U.S. Companies Using Short-Term Loans to Avoid Taxes on Repatriated Cash

I have previously blogged about the use of transfer pricing techniques by U.S. companies to shift profits away from the U.S., which has the highest corporate tax rate (about 40%), to countries with lower tax rates such as Ireland (12.5%). As long as profits made overseas are not repatriated back to the U.S., those overseas profits remain untaxed by the IRS. Critics claim that a much lower tax rate (say, 15-20%) would encourage U.S. companies to bring the profits home in the form of investments and spur economic development and job growth.

Other countries have come to realize their corporate tax rates are too high. For example, Germany has reduced its rate from a high of 45% in 2008 to 15% today. The UK has gradually lowered its rate from 52% in 1981 to a projected 20% in 2015.

Repatriation is more than an economic issue; it has ethical overtones. It also highlights a practice used by some U.S. companies to skirt the repatriation law by taking the “trapped” overseas cash and providing loans to their U.S. parent companies. Under U.S. tax rules, a foreign subsidiary can lend funds to its parent without jeopardizing its untaxed status. Here is how it works:

• The loans have to be short term and can remain outstanding throughout a fiscal quarter as long as they don't cross beyond its end. If they do cross a quarter, they can remain outstanding for a total of 30 days. And that can be done for 60 days a year by any one foreign unit.
• If the borrowing is carefully set up to comply with IRS rules and U.S. auditing standards, the funds can be used over and over without incurring taxes.
• Companies are not required to disclose these moves, which makes it difficult to assess how many use them.

According to the Wall Street Journal, Hewlett-Packard (H-P) entities lent the parent about $6 billion in the year that ended in October 2010. For the 2011 fiscal year and through July 2012, the average outstanding balance of the alternating loans was $1.6 billion.

The sums rivaled H-P's borrowings in the commercial-paper market—the traditional source of big firms' day-to-day funds. Those averaged $1.9 billion over the 2011-2012 period.

More details of H-P's transactions have emerged since a 2012 hearing conducted by the U.S. Senate. The company said it told the Senate panel it used the alternating loans for all but 85 days of the 2011 and 2012 fiscal years. In a 2008 internal presentation, H-P called the loans "the most important source of U.S. liquidity for repurchases and acquisitions."

H-P spokesman Michael Thacker says H-P has "complied fully with all applicable provisions of the U.S. Internal Revenue Code, and auditor Ernst & Young has consistently reviewed and approved the accuracy of H-P's financials." The IRS has never raised concerns about the loan programs, he adds.

American concerns have long argued they should be allowed to bring back some of the estimated $1.7 trillion in profits they hold at their foreign subsidiaries, saying the money could be put to use in the U.S. The firms claim to be deterred by the huge tax liabilities they would incur under current IRS tax rates.

The U.S. is the only major economy that taxes its companies' overseas earnings. Those taxes aren't actually incurred until the money is considered to have been transferred to the U.S. parent, giving companies an incentive to maximize their earnings at foreign subsidiaries and keep them there indefinitely.

People on both sides of the debate argue the system doesn't work, creating perverse incentives that distort companies' balance sheets and deprive the U.S. Treasury of tax revenue. The short-term loans to avoid repatriation and taxes is the main example of the practice.

During the last Presidential election, business interests called for a “tax holiday,” in which American corporations would be allowed to transfer their foreign profits to their American bank accounts at a tax rate under 6 percent for one year. Such a holiday would raise revenues and create jobs in the U.S., according to the WinAmerica Campaign, a coalition of companies including Apple, Google and Pfizer.  

But the last time such a holiday was tried, in 2004, it raised less than $19 billion and did not substantially increase jobs. Most of the repatriated profits went to corporate shareholders, through dividends or stock repurchases.

Instead of a one-off holiday, some corporations — Caterpillar and Kimberly Clark, for example — have called for a permanent fix: a territorial system for taxing foreign corporate profits, as most industrialized countries use. In a pure territorial system, the profits of multinational companies based in the U.S. would be taxed only by the country in which the profit is earned.

But none of our major trading partners takes a pure territorial approach, for two good reasons. First, almost all countries impose domestic taxes on “mobile” corporate income — for example, investment interest or royalties that can easily be shifted from one country to another. Second, many countries still collect taxes on foreign profits of domestic corporations if those profits are earned in tax havens that collect little or no taxes, like Bermuda and the Cayman Islands. These havens violate the premise of the territorial system, which is that corporate profits are taxed somewhere in the world at a reasonable rate.

The ethical issue I raise is: Does a U.S. corporation have an ethical obligation to repatriate profits to the U.S. to pay their “fair share” of taxes and help to stimulate the economy in an increasingly competitive global economic marketplace?  The answer is not a simple one because we could argue about the ethics of having the highest tax rate in the world. We could also argue and debate whether the government uses its tax revenue in an ethical or socially-desirable manner to employee the unemployed, give opportunity to those wanting to improve their economic lot, and help stimulate our economy.

For me, it is time to lower the corporate tax rate to be more competitive with other countries and challenge U.S. companies on their claim to repatriate profits with a lower rate. Without debating how low is low enough to achieve the desired goal, we need to try harder to improve the economic status and wealth of the middle and lower-classes and repatriation with taxation is one way the goal might be accomplished. At least it is worth a try. If corporations do not repatriate with lower taxes but still find ways around their obligation, then they will be exposed for all to see the hypocrisy of their position.

Blog Posted by Steven Mintz, aka Ethics Sage, on April 1, 2013