Cor­po­ra­tions keep cash away from high U.S. taxes

The Washington Times Weekly - - National - BY PA­TRICE HILL

Amer­i­can cor­po­ra­tions seem to be do­ing just about ev­ery­thing with their record $1.53 tril­lion in cash hold­ings ex­cept us­ing it to in­vest and hire in the United States, even though the slug­gish econ­omy could use the boost.

Three-quar­ters of that cor­po­rate cash pile was earned over­seas and is be­ing held out­side the coun­try to avoid the top U.S. cor­po­rate tax rate of 35 per­cent, ac­cord­ing to a study by Stan­dard & Poor’s Corp. It re­mains the high­est rate in the de­vel­oped world de­spite tax re­form pledges by lead­ers of both ma­jor U.S. po­lit­i­cal par­ties.

Those guard­ing the moun­tains of over­seas cash in­clude some of the best-known names in Amer­i­can busi­ness, in­clud­ing Gen­eral Mo­tors Co., Gen­eral Elec­tric Co., Ap­ple Inc. and Google Inc.

While many com­pa­nies are sim­ply rein­vest­ing the cash in their op­er­a­tions in China and other over­seas mar­kets that have been grow­ing faster than their U.S. op­er­a­tions, oth­ers are us­ing it to ac­quire for­eign com­pa­nies. A ma­jor­ity ap­pear to be us­ing the cash as col­lat­eral to bor­row funds in the U.S. to fi­nance gen­er­ous stock buy­back and div­i­dend pro­grams for their share­hold­ers. Only a small frac­tion of the money is be­ing used to in­crease hir­ing, wages and busi­ness ex­pan­sion in the U.S.

Fac­tors con­tribut­ing to the un­prece­dented over­seas cash bal­ances in­clude tax avoid­ance, easy credit con­di­tions and boom­ing over­seas sales.

Sev­eral deals re­cently high­lighted the ex­treme mea­sures com­pa­nies are pre­pared to take to avoid pay­ing U.S. taxes. Drug gi­ant Pfizer this month an­nounced that it would de­ploy some of its $39 bil­lion over­seas cash hoard in a $200 bil­lion bid to pur­chase Bri­tain’s As­traZeneca PLC, with the goal of even­tu­ally re­lo­cat­ing its head­quar­ters to Lon­don so it no longer has to worry about pay­ing U.S. taxes on its earn­ings.

Ap­ple, which has the largest over­seas cash trove by far at $132 bil­lion, is one of the many cor­po­ra­tions that, rather than dip into its cash and take a tax hit, took out debt in­stead to fund a big stock buy­back and div­i­dend pro­gram. The move was spurred by Carl C. Ic­ahn and other ac­tivist in­vestors frus­trated at their in­abil­ity to get their hands on some of the com­pany’s far-flung cash.

Bor­row­ing to buy stock

Among the 80 per­cent of blue chip com­pa­nies listed in the Stan­dard & Poor’s 500 in­dex that con­ducted ma­jor stock buy­back pro­grams last year — of­ten af­ter bor­row­ing the money as Ap­ple did — were Ford Mo­tor Co., Boe­ing Co., Cater­pil­lar Inc., Cisco Sys­tems Inc., 3M Co., Mi­crosoft Corp., Safe­way Inc., and Trav­el­ers Cos.

“Share­hold­ers are push­ing for the re­turn of this cash,” S&P an­a­lyst Andrew Chang said.

Ap­ple and other cor­po­ra­tions are un­will­ing to repa­tri­ate the money and pay high U.S. taxes on it, so they are bor­row­ing money in­stead to sat­isfy in­vestors, Mr. Chang said. He pre­dicted that the trend would ac­cel­er­ate this year.

Cor­po­ra­tions get a dou­ble tax ad­van­tage if they bor­row money to pay stock­hold­ers rather than dip into their cash. They can avoid giv­ing a third of their earn­ings to the federal govern­ment, and the in­ter­est on their debt be­comes a tax-de­ductible busi­ness “ex­pense.”

