Trapped Cash Continues to Grow

According to research by Bloomberg, the largest U.S.-based companies increased the amount of cash held offshore by $206 billion last year. This is cash kept in foreign countries to prevent U.S. taxation. As a result, these multinational companies have now accumulated $1.95 trillion of offshore profits, up 11.8% from 2012. Three companies – Microsoft, Apple and International Business Machines – accounted for 18.2% of last year’s increase. General Electric holds $110 billion overseas, the highest of any U.S. multinational, according to Bloomberg.

A study published by the Congressional Research Service earlier this year found that in 2008 U.S. multinationals earned 43% of their overseas profits in jurisdictions with low tax rates such as Bermuda, Ireland, Luxembourg, the Netherlands and Switzerland. This cash figure was more than five times greater than the share of workers and investments they have in those countries.

The United States, at least theoretically, taxes companies on their global profits. But in most circumstances, taxes on overseas income can be deferred until the profits are sent back to the United States. When companies do repatriate foreign earnings, they can claim a credit for foreign taxes paid. However, if the foreign country’s tax rate is low, they end up paying additional U.S. tax on the amount they bring home.

In the current environment, in the vast majority of cases, the interest cost associated with borrowing funds is considerably less than the tax cost related to bringing home foreign profits. In 2005, there was a temporary tax holiday for repatriated profits, which allowed corporations to bring their foreign earnings home at a 5.25% tax rate. Companies responded by repatriating more than $300 billion in foreign profits, five times as much as normal. However, the desired result – reinvesting the income in the U.S. to create jobs – was not realized. A study by the National Bureau of Economic Research suggested a majority of that income went to shareholders in the form of share repurchases.

Congress and the President generally support new legislation that would make the system more equitable. However, to date, none of the proposed plans has received a vote in a congressional committee. Hopefully, an equitable solution can be determined, as even if the rate were lowered, it would still raise additional taxes that could be used to fund such things as changes and improvements to domestic infrastructure.

When analyzing companies for potential inclusion in client portfolios, we often find that they have considerable cash balances as well as relatively high debt burdens. In such cases, it is important to dig deeper into the financial statements and related footnotes to determine how much overseas cash they may hold as well as what interest rate is associated with their debt.