stock market implications of a global minimum corporate tax (i)

1980s tax planning

I got my first job as the lead (and only) manager of a global fund in 1986. I’d worked for six years as an analyst and manager in the US market and for a couple in the smaller Asian markets. I knew my first task would be to understand Japan, then the largest–and hottest–stock market in the world.

Commissions and fees were high there, trading volume was enormous. At the same time, local brokers had no interest in foreign customers, whom they regarded as not fully human, and were analytically pretty backward anyway. So I was surprised to learn that virtually all the big international brokers operating in Tokyo were posting gigantic losses from their Japan business–high expenses, understandable given the high price of real estate and of imported goods like food, but low revenues. Then I learned why.

Corporate taxes were very high in Japan back then. So foreigners executed all their trades through their Hong Kong offices, where the corporate tax for foreign companies was zero.

today’s world

Ireland is the poster child of large-cap corporate tax avoidance because its corporate income tax rate is 12.5%.

How the shelter works:

–a non-Irish multinational bundles up its intellectual property–brand names, R&D…–, consolidates it in an Irish subsidiary and for its use around the world agrees to pay a royalty to the Irish sub.

–the firm has sales of $1,000,000 in Germany, where the corporate tax rate is 30%. Let’s say expenses, ex royalty, are $600,000, meaning pre-tax income is $400,000. The firm pays a royalty of $200,000 to the Irish subsidiary, however. This is another expense for German operations and cuts pre-income there to $200,000.

–in Germany, after-tax income is $140,000. The royalty income is taxed at 12.5% in Ireland, netting the firm $175,000. Total income for the firm is therefore $315,000. Without the financial engineering, total income would have been $280,000. Overall, good for the firm, good for Ireland, bad for Germany.

my experience

When I started on Wall Street, such financial engineering was frowned upon. Most analysts and portfolio managers at least mentally reduced the resulting earnings downward to remove the zaitech benefit. One prominent UK broker even made it a feature of its research to “normalize” earnings to reflect the home country statutory rate.

Two reasons for this:

–with US companies, at least, repatriating foreign earnings means paying US income on them, minus a credit for foreign taxes paid. So the financial engineering savings are in a sense stranded abroad and not available for capital investment here or for paying dividends to shareholders. Corporate lawyers have long since found ways to make the funds available domestically without incurring a tax liability, however. Dividends are no longer as important to Wall Street as they were back then. And the emergence of Trump and his acolytes as standard bearers for the Republican party has pushed the US way down the list of places companies feel comfortable investing in.

–the thought in the early days of financial engineering was that any such ploy would be short-lived because governments would quickly shut down corporate loopholes.

more tomorrow

Exit mobile version