More­over, in­ter­est rates on the debt are some of the low­est on record, thanks to the Federal Re­serve, which for the past five years has been try­ing to boost U.S. eco­nomic growth by pur­chas­ing more than $3 tril­lion of the most con­ser­va­tive bond in­vest­ments: U.S. Trea­surys and mort­gage­backed se­cu­ri­ties. The Fed’s dom­i­nance of those tra­di­tional mar­kets has driven pri­vate in­vestors into cor­po­rate debt and riskier mar­kets as they seek higher re­turns than the rock-bot­tom yields on Trea­sury bonds.

In­vestors’ thirst for higher-yield­ing cor­po­rate debt has re­sulted in a bor­row­ing binge. Cor­po­ra­tions are tak­ing out nearly $4 in loans for ev­ery $1 in cash they earned in re­cent years, ac­cord­ing to S&P.

Some say the bor­row­ing spree borders on a credit mar­ket bub­ble that is feed­ing stocks be­cause much of the debt is used to re­pur­chase the com­pa­nies’ own shares.

Few take the tax hit

In a sur­vey last month of cor­po­ra­tions with large cash hold­ings over­seas, re­searchers at the Bri­tish bank Bar­clays PLC found that only a small num­ber of com­pa­nies were repa­tri­at­ing their cash earn­ings for use in the U.S.

EBay re­ported re­cently that it is bring­ing home $9 bil­lion in cash to pur­sue “grow­ing op­por­tu­ni­ties in the U.S.” The on­line auc­tion gi­ant also said it is mak­ing pro­vi­sions for higher taxes on for­eign earn­ings in the fu­ture as it trans­fers a higher pro­por­tion of its cash back to the U.S.

Bar­clays found that com­pa­nies like eBay, whose com­peti­tors are mainly in the U.S., are more likely to bring home their cash than com­pa­nies like Ap­ple and Pfizer, whose com­peti­tors re­side mainly in other coun­tries. Com­pa­nies with mainly for­eign com­peti­tors are more likely to spend their cash ex­pand­ing and ac­quir­ing as­sets over­seas, the sur­vey found.

Of all the com­pa­nies with large over­seas cash hoards, Xil­inx Inc., NetApp Inc., Western Union Co. and EMC Corp. are the most likely to repa­tri­ate their money and pay taxes so they can use the funds in the Amer­i­can mar­ket, Bar­clays said.

S&P’s Mr. Chang said that, de­spite all the cor­po­rate machi­na­tions aimed at min­i­miz­ing taxes and max­i­miz­ing prof­its, the pileup of so much cash over­seas seems to have been in­ad­ver­tent for most cor­po­ra­tions.

“We be­lieve most of these [cor­po­ra­tions] did not in­tend to have such a large cash pile sit­ting on the side­lines. If given the choice, most would pre­fer to repa­tri­ate the cash and limit debt is­suance,” he said.

Al­though Congress and the Obama ad­min­is­tra­tion have failed to reach an agree­ment on low­er­ing tax rates, Mr. Chang pins as much blame for the bor­row­ing binge on the Federal Re­serve.

“In our view, the avail­abil­ity of cheap debt has been most re­spon­si­ble for the record cash bal­ances,” as it has sim­ply made more eco­nomic sense for com­pa­nies to bor­row rather than spend down their cash, he said.

“With­out ac­cess to the ac­com­mo­dat­ing credit mar­kets, com­pa­nies would likely not have pro­vided the re­turns that share­hold­ers have be­come ac­cus­tomed to in re­cent years,” Mr. Chang said, voic­ing the wide­spread view that in­vestors in stocks and bonds — rather than work­ers and Main Street businesses — have been the main ben­e­fi­cia­ries of the cash-backed bor­row­ing binge.

Hir­ing drought continues

What­ever the rea­sons driv­ing the trend, econ­o­mists and busi­ness lead­ers from Wall Street to Main Street have been de­cry­ing the drought of in­vest­ment by U.S. businesses in ex­pand­ing plants, up­grad­ing equip­ment, and hir­ing and giv­ing raises to work­ers, even though many of these cor­po­ra­tions are flush with cash and in­creas­ingly bur­dened with debt.

His­tor­i­cally, businesses have de­voted larger shares of their prof­its to im­prov­ing their businesses. Even some prom­i­nent in­vestors who have ben­e­fited from the stock-buy­ing trend have raised alarms about cor­po­ra­tions no longer mak­ing in­vest­ments that pro­duce long-term growth in their com­pa­nies, not just short-term fil­lips in their stocks.

