PwC Report Says Average Corporate Effective Tax Rate Was 26.3 Percent

In addition to our analysis of tax ratios, this year's edition includes a special report on corporate tax reform. The article focuses on efforts by President Obama and Congress to grapple with reform, and shares the perspectives of several industry executives who are closely monitoring the issue and its potential impact on their companies.

                          Table of contents

While in recent years the need for fundamental reform of our tax system has been the subject of extensive academic discussion, and several legislative initiatives have been proposed, the issue now has been elevated by President Obama and Congress. Efforts currently underway could lead to the most substantial changes to corporate tax law since the 1986 Tax Reform Act, with a range of impacts on different industries and businesses.

Faced with a slowly growing economy and expected continuing high rates of unemployment, the president has called for corporate tax reform as one means to improve the economy. The expectation is that a reformed tax system would increase the competitiveness of US companies in the global marketplace, promote investment in this country, and expand hiring. In his State of the Union address, President Obama called on Congress to lower the corporate tax rate and broaden the tax base to achieve revenue-neutral reform.

The administration's fiscal year 2012 budget does not set forth specific proposals for tax reform. The 2012 budget does recommend certain changes previously proposed by the administration to US international tax rules that it argues would reduce "incentives for US-based multinationals to invest abroad rather than in the United States." Treasury officials have indicated that the revenue-raising international tax proposals in the budget, which are opposed by the business community, could be considered by Congress as part of tax reform or as separate legislation.

In Congress, both the House Ways and Means Committee and the Senate Finance Committee are holding a lengthy series of hearings on tax reform. So far, witnesses at hearings have addressed the failure of our tax system to keep up with competitive changes around the world. Finance Committee Chairman Max Baucus (D-MT) has stressed "the need for changes to make the tax code fairer, help businesses to create more US jobs, and reduce the potential for exploitation of the tax code by special interests." Ways and Means Chairman Dave Camp (R-MI) has said: "I am under no illusion that the task before us will be easy. To really reform the tax code in a way that lowers the tax rate, broadens the base, and promotes the competitiveness of American companies, we will need to make some tough choices."

The case for reform seems strong, and the administration and Congress have expressed a commitment to explore how to lessen adverse impacts of the tax system on the economy while improving fairness and simplicity, taking into account the constraints arising because of this country's serious on going budget deficits (as discussed later in this report). While the political parties are sharply divided in Congress, tax reform could be a sufficiently compelling issue that legislators could find common ground in a bipartisan fashion, as happened with the 1986 tax reform process. One lesson from the legislative process that led to the 1986 act is that those industries and businesses that early on become knowledgeable and participate in the legislative policy development are in the best position to have a positive contribution on the final product.

Failure of the US tax system in the global marketplace

Comparisons of the US tax system with the tax regimes of our major trading partners reveal the competitive obstacles facing US multinationals, the first being our high corporate tax rates. The United States has the second-highest combined federal and local corporate tax rate among the 34 countries of the Organization for Economic Cooperation and Development (OECD) -- more than 50% higher than the average of the other OECD countries (see Figure A).

 

Figure A: OECD corporate tax rates

 

(combined federal and local), 2010

 

 

 

Third, the United States also lags in providing incentives for research and innovation. According to the OECD, the US ranks 24th out of 38 advanced and emerging economies in providing tax incentives to encourage research and development. Even this ranking may be considered generous, as it does not take into account the temporary nature of the US research credit and the increasing use in other countries of a preferential rate of tax on income generated from intellectual property (so-called innovation or patent boxes).

Potential obstacles to tax reform

Significant ongoing deficits projected under continuing current tax and spending policies could limit the extent to which tax reform legislation would provide net tax relief to corporations. The administration has proposed that business tax reform must be "revenue neutral" within the business sector, meaning that business tax cuts must be fully offset by other business tax increases, and not by increases in other taxes or reductions in spending. It should be noted that in the 1986 Tax Reform Act revenue increases on businesses exceeded business tax reductions and in effect offset some of the costs of individual tax relief. Treasury Secretary Timothy Geithner has stated, however, that given concerns for competitiveness, net tax increases on corporations are not recommended by the administration.

Requiring revenue neutrality for corporate tax reform would create special challenges for US businesses. Desirable changes that reduce tax burdens and increase competitiveness, such as a lower statutory corporate tax rate, then would need to be offset by other changes that increase tax burdens by an equivalent amount under government revenue projections -- for example, by limiting certain deductions or eliminating tax credits.

While clearly the most desirable outcome for business is a tax reform plan that provides a net tax reduction and significantly enhances US competitiveness, even revenue-neutral reform proposals require careful evaluation and consideration. As a practical matter, each company will need to "run the numbers" and consider how alternative reform scenarios affect its own bottom line. Further, if companies can identify opportunities for "win-win" reforms that a united business community could advance, the path to legislative enactment of these ideas would be significantly enhanced.

Impact of the budget setting

Projected deficits under alternative assumptions

Tax reform discussions in Congress are taking place against a background of increasing concerns over the US budget deficit. The Congressional Budget Office (CBO) projects the deficit for 2011 to be $1.5 trillion, or 9.8% of GDP. In 2010, the deficit was $1.3 trillion (8.9% of GDP), less than the record 2009 deficit of $1.4 trillion (10% of GDP).

Under the official CBO baseline, based on current law, deficits would decline to 3.0% of GDP in 2015 and increase to 3.2% of GDP in 2021. CBO projects the 10-year deficit under its baseline for 2012-2021 at $7.0 trillion. While these deficits are sizable, they are based on certain assumptions that may fail to capture the full extent of the deficits that are likely to arise as a realistic matter.

