Yesterday’s Financial Times contains three (count ’em, three) articles, one on the front page and prominently above the fold, talking about recent efforts by US corporations in lobbying Washington to allow them to repatriate foreign cash holdings while paying little or no income tax.
This appears to be the start of a public relations campaign by the US Chamber of Commerce aimed at persuading Congress to pass a tax amnesty bill like the Homeland Investment Act (HIA) of 2004.
US tax law, unlike that of many other countries, makes multinationals incorporated in the US pay domestic income tax (less a credit for foreign income taxes paid) on any foreign earnings repatriated here. This can be a big deal. For a US company recognizing Asian profits in Hong Kong, for example, the corporate tax is zero. This means a firm bringing money like this back home would typically have to pay 35% of it to the IRS. The funds are probably going to be reinvested in growing Asian businesses. But even if not, unless the funds are crucially needed in the US it would be financially foolish to repatriate it.
HIA allowed firms to pay a maximum of 5.25% tax on any money brought back to the US during a specified period of time. Companies were required to use the repatriated funds only to hire new workers or to invest in plant and equipment. The idea was that this would reduce unemployment and spur new investment. None could be used for stock buybacks, dividend payments or executive compensation.
According to forthcoming research, the reality of the HIA was quite different. Corporations repatriated around $300 billion from abroad. Strictly speaking, all the money was used for the purposes intended. But aggregate employment and capital investment didn’t increase. The funds simply freed domestically generated profits to be used for dividends etc.. In fact, some firms actually used the repatriated funds to replace domestic profits that they shipped abroad.
Proponents of HIA II, which the FT says include Cisco, GE and Microsoft, are not making strong claims this time around. They label the cash, which is estimated at about $1 trillion, as being “trapped” abroad. They argue that maybe $400 million would be repatriated under HIA II, giving the government $20 billion or so in tax money it wouldn’t otherwise have. And the repatriated funds would likely slosh around doing something–presumably economically good–in the US.
So far the Obama administration is saying no, seeing that it’s in enough trouble without advocating a big tax break for cash-rich corporations.
investment implications (there actually are some)
1. I wrote about this topic a bit last April, specifically regarding the large buildup of cash on the balance sheets of technology companies.
2. To be able to pay it out in dividends, a US-incorporated company has to have the cash available in the US. But most publicly-traded companies don’t disclose enough about where there cash balances are, or the cash generating/cash using characteristics of their US and foreign businesses for an analyst to see how well a given dividend is covered. This didn’t make any difference when dividend yields were very low and investors were interested in capital gains. But it does now.
3. It takes a US$1.50 earned pretax in the US to give the same lift to the reported earnings of a US company as US$1 earned in Hong Kong. So a corporation concerned with maximizing eps might well choose to recognize profits in Hong Kong rather than the US, assuming it had a choice. Similarly, a decision to shift the profit stream to the US in order to may dividends–again, assuming this were possible–would mean a structurally lower level of eps. I suspect that at some point, investors will ask for earnings estimates that are “normalized,” in the sense of adjusted to what they would be under a standard 35% tax rate, in order to get a more apples-to-apples comparison.
4. Why lobby for HIA II? The paper I linked to above argues that it makes very little difference to corporations in the aggregate. But there may be firms–most likely in the tech area–who will be forced to borrow or to repatriate foreign cash balances (and pay tax on them), either to be able to maintain the current dividend or raise it. The strongest advocates of a new HIA might well be in this position.