Warning - long, tax wonky post ahead (but I think addressing an important issue)
The NYTimes discusses major U.S. corporations pushing for a "repatriation tax holiday," or as the headline puts it a "Tax Break on Foreign Cash." http://www.nytimes.com/2011/06/20/business/20tax.html?_r=1&hpw I seem to know something about this.
In sum and general, a U.S. Shareholder (defined term) that operates a foreign business in corporate form that earns "active" earnings will not pay U.S. tax on such earnings until the foreign corporation "repatriates" the earnings to the U.S. Shareholder via a dividend. Since in most notable cases the U.S. person controls the foreign incorporated business (generally called a "controlled foreign corporation" or more commonly a "CFC"), a repatriation/dividend will not be undertaken as the accounting rules allow the U.S. Shareholder to "permanently reinvest" the CFC's earnings offshore. That is, the U.S. Shareholder will not have to accrue the future U.S. taxes on such earnings because of the lack of an intent to dividend them "home" to the U.S.
Thus, major U.S. corporations have garnered a nice boost to their bottom line for foreign active earnings that they can claim are permanently reinvested offshore. If these corporations were to bring the earnings "home" to the U.S., they would have to pay a 35% tax on the dividends, and take the hit to their bottom line they previously avoided. These corporations are now asking for a repatriation tax "holiday" to reduce the 35% tax to a tax rate of 5.25%. This was done as part of the 2004 American Jobs Creation Act, the first time in 42 years that the U.S. offered such a holiday. Now, just 7 years later, large corporations are again pushing for another such holiday.
Their argument is that the U.S. would benefit if the corporations could bring these offshore earnings back to the U.S., ostensibly for job creation but not really, but the earnings are "trapped" outside the U.S. because of the 35% tax rate they would suffer upon repatriation. Thus the need for a holiday.
This causes me to ask: well, if the earnings are trapped offshore because of the tax they would suffer upon repatriation, why doesn't the U.S. just tax them now, releasing the remaining earnings to the corporations to do with as they please? Some estimates put these trapped offshore earnings at $1 trillion. If the U.S. taxed the earnings now, that would leave $650 billion the corporations could bring back home, and also put $350 billion into the U.S. gov'ts coffers, partially closing the dreaded deficit (at least for one year). Voila, problem solved!
The problem with this proposal is that it would leave a giant hole in a lot of major U.S. corporations' balance sheets, as they have not accrued the U.S. tax for financial statement purposes, because of the accounting rule I mention above. Opposition to such a measure would make the current push for a tax holiday in Congress look like nothing. However, if I were an enterprising legislator and the congressional winds were right, I might propose a bill that (i) taxed all these offshore earnings retroactively at 35% upon the date of the bill's enactment, but (ii) only taxed at, say, 25% earnings brought "home" between the date of first committee action on the bill and the date of enactment.
If there were a realistic chance of such a bill becoming law, then companies would start to dividend earnings home, and the more companies that did so the more they would push for the bill to be enacted, because if it wasn't then the tax paid on such earnings would be 35% and not 25% (or whatever %). This might amount to a de facto tax holiday, but at least it is one that occurs at a higher rate and solves the "trapped" offshore earnings "problem."
Repatriation Tax Holidays
Jun 23, 2011 by UghComments
Jun 23, 2011, 08:38:05 JanieM wrote:
Ugh -- just want to say thanks for posting this. I've been waiting to see what you were up to in asking for posting rights, and this is a substantive thought train on an interesting topic that I'm not familiar with.
Your idea for a bill sounds great, but basically this is yet another in a long list of features of our current economic and political situation that just makes me furious. I love the quotes around "trapped" and "problem" in the last line. They play up the fact that bitching about having your earnings "trapped" offshore is like bitching about not being able to get inside to see the basketball game because you refuse to buy a ticket. (That's a lame analogy but I'm too tired/hungry to think of a better one.)
Jun 23, 2011, 10:46:27 DaveC wrote:
The flip side is that, even though I drive Fnords these days, having Honda and Toyota plants in the US has all sorts of advantages. The real cost of having the cars manufatured nearer the consumers is much lower, and much "greener" if you are into that. LJ may have to check on this for me, but if Japanese corporations can reinvest their capital gains back into US capital
expenditures, then perhaps everybody wins - the US consumers get lower prices, the Japanese retirees (if they receive dividends) get more bang for their investment buck, lower energy usage, etc. The big issue here is whether Japan is suffering from unemployment that would be relieved if all the cars were manufactured there. (I don't think that Japan has the capacity for more manufacuring jobs right at this time.)
Anyeay, that's how I thought this global economy should work, even with all the problems it is having now. Consumers benefit, investors benefit, and those include very rich people, but not exclusively.
Jun 23, 2011, 12:22:46 Turbulence wrote:
"The real cost of having the cars manufatured nearer the consumers is much lower, and much "greener" if you are into that."
Cite please?
"(I don't think that Japan has the capacity for more manufacuring jobs right at this time.)"
I wonder what the phrase 'lost decade' means and what implications it poses for labor markets?
DaveC, are you ever right about, like, anything?
Jun 23, 2011, 20:06:41 libjpn wrote:
DaveC,
The original impulse for moving manufacturing in the US was to deal with protectionist legislation. I think the question of being 'greener' is always a loaded one because there are so many externalities involved. Also, there is the question of content, which was in the news at the end of 2009 quite a bit
http://wheels.blogs.nytimes...
Ugh, thanks for the wonkiness. I'm not sure how Japan taxes its corporations, but after this weekend, I'll try and find some info. I can note that the US, unlike most other countries, demands that people living overseas pay taxes on their income. There is a foreign earned income deduction, but every 5 years or so, some bright spark suggests eliminating it is a perfect way to get more money. I'm wondering if there is some link between in conception to what is being discussed here.