CBO's baseline projections under current law are based on the scheduled expiration of all temporary provisions of the tax code -- including all of the recently extended 2001-2003 individual tax reductions, currently set to expire at the end of 2012, and individual alternative minimum tax (AMT) relief (expiring at the end of 2011). The projections also factor in expiration of temporary business tax provisions, such as the research tax credit, controlled foreign corporation (CFC) look-through rule, and active finance exception, set to expire at the end of 2011. In practice, it is unlikely that all current-law terminations of temporary provisions (such as middle-income tax relief and the research credit) will occur; if these provisions are extended by Congress, the deficit projection would be higher. The CBO baseline also assumes that discretionary spending will grow only at the rate of inflation, rather than at the faster rate of growth by which it has historically risen.

Under an alternative baseline representative of current policy -- i.e. generally maintaining taxes and spending at their 2011-equivalent levels -- and based on CBO analyses, the 10-year deficit would total $13.5 trillion, nearly double the CBO baseline. This alternative baseline assumes:

• the 2001-2003 tax cuts are extended for all taxpayers after 2012

• the AMT is fully indexed for inflation after 2011

• most other expiring tax provisions are permanently extended

• discretionary spending grows at the same rate as GDP

• military spending on Iraq/ Afghanistan is phased down

• Medicare payment rates for physicians are maintained at the 2011 level.

In view of such large ongoing deficits under a baseline more representative of tax and spending policies now in effect, many analysts believe such policies are unsustainable. They instead believe the country needs budget solutions involving a mix of reduced spending and higher taxes to avoid a possible future fiscal crisis.

Recommendations for deficit reduction

Under recommendations released by the National Commission on Fiscal Responsibility and Reform (Fiscal Commission), co-chaired by former Clinton White House Chief of Staff Erskine Bowles and former Senator Alan Simpson (R-WY), in a December 2010 report, a deficit reduction of $4.1 trillion between 2012 and 2020 would reduce the deficit in 2015 to 2.3% of GDP and to 1.2% of GDP in 2020. The report was supported by an 11-member majority of the members, including three Republicans and three Democrats among the 12 members of Congress on the Fiscal Commission. The report was not officially recommended to Congress because the Fiscal Commission's charter required a 14-vote "super majority" to formally submit a deficit reduction plan.

Under the Fiscal Commission plan, by 2020 taxes would rise to 20.6% of GDP and spending would be 21.8% of GDP. This compares to the 40-year historical average of revenues and spending of 18% and 20.8%, respectively.

Corporate tax reform

Overview

While not providing a specific tax reform plan, the administration's FY 2012 budget notes that the president has called on Congress to work with the administration on corporate tax reform that will "simplify the system, eliminate special interest loopholes, level the playing field, and lower the corporate tax rate" in a revenue-neutral manner.

The president's FY 2012 budget echoes concerns raised by the Fiscal Commission on the need for corporate tax reform to enhance US competitiveness. The Fiscal Commission's December 2010 report states:

"Without reform, it is likely that US competitiveness will continue to suffer. The results of inaction are undesirable: the loss of American jobs, the movement of business operations overseas, reduced investment by foreign businesses in the US, reduced innovation and creation of intellectual property in the US, the sale of US companies to foreign multinationals, and a general erosion of the corporate tax base."

Illustrative Fiscal Commission proposal

The Fiscal Commission proposals would lower the corporate tax rate to a range of 23% to 29%. Its illustrative tax reform plan for corporations features a single 28% rate and a territorial system for foreign-source dividends. The Fiscal Commission report states that the plan would eliminate more than 75 corporate tax expenditures and 30 business tax credits, although it specifically lists by name only several tax expenditures, including the section 199 domestic production deduction and the last-in, first-out (LIFO) inventory accounting (Figure C). The term "tax expenditures" as listed in publications of the Joint Committee on Taxation staff encompasses a broad range of traditional deductions and tax credits, such as the research credit, accelerated depreciation, and long-standing industry-specific provisions.

Although the Fiscal Commission did not release details of its territorial tax system proposal in its December 2010 report, the report makes frequent reference to the need for a "competitive" territorial system like those of other countries.

An earlier report by the President's Economic Recovery Advisory Board (PERAB) stated that a territorial tax system comparable to those of other OECD countries would reduce tax revenues by $130 billion over 10 years, assuming the current 35% federal corporate tax rate. At the lower corporate tax rates proposed by the Fiscal Commission, the revenue loss from a territorial tax system would decline and conceivably could turn positive. This result is because certain foreign income, such as royalties, would be taxed under a traditional territorial system but might avoid taxation under

       Figure C: Fiscal commission illustrative corporate tax reform plan

Because a territorial tax system could subject foreign-source royalties to higher rates of US taxation than under current law, other changes might be considered to maintain and enhance incentives to create and develop intangible capital domestically. A number of countries have adopted "innovation boxes," or special regimes to tax intellectual property at lower rates. OECD countries with such special tax regimes for intellectual property include Belgium, France, Hungary, Ireland, Luxembourg, the Netherlands, Spain, and Switzerland. The United Kingdom recently announced its intention to adopt such a regime for patents effective in 2013.

In contrast to the territorial tax system recommended by the Fiscal Commission, a reform proposal of Senator Ron Wyden (D-OR) and former Senator Judd Gregg (R-NH) would repeal deferral of foreign earnings. PERAB estimated that such an option could increase tax revenues by $180 billion over 10 years. No other OECD country treats active foreign business income in this manner; many US companies argue that such a change would place US tax rules even further outside international norms and harm their ability to compete globally.

Alternative revenue sources

Although the Fiscal Commission proposals included higher gasoline taxes to assist in deficit reduction, it does not propose a new revenue source, such as a broad-based consumption tax. The United States relies on consumption taxes to a significantly lesser degree than other OECD countries; it is the only OECD country without a national value-added tax (VAT) or goods and services tax.

Although the Fiscal Commission did not include a consumption tax in its options, commission member Andy Stern included a hybrid income-consumption tax option in his proposed alternative recommendations. Under his plan, which is based on a proposal designed by Columbia law professor Michael Graetz, a 10% to 15% consumption tax would finance significant individual tax reform and corporate rate reduction.

