Companies often go to great lengths to reduce their tax bills. They may transfer activities and/or tangible or intangible property to countries with lower tax rates. They may also maintain a legal structure that can minimize taxes and facilitate the tax-efficient movement of the company’s cash.
Early in my career, I worked for one of the world’s largest accounting firms and specialized in international corporate tax planning and research. My job was to help companies structure their international operations in a way that minimized their tax bills. I also helped them determine the most tax-efficient way to move cash around the world. In my more cynical moments, I told people the purpose of my job was to tell companies how to shuffle paper around so they could reduce their tax bills and increase the size of the national debt. It should go without saying that I am grateful I found a different line of work. Little did I know then that the work I was doing could have laid the groundwork for the substantial amount of cash many multinational companies hold abroad today. The following chart shows the top 10 holders of cash outside the US as of December 31.
Shares of Apple, Microsoft, Qualcomm, Merck and ebay are currently on BWFA’s “Buy/Hold” list and are held in client accounts.
The question is, “What has led U.S. companies to hold so much cash offshore?”
In theory, companies should minimize their taxes. A lower tax bill results in greater operating cash flow. A company’s ability to generate increasing amounts of cash is a key factor in assessing its worth.
The issue is that companies are likely generating far more cash from their international operations than they anticipated when they started to implement the type of tax planning strategies mentioned above. In addition, the U.S. corporate tax rate has largely been unchanged at around 35% since 1986. Other countries have lowered their tax rates during this period. The change in global tax rates has made it harder for companies to move cash around the world without incurring additional costs.
When a company distributes profits earned by a foreign subsidiary to its U.S. parent, it is allowed to take a credit for income taxes paid in the foreign jurisdiction. When tax rates around the world were higher, companies could repatriate money from subsidiaries in high and low tax jurisdictions. Such tax planning strategies would allow them to, in effect, blend the income and credits and minimize the cost of bringing the cash home.
In short, it is likely that the comparatively high U.S. tax rate has caused companies to continue to expand their operations outside the U.S. At the same time, the demand for U.S. goods in foreign countries has increased. The result is that companies are generating increasing amounts of cash outside the U.S.
In addition, the role of traditional manufacturing businesses that require heavy investment in property, plant and equipment (PP&E) has dissipated. Nine of the 10 companies in the above chart (GE is the exception) do not require meaningful investment in PP&E to operate their businesses. Instead they rely largely on intellectual property such as patents and know-how. It does not cost them much to manufacture and distribute their products. Because they do not need to invest heavily in PP&E, they accumulate even more cash.
The issue would likely be even more acute if there had not been a repatriation holiday in 2004 allowing multinational companies holding funds offshore to transfer cash to the U.S. at a reduced tax rate of just 5.25%. The 2004 holiday was not considered a success as most companies did not use the funds they repatriated (approximately $315 billion) for domestic investment (which was the basis for the 2004 holiday). Once again, Congress is exploring ways to revamp the tax system for firms with overseas operations. Any near-term revenues generated by such changes are being considered as part of an effort to fund a long-term highway bill.