Overseas Cash Hoards: Shareholder Boon Or Taxpayer Burden?

By James E. McWhinney AAA

American corporations are holding something in the neighborhood of $1.5 trillion in cash in the coffers of their offshore entities, often in tax havens where they don't have to pay U.S. corporate taxes. For example, tech-giant Apple is sitting on $100 billion in cash offshore. If that money were brought back to the States, it would be subject to a 35% tax rate, which would equate to $35 billion in lost cash for the company and $35 billion in tax revenue for the U.S. government. Instead, Apple paid Uncle Sam a tax rate of about 2%.

Apple's maneuver is legal, but also controversial. As overall corporate cash stockpiles have grown since 2007, Congress has become concerned. Hearings on the tax implications of the cash hoard were held in mid-2013. While the matter remains unresolved despite nearly a decade of rising interest and attention, the tremendous sums of money involved have kept this topic in the spotlight.

The IRS Perspective

From the government’s perspective, arrangements in which American companies set up offshore entities in order to avoid paying taxes may not violate the letter of the law, but they certainly violate its spirit.

Technology firms such as Apple have become the target of the Internal Revenue Service's attention. These firms often have a small number of highly skilled workers in the U.S. responsible for designing the tech toys and tools that are generating massive profits which accumulate in offshore entities. From the government’s point of view, these firms benefit from American talent in Silicon Valley in addition to a business environment that fosters innovation, creativity and productivity. Accordingly, the argument goes, they should pay their fair share of U.S. taxes.

Moreover, corporate tax laws allow companies to take loans from their overseas entities without paying tax, thus giving them access to these cash hoards. Uncle Sam believes that forgone tax revenue could go a long way toward helping the country pay its debts, create jobs, rebuild its infrastructure and fund social programs to help those in need.

The Corporate Perspective

CEOs, on the other hand, argue that companies are in business to make money and thus should minimize their tax payments. Corporate executives have a fiduciary duty to make every effort they can to further that goal. They also argue that having large stockpiles of cash puts companies in a good position to weather an economic downturn.

Apple (Nasdaq:AAPL) is far from being the only company to hold its profits offshore. Other big tech companies, including Microsoft (Nasdaq:MSFT), IBM (NYSE:IBM), Google (Nasdaq:GOOG), and Cisco (Nasdaq:CSCO) also have significant cash holdings offshore. The tech firms are notable for the size of their cash hoards, but other firms in other industries - from pharmaceuticals to credit card companies - engage in the same behavior. (read the full USPIRG report here)

Shareholders’ Perspective

Shareholders, on the other hand, don't all buy this reasoning. Investors such as the legendarily successful Carl Icahn take a different view.

That overseash cash earns next to nothing for shareholders in a low-interest-rate environment. The money could instead be put to work through acquisitions or investments. If there are no attractive opportunities in either of those areas, those funds could be used to buy back stock (thus increasing the value of outstanding shares), or it could be returned to shareholders through dividend payments.

Citizens' Perspective

Stepping back from the investment angle and looking at the situation as an ordinary citizen, you can see all sides of the argument. As a taxpayer, having companies pay their fair share of taxes seems like a good idea. On the other hand, if you are business owner, reducing expenses is an understandable goal. With your IRA or 401(k) plan likely holding shares in some of these companies, putting that money to work probably seems like the way to go. Finally, if you or any member of your family works for a company that is sending jobs and money overseas, you can see the whole issue from yet a different perspective.

What’s Next?

America’s tax laws are notoriously complex. It is one of the few nations with a tax code that penalizes companies for bringing profits home. Tax reform is a perennial discussion point in Washington, without significant change.

If companies can bring the money home with no penalties, it will likely be good news for the companies and their shareholders but not so great for the government’s tax coffers. Changing the laws to tax offshore profits could boost government revenues while cutting in to corporate profits. A tax amnesty would bring some money home without an immediate boost to government revenue.

The Bottom Line

A number of U.S. corporations over an array of industries have been holding large amounts of cash in offshore funds and thus avoiding paying tax on their profits. It's legal but controversial. From the corporation's point of view, avoiding tax liability may seem like an attractive prospect; however, many members of the U.S. government take issue with that. It's a complex issue with many discordant viewpoints, and history would suggest that legislation is not likely to bring about a rapid resolution.

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