In a separate plan designed by a task force of the Bipartisan Policy Center, jointly chaired by former Senator Pete Domenici (R-NM) and former CBO Director Alice Rivlin, a 6.5% debt reduction sales tax would be implemented. Although referred to as a sales tax in the task force recommendations, it would operate in the same manner as a VAT, with tax being collected at each stage of production and a credit given for prior taxes on production inputs. The consumption tax, which would phase in at a 3% rate in 2012, would apply to a broad measure of consumption and would raise an estimated $3 trillion in revenue between 2012 and 2020.

An alternative approach was taken by Rep. Paul Ryan (R-WI) last year in his "Roadmap for America's Future," in which he proposed an 8.5% subtraction method VAT (also referred to as a business activities tax) as a replacement for the corporate income tax. Like a VAT, but unlike the corporate income tax, the tax in Ryan's proposal would be border adjustable; in other words, it would be levied on imports to the United States and refunded on exports from the United States. The consumption tax was not included in Rep. Ryan's "Path to Prosperity," adopted as the House budget plan for 2012.

Other significant new revenue sources sometimes discussed in the context of deficit reduction are taxes on the emissions of greenhouse gases. The CBO estimates that a cap-and-trade program under which emission allowances were auctioned beginning in 2012 could raise $880 billion between 2012 and 2020, assuming an auction price equivalent to a fee on carbon dioxide emissions of $23 per ton, with the price rising by 5.8% annually. Congressional action in the foreseeable future on cap-and-trade legislation appears unlikely.

Welcome to the tax rate section of the Assessing tax 2011 report. This study covers the following industrial products and services industries: aerospace and defense, chemicals, engineering and construction, industrial manufacturing, metals, and transportation and logistics.

In the aftermath of the financial crisis, as some governments seek to reduce budget deficits by increasing tax revenues, companies' tax affairs are coming under increasing scrutiny both from external stakeholders (e.g., civil societies, shareholders) and within the company (e.g., the board). Tax rate benchmarking can give company executives an insight into trends in their sector relating to key tax ratios, and how their ratios compare to those of their peers. And tax is a business cost, so as companies continue to improve and shape their tax functions, tax rate benchmarking can provide valuable data and insight into the process.

This study uses publicly available data. We have reviewed key tax ratios for over 300 industrial products and services companies, and collated and analyzed the ratios to highlight trends by year and by sector. Data was drawn from data providers and from individual company reports. With this study as a basis, we can create a customized report, for any company, which compares a company's key tax ratios against those of its peers. Companies use tax rate benchmarking data to compare their performance in a particular year or over a specific period. This can be useful for writing and reviewing tax strategy, communicating with the board, and setting performance measures. Forty-three percent of companies in a 2008 survey¹ indicated that the primary performance measure of the tax department was the effective tax rate (ETR).

The global financial crisis has accelerated the shift in economic power to emerging economies. The E7 emerging economies (China, India, Brazil, Russia, Mexico, Indonesia, and Turkey) are likely to overtake the G7 economies (US, Japan, Germany, UK, France, Italy, and Canada) before 2020². A number of these countries figure prominently in this 2011 tax rate benchmarking study, which demonstrates both the opportunities and challenges this shifting balance of economic power presents companies and their tax departments.

We found differences in key tax ratios between the sectors within the industrial products and services industry. Companies in some sectors found 2010 to be tough, with the economic recovery being fragile, unpredictable, and varied from region to region. Others fared much better -- aerospace and defense (A&D) companies, for example, found that activity remained strong with military spending and security remaining a priority for many governments. Industrial manufacturing (IM) companies also found that demand from emerging economies pushed the price of commodities up. Companies that cut production costs and workforce in response to the financial crisis are now focusing on improving processes and continuing cost reductions to remain competitive and broaden product portfolios to mitigate market uncertainty.

This study presents a high-level analysis of key tax ratios. We have not adjusted for one-time distorting items or losses. In the study, losses, tax refunds, and exceptional items can serve as drivers of the individual company's tax ratios, although our use of a statistically trimmed sample minimizes the impact of these drivers on the study conclusions. We compiled data from publicly available financial statements for the past three years through December 2010 (although for a small number of companies, data for the year to December 31, 2010, had not been released).

The report provides overall highlights and trends in tax ratios for industrial products and services companies as well as detailed analysis and commentary for each sector.

 

Figure 1 -- ETR of industrial product companies 2008-2010

 

 

 

• The average ETR for industrial product companies (all sectors) fell between 2008 and 2010 by one percentage point. This was a small movement that could reflect a number of factors, such as a reduction in statutory tax rates around the world and utilization of losses incurred during the financial crisis.

• Impact of foreign operations was the largest favorable driver of the ETR in the peer group and reported by the largest number of companies, a reflection of the global nature of this sector. The ETR benefit from operating internationally (i.e., in jurisdictions with lower tax rates than the parent company) is greatest for the IM sector (a benefit of 7.9%).

• Tax incentives were also a favorable driver, but reported by fewer companies. For the companies that report this item, the average impact was a reduction of ETR by 2.1 percentage points. Incentives include research and development credits, tax holidays, and were more significant for the A&D sector, where more than 80% of companies show this as a reconciling item and the average impact was a reduction in ETR of 4.0 percentage points.

• Tax losses are an unfavorable driver. Owing to the financial crisis and the ensuing recession, some companies incurred losses that cannot be used. More than half the companies item, and although the item can be both favorable and unfavorable, the net effect was to increase the ETR by an average 1.4 percentage points. However, this is not a structural driver so it will be volatile from year to year.

• The three-year average cash tax rate was 22.6%, below the three-year average effective tax rate of 25.6%. The cash tax rate covers a wide range (the range between the quartiles in 2010 was 23.2 percentage points) and some distorted ratios were evident because of losses.

Effective tax rate for industrial product and services companies

The ETR is the tax provision as a percentage of profit before tax, as taken from the face of the income statement. It provides a basic view of the impact of tax on results. Analysts often examine the ETR to determine a company's ability to manage its tax burden. Figure 1 shows the distribution of ETRs for industrial products companies from 2008 to 2010.

