’s complicated effects on their business operations, changes to the global trade environment and the introduction of new trade tariffs may complicate their operations and supply chains, increasing their costs or forcing them to restructure to maintain efficiencies. The United States has proposed changes to its dealings with several prominent trading partners, including Mexico, Canada and China. Several changes are expected to go into effect in 2019.

Most affected by tariffs may be the pharmaceutical and medical device sectors, which have a significant global manufacturing footprint and could see notable disruptions as they seek to move raw materials and finished products from global manufacturing facilities to their paying customers in the US. US medical device manufacturers could face higher costs for materials, especially those made of metal, while drug manufacturers could see increased costs for chemicals used in manufacturing. Hospitals could face higher costs for medical goods or shortages if supply chains face major disruption.

The medical device trade group AdvaMed told HRI that it identified $3.5 billion in products affected by a recent round of tariffs China imposed in retaliation against US tariffs, adding up to $754 million new annual taxes. For the US life sciences industry, which exports tens of billions of dollars in medical products each year, reciprocal tariffs could endanger revenues by making US-made products less competitive with foreign counterparts.

Implications

Be prepared to act

For both tax reform and trade-related issues, many companies are now in a holding pattern, awaiting guidance and action by government regulators before responding. On trade, while some actions will have recently gone into effect, others—such as trade tensions with China—are ongoing. This gives companies time to fully understand and analyze their business, partners and supply chains. Companies should consider a range of options, including business unit reorganizations, and be ready to act quickly to realize potential gains from changes to the tax code or trade environment. Prepared companies can rapidly realize advantages over their competitors by taking such actions as reorganizing business units to reduce tax liabilities.

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Use tax savings to position for success

Some healthcare companies will have access to a substantial amount of capital to help them gain a competitive advantage. Before tax reform enactment, healthcare companies in the S&P 500 held an estimated $186 billion in cash overseas at the end of 2016, according to a Credit Suisse analysis, and they may now begin repatriating those funds at favorable rates.2

Companies can spend their tax savings in different ways, including reinvestment, acquisitions and stock buybacks. How they spend that money will affect the public’s perception of them, according to respondents to an HRI survey. Sixty to 72 percent of respondents would have a positive opinion of a life sciences company, health insurer or hospital that used its tax savings to hire more staff, while 38 to 39 percent would have a negative opinion if the same company were to repurchase shares of its stock from investors.3

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Figure out what operational changes the new tax law will require

Companies must come to terms with a simple fact: The old way of doing business no longer may be the most effective or efficient way under the new code. The changes may require new supply chains, business unit reorganizations, benefit redesigns for executives and staff, investments in technology, and staff training. Operational agility will permit companies to act quickly when necessary, but that will require planning and creativity.

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1 Congress, “H.R.1 - An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” Dec. 22, 2017, https://www.congress.gov/bill/115th-congress/house-bill/1

2 Credit Suisse, “US Biopharma Tax Analysis” Nov. 29, 2017

3 PwC Health Research Institute Top Health Industry Issues consumer survey, “Many [hospitals/health insurance companies/pharmaceutical and medical device companies] received a tax savings under last year’s tax reform law. How would your opinion of a healthcare company change if you knew that it used a significant portion of its tax savings to:” September 2018

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Benjamin Isgur

Health Research Institute Leader, PwC US

Kelly Barnes

Global and US Health Industries Leader, PwC US

Karen Young

US Pharmaceutical and Life Sciences Assurance Leader, PwC US

Gurpreet Singh

Health Services Leader, PwC US

Jeff Gitlin

US Health Industries Advisory Leader, PwC US

Kathleen Michael

US Health Industries Tax Leader, PwC US

Tim Weld

US Health Industries Assurance Leader, PwC US

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