As business brings back foreign profits, should Minnesota get piece of the action?

Minnesota could see state corporate tax revenue rise by hundreds of millions of dollars in the next few years thanks to federal tax reform. But a battle is brewing between private businesses that would pay for the huge windfall and public officials who hope to collect it.

For decades, some Minnesota companies have deferred paying federal and state taxes on cash, accounts that can quickly be turned into cash and noncash investments earned by or booked to foreign subsidiaries. The $55 billion in foreign profits now sheltered abroad by state-based businesses is part of a $2.6 trillion pool of foreign profits sheltered collectively by U.S. corporations.

The federal tax reform act passed in December requires that these profits be included as income for 2017. The law then allows companies to take up to eight years to pay the federal taxes due — 15.5 percent on cash and accounts and 8 percent on noncash foreign investments, a process called repatriation.

In Minnesota, Revenue Commissioner Cynthia Bauerly plans to collect state taxes on Minnesota companies' repatriated profits.

"The Department of Revenue administers the code as written," she said. "Currently there is a tax on repatriated income. We don't have the power not to collect a tax."

Under current law, Revenue Department researchers estimated that state taxes on foreign profits of Minnesota companies could yield a $356 million windfall to the state for fiscal years 2018-2021.

If the state Legislature passes a law to make the state conform with the new federal tax law, but makes no other changes to state tax policy, the four-year state tax windfall could bring in an additional $383.4 million for a total of $739.4 million in new revenue.

Some in Minnesota's business community question the state's right to tax the foreign profits because they are earned outside Minnesota by foreign subsidiaries. Tax advisers from more than 50 companies belonging to the Minnesota Business Partnership now hold ongoing meetings to discuss the issue.

Every option, including the option of a lawsuit, "is on the table," said Charlie Weaver, who directs the partnership, a group that includes most of the state's top CEOs.

The business community has pressed members of the state Legislature on the foreign profits tax issue, especially the heads of the Senate and House finance committees, Weaver said. Business leaders want to resolve the legal authority of the state to tax foreign profits. If the state is allowed to collect state taxes on foreign profits, Weaver added, business leaders want the tax proceeds used to "improve the business environment" or they want the Legislature to adjust state rates to make the tax "revenue neutral."

But state foreign profit levies are already part of a tax reform quid pro quo in which the nation's statutory corporate tax rate was cut from 35 percent to 21 percent. That reduction will, according to the Congressional Budget Office, produce enormous corporate revenue increases in the next decade. The extra income will offset the cost of all federal and state foreign-profits taxes many times over.

State Sen. Roger Chamberlain, R-Lino Lakes, chairman of the Senate Tax Committee, called the federal foreign-profits changes "a good thing," but said Minnesota lawmakers will need to take a hard look at the latest budget numbers, as well as any potential legal challenges, before they make any changes in the state tax code.

"Should we tax the way it is, or should we not?" he said after Wednesday's release of the February budget and economic forecast. "We just got new numbers from the Department of Revenue, so we are going to go through and start crunching numbers to see how we can have the greatest impact to Minnesota."

Most individual Minnesota businesses contacted by the Star Tribune either declined to comment or did not respond. But Medtronic and 3M, the two companies that will account for the vast majority of the state's repatriated income, have made financial moves. Medtronic took a $2.2 billion charge in the fourth quarter of 2017 that a company spokesman said would go to pay federal and state taxes on repatriated foreign income. At 3M, a spokeswoman said the company's $745 million fourth-quarter charge for repatriation applied only to federal taxes. In addition, she said the company "is aware of the Minnesota Commissioner of Revenue's plans."

Most state legislatures will likely need to pass specific laws to exclude repatriated foreign profits from state income taxes because most states use federal taxable income to compute state taxable income, said Robert Willens, a former managing director of Lehman Brothers.

That corporations will be paying state taxes on buildings, property and equipment located in foreign countries likely will not matter, said Willens, who now runs a private consultancy specializing in corporate tax issues.

"The fact that the earnings are unmovable has nothing to do with it," Willens said.

Minnesota's right to tax foreign profits turns partly on a concept called "water's edge." The concept requires that foreign profits relate to a U.S. company's domestic business activities in order to be taxed. Minnesota is a water's edge state.

A recent analysis by the Grant Thornton accounting firm's Minneapolis office noted that Minnesota "faces one of the more complex tax policy development challenges to be found anywhere in the nation."

"For example," wrote Grant Thornton's Christopher Martin, "a construction company may hold Brazilian oil and gas investments that are managed separately and have no connection to their business activity in the U.S. Minnesota would be prohibited from taxing the income the Brazilian entity earned over time if it was not integrated with domestic operations."

Beyond the question of determining excluded income, Minnesota's ability to attract new businesses and to expand existing ones is on the line, said Denise Roy, a tax specialist at Mitchell Hamline School of Law.

Roy does not believe a one-time state levy on foreign profits will cause corporations to leave Minnesota, but she "can imagine this doing damage to businesses' relationship with the state" that "could hurt down the road."

The state's current corporate tax rate is among the highest in the country. The 9.8 percent state corporate tax rate is less than tax reform's federal rate of 15.5 percent on repatriated cash and cash convertible accounts, but more than the 8 percent federal levy on repatriated noncash investments.

Whatever rate the state chooses to charge, each corporation will be required to pay its entire bill for foreign profits this year unless the Legislature passes a new law to extend the repayment period as Congress did, said Dudley Ryan, a senior tax accountant at CliftonLarsonAllen.

The money at stake is "a significant change to taxpayers who are affected," Ryan said. "When a windfall comes from a small number of taxpayers, you have to think about that."

Washington correspondent Jennifer Brooks contributed to this report. Jim Spencer • 202-662-7432