As might be expected, there were more companies with extreme values (less than 0% and greater than 60%) in 2009, as the financial crisis took its toll and ETRs were distorted by losses and tax refunds.

In 2008, the most common ETR range was 31%-35%. This contrasts to 2010, when the most common range was 26%-30%. The difference could be the result of a number of factors, including the result of reducing statutory tax rates around the world and utilization of losses incurred during the financial crisis. We examine the drivers of the ETR later in this study. Figure 2 shows the average ETR over the three years of the study.

 

Figure 2 -- Effective tax rate for all companies

 

 

 

Figure 2 shows that the average ETR for IP companies fell by one percentage point over the three years. The lower quartile increased slightly and the upper quartile decreased by 1.5 percentage points. This small narrowing of the range may be a result of increased focus by companies at the top end of the range on managing tax, and awareness by companies at the bottom of the range of current scrutiny of companies' tax affairs.

Losses resulting from the financial crisis and recession can create distorted ETRs. Our study revealed ETRs in excess of 6000% and below 4000%. We analyzed ETRs for the companies that had been profitable and paid tax in each of the last three years.

The average tax rate of profitable companies was 29.4% over the three years. ETRs fell from 2008 to 2010 in both the upper and lower quartiles and the average, although the range between the quartiles remained constant.

Drivers of the effective tax rate of industrial product and services companies

A number of factors determine the ETR. These can be both structural and recurring, such as lower tax rates resulting from overseas operations, tax incentives, or items such as losses and prior-year settlements that may not necessarily recur.

We have analyzed and summarized common drivers and their impacts on ETRs. The reconciling items, as disclosed in the statutory/effective rate reconciliation, were analyzed, collated, and averaged over the study companies. Figure 4 illustrates some drivers of the effective rate and shows how frequently they appear in companies' statutory reconciliations. The bars show the number of companies reporting the driver, and the line shows the impact of the reconciling item averaged over companies reporting it.

 

Figure 3 -- Effective tax rate for profitable companies

 

 

 

 

Figure 4 -- Drivers of the effective tax rate

 

 

 

Impact of foreign operations

Impact of foreign operations is usually a structural, recurring driver that was reported by the majority of companies in the study. This reconciling item allowed companies to reduce their ETRs by 2.6 percentage points on average.

Tax incentives

Tax planning using tax credits and incentives to reduce the ETR gave an average benefit to companies in the study of 2.1 percentage points. Descriptions included domestic manufacturing deduction, production-related deductions, research and development credits, general business credits, and tax credit for domestic equipment purchases.

Tax reserves adjustments

Included in this category are contingent liabilities, changes in prior-year estimates, reduction in tax reserve, and audit settlements. The average benefit was to reduce the ETR by 0.5 percentage points. In contrast to foreign operations, these adjustments are not likely to be structural or recurring.

Various other adjustments

This included descriptions such as acquired IPR&D, stock options, intrinsic costs warrants, and cash surrender value of life insurance, which are consolidated under one heading to avoid excessive detail.

Tax losses and change in valuation allowance

Tax losses and change in valuation allowance represented an unfavorable driver overall to companies during the study. Descriptions included losses not available to carry forward, effect of non-recognition of deferred tax assets, change in valuation allowance, recognition of previously unrecognized deferred tax assets, and tax losses utilized. Although reconciling items moved in both directions, the net of these for companies overall was an increase of 1.4 percentage points in the year.

Non-deductible expenses and nontaxable income

An unfavorable driver with an average impact of 1.7 percentage points, this reconciling item frequently had broad descriptions such as 'permanent differences' and 'non-taxable income.' Individual reconciling items were both favorable and unfavorable. Other descriptions included tax-exempt interest income, effect of other disallowed expenditure and income not subject to tax, and capital loss benefits.

 

Figure 5 -- Effective tax rate by country

 

 

 

Companies in the study are headquartered in different countries. In a number of countries, there are sufficient companies (six or more) to prepare a trimmed mean average ETR and to compare ETRs on a country basis.

Figure 5 shows ETRs for eight countries where there is sufficient data (number of companies shown in brackets) to compare ETRs.

 

Figure 6 -- Cash tax rate all companies

 

 

 

Cash tax rate for IP companies

The cash tax rate is the cash tax paid in the year (as disclosed in the cash flow statement or supplementary information to the cash flow statement) as a percentage of income. There is an element of timing mismatch; for example, in some territories 50% of tax due on profits is not paid until after the year-end.

The three-year average cash tax rate was 22.6%, below the three-year average effective tax rate of 25.6%. The cash tax rate covers a wide range (the range between the quartiles in 2010 was 23.2 percentage points) and some distorted ratios were evident because of losses. We reviewed the cash tax rate for companies that had been profitable and paid tax in each of the last three years.

The three-year average cash tax rate was 25.9%, which compares to the average effective tax rate for profitable companies of 29.4%. In each of the upper quartile, average, and lower quartile, the cash tax rate decreased. The range between the quartiles was wide, indicating a broad range of cash tax rates reported by the companies in the study.

Comparison between sectors

The study covers six IP sectors: A&D, chemicals, engineering and construction (E&C), IM, metals, and transportation and logistics (T&L). In the study, we provide detailed analysis and commentary for each sector, as well as a summary of the sector overall.

The economic environment influences the breakdown of effective tax rates by sector (illustrated in Figure 8). For example, we found evidence of difficult trading conditions in the E&C sector, with 16 companies in a tax credit position in 2010, whereas only one company in the IM sector had a tax credit in 2010. Figure 9 shows the position for companies that were profitable and paid tax in each of the last three years.

As companies with losses are removed, the metals sector has moved to the left of the chart, a reflection of very volatile rates for profitable companies in this sector in 2010. The IM sector has moved to the right of the chart, reflecting the benefit obtained from 'impact of foreign operations' and 'tax incentives.'

