Apples offshore profitscash situation echoed by many companies
The political fires are being ignited for the fall campaign, and taxes and tax policy is a much-discussed topic. The debate continues over tax rates and one’s “fair share.” The politicians tend to view any successful individual or company as not paying enough in income taxes. Offshore profits that have been taxed at low rates continue to be the target of the tax sound-byte torpedo that is trying to sink the successful operations of companies that may have legitimately earned profits in non-U.S. markets.
Bloomberg recently reported that foreign profits accumulated by 70 of the largest U.S.-based companies grew by nearly $200 billion in 2011 over 2010. The 70 companies alone now have $1.2 trillion in profits held outside the U.S. The media often interchanges the terms “profits” and “cash.” Often profits reflect large cash balances, but not necessarily. With respect to any large cash balances held by a public corporation, shareholders and analysts often ask about the plan for the use of the accumulated cash.
One of those 70 companies is Apple, which has been accumulating cash as it earns profits from its product and application sales. Much press attention was given to Apple’s announcement in March for its resumption of a quarterly dividend of $2.65 a quarter and share repurchase plans. The dividend to be paid in 2012 is the first since 1995. The funding for the dividend reportedly will be from the company’s U.S.-based cash.
Also reported was an issue that was impacting the decision to pay out more of its cash. This limitation is the U.S. corporate income tax that is levied on offshore profits if the profits are repatriated back to the U.S. Apple reported its March 2012 quarterly earnings April 24 and reported it has more than $100 billion of cash and marketable securities on its balance sheet. The announced dividend and share repurchase plans will use less than half the company’s available cash and marketable securities. Apple also reported in its SEC filings that its effective tax rate is 24.8 percent for its most recent fiscal year.
Apple’s offshore profits/cash situation is echoed by many U.S. companies. The U.S. tax system is unlike most of the rest in the developed world, and many U.S. companies have arranged their structures considering the U.S. system. It often results in foreign earnings staying offshore.
The U.S. taxes foreign earnings when they are retreated and offers a foreign tax credit for any foreign taxes paid on the earnings. The rest of the world uses what is called an exemption system, which typically does not tax or “exempts” profits from active foreign subsidiaries from home country taxation. All of the U.S.’s major trading partners (U.K., Canada, Germany, France and Japan) use some form of an exemption system for taxation of the companies located in their respective countries that have foreign operations.
Adding to the tax misery is the fact that only Japan has a higher corporate income tax rate than the U.S. The U.K. announced in March that it is continuing to reduce its corporate tax rate and that the U.K. corporate tax rate will be set at 23 percent in April 2013. Canada has a corporate tax rate (federal and provincial combined) in the range of 25-26 percent, depending on the province. The U.S. corporate rate when combining federal and state is nearly 40 percent. Thus, based on taxes on home country generated income, the U.S. rate is significantly higher than its trading partners.
There are media reports that indicate upward of $2 trillion of profits of U.S. corporations are sitting offshore and have not yet been subject to U.S. federal corporate income tax. The ultimate U.S. tax cost of repatriating the cash is large as for many of the companies. Though it is not provided in SEC filings, it is thought that a significant amount of the offshore cash may be sitting in lower taxed jurisdictions such as Ireland, Switzerland or the Netherlands. The information from the last dividend tax holiday in 2004/2005 confirmed this was the case seven years ago.
In 2012, there may also be profits in the recently developed markets such as China, Brazil and India, and some are being reinvested to grow operations in those markets or for foreign acquisitions. In 2004/2005, the U.S. did enact a one-time dividend holiday, with an effective federal tax rate on 5.25 percent levied on qualifying dividends. That limited tax holiday resulted in more than $300 billion being repatriated back to the U.S. mainly from technology and pharmaceutical-related companies. There is renewed discussion in Washington of a new dividend tax holiday and whether it should be enacted.
The mere idea of allowing certain corporate profits to escape significant U.S. tax must create nightmares for some legislators in Washington. It may actually require a pragmatic decision in making the U.S. tax system competitive for tax purposes. A vote for such a proposal does not necessarily translate into a vote for a tax cut but for an increase in tax revenue. Many may argue it is a vote for growth by allowing cash to return to the U.S.
The vote will require leadership in doing something that may not necessarily be popular with the electorate. Yes, a tax holiday will result in the government forgoing some corporate tax revenue. However, if the cash is used to pay a dividend, the dividend will be taxed at 15 percent by individual shareholders of the dividend paying companies. Many will say 15 percent of something is better than 0 percent of nothing. Or to put in another way: Nothing ventured, nothing gained.
Michigan Representative and Ways and Means Committee Chairman David Camp has proposed an exemption system to place the U.S. in a similar position with respect to the taxation of overseas subsidiary profits as many of the major trading partners mentioned earlier. The proposal also includes other changes in corporate taxation as part of a major corporate tax reform package. The proposal has sparked a fair amount of discussion among companies, their advisers and politicians.
The Obama administration has gone in a different direction and wants Congress to consider a minimum tax for offshore profits similar to the “Buffet Rule” it is proposing for individual taxpayers. The administration also wants to adopt new provisions in the tax code that impact the timing and recognition of certain deductions and foreign tax credits related to offshore profits.
The ultimate question that needs to be answered in Washington is how to balance raising revenue, fairness and growth, and which of these is the higher priority. The recent Apple announcement of returning only its U.S. cash to its shareholders reiterates the issue of whether current U.S. tax policy is appropriate given the current state of world trade and tax competition.
Bill Roth is a tax partner with the local office of BDO USA LLP. The views expressed above are those of the author and are not necessarily of BDO. The comments are general in nature and not to be considered specific tax or accounting advice.