“Too many com­pa­nies have cut cap­i­tal ex­pen­di­tures and even in­creased debt to boost div­i­dends and in­crease share buy­backs,” Larry Fink, chair­man of Black­Rock, which man­ages $4.3 tril­lion in in­vest­ments, said in a let­ter to the chief ex­ec­u­tives of the world’s 600 largest cor­po­ra­tions. He said this prac­tice can “jeop­ar­dize a com­pany’s abil­ity to gen­er­ate sus­tain­able long-term re­turns.”

With cor­po­rate prof­its at the end of last year hit­ting a record high 11 per­cent of eco­nomic out­put even as mid­dle-class wages stag­nate, Jerry Jasi­nowski, for­mer pres­i­dent of the Na­tional As­so­ci­a­tion of Man­u­fac­tur­ers, said cor­po­rate Amer­ica is start­ing to look like Dis­ney’s stingy char­ac­ter Scrooge McDuck.

“Our big­gest cor­po­ra­tions have been sit­ting on a lot of money for many years, and it is not a tran­si­tory phe­nom­e­non. That fa­bled money bin just keeps grow­ing,” while com­pa­nies listed in the S&P 500 in­dex have been in­creas­ing in­vest­ment in their businesses by only 0.8 per­cent a year, he said.

“In­stead of launch­ing new prod­ucts and iden­ti­fy­ing new mar­kets, they have be­come ob­sessed with con­trol­ling costs and fi­nan­cial trans­ac­tions,” he said. “Com­pa­nies have be­come no­to­ri­ously re­luc­tant to hire and slow to raise com­pen­sa­tion for those not in the front of­fice. This is caus­ing hard­ship for many people — in­fla­tion has out­paced wage gains for the past five years — and is un­der­min­ing the econ­omy that these businesses de­pend upon for their big prof­its.”

Frus­tra­tion in Congress

Frus­tra­tion over the per­sis­tent tax avoid­ance and busi­ness’ hoard­ing prac­tices is grow­ing in Wash­ing­ton. For sev­eral years, Pres­i­dent Obama and Repub­li­can lead­ers have ad­vo­cated re­form­ing the tax code to re­duce the top cor­po­rate rate to 25 per­cent to 30 per­cent, elim­i­nat­ing or par­ing back loop­holes such as busi­ness de­pre­ci­a­tion and ex­pense de­duc­tions.

Mr. Obama has pro­posed tack­ling the cor­po­rate tax code as part of a broader cam­paign to curb the budget deficit, while Repub­li­cans want broader tax re­forms that en­com­pass both cor­po­rate and in­di­vid­ual taxes.

The stale­mate blocked most re­form ef­forts this year, al­though new Se­nate Fi­nance Com­mit­tee Chair­man Ron Wy­den, Ore­gon Demo­crat, re­cently out­lined his ideas about tax re­form for the first time.

Short of over­haul­ing the tax code, a grow­ing num­ber of leg­is­la­tors ad­vo­cate an­other tax “hol­i­day” like one en­acted in 2004 that would tem­po­rar­ily lower the rates paid on repa­tri­ated cash as an in­duce­ment to get cor­po­ra­tions to bring money back home. In his high­way reau­tho­riza­tion bill sub­mit­ted last month, Mr. Obama pro­posed us­ing such a tax hol­i­day as one way of pay­ing for roads and bridges.

The hol­i­day likely would pro­voke a “mad rush of repa­tri­a­tion,” and no doubt would be suc­cess­ful at tem­po­rar­ily fill­ing federal cof­fers with a gusher of one-time tax pay­ments, said Mr. Chang, but the money more likely would con­tinue to be spent en­rich­ing share­hold­ers rather than in­creas­ing hir­ing and busi­ness ex­pan­sion in the U.S.

AS­SO­CI­ATED PRESS

Ap­ple Inc. holds $132 bil­lion in cash abroad, the largest amount by far of any U.S.-based com­pany. Ap­ple and many other Amer­i­can cor­po­ra­tions are rein­vest­ing the money they amass into op­er­a­tions in China and other over­seas mar­kets.

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