There was some volatility in ETRs in each sector. Figure 10 shows the percentage of companies in each sector that saw increases or decreases of more than 5% in ETR in 2009 and 2010. Apart from IM, all sectors had more companies experience decreases in ETR compared to those with increases.

 

Figure 7 -- Cash tax rate of companies that have been profitable

 

and paid tax in each of the last three years

 

 

 

 

Figure 8 -- Three-year average ETR by sector

 

 

 

 

Figure 9 -- Three-year average effective tax rates for profitable

 

companies by sector

 

 

 

The benefit to the ETR from operating internationally (i.e., in jurisdictions with lower tax rates than the parent company) was greatest for the IM sector (a benefit of 7.9%). A high percentage of the companies in all sectors reported this reconciling item, a reflection of the global nature of the sector.

However, it should be noted that the variations between sectors in Figure 11 depend on the location of the parent companies in each sector. For example, Japan- and US-based companies will have higher statutory rates, which will lead to a larger reconciling item for similar international operations than the rates for a company situated in the UK, which has a lower statutory rate.

 

Figure 10 -- Increase or fall in ETR by more than

 

5 percentage points

 

 

 

 

Figure 11 -- Impact of foreign operations by sector

 

 

 

 

Figure 12 -- Impact of tax incentives by sector

 

 

 

While the impact for a T&L company was greater, at 4.2%, this was reported by just over 10% of companies and so had less impact on the sector. In the other sectors, roughly half claim tax incentives, and the average impact on the ETR was around 2 percentage points.

Industry picture: Benchmarking overview for key sectors

Tax rate benchmarking for the aerospace and defense sector

In 2010, activity remained strong in the defense market because military spending and security remained a priority for many governments. The demand for defense products increased due to the growing threat of additional terrorist activity emerging nuclear states, and continuing conventional military threats. However, this demand was counter-balanced by high budget deficits, which forced many governments to work to reduce their budgets and their debt, which affected those companies most dependent on government spending.

In 2009, the civil aircraft market was hit by a decline in passenger and freight traffic, although some companies experienced a rebound in 2010. Companies are focusing on improving their processes and continuing cost-reduction efforts in order to remain competitive and broadening their product and services portfolio to mitigate against market uncertainty.

The A&D study included 57 companies from the aerospace, defense, diverse industrials, electrical equipment, and industrial machinery segments (see the complete list of companies at the end of the section). Three of the companies had not released 2010 data at the time of the study.

 

Figure 13 -- Effective tax rate (all companies)

 

 

 

The three-year average effective tax rate for the A&D sector was 27.1% (Figure 13). The average remained largely constant, with a fall of just over two percentage points. There was a similar trend in the upper and lower quartiles with a fall of 3.1 percentage points in the upper quartile and 2.3 percentage points in the lower quartile. The reduction in ETR might have resulted from the lowering of statutory tax rates around the world. The lowest ETR in 2010 was -185.7% and the highest 64.8%, a range of 250.5%, showing volatility in ETRs in the sector. Seven companies had a tax credit in 2010 compared to seven in 2009 and three in 2008. More companies in the sector showed a decrease in ETR of greater than 5% between 2009 and 2010 (15 companies) than an increase of greater than 5% (10 companies).

 

Figure 14 -- Effective tax rate (profitable companies only)

 

 

 

The three-year average ETR was 29.1% and there was a fall in the average and quartiles of two to three percentage points. The minimum ETR was 2.5% and the maximum 64.8% in 2010.

Total income before tax for companies in the sector in 2010 was $64 billion compared with income before tax in 2009 of $40 billion, an increase of 52%. A similar increase was seen in the tax charge for all companies of 58%, but cash tax paid between 2009 and 2010 decreased by 8%, a lag due to the payment on account regimes in force.

Drivers of the effective tax rate

To better understand the variation in ETR in the sector, we reviewed the 2010 statutory/effective rate reconciliation in company accounts (46 were available at the time of our analysis).

ETRs of our sample were below relevant statutory rates for all but three of the companies reviewed. The reconciling items, as disclosed in the statutory/effective rate reconciliation, were analyzed, collated, and averaged over the sample. Figure 15 illustrates some drivers of the effective rate and shows how frequently they appear in companies' statutory reconciliations. The bars show the number of companies reporting the driver, and the line shows the impact of that reconciling item averaged over companies reporting it, excluding single outlying ratios in excess of +50% or -50%.

Reconciling items for the industry were discussed earlier in the report. However, the most common reconciling item for the A&D sector was the impact of foreign operations, a function of the global nature of this sector. Tax incentives were also reported by a high number of companies in the study with descriptions including tax benefit, domestic manufacturing deduction, production related deductions, additional tax deductions, research and development credits and general business credits. These items have the highest favorable impact on the ETRs of companies in this sector. Both tax incentives and foreign operations are likely to be structural and recurring. Tax losses, which is the next-most favorable reconciling item is reported by fewer companies and are less likely to recur as the recovery takes hold.

 

Figure 15 -- Drivers of the effective rate

 

 

 

The cash tax rate is the cash tax paid in the year (as disclosed in the cash flow statement or supplementary information to the cash flow statement) as a percentage of income. There is an element of timing mismatch; for example, in some territories 50% of tax due on profits is not paid until after the year-end. Cash tax paid is not disclosed in publicly available accounts in some territories. Figure 16 shows the cash tax rate for all companies where available.

 

Figure 16 -- Cash tax paid as a percentage of income before tax

 

(all companies)

 

 

 

Figure 17 is similar, but excludes those companies with a tax refund or loss in any of the three years, which gives a picture of falling cash tax rates.

Declines in the cash tax rate for profitable companies may be a result of losses in the group.

 

Figure 17 -- Cash tax paid as a percentage of income before tax

 

(profitable companies only)

 

 

 

 

Companies included in the A&D sector in this study

 

Figure 18 -- Effective tax rate (all companies)

 

 

 

In 2010, many chemicals companies demonstrated a better-than-expected recovery from the economic downturn due in part to strong growth in emerging markets and favorable exchange rate movements. The major drivers for many chemicals companies are the need to increase food production, reduce dependence on fossil fuels, and keep the environment safe. Many companies are predicting uncertain times ahead, particularly with volatile raw material prices and exchange rates. Many chemical companies undertook cost-cutting initiatives over the past few years in order to weather the storm.