Jun 26, 2011, 08:36:34 Ugh wrote:
LJ - Japan has a corporate income tax rate that used to be close to the US's but I think it was going to go down to mid-20%s, though I believe the tsunami changed those plans. They also recently went to a "dividend exemption" system whereby dividends from active earnings from foreign subsidiaries are 95% exempt from tax, i.e., they moved from a worldwide system like the US has to a (mostly) territorial system that exempts foreign earnings.
Similarly, the U.S. taxes its citizens on their worldwide income with, as you say, sometimes a foreign earned income exclusion/deduction, plus a foreign tax credit for foreign income taxes paid by the citizen (but not in excess of what would otherwise would have been the U.S. tax on that income). The parallel to the corporate income tax is that both are (supposedly) worldwide systems. If the corporate income tax goes territorial, it will be interesting to see whether they make a similar change to the individual income tax, though I've not heard such a change discussed recently.
Jun 26, 2011, 08:47:46 Ugh wrote:
Janie - your welcome.
The problem with such a bill, other than it would never pass IMHO, is that it similarly blows a hole in corporate balance sheets (though perhaps a smaller one) as retroactively taxing the offshore earnings. This could be mitigated with, say, a 5 or 10 year phase in rule. But again, it would never happen, though it would be interesting to see what would happen if an influential House member introduced such a bill.
If I had to bet what would happen in the next couple years vis a vis "tax reform." The U.S. ends up with (effectively) a territorial tax system for active foreign business income, a lower corporate tax rate for income earned here in the U.S., and a VAT.
Jun 30, 2011, 05:43:49 Ugh wrote:
Interesting commentary by a tax apostate:
http://www.huffingtonpost.c...
Jun 30, 2011, 11:22:18 ccdg wrote:
The expectation for those repatriated dollars is:
"There are 42 billion reasons to bullishly speculate on Microsoft.
If some or most of Microsoft's (MSFT - News) $42 billion cash hoard held outside the U.S. is repatriated and given to shareholders via special dividends and stock buybacks, the stock could advance."
The right play on the stock is explained at Barron's <a href="http://finance.yahoo.com/ba...">here</a>
Not sure that bodes well for the plan to use it for job creation.
(first try at html here, who knows)
Jun 30, 2011, 23:26:51 Ugh wrote:
Thanks for the link Marty, it's an...interesting analysis. I'm not sure why paying a special dividend to shareholders would cause the stock to "advance." As the article itself notes, if a special dividend is paid by a corporations, the strike price of holders of call options is...reduced, as would be expected as the corporation is now worth less than it was because it got rid of an asset (cash) in exchange for nothing.
Further, in any repatriation tax holiday that I'm aware of there would still be some residual tax. Thus, and assuming a 5% holiday tax rate, a corporation that repatriates one dollar in cash ends up with 95 cents. So, it's automatically reduced its value by that much (assuming there is no discount built-in to the stock for not being able to repatriate cash to the U.S., which there probably isn't), and then further reduced it by a dividend.
A more interesting question is, what is Microsoft doing sitting on $50 billion in cash/short term investments (per their March quarterly balance sheet)? That's almost 3 times their net income from last year. I hope they have good investment managers (and, of course, if they paid out a lot of that cash to shareholders the stock price would decline, making the options held by management less valuable. Hmmm.)
Jun 30, 2011, 23:31:14 Ugh wrote:
As to that last point, I believe it is the case that the strike price of call options granted to management and other employees of the corporation DO NOT reset when the corporation pays a special dividend. I'd be curious if anyone knows this for sure.
Jun 30, 2011, 23:51:49 ccdg wrote:
I called a guy who tells me the strike price of options do not reset with a special dividend even if it is considered a return of investment. So, I'm 99% sure you're right.
Jul 01, 2011, 05:59:08 Ugh wrote:
Thanks. And thus we see the purported incentives intended to align management interests with that of shareholders again be not so much.
And hence Warren Buffett not being into options.
Jul 01, 2011, 08:38:45 ccdg wrote:
Since we started expensing options (which is seriously cut back under IFRS) they haven't been as bad as a practical matter. In some ways they are preferable to simply tying bonuses to stock price, at least the price has to sustain over some longer period to be valuable.
Jul 08, 2011, 11:38:55 russell wrote:
So, options are cool?
Give them to everybody, not just upper echelon managers.
Make everybody rich.
Jul 08, 2011, 11:45:29 ccdg wrote:
We have at every company I ran.
Jul 08, 2011, 11:48:07 ccdg wrote:
Just to add, at my last company, after the 2001 meltdown, the employees made it clear they preferred cash bonuses to options. So we changed the comp plan to be more weighted toward cash.
Jul 09, 2011, 02:56:02 Ugh wrote:
I loved the debate over whether options should be expensed under the accounting rules, with management arguing both that it would be a horrible hit to their bottom line so that they would stop granting them (and losing their incentive effect) and that it didn't really matter for investors because the current disclosure rules were fine and thus the economic expense of options was appropriately baked into the stock price.
Those two arguments didn't really seem to jibe to me, and only later did I realize that, even if employee stock option expenses were reflected in the stock price of a publicly traded company, it mattered a great deal to management whether such option grants were included as a line item on the financial statements, as bonuses and other compensation were often tied to net income, or EPS, or some other actual financial statement line item that would have been smaller had stock option expenses been included.
It was cooking the books, plain and simple, whether blessed by the FASB or not.
Jul 14, 2011, 01:22:31 russell wrote:
"We have at every company I ran."
That's great, but outside of a select few industries, and generally only certain classes of employee within those select few industries, it's not common.