The chemicals study includes 44 companies from the commodity chemicals, specialty chemicals, oil and gas, waste, diverse industrials, and household products segments. Three of the companies had not released 2010 data at the time of this study.

Effective tax rate

The three-year average effective tax rate for the chemicals sector was 23.9%. The average increased by 4.7 percentage points from 2008 to 2010 but there was a reduction in the range between the quartiles, from 20.8 percentage points in 2008 to 12.7 percentage points in 2010. Companies in the upper quartile may have benefited from lowering of statutory tax rates around the world. The lowest ETR in 2010 was -72.5% and the highest 145.0%, a range of 217.5%, showing volatility in ETRs in the sector. Three companies had a tax credit in 2010 compared to 10 in 2009 and 10 in 2008, indicating the beginnings of the recovery in the sector.

Thirteen companies in the sector showed a decrease in ETR of greater than 5% between 2009 and 2010 compared to 11 companies with an increase of greater than 5%. To eliminate the ratios for the companies most affected by the financial crisis, we removed companies with a loss or tax refund in any of the three years. The resulting ratios are shown in Figure 19.

 

Figure 19 -- Effective tax rate (profitable companies only)

 

 

 

The total income before tax, taking all companies in the sector into account was $115 billion in 2010, an increase of 48% over 2009. The tax charge increased by 41% over the same period, although the recovery in cash tax paid lags behind income and tax charge due to the payment on account regimes in force.

Drivers of the effective tax rate

To assist in understanding the sector ETR variation, we reviewed the 2010 statutory/effective rate reconciliation in company accounts (38 were available at the time of our analysis). ETRs of our sample were below relevant statutory rates for just over two-thirds (68%) of the companies reviewed.

The reconciling items, as disclosed in the statutory/effective rate reconciliation, were analyzed, collated, and averaged over the sample. Figure 20 illustrates some of the drivers of the effective rate and shows how frequently they appear in companies' statutory reconciliations. The bars show the number of companies reporting the driver, and the line shows the impact of the reconciling item averaged over companies reporting it, excluding single outlying ratios in excess of +50% or -50%.

 

Figure 20 -- Drivers of the effective rate

 

 

 

Cash tax rate

The cash tax rate is the cash tax paid in the year (as disclosed in the cash flow statement or supplementary information to the cash flow statement) as a percentage of income. There is an element of timing mismatch; for example, in some territories 50% of tax due on profits is not paid until after the year-end. Cash tax paid is not disclosed in publicly available accounts in some territories. Figure 21 shows the cash tax rate for all companies where available.

 

Figure 21 -- Cash tax paid as a percentage of income before tax

 

(all companies)

 

 

 

Declines in the cash tax rate for profitable companies may be a result of losses in the group.

 

Figure 22 -- Cash tax paid as a percentage of income before tax

 

(profitable companies only)

 

 

 

 

Companies included in the chemicals sector in this study

 

Although signs of recovery were evident in 2010 compared to 2009, 2010 still saw a number of companies in this sector reporting a loss. The tough conditions were felt in both the residential and non-residential construction sectors with challenging conditions in the homebuilding industry. House sales generally remained volatile during the year. Non-residential construction also suffered with many companies being forced to revaluate the size, timing, and scope of their capital spending plans. On top of this, raw material costs increased during the year. Many E&C companies undertook cost-cutting initiatives over the past few years in order to weather the storm. The E&C study includes 52 companies from the building materials, commercial vehicles, trucks, heavy construction, and home construction segments. One company had not released 2010 data at the time of the study.

Effective tax rate

The three-year average effective tax rate for the E&C sector was 23.8% (Figure 23). This average dropped almost six percentage points from 2008 to 2010, and similar declines were seen in the upper and lower quartiles. Sixteen companies have a tax credit in 2010 compared with 17 in 2009, evidence of the continuing difficult trading conditions within this sector. The lowest ETR in 2010 was -875.0% and the highest was 101.0%, a range of 976.0%, showing that a good deal of volatility remains in the sector. Twenty-one companies in the sector showed a decrease in ETR of greater than 5% between 2009 and 2010 compared to 11 companies with an increase of greater than 5%.

 

Figure 23 -- Effective tax rate (all companies)

 

 

 

 

Figure 24 -- Effective tax rate (profitable companies only)

 

 

 

The total income before tax, taking all companies in the sector, was $20 billion in 2010, an increase of 52% over 2009. The tax charge increased by 49% over the same period, an indication of the recovery, although the recovery in cash tax paid lags behind income and tax charge due to the payment on account regimes in force.

Drivers of the effective tax rate

To assist in understanding the variation in ETR in the sector, we reviewed the 2010 statutory/effective rate reconciliation in the company accounts (available for 47 companies at the time of analysis). ETRs of our sample were below relevant statutory rates for 31 of companies reviewed.

The reconciling items, as disclosed in the statutory/effective rate reconciliation, were analyzed, collated, and averaged over the sample. Figure 25 illustrates some drivers of the effective rate and shows how frequently they appear in the companies' statutory reconciliations. The bars show the number of companies reporting the driver, and the line shows the impact of that reconciling item averaged over the companies reporting it, excluding single outlying ratios in excess of +50% or -50%.

Of the companies analyzed, 18 had a loss in 2010 and the drivers of the ETR reflect this. Tax losses and change in valuation allowance is an unfavorable driver, with an average impact of 7.3%. The most common reconciling item for the E&C sector was the impact of foreign operations, a favorable driver of 0.9%. Tax incentives were a favorable driver, average 2.0%. The 'various other adjustments' category includes depletion allowances, worthless stock, and gain on sale of subsidiaries.

 

Figure 25 -- Drivers of the effective rate

 

 

 

The cash tax rate is the cash tax paid in the year (as disclosed in the cash flow statement or the supplementary information to the cash flow statement) as a percentage of income. There is an element of timing mismatch; for example, in some territories 50% of tax due on profits is not paid until after the year-end. Cash tax paid is not disclosed in publicly available accounts in some territories. Figure 26 shows the cash tax rate for all companies where available.

 

Figure 26 -- Cash tax paid as a percentage of income before tax

 

(all companies)

 

 

 

 

Figure 27 -- Cash tax paid as a percentage of income before tax

 

(profitable companies only)

 

 

 

 

Companies included in the E&C sector in this study

 

Many companies in the IM sector returned to growth in 2010 with a higher demand for products than in 2009. The price of commodities increased, reflecting the expectations of increased demand from emerging economies. The speed of growth in the developing markets like Brazil, China, and India favored companies with diverse international operations.

Companies cut production, costs, and workforce in 2009 in response to the financial crisis. The IM study includes 62 companies from the general industrials, construction and materials, and industrial engineering segments. Five of the companies had not released 2010 data at the time of the study.

Effective tax rate

The three-year average effective tax rate for the IM sector was 27.3%. The average fell by one percentage point between 2009 and 2010 and the range between the quartiles dropped from 16.0 percentage points to 10.2 percentage points in the same period. Over the three-year period, the range between the quartiles was greatest in 2009, when the economic crisis was at its height, and the ETRs of a number of companies were distorted by losses and tax credits. The lowest ETR in 2010 was -37.6% and the highest 70.8%, a range of 108.4%. One company had a tax credit in 2010 compared to 13 in 2009, showing the recovery in the sector.

Twelve companies in the sector showed a decrease in ETR of greater than 5% between 2009 and 2010 and 13 showed an increase of greater than 5%.

To eliminate the ratios of those companies most affected by the financial crisis, we eliminated companies with a loss or tax refund in any of the three years. The resulting ratios are shown in Figure 29.

 

Figure 28 -- Effective tax rate (all companies)

 

 

 

 

Figure 29 -- Effective tax rate (profitable companies only)

 

 

 

The total income before tax, taking all companies in the sector, was $20 billion in 2010, an increase of 60% over 2009. The tax charge increased by 61% over the same period, although the recovery in cash tax paid lags behind income and tax charge due to the payment on account regimes in force.

Drivers of the effective tax rate

To assist in understanding the variation in ETR in the sector, we reviewed the 2010 statutory/effective rate reconciliation in company accounts for the 39 companies where this was available at the time of our analysis. ETRs of 13% of companies were above relevant statutory rates while the remaining 87% of companies had ETRs below statutory rates.

The reconciling items, as disclosed in the statutory/effective rate reconciliation, were analyzed, collated, and averaged over the sample. Figure 30 illustrates some drivers of the effective rate and shows how frequently they appear in companies' statutory reconciliations. The bars show the number of companies reporting the driver, and the line shows the impact of that reconciling item averaged over companies reporting it, excluding single outlying ratios in excess of +50% or -50%.

 

Figure 30 -- Drivers of the effective rate

 

 

 

Cash tax rate

The cash tax rate is the cash tax paid in the year (as disclosed in the cash flow statement or supplementary information to the cash flow statement) as a percentage of income. There is an element of timing mismatch; for example, in some territories 50% of tax due on profits is not paid until after the year-end. Cash tax paid is not disclosed in publicly available accounts in some territories. Figure 31 shows the cash tax rate for all companies where available.

 

Figure 31 -- Cash tax paid as a percentage of income before tax

 

(all companies)

 

 

 

 

Figure 32 -- Cash tax paid as a percentage of income before tax

 

(profitable companies only)

 

 

 

Although 2010 saw the start of a slow recovery for the metals industry, trading conditions remained tough with a number of companies reporting losses in the period. Strong demand from emerging markets was the main driver for the recovery with significant investment in automotive, construction, and infrastructure projects. Elsewhere, the automotive and energy industries appeared to recover more than some non-residential construction. Although the economy is expected to recover in 2011 and demand from the emerging markets is likely to remain strong, the outlook for 2011 remains uncertain with large geographic variations in demand and high raw material costs. Most companies in this sector introduced cost-savings measures over the last few years in order to survive the economic crisis.

The metals study includes 42 companies from the iron and steel, general mining, aluminum, and nonferrous metals sectors. Eight of the companies had not released 2010 data at the time of the study.

 

Figure 33 -- Effective tax rate (all companies)

 

 

 

The three-year average effective rate for the metals sector was 24.2%. The average dropped by two percentage points from 2008 to 2010, with the range between the quartiles declining by less than one percentage point, from 20.2% in 2009 to 19.3% in 2010. The lowest ETR in 2010 was -235.2% and the highest was 6,975.4%, a range of 7,210.6%, showing significant volatility in ETRs in the sector. Eight companies had a tax benefit in 2010 compared to 12 in 2009, showing the beginning of the recovery in the sector.

Fourteen companies showed a decrease in ETR of greater than 5% between 2009 and 2010 compared with 13 companies with an increase of greater than 5%.

 

Figure 34 -- Effective tax rate (profitable companies only)

 

 

 

 

Figure 35 -- Drivers of the effective rate

 

 

 

The total income before tax, taking all companies in the sector, was $80 billion in 2010, an increase of 200% over 2009. The tax charge increased by 100% over the same period, an indication of the recovery, although the recovery in cash tax paid lags behind income and tax charge due to the payment on account regimes in force.

Drivers of the effective tax rate

To assist in understanding the variation in ETR in the sector, we reviewed the 2010 statutory/effective rate reconciliations in the company accounts. This was available for 34 of the companies studied.

The reconciling items, as disclosed in the statutory/effective rate reconciliation, were analyzed, collated, and averaged over the sample. Figure 35 illustrates some of the drivers of the effective rate and shows how frequently they appear in companies' statutory reconciliations. The bars show the number of companies reporting the driver, and the line shows the impact of that reconciling item averaged over companies reporting it, excluding single outlying ratios in excess of +50% or -50%

The most common reconciling item for the metals sector was the impact of foreign operations and this had an average impact of -0.5% on the ETR. Non-taxable income and non-deductable expenses were also reported by a large number of companies in the study, including descriptions 'included income not subject to tax' and 'permanent differences.' These items are likely to be structural and recurring. Losses are reported as an unfavorable reconciling item (+2.2%) although these are less likely to recur as the recovery takes place.

Cash tax rate

The cash tax rate is the cash tax paid in the year (as disclosed in the cash flow statement or supplementary information to the cash flow statement) as a percentage of income. There is an element of timing mismatch; for example, in some territories 50% of tax due on profits is not paid until after the year-end. Cash tax paid is not disclosed in publicly available accounts in some territories. Figure 36 shows the cash tax rate for all companies where available.

 

Figure 36 -- Cash tax paid as a percentage of income before tax

 

(all companies)

 

 

 

Figure 37 shows a trend of increasing cash tax paid in the average and upper quartile, with a decreasing rate in the lower quartile. The average rate over the three years of the study was 32.8%.

 

Figure 37 -- Cash tax paid as a percentage of income before tax

 

(profitable companies only)

 

 

 

 

Companies included in the metals sector in this study

 

The T&L sector started to recover in 2010, although some areas of the sector bounced back faster than others. Asia and the emerging markets drove the majority of the recovery with Europe and the US much slower. Shipping freight volumes recovered, mainly due to the increased demand from Asia. Generally, air transport had a more difficult year, although international customer and freight demand started to rise, disruptions caused by the ash cloud in Europe, the H1N1 influenza in Asia, increased bomb threats, and bad winter weather all caused significant disruptions and losses to air travel. Package delivery companies continued to see a fall in letter volumes due to increased use of electronic mail, although package shipping increased because of the increase in online shopping. Many T&L companies undertook cost-cutting initiatives over the past few years in order to weather the storm.

 

Figure 38 -- Effective tax rate (all companies)

 

 

 

Effective tax rate

The three-year average effective tax rate for the T&L sector was 24.0%. Rates remained steady over the three years in the average, upper, and lower quartiles. The interquartile range was wide, 30.8 percentage points in 2010, reflecting the volatility in ETRs in the sector.

 

Figure 39 -- Effective tax rate (profitable companies only)

 

 

 

Eighteen companies showed a decrease in ETR of greater than 5% between 2009 and 2010 compared to 11 companies with an increase of greater than 5%.

 

Figure 40 -- Drivers of the effective rate

 

 

 

The three-year average ETR was 32.2% and there was little variation in the upper quartile or average over the three years. The range between the quartiles was narrower for profitable companies compared to all companies, indicating that most profitable companies had ETRs in a narrower range. The lower quartile fell by three percentage points. The minimum ETR was 2.1% and the maximum was 48.1% in 2010.

The total income before tax, taking all study companies in this sector, was $75 billion in 2010, an increase 150% over 2009. The tax charge increased by 50% over the same period, an indication of the recovery, although the recovery in cash tax paid lags behind income and tax charge due to the payment on account regimes in force.

Drivers of effective tax rate

To assist in understanding the variation in ETR in the sector, we reviewed the 2010 statutory/effective rate reconciliations in the company accounts for the 54 companies where this was available at the time of the analysis.

The reconciling items, as disclosed in the statutory/effective rate reconciliations, were analyzed, collated, and averaged over the sample. Figure 40 illustrates some drivers of the effective rate and shows how frequently they appear in companies' statutory reconciliations. The bars show the number of companies reporting the driver, and the line shows the impact of that reconciling item on ETR averaged over the companies reporting it, excluding single outlying ratios in excess of +50% or -50%.

The most common reconciling item for the T&L sector was impact of foreign operations, which reduced the average ETR by 1.4%. Tax reserve adjustments were the most favorable driver for this sector, reducing the average ETR by 5.8%, although this item is less likely to be recurring. Reconciling items due to tax losses were reported by over half the companies in the analysis but the net effect, averaged over the companies reporting the item, was -0.6%, a result of both positive and negative drivers.

Cash tax rate

The cash tax rate is the cash tax paid in the year (as disclosed in the cash flow statement or supplementary information to the cash flow statement) as a percentage of income. There is an element of timing mismatch; for example, in some territories 50% of tax due on profits is not paid until after the year-end. Cash tax paid is not disclosed in publically available accounts in some territories. Figure 41 shows the cash tax rate for all companies where available.

 

Figure 41 -- Cash tax paid as a percentage of income before tax

 

(all companies)

 

 

 

 

Figure 42 -- Cash tax paid as a percentage of income before tax

 

(profitable companies only)

 

 

 

Source of information

We based our financial analysis on a number of ratios derived from publicly available information. This allowed for a large sample size of 318 companies without the need to contact each company, giving us a dependable overview from which to draw our conclusions.

Statistical analysis

Trimmed average

We based our conclusions on a statistical analysis of the ratios. In a tax benchmarking survey of this nature, particular ratios may be distorted because of one-off, nonrecurring items. Exceptional items, for example, often attract associated tax at rates far from the statutory rate.

It was necessary to exclude these extreme values, and this was done consistently by taking a trimmed average of a particular sample. The trimmed average is the average result of the data, derived by excluding 15% of the data points from both the top and bottom of the data set. It is a robust estimate of the location of a sample, excluding outlying data points.

Quartiles

These record the ratio where 75% (upper quartile) and 25% (lower quartile) of the sample companies lie below these points. By displaying results in this manner, it is possible to identify the range in which the results of the majority of companies fall.

² The World in 2050. The accelerating shift of global economic power: challenges and opportunities. PricewaterhouseCoopers LLP

© 2011 PricewaterhouseCoopers LLP. All rights reserved. "PricewaterhouseCoopers" and "PwC" refer to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate legal entity. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. NY-11-0728